The role of fiscal decentralization in municipal budgets: Case of the Czech Republic

Andrlík, Břetislav; Halamová, Martina; Formanová, Lucie Article The role of fiscal decentralization in municipal budgets: Case of the Czech Republic DANUBE: Law, Economics and Social Issues Review Provided in Cooperation with: European Association Comenius (EACO), Brno Suggested Citation: Andrlík, Břetislav; Halamová, Martina; Formanová, Lucie (2021) : The role of fiscal decentralization in municipal budgets: Case of the Czech Republic, DANUBE: Law, Economics and Social Issues Review, ISSN 1804-8285, De Gruyter, Warsaw, Vol. 12, Iss. 1, pp. 61-76, https://doi.org/10.2478/danb-2021-0005 This Version is available at: https://hdl.handle.net/10419/242181 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-nd/4.0 THE ROLE OF FISCAL DECENTRALIZATION IN MUNICIPAL BUDGETS: CASE OF THE CZECH REPUBLIC Břetislav Andrlík1, Martina Halamová2, Lucie Formanová3 Abstract Immovable property tax is one of the key elements of fiscal decentralization in the Czech Republic. It is the only tax that is directed to municipal budgets in the full amount. It is also the only tax the total receipts of which can be influenced by municipalities by means of corrective features. Although the significance of immovable property tax in the process of fiscal decentralization is undeniable, its role in municipal budgets is much discussed. The goal of the article is to evaluate the role of immovable property tax in budgets of Czech municipalities through its impact on the resulting balance of financial management of a particular municipality. The role of immovable property tax is assessed against its importance for the municipal budget. The data concerning financial management of municipalities, the amount of receipts of immovable property tax and the possibilities of utilization of the local coefficient in the year 2019 are analyzed in detail. The results identified by the analysis are compared with the situation in 2012 and it may be stated that although the role of immovable property tax in municipal budgets has decreased if compared with the year 2012, it still represents a significant income of Czech municipalities. At the same time, the current economic situation suggests that the importance of immovable property tax will increase in the years to come. Keywords Immovable Property Tax, Local Coefficient, Fiscal Decentralization, Municipal Budget, Budget Balance I. Introduction Property taxes form a traditional part of tax systems. According to OECD (2020), taxes on property are included into group 4000 and are defined as “recurrent and non-recurrent taxes on the use, ownership or transfer of property”. As part of the definition, OECD 1Mendel University in Brno, Faculty of Business and Economics, Zemědělská 1, 613 00 Brno, Czech Republic. E-mail: xandr[email protected]. 2Mendel University in Brno, Faculty of Business and Economics, Zemědělská 1, 613 00 Brno, Czech Republic. E-mail: xhalamo[email protected]. 3Mendel University in Brno, Faculty of Business and Economics, Zemědělská 1, 613 00 Brno, Czech Republic. E-mail: xf[email protected] 62 Břetislav Andrlík, Martina Halamová, Lucie Formanová: The Role of Fiscal Decentralization in Municipal Budgets: Case of the Czech Republic (2020) includes the following items into property taxes: taxes on immovable property or net wealth, taxes on the change of ownership of property through inheritance or gift, and taxes on financial and capital transactions. Kubátová (2018) mentions that the taxation of property ensures the essential criterion of fairness in the form of the ability-to-pay principle thanks to the reflection of wealth, and thus the taxpayer’s ability to pay, in the property owned. Musgrave and Musgrave (1994) support the reasoning of property tax existence with the benefit principle, pursuant to which the value of the property increases thanks to the use of public services associated with its ownership and use. Property taxes played the key role in tax systems of the past. Over the time their importance has been surpassed mainly by income taxes, and, since past century, also by value added taxes (Kubátová, 2018; Radvan, 2007). Therefore, the role of property taxes as public budget revenues is rather marginal at present. This trend is clearly apparent in the Czech tax environment, where the share of property taxes in the GDP lies at the bottom of European values. In 2018, this share was 0.6% of GDP, while the EU average was around 2.5%ofGDP(EuropeanCommission,2020).Foralongtime,the OECD has recommended governments to increase the proportion of property taxes, primarily at the detriment of more distorting taxes, such as income taxes (Hrdlička et al., 2010). Vasiliauskaite and Stankevicius (2013) reason that property taxation should be increased because of its minimal negative impact on economic growth. The same authors, as well as Andrlík (2010a) mention the stability of property taxation revenues enabling precise budgeting, which is a significant attribute particularly for indebted countries or municipalities. Zasova and Pluta (2019) stress the ability of property taxation to reduce inequality of incomes in the society, which stems from the fact that the scope of property owned is most often dependent on the income. The importance of immovable property