CLUSTER ANALYSIS OF TERRITORIAL COMMUNITIES’ BUDGET EXPENDITURE STRUCTURE IN UKRAINE UNDER FISCAL EQUALIZATION
Authors: Khodyko Dmytro 
Published: October 2021

The national fiscal equalization mechanism currently in force in Ukraine functions according to the tax capability criterion based on local budget revenues from personal income taxation. Potential conflicts of interest are inherent to this criterion due to differences in full revenue structures of territorial communities’ budgets, as well as their public service capacity and capital endowment, so that local authorities may not be motivated enough to use central government transfers to stimulate wider demand for productive labor in the community.
Based on the relative budget expenditure indicators for 872 Ukrainian territorial communities, according to the 2020 totals, five categories of expenditure structure were identified using k-means cluster analysis:
1) the share of administrative spending in general fund expenditure is between 30% and 50%, the share of capital expenditures is at most 25% of total budget expenditure;
2) the capital expenditure share is at least 20%;
3) the share of wages is at most 75% in general fund expenditure;
4) the administrative spending share is higher than 50%;
5) the administrative spending share is lower than 30%, capital expenditure does not exceed 20% of the total.
Parameters were estimated for log-linear dependency between general fund revenues per capita and ratios of direct/reverse transfers from central government budget, within the identified clusters and the full sample. The results allow noticing that the dependency between the revenue values and transfer ratios is statistically weaker and less elastic for clusters 2 and 3. Besides, the cluster groups show the statistically significant difference in average population of the respective communities, with lower population in clusters 1 and 4, moderate in 2 and 5, and higher in cluster 3.
The differences in expenditure structure between donors and recipients of the fiscal equalization mechanism are most evident in modestly populated communities, i.e. with approximately 10,000 populations (clusters 2 and 5), where the analysis reveals subsidizing of higher administrative expenditure and capital investment shares at the expense of communities with more efficient administration. The potential conflict of interest is further amplified by lower differentiation in transfer ratios of communities with lower wage share, which predominantly act as donors through reverse budget transfers (cluster 3), as well as of communities with high capital expense shares, which are predominantly recipients (cluster 2).
The identified interests and issues of the communities constituting the expenditure structure clusters allow suggesting two model priorities for inter-municipal cooperation. The first one is common projects in public services provision between the modestly populated communities with high wage shares and unequal endowment in investment resources. The second one is the shared commercial use of resources in least financially capable communities, funded by donor communities with comparatively low wage share which, in their turn, would require further optimization of administrative expenditures to be able to implement the projects of this kind.