Local authorities shall be entitled, within national economic policy, to adequate financial resources of their own, of which they may dispose freely within the framework of their powers.
Representatives of local and regional authorities presented a number of structural problems which, they believe, characterise the financial architecture of local and regional authorities in Ukraine:
lack of progress in the consolidation of the local financial system since 2001;
complicated budgetary programming at central government level, showing no respect for local and regional authorities’ interests;
structural weakness in local and regional authorities’ financial powers;
lack of proportion between own resources and the powers assigned;
central government levies adversely affecting total revenue from local taxation;
under-financing of the powers delegated by central government;
absence of clear and comprehensible criteria on inter-budgetary relations;
absence of appropriate equalisation at the level of regions (oblasts);
need for stronger interaction/co-operation with the Ministry of Finance.
Ukrainian local authorities’ budgetary situation very much depends on the general economic and financial situation of the country. In economic terms, local authorities’ budgets are very large: approximately 7.2% of the country’s GDP is generated at local level (excluding inter-budgetary transfers). The Ministry of Finance estimates the total amount of local authorities’ budgets for 2013 to be UAH 220 billion. Total expenditure in the 2013 national budget is UAH 410.66 billion, with a maximum deficit of UAH 50 billion (including Naftogas with UAH 82 billion). In the first six months of 2013, expenditure totalled UAH 112.1 billion, i.e. 13.2% higher than in the same period of 2012.
Nevertheless, two preliminary factors are important: the level of per capita GDP, compared to that of emerging countries (as an indicator of the success or failure of an economic development policy and, therefore, of the need for reforms at every tier of government).
The chances of maintaining or striking a national budgetary balance in the medium term (as an indicator of the need to conduct a policy of budgetary discipline for the years to come in accordance with IMF declarations).
An analysis of the situation in Ukraine in 2011 (in terms of purchasing power), as compared to other countries of eastern Europe on the basis of IMF data, is explicit enough: with a per capita GDP below EUR 10,000, Ukraine ranks below Serbia (approx. EUR 15,000), Croatia (approx. EUR 25,000) and Slovenia (approx. EUR 38,000), and lags far behind the countries of the Eurozone (approx. EUR 45,000). The country’s backwardness in terms of competitiveness and potential growth in productivity, and in terms of the modernisation of administrative structures, is fairly clear to see. We need to know whether there are any signs of a positive development in GDP growth.
The general prospects of economic growth for Ukraine are not very promising, although the government is placing a particular emphasis on reviving industry in the sectors with high technical and scientific potential, and hopes that this policy will have positive effects on the labour market. International observers expect growth to decline in 2013, whereas the national budget for this year is based on GDP growth estimated at 3.4%.
Furthermore, another revealing statistic is the growth in total public debt between 2003 and 2013. Although the cumulative public debt fell slightly in 2011-2012 (around 40% of GDP), the situation is still tense, because the projections in the “stand-by arrangement” with the IMF are not being achieved, making it likely that the government will persist with its current policy, either by increasing revenue or by cutting expenditure, or by doing both. The leeway for a less tight budgetary policy vis-à-vis local and regional authorities is very limited.
The table which appears in Appendix III, based on data from the national statistics office, shows considerable discrepancies between Ukrainian regions in terms of annual income. The figures also show how important equalisation policy will be, if Ukraine decides to take action for regional development and to introduce vertical and horizontal financial equalisation. In this context, the Law on the stimulation of regional development, which was amended in 2011, should be mentioned: according to the Ministry for Regional Development, the purpose of this law is to support the economic, social and ecological development of the regions, drawing on the EU’s regional policy. It is based on a “regions in crisis” concept and lists a number of assistance measures from which these regions may benefit for a period of seven years (with a possible extension for a maximum of another five years). According to the Ministry, no such measures are being implemented in the regions which are in crisis. The figures in this table will therefore need to be checked to gauge the success or failure of the measures intended to balance the country’s economic development.
A draft law on “the foundations of regional policy” is currently being prepared, with the associations’ participation, with a view to implementing the decision taken by the Council of Regions in March 2013. This draft law is to define the main legal, economic, social, ecological, humanitarian and organisational aspects of Ukraine’s regional policy.
