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1 The Fiscal Decentralization Initiative for Central and Eastern Europe (FDI-CEE) is a grant program designed to assist transition economies carrying out intergovernmental reform. It is designed to provide institutions (central governments, parliaments, subnational governments, and associations of local authorities) with technical and financial resources to analyze problems, develop solutions, and implement improvements in local government policy and management. FDI seeks to assist transition economies in the areas of capacity building, institutional strengthening and training, fiscal decentralization, and improving fiscal management. Its major objective is to facilitate the analysis of policy options and develop a knowledge base, thereby enhancing the capabilities and effectiveness of newly formed local governments throughout Central and Eastern Europe. The program is driven by the needs of governments and other institutions in the process of fiscal decentralization. Donor agencies support the process with financial and technical resources, and by facilitating access to global knowledge and experience. A unique feature of FDI-CEE is its use of grant funds to support activities carried out by CEE institutions and experts who identify key issues and solutions. FDI-CEE is a joint undertaking of the Council of Europe; the Organisation for Economic Co-operation and Development; the Economic Development Institute of the World Bank; the U.S. Agency for International Development; the Ministry of the Interior, Denmark; GTZ, Germany; the Ministry of Foreign Affairs, Italy; and the Canadian International Development Agency. Recommended citation: Raita Karnite, Karen Hotra, and Nita Congress, eds., Fiscal Decentralization in Latvia: National Needs Assessment Seminar Report: Proceedings of Fiscal Decentralization in Latvia: Problems and Developments Conference 31 October - 1 November 1996, Jurmala, Latvia, (Karlis Streips, translator) (Strasbourg/Paris/Washington: Fiscal Decentralization Initiative of the Council of Europe/OECD/World Bank, 1998). i

2 Fiscal Decentralization in Latvia: National Needs Assessment Seminar Report Proceedings of the Fiscal Decentralization in Latvia: Problems and Developments Conference 31 October - 1 November 1996, Jurmala, Latvia The views expressed in this document are those of the authors and do not necessarily represent those of the Fiscal Decentralization Initiative or any of its partner organizations.

3 Local Government Functions in Latvia and Their Financing iii Contents Preface...v Foreword...vii Local Government Functions in Latvia and Their Financing...1 The Social Welfare Functions of State and Local Governments and Their Financing...17 Facts, Desires, Opportunities, and Problems of Fiscal Decentralization and the Wages of Educational Workers...25 The Functions of Local Governments in Latvia and the Finances to Perform Them...35 Local Government Income...41 Local Government Income in Latvia...55 Local Government Finances and Their Independence...59 Real Estate Registration, Cadastral Evaluation, and Taxes Based on Property Value...63 Local Government Fiscal Equalization in Latvia...69 Local Government Fiscal Equalization: A Prerequisite for Decentralization of State Authority...81 Fiscal Leveling System From the Perspective of Donor Local Governments...85 Administration of the Local Government Fiscal Equalization System...91 The Institutional Basis for Local Government Financing...95 The Institutional Basis for Local Government Budgets The Local Government Perspective Problems of Local Government Budgeting, Bookkeeping, and Auditing Principles and Development of Budget Elaboration Resolutions of the National Needs Assessment Seminar Appendix: Seminar Participants...153

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5 Preface Andris Jaunsleinis, Chairman, Union of Local Self-Governments of Latvia In contradiction to practices prevailing in European democracies, as well as guidelines set by the Council of Europe and the European Union, Latvia is experiencing an ongoing process of methodical centralization of authority. This process has been accompanied by a tendency to shift responsibility for complicated functions such as payment of teacher salaries, social payments, and social care programs to local governments, while providing for a corresponding fiscal decentralization. Parliament has been forced to take a back seat to government leadership incentives, and Latvia has not yet developed a sufficiently active society of citizens. The current political system in Latvia does not rule out the reestablishment of an authoritarian regime. An example of how this can happen is provided by our neighboring country of Belarus: the difference is in personalities; the scenario is the same. Neither Parliament nor the government has paid any heed to documents adopted by a conference of Latvian local governments on April 19, by a conference of the Latvian pagasts on September 27, and by the Union of Local Self-Governments of Latvia, with respect to administrative-territorial reform and to the financing of local governments in 1997 despite the fact that the first two events mentioned attracted 420 and 350 participants, respectively. I hope that this seminar will lead to greater understanding and that we will all learn a great deal from the proceedings. v

