metadata: authors: 0: author: Sewell, David
1: author: Wallich, Christine
count: Albania
docna: 0: docna: Fiscal decentralization and
            intergovernmental finances in the Republic of Albania
docty: Policy Research Working Paper
subtopic: Health Care Services Industry,Public Sector Administrative & Civil
            Service Reform,Educational Sciences,Hydrology,Food Security,Democratic Government,Public Sector Administrative and Civil
            Service Reform,De Facto Governments
teratopic: Finance and Financial Sector Development
abstracts: cdata!: Economic decentralization emerged as an
            issue in Albania following the first election of a
            noncommunist government in Albania in 1992.  It is one of
            many challenges in creating a fiscal system that supports
            reform.  Decentralization has begun with the central
            government's transferring spending responsibilities
            primarily for some local infrastructure services to local
            governments.  But, given Albania's small size, it is
            unclear whether "people" services such as
            education and health care need to be delegated to local
            governments.  Although the destruction of local health and
            education facilities accompanying the demise of the old
            regime argues for giving communities a greater sense of
            ownership of these facilities, they should not be handed
            down without mechanisms to ensure uniform service standards.
            Draft laws focus on the transfer of assets (schools and
            clinics) to local jurisdictions but are vague about
            responsibilities for recurrent spending.  And because local
            spending responsibilities are expanding, local governments
            need increased revenues to finance them.  Providing an
            adequate social safety net is vital in Albania - the poorest
            of the economies in transition - and the government has
            taken steps to ensure that parts of it are locally
            administered, though centrally funded. The key to a
            well-designed intergovernmental financial system is to
            clearly define spending responsibilities so that a revenue
            system can be designed to accommodate them.  Such a system
            would combine revenue-sharing, own-source revenues, and
            intergovernmental transfers.  Tax-sharing of central
            government revenues based on district of origin cannot be
            the only means of local finance in Albania, as most revenues
            are collected in only a few districts.  To meet financial
            needs, local governments need some authority over
            significant own-source revenues (such as user charges and
            property and vehicle taxes).  Privatization revenues can
            also help local governments but only in the short run, as
            they are nonrecurrent.  Matching grants with spillover
            effects may be appropriate.  And for low-income regions
            incapable of meeting their spending needs alone, a
            transparent, equalizing transfer system should be developed.
            Albania's draft laws allow for this possibility, having
            established constituent and independent budgets for the
            local level.
geo_reg_key: 517208,517190,517191
repnme: repnme: Fiscal decentralization and
            intergovernmental finances in the Republic of Albania
display_title: Fiscal decentralization and
            intergovernmental finances in the Republic of Albania
listing_relative_url: /research/1994/11/697931/fiscal-decentralization-intergovernmental-finances-republic-albania
topicv3: Agriculture and Food Security m1326205 435,Water m1326522 137,Education m1327048 470,Public Administration m1327723 723,Health m1504661 3480
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Finance and Financial Sector Development
origu: Office of the Director-407
no_of_pages: 66
model_extractions: POLICY RESEARCH WORKING PAPER 1384

# Summary findings

Economic decentralization emerged as an issue in Albania following the firsr election of a noncommunist government in Albania in 1992. It is one of many challenges in creating a fiscal system that supports reform.

Dccentralization has begun with the central government's transferring spending responsibilities primarily for some local infrastructure services to local governments. But, given Albania's small size, it is unclear whether "peopleW services such as education and health care need to be delegated to local governments. Although the destruction of local health and education facilities accompanying the demise of the old regime argues for giving communities a greater sense of ownership of these facilities, they should not be handed down without mechanisms to ensure uniform service standards.

Draft laws focus on the transfer of assets (schools and dinics) to local jurisdictions but are vague about responsibiliries for recurrent spending. And because local spending responsibilities are expanding, local govermments need increased revenues to finance them. Providing an adequatc social safety net is vital in Albania the poorest of the econorrmies in transition - and thr government has taken steps to ensure that parts of it are locally administered, though centrally funded.

The key to a well-designed intergovernmental financial system is to clearly define spending responsibilities so that a revenuc system can be designed to accommodate them. Such a system would combine revenue-sharing, own-source revenues, and intergoc;ernmental transfers.

Tax-sharing of central government revenues based on districr of origin cannot be the only means of local finance in Albania, as most revenues are collected in only a few districts. To meet financial needs, local governments need some authority over significant ownsource revenues (such as user charges and property and vehicle taxes). Privatization revenues can also help local governments but only in the short run, as they are nonrecurrent.

Matching grants with spillover effects may bc appropriate. And for low-income regions incapable of meeting their spending needs alone, a rransparent, equalizing transfer system should be developed. Albania's draft laws allow for this possibility, having established constituent and independent budgets for the local level.

- This paper a product of the Infrastructure Team, Europe and Central Asia, and Middle East and Norch Africa regions' Technical Departrnent, and the Office of the Director, Europe and CentralAsia, Country Departmentll-is partofalarger effort in the Bank to study the problems of the development of local and subnational governments and issues of intergovernmental finance in the economies in transition. Copies of thispaper are available free from theWorld Bank, 1818 H Street NW, Washington DC 20433. Please contact Gemma Langton, room H11-075, extension 38392 (57 pages). November 1994.

_The Policy Reserch Working Paper Seris dissemates the findings of work* i progress to encouage tbe cxhange of ideas abour development usucs.An objectie of the series is toget th ndings ouz quickly, euen if the presentations ar less thanfzu MipolisheS Thc papers cary tc names of the autors and sould be used and citedaccorngly. The fiindngs intcrpre4tion4 and cncusions are the auhors' oKm and shosdd not be attribu to the World Bank, its Executive Board of Directors, orany of its menber countres._ Produced by the Policy Research Dissemination Center
# **FISCAL DECENTRAUZATON** AND **INTERGOVERNUMETAL FL4ANCES** IN THIE **REPUBLIC** OF **ALBANIA**

by David Swell and Christine I. Wallich

## World Bank

For helpful comment and suggestions, thnks ae due to Volilnet Ademi, Zuhcr Bcci and Malo HziDf the Council _of_ Mint of the Republic of Albania; to David Gentry, US Trasury Advisor to the Publc of Abania; and to M.C. Andrews, Teres Basier, Kemal Dcrvi, Caroe Freud, Dominique Dwor-Frccaut,, fllea Goldsi, Richard Hamilton, ichael Xoch, fJyte LurAra, lazw Loos, Richard Macoes, and Guian Ovalioglu, of tu- Central Europe DepartmenL
# TABLE OF CONTENTS

|L|INTRODUCTION.<br>............................................|1|
|---|---|---|
|IL|ALBAN[A:- EUROPE'S MOST RECENT REFDORMER....................|4|
||The Legacy ofthe Past<br>..................................|...<br>4|
||The Restoration of Growth and Stability.........................|7|
||Some Challenges for Decentralization Policies.......... .............|9|
||Comparative Sizes of Local Governments in Albana<br>......<br>.........|...<br>10|
|m.|WHEIHER AND HOW TO DECENTRALIZE: WHAT ARE||
||ALBANIA'S OBJECTIVES......................................|12|
|IV.|THE LEGISLATIVE AND REGULATORY FRAMEWORK||
||FOR DECENTRALIZATION....................................|14|
||The Constitutional Framework.-..<br>...........................|.<br>14|
||Recent Legislation Affecdng Local Government......<br>.............|..<br>14|
||Prefectures.......................................|16|
|V.|ASSIGNING EXPENDIURES F<br>.<br>...............................|..<br>17|
||Piiples<br>of Expenditure Assignment...........................|17|
||Who Does WhatinAlbania?...........<br>.....................|.19|
||Responsibilities for Local Inefrastucture Services<br>.19||
||Responsibilities for Non-Infrastucture Services .23||
||<br>IssuJes Raised by Present Expenditure Assignments .24||
|VI.|REVENUE ASSIGNMENT AND DESIGN-INANCING MODAIS.|27|
||Constient and Independent Local Budgets .29||
||Local Taxes .30||
||Equalization .33||
||<br>Other Possible Local Taxes .34||
||Business Taxes .35||
||Revenue Sufficiency ......................................|36|
||<br>User Changes, Local Pricing Discretion and Central Pricing Mandates .37||
||A Smaller Role for Social Pricing?............................|40|
|VL|TRANSFERS, INTERGOVERIMENTAL GRAS<br>AND OTHER||
||SOURCES OF LOCAL GOVERNM[ENT FINANCE.....................|42|
||Transfers.<br>............................................|42|
||PrivatizationRevenues.....................................|43|
||Local Government Borrowing?<br>7<br>...............................|43|

# VIi!L THE CONTINUING PROCESS OF INTERGOVERNMENTAL RELATIONS .

45
46 IXL SUMMARY AND CONCLUSIONS .........

.......................

# ISIT OF TABLES

|Table<br>1.|Economic Indicators<br>.7.............|7|
|---|---|---|
|2.|Size of Local Government Units in Albaia, July 1992<br>.....................|<br>11|
|3.|Urbanization and Number and Size of Local Government Units:<br>Albani and Other Central and Easten European Counties|.........<br>.-<br>52|
|4.|Government of Albania: 1993 Budget Spemding by<br>.......................<br>Miistries in Adminisatve Unbits ct Subuational Levels|53|
|_5._|Functions presently under Consideration for Transer to Local<br>Goverments in Albania and Efficient Fiancing of these Functions .<br>.....|........<br>54|
|6.|Goverment Revenue and Population by Major Districts, Albania .5..............|<br>.|
||LT<br>OF BOXES||
|Box<br>1.|Transfer of Power from Central Govemment Adminis<br>on .................. .|3|
|2.|Objectives of Local Government Fiancig Systems<br>........|13|
|3.|Who Does What Functions of Central and Load Governments ........|i8|
|4.|Financing Local Govemment ......................................|28|
|_5._|Fees as Own Source Revenue for Local Governments .......<br>.............|....<br>39|
# FISCAL DECENTRALIZTION AND INTERGOVERNNTAL FINANCES IN THIE REPUBLIC OF ALBANIA

# _1._ INTRODUCTION

1. Albania was the last of the counties in Central and Eastern Europe to begin the process of political and fiscal decentralization and is still in the early stages of this process. Decentralizaton has, nevertheless, been a priority of the current government of Albania, which is also the first democratically eleced non-owmmunist goverment in the country's history. The government was elected in March, 1992, passed legislation setting up local governments in June 1992 and held the first elections for these local governmens in July, 1992. The Council of Mnister subsequendy held a colloquium on public administraionreform and decentraization in March 1993.' At thattime, Albaniawas just emerging from some of the most difficult macroeconomi **c** ircumstances encountered by any of the former command economies of Central and Eastern Europe in their transition to mariet economies. Recent successes in - - macroeconomic policy a substantial amount of price stability was atained by mid-1993 have given the government some much needed breathing room. This gives it the opportunity to consider construction of a fiscal framework that will allow central and local govents to be established on a sound long-n basis.

2. The emergence of greater interest in decenaization of goverment in Albania is to be expected. In part, the desire for acrrent empowerment by local governments represents a reaction to the
-2 -

overcentralization, rigid party control and tightly regimented behavior that formerly characterized Albanian government and society. In part, decentralization represents the public sector equivalent of privatization of the production of private goods and services. Another practical reason for interest in decentralization and deconcentration in Albania results from the emphasis, in a post-socialist market economy, on increasing efficiency in service provision. Problems in transportation and communications, outlined below, also make it difficult (indeed, always made it difficult) to operate a highly centralized government efficiently. For all these reasons, some deconcentration of power to local officials has already en place within the govenment of Albania although the center is proceeding very cautiously (the terminology of the decentaliztion debate is discussed in box 1).

