Chapter 5
Chapter 5
Chapter 5
INTRODUCTION
In many countries, the responsibilities for the provision and financing of public
services are being increasingly decentralized. In transition and developing
economies, the expanded local government role in service delivery is often
hindered by limited financial resources, as well as weak institutional capacity
particularly in terms of inadequate finance, practices management, and know-
how. Many Urban public authorities in developing countries have come under
increasing financial pressures. They now face a rapidly growing demand for
urban services as a result of continuing rapid urban population growth;
however, their capacity to supply urban services as well as to undertake the
necessary infrastructure development, is severely constrained by a shortage of
fiscal resources.
Dear learners, in this chapter you will study in detail the roles of governments
(both central and local) in the urban economy; revenues and expenditures of
urban governments (local urban finance) and about the strategies employed by
municipalities to cope up with urban fiscal stress.
This section describes the different roles each level of government can take in
providing services to urban communities. The relative strength of these roles at
each level of government varies from country to country depending, among
other factors, upon the legal framework, the political-administrative structure,
or the economic strength of each government level.
Central Government
Among the several roles the central government can play in the provision of
urban services, three deserve particular mention: the assignment of
responsibilities, the payment of grants or subsidies to implementing agencies,
and the direct provision or sponsorship of loan finance.
The central government may involve itself in urban loan finance in three roles.
First, it may act as a direct lender of funds. This is especially appropriate where
policy requires the subsidization of lending terms or where the payback period
needs to be longer than that normally available on commercial loans. Second,
central government may sponsor loans from other domestic or external
institutions. In the domestic market, such sponsorship can take the form of
central government guarantees for lending institutions or their borrowing
instruments which would otherwise not be prepared or able to provide funds to
local authorities; or the central government might offer tax relief and/or
relatively cheap funds (for example, from employee savings or pensions funds)
to designated lending institutions. Such arrangements are particularly relevant
to housing mortgages for low-income households.
Other roles- The central government plays other important roles in relation to
urban governments through:
The designation of the local tax structures and the scope for the levying
of charges;
Local Government
Generally, local urban authorities are assigned responsibility for the provision
of the types of services which can most efficiently and effectively be delivered by
a decentralized form of government. Local governments normally are allocated
responsibility for detailed urban planning and urban development control. They
are responsible for controlling both land development and land uses, as well as
providing basic urban infrastructure services such as water supply, roads,
sewerage and drainage systems, and parks and recreational facilities.
Local governments have, over the years, expanded their activities into the
production of private goods and services, such as housing, recreation and
sporting facilities, and health services. In most cases, they have extended into
these functional areas to provide subsidized services to low-income residents
who would otherwise be unable to afford these services at the private market
price. In other cases, local governments have made use of grants or vouchers to
subsidize the private provision of these types of services to the poor. In all
these cases, local governments play an important redistributional role in the
provision of subsidized or free services to low-income residents including the
provision of basic human needs such as shelter, water supply, and access
roads.
Plan, control, and monitor the use of land and environmental assets; and
Local municipal governments have two primary sources of revenue. The first
are revenues(i.e. internal) that they collect themselves including local taxes,
service charges, fees and licenses, rental income from buildings and facilities,
interest income on municipal investments, as well as income from sales of
municipal assets. The other major sources of revenues include central
government transfers, grants, aid donation and borrowing, and external
A. User Charges
In general, central governments set taxation rules and generally take the best-
yielding taxes for their own use. Local municipal governments do not have
sufficient access to tax sources that would free them from dependence on
intergovernmental transfers. These level governments utilize three basic forms
of local taxation: i) property tax; ii) local income tax; and, iii) taxes on
expenditures.
The base of the tax, i.e. the property, is immovable and cannot, therefore
provides the locality with permanent tax income;
Income Tax
This category of local government revenues comprises a broad list of local sales
taxes, royalties, entertainment taxes, licenses and permits, and vehicle taxes.
These taxes are generally described as indirect taxes because they are usually
passed on by the payer to the end user. Indirect taxes can be described as
follows:
C. Intergovernmental Transfers
There are five major types of direct financial support, or transfers, that central
government provide to local governments. These are Capital investment, Tax
credits, Shared taxes, Grants in aid, and Loans. These categories concern the
form and method of allocating the transfer, not the source of the funds.
Tax Credit- Tax credits (sometimes called ‘tax expenditures’) are not direct
transfers of funds or facilities but are credits that the central government
allows to taxpayers for either contributions to, or loans to, local government.
The major uses of tax credits are found in (1) the deductibility of local taxes
from national taxation, and (2) the exclusion from central government taxation
of income earned on bonds issued by local governments.
Tax credits can also be given for contributions and/or taxes paid to local
governments. For example, businesses may be able to deduct local property
Shared Taxes- Shared taxes are taxes that are collected by the central
government and then partially, or wholly, refunded to the jurisdiction from
which they were collected. In practice, the shared tax may be either a
percentage of a nationally collected tax (for example, 25 percent of the sales
tax) or it may be a supplement to the national tax (for example, additional one
percent to an existing three percent base of the sales tax.) Either way, the
impact on the taxpayer and the yield to the local government is the same.
Grants- Grants are direct fund transfers which differ from shared taxes only in
the fact that the amount allocated to a local authority is not based on the
amount of a specific tax that is collected in that authority's jurisdiction.