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7 Foreword Anatolijs Gorbunovs, Minister, Environmental Protection and Regional Development In opening this seminar, I would first like to offer my thanks to the organizers of the event as well as to the World Bank, the Council of Europe, the Organisation for Economic Co-operation and Development, and the Economics Institute of the Latvian Academy of Sciences for their support and assistance in organizing this seminar. I feel that we have chosen the correct time for this seminar. Currently, as the government has submitted a proposal for next year s budget to Parliament, the issue of fiscal centralization or decentralization may move beyond theoretical consideration and into specific discussions. I would like to wish this seminar every success in its procedure and to share with you a few observations I have made while working in my current post. My basic conclusion is that, as we distribute responsibility between the central and local governments, it is very important to provide local governments with the financing they need to perform their functions. Because the proposed budget has insufficient financing for these functions, local governments are justifiably worried about two things. First of all, the share of the total budget that is allocated to local governments is inadequate. At a time when we are moving toward a balanced budget in this country, it is very important that the proportion between the state s share and the local governments share in that budget not change. I have argued as much at government meetings. However, I understand the government s position, as well as that of my fellow ministers, because it would be difficult to accept this budgetary principle at a time when reforms are proceeding in such important sectors as health care, education, and social security. The second thing that is worrying local governments is the tendency toward centralization in our financial system. It is good that this seminar will offer people a chance to debate the issue not at an abstract, but at a very concrete, level. For example, health care financing reform in Latvia is a centralizing process, but the regulations that are to govern the process have received majority support, as has the principle that the money follows the patient and that the resources are guaranteed. The next significant issue deals with government income. Indeed, the main object of debate in Parliament has been about the income section of the budget. Debates over expenditures will be easier. With respect to local government taxes, we all agree that there should be direct local government taxes, including a real estate tax. It is not possible, however, to institute such a tax immediately. There are two reasons for this. The first problem is that there are still disputes over income forecasts, and the range of numbers mentioned during these discus- vii

8 viiifiscal Decentralization in Latvia: Proceedings of the National Needs Assessment Seminar sions is far too large to be permissible. Discussions about budgetary income in Parliament also have to do with these forecasts. A second question deals with the tax base of Latvia s local governments and efforts to bring some order to this tax base. We have two types of experience positive experience from Riga and Ventspils, and negative experience from Daugavpils and Rezekne. It is not really an issue of whether local governments can administer the tax. Rather, the issue has to do with the fact that the government has determined, and Parliament has approved, an income forecast that does not correspond to the actual situation at the end of the year. Local governments are also worried about the fact that the law on local government fiscal equalization was not submitted to Parliament at the same time as the proposed budget for These objections are justified. The government has begun restructuring in many areas, and the pace of these reforms is often much more rapid than the development of the necessary legal foundations in Parliament. We must, however, keep talking about the fiscal equalization system and the extent to which it corresponds to the population in each respective territory. A great role in developing this system was played by the Economics Institute of the Academy of Sciences, and by Raita Karnite personally. There, is, however, one serious contradiction in that system, and that is that the fiscal equalization base for local governments has not yet been set in law, and the base continues to shift. The government should provide for the stability of the system, but at a time when reform of the country s health care and education systems is proceeding, the fiscal equalization system is constantly forced to adapt to the pace and demand of the reform process. We must nevertheless ask whether these reforms are aimed at the provision of better services to the population, at the bringing of greater order to financial matters, and at the optimization of the way in which we divide functions between the government and local governments. We cannot accept a situation where the wealthier local governments which are supposed to pay money into the equalization fund fail to do so, while the regions and cities that deserve money from the fund make demands to receive it. There are other problems. For example, the Ministry of Finance has asked for another 1.5 million lats from Daugavpils, but, in that case, per capita resources there will be lower than in many local governments that receive subsidies from the fund. Two possible solutions could avert this situation. First, the state should provide a greater share of the financing in the equalization fund. Second, a system of reserves should be established in the fund to deal with specific crises in specific local governments including instances when income forecasts for a local government have proved to be incorrect. A second issue with which we must deal unfortunately is the matter of fiscal reporting by local governments. Many times, the information that is collected by various state institutions proves to be less than objective and cannot be compared with other data. When we speak of fiscal decentralization, we must ask whether all local governments are prepared to use and implement a decentralized financial system. Even some local government leaders have admitted that a great many local territories in Latvia are not pre-

9 Foreword ix pared for this. Furthermore, mutual settling of accounts is not always proceeding appropriately; this means that local governments that offer educational or health care services to the residents of other local governments do not always receive financing for these services. In conclusion, I would like again to express my satisfaction at this opportunity to discuss these very important questions with experienced local government leaders. My hope is that participants will express not only criticism but also recommendations, so that at a time when in many spheres there are changes in financing procedures, decentralization and centralization do not become ends unto themselves. After all, there are many places in the world where both elements are found in a single system. I wish you all the best as the seminar proceeds.