3. With a population of under _3.5_ million, Albania is a small country and questions might well be raised as to how much decentralization of govemment is appropriate in these circumstances. It is clear that we should not be considering the type of extensive decentralization that might be appropriate in a federal state such as Russia with its many constitaent republics, nationalities, language and ethnic groupings and huge expanse of territory covering 11 time zones. However, the efficiency argument for local responsibilities for service provision as distict from national provision also applies in Albania's dcrcstances in some sectors (section V). Indeed, all continents have examples of democratic countries with populations in the range of _3-5_ million which have well developed local government sectors based - - on a commonsense division of powers. These countries Costa Rica is an example provide possible models for fixture development of the rnlationships between Albania's local and central governments.
-3 -

<!-- Start of picture text --> lBo 1: Transfers of Power from Central Government Administration<br>Four types of transfer of power from centrl govcrnmcnt administrtion can be distinguished on the basis<br>of the organization to which powcr is tranufcmred. The following terns are widcly used in the literture to idcntify<br>thcse four powcr transfers.<br>Deconeentradon implies a shift in the authority of national government officials away firom those wodring<br>in the capital to those workng in more dispersed locations. Some 9.1 million lek out ofa totalannual Budget for the<br>govenunent of Albania in 1993 of 49.9 million let, or slightly more than 18 %, is delivercd in such a deconccnbtated<br>manner. Seven ministries dceliver services on a deconcentrated basis; the major ministries invohecd being those for<br>Agicure, Constuction, TIansport, Education and Heath.<br>Deklgation of powers means that local governments undertake cetin functions an behalf of the cental<br>govement. In such delepted fields of autnority, local g,overnments arr sill subject to the control of the cntral<br>government and are responsible to thbe laktcr for their actions. The govermnment of Albania has recently begun to<br>dclgae mo 'omimportantpowers and reponsibiLieto thc newly lected localgovernments. Thus, municipalites and<br>communs have been given grants to disatibute social assistanc in 1993. While the guidelncs fr social assisance<br>payments have been dcveloped by central government ministries and cach municipality and commune, has a fixed sum<br>to distibute, the municipalities and communes will themslves decidce which families will receive this aid and how<br>much each fainily will receive.<br>Deeentralztion meams that fall authority to make and cany out decisions is tranferred to local<br>governments, which are solely rssponsibk to thcir own electors for thcse decisions.<br>Dcvolution is a closely related tem often used to describe the siuation where significant amounts of<br>legislative and fiscal authority are trnsfcrred from central to subnational governments.<br>Both decentralization and devolution of powrs areunderactive consideration by thcgovernmentofAlbania<br>at the presnt time.<br><!-- End of picture text --> 4. After giving some background data on Albania and its recent legislation concerning local govemment, the following sections of this chapter will examine the assignment of functions between central and local governments (section V) and their financing (section VI). The system of transfers (sectio VII and the ongoingprocess of intergovenmental relations (section VIM) wil thenbe eamined A final section provides a summary and concluding thoughts.
-4 -

# **II. ALBANIA:** EUROPE'S MOST RECENT REFORMER

**_5._** Albania is among the smallest of the Balkan states, with a population of roughly 3.4 million in 1992 and a land area of nearly 29,000 square kilometers. About 70% of the territory of Albania is mountainous and the population predominantly lives in rural areas and is engaged in agriculture. The largest city is the capital, Tirana, with a population of some 270,000, and the average size of its 47 cities is 28,000. Some 65% of the population lives outside urban areas, and in 1992 agriculture employed half of the labor force and accounted for half of total output (See Map).

6. Of all the former command economies in Europe, Albania was the poorest, and the most rigidly controlled. In emerging from the totalitarian period, from 1992 to the present, Albania has implemented one of the more successful stabilization programs in the region, and has liberalized the major part of its economy. In 1993, Albania manifested one of the highest growth rates in Europe (11 percent), and has reduced inflation to less than two percent a month since mid-1993. Virtually all agricultura **l** and has been privatized, state farms disbanded, and most small and medium size enterprises privatized. This section briefly descriLs Albania's troubled earlier history and subsequent macroeconomic and struchtual achievements, as background to the discussion of decentralization that follows.

## The Legacy of the Past

7. Until compaatively recendy, Albania was ruled by a vicious and paranoid dictatorship. Under the regime set up by Enver Hoxha, as many as three out of four families were touched by police - repression, according to some estimates with family members being jailed, exiled or otherwise harassed for political reasons. The number of ex-political prisoners of the regime is so large that they now constitute a major political force, and a separate Ministry is devoted to their welfare. Ihe extent to wMich
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_-5 -_ _the_ regime was concerned about threats from abroad is shown by the pillboxes that are in almost every field. They are rarely out of sight in the countryside and will be one reminder of the Hoxha regime that may be evident for centuries. An indication of the extent of the intrusion of the Hoxha regime into tie affairs of individuals and families is that it made family planning illegal. The extent of collectivisation and associated prohibitions on ownership of private property is illustrated by the fact that private automobile ownership was banned until 1991. In 1976, private ownership of productive assets was formally prohibited in the Constitution.

S. The Hoxha regime also imposed complete central control over the economy and kept its people isolated from the rest of the world to an extent unparalleled in any of the former command economies. The policy the regime followed from 1975 to the death of Hoxha in 1985 was one of total autarky. Indeed, the principle of autarky - called self-reliance - was written into the 1976 Constitution. The latter prohibited any foreign credit, aid or investment.

_9._ The demise of communism in 1991-92 led to economic chaos. For 45 years, central planning had decided, allocated and distributed everything in all sectors. When it was abolished, no alternative allocation mechanism was in place and the result was a freefaU in economic output. In this respect, the process of transition was not too different in Albania than from that in many other former command economies.

10. What did distinguish Albania from other Central and East European economies where communism also collapsed in this period, however, was the breakdown in public order and the physical destruction of social capital that accompanied the fall of the old regime. Some of this might seem to be the
-6-

equivalent of the population shooting Itself in the foot. Thus, slightly more th a third of the schools in Albania were badly damaged or destroyed in the process. The majority of local health center were also badly damaged, with 24% of these centers and a further 65% of local hoalth posts being either completely destroyed or occupied by squatters. The destruction of cooperative and state farm buildings also destroyed administrative centers and offices for many rural local governments. There was also significant destruction of some goods-producing capital, such as the irrigation network on the former cooperative farms which accounted for three quarters of land under irrigation. Much of the propert that was destroyed would be identified as belonging to the local community in many western states, and its destruction speaks eloquently about the alienation of the population from the former regime, the extent to which public services were previously delivered together with a hated ideology, and the absence of a feeling of local ownership or community commitment with respect to the activities using these facilities.

11. Although Albania was already one of the poorest countries in Europe before these events, the collapse of central planning and the breakdown in public order led to a decline of slightly more than 40% in output in 1990-1992. The distress of the population was shown to the West in stark fashion in March 1992, when television recorded the arrival in Italy of some 20,000 youths and men who had seized ships in the Durres area. A recent estimate is that out of 3.4 million Albanians, nearly half a million are now illegal emigrants in neighboring countries - including a quarter of a million who left Albania in the year following the March 1992 elections which led to the installation of the first elected non-Communist government.

12. The decline in economic output of more than 40% in 1991-1992 bad other macroeconomic consequences. When output fell, so too did the principal source of government revenues, from state-
-?7-

owned enterprises. Further, control over most categories of government expenditures almost disappeared.

As a result, the fiscal deficit exploded to about 42% of GDP in the first siC months of 1992. Money was printed to fmance the deficit and the resulting inflation rate in early 1992 was 14% on a monthly basis. Actual inflation for all of 1992 was 237%.

||**'Talb**|**le**I**Albania rAe**<br>|**nummie**<br>Tndliea<br> <br>|nters<br> <br>||
|---|---|---|---|---|---|
|||_=9%|14')<br>U|<br>I'OP<br>_._<br>.|1993|
|| GDP<br>Grow*.<br>(Percent<br>Change)|10|-10|-28|-10|11|
|Revenues<br>% GDP|48|47|31|25|28|
|**Expenditres**<br>% GDP<br>_|57<br> <br>_<br>_|_61_<br>_<br>_<br>_|62<br>_<br>_<br>_|47<br>_<br>_<br>_|45|
|DeSickt-9||-15|44|-22|-16|
|(Pern<br>Cbange).<br>|o<br>|O<br>|104|237|31|
|_Indudes_speding are|sfrom199|0.||||

# The 1 _1hwti_ of Grwh and SbbiCty

13. As noted, the first non-communist goverment in Albania was elected in March 1992. Its priorities were to launch structura reforms **to** establish a market economy and to introduce a comprehensive program of stabilization measur. Its success in the latter respect, coupled with high per capita foreign aid flows and remittances from the large numbers of Albanians who have moved abroad to get work, have contibuted to a remarkbly rapid economic unaround in inflation and output Mainly through reductions in expenditures, the budget deficit was reduced to 16% of GDP in 1993 by the new government, of which two-thirds was financed by concessional foreign aid. Remittances from those working abroad al.so contributed $200 million, and subsdanly eased the balance of payments. As a result of the stabilization program, the lek - which had been allowed to
float-was stable by the begining of 1993 and inflation in 1993 of 31 % was a far cry from the 2379% level of the previous year. As of mid-1994, iere was evidence of an appreciation of the real exchange rate in the freely floating market, and inflation had falen further, to 18 percent, on an annualized basis.

14. Although admitedly it started frm a low economic base, Albaniaes GDP growth of 11% in 1993 was one of the greatest of all te former command economies, and the highest in Eumpe, east or west. In 1994, growth performance has been similarly robust. While the recovery primarily had its orgin in agriculture, constuction and other private services also expanded substtally. The adjustment process was, of course, not without costs, particlarly for those in the public sector. Unemployment rose to about 26% of the labor force as a result of layoffs in the state-owned industrial enterpises and real wages have fallen. Nonetheless, in ihe recent Eurostat survey , the _overwhelming_ majorty of Albanians agreed that they were "better off than before the reforms", a result which contrasted stingly with the generally pessimistic evaluation regee d in other Eastem European countries.

_15._ The susinabiity of the macroeCoDnomIc adcievements to date and their conversion into long term growth will depend on furter far-reaching strucural refonns. Thus far, Albania has privadzed viraly all agricultura **l** and, and the output response has been substantiaL. Privatization of trucking and the retail sector has been followed by privatizon of small and medium term enterprises. Remaining challenges include the buiding of iucture required by the private sector, privatization andior restructuring of the remaining state enterprises, and the creation of a banking system so that credk can start flowing to new acdvities.
- _9_ -

16; Writh its location close to EU markets, and its low labor costs, Albania should be able to expand trade and attract some foreign mvestment enabling the country to better exploit its natur endowments, especially in naturl resources, tourism, water resources and agriculture.

# **Se _es for D** Policies

17. Albania remains the poorest state in Central and Eastem Europe, with per capita GDP of rougly $340 in 1993. There are perhaps more graphic indicators of the country's standard of living than even these rather bleak income statistics. FoX instance, it is estimated that there are only _7.5_ square meters of housing per person in Albania, and the country with the next lowest housing stock in Central and Eastern Europe is Romania which has 15 square meters per person. By way of contrast, Hngary has the largest stock of housing in Central and Eastern Europe with 26 square meters per peson.18. Difficulties in tortaton and communications were alluded to above as makidng it difficult for a higbly centralized form of government to be efficient The country is mountainus and many villages are inaccessible by motor vehicle. About 400 villages with an estimated population of 1.5 million people are not accessible by motor vehicle for part of the year. In addition, there is no telephone service to many municipalities. Thus, not only is Albania poor, but there are significant _regional dixparides_ within the country, with some areas served much better than others.