Article 142 of the Constitution defines the material and financial foundations of local self-government. Article 142 (3) states that “The State participates in the formation of revenues of the budget of local self-government and financially supports local self-government. Expenditures of bodies of local self-government, that arise from the decisions of bodies of state power, are compensated by the state.” The arrangements are detailed in Section III of the 1997 Law on local self-government in Ukraine. Article 62 of that law, in particular, contains provisions on the State’s obligation to support local authorities financially, on the system of financial supervision, guarantees of a basic income and the criteria to be met, and on the conditions for State levies and the criteria applicable to local authorities’ “minimum” budgets. In 2011, several amendments came into force. According to Article 66 (1), “local budgets must be sufficient to enable local authorities’ bodies to exercise their statutory powers and to supply services to the public which guarantee a minimum level of social services”. Article 7 (3) of the Budget Code sets down “the principle of the independence of the state budget and local budgets”, while other fundamental provisions are in Section IV, “Inter-budgetary relations”. The Fiscal Code and various other specific laws also contain some relevant provisions.
As to revenue, under the 2011 Tax Code, taxes and other national revenue (Article 9) include corporate taxes, income tax, value added tax (VAT), taxes on public enterprises and the initial registration of vehicles, environmental tax, taxes on the transport of petroleum products and the transit of natural gas and ammonia through Ukraine, petroleum taxes, customs duties and taxes for the exceptional use of water and forestry and agricultural resources.
Under Article 10 of the Code, local taxes and other local revenue include property tax (other than land tax) and unified taxes. Local charges include administrative fees for special commercial activities, parking fees and tourist taxes. A new property tax was due to be introduced on 1 July 2012, which should have improved municipalities’ tax situations. But it is doubtful whether the positive effects expected by the government will materialise. This tax affects only 1% of the buildings and will bring only 100 million UAH into the local budgets, which is not very significant. Moreover, local authorities cannot influence neither the administration nor the rates of the tax. Charges for administrative services are another important source of income. A draft law on the “list of administrative services and the related payments (administrative fees) for their provision” is currently being discussed by the associations and the relevant ministry.
Local budgets are made up therefore of own resources, quotas of related national taxes and state transfers. Own resources also include taxes on the profits of local enterprises, payments by enterprises to local land-owners and income generated by the privatisation of local enterprises or by property management. The most important tax is the income tax (the advertising tax has been abolished recently). With the reforms of 2011, Ukraine is working towards increased tax competition between municipalities, a simplification of the tax system and, in principle, an increase in the size of local authority budgets. Apparently, these measures have not (yet) brought about an increase in local authorities’ own resources although there has been a major change in Kyiv, where the city’s revenues rose by 15.4% between 2011 and 2012. The Ministry of Finance states that local government revenue was stabilised in 2012 through a series of government measures including an expansion in the sources of revenue, which produced a total of UAH 11.3 billion in tax revenues.
Municipalities encounter some difficulties where it comes to managing taxes, as the Ukrainian tax system as a whole is overly complicated. Experts from the World Bank reported that there were 135 different types of tax in Ukraine. During the visit, government representatives repeatedly emphasised the importance of the local authorities’ economic commitment and the rapporteurs are convinced therefore that the state, which has powers in the tax sphere, also has a particular responsibility for establishing a simple, transparent and efficient financial system.
Simplifying the organisation of local taxes and fees would also form part of this new system. Existing structures are so complex that tax collection is scarcely profitable. In response to this problem, in 2011, the state amended the Tax Code. It replaced 12 low-revenue taxes with only five (taxes in the transport, tourism and business sectors and a value added tax on business purchases). However, some local authorities complain that the situation has deteriorated: ten local taxes have been abolished or transferred to the state, including taxes in the transport and procurement sector. According to officials from the city of Ivano-Frankivsk, the new Tax Code, which came into force on 1 January 2011, has caused a loss of revenue of UAH 20 million out of a total of UAH 670 million in budgetary revenue. In addition, subsidies for the education and public health sectors have been reduced by UAH 20 million. At the same time, the single tax was not part of the taxes included in the calculation of transfers (i.e. from the so-called “basket of profits”) and transferred to the development budget. Moreover, payment for land currently goes into the budgets of towns, villages and rural settlements. (Previously 60% went to the towns of local importance, villages and rural settlements and 75% to the towns of regional importance.) Consequently, the loss from market change has been almost compensated, although, for a number of towns, for example for Khmelnytsky, the market change was very significant.