tax for municipalities is evidenced also by Andrlík and Formanová (2014). Political leaders tend to assume quite opposite approaches despite these recommendations. Act No. 357/1992 Coll., on Inheritance Tax, Gift Tax and Real Estate Transfer Tax, was repealed in 2013. Inheritance tax was abolished altogether, and under Act No. 586/1992 Coll. on Income Taxes, inheritance is exempt from taxes in most cases. The subjects of the Act since 2014 include also donations, which are referred to as gratuitous fulfillments. Under the Senate Ordinance No. 340/2013 Coll., on Immovable Property Acquisition Tax, the real estate transfer tax was replaced. However, with effect from 26 September 2020, it was finally decided on the abolishment of the tax (Ministry of Finance of the CR, 2020d). The only existing property tax in the Czech Republic within the OECD classification is immovable property tax at present. Immovable property tax is regulated by Act No. 338/1992 Coll., on Immovable Property Tax, and is divided into the tax on lands and tax on buildings and dwelling units. Unlike other direct taxes (e.g. income tax) immovable property tax has not gone through dramatic changes. One of noticeable changes of legal regulation may be considered the introduction of the local coefficient in 2009, which gave municipalities, the net recipients of the tax, more powers to influence its final amount. The tax rates doubled the year after, which meant an increase in the receipts of the tax by more than CZK 2 billion (Ministry of Finance of the CR, 2010; Ministry of Finance of the CR, 2020a). The last substantial DANUBE, 12 (1), 61–76, DOI: 10.2478/danb-2021-0005 63 change was adopted in 2014 in the context of significant changes in private law leading to the origination of the new Civil Code (Andrlík and Formanová, 2015). The term real estate tax was replaced with the term immovable property tax for the sake of harmonization of both regulations. The amount of the analyzed tax is not a substantial revenue of public budgets. The small share of immovable property tax in total tax revenues of local governments is shown in Table 1. This share was approximately 4% in the year 2009; 5% in 2010–2015; 4% in 2016–2018; and only 3% in 2019. The decrease in the share of the monitored tax in total tax revenues is mainly due to a more significant growth in total tax revenues and only a very low growth (or a slight decrease) in the immovable property tax revenues. Immovable property tax may be perceived as utterly insignificant in comparison with the total (national) tax revenues, as it accounts only for 1% of total tax revenues. Since 2016 this value has been below 1% and its share has a declining trend. Table 1: Share of immovable property tax in total tax revenue of local governments (LG) (mil. CZK) 2009 2010 2011 2012 2013 Total tax revenue of LG 180,340 187,984 187,161 191,009 208,443 Immovable property tax 6,320 8,664 8,609 9,602 9,736 Immovable property tax (%) 4 5 5 5 5 2014 2015 2016 2017 2018 Total tax revenue of LG 219,391 226,301 249,498 270,743 295,190 Immovable property tax 9,973 10,334 10,586 10,765 10,856 Immovable property tax (%) 5 5 4 4 4 2019 Total tax revenue of LG 320,174 Immovable property tax 10,909 Immovable property tax (%) 3 Source: Ministry of Finance of the CR, 2020a; Ministry of Finance of the CR, 2010 Although the share of immovable property tax in the total tax receipts is not significant, there are a lot of reasons justifying its existence in the tax system of the Czech Republic. One of the advantages of the tax is its tendency to progressivity. It is based on the ability-to-pay principle and contributes to the fulfilling the redistributive role of taxes (Kubátová, 2018). Immovable property tax is thus able to reduce economic inequality in the society through higher taxation of rich taxpayers. Another argument justifying the existence of the discussed tax is supported by Andrlík (2010b), Jackson and Brown (2003), and Sedmihradská (2010), who maintain that the taxation of property leads to its better 64 Břetislav Andrlík, Martina Halamová, Lucie Formanová: The Role of Fiscal Decentralization in Municipal Budgets: Case of the Czech Republic management. According to Kubátová (2018) an asset of immovable property tax is also the fact that its effect on labour is not distorting. Whereas income taxes are likely to demotivate taxpayers and lead to reduction of work, aiming at lower or no taxation, the tendency of immovable property tax payers to limit tax liabilities by not owning property is minimal. This is attributed to the fact that immovable property must be permanently used either for living or for business due to the fact that ownership entails lower costs than long-term lease. Another positive feature of immovable property tax is its fixed tax base restricting tax evasion (Zasova and Pluta, 2019). Andrlík and Formanová (2015) also mention the minimal sensibility of the analyzed tax to economic fluctuations, which allows for easy predictability of tax receipts. Immovable property tax is one of the taxes whose full amount goes into one budget, i.e. into the budget of the municipality in whose cadastral district the immovable property is located. This tax is an important (and the only one, as far as taxes are concerned) instrument of their financial autonomy. The key