19. The poverty of this country, and its previous mimanagement by the fonner communist regime, are reflected in other statistics for local infrastructure. For instance, of the 250 water supply systems in Albania, only one provides 24 hour service to its customers. In Durres, which is
- 10-

Albania's second largest city and principal port, about 30% of households with a tap get no water at all and the remainder get service for an average of 3 hours a day. In the past 10 years, the origi of 4 typhoid epidemics has been taced to contamination of its water supply. Indeed, it is estimated thut from 50 to 75% of all drinking water sources in both rural and urban areas in Albania are contaminated. Further, only 60% of prmary health care centers have any source of heating, while only 40% have running water and 14% have basic laboratory equipment

# **mrive SEi of1** Lca Go in Albnia

20. Table 2 presents some information on the sizes of local government units in Albania - - districts, municipalities, and rural communes at the time of the first local elections in July 1992. While the 37 districts have an average size of close to 100,000, there is considerable dispein in their size. The addition of 10 new districts betwen 1991 and 1992-six of which had an urban popuation of less han 10,000-contributed to this dispersion in size. The 47 municipalities **also** w considerable deviation arund their average size of roughly 28,000. The average size of the 309 ural communes is close to 7,000, and it can be seen that the communes are much more im size than the other units of local govemmment. While not shown in the table, the rural comprise up to 24 villages, with the average number of villages per commune being si y over 9. Average vfllage size, in tur, is 764 and is relatively homogeneous.
- 11 -

|; -<br>.<br>*e.<br>; .<br>.<br>.<br>T.able2.-<br>I<br>fe'f1AdGrmm<br>UmbimJAbim:<br>*<br>*<br>.<br>.*<br>*<br>* -<br>||
|---|---|
|:jmly1992.||
|Numbar<br>47|309|
|Size Range<br>23,789-414,367<br>2,534-270,000|12-18,791|
|Avege Size<br>96,118<br>27,801|6,963|
|Standard<br>Deviation<br>_79,434_<br>49,622|_1,23|_|
|_._<br>=Dcepnt<br>of S<br>_;Ai;_Governmn_of_Aibanl||

21 The size of local goverments and the degree of urbanizadon of a country influence the costs of local governments and the extent to which the latter can capture economies of scale and be<sup>viable</sup> as independent units. Table 3 presents some comparative stdstics in this respect for Albania<sup>and</sup> other Central and Eastern European counties. It is evident that Albania is by far the least urban<sup>of</sup> these countries, using the _Work! Development Report's_ definition of urban as being the percent of<sup>the</sup> population living in cities of more than 10,000. At the most aggregate level of local government,<sup>the</sup> rethe or district level, Albania's local government units are smaller in size than those of most<sup>of its</sup> neighbors in Central and Eastern Europe. On the other hand, Table 3 indicates that the lowest level of local government in Albania, comprising the municipalities and rural communes, has a larger average size than that in other Central and East European countries with the exception of Poland and Bulgaria.2
- 12 -

# m **WETR** AND **HOW** TO DECENTRALIZE: **WHAT** ARE

## **ALBANIA'S OBJECTIV?**

22. There is no single "tight" system of local government finances: much depends on what a country wants to achieve (see Box 2). Balancing objectives-efficiency, revenue adequacy, equity, local government autonomy, and the like-can be difficult. For instance, too generous support for local governments may discourage their own revenue effort and hence autonomy and undercut central stabilization policy. Different countries also attach different priorities to each of these objectives, and these priorities may change over time. Not all these objectives can be achieved simultaneously, and choices need to be made. In Albania today, the overriding objectives in the intergovernmental system would seem to be: (i) consistency with macroeconomic stabilization policy; (ii) administrative simplicity; and **(iii)** sufficient equalization to avoid the emergence or worsening of service differentials if key areas such as education and health are handed over to local governments, where the nation as a whole stands to lose if poor areas underspend. In addition, a means of fiacing local infastuctre development is also a priority.

23. Given the above discussion of Albania's macroeconomic. situation, Albania's administrative and revenue constraints, and the need for greater efficiency in service provision, the following general objectives should be taken into account in designing its intergovernmental system: First; administrative constraints, the need for continued macroeconomi **c** ontrols and the superior taxing power of the central governments (as in most counties) suggest that local goverments wil thus remain transfer-dependent for some time to come. Second, Albania should more clearly assign spending responsibilities and give expenditure discretion to subnational governments in appropriate areas to increase the efficiency of public
- 13 -

<!-- Start of picture text --> mE 2: Oh1*ist of dmiln CI mnnmt Fkancg Sas<br>An ide; al natm of local govcrnmnt financing would:<br>* try to ensure corespondence bewten subnational expenditure responsibilities of local governments<br>and their financial resources (ncluding transfer from the central government) so that functions<br>asigned to local govemmaens can bc effecdvcly carried out;<br>* increase the autonomy of local govenuments by incorporating incentives for them to mobilize<br>rcvenues of their own;<br>* support (and not undermine) the center's macrocOnomic mnagement policies;<br>* give expendiure discretion to subnational governmts in apprpriate areas to increas the efficiency<br>of public spending, and to improve the accountability of local officials to their local constituens for<br>provision of local services;<br>* incoxporte itergovenmental tnsfers tat are transpareat and based on objectivc, stable,<br>nonnegotiated criria;<br>* minimize adminstrative costa and threrby economize on sace adnistratve resourncs;<br>* provide "equalzation' payments to offset differences in fiscal capacity among localitis and so ensure<br>that poorer localidts can offer suffcient amounts of key public services;<br>* incorport mechanisms to support public infrastructu development and its appropria financing,<br>. . S* support the emergence of a Local govenmment role consistent with nmaket-orented reforms.<br>spending, and to imprve the accountability of local officials to their local consiuents for provision of<br>local seroies. Ihird, larity and a full understanding of the budgetary implications of the expenditres<br>assigned to subnational governments is needed to design the intergovernmental system and to detemine<br>both the level of revenue and the revenue-elasticity local govenmments will need. Fourth, since economic<br>efficiency is an important goal, the central government should encourage local goverment revenue<br>mobiliatiom For efficient local government operations, some autonomous taxing power must therefore<br>be assigned to subnational governments. Fiffth, for the above reasons and since equity may well be a<br>dominamt goal given regional disparities, a formula grant should weigh heavily in the system, and a<br><!-- End of picture text -->
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premium should be placed on developing transparen **t** brmula indicators to support some equalization of per capita local government fiscal capacity. Sixth, since many functions suitably delivered by local governments are most appropriately financed by user fees and are not at present so financed, or have uniform national prices which are set without regard to local cost conditions, greater local pricing discretion will also be desirable. Finally, given the infrastructure bacldog, the system should incorporate mechanisms to support public infrastructure development and its appropnate financing by central or local govemmen;s.

# IV. THE LEGLILATIVE AND R=EGULATORY FRAMEWORK

# FOR DECENTRAAITION

# **Ihe** Constiutional Framework

24. Three layers of government are specified in the draft constitution now being considered by the Constitutional Commission of the Albanian Parliament: the communes and municipalities, the 37 district goverments (the higher level of local govemment), and the **central** govenment. The draft consiuon defines the relationship between these layers of government and the issue of the role of the judiciary in adjudicating disputes between layers of government in general terms. (chart 1)

# Recent Legislation Affecting Local Government

25. Albania has taken a number of steps towards decentralizing and deconcentratin **g** overment functions. Most importantly, _The Law on the Organwizadon andFuwfioning f Local Governwm (Law_ No. 7572) was passed on June 10, 1992 and was immediately followed by the first local elections of district, commune and municipal officials in July 1992.
# Figure 1 Goverment structure

<!-- Start of picture text --> Local Central government<br>government Council of Ministers<br>Ministries Prefectures<br>l~~~~~~~~~~~~~~~~~~~~~~~__________ I___,, l _<br>Ministry of<br>Rethes , Ii.* * .. Fi<br>-<br>(37 districts)<br>Bashlsi Communa<br>(47 municipalities) (309 rural communes)<br><!-- End of picture text --> _Note:_ According to the draft Constitution, local governments and the central government have equal power. Dotted lines indicate the Ministry of Finance is the principal source of funding for local governments.
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26. The problems that have emnerged since the local elections have their origin primarily in vagueness in this Law, which gave local governments an impressive number of responsibilities but did not specify either how these responsibilities were to be financed, or the division of labor where local and national govermments share responsibilities.

27. The division of powers and the fiscal capacity to carry out these powers need to be clarified to promote accountability of both levels of government. Until these problems are resolved, there is also likely to be considerable frustration of central and local government officials leading to a corresponding amount of intergovernmental tension. In addition, lapses in service provision may occur if responsibilities remain unclear.

'28. The government of Albania moved to address these outstanding issues inmid-1993 by establishing an intergovernmental Task Force on decentralization charged with preparng legislation on the functional responsibilities and financing of local governmet This legislation consists of: (i) a Law on _Local Budgets; Cn)_ amendments to the Law on _The Tax System in the Republic of Albania_ and a Law _on Asset Ownersip ofLocal Government._ The first two address the financing of local government and deal with both transfers from the central government and revenue sources that the local govemments have the power to tap themselves- The Law on _The Asset Ownersh*p of Local Gow>ment_ is an indirect attempt to assign spending responsibilities to local governments by allocating ownership of govrnmental assets between central and local governments. 'The status of this legislation as of the first quarter of 1994 is that theLaw _on Local Budgets_ was passed by Parliament on December 22, 1993 (Law No. 7776), while the other legislation is in draft fbrm and is still being considered wihin the government. These laws address the key dimensions of designing an intergovernment system: the allocation offunctions and their
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financing.

# Prfectures

29. Another interesting development in the process of decentralization and deconcentration in Albania has been the introduction of a prefecture system. The prefecture system in other countries which have such an institution is the regional ann of the central government, although the importance of the prefects has greatly diminished with the rise of elected subnational governments in countries such as France.

30. _The Law of Prefectures_ (Law No.7608) was passed on September 22, 1992. The introduction of this Law closely followed the first local govenment elections, in which the opposition parties in Parliament did much better than they had in the previous national elections in March 1992. The primary objective of the prefectures is stated in the _Law of the Prefectures_ as being "to coordinate the activity of the ministries and other central institutions in the administrative territorial units". Article l of the Law indicates that the prefectures are not to have supervisory powers over departnents of the central govenment, however: any disputes between the prefectures and the departments are to be settled by the Council of Ministers.

31. Article 4 of the _Law of Prefectures_ is careful to specify that the Prefectres and elected local governments are to be totally independent institutions. The prefectures are, however, given the right to stay local goverment by-laws or legislation while the courts decide whether this legislation is constittional. The _Law on Local Budget_ indicates that the Prefectures are to have no responsibilities with respectto local govenmentbudgets; the Law specifies that a copy of these local budgets are simply to be forwarded to the relevant Prefecturs for information.
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32. The functions of the Prefectures therefore remain somewhat of a mystery at the present. In July 1993, however, the government approved the formation of 12 Prefectures with a total establishment of 180 positions. It may be that the prefects will have potential significance. _The Law of the Prefectures_ emphasizes a substantial role for them in internal security: they are to be responsible for civil defence, for example, and to "supervise" toe police.

# V. ASSIGNING EXPENDITURES

## **Plriniples** of **Expenditure** Assignment

33. What are the respective roles of central and subnational governments? Typical functions of both levels of govermnent are indicated in Box 3. Traditional public finance theory suggests that an "efficient" expenditure assignment between levels of government is based on the geographic dimensions of benefits. 'hat means, ideally, that each locality should provide, and pay for, services whose benefits accrue within its boundaries, and, to the extent possible, spending responsibilities should be given to the _lowest_ level of government _consistent ith the efficient perfomance of that service._ The reasonig is that local populations with differing tastes and preferences will receive those public services which they want-not what is centaIly determined. Thus, the center will be responsible for functions with national benefits while loca governments will provide services to benefit local residents.

34. This decentralization principle has important corollaries. Where there are important economies of scale, for instance, it may make sense to centralize provision of such services. In addition, a case is often made for central government involvement in sectors such as health and education on the grounds of "spillover effects", or "externalities." Spending in these sectors is important for national economic
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# Box 3: Who Does What? Functions of Central and Local Governments

Typical Central Function. Among the functions commonly assigned to the central level of govcmment are: defense, post, and telccommunications; national roads and highways, poiu and civil aviation (if these are in government hands at all). Then services provide benefits beyond any one local jurisdiction and are typically the responsibility of the national budget The courts, enforcement of national laws, foreign afrairs and diplomacy, industrial and environmentl lcgislation and intenregional commerce are also usually seen as 'national level" functions of government.

Typical Local Functions. Among the public services best delivecred at the local level (with local decisionmakers deciding what services _am_ provided, to whom, and in what quantity and quality) are: transportation services such as construction and maintenance of local roads and provision of public trmnsit; security scrvices such as fire protection and enforcement of local laws; public utilities such as those for water, sewage and various forms of energy distribution; general urban services such as provision of parks, recreation facilitics, markets and slaughter-houscs. These are alt eximples of services whose benefits favor the local area, and which are often provided by local govermments.

Spilbvers. In between are cxpenditures on education and health and social welfare. On the one hand local schools and clinics clearly benefit rcsidents of the local area; on the othcr, a wcl-cducatcd and healthy population has national benefits also. Because of these benefit 'spill-overs", the responsibility for education and health is oftcn a national one, or when it is local, the central govermcnt may assist local govemmcnts in providing services to a certain standard. In the later instance, the srvice is delegated, but not fully decentmlized.

Shared Responibilities. Sometimes both kves of government share spending responsibility within a sector: local governments may provide tindergarten and primary education wfit Lhe central govement providing higher education, for instance. In practicc, thcre is much variability in spcnding responsibilitics and while the allocation of functions described here provides a guide, the decisions as to which level of government provides a service ar as much a finction of t country's historical and political heritage and tradition of local autonony as of the economic efficiency principles we have outlined.

