Decentralization in Hungary - Case Study Example

Decentralization in Hungary Introduction Hungary went through many structural changes after the fall of Socialist in Central and Eastern Europe. During this period two basic processes dominated the structural change, one is privatization and other is decentralization. Decentralization can have both beneficial and harmful effect on any economy. It was found that in the process of Decentralization, political decentralization had a significant contribution on efficient economic adjustments during transitional recession. Through the process of decentralization local governments who were under fiscal pressure enjoyed autonomy regarding the broad expenditure which they have to deal with. This resulted in huge advantages to the Hungarian economy both at micro and macro level. But Hungary had to face many problems due to fiscal, political and administrative decentralization, like conflicts between different stakeholders in the economy. Many local government associations, sector ministries, different local government bodies and various sectoral business groups have different types of interests in the intergovernmental relations. Through the process of decentralization, Hungary was burdened with many conflicts like creation of sensitive and weak points of intergovernmental relations, unfunded mandates, moral hazards, unclear assignment of expenditures etc. This report will take a look at the effects of decentralization on the Hungarian economy and what negative impacts it had on their economy. Discussion Political and Legal Framework Initially due to the presence of Soviet council system in Central and East European countries, Hungary had a very formal and centralized government structure. The real power during that time lay in the hands of communist party and the formally elected bodies in the country didn’t have any real power. The reform of the Hungarian local government started during 1980s. The Local Government Act 1990 resulted in the political collapse of the centralized system and a new democratic system of governance was formed. This type of government system gave democratic right to every settlement. The new decentralized system is a unitary government system which has two sub national tiers. These include municipal government at the settlement level and county government at the regional level. Each of them acts independently and thus they are essentially they are self-governing units with each having their own responsibilities. Local governments exercise their rights and power through the elected council. Chief administrator looks after their major administrative functions. The number of local governments started to multiply from 1523 in 1990 to 3154 in 1999. This was due to the forced amalgamation policy carried out in the 1970s. Budapest which is the capital of Hungary accounts for nearly one-third of the GDP of the country. The local government of Budapest has joint revenues of Municipality and districts and they have to allocate the funds accordingly as per their expenditure needs (Wetzel and Dunn, 2000). In 1996, Act on Regional Development and Regional Planning was passed. The main goal for this law was to ensure that regional policy of Hungary was compatible with the Goals of European system. Local Public Services The size of Hungarian public sector is large as compared to other European economies. In 1995 it was found that Central government expenditures comprised of 51% of the GDP while in1998 it was 46%. This indicated that the Hungarian government was able to reduce their public expenditure due to decentralization (Halász and Nagy, 1998). Figure 1: Hungary Government Spending Source: Tradingeconomics.com The process of decentralization has improved the service delivery by public bodies. It is the job of local government non-budgetary institutions to provide good service delivery to common public. The local government has maintained acceptable level of public service delivery in spite of fiscal squeeze which they were facing. The local authorities adjusted due to change in the financial environment. After decentralization, the decisions on expenditures were transferred from central to local governments. Though in some instance this freedom led to mismanagement by many local bodies but the overall effect of such a decision was more efficient public sector (Laffont, 2001). Local Government economic and finance resources The Local self-government Act provided wide revenue sources for local governments. In the last 5 years, the local revenues accounted for 30% of the total revenues. There were various sources of revenues for the local government namely local taxes, user charges, revenues from entrepreneurial business, sell of commercial properties and assets. Within the local taxes, there were five categories like tax on buildings, tax on business, tax for communal services, tax on tourism and tax on plots. The fiscal transfer of central government accounted for 70% of the total revenues which includes several types of grants like normative grants, matching and non-matching grants. In the last five years, the structure of revenues in Hungary proved to be stable though the entire intergovernmental fiscal system was modified frequently (Balas and Hegedus, 2000). Figure 2: Revenues of Local Government in Hungary Source: The Budget Data in Consulting, 1998 The financial resources of Hungarian local bodies like municipalities increased after the decentralization process. The local bodies were independent from the centralized decision making process. The local tax law came into effect following Act 6 on local taxes which came into effect on 1991 and was amended by the Parliament every year (Bird and Wallich, 1998). Business turnover tax The local business turnover tax is paid by companies which reside within the local body like a municipality. This tax makes up for 16% of the total municipal income which is levied on the net income of the company. Municipalities represent economically depressed regions where they previously could not collect much revenue from this source. After decentralization of the economy, the revenue from this source started increasing, and it reached up to 30% presently. Revenues from sale of local government assets Considerable assets were transferred to the local government between 1990 and 1995. After decentralization process in 1995-97, the revenues from this source were around 35% but it decreased in 1998 which indicated that it was onetime revenue. Business tax It represents the gross turnover tax which is levied on the manufacturers. This tax does not cover the retail sales. Such kind of tax is levied on all public and private bodies. This includes Communal tax, land tax, tax on Tourism and property tax on privately owned properties. This kind of tax formed 7.5% of the total tax of Central Government