importance of the discussed tax thus rests in its significance for municipalities, where it strengthens their independence of state or regional budget. At the same time, because its amount may be adjusted, it allows for adapting tax revenues to the specifics and needs of a municipality. In the Czech Republic, this is the only tax that may be referred to as a local tax (with a certain limitation), whereby its role in the process of fiscal decentralization, i.e. extension of fiscal powers of lower administrative units increases. According to Radvan (2007), a local tax is “a statutory levy of a monetary nature directed to the municipal budget, which may be introduced or abolished by the self-governing territorial unit and which can be influenced by that unit in any way”. Immovable property tax has all the apt characteristics of a local tax, including in particular the fixed tax base disabling transfers of the subject of the tax in order to reduce tax liability; sufficiently high, stable and predictable tax receipts; easy administration handled by the relevant revenue authorities; feasibility of inspection thanks to records in the land register preventing tax evasion; and good visibility of the tax encouraging responsible conduct of local politicians due to interest of taxpayers (Sedmihradská, 2016). Although municipalities cannot entirely abolish immovable property tax, they have instruments for influencing the resulting tax receipts. Powers of municipalities concerning immovable property tax were relatively limited until the year 2008 (Sedmihradská, 2013). They could affect the rate of tax on buildings and dwelling units through coefficients multiplying the rate. This correction coefficient was determined according to the population and could be reduced by the maximum of three categories or increased by one category. Municipalities were also able to apply the coefficient only in some parts of their territories. Another coefficient (amounting to 1.5) then could be used by municipalities for the adjustment of tax rate concerning buildings and dwelling units intended for recreation or business, or those used as a garage. This coefficient applied for the entire municipal territory. Municipalities saw an important change in 2009, when their possibilities to influence the amount of taxes were extended by the addition of a third coefficient, referred to as local coefficient, which can be introduced by municipalities at the values of 2, 3, 4, or 5. The local coefficient, unlike the first two, multiplies the resulting tax on all lands, buildings DANUBE, 12 (1), 61–76, DOI: 10.2478/danb-2021-0005 65 and dwelling units, which means the final tax receipts may be increased five times at the maximum. A certain disadvantage is that the local coefficient must apply to the entire municipality, and thus tax cannot be raised in some parts only. Nevertheless, the situation is likely to change in 2021: the government’s proposal of an amendment in the area of taxation (on the agenda of the Chamber of Deputies in October 2020) includes a change in the application of the local coefficient that would enable its introduction in some parts of the municipality only. The Committee on the Budget has proposed that municipalities may apply the local coefficient in the range of 1.1 to 5, rounded to one decimal place (Chamber of Deputies of Czech Parliament, 2020). Thus it may be observed that legislators try to change the setting of corrective features of immovable property tax so that municipalities have more opportunities to influence the tax and can better adjust it to local conditions. At the same time, the government believes that the proposed changes will lead to a better use of corrective features, which is not exhaustive at present (Chamber of Deputies of Czech Parliament, 2020). According to information from the Financial Administration, only 624 municipalities out of the total number of 6,252 decided for the introduction of the local coefficient in 2020, which is less than 10% (Financial Administration, 2020; ČSÚ, 2019). Despite the above arguments supporting the existence of immovable property tax, the tax is often seen as insignificant or unfair, which leads to considerations about its abolishment. The main problem causing disapproval of immovable property tax is its understanding as a form of double taxation, due to the fact that the tax is paid on property purchased by the taxpayer with money that was taxed in the past (Andrlík and Formanová, 2015; Kubátová, 2018;Sedmihradská,2010).Therefore,manypeopleseethe taxasunfairanddemotivating. However, as pointed out by Prabhakar (2008) double taxation is present in all tax systems that include more than one type of tax. For instance, payment of value added tax may also be considered as double taxation, because taxpayers pay the tax from funds that have been taxed. The costs of the tax administration also contribute to the discussion about efficiency of the tax concerned. Based on the results presented by Pudil et al. (2003) and Andrlík (2010b) it may be observed that administrative costs regarding property taxes are very high, and thus the main criterion of tax effectiveness is not met. However, it must be noted that extremely high administrative costs were associated primarily with inheritance tax and gift tax (Andrlík, 2010b), which were