Govemnment Provision versus Privatization. The assignment of functions between the levels of govcnmuent might seem to be complicated in the economics in transition by the fact that provision of many goods and scrvices previously supplied by govcrnments are now being privatizcd. In fact, the extent to which goods and services now supplied by governments are public rather than private goods is debatable even in the market economics. Many market economies are currently privatizing functions such as utilities in transportation and communications; even entire postl systems are bcing considered for privatzation in some countries.

Responsibilit versus Delivery. Finally, govemments need not always themselves directy provide services for which thcy are responsible. In market economies, many local governments contact for serviocs to be delivered by the private sector garbage collection is a typical example. Local governents can even contact with _higher_ levels of governmcnt Canada's Royal Canadian Mounted Police supplies services under contract to many provinces and municipalities. Equally, even if the central govermment is responsible for functions such as poverty rdief, it does not need to deliver the required services itself and can delegate these functions to local goverments. For instmce, the Albanian social assistance progrm, _ndihme economike,_ is centrally funded but managed by local govemnments.

development and national welfare and income distrbution, and if left to local governments alone, they may not provide enough of these services because only some of the benefits will accrue to their local
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residents. Commonly, the central government may delegate responsibility for functions with such external benefits to local governments but also provide transfers to increase their supply. In transition economies, it is also often argued that responsibility for the social safety net should not be left to local goverments. If one believes that the provision of a safety net Is a national priority during the difficult transition ahead, then the center should have a predominant role in its financing (as it does in Albania).

# Who Does What in Albania?

35. The traditional "benefit area" division of responsibilities between central and local govements, based on public finance theory, holds that local government **s** hould provide services ftat benefit the local jurisdiction while the central govermnent provides those with a national benefit area (Musgrave 1983). How Albania's assignments square with these principles is described below.

# Reonsibilities for Local Infrastructure Services

36. Current thinking concerning the allocation of responsibilities to local governments in Albania seems to parallel the assignment of such responsibilities in theory and in many market economies. The draft Law _on Asset Ownershzp of Local Government_ proposes to transfer to local government **s** ignificant responsibilities for local infrastructure, including facilities and equipment fbr streets and streetlighting, water and sewerage systems, urban transit, firefighting, garbage collection and local recreational and cultural facilities such as museums, sports stadiums and parks. Local police powers are the only function often undertaken by local governments in market economies that do not appear to be under consideration fDr transfer to local governments in Albania. The proposals also include transfer of all local
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"hardc infrastructure services with the exception of electricity reticulation. Most of these services are now provided by stat. enterprises reporting to the M7mistry of Construction.

37. As noted above, assigning responsibiity for provision of infstcture services to local government does not mean that this level of government has to provide these services. For instance, the central government is interested in privatizing solid waste management services even before transferring - responsibility for them to local governments including streetcleaning, solid waste collection from households and maintenance of public parks. These services are presently provided by 64 state enerprises. It is anticipated that these services can be provided by performance contracting with the private sector, as in many OECD economies.

38. Water and Sewerage Systems. Some responsibilities for these functions have already been transferred to local governments. For instance, there are 75 water borne sewerage systems serving some 30% of the populaon in Albania and 250 water systems serving 80% of the population. The central government continues to maintain juridiction over all of the 75 sewerage works but only 6 water works which rely on the same water source. The remaining 244 water works are the responsibility of the municipalities and districts they serve, in the limited sense that these local governments are responsible for paying for their operation and maintenance costs from tariff revenues. Such investments as there are in these water systems are sfill controlled centraly, however, with investment priorities being determined at the national level as part of the public investment program. This may be all that can be done for the time being, but over time, and as fiscal accountability increases, greater decentralization will be appropriate. Furtier, the water tariffs that local governments can charge are subject to a price ceaing set by the central government without regard to cost differences between areas or any particular level of
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cost recovery. This kind of central pricing mandate prevents localities from moving towards cost recovery (section VI).

39. Irrigation. The development of local authority for irrigation systems in agriculture is an example of the development of local govenment which is comparable to the formation of the many special purpose districts in OECD countries. Although Albania is rich in water supplies, seasonal irrigation and drainage are necessary for adequate crop growth, especially in the country's fertile coastal plaiL Some 417,000 hectares, or roughly 60% of all arable land, were serviced by irrigation systems before 1991. Unfortunately, this irrigation system was one of the principal pieces of social capital which suffered extensive destruction in the jacqueries accompanying the fall of the old communist regime in 1991-1992. Destruction and theft was confined mostly to the former cooperative farms which accounted for 74% of the total area under irrigation, and extended from pumping stations to high voltage electricity lines and even to the concrete linings of irrigation canals. In addition, the operation and maintenance of the irrgation system was previously based on the old cooperative and state farm. Privatization of the latter posed institutional problems in underting maintenance and collecdng user fees from the multitude of - newly-created small holdings some 400,000 farms averaging about 1.4 hectares have been created as a resut of priaization by the end of 1993. These factors, along with restrctions on system maintenance because of central budget constraints, reduced irrigation to 31% of the irrigation "command" area in 1992 and 19% in 1993. These were dramatic developments in a poor economy where agriculture is the main employment for 50% of the labor force.

40. Rehabilitation of the most cost-effective parts of the irrigation system has accordingly been a priority for the government and international lending irstitutions. (The first World Bank operation in
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Albania - the Critical Imports Project in 1992 - included an irrigation component for the most urgent repairs to infstructure and also provided funds to prepare a Water Code and legislation for Water Users' Associations). A proposed $10 million Intemational Development Association credit is presently being appraised by the Bank for rehabilitation of irrigation and drainage systems serving some 57,000 farm families in 7 districts in the coastal plains.

41. At present there are 37 district-based Water Enterprises, although it is suggested that these Enterprises might evenually be merged into larger organizations covering the main river basins in the country. The Water Enterprises in turn sell water on a wholesale basis to emerging Water Users' Associations, which are based on villages. Although the irrigation system was previously based on cooperatives and state farms whose boundaries did not necessarily coincide with those of villages, after the pivatization of agriculture, the villages were found to be the only well-fnctioning local social unit in the countryside. The Water Users' Associations are comprised of elected village representatives who consolidate water purchases from individual farmers, collect water fees and enter into contracts with the Water Enterprises for scheduled deliveries.

42. Transport Of the **various** means of transport, local govenments have no responsibility for mae transport, ports and railroads, but they do have responsibility for local roads. Roughly 8,200 km of the toal naional road network of 18,000 km. are classified as "local' roads connecting small urban centers with rura communities. A fur-ther 7,800 km. of "main" roads connect main cities with each other, and the 1,800 m. of "economic" roads serve industrial and mining centers. Excluding the economic road network, local roads constiu 51% of the road network but are allocated roughly 30% of total road expendiures in the national Budget. Owing to economic stringency, most road expenditures have been
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restricted to basic maintence in recent years. Recommendationa **s** to total expenditures in the National Budget, as well as the allocation of expenditures between main and local roads, are made by the Nationl Roads DepartnenL This Deparment also provides temhnical assistance to local governments and supervises road works that local govements undertake.

# Responsibilities for Non-Infrastructure Services

43. The draft _Law on Avset Ownership of Local Government_ also indicates a willingness to have a considerable local government presence in the delivery of 'people' services. Social insurance _(ndUame econonaike),_ is now a centrally funded program that is managed by local goverment Also under consideration is the transfer w the communes and municipalities- of all facilities for _ldndergarten,primay_ and _secondwry schooling_ as well as _vocational schools_ and schools for dte _hanIcaped._ In the health sector, the draft _Law on Asset Ownership ofLocal Govenmnt_ proposes a transfer of fcities such as _ambulances, pediatic dliics, health centes and local clinics_ to communes and municipalities. _Hospits_ and other healt facilities would be devolved to the district level of local goverment It is recognized, however, that efficiency in the health system could be improved through establisbment of catchment areas for secondary health facilities which are larger than the existing districts. For this reason, most district hospitals are being downgraded so that they offer only the most basic inpatient care while a smal group will be upgraded to offer comprehensive care to larger multi-district catcbment areas. Responsibility for _publc welfamw inttutions_ such as _orphanages_ and _old-age homes_ are covered by the new _Socal AssistanceLaw_ (Law No. 7710, adoptedbytheAlbanianParliamentonMay 18, 1993). Institutions with district, commune or municipal responsibilities are trsfered to those levels of government while institutions dealing with multiple districts are administered directly by the M inistry of Labor znd Social
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Protection. Each ofthese assigments of responsibilities raises issues which are discussedfurtherbelow.

# **Jaues** Raised by Present Expenditure Assignments

44. Capital vs. Recurrent Spending. Some concerns about the proposed transfers should be flagged. First, it is not clear if _operating responsibiry_ comparable to responsibilities for facilities will be transfered to local governments: the draft _Law on Asset Ownership of Local Governnent_ only deals wifth facilities. It might seem commonsense that capital and operating responsibilities for these fimutions should go together, but no proposals have yet been made public concerning future operating responsibilities for local infrastruture. Local govermnent **s** hould be assigned responsibilty for capital ependitures in sectors for which they also have recurrent responsibility. Substantia problems would aise if operating and capital responsibilities were separated for the same finctions.

45. QuaElty Standards. Second, the proposed trafer of responsibility in education and health raise questions as to whether _national sandards_ will be atained by local governments; for instance, in adherence to nationl curricula or in hiring suitably credentiaIed teachers and medical personnel. Since the responsibilities for health and education under consideration for transfer to local governments can realisdcally only be financed by transfers from the central government, requirements concerning stanads _should be a condition of such grants._ The _Law on Local Budgets_ has provisions for such conditional grants in its 'constituent budget section (see Section VI below).

46. Maintenance and New Investment. Nor does the draft _Law on Asset Ownerslh of Local Government_ indicate who wil be responsible for _incremental capital expenditures_ in these areas. Who
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will build new schools or new hospitals or maintain existing ones? If local governments are to have responsibilities for infrastructure, they need to be able to finance them. But perhaps the center plans to retain this responsibility. Some possible capital and infrastructure financing mechanisms are outlined in section VI below.

47. Social Assistance. Social assistance in Albania is at present centrally funded but locally managed, and provides benefits for families whose incomes fall below subsistence levels. The program is funded by a quarterly grant to communes and municipalities from the Ministry of Labor and Social Protection. Funds are allocated on the basis of indicators of need such as the number of disabled, the number of unemployed whose entitlemen **t** o benefits will expire in the forthcoming quarter, etc.

48. While the Ministry of Labor and Social Protection determines these guidelines, communes and muncipalities themselves decide which families receive aid and how much each family will geL Further, the scheme is administered at he local level by administrators who are hired and employed by the local governments, but have been trained in part by the Mimistry of Labor and Social Protection and are paid for by the grant to local governments.

49. In many ways, the new _Social Assistance Law_ is a model for _delegation_ of responsibilities and financing of functions from central to local goverments. The conditional gants for this purpose are easily included in the constituent" budgets of local governments as specified in the proposed _Law on Local Budgets._ 50. Education. As can be seen in Table 4, Education is presently the second most de a
_-26_ ministry after Construction. Only a third of the ministry's budget is being supervised directly from Tirana, while two-thirds is managed by employees of the Ministry at the local level. The draft _Law on Asset Ownership of Local Govermnent_ would imply a transfer of responsibility to the _elected local governments_ for _physicalfacilities_ in education.

51. No proposals have been made public for comparable _operating_ responsibilities to be transferred to these local governments, however. Will local governments be given full responsibility for primary and secondary education? This could very adversely affect educational quality, if underfinanced localities cannot afford to hire qualified teachers or maintain full curricula. It would certainly lead to emerging differentials in service provision unless the center requires standardization of teacher quality and curricula or other conditions, as appropriate.

_52-_ Any transfer of educational responsibilities to local government **s** hould be financed by transfers through the 'constituent" sections of local budgets (see Section VI below). Such transfers are strictly conditional grants. The Ministry of Education should require quality assurances as conditions for such grants-such as that only nationally credentialed teachers be hired or that a national curriculum be adhered to.