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11 Local Government Functions in Latvia and Their Financing Janis Rusko, Deputy Chairman, Union of Local Self-Governments of Latvia, and Chairman, Riga Regional Council THE COMPETENCE AND FUNCTIONS OF LOCAL GOVERNMENTS A look at the main local government functions that are set out in paragraphs 15 and 16 of the law on local governments shows that the operations of local governments are intended to ensure the human rights and civil rights that the state guarantees in its constitutional law on the rights and obligations of the individual and the citizen. These include the right to education, the right to health care, the defense of children s rights, among others. Paragraph 5 of the local government law grants local governments full independence within the limits of their competence. This does not mean that local governments have free license to act as they will, but it does mean that issues that by law have been turned over to the competence of local governments may not be decided in other institutions, including those of state governance. If the matters that have been turned over to local governments are not handled properly, the losers are the residents of the respective territory, as well as the authority of the local government that has failed in its duties. To avoid misunderstandings and conflicts between local governments and the institutions of state governance, it is absolutely essential that local government functions and state functions be separated and defined very clearly. Moreover, the functions of pagast, 1 town, and city local governments must be set apart from those of regional local governments. This was more or less accomplished in the law on local governments. The concrete specification of local government functions serves as a basis for establishing local government budgets in keeping with the specified functions. The rights, obligations, and financing sources of local governments are set out in the second chapter of the local government law. Paragraph 6 of the law systematizes local government competence, dividing it into mandatory and voluntary spheres (see table 1). Table 1. Local Government Functions Function Specification of function Source of financing Mandatory permanent Law on local governments Local government budget Mandatory temporary Legislation As specified in law Mandatory one-time only Cabinet of Ministers order Cabinet of Ministers reserve fund or local 1 The pagast is the smallest administrative-territorial division in Latvia. 1

12 2Fiscal Decentralization in Latvia: Proceedings of the National Needs Assessment Seminar government budget if agreement is reached Other local government functions Agreement As specified in agreement or under terms of fiscal equalization law Authorized by state institution Agreement Budget of respective state institution Voluntary Decision of local council Local government budget THE MANDATORY SPHERE Most local governments functions in Latvia are mandatory in nature. These functions are listed in paragraphs 15 and 16 of the law on local governments (provision of communal services, education, health care, etc.). The performance of these functions is supposed to be financed from the budget of each local government, and the procedure for executing the functions is governed by a number of other regulations. Local governments also are mandated to perform a number of so-called temporary functions. These have to do with the restoration of property rights to former property owners, as well as the elimination of other Soviet era injustices (denationalization of buildings, privatization of rural lands and land reform in urban areas, restoration of property rights to enterprises, restitution of property and other compensation to the politically repressed, calculation of privatization certificates). These tasks are governed by specific laws, and the source of their financing is supposed to be defined in negotiations with the Cabinet of Ministers. The law on local governments also states that the Cabinet of Ministers may assign onetime-only tasks of a mandatory nature to local governments. In this case also, the source of financing is to be agreed upon by the local governments and the Cabinet of Ministers. THE VOLUNTARY SPHERE On a voluntary agreement basis, local governments may undertake the functions of certain institutions of state governance provided that this is permitted by the law that governs the specific issue. In such instances, the local governments receive the budget funds that have been allocated for the performance of the respective function in the national budget. The functions must be performed in the same way as they would by the state governance institution. The state institution is charged with ascertaining that the function that has been entrusted to the local government is actually executed; thus, the respective state institutions have controlling authority over the process. The performance of these functions is the full responsibility of the state institution or the local government that is charged by law with executing the functions. The functions that local governments undertake voluntarily are mostly examples of local government initiative. These functions are fully dependent upon the needs and desires of the population, as well as the financial abilities of the respective local government. The only limitations on this local government initiative are set forth in paragraph 12 of the local government law, which specifies that local government initiative may not apply to matters that are under the jurisdiction of Parliament, the Cabinet of Ministers, other institutions of state governance, or the courts or other local governments; nor may it apply to activities that are barred by law.