abolished due to low effectiveness. Whereas most economists are advocates of property tax, the society perceives this sphere as very unpopular mainly due to good possibility of its supervision and minimal chance to avoid tax liability (Norregaard, 2013). Since it is a direct tax, taxpayers are aware of the tax burden and they often tend to perceive it as higher than it actually is. This is emphasized by the fact that property tax is not withheld but is paid by taxpayers from their own accounts. Besides, immovable property tax is mature once or twice (if the amount of CZK 5,000 is exceeded) a year, which means that a taxpayer has to spend quite a large amount of money at a time. The deputies of ODS (Civic Democratic Party) strived to abolish the tax in 2003. They reasoned their proposal mainly with the disproportion between the low receipts of the tax and high costs of its administration, demotivating nature of the tax, and the argument of 66 Břetislav Andrlík, Martina Halamová, Lucie Formanová: The Role of Fiscal Decentralization in Municipal Budgets: Case of the Czech Republic double taxation (Chamber of Deputies of Czech Parliament, 2003a). Their proposed bill was finally rejected inter alia on the grounds of the importance of immovable property tax for municipalities. In its opinion of the bill, the government stated that if the bill was passed, 92% of municipalities would suffer loss of tax revenue (the bill intended to compensate municipalities for the lost revenue through increasing shares in VAT and income taxes). Moreover, abolishment of immovable property tax would contradict the effort to strengthen municipal powers as part of public administration reform (Chamber of Deputies of Czech Parliament, 2003b). Despite the unpopularity of immovable property tax and efforts to abolish it, political leaders clearly understand the importance of the tax for municipalities and their fiscal autonomy. The goal of this article is to perform detailed analysis and use it for the determination of the significance of immovable property tax in the Czech Republic from the viewpoint of a municipality as the net benefactor of the analyzed tax receipts. The key role of immovable property tax consists in its benefit for municipalities. On the basis of the performed analysis and identification of the importance of the tax, this article shall define the impacts of existence or nonexistence of immovable property tax on the municipal budget and its final balance. Considering the possibilities of municipalities to influence the amount of tax using corrective mechanisms, another goal hereof is to evaluate the impacts of introducing the local coefficient on the municipal financial management from the viewpoint of final tax receipts as the most significant corrective feature. This means that the importance of immovable property tax is evaluated against its potential to prevent a municipal budget deficit through its very existence. Subsequently, the importance of the tax is evaluated in terms of its ability to balance a deficit of the budget or ensure its surplus by means of introducing or increasing the local coefficient. The role of immovable property tax municipal budgets is then discussed pursuant to the results achieved. In order to meet the goals, we have used the data on the financial management of individual municipalities and the application of the local coefficient, provided by the Financial Administration of the Czech Republic and the Ministry of Finance of the Czech Republic through the analytical section of the portal entitled “Monitor – Complete overview of public finance”. The subject of the analysis has been data for the calendar year 2019. The concrete data sources are stated in the References. We have primarily used the analytical method based on detailed examination of the relevant data sets. The analysis has focused on the interrelationships between the municipal budget balance and other indicators such as total income and expenditure, revenue from immovable property tax, utilization of the local coefficient, its amount, or the population. Interim results of the analysis are subsequently compared with the results of research conducted by Andrlík and Formanová (2015) using data from 2012. The descriptive method is then used to describe the facts following from the analyzed data. In conclusion, the synthesis of the obtained findings has been made to serve as the basis for discussion and formulation of conclusions. DANUBE, 12 (1), 61–76, DOI: 10.2478/danb-2021-0005 67 II. The Role of Immovable Property Tax in Municipal Budgets in the Czech Republic The full amount of immovable property tax goes to the budgets of municipalities. Table 2 below shows the proportion of immovable property tax in incomes of municipalities. The analyzed tax represents an average of 8.21% of the total tax revenues. In some municipalities, immovable property tax accounts for almost 6% of all incomes. The median of the proportion of immovable property tax in the total tax revenues is 7%. Although in general, the tax does not represent a substantial income for municipalities, it cannot be considered a negligible income. It always depends on the concrete municipality because the proportion of immovable property tax in either total income or tax revenues differs among municipalities. Whereas