53. Elealth. Health spending authority has also been substantially deconcentrated in thr past sixtyone percent of the Ministry's budget for 1993 being under the authority of Ministry officials working at the District level. New national health strategies currently being presented and discussed would appear to call for even more emphasis on such deconcentrated management. The government's strategy paper of April 1993, "A New Policy for Health", calls for substantial rationalization of health care delivery,
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including substantial reductions in facilities, bringing the remainder up to a filly operational state, and appointment of District Health Directors who will be responsible for all public health activities in their respective districts.

_54._ The proposed transfer of capital responsibilities in health to local governments in the draft Law _on Asset Ownership of Local Government_ appears to conflict with the emphasis on deconcentration in the emerging national health strategies. For instance, as in the case of education, it is proposed in the _Law on Asset Ownership of Local Goerment_ that capital responsibilities in health will be transferred to local govrernments. If so, who will cover recurrent costs? Again, it would seem to be a mistake to separate operating and capital responsibilities.

_55._ As a final comment, developments in the field of health illustrate that uncerminty about the extent of deconcentration and decentralization poses problems for planning by local goverments. This uncertainty is best removed. Further, quality control and coordination issues remain.

# **VI. REVENUE** ASSIGNMENT AND **DESIGN-FINANCING**

## MODALITIES

56. The key challenge in financing local governments in transition economies is to determine the actual costs of providing the services they are expected to provide, and design a system for tax assignments, shared taxes, transfers and fees that provide sufficient revenues to meet the assigned expenditures. General principles of financing local govermments are set out in box 4. Box 5 considers other sources of local government revenues such as user charges. Table 5 suggests possible financing
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vehicles for the various functions to be assigned to local governments in Albania.

# Jox 4t Eaudag Local Commuat Taxes and Tflutem

Where it is impractical to impose fers or le user charges, services should be inRanced principally by tae kvied on bha residents. In many market economies, local governments rely principally on the property tax, but revenues can, in principle, come from many sources, and there are several modes for providing local governmt wih revenues. For example, taxes can be "assigned" to different levels of government or shared bdeween kvels of government. Some countries allow "joint" tax powers (sharig the tax base) by alowing loca surchares on federal taxes, such as the personal inome tax.

Redirecfion of a large share of revenues to local governments can restrict the center's macro-eckonic fexibility, hwever. and eare needs to be taken in decidig which txes to assign to bcal government. There are obviou advantages to assignments of particour taxe such as the propery ta to the excuive use of lcal govenmet and "piggybacking' or surcharge schemes which allow localties to set their own tax rates on tax bases shared with higher levels of government Such exclusive assignment of tax bases and piggybacking arrangements incrae the accountability of local governments and reader them less vulnerable to unilateral withdrawal of support from higher level of government.

In most countries, subnational revenues are supplemented by _asfr, smnce the ceal govement typicaly takes the highest yield taxes for itself, and subnationl governments are assigned more exnditure functions than can be finnced by their own revenue sources. In addition, servic provided by local governments acting s the agent of the central government should be rmanced by approprie transfer paymens from the national budget The firt step in desgning a ransfer system is to detrmine the aggregate volume of the transfer; the second is to determine its distribution across governments. Transfers can be negotiated on an ad hoc basis or, preferaly, set according t some dear and agreed criteria -often a formula is used to provide budgetary certainty. This trafer formula wll typically: _0)_ esfimate minimum or "normed" subnational expenditure "needsw (based o assigned expenditures and often related to population, per capita icome, social ndicatrs or the actual cst of delivering sercs); and (ii) assess the blal goveknment reveues ("own", assigned or shared) available to finance these needs. In designg the transfer, central governments are often concerned at local govenments "revenue effort wil decline if they become too dependent on transfers. Depeding on bow muc interegiona equalization of expendiures is desiked, transfers wil fill all or part of the expenditureirevenme "gap".

To encourage or require spending in speciic areas, *mah or conditional grants may be usedL Matcbing grants augment local spending for a spedcic purpose by prsbed amounts of support by higher levd governments (e.g., dollar for dolar). A problem with most (but not all) matching grants is that they may provie greater benefts to wealthier local governments that ca- afford greater discreinary expeditures. Conditional grant are the usual form of support where bigher levels of government are ddegat functions to lbwer levels. For istance, support for health servi may be cond;il on residents from other locafis having access to treatnent; support for education may be condhional upon adoption of a prescnrbed currkula A blak grant is a conditional grant resricted to a specific set or expenditures, or one that may be used for a broad category of expenditures and which has only gener conditions atached.
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57. The new local financing system under consideration in Albania envisages two sources of fiuding: the taxes and fees that the local governments can raise for themselves (described in the proposed changes to the law on _The Tax System in Albania),_ and ransfers from the central government (described in the _Law on Local Budgets)._

# Constituent and Independent Local Budgets

_58. TheLawonLocalBudgets_ envisages local budgetary discretion in funding and providing some local services. According to the Law, each local government will have two parallel budgets. First, the _consitent_ local budgets will be comprised of funds from the central government for "delegateid programs supervised by the central goverment ministries, but carried out at the local level. **These** are stridy conditional grant for performing specific functions and funds are not transferable between programs.

_59._ The second component of local government budgets is to be called the _independent local budget_ section and fimds here may be used for any purpose specified by local goverments. Revenues in the independent budgets are to be derived from local taxes, fees, income from revenues and asset sales of enterprises owned by local govenments, and funding from the budget of the cental government. Revemnes in this independent local budget can be transferred between uses. In effect, the central government contribution to this component of local government budgets amounts to a unconditional block grant.

60. The _Law on Local Budgets_ came into effect in December 1993. It represents an imaginative
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approach to fmancing local governments. It should increase accountability and transparency with respect to intergovernmental finmcial relations amd represents a marked contrast with the individually negotiated transfer that were characteristic of the previous regime.

Local **Own** Source Taxes 61. Most of te 22 revenue instruments now proposed for local governments in draft amendments to the Law on the _Tax System in the Republic of Albania_ are very minor "service fees". These are charges for services such as fees for registering mortgages and other legal documents. The objective of these service fees is simply to recover costs incurred in their provision; they are not true general revenueraising instruments. Albania has not yet decided how much additional revenue will be given to local govements over and above that arsing from taxes assigned to them in the draft law on taxes. Almost certainly the required revenues will be substantial because the assigned taxes will not likely yield very much -in many countries they would be considered "nuisance taxes" -complicated to administer and genaering very little revenue.

62. Ihe objective of local autonomy involves local governments having the power to raise their own revenues, being able to set their own tax rates and being answerable to their electors for these txing decisions and the level of services they finance. In this respect, there is a very positive feature of the draft amendments to the Law on the _Tax System in the Republic of Albania_ which are being proposed to accommodate local governmen **t** axes. In many instances, local governments are given a range of rates that can be applied for a particular tax. This element of discretion in local setting of tax rates is **to** be welcomed. Indeed, as we shall see it might be emiuated in other areas where price or rate fiing by the
- 31 -

central govenment considerably detracts from local government fiscal flexibility and discretion. As we saw in box 3, there is wide agrmet on te principles that should determine the selection of local taxes. Most notably, it is recommended that local govemment should levy taxes on inmnobile bases and preferably bases that reflect benefits received from local govenmment services. Other characteristics of a good local tax are that it be visible, have a stable and predictable yield, be relatively easy to administer and not be 'exportable" 63. Property Taxes. Most of these criteria of a good local tax support the use of a ax on immobile property and there is also considerable intuitive appeal to the use of property taxes. Local property values are closely linked to the extent of the infrastructure services that support them, such as street construction, maintenance and lighting. Property taxes are therefore attractive on "benefit"

**-S.**

64. The use of property taxes is widespread. Out of 24 OECD coutries for which data are available, for instance, 20 levy some form of property taxation. Property taxation has been a mainstay of local governments in English-speaking countries, but is not restricted to them. The property tax is the main source of local govenment taxation in Holand, and bas also been introduced in recent years in Mediterranean countries such as Portugal, Spain and Italy. The case of Italy is perhaps most interesting, because it is Albania's neighbor and the principal national donor of aid to Albania. It has long been recognized in Italy that the country's local governments have been overly dependent on transfers and need to acquire their own sources of revenues to increase their autonomy. A national property tax has been introduced in taly and is to become a local property tax with locally established rates in 1994.
-32 -

65. In dhes. circumstances, it is natural that the govenment of Albania has been interested in introdudng a property tax , primarily to support local government. The government has sought advice from the U.S. Treasury and tho Harvard Instituto for International Development onto formation of such a ta7 Some preliminaw steps would be necessary to implement a conventional property tax, including the introduction of a cadastre, or land ownership register. The government has not, however, been able to auract the interonal assistance necessary to introduce such a full-blown property tax and has decided to introduce a more limited version. The _Property Tax Law_ passed in mid-March 1994 requires the central government to undertake property valuation, to set the rates and to administer **the** tax, but for **60%** of the revenues to be distributed to local governments according to the source of the revenues. In rural areas, the tax would be assessed on the ferdlity of land, like toe presumptive taxes assessed on agriculture in many developing countries. In urban areas, the tax would be restricted initially to the value of buildings.

66. Some comments on the proposed Albanian property tax are called for. First, there is little sense in which toe tax is now a _local_ property tax, since neither the assessments of property values, nor the tax rates nor the adminitration of toe tax are to be performed by local government. The assessment of property tax values and perhaps even administration of the tax are not essential to its character as a local tax. Higher levels of govermment commonly intervene in or even determine assessments of property values in many counties for various reasons. One reason that might alone justify central government detmination of assessments in Albania would be to have comparable property values for calculation of equalization of local government fiscal capacities.

67. The freedom of local governments to set local tax rates is, however, essential to the property tax
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being a true local tax. If local governments do not determine the tax rates, the proper"t tax is merely another source of revenue to local governments and does not contribute to their accountability to local taxpayers nor to their autonomy.

# Equafzatlon

68. Property taxes will obviously yield greater revenues to some municipalities and communes than others. Not all municipalities wilL have as valuable a property tax base as Tirana, where rents of $1,000 a month were paid for prime retail locations in early 1993 at a time when anmual GDP per capita was much less than $300. Equally, communes with prime agricultura **l** and will obtain greater revenues than others from the property tax. "Equalization" grants from the central to local governments may be desirable to assist local governments with such lower yielding tax bases.

69. Many industrial states such as Canada and Germany and some developing countries such as Morocco have the goal of equalizing revenues of subnational governents. The objective of these revenue equalizaion programs is not to provide some form of guaranteed income for local governments but to attain goals which directly benefit _indiviual citizens-goals_ such as treating citizens equitably no mar where they live in the country and increasing efficiency in the allocation of resources and hence the standard of living. The equity goal is an adaptation of the rule that likes should be treated alike by government In a regional context, this means that individuals who are equally well-off should be treated the same no matter where they reside in Albania.

70. Equalization is necessary to attain these equity and efficiency goals because the 'fiscal capacities"
-34-

of local goverments differ. Thus, the fact that rental values are higher in Tirana than in less well-off localities would be reflected in higher per capita realizations of a property tax levied at the same rates throughout Albania. The result would be the residents of Tirana would benefit from greater "net fiscal benefits" because the city would be able to finance its municipal services with less fiscal effort than ocher cities.

71. Equalization compensates for such difference in fiscal capacities between local governments by redistruting income to the less well-off local govermments. Not only will this increase equity but it will also efficiency in the allocation of resources. Without equalization, people will eventually migrate to capre such net fiscal benefits and such migration is inefficient. To attain efficiency in the allocation of resources, the productivity of workers (and for that matter, capital), has to be the same in all areas of the country. Otherwise, national output could be increased by moving labor and capital around until producdviy is equalized. Ths is exactly what normal migration to get better jobs achieves, but productivity is not increased if migration occurs to capture the fiscal benefits descnbed above. Equalization payments to local governments with below-average fiscal capacities will allow them tD increase their services or lower their tax rates. This will, in turn, reduce fiscally-induced migration.

# Other _Possible_ Local Taxes

72. Local income taxes are the principal source of tax revemne in about half of the OECD countries. They are particularly important in the Scandinavian countries (Sweden, Denmark and Norway), where local govemments have been assigned significant roles in the delivery of the 'people" services of health, education and social welfare services and are, as a result, relatively large in relation to central
_-35_ governments. The local governments in these Scandinavian countries determine their own tax rates as a share of the national government's income tax base. 'The larger subnational governments in some odter countries, such as the provinces in Canada, also apply surcharges on income tax bases determined by central governments. In the opinion of many experts, such surcharges or piggy-backing arragements should be used more widely, since they preserve a common tax base, maintain the autonomy of local governments and make them accountable to local taxpayers.

