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Equalizing the income of urban and rural municipalities: a comparison between Spain and Canada (Ontario)

Over the next four years, in the EU research project LoGovwe will compare in several countries, both European and non-European, the different institutional and functional features of urban and rural municipalities. One of the aspects that we will consider is that of municipal financing. In the following, an initial, provisional and elementary comparison is drawn between the financing of Spanish municipalities and those of Canada. I thank Enid Slack of the University of Toronto for her crucial insights that have helped me understand the Canadian local financing system.

With global data, both in Spain and in the different provinces of Canada (since in this country local governments concern each province) revenues from own taxescontribute the majority of municipal revenues. The greatest differences are observed in the typologyof taxes from which the income derives and in the other complementary sources of financing (borrowing excluded). Let us start with a simple description of the sources of municipal income in each country.

a) In the case of Canada, the second source of income, after taxes, is the feesfor the providing of municipal services, while in Spain the State transfers(grants) are determinant. Contributions of developers, which in Canada are relatively important, in Spain are more difficult to identify, although they can be indirectly located among the so-called “property returns” (ingresos patrimoniales). Considering the data provided by Andrew Sancton (Canadian Local Government: An Urban Perspective, 2.ed., Oxford University Press, 2014, p. 296) and the official Spanish figures of 2015, a simplified, rounded and schematic comparison would be like this:

b) Beyond the obvious differences in the general sources of income, a salient and relevant data is the greater or lesser diversity of local taxes. In the case of Canada, 97 % of the tax revenue comes from property tax, while in the case of Spain the revenues of the comparable tax (impuesto sobre bienes inmuebles: IBI) are relatively smaller (66.91 % of all municipal tax revenues, fees excluded). By the way, at this point the statistics of the OECD (2018: 78) are equivocal, since they account for municipal tax revenue the shares of municipalities in some State taxes (on income [IRPF] and on sales [IVA), which are rather State transfers, not local tax revenues.

As it has been seen, the total amount of State or provincial transfersis a major differential element between Canada and Spain. This is precisely what I am going to focus on now, because here is where the elementary difference between urban and rural municipalities becomes more relevant.

Spanish municipalities obtain an important part of their resources through unconditional financing from the State. The regional governments (comunidades autónomas) provide much less funding, and it is usually conditioned. Unconditional State transfers are remitted to all municipalities, both rural and urban. These transfers are fundamentally based on the populationof each city, as accounted in 2003. In strict legal terms, the State transfers to the larger cities rely on the income collected by the State through the State income and added value taxes (Sections 111 and 112 of the Law on Local Finance [Ley de Haciendas Locales]), while the transfers to the smaller cities and villages are directly based on the population (Section 124 of the Law on Local Finance). This notwithstanding, the Law guarantees the effective income of each municipality prior to 2003, based on its population. In its actual outcomes, this transfers scheme greatly favors the largest municipalities(the urban ones). On this elementary description of the Spanish State transfers scheme a preliminary comparison can be made with that of the Canadian provinces.

It has been noted before that in Canada, local financing relies primarily on property tax and user fees. Canadian provincial grants do not fulfill – in global terms – a central role in the municipal financial system. First, because the total amount of the grants is relatively low (half that in Spain), and second because the grants act only as an instrument to correct imbalancesbetween urban and rural municipalities. This is: the large (urban) municipalities do not receive unconditional provincial transfers. Urban municipalitiesare basically financed with the revenues of property taxes and fees. In contrast, rural, small or remote municipalitiescan hardly relay their finance on the property tax, precisely because the tax base of the property tax (the assessed value of households) is low or very low. An increase in the tax rate to compensate the weakness of the tax base is not seriously thinkable. Both for political reasons (no elected representative will raise the tax rate if he/she wants to be reelected) or simply because in small municipalities demographic movements are very sensitive to tax increases (“vote with the feet”). This can explain why the financing of rural municipalities is highly dependent on provincial aid.

At this point, the central question now is how provincial aid is distributedto rural municipalities. Taking Ontario as a reference, we see that provincial transfers are articulated through the so-called Ontario Municipal Finance Partnership, which in its 2019 version contributes 505 million Canadian dollars ($) to 389 municipalities. The grant includes four types of grants or transfer programs. Through these four programs, which can act in a complementary manner, the different grounds and dimensions of the rural financial deficit are identified.

a) The first component of the Ontario grant scheme is the Assessment Equalization Grant($ 149 million in 2019). This subsidy is aimed directly at compensating the small municipalities for the low assessed value of rural property. The assessed value of each household is the one which defines the tax base of property tax. To allocate grants to each municipality It is firstly calculated the average of the assessed values of households in all municipalities of the province. In a second step, the average values of households in each municipality are also calculated. Once these two magnitudes are obtained, the difference between the average value in all Ontario and the average value in a specific municipality is the indicator for the grant allocation. Consequently, this subsidy does not properly equalize the incomes of all municipalities. It simply ensures that those municipalities whose households show a low market value obtain the average incomeof all municipalities in the province.

b) The second component of the Ontario transfers scheme is the Northern Communities Grant(89 million in 2019). This fund, designed for rural and heavily depopulated areas of northern Ontario, is uniform. It is based on the number of hosuseholds, and the per-household amount is $ 240.50.

c) The Rural Communities Grant(150 million in 2019) provides funding to municipalities based on the proportion of their population residing in rural areas or small communities. This proportion of “rural” population is measured by the “Rural and Small Community Measure” (RSCM). In the application of this fund, municipalities are classified into two big groups: municipalities with more than 75 % of “rural” population; and those whose rural population ranges from 25 to 75 %. Logically, the latter group receives fewer transfers in this concept than the first group.

d) Finally there is also the Northern and rural Fiscal Circumstances Grant. This subsidy provides targeted support in recognition of the special needs of some small rural municipalities. Those special circumstances are measured by the “Northern and Rural Municipal Fiscal Index” (MFCI), which grades the financing needs from 1 to 10.

The entire transfer system relies on the hypothesis that the tax base of the property tax is very low in rural municipalities. But the four-party structure of the grant allows analyzing the alleged financial deficit from different angles: the assessed value of households; the portion of rural population; and the real financial needs of each municipality.

In a brief comparison with the municipal regime in Spain, several initial statements can be made. First, unconditional grants in Ontario are not a general element of local financing(as in Spain), but a corrective instrument for imbalances between urban and rural municipalities. This means that Ontario urban municipalities are financed almost exclusively with their own taxes, not with transfers. Second, unconditioned provincial grants in Ontario do not simply refer to the population of each municipality (as in Spain), but instead take into account other indicators of real financial needsand the type of population of each municipality (more or less “rural”).

It is still too early to essay possible comparative conclusions. A priori, local subsidies in Canada present the appeal that they are directly aimed at correcting or compensating the income deficit of rural municipalities. But it must be taken into account that this is caused, to a large extent, by the financial hegemony of the property tax, which some scholars consider a weakness of the Canadian financing scheme. The Spanish system diversifies the sources of financing to a greater extent, giving greater prominence to state transfers. This facilitates sustained financing of local governments in all phases of the economic cycle. But the problem in Spain is that State transfersdo not properly equalize. They do not take into account the singular factors of financial deficit, nor the demographic features that determine this deficit, such as the aging of the population and the demographic dispersion (or “rurality”) of each municipality. The question then is whether in Spain the role of these equalizing transfers is functionally fulfilled throughout the upper-tier of local governments, the provincial councils, basically funded by transfers of the State. This issue will be analyzed in the oncoming months.

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