Chapter

25 Bulgaria

Editor(s):
Teresa Ter-Minassian
Published Date:
September 1997
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Author(s)
Željko BogetiĆ

Bulgaria’s prereform economy, roughly before 1991, was a highly centralized state, similar to most countries of the former Soviet Union. With the radical liberalization and stabilization program adopted in February 1991 by the government led by the former opposition, the country entered the transition to market in a political and macroeconomic tumult that continues several years later. This coincided with severe external shocks that were largely responsible for large declines in output and foreign trade: the former Council for Mutual Economic Assistance disintegrated, and foreign trade flows with the former Soviet Union, on which much of Bulgaria’s industry depended, collapsed. In 1990–93, output declined by over 20 percent and at the end of the period unemployment reached 14 percent (Bogetić, 1996).

The worsening economic situation affected government finances adversely. Total government revenues fell from almost 60 percent of GDP in 1989 to below 40 percent of GDP in 1994, reflecting a severe erosion of the traditional tax bases (such as the profits tax and trade and nontax revenues). As privatization proceeded at a slow pace, largely led by enterprise insiders, the profits tax base eroded as a result of informal profit shifting from state enterprises to managers and insiders, who often bought cheaply and sold dearly to those enterprises (Bogetić and Hillman, 1995). Government expenditures also fell, but budget deficits remained high and, in combination with a lax monetary policy, continued to sustain inflation.

Politically, Bulgaria’s transition has been characterized by numerous changes in governments and frequent changes in cabinet posts. Against this backdrop, early in the transition, the government adopted a Law on Self-Government that grants wide autonomy to local governments, signaling a major decentralization drive. However, several years later, implementing decentralization has proven difficult, and many questions and policy dilemmas remain.

The chapter begins with an overview of the current state of intergovernmental fiscal relations in Bulgaria, focusing on certain issues that are likely to constrain the process of decentralization. It then discusses major issues in the current debate on this process and suggests how their resolution and implied policy choices might affect decentralization. Finally, it attempts to draw some broader lessons from Bulgaria’s limited experience with decentralization.

Intergovernmental Fiscal Relations

Bulgaria is a unitary state, with the present vertical structure of government reflecting the system that had been put in place in 1987. There are 9 regions, 255 municipalities, and over 3,900 settlements. The regions are the arms of the central government without autonomous budgets. The districts, indicated in Figure 1, are not operational, and there is uncertainty about their future. This means that, de facto, Bulgaria has only two layers of government: central and local. Municipalities have elected mayors and municipal councils, usually comprise a number of settlements and, since 1992, have their own budgets, although their revenue sources are still mainly shared or transferred from the center. An average municipality of 30,000 has about 20 settlements. Settlements are the smallest unit of government with an elected mayor, but no budget.

Figure 1.Bulgaria: Executive Power System and Structure

Source: World Bank.

Tax Assignment

In Bulgaria, local governments have a limited tradition of, and actual power to, tax. It was only in 1991, with the passage of the Law on Self-Government, that local governments received limited formal autonomy. In practice, local governments were allowed to have their own budgets for the first time only in 1992. There has been growing realization, at the rank-and-file level of the central bureaucracy and in municipalities, that a successful decentralization of expenditure responsibilities and effective management of budgetary resources at the local level requires greater autonomy in raising revenues. But this realization has not gained broader political support, particularly at the central government level, where pressures from local governments for greater budgetary autonomy clash with the inertia of centralized management practices and vested interests. In addition, the need to control the central government deficit under conditions of shrinking tax base and high budgetary interest payments limited the central government’s ability to grant more revenue-raising autonomy to local governments. As a result, the tax assignment has remained ambiguous and nontransparent.

Municipalities have three main sources of revenues: (1) local taxes, fees, and charges; (2) shared taxes; and (3) transfers from the central government. The only shared taxes are the profits tax and individual income tax, while indirect taxes accrue to central government. The shares of revenues from different sources fluctuated over time, reflecting the year-to-year instability of local government finances. In 1996–97, the transfers to the municipalities were reduced due to severe budgetary pressures at the central government level.

The proportion of local tax revenues in total revenues of municipalities remains small—between 5 and 12 percent—reflecting the low autonomy with regard to authority to tax. Until 1993, transfers (grants) from the central government were more important: they accounted for close to a half of total revenues of municipalities. But from 1994, transfers were reduced as central government fiscal problems intensified. Municipalities receive over half of their total revenues from the two shared taxes: profits tax and income tax. Until 1993, they also received a share of the turnover and some excises.