73. It is generally agreed, however, that piggy-backing by subnational governments on a multilvel consumption tax such as the VAT would be very difficult if not impossible. Albania's proposed reliance on a value-added tax as the principal national source of tax revenue, as well as the prospective unimportance of income taxes for the immediate future, suggest that local governmet surcharges on a central governmen **t** ax base are therefore not a practical possibility in Albania

# Business Taxes

74. There is also general agreement that local governments should be restricted from tapping some forms of revenue in order to perform their important role in efficient allocation of resources. The principles that should be observed are that local government taxes should not distort the location of factors and that local governments should not have a claim on taxes generated in their localities that arm borne by _nonresidents._ Natural resource revenues are a case in point that are of some significance, given that Albania is one of the largest producers of chromium in the world and is an exporter of other minerls as well. Higher property tax rates for businesses than housing which are not justified by differences in service levels are another example,' as are sales taxes applied at other than. the retail level such as the
-36 -

present turnover tax in Albania.

_75._ While it may be attractive for local politicians to try to shift the burden of taxes to nonresidents, such tax exporting artificially cheapens and inflates local provision of services and thereby erodes dte efficiency benefits contributed by local governments. To prevent the "exporting" of such taxes to nonresidents, the central government should restrict their use by local goverment.

76. Business taxes used to raise revenues (and not charge for services rendered) are considered undesirable for the above reasons. Business taxes in France and Canada are cases in point. The tar.e professionelle raises 40% of local taxes in France and it is estimated that from _42%_ to 739% of this tax is exported beyond the taxing locality.9 Business taxes account for about one- tenth of local taxes in Canada and it is estimated that from 16% to 100% of such nonresidential local taxes are exported from the locality levying the tax.

# Revenue Sufffriency

77. What other revenue options are there? The center could simply share some of the revenues it collects with local goverments. Simple revenue-sharing according to the area of origin of central - - goverment taes the "derivation" prnciple could be problematical, however, since it could be severely "counter- equalizing". As shown in Table 6, most revenues are collected in only a few districts -Tirana and Durres collect almost 50% of all revenues, but have less thm 20% of Albania's populaon. Thus, the simplest scheme of sharing revenues according to the district of their origin (or collection) would not be adequate to support main e of national standards in services such as health, education
- 37 -

and social assistance. Put another way, the poorer districts would not be able to provide adequate levds of services, including those that are commonly thought to have large spill-overs, if central revenues were shared by district of origin. Revenue-sharing also suffers from other problems, in that it decreases the acoountability of local governments. As U.S. experience under the Reagan administration also indicates, revenue-sharing can be altered unilaterally by higher level govemments and consequently decreases the autonomy of local governments. Some othrr sharing basis than this derivation principle, probably a formula based on expenditure needs andlor other indicators, would be appropriate (see Section VI).

78. Lecal vehicle taxes could also be used with profit in Albania. Private ownership of automobiles was banned in Albania until early 1991, but there is evidence of impressive growth in their ownership since then - and in the private and social costs of such growth. For instne, in 1993 Albania had the highest road accident rate in Europe, leading to a death rate per vehicle-kilometer about 20 times that in Italy. A _local_ tax on moveable property - automobiles and other vehicles - would be a useful proxy for a tax on local road use. Those fortunate enough to own cars in Albania are much beter off than the rest of the population and can well afford to pay this and other taxes on road use (such as import duties for automobiles, licensing fees and excise taxes on automotive fuels imposed by the central govemment.)

# User Charges, Local Pricing Discretion and Central **Prieing** Mandates

79. In additionto revenues from taxes (for the independent budgets), and block grants (for consotent budgets), local governments in Albania also derive income from enterprises _dat_ now fall or wil fall under their responsibility, including _local uiities._ At present, the central goverment maintain
-38 -

jurisdiction over all 75 of the water borne sewerage works and for 6 of the nation's 250 water systems. Sewerage service, where provided, is at no charge to the consumer with costs of provision being assumed in the national budget. In the case of the water works, invesunent priorities, funding for investment and prices or tariffs to consumers for all 250 systems have been set by the central government. The local governnents which have responsibility for operation and maintenance of 244 of the water systems are expected to finance the service with revenues from tariffs. However, the tariff has been set by the central government at a uniform nation-wide level that ignores local cost differences in supply of these serices and has not covered operating and maintenance costs except for a few works. Not **unnaturally,** the result has been a lack of comnitnent to the service by the local authorities and deferred maintenance. Further, customers are billed at a flat rate that gives them no incentive to conserve. Local authority to set tariffs and an appropriate pricing policy is essential to improve service and promote fiul cost recovery for these utilities.

s0. Conceming irrigation pricing in agriculture, Albania is credited by intemational specialists with having established a simple and effective user-pay system which could provide efficient water pricing on a per-unit basis. Current pricing levels, however, are insufficien **t** o oDver overall costs of system operation and maintenance and to pay for investments required for system rehabilitation. In addition, and as for other utilities, fees are centrally fixed and do not make allowance for different levels of costs for providing water or artificial drainage in different areas. It will therefore be necessary to revise the curent level of water charges to attain full cost recovery and reflect actual district-based expenditures incurred by the respective Water Enterprises and allow greater local pricing discretion and cost recovery. In these and other examples of utility pricing, an appropriate role for the central govemment would be to set framework policies to guide local tariff determination and to abstain from micromana6cment of
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local utility pricing.

# Box 5: User Charges and Fees as "Own Source" Reveaue for Local Govemments

The principal "own source"revenues of local governments, or revenues dtat they themselves levy, are fees or charges and taxes. The distinction between the two revenue categories is that taxes are compulsory paymens for public services which do not vary with the level of consumption of specific goods and services, whereas charges and fees are collected from the recipients of specific services and often vary with the extent of consumption of the service. Charges and fees dierefore represent a specific attemp **t** o link the benefits and costs of local government servics and are often referred to as user fees.

Three ypes of fees or charges have been distinguished: public prices, specific benefit charges and service fees.3 Public prices consist of direct charges for services consumed, suc.l as bus fares or public utility rates for water reticulation or entrance fees for public recreational facilities such as swinuning pools. Specific benefit charges charges are more indirect in nature, such as "development charges" or 'local improvement charges" levied to cover the costs of local improvement **s** uch as sewer extension, streeghdighting or other infrasmuctre costs associated with the development of new housing subdivisions or estates. Finally, service fees are chages for bureaucratic services such as provision of marriage licences or other mnandatory legal documents.

ft is not often appreciated how important user fees and charges are as a source of lcal government revenue in developed countries. For instance, they account for as much of 40% of revenues raised by local taxes in OECD counties. The feeling thatbeneficiaries of many local government services should pay their own way is also strong in some countries. Thus, the U.S. Advisory Committee on Intergovernmenta Relations has found that Ameria express a strong preference for user charges as opposed to odier means of raising government revenues.<sup>5</sup> Many experts think dat even more use might be made of user fees than at present by local governments; their motto is 'wherever possible, charge'.' The case for using user charges to pay for services is in fact an impornt corolary of the principal rationale for local government, which is its efficiency role. As in private muakets, users of local govennment services have the choice of buying or not buying services and their actions indicate whether provision of services is efficient _fees cover costs of provision._ It is also relevant to consider the conditions under which the use of fees and charges are inappropriae. First, distributional effects should not be important considerations where user fees are contemplated; here there is a feeling that beneficiaries should not be required to pay their own way. In addition, it must be possible to identify beneficiarie **s** o that those who are not willing to pay for the service can be excluded. Nor should externlities be significant Thus, local government health clinics in OECD countries often choose not to impose user fees for immunizaton against contagious diseases, for example.

We conclude that there is a strong case for user fees as a principal source of local government revenue and we suggest hat more use might be made in Albania of such fees.
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A Smaller Role for Social Pricing?

81. As is well-known, the former command economies used pricing policies as a tool for redistnrbuting income. Albania provides a number of examples of pricing policies, often involving local utilities or affecting local goverments, that have been apparently undertaken either for distributional reasons or in the belief that price ceilings imposed would contribute to macroeconomic stability. What is interesting is that such policies often have perverse or questionable distributional effects. The crosssubsidies involved in the present uniform national pricing policy for water services to households are a case in point, since costs of supply vary by locality in a way that is not obviously correlated with the need for income support. Nor is it obvious why the 30% of the population which receives sewerage services at no cost are more deserving than those who receive no government-provided sanitation service at all.

82. There are, in fact, more obvious examples of mischievous effects of misguided pricing policies for i ructure and other utilities than those mentioned. For instance, automobile owners are among the better off in Albania, and until recently tbey have also benefited from subsidized fuel prices. These subsidies, indeed, were large enough so that foreiga vehicles entered Albania to buy fael. In addition, large numbers of electric appliances have been imported into Albania in 1992-1994 by its more fortunate cifizens, who have also benefited by the fact that electricity has also been supplied to households at one-tenth of its cost of production.

83. Indeed, underpricing (or cross-subsidizing) local services rarely leads to the desired resut of helping the poor more than those with higher incomes. Consumption of most goods normaly rises with income, and subsidies for these "normal" goods therefore give the least help to the poorest In fact,
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it is now a common finding that subsidies for infrastructure benefit the better off much more than those with lower incomes. This finding is frequently trumpeted with respect to subsidies for electricity, but appears also to apply even to household water supply and sewerage systems." The point is simply that the poorest often do not have access to these services. Such subsidies and cross-subsidies also violate principles of good governance in that they are not transparent and their effects, as we have seen, may not be self-evident. In Albania, it is almost certainly the case with respect to cross-subsidies that as "in most countries, more efficient and effective instruments should be used **to** help the poor. 'I 84. These policies with respect to subsidies and cross-subsidies are now changing. For some of the fuels mentioned above, the government has moved to adopt market prices and for others prices close to cost recovery levels have been imposed. Thus, automotive fuel prices were raised to European levels in 1993. Most recently, in a decision of 31 March, 1994, the government raised tariffs for household electricity usage sixfold, raised kerosene prices fourfold and raised tariffs for gas and steam heating four- to sixfold. Prices for wood and coal for heating were freed to find their market levels.

85. The government has followed an interesting strategy in raising some of these prices, by adjusting public sector wages and transfers to households to compensate for overall loss of purchasing power. While this strategy does leave the newly emerging private sector to fend for itself (as perhaps it should), it affects just over half of total budget expenditures.? This strategy was first adopted in raising the price of bread, and its success appears **to** have convinced the government to move towards market prices for many other goods that have a less dramatic impact on consumer budgets. Another apparent motive in raising these prices is to get them to cost recovery levels so that the services concerned can then be successfully privatized. In this connection, it is of interest that the government
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has expressed an interest in privatizing services such as solid waste collection and streetcleaning which are presently provided by state enterprises reporting to the Ministry of Construction.

# VII. TRANSFERS, INTERGOVERNMENTAL GRANTS **AND OTHER** SOURCES OF LOCAL GOVERNMENT FINANCE

## **Transfers**

86. Finally, the precise nature of central govermment transfers to the constituent and independent local budgets are not fully spelled out in the _Law on Local Budgets._ Ideally, these should be determined in a transparent fashion and be stable and predictable over time. The 'negotiated or 'bargained transfers between levels of govermnent typical of the old command econmy are not compatible with local autonomy and accountability. In addition, the transfer system should provide for some equalization. It is likely that local govemnments **in** Albania will be highly "transfer dependent for a long time. The design of these transfers is thus an important consideration.

87. The government of Albania could perform an equalization function when it provides, as is planned, some unconditional tansfers to local govemmes. Equalizaon of per capita revemne capacities of local governments might be adopted as an explicit objective of central govermnent contributions to the "independent" sections of these local budgets. The extent to which the transfers to 'constituent budgets" are equalizing will depend on how the underlying central services (education, health, etc.) are themselves distributed.
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Ptlvatization Revenues 88. Local governments in Albania have recendy been given control of some small and medium enterprises. Given the inadequacy of other revenue sources to local governments in many countries in transition, local governments may be temptez to augmen **t** heir small revenues by extracting monopoly rents from enterprises under their direct control and by becoming entrepreneurial" with their newly acquired assets.

