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Local Government Own Revenue, LandUse, and Economic Development Policiesin Serbia: The Case of NisTony LevitasIDG Working Paper No. 2009-03March 2009

Local Government Revenue, Land Use, and EconomicDevelopment Policies in Serbia: The Case of NisTony LevitasMarch 2009AbstractThe purpose of this note is to help both local and national government officials think throughpossible strategies for addressing one of the fundamental issues facing Serbian municipalitiestoday: How do Serbian local governments increase the revenues they need to improve theirpublic infrastructure while simultaneously creating an environment favorable to privateinvestment and local economic development? This is a dilemma that local governments facethroughout the world but which is particularly pressing in many developing and transitioncountries where local governments must address huge deficits in urban infrastructure without atthe same time over taxing their business communities upon which their future growth depends. Itis also of particular importance in Nis, the third largest city in Serbia and the economic engine ofthe southern and least developed part of the country.IDG Working Paper 2009-03

Local Government Revenue, Land Use, and EconomicDevelopment Policies in Serbia: The Case of NisTony LevitasThe purpose of this note is to help both local and national government officials think throughpossible strategies for addressing one of the fundamental issues facing Serbian municipalitiestoday: How do Serbian local governments increase the revenues they need to improve theirpublic infrastructure while simultaneously creating an environment favorable to privateinvestment and local economic development?This is a dilemma that local governments face throughout the world but which is particularlypressing in many developing and transition countries where local governments must addresshuge deficits in urban infrastructure without at the same time over taxing their businesscommunities upon which their future growth depends. It is also of particular importance in Nis,the third largest city in Serbia and the economic engine of the southern and least developed partof the country.The note is divided into two parts. The first part highlights the most pressing problemsconcerning the nature and structure of local government own revenues. Special attention is paidto the policy issues—both local and national—raised by the devolution of the property tax andother revenue collecting powers to municipalities. I also discuss the land use and landdevelopment fees; the business sign fee; the self-contribution fee; and utility pricing. I includeutility prices in the discussion because while income earned by utilities from the sale of goodsand services are not general budget revenues of municipalities, they are of critical importance inhelping local governments meet their infrastructure needs. They also directly and indirectlyaffect the business community.The second part of the note looks at these same issues in Nis today. On the one hand, I situatehow Nis is using its own revenue raising powers within the larger context of what seems to begoing on elsewhere in the country. On the other hand, I outline select policy directions designedto increase Nis’s own revenues and improve the local business environment.Both parts of the note should be regarded as something of a work in progress. This isunavoidable because many of the own revenue powers of Serbian local governments are both influx and conceptually problematic. Indeed, there is little question that they will change in theimmediate future as more and more jurisdictions take over the property tax; as utility financingIDG Working Paper 2009-031

practices move closer to European norms; and as urban construction land is devolved andprivatized.Nonetheless, I hope the note will help clarify the policy issues related to improving localgovernment own revenue powers, and of aligning these powers with more general economicdevelopment strategies. Indeed, I hope the note will provide a constructive framework for thefurther discussions of these issues at both the local and national level, as well as perhaps toilluminate some of the practical problems of addressing the tension between local governmentrevenue mobilization, and improving the enabling environment for businesses in the developingworld.Part I. Historical Legacies and Current Trends in Local Government Own RevenuePowers and PoliciesSerbian local governments, like most of their continental European counterparts, derive themajority of their revenues from grants, transfers, and shares of national taxes. Until the passageof the 2007 Law on Local Government Finances however, these grants, transfers, and tax shareswere set annually in the Republic’s Budget Law. As a result, the primary sources of localgovernment revenue were open to both bargaining and uncertainty. At the same time, Serbianlocal governments had few true own tax powers and thus limited ability to increase theirrevenues. Taken together, these structural weaknesses have meant that Serbian localgovernments have looked historically first to the national government to improve their finances.Or put another way, they have been essentially “revenue takers.”The Local Government Finance Law, however, went a long way towards eliminating theseweaknesses. On the one hand, the law defined the most important local government transfers andtax shares in framework legislation. This has radically reduced the bargaining and uncertaintythat surrounded the most important local government revenues. On the other hand, the Law madethe property tax a local government own revenue and obliged municipalities to take over thetax’s administration by January 1, 2009. As a result, many municipalities are now setting uplocal tax departments to administer the property tax as well as other own revenues that hadpreviously been administered for them by the Republic Tax Offices of the national government.Taken together, the stabilization of national government transfers and shared taxes and thedevolution of own revenue powers to local governments can be expected to lead to a progressiveshift in the perspective of Serbian municipalities away from being “revenue takers” and towardsbecoming “revenue makers.” This, at least, has been the experience in other countries in theregion.As elsewhere, however, this shift in perspective will be complicated by the general tendency oflocal governments to tax enterprises—who do not vote—more heavily than individuals—whodo. Moreover, it will be taking place within an institutional, historical, and legal environmentthat remains confused with respect to both the nature of certain own revenues, and how localgovernments can (and should) impose and administer them.IDG Working Paper 2009-032