Within local revenue sources, a notable feature of the Bulgarian tax system is the relative insignificance of the property tax, which is also indicative of the state of decentralization. This tax is a cornerstone of local taxation in many developed countries. In developing countries, however, this tax is much less dominant among local revenue sources, as it is frequently plagued by problems of outdated and irregular assessments, poor cadastres, and little control of local governments over the rates.

In Bulgaria, local sources of revenues accounted on average for only 12 percent of total revenues of municipalities in 1994. The property tax accounted for only 2.1 percent of those revenues. The reasons are threefold. First, the rates of this tax have been very low, albeit with some variation among cities. Second, the assessments on which this tax is based are not regularly updated, which leads to an erosion of the base in the presence of moderate to high inflation. And third, until very recently, local governments had no control over the rates and assessments, which were decided at the central level; de facto, the property tax was a “central government” tax. Most recently, the rates were raised to more realistic levels (Varga, 1996). The vehicle registration tax, a generally good and equitable local tax, has not represented a significant local revenue source. Various fees and nontax revenues were far more important revenue sources for local governments than the property and vehicle taxes; they accounted for 9.9 percent of total municipal revenues. But many of these fees are often “nuisance charges,” controlled from the center, while some major scarce goods continue to be provided at the local level below cost (including water, sanitation, and electricity). Therefore, there is scope for a much wider use and more realistic rates for user charges at the local levels.

A striking conclusion arises from this brief overview of local revenues of municipalities: one may conclude that no tax in Bulgaria fully satisfies the criterion of clarity of tax assignment, whereby local governments should have full control over the rates of local taxes. Indeed, in her comprehensive survey of Bulgaria’s taxation, Varga concludes that there are no local taxes, “as regions and municipalities have no taxing powers” (Varga, 1996, p. 83).

Shared Taxes

Shared taxes account for about half of total revenues of municipalities (Table 1). Two key taxes that are shared among the central and local governments are profits tax and individual income tax. Before the introduction of the VAT in 1994, the old turnover tax was also shared. But when the VAT—a central government tax—replaced the turnover tax, its revenue was not shared with the local governments. The profits tax performance has been deteriorating, reflecting pressures on profitability of state enterprises, arising from the competition from the private sector (which has been more difficult to tax), external shocks, but also the appropriation of profits by state managers (Bogetić and Hillman, 1995). Individual income tax, which is essentially a wage and salary tax collected at the source, has remained an important local revenue source.

Table 1.Bulgaria: Structure of Municipal Budgets(In percent)
19901991199219931994
Revenue100.0100.0100.0100.0100.0
Own source revenues11.14.45.15.012.0
Property tax and inheritance tax3.70.70.71.22.1
Fees and other revenues7.43.54.43.89.9
Shared revenues50.972.348.746.763.6
Profit tax7.427.721.911.617.6
Income tax38.832.221.521.946.0
Turnover tax4.78.15.211.01.4
Other shared taxes4.32.1
Transfers38.023.346.248.019.3
Expenditure100.0100.0100.0100.0100.0
Current85.388.789.289.990.1
Capital14.711.410.810.18.9
Source: Ministry of Finance.
Source: Ministry of Finance.

As regards the profits tax, there is a “municipal tax” (see Varga, 1996), which is levied on all enterprises with state or municipal ownership in excess of 50 percent in a given municipality. The municipal tax is levied on accounting profits (adjusted for tax purposes) at the rate of 6.5 percent. In addition, a standard 36 percent profits tax is levied on all state enterprises under local jurisdiction. Within this standard profits tax rate 2 percentage points are earmarked for the irrigation fund.

As for the individual income tax, the sharing proportion was determined every year in the budget law, leading to much central-local government bargaining. In 1991, this proportion was 70:30 in favor of local governments, but since then, the local proportion of this tax has been declining so that in 1996 the proportion was 50:50. Although this tax remained an important source of revenues for municipalities, the constant bargaining, instability, and unpredictability of shares has constrained the financial autonomy and budget planning of local governments. It has been suggested that a preferable solution for Bulgaria and many transition economies would be a “piggybacked” income tax that the municipalities would be free to impose in their territories, on the same base—incomes—but within specified limits, over and above the standard, “central” income tax rates (Martinez-Vazquez, 1995a). Such a “concurrent” tax would take advantage of this stable, shared income tax base, while providing local authorities with greater autonomy in setting rates, and greater stability revenues over time. Similar piggybacked taxes have been implemented successfully in, among others, Canada and some Northern European countries, and other piggybacked taxes, such as on the corporate income tax, are common in a number of countries (see Chapter 3).

