Coordinating Central and Local Governments Policy in Iceland. Björn Rúnar Guðmundsson Head of Economic Department Ministry of Economic Affairs

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1 Coordinating Central and Local Governments Policy in Iceland Björn Rúnar Guðmundsson Head of Economic Department Ministry of Economic Affairs

2 A bird s eye view: Municipalities in Iceland Overall number of municipalities in Iceland is 77 with an average number of inhabitants just over In reality it makes more sence to look at the larger capital-area on one hand and the rural areas on the other hand. Strong centralication trend. About 75 per cent of the population lives in the 15 municipalities in the larger capital-area.

3 Population development in Iceland, Larger capital-area The rural areas Average rate of growth 1.9% Average rate of growth -0.2% Source: Statistics Iceland

4 Autonomy of local governments is very high in Iceland. By international comparison icelandic municipalities enjoy a high degree of freedom in the public financial area. Number of municipalities has decreased rapidly, but is still very high. There is a politicial consensus in Iceland that the role of municipalities in providing public services should be increased. Article 61 of the Local Government Act requires that municipalities revenues match expenditure as far as possible. This loose phrasing can invite difference in interpretation. The three-year plan stipulated by the Local Government Act is not perceived as binding restrictions in all municipalities.

5 Main expenditure categories of local governments in Education and child care 48,5% Youth and sports Social Service Mutual cost Culture Traffic and transportation Environment Construction and planning Other 12,4% 11,0% 7,6% 4,2% 4,0% 2,5% 2,1% 7,9% 0% 10% 20% 30% 40% 50% 60% Source: The Association of Local Authorities in Iceland

6 Current division of public spending between levels of government. Public consumption, % of GDP Total public investment, % of GDP 16,0% Local governments Central government 3,0% Local governments Central government 14,0% 2,5% 12,0% 10,0% 2,0% 8,0% 1,5% 6,0% 1,0% 4,0% 2,0% 0,5% 0,0% ,0% Source: Statistics Iceland

7 Poor overall performance in the last three decades Income balance of central gov., % of GDP Income balance of the local gov., % of GDP Since 1980 local government sector has only had positive income balance 8 times (central government 12 times). Both local and central government show a clear pro-cyclical behaviour. In 2008 the income balance of the central government is shown and calculated without large takeover of lost claims from the Central Bank. Including these items central government deficit amounts to 13.6 per cent of GDP Central government average -0.46% Local governments average -0.33% Source: Statistics Iceland

8 Correlation between the output gap and the income balance of central and local governments (% of GDP) Output gap (x-axis), Income balance of the central government (y-axis) Output gap (x-axis), Income balance of local governments (y-axis) ,0-2,0 0,0 2,0 4,0 6,0-1 0,5 0-4,0-2,0 0,0 2,0 4,0 6,0-0, y = 0,8732x - 0,6324 R² = 0,6865-1,5 y = 0,0961x - 0,5534 R² = 0, Source: Statistic Iceland and the Ministry of Finance

9 Evolution of local governments revenues and expenditures, % of GDP Total income Taxes Grants Other revenue Total expenditure Current expense Nonfin. assets Income balance Source: Statistics Iceland

10 Main income and expenditure components of local governments operations Income Expenditure 21 Compensation of employees 9,7% 4,6% 17,6% 54,8% 111 Taxes on income and profit 113 Taxes on Property 114 Taxes on goods and services 13 Grants 4,7% 3,4% 1,9% 4,0% 3,6% 13,5% 40,3% 22 Use of goods and services 23 Consumption of fixed capital 24 Interest 25 Subsidies 13,3% 14 Other revenue 28,3% 27 Social benefits 28 Other expense 31 Nonfinancial assets (Investment) Source: Statistics Iceland

11 Share of sub-central government expenditure in total government expenditure State or regional level Local level OECD average 80% 70% 60% 50% Iceland 40% 30% 20% 10% 0% Greece New Zealand Portugal Luxembourg Slovak Republic France Hungary United Kingdom Iceland Italy Poland OECD average Norway Netherlands Austria Ireland Czech Republic Finland Belgium Sweden Germany Spain Korea United States Denmark Canada Source: OECD National Accounts. All functions, average , except; Korea ( ), Hungary ( ) Poland ( ), New Zealand ( ) and Slovak Republic ( ). For the US, National Accounts do not provide a breakdown between state and local governments.

12 Economic consequences of local government autonomy Per-Capita administrative cost and size of municipalities One obvious consequence of small municipalities is administrative inefficiencies. Administrative cost in the smallest municipalities are up to ISK per inhabitant in 2008 but down to in the largest municipalities like Reykjavík and Kópavogur Source: The Association of Local Authorities in Iceland. Reykjavík is not included.

13 Economic consequences of local government autonomy Icelandic local authorities borrowed considerably in foreign currency giving them a significant exposure to fx risk which has had negative balance sheet effects for many municipalities. The share of foreign debt ratio in 2008 was 42 per cent in long term debt which amounts to bn. ISK, 7.6% of GDP......but 28 per cent in Off-balance sheet debts amount to 52 bn. ISK in About 80 per cent of this debt is held by the municipalities in the larger capital-area. Currency composition of local gov. long term debt in 2008 Debt in millions of ISK Debt in foreign currency Another issue relates to competition among local authorities which under certain circumstances can lead to ineffective distribution of resources. Recent housing boom is a case in point Source: Statistics Iceland

14 Number of municipalities Local government budget framework has to be strengthened Local governments are currently required to led revenues match expenditure as far as possible. This should not be seen as a soft budget regime. At the same time it can hardly be seen as a hard budget condition. It is somewhere in between Number of years with negative balance During period 30 municipalities have negative overall balance......up to 16 per cent of income. One municipality had a negative result each year during the seven year period. During the last few years off-balance sheet items have increased dramatically Current regulatory framework needs to be strengthened. 2 0 Years Source: The Association of Local Authorities in Iceland.

15 Coordination between central and local government needs to be increased. From an economic policy point of view the central government has to have a lever on overall public sector fiscal position. This is particularly important in a crisis situation. In general, however, effective fiscal policy is crucial, particularly should Iceland join the EU. Accountability in relation with transfer of services from central to local governments has to be strengthened. As new tasks are assigned to local governments, funding has to be secured.

16 Re-inventing the wheel is unnecessary Adopting international best-practice. A framework for policy coordination has already been put in place and there is a genuine understanding at both local and central government level for the need to increase policy coordination among different levels of government. Studies are under way looking into which setup will be most useful for Iceland. A mixture of legal reforms, budgeting rules and increased enforcement mechanism is needed in order to enhance policy co-ordination between different levels of government. The time to implement significant reforms in this area has probably never been better than right now.