tax in 1999. Thus after decentralization this tax did not formed a major part of the tax structure. It was found that local governments earned their maximum revenue from business tax (Stec, 2012). Figure 3: Revenue of local government from assets After decentralization, the local governments of Hungary efficiently provided public services like basic health and social welfare provisions, primary education, public lighting, waste disposal, cemeteries and public roads. Before Decentralization in 1996, the tax structure comprising of borrowings, own revenues and transfers were not sufficient enough to cover their total expenditures. This resulted in residual deficits for the Central government. During the same periods some local governments also started defaulting on their debt and thus needed additional resources from the Central government. This was due to imbalance between revenue assignments and expenditure responsibilities and lack in the transparency in the use of public moneys. Facing such major macroeconomic crisis, Hungary in 1995 implemented a stabilization program. The stabilization program which was implemented comprised of three elements which resulted in greater discipline of finance management by the local governments (Tóth, 2009). The first step was introduction of high powered incentive scheme which forced the municipalities to reduce their spending. Figure 4: Hungary Local Government Accounts The second step was that the annual borrowing of the local governments was subject to cap which was around 70% of the total revenues minus the costs of debt servicing. Third step was enacting on the local bankruptcy law to prevent bailouts of local governments by the central government. Following this the local governments were able to meet the fiscal targets. Still there was presence of systematic imbalances in the financial structure of local government. It was found that revenue and expenditure assignments were not properly matched. The system of transfer resulted in inappropriate incentives thus leading to local governments claiming additional amount of grants to manage their financial difficulties. Though amount of such grant remained at around HUF 6 billion between 1996 and 1997, almost 0.1 percent of GDP, the number of bodies who applied for such grants increased by 25 percent (Kopanyi, 2000). Though initially due to decentralization the public services improved, later the services slowly started degrading. Such degradation implied that the economies of scale were not properly exploited which led to poor services quality and high costs. Efforts have been made to make the delivery service cost effective through creation of regional development units and functional associations. But such kind of associations was constrained due to limited legal status and they didn’t have the ability to receive grants or collect their own revenues from the state. The roles and responsibilities of many regional level bodies were unclear in nature. This compounded the problem of problem of coordination and undermined the efficiency of service delivery. Though the local expenditures of the local government as percentage of GDP declined due to tighter borrowing constraints and decline in transfers, it was not possible for them to keep the expenditures at the same level. This was mainly due to amortization of local assets which has not been incorporated properly in their local spending decisions since the renewal of assets was postponed repeatedly (Todor, 2002). Fiduciary and Accountability Responsibility Through the process of decentralization design of a good incentive system and efficient governance system is aimed at. Full accountability refers to caring of public funds and managing the fund on behalf of people transparently according to known principles and standards. Financial control and full accountability is simply not a question of legislation but of democratic practice. Thus to move from a central directive system to decentralize system on the basis of devolution of power and public accountability can happen only as fast the participants are prepared to go. Hungary was quickly able to adapt to such process of accountability. But though many think that decentralization reduced corruption by increasing efficiency and transparency, in actual sense it merely changes the location of corruption, the identity of the beneficiaries and perpetrators and the amounts involved. Corruption was found in Hungary which showed that though there was presence of county level planning but there was no external control of current expenditures. So here the external audit is limited in such cases. Conclusion Hungary has been a pioneer in the reform of local government among transition economies. It has done it through a series of legal reforms since 1990. Hungary has decentralized the sate administration and re-establishes autonomy of local government. Through the process of decentralization the public delivery system became little bit more transparent initially, but after some time it became fragmented. The various types of taxes which were implemented were structured in such a way it resulted in increased earning by the local bodies after decentralization. This resulted in corruption in the system. The system of decentralization led to adequate lowering of government expenditures which they mainly targeted. Hungary implemented the accountability and financial control of the local bodies successfully. But Hungary still has a long way to go because decentralization has both advantages and disadvantages associated with it and it needs to correctly structure its policies to use it to their advantages. References Balas, G. and Hegedus, J. (2000). Local Self-Government And Decentralization In Hungary. Retrieved from: http://www.fes.hr/E-books/pdf/Local%20Self%20Government/03.pdf. Bird, R. and Wallich, C. (1998). Financing Local Government in Hungary. Retrieved from: http://www-wds.worldbank.org/external/default/WDSContentServer/IW3P/IB/1992/03/01/000009265_3961002140306/Rendered/PDF/multi_page.pdf. Halász, G., and Nagy, J. (1998). Reforms in Education Financing London: Bokros and Dethier. Kopanyi, M. (2000). Hungary: Modernizing the Subnational Government System. Washington: World Bank Publications Laffont, J. (2001). Fundamentals of Public Economics. Cambridge: The MIT Press. Stec, I.B. (2012). Hungary: An Unfinished Decentralization? Retrieved from: http://munkschool.utoronto.ca/imfg/uploads/214/imfg_no_11_barationline_final_(2).pdf. Todor, A. (2002). Decentralization and State Capacity. California: Editura Lumen Tóth, K.B. (2009). The Impact of Fiscal Decentralisation in Hungary. Retrieved from: http://ethesis.unifr.ch/theses/downloads.php?file=Beer-TothK.pdf. Wetzel, D. and Dunn, J. (2000). Fiscal Decentralization in Former Socialist Economies. Progress and Prospects. New York: The World Bank. Read More