Transfers

Transfers from the central government have been an important source of revenues for municipalities. In the 1990–93 period, their share in total municipal revenues fluctuated between 23 percent and 48 percent, with increases reflecting rising dependence of the municipalities from the center. As the fiscal problems intensified and the local government lost a share of the turnover tax (which was replaced by a VAT in 1994), the dependance of local governments on central transfers increased. In 1995, the total amount of transfers reached 74 percent of total local revenues (or 3.4 percent of GDP).

There are two types of grants: general purpose grants and specific grants for capital expenditure. General purpose grants, which are the dominant form of transfers (Table 2), are based on a transfer formula determining the level of transfer in each municipality. The specific amounts of transfers to municipalities are determined in annual budgets. Key factors in the transfer formula are the level of transfer in the previous year and an assessment of local needs. In addition, there is a redistributive mechanism built into the formula so that poor municipalities receive higher than average transfers. The transfer formula also incorporates tax effort and a number of other social variables relevant for equalization.1 While this was a change in the right direction, the current transfer system continues to be adversely affected by the lack of clarity in expenditure assignments.

Table 2.Bulgaria: Types of Transfers and Their Relative Importance
Type of TransferIn Billions of LevaIn Percent of Total
General grants (“subsidy”)30,58183.6
Specific grants5,46014.9
Remittance to the center5151.4
Total36,556100.0
Source: The 1996 budet, Sofita (English translation).
Source: The 1996 budet, Sofita (English translation).

Specific grants are given for capital expenditure purposes only. Each year, municipalities submit their lists of investment projects to the Minister of Finance, who decides which projects get funded based on specific sector priorities (water supply, health, social welfare, education, and environment).

Expenditure Assignment

Government expenditures have been under pressure from declining government revenues and the need to maintain budget balance for macroeconomic stabilization purposes. Indeed, the decline in revenues in Bulgaria has been rapid and significant, more reminiscent of the situation in former Soviet republics than in other Eastern European countries. It was accompanied by a significant decline in the size of government, measured by total expenditure-to-GDP ratio. But expenditure responsibilities of the local governments (health, education, and so on) have not been reduced commensurately. Moreover, under pressure to keep its budget deficit under control, the central government took away some revenue sources, such as the turnover tax, from the local government. Macroeconomic fiscal pressures in many transition countries have pushed the central government deficit down to the local level (Bird, Ebel, and Wallich, 1995). As a result, expenditure pressures on local governments have increased, while adequate revenue-raising instruments have not become available.

In response to budgetary pressures, local governments have been reluctant to reduce employment, particularly in the large sectors such as education and health, which hide considerable inefficiencies and over-staffing (see Bogetić and Chattopadhyay, 1995). This has compounded the budgetary problems of local governments and contributed to continued tensions between the central and local governments under conditions of fiscal stress.

A review of formal expenditure assignments in Bulgaria (Table 3) reveals that many services that, on the basis of the “benefit principle,” should be provided locally (such as primary education, primary health, local road maintenance, and, partly, garbage collection) are indeed assigned to local governments. Furthermore, typical central government functions, such as defense and security and foreign economic relations, are assigned to the central government. So, prima facie, there is no gross expenditure assignment mismatch from the point of view of the standard textbook division of central and local government functions. However, a closer examination of this assignment and its functioning reveals at least two issues of concern: the lack of clarity in the assignment of several important expenditure activities and the negative budgetary and efficiency impact of lingering mandates and norms from the central to the local governments.