Loans- Loans are the fifth major category of transfers. Central government
involvements in loan activities for local governments usually take the form of
three alternatives: Loan guarantees, Loans or grants to lending institutions
which lend to municipalities, and direct loans.
Loan guarantees are used to secure loans from commercial lenders to local
governments with the central government assuming the risk of default.
Expenditure data for municipalities are categorized under general fund (for
general expenditures of the local government) and several other special funds.
The major categories of expenditures that one is likely to encounter include:
Administration, Health, Water/sewer, Roads/bridges, Housing, Education,
Health/sanitation, Parks/recreation, Markets/sales houses…
There are a number of ways in which a local municipal government budget can
be strengthened. Foremost is the conservative estimation of both revenues and
expenditures. This means that in estimating revenues, real best estimates are
used without straining to raise revenue estimates to avoid tax increases or
having to consider appropriation cuts. Similarly, appropriations should be fixed
at levels determined by the best estimates of available work, services, and price
levels for the year. Budgets predicated on inflated revenue estimates and
shaved appropriations may be only narrowly balanced under the best of
conditions and are readily unbalanced by external pressures.
First, they can seek to raise additional revenue through a variety of means
such as increasing their user fees and charges, raising local taxes,
Second, they can seek to improve the efficiency and effectiveness of their
operations through productivity improvement programs; more efficient
programming, planning, and budgeting; cutting back some programs; using
low-cost approaches; or achieving cost savings through the use of private
contractors.
Third, they can reduce the scope of their activities by greater use of private
participation in the provision of urban services under self-help activity
systems and through mobilization of nongovernmental resources. Further,
in situations where urban authorities are providing purely private goods
such as car parking facilities and recreation facilities, they could withdraw
and allow the private sector to finance such facilities.
Equity relates to how the benefits and costs of urban government budgets
should be distributed among residents. Equity or fairness in taxation involves
two main principles. The principle of horizontal equity requires that people in
equal positions be treated equally. For example, large variations in property tax
assessment on homes of similar value would be considered to be inequitable in
terms of the principle of horizontal equity. The principle of vertical equity is
based on the concept of the ability of consumers to pay for services, that is,
those with a greater ability to pay are charged a greater tax burden. Most
concerns about local tax systems have centered on the vertical equity issue and
on the possibility that local taxation might be regressive, that is, low-income
residents pay a greater percentage of their income in local taxes and charges.
Urban authorities and municipal governments have to utilize and exploit all the
possible revenue sources effectively in order to cope up with acute financial
stress. In the previous section we have indicated the different sources of
revenues including local taxes such as property tax, service charges, fees and
licenses, rent for the use of buildings and facilities, interest on any investments
as well as miscellaneous sources such as from the sales of assets, central-
government grants …etc. Local governments have to make greater efforts to
mobilize more revenue from their own sources. It is important for urban local
governments to review their own efforts thoroughly to increase their level of
financial self-sufficiency by accelerating the growth of their own source
revenue. These efforts may involve the following measures:
Service charges
Urban public authorities customarily make charges for many urban services
and facilities. Housing for rent, water supply, sewerage, parking lots, toll roads,
slaughter houses, markets, health clinics, recreational facilities, and refuse
collection are frequently the subject of charges. Local governments must seek
to define their objectives clearly. When imposing service charges, two common
alternatives are:
Questions of equity may arise. A full-cost recovery approach may mean that
housing or water facilities cannot be provided to people who are poor and in
desperate need of them. Thus, a combination of the two approaches may be
appropriate whereby market-level charges to those who can afford them make
it possible to cross subsidize below-cost charges to the poor.
Often there is considerable scope for improving the ways urban government
agencies use the resources currently available to them. Undertaking measures
to improve efficiency and effectiveness in the provision of urban services aims
both at reducing the cost of providing each category of service and at ensuring
that the type and nature of the services are the most appropriate for achieving
the authority's objectives (which in turn should reflect the government urban
policy objectives).
There are five main methods of improving the efficiency and effectiveness of
urban governments:
Ensuring that adequate funds are available for the operation and
maintenance of capital infrastructure,
The reality of the widening gap between the demand and supply of urban
services inevitably compels many urban authorities in low-income communities
to hand over responsibility for the provision of selected urban services to
community self-help organizations. In these cases, some urban authorities
have been able to withdraw from the provision of selected activities and have
re-allocated the resource savings to other essential services.
What types of urban services are most appropriate for self-help service
delivery?
Increasing the role of the private sector in the provision of urban services may
also lead to the complete withdrawal of the government from providing services
which are purely private in nature and which the private sector is perfectly
willing to undertake in a free market situation. In some cases, private firms are
substantially disadvantaged by the presence of government competing with
them in the same market. This is so if the government is selling private goods
or services at a subsidized price to consumers and is, therefore, not fully
recovering all the costs attributable to those goods or services.
It often has access to capital sources which may not be readily available to
public authorities.
Attempt the following questions. Do not copy directly from the material. Write
in your words.
1. Mention and discuss in brief the roles of central and local government in the
urban economy in the Ethiopia context.
2. Taking any municipality with which you are familiar, explain it roles and
responsibility in the provision of different services to the community.
3. List the weaknesses and strengthen of the municipality (Q2) and try to tress
out the reasons behind.
5. Some scholars argue that community, special the poor, should pay user
chares. Others defend this view. What is your position? Substantiate your
argument with examples.
6. Mention and discuss the economic and non-economic rationalities for direct
central government fiscal support to local governments.