13 Local Government Functions in Latvia and Their Financing 3 To optimize the performance of their functions, local governments have their own budgets and properties, and they have the right to levy local fees. Local governments are charged with planning their budgetary expenditures and with rational management of their properties. Local governments may establish businesses and participate in enterprises with their budget funds. The law permits several local governments to join together in resolving issues common to more than one administrative territory. For example, local governments have joined together in establishing population registry offices, in building roads, in collecting waste, etc. In such instances, the respective local governments sign an agreement which specifies which local government is undertaking the functions of another, what the financing mechanism for the joint scheme will be, and what other matters must be addressed in the performance of the specific function. The responsibility of each party to the agreement vis-à-vis its residents, however, is independent. In cases where the terms of the agreement are not fulfilled, each local government is left to seek other options for resolving the specific problem. The local government law sets out a general declaration of local government functions. The unification of information, as well as the collection and analysis of statistical data are facilitated by a special system known as the budget classifier. The budget classifier arranges local government functions by sector. MANDATORY LOCAL GOVERNMENT FUNCTIONS Local government functions in Latvia have changed over time. Further changes can be expected in the future, because the distribution of competence between the state and its local governments should be based on the principle that functions are to be delegated to the level of state governance that is appropriate in terms of economic requirements and the public interest. Balanced development can be achieved if: the abilities of citizens to influence the resolution of various problems are maximized; public income is used economically and in full observance of the specific characteristics of the respective administrative territory, as well as the needs of its population; and the respective authority considers a variety of mutually competitive resolutions to each problem. Functions of Pagast and Town Local Governments 1. Economic functions Organization of communal services: water and sewage, heat, sewage purification, collection and disposal of household waste Organization of public service and amenities: construction, reconstruction and maintenance of roads, streets, and squares; establishment and maintenance of parks

14 4Fiscal Decentralization in Latvia: Proceedings of the National Needs Assessment Seminar and green (recreation) zones lighting of public territories anti-flood efforts establishment and maintenance of cemeteries and disposal facilities for dead animals maintenance of protected natural objects of local significance Establishment and maintenance of local government housing facilities Territorial planning and supervision of construction Organization of public transport within a town Facilitation of entrepreneurship 2. Education Establishment and maintenance of preschool facilities Establishment and maintenance of beginning schools, primary schools, and high schools Establishment and maintenance of extracurricular children s facilities Compensation of public transportation expenditures by schoolchildren 3. Culture and athletics Establishment and maintenance of public libraries Establishment and maintenance of local government museums Maintenance of cultural monuments of local significance Establishment and maintenance of cultural halls, and organization and facilitation of various activities therein Subsidization of mass media of local significance Construction and maintenance of athletic facilities, and organization and facilitation of athletic events 4. Social welfare Payment of support for poor families Home care for elderly or incapacitated individuals Social aid to disadvantaged persons 5. Public order and security Establishment and maintenance of municipal police services

15 Local Government Functions in Latvia and Their Financing 5 Subsidization of the material base of the national guard Registration of dogs and impoundment of loose animals Opposition to alcoholism and immorality 6. Governance Maintenance of land commissions Establishment and maintenance of pagast and orphan courts Privatization of housing Organization of elections Registration of acts of civil status, census of residents Collection of statistical data Administration of mandatory regulations Administration of local government taxes and fees Administrative functions Functions of Regional Local Governments 1. Health care Establishment of a base program of health care Establishment and maintenance of hospitals Establishment and maintenance of outpatient care services Establishment and maintenance of paramedic/emergency services Establishment of health insurance institutions Organization of training for medical personnel 2. Social welfare Establishment and maintenance of orphanages and foster care institutions Establishment and maintenance of senior citizens homes Establishment and maintenance of homeless shelters Coordination of pagast and town social welfare services

16 6Fiscal Decentralization in Latvia: Proceedings of the National Needs Assessment Seminar 3. Education Establishment and maintenance of educational institutions for children with mental or physical handicaps Establishment and maintenance of residential schools Organization of adult education programs Establishment and maintenance of a school board 4. Culture and athletics Establishment and maintenance of sports schools Organization of cultural and athletic events of a regional nature Establishment and maintenance of regional libraries, museums, and cultural institutions Organization of the protection of cultural monuments of regional significance, as well as protected natural objects 5. Economy Provision of public transportation services Disposal and processing of household and industrial waste Development of socioeconomic development programs and regional territorial plans Facilitation of business activity Administration of roads funds 6. Administration Election of assistant judges Organization of local government elections Collection of statistical data Establishment and maintenance of administrative and state language commissions Administration of mandatory regulations Organization of the work of civil defense systems Administration