Table 3.Bulgaria: Expenditure Assignment
Central Government1MunicipalitiesSettlements
Defense
  • Entire responsibility
Justice and internal security
  • Entire responsibility
Foreign economic relations
  • Entire responsibility
Education
  • All university and research institutions; some technical and vocational schools
  • All expenditures (capital and current) of primary and secondary schools)
  • Some kindergartens
  • Some technical and vocational schools
  • Some kindergartens
Health
  • Medical research institutes
  • Special service hospitals (cardiology, oncology, etc.)
  • Tertiary care and psychiatric hospitals
  • Polyclinics
  • Some primary care
  • Drugs
  • Some primary health clinics
Roads
  • Construction of all roads
  • Maintenance of state highways and any other roads linking cities and villages
  • Maintenance of III and IV class roads and urban streets
  • Maintenance of local network road
Public transportation
  • Airports
  • Railway subsidy
  • All modes of city transport
  • Subsidy to inter-village bus service within municipalities
Fire protection
  • Most fire protection services
  • Equipment for volunteer services
Libraries
  • National Library (Cyril and Methodius)
  • Local libraries
Police services
  • National militia and traffic police
  • Sofia signed contract with national militia; other municipalities get service free
Sanitation
  • Part of garbage collection and street cleaning
  • Part of garbage collection and street cleaning
Water and sewerage
  • State enterprises except for Sofia
  • Some construction and operation
  • Some operation
Public utilities
  • Electricity subsidy
  • Heating subsidy since 1992
  • Heating subsidy until 1992
  • Water supply infrastructure
Housing
  • Financing, building, and subsidizing for residential ho using
Price subsidies
  • Mass transport
  • Drugs
Welfare Payments
  • Unemployment
  • Social assistance
  • Homeless; disabled; orphans; subsidies for large families
Enterprises in productive sector
  • Capacity to invest in joint ventures including banks
  • Keeps a share of the proceeds from privatization of state and local enterprises
Environment
  • Responsible for national environmental issues
  • Local environmental issues
Enterprises
  • State enterprises
  • Local and municipal enterprises (transport, construction, and other local services)
Source: World Bank (1994).

There is an intermediate level of government between the central government and the municipalities: the regional government. However, regional governments are just agencies of the central government without discretion and without budgets. For these reasons, regional governments are not shown in the table as separate from the central government.

Source: World Bank (1994).

There is an intermediate level of government between the central government and the municipalities: the regional government. However, regional governments are just agencies of the central government without discretion and without budgets. For these reasons, regional governments are not shown in the table as separate from the central government.

First, several services (for example, water supply and regional hospitals) that would naturally fall under the category of regional or special district levels of government are, in the absence of such a layer of government, assigned to either the central government (as in the case of water systems) or to specific local municipalities (as in the case of certain hospitals serving several municipalities). This might not pose a problem if such assignments were backed by adequate revenue sources and institutional capacity to implement and monitor programs. In practice, however, there is a danger that such services fall between the cracks of two major levels of government and that their functioning becomes a function of intergovernmental bargaining over the budgets; in that case, functions with the least clear expenditure responsibility are Likely to lose in such bargaining. In fact, there is some evidence that this is happening with regard to hospitals (Normand, 1995).

Second, budgets are still fraught with expenditure norms related to wages paid to municipal employees that, although officially abolished in 1990, continue in practice in a number of municipalities (World Bank, 1994). Originally, the norms were specified either in terms of physical units or costs of specific expenditure items and were mandatory for each municipality and/or relevant line ministry. These norms introduce downward inflexibility in the local budgets, and severely limit within-budget adjustments at the local level that may be necessary. As a result, they also may result in an inefficient pattern of local services, whereby some items are oversupplied (for example, hospital beds and school classrooms), while there may be shortage of others (for example, primary health facilities, teaching materials, and equipment). Indeed, the health sector reflects this pattern of extensive tertiary facilities and has one of the highest ratios of hospital beds per capita in Europe, with relatively modest indicators of health care outcomes.

Furthermore, the lack of clarity of expenditure assignment in some activities and inflexibility in others may cause the central government transfers to be misdirected: a good design of transfers presupposes clear tax and expenditure assignments, from which the need for equalization may be derived through a formula reflecting the precise nature of equalization sought. In this regard, one may argue that as long as the tax and expenditure assignments are not fully clarified, central government transfers will likely continue to change frequently, contributing to the instability of intergovernmental finances.

Capital Budgets

A large share of the capital budget is devoted to sectors and programs with heavy involvement of local governments: health, education and housing, and community services (Table 4). These three sectors account for almost two-thirds of the capital budget.

Table 4.Bulgaria: Shares of Central and Local Governments in the Capital Budget, 1993(In percent)
SectorCentral GovernmentMunicipalitiesSector Share in Total Budget
Legislative and judicial systems100.02.5
Science100.00.6
Education48.951.118.6
Defense and police100.03.7
Health37.562.515.3
Social security issues53.946.11.0
Housing and community services15784.328.8
Culture92.27.81.0
Economic activities68.631 428.4
Total47.252.8100.0
Source: Ministry of Finance.
Source: Ministry of Finance.