The example of property tax illustrates some of the typical features and problems of local taxation:
The tax base was restricted by a wide range of exceptions and exemptions (according to the Ministry of Finance, in 2003, these exemptions amounted to 66.7% of fiscal capacity).
There is no competition between local authorities owing to the upper limits that are placed on charges.
The administrative costs of tax collection are very high.
The entry into force of the new property tax was put back from 1 January to 1 July 2012. The calculation processes are complex and the entry into force could be deferred still further. Several amendments enhancing local authorities’ tax capacity were introduced through the reform of the Budget Code in 2011.
The association therefore asks for the tax base to be broadened and for there to be fewer exceptions and exemptions so that local authority revenues can be increased.
As to the profits of local enterprises, because the state has consistently limited charges for housing or public services at local level, most local enterprises are in debt and cannot make the profits that would enable them to make the necessary investments.
The local authorities receive revenue from personal income tax. The rate of this tax is, however, limited to 15% and has not changed, so that the revenue it creates for authorities depends on economic activity and, in particular, on wage increases and the employment situation, in other words the number of people liable for tax. Furthermore, a vast network of exemptions limits the base of this tax. Lastly, this tax causes inequality between local authorities because it is collected according to the person’s workplace. It favours “rich” cities, reduces the scope of the tax in rural zones and makes a system of financial equalisation necessary. Rural authorities depend largely on state subsidies because their revenues from this tax are low.
To strengthen the economic base of local communities in the medium term, the rapporteurs propose to increase the production of clean, renewable energy but this possibility has largely been overlooked in Ukraine until now. Geothermal, solar and wind energies, together with biofuels and waste burning, accounted for 0.71% of primary energy production in 2008 whereas nuclear power (28.8%), coal (41.4%), natural gas (22.1%) and oil (5.3%) provided a large share of the country's energy. However, the potential for the incomes of municipalities to be increased by an increase in the production of renewable energies is considerable. It would result among other things in a growth in the direct profits of local energy production companies (which are not subject to financial equalisation), an increase in the incomes of the employees of production plants, the management of resources at local level instead of buying energy from abroad and stabilised incomes for renewable energy producers.
The “underground economy" reflects an undeniable reality in Ukraine and implies a considerable reduction of tax revenues, the government is currently considering the possibility of lowering personal income tax (from 15 to 10%). Such a measure would also have an impact on local authorities, but without a reform of the legislation on pensions, it will have no impact on wages in terms of bringing them closer to those of the "shadow economy”.
The budgetary system
The Ukrainian budgetary system is divided into two levels: the state budget and the local authority budgets (12 086 in total). A vertical inter-budgetary transfer is made between the two levels and the state has inter-budgetary links with 692 budgetary systems at local and regional level.
The main aim of inter-budgetary transfers is to balance local and regional authority budgets. They are calculated according to general criteria on the basis of Cabinet Decree No. 1149 of 8 December 2010. For the calculation, the key indicator is the balancing coefficient which is used to calculate the amount of tax revenue left over for use by regions and communes with surpluses. The previous system did not include any incentive measures, whether aimed at regions in debt, to encourage them to increase their own tax resources (as debts were covered more or less by state transfers) or at regions with surpluses, to encourage them to increase their tax revenues, as surpluses were capped by the state. Despite a few amendments made to the method to calculate tax capacity (Articles 64 and 66 of the 2011 Budget Code), there has been no change in the coefficient system or the high degree of centralisation of inter-budgetary relations.
The total value of inter-budgetary transfers comes to 44% of the state budget, 42% of which goes into the general fund. Special transfers are made with the specific goal of guaranteeing comparable levels of social protection and fostering local and regional economic and social development (particularly in the building and construction sector). Amounts of equalisation are calculated on the basis of individual inhabitants (and consumers of local services) and while attempting to strike a balance between the revenue and expenditure of local and regional authorities. The Budget Code establishes which local revenues are to be included in the inter-budgetary transfer system (Articles 64 and 66 (AR of Crimea)) and which must not be included (Article 69). Through this mechanism the state can increase or reduce the fiscal importance of these revenues for the local authorities which impacts their autonomy within the meaning of Article 9, paragraph 1 of the Charter, by including particular types of local authority revenue in the inter-budgetary relations system or excluding them from it. As a result the system lacks transparency and is relatively complex and unstable, making the local tax system somewhat unpredictable. Furthermore, there is little interest for an authority in setting up a "financially advantageous" tax in the medium term if it must fear that this source of revenue will ultimately be incorporated into the state’s inter-budgetary system.