17 Local Government Functions in Latvia and Their Financing 7 The local governments of the country s seven major cities perform the functions of both levels of local government. Each local government function involves a certain range of work that must be done. This work can be looked upon as a specific program, and, for each program, the minimum necessary amount of resources, including financing, can be defined. I submit to the reader a calculation of the minimum financing that will be needed in 1997 for the most important local government function health care as well as an analysis of this calculation. HEALTH CARE FINANCING Health care financing has currently entered a period of stagnation in Latvia. For the third year, health care institutions at the secondary and primary levels have worked with essentially an unchanged amount of financing. (When measured on a per capita expenditure basis, the financing has remained at approximately 21 lats per resident per year.) The range of services made available to the population is diminishing. The structure of financing sources for health care programs has changed. In 1994, health care was fully financed by local governments. Sensing that local government resources were about to run out, the Cabinet of Ministers mandated in 1995 that patients must themselves pay up to 25 percent of the cost of each health care service. Hospitals, polyclinics, and emergency care facilities had great difficulty in collecting even this sum, however. Collection of the payments ran to no more than 12 to 13 percent. In 1996, the budgets of regional local governments were cut by 25 percent from The health care system suffered as a result, and there are rural regions in Latvia where health care financing amounts to only 16 lats per resident per year. The situation in the Latvian health care system is dire. This is clearly stated in a resolution adopted on 14 September 1996 by the Latvian Intelligentsia Association and the Latvian Medical Association: The reform process which is characterized by a transformation from a socialist economy to a free market economy requires radical transformation of the system of social protections for the population. The fate of many residents of Latvia indicates that a great share of the population has been unable to reorient to life under the new circumstances to find work, to retrain, to take responsibility for one s self, to care for one s own health and education. The quality of life of those who have been pushed away from society is deteriorating, and they have difficulty integrating into a free market society. It is, therefore, impermissible for the state to reduce its liability in the field of health care without simultaneously increasing the liability of nongovernmental structures and individual residents in this field. The situation is exacerbated by the Latvian economic crisis. The available amount of social aid does not make up for the poverty of the population. Some residents have no feeling of trust in their future. A lack of knowledge, poverty, corruption, a lack of rights, apathy all of these factors have led to socially unacceptable consequences, including a demographic crisis, illiteracy, high incidence of disease, alcoholism, narcotics abuse, prostitution, et al. The future survival of the Latvian nation is under serious threat.

18 8Fiscal Decentralization in Latvia: Proceedings of the National Needs Assessment Seminar The Latvian Intelligentsia Association and the Latvian Medical Association call on the Latvian Government and Parliament: To write and to adopt urgent laws and programs that would provide real solutions to the enormous demographic, socioeconomic, and health care problems that face the population; To give priority to health care, educational, and cultural financing when developing state and local government budgets; To maintain a balanced approach to the budget process so that forced market liberalization, the establishment of a balanced budget, and the narrowing of social programs do not cause irreversible harm to socially unprotected residents of Latvia and do not increase social tensions in the population; To implement a gradual transfer to a system of medical insurance in 1997; To facilitate the operations of the Health Care Support Fund to allow medical personnel, other specialists, social workers, private business people, and philanthropists to join together to resolve the enormous problems of health care and demographics in Latvia and to raise additional resources; To ensure that in 1997, the health care base program in Latvia will provide no less than 29 lats per resident, thus bringing Latvia closer to the health care spending level of the European Union. The Latvian Intelligentsia Association and the Latvian Medical Association call on the Latvian Government and Parliament to seek a balance between the development of a market economy and the survival interests of the nation. Calculation of a Normative for Per Capita Health Care Financing in 1997 As in other sectors of the economy, minimum finance levels in the area of health care are calculated by specialists in this case, health care economists with the assistance of health insurance specialists and local government employees. Such a calculation has been prepared for The calculation is based on documents approved by the Ministry of Finance (30 June 1993 No /185) and the Welfare Ministry (2 July 1993 No , as well as 25 August 1995 No. 225) which specify The Methodology for Financing Medical Institutions (Enterprises) and Implementing Reform in Their System of Governance. Also used in the calculation were finance reports from the country s health insurance system for 1995 and the first quarter of 1996, as well as analysis data for each sector of expenditure.

19 Local Government Functions in Latvia and Their Financing 9 1. Outpatient care Number of points per resident in 1995 Change according to 5th expenditure from criteria for evaluating health care services Planned number of points per resident Average value of each point according to physical expenditures 1, % 1,426 Ls Ls 7.84 Per capita expenditures for outpatient care for the year 2. Inpatient care Number of bed days per resident for the year Average value of each bed day according to normative Total cost of bed days per resident Manipulations above 1,100 points per one resident in inpatient care in 1995 Change according to 5th expenditure from criteria for evaluating health care services Planned number of points per resident in inpatient care Average value of each point according to physical expenditures Total expenditures for manipulations above 1,100 points/one resident in inpatient care 1.44 Ls 9.55 Ls % 576 Ls Ls 3.17 Ls Per capita expenditures for inpatient care for the year (Ls Ls 3.17) 3. Per capita expenditures for emergency care for the year Ls Per capita expenditures for the maintenance of centralized services and other expenditures for the year (This reflects transportation services, centralized procurement, payments under agreements with outpatient and inpatient institutions) Ls Per capita structural changes in the base program and the state program in medical care (Addition of tuberculosis treatment, narcology, oncology, and psychiatry to the list of base program services) Ls Cost of services provided under the base program at state medical facilities: Actual expenditures, of that state subsidy Financing of other undertakings Ls 3.59 Ls 2.67 Ls Per capita expenditures on the health insurance system for the year Ls 0.48 Total health care expenditures Partial payment for medical services by patient, up to 25% (under Cabinet of Ministers Reg. No. 171, 14 May 1996) Actually collected partial payment for medical services (13%) Ls Ls 7.42 Ls 3.86 Total minimum normative for the per capita financing of base program medical care No-cost medications Absolutely minimal normative for per capita financing of base program medical care from local government budget resources Ls Ls 1.19 Ls Based on these calculations, the needed amount of health care financing in 1997 can quite easily be determined.