In health and education, the split between local and central government shares is roughly equal, while local governments spend most of their capital budgets on housing and community services. Given the formal assignment of spending responsibilities, local governments should account for over half of the total capital budget. In practice, however, their role is much more limited: only every third local government project makes it on the final capital budget list (World Bank, 1994). This reflects in part the lack of realistic priorities in the investment budgets of local governments, the lack of institutional capacity to appraise and rank projects at the local level, and the consequent capital expenditure pressures “from below” on the Ministry of Finance, early in the budget process. Furthermore, the Ministry of Finance exercises considerable discretion in reviewing initial investment proposals from the municipalities. It eventually draws a list of projects included in the capital budget, and, in consultation with the Ministry of Regional Development, the medium-term public investment program.

Another issue is that capital budgets were first to be cut, both at the central and local levels, in response to the decline in revenues and the need to contain the budget deficit. In addition to the real decline in capital budgets of municipalities, its share in the total municipal budget shrank from 14 percent in 1991 to 10 percent in 1993 (see Table 1). This has resulted in a large number of unfinished investment projects, many of which are not likely to be completed (Bogetić, 1996).

Local Government Borrowing

Bulgaria’s municipalities follow a simple “golden rule,” as in Germany: they are prohibited from borrowing for current expenditures, but may borrow for investment purposes. In practice, however, there has been little or no municipal borrowing from the banks. The only borrowing that has occurred has been from the central government. This reflects a combination of factors, including the fragility of the financial system, high interest rates, and an often forgotten constraint—the lack of adequate legal and institutional mechanisms for borrowing against collateral that prevents most lenders to lend for long-term projects, even local governments, despite the implicit or explicit government guarantees (Bogetić and Fleisig, 1997).

Local Dimension of Expenditure Management

Local governments everywhere have significant spending responsibility. But quality expenditure management framework and practices are, surprisingly, often lacking precisely at the local level, even when expenditure management by the central government is sound. This is even more the case in Bulgaria where local governments in the past were little more than a passive spending agency of the central government, implementing the plan through a variety of mandates and specific expenditure norms. This practice lingers six years after the beginning of economic reforms. One example is the large list of projects that municipalities annually submit to the Ministry of Finance, which often have not been screened or appraised appropriately and bear little direct relation to the budgetary realities of the municipalities or the overall budget. Recently, the Ministry of Finance has commendably started providing guidelines to the municipalities about the likely revenue envelope earlier in the budget process than in the past. But to make the budget process at the local level effective, there is a need for large-scale training in expenditure management, project appraisal, and for improving the overall implementation capacity of local governments.

The proliferation of extrabudgetary funds has also been noted as a general and local fiscal problem, reducing transparency and fiscal accountability (World Bank, 1994). Clear accounting and reporting rules, and the consolidation of many of such accounts is required to enhance fiscal transparency, accountability, and, ultimately, the quality of governance at the local level.

Major Issues

The overall pattern in the evolution of intergovernmental finances in the early transition period (1990–94) has been characterized by three trends: rising expenditure pressures on local governments, continued inadequate and unstable revenue sources, and slow response of local governments to the need for new techniques of expenditure management and project appraisal. These trends gave rise to a situation in which there has been little effective and orderly decentralization, and some key policy issues have been left unresolved. Some of these issues are discussed below.

What Should Be the Next Steps in Decentralization?

This question has been implicitly or explicitly asked by several analysts of Bulgaria’s finances (Martinez-Vazquez, 1995b; Chand and Lorie, 1993). The lack of a clear target model of decentralization has hampered the development of a strategy and steps toward that model. While Bulgaria has adopted the European charter for self-government as a model, the new legal framework remains often at odds with the old practice of centralized fiscal management.

While no ready-made prescription is available, a good start in the decentralization strategy would be to focus on expenditure activities that are subject to overlapping or competing jurisdictions and to clarify the appropriate level of responsibility. At the same time, it would be advisable to assign the local governments full responsibility for certain revenue sources (for example, property tax, the motor vehicle tax, and most fees and charges) and to strengthen their institutional capacity to exploit fully these powers (for example, through improvements in their property cadastres).

