The Spanish local financing scheme and the rural-urban interplay: do state transfers produce balancing effects?

In the framework of the European research project LoGOV, at the Institute of Local Government Law (IDL-UAM) we have begun to analyze the Spanish local financingsystem, with a focus on the possible structural differences between small or medium-sized municipalities and large or very large ones. For a first economic approach to local financing, on April 12, 2019 we invited Professor Alfonso Utrilla de la Hoz, from the Complutense University of Madrid.

Regarding the future work of the LoGOV project, some issues of the presentation of Professor Utrilla’s can be highlighted (obviously, the analysis and conclusions are mine):

  1. First of all, the Spanish municipalities have wide financial capacitydue to their own resources (basically, local taxes such as the Real Property Tax). This means that state transfers have a complementaryand not a primaryrole in the financing system. State fiscal transfers could be articulated, in this sense, as a tool for balancing the financial system as a whole.
  2. Once pointed out the possible balancing utility of the state transfers, we must verify to what extent those transfers, as regulated in current Law of Local Financing (2004), really contribute to the correction of the existing financial imbalances. According to the current Financing Law, the rebalancing effect may actually exist, but more as a secondary and random consequence than as an effect directly foreseen by the law. Let’s see:

a) The legal transfer scheme does not relay on a calculation of financial needs(that is, the effective cost of municipal services). The financial system as a whole is based on political agreements settled in the 70s. Those agreements were closely linked to the population data, but they did not take other variables into account. The effective flow of transfers deriving form that legal scheme was finally consolidated in the Law of Local Financing (2004), taking as reference the figures of effective transfers of 2003. In sum: State transfers are calculated today by reference to the figures actually transferred in 2003 (which were in turn directly based on the population of each municipality).

b) Given that state transfers are not based on real financing needsand do not take into account either the fiscal capacity or the fiscal effort (the global tax burden effectively borne by the citizens in each municipality), some large municipalities show relative overfunding(in comparison with other large municipalities or with small municipalities). This relative overfunding can be seen in the statistics of municipalities’ expenditure per capita. The possible rationales for this relative overfunding (for example, the diseconomies of scale that some cities bear, or the large cities expenditure caused by the floating population) are not questioned now. What is remarkable now is that, to the extent that the legal transfer scheme does not pay attention to data on fiscal capacity and fiscal effort (magnitudes that, if taken into account, would normally favor small municipalities), state transfers do not produce real rebalancing effects.

c) Notwithstanding the above, precisely the fact that the system rests on the 2003 population data could have led to some not-foreseen balancing effects:

– The municipalities that have gainedpopulation since 2003 (normally, the largest municipalities) would have seen how their demographic increase (and therefore of spending needs) would not be supported by a relative improvement in the income transferred.

– And the municipalities that have lost populationsince 2003 (usually the smallest ones) would have received financial transfers above what would correspond to their current population.

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