20 10Fiscal Decentralization in Latvia: Proceedings of the National Needs Assessment Seminar Table 2. Calculation of Normative for Health Care in 1997 Population ( ) Differentiated coefficient 2,529, Type of expenditure Lats per resident Total lats in country Local government budget minimum normative ,338,096 Developmental expenditures ,362,631 No-cost medications ,000,000 Total ,700,727 Conclusion The current system of health insurance in Latvia can satisfy the demands of the population only if per capita annual financing increases. This increase could be identical to the growth rate of the national budget as such. Mandatory health insurance is certainly necessary in Latvia, because to a certain extent such a system serves the principle that money is collected from a healthy individual to cover sickness in the future. Before this can happen, however, Parliament must adopt the necessary legislation, and the Cabinet of Ministers, as well as the individual ministries, must develop appropriate regulations and normative acts. A period of transfer must then be defined, and an appropriate system of financial governance must be established. Health care must be left in the hands of regional local governments for the time being. The optimization of health care institutions cannot be a fully self-regulated process where finances are the only factor to be considered. Eliminating local government health insurance institutions and replacing them with regional systems is not feasible at this time, because many health care institutions are poorly provided with computers. Insurance documents are filled out by hand and are collected at the existing health insurance institutions. Excessively rapid change may lead to a situation where it takes several months to calculate the points for each patient. During this process, finances will not be received, and institutions will fall behind in their own payments. It would be dangerous to privatize those health care institutions that are the only ones in any specific territory. This is particularly true of primary health care institutions in rural areas (pagasts and small towns and villages). OPPORTUNITIES AND CONDITIONS FOR FURTHER DECENTRALIZATION OF STATE AND LOCAL GOVERNMENT FUNCTIONS 1. The state transfers the responsibility for vocational education and middle-level technical education to the regional local governments. Condition: Financing per student must be maintained at no less than the 1996 level financing is calculated as a single sum on the basis of the number of students. This sum will be transferred in the form of a targeted subsidy to the various regional

21 Local Government Functions in Latvia and Their Financing 11 local governments which, for their part, will be banned from using the money for any purpose other than this type of education, as well as adult education. Result: Regional local governments will be able to react much more effectively to demand in the regional labor market, and the demands of investors for training or retraining of employees will be met more quickly. Unemployment will be reduced, and competitiveness in the labor market will be enhanced. 2. The state transfers responsibility for second and third category roads to regional local governments. Condition: Appropriate financing must accompany responsibility. The existing financing levels that have been calculated under the state roads fund algorithm must be maintained. Result: Because one function of regional local government is the provision of public transportation, those roads that are used by public transportation vehicles will be better maintained. The ability to avert transportation problems in the winter and spring will improve. 3. Health care remains a responsibility of regional local governments. Condition: Per capita annual financing does not decline. The state does not reduce its base program. Finances are transferred to regional local government budgets in the form of targeted subsidies. Result: The optimization of the health care system proceeds with maximum attention devoted to the interests of the population. Investments in the health care infrastructure are not forgotten. 4. The state transfers responsibility for firefighting services to the local governments. Condition: A normative is calculated to serve as the basic indicator in calculating the sum of the targeted subsidy that is to be transferred to each local government. Result: A homogeneous and equally dispersed system of fire safety is developed in each region which is able to respond efficiently and effectively to fire safety problems, thus averting losses to the regional economy. 5. Local governments give greater rights to the directors of their budget institutions, while simultaneously demanding greater responsibility on the part of the directors; budgets are established on the basis of the program principle, and finances are distributed on the basis of the principle of union of results. Condition: Agreements must be signed with the budget institution directors; these specify that the directors are liable with their own personal property for institutions financial operations, and address the issue of cooperation with public councils.