e.g. in Volevčice (district of Most, population of 111 as per 1 January 2019 (ČSÚ, 2019)), immovable property tax accounts for more than 69%, in Borek (district of Prague-East, population of 320 as per 1 January 2019 (ČSÚ, 2019)), the tax represent only 0.02% of all tax revenues of the municipality. Most often, the structure of realestate in the given municipality plays the mostimportant role. Municipalities wherethe tax forms an absolute majority of tax revenues are usually located in industrial regions and their high revenues are primarily attributed to the high tax liability of industrial facilities (power plants, big companies etc.). Such municipalities tend to use the highest possible values of the local coefficient, which increases the resulting tax receipts up to fivefold. However, many municipalities achieve significant incomes even without the application of the local coefficient. The above mentioned Volevčice collect the highest immovable property tax of all Czech municipalities without the use of the local coefficient due to the presence of CCGT Power Plant Počerady in its territory. Table 2: The significance of immovable property tax in the budget of municipal units in 2019 Average Maximum Minimum The share of immovable property tax in the total municipality tax revenue (%) 8.21 69.10 0.02 The share of immovable property tax in the total municipality income (%) 5.84 63.42 0.01 Source: Ministry of Finance of the CR, 2020a; Ministry of Finance of the CR, 2020b; Ministry of Finance of the CR, 2020c The goal of the article is to evaluate the significance of immovable property tax for municipal budgets. First, the financial management of municipalities and balances of their budgets must be examined. Over 72% of municipalities ran a budget surplus in 2019. Their incomes often significantly exceeded their expenditures. 1,714 municipal units, i.e. 27.42% ended the year with a budget deficit. The largest proportion of municipalities whose incomes were not sufficient to cover all the expenses in 2019 was represented by medium-sized units (2,001–8,000 inhabitants). More than 41% of municipalities ran a deficit in this group. In the group of small municipalities (population 2,000 and less), 26% ended the year with a deficit; among the largest ones (8001 and more inhabitants), 38% ran a deficit. It may be said that municipalities managed their finance well in the 68 Břetislav Andrlík, Martina Halamová, Lucie Formanová: The Role of Fiscal Decentralization in Municipal Budgets: Case of the Czech Republic monitored year, and almost three quarters of them reported surplus. This means that it was mostly the medium-sized municipal units that had to face insufficient income versus the expenditure incurred. Of the 1,714 municipalities where a budget deficit has been identified, only 192, i.e. 11.20%, used the local coefficient. Among the municipalities whose income exceeded the expenditure, 407, i.e. 8.97% applied the local coefficient in 2019. More often the coefficient was utilized by units running a deficit. This may be explained by the effort of the units with a long-term deficit to reduce the deficit or attain a surplus. It may also be interpreted in such a way that the local coefficient is not a sufficiently strong tool leading to higher revenues at present. Although municipalities use the local coefficient, they are not able to achieve a positive balance of their budgets by its means. Thus, it is possible that municipalities do not exploit the coefficient to its maximum or that immovable property tax does not represent an amount significant enough to balance the budget even if it is multiplied by the coefficient. Table 3: The relation between the budgetary balance and application of the local coefficient in 2019 Total Municipalities with Municipalities with (%) local coefficient local coefficient Municipalities with budget deficit 1,714 192 11.20 Municipalities with budget surplus 4,538 407 8.97 Source: Ministry of Finance of the CR, 2020a; Ministry of Finance of the CR, 2020b; Ministry of Finance of the CR, 2020c The importance of immovable property tax for municipal budgets will be assessed from two viewpoints. Firstly, its importance will be evaluated against the impact of the potential loss of immovable property tax receipts on the total balance of municipal finance. In other words, we will assess what would the non-existence of immovable property tax mean for municipal budgets with a deficit. The findings will suggest to what degree Czech municipalities depend on immovable property tax. Subsequently, the relevance of the discussed tax will be viewed from the point of fiscal decentralization. The relevance of the tax for municipal budgets will be evaluated on the basis of possibilities to improve municipal financial management, for instance to reduce the budget deficit, through the application of corrective features of the tax. The impact of the local coefficient on the resulting balance of the budget will be examined, because the local coefficient may be considered an important tool leading to the increase of immovable property tax receipts. The immovable property tax significance will be assessed according to its ability to enable municipalities obtain sufficient revenues to cover all the expenditure. 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