89. Albania appears to have found the means to avoid this problem in Decree No. 248 of 1993 onMeasuresjbr _theAcceleration of Pnvatization of Small andMedium Enterprises._ All of the properties concerned are to be sold by public auction within a relatively short time period, and there is some evidence that the small and medium private enterprises that are the subject of Decree No. 248 appear to be moving expeditiously into private hands. The decree also specifies that local governments are to receive 28 percent of the net proceeds of privatization of small and medium enterprises.

90. More generaRy, it is importan **t** o ensure that local governments have adequate revenues to fiance their finctions, so that they do not see enterprise ownership as a necessary source of finance, as has happened in many other transition economies. 'Enterpreneurialism" in local government and ownership of enterprises by local government is not to be encouraged.

# Local Government Borrowin?

91. The _Lawfor Local Budgets_ (Article 6c) indicates that local governments can only borrow
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for investment. This is fully appropriate. Investment in infrastructure such as local road construction or sewer extensions leads to future benefits and is most appropriately financed by long-term borrowing. It would obviously not be desirable to require that these investnents be financed out of current local government revenues.

92. Albania has greater needs for rehabilitation and replacement of public sector capital than most of the economies in transition. Recall that in the breakdown of public order accompanying the _fall_ of the old regime in 1991-92, more than a third of the schools and roughly a quarter of all local health centers were either badly damaged or destroyed. If responsibility for many of these public facilities is **to** be devolved to local goverunents, as is proposed, some method of long-tem financing for construcdon and repair of these structures will have to be devised.

93. The development of capital markets in Albania will satisfy these local government borrowing needs only in the long run. In the short run, much capital expenditure on local infastructure is being finaced by foreig grants or loans at concessional terms.<sup>1</sup> ' In the transition period, however, alteative arrangements need to be developed to permit capital expenditures to be financed-by central or local g,overnments or their utilities. Other countries that have faced thin or nonexistent capital markt for local infrastructure have dealt with this problem (or are proposing to deal with it) by creating municipal credit agencies for local governments. In these arrangements, loans are supposed to be made only to creditworthy local governments: creditworthiness being assessed on the basis of plans for cost-recovery or on the promise of future streams of transfer payments from central governments. Loans are usually for capital spending on health, education, utilities and transport and are not extended for capital formation in other commercial enterprises that may be owned by municipalities.
_-45_ 94. Experience in the establishment of such municipal credit agencies has frequently been disappointing.U Accordingly, direct involvement by the Ministry of Finance and Economy may be necessary both in approving and supplying funds for local govemment capital projects in the near fiuture in Albania, in the context of a formal public investment program that includes local investmens.

# **VIII. THE** CONTINUING PROCESS OF **INTERGOVERNMENTAL**

## RELATIONS

95. The process of managing intergovemrmental relations will not cease after the present legislation has been adopted and implemented. There will be a continuing need to perfrm technical and nonlpolitical functions concerming intergovernmental relations in the Government of Albania. Because of the role currently being played by the Council of Ministers coupled with the short term desire to limit bureaucracy, this is likely to be an effective location for an _intergovernmentaO coordinationfnction._ 96. An important role for such a coordinatdng body arses from the fact that ceral government contributions to each local government budget are to be presented for approval to Parliament each year under the _Lawfor Local Budgets._ The intergovernmental coordinating body might be given the task **of** analyzing local goverment submissions and preparing recommendations on these budgets. Parliamentary deliberations might also benefit from preparation of an annual report to Parliament by the Mbinier for Local Governments, which would be prepared by the coordinating body. Such a report would present social, economic and financial data relating to the revenues and responsibilities of local governments.
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97. Finally, the body might provide technical assistance for local govenment to build up financial and other management skills. The body might also assist local governments in making formal cooperative arrangements where they have common interests, such as to provide services where cost savings are possible or, to give an actual example, 6 local govermments obtain their water supplies from a common source. On the other hand, the suggested body could also play the role of an arbiter where the interests of local governments conflict.

# **IX.** SUMMARY AND CONCLUSIONS

_98._ Several conclusions emerge from this examination of decentralation initiatives in Albania. Albania's small size is obviously one of the factors that must be taken into account in assessing present proposals for and progress in decentralization. Functions that might be undertaken by local governments in other countries may well be appropriate for the central government in Albania. But while Albania may be small, this does not detract from the traditional economic argument for local government where public services are of purely local interest and their benefits are confined to restricted geographic areas. The central government of Albania should not be responsible for activities such as local rat catching or filling in potholes in village streets. These tasks can be left to local government **s** o that the government of Albania can devote itself to appropriate national concerns such as defence.

99. The wisdom of decentralizing non-infrastructure "social" services such as education or health is another mattr. What may distinguish Albania from other former command economies, however, is the ferocity with which the population detested the former highly centralized communist regime, and this may account for some of the fervor with which the prospect of decentralized govaernment isviewed. This
-47 -

baclkground needs to be taken into account when one wonders whether Albania can "afford' some decentadiation in provision, for instance, of services such as education. The severe damage or outright destruction of a third of the schools and a quarter of all local health centers which accompanied the demise of the old regime is a very good argument for attempting to get local communities more Involved in the operation of these facilities and in giving the communities somei sense of ownership of those facilities. As is well-known in OECD states, local governments are usually willing to contribute to the financing of facilities such as local schools, even if provision of this and similar 'people" services is the primary responsibility of higher levels of government. Of course, central quality control fthough conditionality of transfers remains appropriate to ensure service provision levels do not diverge across localities in these key sectors.

100. Indeed, Albania's experiences under the Hoxha regime provide many good illustrations of the validity of arguments for decentralized management of the economic system. Ihey also serve as a potent reminder that externality arguments for involving higher levels of government do not mean that functions can be safely left to the latter and are not a magic wand that will make problems go away. lTus, the citizens of Albania's second largest city, Dunres, who have had to suffer through four typhoid epidemics in the last ten years because of contamination of the water supply fuimished by the central government, can attest to the fact that central provision of services does not necessarily take care of eternalities. Of course, for efficient local provision, adequate revenue efforts, appropriate pricing, and - a well-designed transfer system will be needed each of which will take major efforts.

101. _Lack of clarity_ in draft legislation with respect to responsibility of the two levels of government for major functions -particularly for health and education -remains a concern.
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Accountability requires clear lines of responsibility. The draft _Law on Asset Ownership of Local Gowrnament_ does not indicate which level of government would be responsible for incremental capital costs and recurrent costs in education and health. There is already an example of the consequences of such muddied lines oZ responsibility in the provision of city water supplies where the local authorities are responsible for operations and maintenance and the central authorities are responsible for investment and set water rates or tariffs for users. The latter have frequently not been sufficien **t** o cover operating and maintenance costs. The result has been a lack of commitnent by the local authorities to provision of water service, deferred maintenance and underinvestment. One should likewise be concerned what continued uncertainty about the possible extent of fiscal and administrative decentralization in Albania poses problems for forward planning in many fields such as health. This uncertainty is best removed as expeditiously as possible.

102. As regards _the organization of governmental serrices,_ the appropriate spatial units for decentralization and deconcentratio **n** eed not be regarded as fixed in stone and need not coincide with the present structure of local government. The creation of 11 new disticts since 1991 appears to have been a resonse to political pressures from local interests who thought their constituencies were being ignored. It would be.somewhat surprising if the results of such redistricting coincided with the optima size of units for many administrative purposes and, in any event, the size of the latter may wetl fluctuate over time. For many functions, what may be needed is the equivalent of the "special purpose" districts that have been created in many OECD- states. For instance, appropriate "hydraulic" units for the irrigation network in agriculture would be more logically based on the main river basins in Albania than on the existing 37 districts. Such a reorganization of areas for irrigation provision would be quite compatible with decentralized responsibility for demand management among users' associations of
_.49_ farum . Similarly, the Ministry of Halth is presendy considering the creation of what are in effect 'fil-service' hospitals for catchment - that exceed the size of present disricts and limiting the services prvided in existing district hospitals.

103. Tuming to the _inancing of local gowvem senrice,_ the traditional sources of "own" revenues of local goverments in many OECD counties are user fees and property taxes and both can be applied in Albania. AlbaniaWs determination to install a propety tax with most revenues from the tax being assigned to nUmicipalitiei **s** noteworthy in this regard. Whie central govenment administation of assessment is acceptable and even recommended for pupose of establishing qalizaion paymens, local freedom to set property tax rates is an essential ftre of eventual local goverment autonomy.

104. Winh respec **t** oforfr _dth servies of locuSalldes,_ it would be best **tD** avoid using pricing or tariff-sting as a means of income r ition as appear to have been the objective in the past Holdinlgto the exitig patter of utiity prices with the go- of restaining inlation is also a quesdonable use of public policy. There is little doub **t** hat the beter off have benefed di rI ly from some of these policies in Albania, whether they have involved subsidies for automtve fuel or household electricity, the prwvision withwut chrge of sewerage services to the 30% of Albanan who can benefit from this service, or to the 80% of tbe popuation who are provided with household water supplies. The goverment has already increased _automotive_ fuel prices to European levels and on March 31 1994 insed household elericity prices roughly sixfold. Sewer and water chages should similarly be moved to levels which permit fll cost recovery as soon as possible.

1OS. The past and present practice of imposing unforn natonwideprices for local utilities also
_-50_ Involves cross-subsidies of dubious distributional merit. More particularly, however, in fields such as household water reticulation and irrigation in agriculture it ignores underlying cost differences between locations which are appropriately reflected in prices. The practice of pricing below cost :rcovery levels is a hangover from central planning and the antithesis of the decentralized management that many of these services need. There are many instances in both infrastructure and 'people" services where efficiency and responsiveness to demand could be inproved through decentralized or deconcentrated but in any event more autonomous management. Much effort is now being devoted to building up such decentralized and deconcentrated management capacity in particular areas so that it can better respond to the need of local populations. Ihis, for instance, is a principal thrust of the National Primary Health Care Plan that the Ministry of Health has drafted.

106. The practice of imposing unifb %n national prices for local public utilities, even where local costs of supply differ, may be a throwback to old habits of highly centralized government. Similirly, we noted that the property tax, which is to be the principal revenue source for local govermnent, will have rates specified by the central government. We recognized, however, that although local governments have been given some flexibility in choosing rates for other local taxes. A desire for local government may be meaningless if _ftis_ level of government is not given sufficient power to raise its own revenues, set its own tax and user fee levels and be responsible to its own electors for these taxing decisions and the level of services it provides. At some point, local government in Albania means cutting the apron strings to Tirna.

107. Finally, whether government is moving towards greater decentralization or deconcentration of programs, it is dear that oentral budget _tranfers_ will remain the dominant source of financing for
- 51 -

many of these functions for the foreseeable future. It is quite feasible for some of these services to be delivered by local governments but for central government interests in having national stadards in provision of these services to be attained by appropriate design of conditional grants or transfer payments. The accountability of both local and central governments will be enhanced by such transparen **t** ransfers, as opposed to the individually negotiated transfers that have been common in the past. In the "constituent" and "local" budgets adopted under the _Law on Local Budgets,_ Albania hds developed a novel intergovemnmental financing vehicle which increases transparency of and accountability for intergovernmental fiscal flows and which should be of some interest in the rest of the world. Finaly, if more reliance is to be placed on local **"own"** revenue sources for local governments, we noted the need for consideration of "equaization" payments to those local governments ta will inevitably have lesser fiscal capacity per capita.