Some local authorities complain about the criteria for the distribution of transfers, which give the state wide-ranging discretionary powers, or object to the total lack of equalisation criteria. As to the regional development fund (Article 24(1) of the Budget Code), it comprises funds equivalent to 1% of the national budget, which amounted to about UAH 400 billion in 2013. Of this amount, 1% (UAH 4 billion) is earmarked for the fund. Seventy per cent of the fund is allocated according to the number of inhabitants in each region while the other 30% takes account of criteria linked to their economic strength. UAH three billion is allocated for economic and social development. Added to this are various grants (such as UAH 3 billion for national roads). UAH 1.4 billion is reserved to finance projects of national importance. These funds were allocated by the Verhovna Rada’s Budget Committee as follows: 50% was assigned to the regions but eight regions received nothing, three regions received 70% of the allocation and the others shared the remainder. Despite the criteria that were set for the allocation of the funds (Cabinet Decision No. 6565 of 4 July 2012) decisions were taken for political motives. When the funds were allocated to the regional development fund, the allocation criteria were modified in parliament.
The example of the regional development fund illustrates another structural problem with Ukraine’s budget programming. Although the introduction of budget planning based on specific programmes theoretically allows for more accurate allocation of funding, it is necessary to frame the goals to be achieved as precisely as possible. Yet, firstly, there is a very large number of specific programmes – the City of Kyiv alone is supposed to be implementing around thirty – and, secondly, goals are often set according to quantitative not qualitative indicators. There is therefore a risk both that programmes will overlap (for example, in rural areas, forty different programmes, whose timeframes have sometimes partly overlapped, have been adopted since 1991) and that the programmes are not suited to the aims that have been set or, worse still, that there was no justification for the funds to be allocated in the first place.
It is also problematic that the majority of oblasts do not have Strategic Development plans, and therefore cannot define priorities for using the financing from the Fund. As a result, the projects which are submitted for government approval are not the projects designed for resolution of the issues of local development, but for construction of facilities intended for social needs (schools, hospitals).
Another problem has to do with the application of budgetary rules to small local entities. They are also subject to the Budget Code but their situation is very different as they have small populations, a high number of retired inhabitants and, generally, a low tax capacity. Consequently, the authorities in these villages or settlements, particularly those in rural areas, ask for the regulations to be adjusted to their special circumstances. It is to be hoped that the 2011-2015 Programme for the Development of Small Villages (Cabinet Decision No. 1090 of 29 November 2011) will provide a means of strengthening the economic and budgetary situation of this type of authority, knowing that 75% of village councils cannot carry out their responsibilities provided by this law.
Local and regional authority budgets are divided into two components (Article 13 of the Budget Code). The first is a “general” fund, which is used to finance general compulsory spending (basket 1, Articles 88 to 90 and 64 to 66 of the Budget Code) and the second a “special” fund, used to finance specific projects (basket 2, Articles 91, 69 and 71 of the Budget Code).
According to the Ministry of Finance, taken as a whole, 40% of local and regional authority budgets come from state transfers and 60% from own resources (local personal income taxes). Local and regional authorities’ own resources are not included in the equalisation system. On the other hand, according to the information provided by the Association of Ukrainian Cities, local budgets are increasingly dependent on state transfers (43.3% in 2007, 46.7% in 2009, 52.3% in 2011 and 53.6% in 2012).
During its visit, the delegation was told that 98% of first-component expenditure was destined to cover mandatory expenses resulting from the execution of delegated powers and staff wages. The local and regional authorities regret the fact that the state only pays about 80% on average of the necessary transfers to cover mandatory expenses. In their view, the situation could deteriorate still further in 2013, as the state is missing about UAH 30 billion to cover these expenses. The result is a structural deficit of 20% of the first component, which contains the major local revenue of personal income tax (at a maximum rate of 15%).
Local authorities therefore finance both delegated state powers and this 20% deficit through their own resources. About 10% of the first and second components combined are covered by local authority’s own resources. Half (5%) is used to fund delegated powers in the first component of the budget. The second component is financed by local company tax. Authorities have the right to negotiate short- and medium-term loans with the Treasury under conditions set by Article 73 of the Budget Code.