A special issue arises with respect to the fiscal status of several large cities, including Sofia, Plovdiv, and Varna. It is common even in developing countries for large metropolitan areas to have special fiscal status and a degree of fiscal autonomy beyond the one granted to other local governments (Bahl and Linn, 1993). This allows greater correspondence between local benefits and expenditures in areas of considerable concentration of publicly provided goods and services, which should increase the efficiency in their provision and facilitate their sustainable financing. Bulgaria could consider such special regimes for the largest cities.

Are the Perils of Decentralization Too Great?

The view has been put forward by some (Prud’homme, 1995) that decentralization per se is not a panacea and that it may hamper macroeconomic and fiscal management. Furthermore, the generally strong case for decentralization rests on certain assumptions on the state of local implementation capacity that may be limited in many countries (Tanzi, 1996): the power and ability to tax, effective tax-sharing arrangements, adequate performance of local and national civil service, and sound expenditure management. All of these concerns are certainly relevant to an assessment of the desirable decentralization in Bulgaria. They call for a concerted effort in building local capacity and a local civil service capable of designing, monitoring, and implementing effectively spending programs in the areas of responsibility of the local governments. On the other hand, it may be argued that local implementation capacity is not likely to improve unless and until expenditure responsibilities are effectively devolved to that level of government (McLure, 1995).

Three issues specific to Bulgaria are also likely to influence the choice of decentralization strategy and to constrain the pace of its implementation: the inertia of centralized management and the lack of tradition of local government, the fears of losing macroeconomic control, and the territorial dimension of Bulgaria’s politics (the Union of Democratic Forces dominating in major cities, and the Bulgarian Socialist Party in secondary towns and villages). In the past, all three have contributed to the slow and haphazard decentralization. First, the lack of tradition simply reflects the cultural inertia that requires time to overcome. New government institutions and rules of conduct can take root but only after a process of “learning,” the length of which depends on a number of cultural and local factors (for example, the strength of local civic associations, the extent of horizontal local social networks, and the education level and skills of the local civil service).

Second, Bulgaria’s economy has been under constant fiscal stress since the beginning of the transition. At the outset, the deficit of over 16 percent of GDP had to be drastically reduced in 1991 to prevent hyperinflation. But the high interest payments, which emerged soon thereafter, put further constraints on primary expenditures in the budget. And these developments took place against the backdrop of a severe revenue decline, driven by declines in the bases of the profits tax, trade taxes, and in nontax revenues inherited from the previous regime. The resulting chaotic fiscal and macroeconomic conditions were not a favorable environment for a genuine and carefully thought-out move toward decentralization.

And third, Bulgaria’s divided polity, in which the socialist party dominated the politics of the country for most of the transition, while the opposition remained on the sidelines of policymaking (except in 1991 during the radical liberalization and reform program launched by the government led by the Union of Democratic Forces) resulted in much political instability, frequent changes of governments, and government reshuffles. Such a situation did not favor shifting political power to large municipalities where the opposition was strong. Even with the most decentralized-minded government, incentives for central government to embark on significant decentralization would have been minimal in such a setting. More generally, these factors are not dissimilar to what has been happening in other transition economies. To that extent, a broader lesson from Bulgaria’s experience may be that instituting and implementing a well-designed decentralization strategy during a prolonged fiscal and macroeconomic crisis is extremely difficult. And when the key political groups in the transition are divided into identifiable territorial units of government, a divided polity will not contribute to decentralization.2

Are the Benefits of Decentralization too Elusive?

Theoretically, benefits from decentralization are rooted in the argument for greater efficiency in public goods provision and their closer correspondence to local demand (Musgrave and Musgrave, 1989). Implicitly, this argument assumes existence of effective institutional mechanisms for expressing local preferences for public goods within a local political system, accountable and responsive local governments who also have considerable autonomy, and effective grassroots organizations (Putnam, Leonardi, and Nanetti, 1993). The aforementioned lack of tradition of autonomous local governments in Bulgaria is therefore a constraint on the process of decentralization. But its existence should not make that process less possible or desirable than in any other country. In Italy, for example, regional reforms were introduced in the 1970s and often in communities that had little prior experience with decentralized management. Nevertheless, they had beneficial effects on many such communities. Key to the success of these reforms were building on and a new growth of many civic community associations, which ultimately strengthen the functioning of democratic institutions and help improve the responsiveness of local officials to local demand (Putnam, Leonardi, and Nanetti, 1993; Tullock, 1994).