22 12Fiscal Decentralization in Latvia: Proceedings of the National Needs Assessment Seminar Result: Budget institution resources are used with maximum effect. The interest of institution directors in leadership results increases. URGENT ISSUES As overall financing declines, the most rapid deterioration in expenditures is experienced in the sector of infrastructural investments. Centralized water and sewage systems, water purification systems, waste collection and disposal systems, central heating systems, and similar structures are not renewed and modernized. Experience from other parts of the world suggests that at least 10 percent of a local government s budget must go toward infrastructure investment each year. The problem, of course, is that the full budget of many Latvian local governments at this time is smaller than one-tenth of the budget of a local government in one of the European Union countries. If Latvia decides to eliminate the regional local governments, the first effect will be one of centralization of authority and finances. A further consequence might well be limitations on local government autonomy in making decisions. A negative symptom of this threat is that the State Audit Office already has the right to review the utility of local government expenditures. Current events suggest that the Government of Latvia does not recognize the principle of subsidiarity. PLANNING OF EXPENDITURES: BASIC PRINCIPLES Effectiveness. If the operations of a local government are to be considered effective, the needs and desires of the respective population must be satisfied as completely as possible. This can best be achieved if the system of governance in the state conforms to the principle of subsidiarity i.e., the state does not interfere with local government competence in the distribution of budget resources by sector, while simultaneously providing for the publication of annual reports on local government finances, analyzing the finances both in absolute and relative terms, and developing ranking tables with respect to the financing of the most important functions. Justice. When national budgets are approved, it must be ascertained that local governments receive the finances they need to fulfill all mandated functions. Norms of minimum financing must be developed for each specific function; these norms must be calculated on a per capita (one resident, one student, etc.) basis each year. Stability. A key issue is maintaining stability in the distribution of functions over a longer period of time. A system in which functions are the responsibility of the central government one year, and of the local governments the next, serves only to facilitate insecurity in the system and strategic developmental planning is made impossible. Furthermore, local government income sources must be defined by law, and it must be mandated that changes to these sources may only be made by parliamentary approval no less than two years before the respective changes take effect.

23 Local Government Functions in Latvia and Their Financing 13 APPENDIX A. EXPENDITURES IN DISTRICT GROUP, 1995 Culture and sports 6% Other 3% Economy 5% Administration 9% Health care 48% Social assistance 13% Education 16% Objective Lats per capita Health care 19.8 Education 6.4 Social assistance 5.3 Administration 3.7 Economy 2.1 Culture and sports 2.3 Other 1.3

24 14Fiscal Decentralization in Latvia: Proceedings of the National Needs Assessment Seminar APPENDIX B: EXPENDITURES IN CITIES GROUP, 1995 Culture and sports 4% Other 6% Health care 29% Economy 21% Administration 6% Social assistance 11% Education 23% Objective Lats per capita Health care 21.7 Education 17.6 Social assistance 8.7 Administration 4.5 Economy 16.1 Culture and sports 3.3 Other 4.7

25 Local Government Functions in Latvia and Their Financing 15 APPENDIX C: EXPENDITURES IN RURAL LOCAL GOVERNMENTS GROUP (PAGASTS, TOWNS), 1995 Other 7% Health care 2% Culture and sports 8% Education 33% Economy 20% Administration 17% Social assistance 13% Objective Lats per capita Health care 1.1 Education 19.4 Social assistance 8.2 Administration 10.5 Economy 12.5 Culture and sports 5.1 Other 4.2

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27 The Social Welfare Functions of State and Local Governments and Their Financing Agrita Groza, Director, Department of Strategy and Development, Ministry of Welfare Since the restoration of Latvian independence, new economic and political relationships have been developed in the country. Society has experienced many changes, both in terms of its understanding of values and its attitudes toward general humanity. Radical changes have occurred not just in the country s economy and politics, but also in the educational, cultural, and social spheres. The relations among winners and losers, givers and takers, have shifted fundamentally. The process of moving toward new economic relationships has led to a serious economic decline in Latvia, which has found expression in a narrowing of production and a deterioration in the standard of living of the population. In Latvia, the transformation to a market economy has been accompanied by a serious economic crisis. Per capita gross domestic product dropped by one-half between 1990 and Full price liberalization took place in December Inflation reached 958 percent in 1992, but stringent financial policies helped reduce that figure to just 23 percent in State policies since 1991 have led to a high level of commercialization with respect to many of the goods and services that are fundamentally necessary to society (food, health care, housing, education). State subsidies in many sectors have been reduced considerably or even repealed (between June 1993 and August 1996, for example, the government set rent ceilings, but these have now been removed). The 1995 banking crisis had a negative effect on the economy and on the population s standard of living. Latvia s economic growth indicators ground to a halt, and the development process was hampered very severely. The bank crisis also hurt the financing of social programs, especially in the areas of health care and social welfare. The goal of social policies is to create a stable and universal social security net that protects the welfare of the nation and facilitates improvements in its standard of living. In order to achieve this, the state, its local governments, and individual residents all have specific obligations and responsibilities. Two major principles underlie Latvia s social security policies, which were initiated in 1990: Social protection must be guaranteed to the residents of the state, while simultaneously increasing the responsibility and participation of residents in defending those individuals who are unable to work, setting out social guarantees in the law to reduce poverty. The financial and organizational structure of social insurance programs must be regulated; social services and support payments that are financed from local government 17