It should be noted that changes to the Budget code were introduced in 2012 in terms of the transfer of some taxes to the second basket of revenues in the oblast budgets and the budget of Autonomous Republic of Crimea. Their amount is estimated to be UAH 1 billion. They will allow to improve the condition of the oblast budgets significantly, primarily in terms of financing the preparation of technical documentation for projects which are financed from the Regional Development Fund and also for co-financing these projects
According to the national audit office, local and regional authorities do not always manage state funds "properly". Sometimes funds are misappropriated in various ways such as the use of funds for different purposes than those outlined in the relevant documents, failure to invest funds properly for want of a precise timetable and the reallocation of unused resources.
With regard to the issue of misappropriation of national funds by local authorities, the national audit office investigated some examples in 2012 which were linked to development funds connected with investments for the 2012 European football championships. The City of Ternopil failed to comply with the funding conditions, and used funds which should have been reserved for investment in infrastructure to finance wages for doctors, teachers and others. In such cases, the legislation provides for penalties against the officials concerned and the possibility of asking for the funds allocated by the state to be reimbursed. The associations emphasise that the inability of local authorities to comply with their budgetary obligations very often stems from the shortcomings of the inter-budgetary system that has been set up.
According to the national audit office it is important for local authorities to use state funds more efficiently. The audit office would be prepared to co-operate with the authorities to improve the application of the rules but to date, no towns have contacted it to ask it for help in improving internal auditing procedures at local level. The audit office has, however, received such requests from ministries. The legislation will have to be amended for there to be any increase in the influence of the audit office on the local and regional authorities.
Opinions differ as to the efficiency of the Treasury. The Deputy Minister of Finance’s views are based on the fact that the Ukrainian Treasury’s system is characterised by daily payments. In his opinion, the system functions and ensures that financial operations take place in real time. For the authorities, the fact that all financial operations pass through the Treasury has a negative effect as the Treasury can delay or prevent payments in order to “manage its cash flow” and hence control the whole procedure. The associations therefore demand that an amendment be made to the legislation to increase the liability of the offices of the Treasury when there are irregularities in financial operations.
There has also been some criticism about a certain lack of efficiency in collecting taxes on the part of the various state authorities, which are accused of being incapable of guaranteeing fair and regular taxation. The city of Ivano-Frankivsk has set up a special committee to deal with tax problems in co-operation with the tax authorities, the employment office and social services. Most of Ukraine’s districts and regions have set up a consultative committee of this type.
As to Ukraine’s budgetary procedure, the local and regional authorities assert that more co-ordination is needed with the relevant government departments. Under Article 75 of the 2011 Budget Code information must be disseminated about the method of calculation, at national level, of funding destined for local budget projects. The authorities have introduced a new method of budgetary programming at local level, which, according to the Ministry of Finance, should make medium-term programming easier and optimise the use of financial resources. This method will be used in 2013 by some 700 Ukrainian municipalities.
With regard to the forms of interaction between the local and central tiers of government in the sphere of public finance, in 2004 the IMF proposed that an intermediate institution should be established to analyse and prepare decisions on the country’s budgetary policy. The rapporteurs take the view that a rule should be introduced into the national budgetary procedure that local authorities should always be consulted first so that they can be more closely involved in estimating tax revenues and so that it is easier to prepare local budgets in the course of the year. This would ease the process of passing on the effects of national tax reform to local budgets. Similarly, the publication of tax data at regional level should be stepped up. The Rapporteurs believe that this kind of co-ordination between the association of local and regional authorities on the one hand and the relevant ministries on the other, under the responsibility of the Ministry of Finance, could significantly improve the co-ordination of the budgetary policies of the two tiers of government. In order to avoid a constant planning of deficit for the cost of implementing the “delegated” competences, it is reasonable to define and formalise the overall size of expenditures for the implementation of such competences in the legislation.
The rapporteurs consider that in practice, in view of the restrictions on the system of inter-budgetary relations, the situation of Ukraine’s local finances does not fully meet the requirements of Article 9 of the Charter as regards the need to have a stable and independent financial basis and sufficient own resources. The rapporteurs believe that strengthening the local authorities’ financial autonomy should form part of Ukraine’s local government reform agenda in order to bring the situation into line with Article 9. The situation in this respect, as the rapporteurs see it, does not make it possible to find that all the paragraphs of this article are being complied with.