108. Albania took a radical step away from the past and towards joining the family of democraic nations when it introduced elected local governments in July of 1992. The promise of better governance associated with autonomous la governments which are responsive and responsible to local electorates for the pricing and provision of local services still lies largely ahead. Despite the difficult conditions associated wii the birth of one of the world's newest democracies, however, there is little doubt that Albania is on the pat to this goal.
**-** " *1 -

|__._._._:_.._._._:_._Xter|;<br>..||.<br>;<br>.<br>i<br>Tah<br>*<br>**Eu**<br>**ron**<br>EarapeanCo|le 3:.r.<br>*<br>*<br>-b-<br>untriesand Albaiza|.|||
|---|---|---|---|---|---|---|---|
|||S|ize<br>of Local**Go**|**vernment**|||**Urbanii**|
|Country|Typo of Loc¢al<br>Government|<br>Name|Number|Average<br>Pbpulation|Ra<br>minumum|nge<br>maximum|Percent of<br>Population Living<br>in Urban Areas<br>(Towns ><br>10,000) 21|
|Albania|Districts<br>Municipalitia/<br>Communes|_rethe_<br>_baXshki/comuna_|37<br>352|96,118<br>6,936|23,800<br>1,300|414,350<br>270,000|35|
|Bulgaria|Countica<br>Municipalities|_oblast_<br>_obshitna_|_9_<br>_255_|941,413<br>33,226|630,500<br>1,650|1,218,600<br>340,800|68|
|Czech Republio<br>1/|Districts<br>Municipalities|_okres_<br>_mesadkyurat_|75<br>5,768|133,300<br>1,735|50,000<br>S0|230,000<br>1,200,000|78|
|Hungary<br>.___<br>_|Counties<br>_<br>Municipalities|_megye_<br>_onko,rmanyzas_|19<br>3,070|SS7,447<br>3,450|212,000<br>200<|1,956,800<br>243,000|61|
|Poland|Municipalities|_gmynza_|2,383|_16,050_|_858_|848,514|62|
|Romania|Counties<br>Municipalities|_judea_<br>_munfc(pl/orasl_<br>_commune_|41<br>2,948|564,672<br>7,853|237,900<br>500 <|2,318,900<br>2,036,9W|53|
|The Slovak<br>Republic|Distriis<br>Municilities|_okres_<br>_okresni urat_|37<br>2,834|140,540<br>1,834|44,000<br>50<|441,000|78|

Excluding guope which is di utncth and municipality. 2a Data are for Czechoslovakia before it scparation into tho Czech and Slovak Republics Source: Depa_ment of Statists, Government of Albania: data for other countries supplied by Felix Jakob; data on population in urba amas from _World Dcvelopment Report,_ 1992 (Washington, D. C.: World DLnk, IM), Tablo 31, p. 278.

**lmm15-kaSw4**
53

|S~~~~<br>**.g .......**<br>_;:::A_<br>_X_<br>1<br>ESA<br>.1<br>MINISTRIES WHICH SPEND<br>|_V4.:.S_<br>|gnr<br>|::<br>. <br>7<br>9o<br>W<br>Lek<br>|<br> able_:.4_,-Z<br>pRnti<br>of 7Albai<br>si<br>A<br> <br>|. ....<br>'V--,<br>.>. '<br>.<br>.<br>a<br>at<br>|vX<br>X'<br>n-,,<br>i-a<br>|.....<br>|<br>Perc<br>|**_-n;_**<br>ent<br>||
|---|---|---|---|---|---|---|---|---|---|---|
|ATSUBNATIONAL LEVEL|Distdcts|Municipalities|Communes|National|TOTAL|Districts|Municipalities|Communes|National|TOTAL|
|Ministry of Agriculture &Food|133,700|-976,3|00||1,110,00a|12|-||8|100|
|Ministry of Construction|112,232|2,925,620||216,470|3,254,322|3|_90_||7|100|
|Ministry of Transport|677,445|188,300||1,525,255|2,391,000|28|8|-|64|100|
|Ministxy of Education|169,132|<br>882,541|1,444,552|1,259,645|<br>3,755,870|_5_|23|38|34|100|
|Ministry of Health|2,058,000||-|1,338,000|3,396,000|61|-|-|39|100|
|OthersnI/|118,101|383,004|13,398|233,621|748,124|1C|_51_|2|31||
|TOTAL|_3,26,610_|I<br>_4,379,46j_|1,457,950|_5,549,291_|14,655,31|61I_<br>22|30|10|3|1o|

# SBrne: Minity of Finance and Economy, Government of Albania

1/ Ministry of Culture, Youth mad Sport; Ministry of Trade and Foreign Economic Relations.
- 54 -

# Table S

# Functions Preseotly under Conideration for Trafer to Local Governments in Albania and Eflient Fhaandng of these Function 1t

|; m<br>-<br>.SERV'.CES.|.<br>Lol<br>Tax.|.~~~~LtS<br>Usr<br>lUwr-<br>Charges|C,nt,a-:<br>Centiv.<br>Transfiers|Loans =|
|---|---|---|---|---|
|Public Utilities (a)|||||
|Water supply|S|P||A|
|Seweage|S|P||A|
|<br>Drainagp<br>Marketsand abottoirs|P<br>S|P(b)<br>P||A<br>(A)|
|Transporttion|||||
|Highways and atrcs<br>Public<br>s|P<br>S|P(b)<br>P||A<br>(A)|
|Genncrl Urban Services (c)|||||
|Rfue colection|P|||(A)|
|Pub and ecratimon|P|||(A)|
|Fir proltction|P|||(A)|
|Generaladministration|P||||
|Socia_Sevces_(d)|||||
|Educaton (other tn<br>univesities)|||P|(A)|
|Hea(other_hn_natonal filitie)|||p|(A)|
||SociaAssistane|||P||

- ^mou: P = Primary source of fuiance

- S = Secondary source of finae

A = Borrowing is appropiat for major capital expenditures

- (A) = Bozrowing is approprate, but likly to account for a sall share of total cos.

Source: Adapted firn Roy W. Bahl and Johanncs F. Linn, ?The Assigment of Local Govcmrment Reveu in Developing Counities in _Tar Assignment it Federal CDwabls,_ ed. Charles E. McLure, Jr. (Canberra: Austrlian National Universty Pess, 1983), p. 179.

it Under the previous socialist system only a fcw of the functions in the tabl (such as utes for water supply, electricity, pubLic transit) were supported by user fees and the latecr fcll far short of cost recvery. (a) Utilitics not being considcred fur tRnMsfr to local govcrnments include eleticity and teleommnicatios. (b) Development chage (i.e., special aesamencs, vloditon charges, etc.) are appropriate for drinage, higwys and strects cspecially where their benefits are spatially well defined wihn a juridito (e) Local law enforcement is the princia general urban service not being conidered for tranfr to local governments. (d) k is assumed that user charges and l t will play a leser role in financing social servics for the foreseeable fiture.
_-_ - 55 Table 6 Government Revenue and Population by Major Districts, Albania

|Pr,ipor:on<br>orRevenuem<br>U<br>Pzo<br>1<sup>'ugiiulIP'jiollo</sup><br>,DiL,iicL :<br>*Janumry-NvcmL-er<br>192<br>1990|
|---|
|Tiau<br>24.2<br>11.5|
|Durrea<br>22.7<br>7.7|
|FMc<br>10.9<br>7.7|
|EPun<br>_5.9_<br>7.6|
|Koran<br>5.7<br>6.7|
|Othem<br>30.6<br>58.8|
|TOTAL<br>100.0<br>100.0|

aurce: Ministry of Finance, Goverrment of Albania.
- 56 -

# BBLIOGRAPHY

- Bird, Richard M. _Chargingfor Public Services._ Toronto, Ont.,Canadian Tax Foundation, 1986.

- and Enid Slack. _Urban Public Finance in Canada._ Toronto, Ont., John Wiley

- and Sons, 1993.

- Dihlinger, William. _Decemralizadon and its Implicaions for Urban Service Deivery._ Washington, D.C., The World Bank. Urban Management Programme Discussion Paper No.16, 1993.

- Fitzgerald, Bruce. _Cross-Subsidies: There Should be Better Ways to Help the Poor._ HRO Dissemination Notes, No. 26. Washington, D.C.: The World Bank, April 11, 1994.

- Kelly, Roy. "Implementing Property Tax Reform in Transitional Countries: the Experience of Albania and Poland.<sup>t</sup> _Joumal of Environment and Planning,_ (forthcoming 1994).

- Kincaid, John. 'Financing Local Govemment in the United States," in _Local Government: An Interationa Perspective,_ eds., J. Owens and G. Panella (Amsterdam: North-Holland, 1991), p. 142.

- McMflIan, Melvflle L. "A Local Perspective on Fiscal Federalism: Practices, Experiences and Lessons from Developed Countries". Washington, D.C.: The World Bank, Public Economics Division, processed, 1994.

- Ovalioglu, Gulhan. 'Fiscal Decentraization and Local Government Finance in Trnsitional Economies: Ihe Case of Albania." Unpublished MA paper, June 1994.

- Prud'homme, Remy. "Decenrization of Expenditures or Taxes: The Case of France." ID R.J. Bennett (ed.), _Decentralization, Local Governments and Markets._ Oxford: Clarndon Press, 1990.

- _Sewel, David. Fiscal Issues in Decentralzaion in Albania_ Discussion Paper prepared for the Council of Miisters, Republic of Albania. World Bank, Europe and Central Asia, Middle East and North Africa Regions Technical Department, Feb. 19 1993.

- Shah, Anwah. _The Reform of Intergovenental Fiscal Relations in Developing and Emerging Mar*et Economies._ Policy and Research Series No. 23. Washington, D.C.: The World Bank, June 1994.

- Thirsk, Wayne Ri "Political Sensitivity versus Economic Sensibility: A Tale of Two Property Taxes.? In Wayne R. Thirsk and John Whalley ed., **_Tax_** _Policy Options in_ **_te 1980's,_** Canadian Tax Paper No. 66. Toronto, Canada: Canadian Tax Foundation, 1982, pp. 3S4-401.

- World Bank, _Infraosruefr Develpment._ World Development Report, 1994. Washington, D.C., 1994.
_- 57_ -

1. David Seawll, _Fiscal Insues_ **_in_** _Decensralizadon in_ **_Albania_** A Discussion Paper prpared for the Council of Ministers, Repblic of Albania. World Bank, Europe and Central Asia, Middle Est and NorLh Africa Regions Technical Dpautment, Feb. 19 1993.

2. Small sizea of local govenments are not confined to central and eastern Europe, of course. Thus, Kincaid repoit that "72 percent of all gcneral-purpose govemments in the United State. have fewer than 3,000 reidents, and more than half (55.4 peracnt) have populations under 1,000." John Kincaid, "Financing Local Govemment in the United States," _Local Government: A.n Inbernatonal Perspective, eds.,_ **_1,_** Owens and G. PanelU (Amstrdam: North-holluand, 1991), p. 142.

3. Richard M. Bird and Enid Slack, _Urban Public Finance in Canada_ (Toronto, OntM,: John Wiley and Sons, 1993), p. 69.

4. See Melville L. McMiUnam, "A Locil Perspsctive on Fiscal Federalism: Practices, Expinces and Lessons from Dcvlped Countrics", (World Bank Worling Paper, forthcoming 1994), p. S-1.

S. Ibid., p. 36.

# 6. Sce in particular, Richard M. Bird, _Chargingfor Public Servces,_ (Toronto: Canadian Tax Foundation, 1986).

7. See Roy Kely, "Implementing Property Tax Reform in Transitional Countries: the Experience of Albania and Poland", _Journal of Environment and Planning,_ (forthcoming 1994).

S. See Wayne R Thinrk, _"Political Sensitivity versus Economic Sensibilty: A Tal of Two Property Taxes,"_ in Wayne R. Thirsk and John Whalley ed., _Tax Poliy Options in she 1980's,_ Canadian Tax Paper No. 66, (Toronto, Canada: Candian Tax Foundation, 1982), pp. 384-401.

9. See Rany Prd'homme, "Decentrlization of Expenditures or Taxes: The Case of _France_ in RJ. Bennett (ad.), _Decentralzaton, Local Governments and Markets,_ (Oxford: Claendon Press, 1990).

_10._ Sae McMiuan, 1994, p.33.

11. See World Development Report 1994, _Inftruastrure for Development,_ (Washington, D.C., The World Bani 1994), Chapter 4, pp. 8-81.

12. BTuce Fitzgerald, _Cross-Subsidies: There Should be Beter Ways to He4 the Poor,_ HRO Dissination Notes, No. 26, April 11, 1994, (Washington, D.C., The World Bank, 1994), p. 1.

# 13. In 1993, vuges and salaries accounted for 16.3% and tansfers to households 34.5% of pubic _expaeitue._

14. While many exmples could be gien, the rehabiliaion of urban water supplies provides a good illstrton. The Ilian govcnunent has .committed resources **to** improving the wate supply and sewerage system in Tirana, the capil and lagest city in Albania. The World Bank Group is addressing improvement of the watr and sewage _sym_ in Dure, the next largest city in Albania. The neighboring KaCvaja District has also received a grant from the German goverment to upgrde the distribution system of its Water Works.

_15. Wiliam DMinger, Decenrralbation and its Iplicatonsfor Urban Servie Delivery,_ Washington, D.C., The World Bank, Urban Managenmnt Progmnune Discussion Paper No.16, 1993), pp. 32-34.
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