28 18Fiscal Decentralization in Latvia: Proceedings of the National Needs Assessment Seminar resources must be developed and expanded, thus helping to improve the lives and standards of living of people who have found themselves needy or in a crisis situation. The main purpose of a social security system is to provide the social services that are needed if people are to live respectable lives. Social security must be enhanced, and social justice must be facilitated. In 1995, a package of social legislation was adopted, and this marked the beginning of a new process of social security reform. The package included seven laws; these covered social security, the social tax, state pensions, mandatory social insurance in the event of unemployment, accident insurance at work and workrelated disorders, sickness and maternity support payments, and social assistance. One result of this legislation will be the implementation of a social insurance system where disbursements are directly dependent upon contributions. This will increase the interest and responsibility of individual residents in dealing with their own economic and social status. The new law on the social tax provides that from now on, social tax payments will be registered separately for each individual, with a separate account being opened for each insured person. The extent to which this reform process will be successful will largely depend on the government s ability to stick to its guns on policy matters, warding off pressure from various interest groups especially those that inevitably will argue in favor of lower contributions to the system. The reform period has created a wide variety of problems for the Latvian economy, and this has affected both the state and its local governments. Many new functions have appeared for both levels of government which did not exist in the old system and for which the state and local governments are not ready, largely because of inadequate financing. This is demonstrated by the low levels of financing for health care and social assistance in Latvia. There is no money at all for some functions, which means that the purpose of future reforms must be to establish expenditure policies that provide appropriate financing for all functions and that lead to more purposeful and effective use of expended funds. The laws and regulations that set out social policy in Latvia also define the obligations of the state and local governments with respect to carrying out this policy. The state has two major options in this area: either it can create a lawful foundation upon which other providers of social welfare services can operate, or it can itself become the provider of such services for the entire population. In Western countries, governments usually choose the first of these options regulating social policy, but not always administering or offering the services themselves. Local governments play their role, and the state, when dividing up the functions, seeks to decentralize the process and to expand the role of society in dealing with various issues. The task of the state is to develop national policy in the areas of social security and health care; to discuss this policy; and to use political, economic, and legal levers to solve problems and issues of social insurance, social care, social assistance, labor, health care and fitness, environmental protection, pharmaceutics, pensions, job protection, unemployment, etc. Demographic policies must be designed and implemented, and the coordination of national social security legislation must be facilitated. Laws must be harmonized with the requirements of the European Union and the Council of Europe.

29 The Social Welfare Functions of State and Local Governments and Their Financing 19 How is this done in Latvia? In the social insurance sector, the implementation of the major functions is the responsibility of the state and its institutions. They implement the policy by governing the special social insurance budget and by providing social services. In the health care sector, the state implements national policy and participates in the implementation of primary and secondary health care programs. Direct responsibility for all but tertiary health care and state care is in the hands of the local governments (the regional governments and the major cities). The role of local governments is to provide primary and secondary health care services to the residents of their territories. The function is financed from local government budgets, which are made up mostly of individual income tax receipts. In 1994, the average per capita expenditure on health care by local governments in Latvia was 16 lats; in 1995 and 1996, the figure was 21 lats. In the area of social care and assistance, the role of the state is to provide state social support payments and programs; to care for children whose parents are unknown; to establish and maintain state vocational education and professional rehabilitation centers; to establish and maintain social care institutions for children and adults with mental disorders, facilities for the visually handicapped, and orphanages; as well as to provide social aid to the homeless, who often cannot be attributed to a specific local government in that they have no address. Another important state function should be to ensure the participation of state funding in local government social support payments, especially social aid to needy families and subsidies for housing payments. Unfortunately, due to a paucity of funds, the state has been unable to ensure this participation. The obligations of regional local governments include the maintenance of educational institutions for orphans and other children who have been left without parental care, senior citizens homes, social rehabilitation day centers for children and adults with mental disabilities, rehabilitation day centers for people with physical disabilities, and service housing for people who need special care. The obligations of pagasts and town local governments are to provide for the evaluation of individual family income and property; payment of local government social aid support; home care for people with mental or physical disabilities, as well as for pensioned individuals; social rehabilitation for people who have been freed from incarceration; and social rehabilitation for individuals who have become dependent upon narcotics or alcohol. Some of these functions are not being performed in all local governments again due to a lack of funding. In the area of employment, the state develops and implements a unified employment policy. In the context of the state s new economic policies, the most important factor in the labor market is to ensure that employers can find adequately qualified labor when and where needed while simultaneously satisfying the needs of job seekers.