Should There Be Controls on Local Government Borrowing?

Given considerable pressures on local governments to spend, the current prohibition to borrowing to finance current expenditures is desirable. In principle, a case can be made for allowing a limited amount of borrowing for investment purposes. However, in Bulgaria’s current circumstances of severe fiscal and macroeconomic imbalances, weak financial system, and limited own resources of local government, the question arises whether the golden rule should be strengthened to prohibit any local borrowing. There is no simple answer to this question. Perhaps the fiscal authorities should monitor the local fiscal situation closely and be prepared to tighten borrowing limits if signs of rising deficits and indebtedness of local governments emerge. At the same time, the imposition of a no deficit rule must be accompanied by tighter controls on quasi-fiscal activities of local governments, including arrears (see Mihaljek and Hewitt, 1993, for a discussion of a similar case in the former Yugoslavia).

In the medium to long term, as Bulgaria’s financial system is consolidated and strengthened, local governments with sound finances and credit rating should be able to tap banks and the capital market for financing quality projects, and the discipline of the financial market should be relied upon to a greater extent as a constraint on local borrowing.

The question of borrowing controls is, logically, part of the larger question of whether there is a need for (and what type of) explicit constraints on the deficits of local governments, including the forms of their financing. Clearly, as decentralization proceeds and local governments gain more financial autonomy, it will be increasingly important for local governments to manage their finances in a fiscally responsible manner. Otherwise, local fiscal deficits would offset sound fiscal management at the center. Furthermore, decentralization poses special challenges to macro-management even in the presence of hard budget constraints on local governments, as changed composition of local spending and revenue sources alone may have expansionary effects on the aggregate demand (see Chapter 1). This means that, as decentralization proceeds, local governments will need to become more involved in the process of fiscal macro-management. In Bulgaria, this raises the question of an appropriate institutional coordinating mechanism beyond the Ministry of Finance, which would serve at least as a forum for reconciling and coordinating local fiscal matters with national spillover effects.3

Concluding Remarks

This chapter has attempted to present a brief overview of Bulgaria’s intergovernmental finances and to discuss some key policy issues currently facing the authorities. Several conclusions of broader interest may be drawn from the preceding analysis.

  • Decentralization may bring important efficiency gains. But it is difficult to design and implement in the tumult of fiscal and macroeconomic crisis that often accompanies the transition to a market economy. Also, heightened political divisions may not bode well for decentralization. This may require postponing a major decentralization drive during the most unstable stages of the transition. Perhaps this is a matter of sequencing: legislative and capacity building effort may proceed first to prepare the ground for the implementation of decentralization under subsequent, more stable conditions.
  • Clarifying revenue and expenditure assignments is critical to the design of an effective system of intergovernmental relations. That clarification is also necessary to design an effective and stable system of intergovernmental transfers. Uncertainty about tax or expenditure assignments and about the level and timing of transfers hinder effective budgetary management at the central, as well as the local government levels.
  • Local borrowing is an issue of special importance owing to its potentially destabilizing impact on the overall finances of the country. Greater reliance on clear and firmly implemented rules of borrowing, perhaps as simple as the rule of “no borrowing for current budget” are likely to be needed in the transition, until the discipline of the market becomes an important supplemental instrument of control of unwise borrowing.
  • Strengthening local government’s institutional capacity for public expenditure management, accounting and budgeting, local taxation (for example, property tax and vehicle tax), and project appraisal is necessary to make decentralization succeed.
The author wishes to acknowledge detailed, helpful comments from Teresa Ter-Minassian, Janet Stotsky, and Gerd Schwartz.
1For a detailed review and critique of Bulgaria’s system of transfers, see Martinez-Vazquez(1995b).
2An extreme example of this situation is the almost complete centralization of fiscal powers in the neighboring Republic of Serbia after the breakup of the former Yugoslavia. The capital city of Belgrade, which had enjoyed considerable fiscal autonomy in the former country, was virtually stripped of most of its fiscal authority, as was the case in other municipalities. As the opposition increasingly gained the upper hand in large cities—their rise culminating in the victory in local elections in October 1996, subsequent mass demonstrations and sharp political divisions—the central republican government has little incentive to return fiscal autonomy to these municipalities. It is likely that genuine decentralization will have to await a more stable political and macroeconomic environment in that country.
3One such forum could be the regular meetings of the Ministry of Finance with the association of mayors.
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