Table 1 presents the share of local government own revenue in total revenues in 2007. By ownrevenue, I mean a fee, charge, or tax over which a local government has—at minimum—somecontrol over the relevant rate. As can be seen from the table, the most important localgovernment own revenues are in one way or another directly related to real estate (land andbuildings). Here I am talking about the property tax (4.2 percent); the land use fee (5.2 percent);the land development fee (13.1 percent); the land lease fee; and fees from the rental or use ofpublic assets (2.9 percent).In the rest of this section, I briefly review the status of the most import of these own-revenues.Here I highlight some of the conceptual and practical problems associated with them both asspecific sources of income, and as part of a more general system for financing urbandevelopment.Table 1. Own Revenues, all Local Governments, 2007Budget CodeTotal current Revenues700000Self Contribution711180Property Tax713120of which physical persons713121of which legal persons713122Vehicle Registration Fee714513Road Fees714514Hotel Tax714552Business Registration Tax716110Land Use Fee741534Other 741other 741Rental of Municipal Premises742142,742151-2Land Lease Fee742143 153Land Development Fee742253Income from sale of goods and servicesother 742Total Local Government Own RevenuesA.dinars% of 4,870,693,72435.6The Land Use and Land Development FeesThe land use and the land development fees deserve special attention because they are particularto post-Yugoslavian countries. Both fees were introduced in the late 1970s and have a dualcharacter. On the one hand, they were designed to provide local governments with some of therevenues they needed to maintain and develop urban infrastructure. On the other hand, theyrepresented an attempt to introduce elements of a capital market in land into the socialistIDG Working Paper 2009-033

economy by charging users of publicly owned assets differential prices for real estate based onits location.The land use fee is charged every year on the basis of how many square meters of land a givenbuilding takes up. Local governments are allowed to set the fee on the basis of zones that at leastin theory reflect the amount and quality of urban infrastructure that has to be maintained in givenparts of a municipality. Typically, local governments also charge differential rates for businessesand residents, as well as for public institutions like schools and hospitals. Here, it is interesting tonote that neither the old Law on Urban Construction Land, nor the new Law on Planning andConstruction explicitly mentions using the “type of activity” to which the land is put as a basisfor setting the fee. 1 Local governments, however, justify distinguishing between business andresidential users by arguing either that businesses put more stress on urban infrastructure thanhouseholds, or simply by saying that business can afford to pay, while households cannot.The recurrent nature of the fee and the fact that it is higher in more desirable (developed) areas ofthe municipality makes it similar to a property tax. At the same time, the fee is called a feebecause in theory it is supposed to represent the real costs of providing a particular publicservice. In practice, however, this idea is essentially a fiction because the level of the fee is notrelated to any objective calculation of the costs of “maintaining public infrastructure.” 2 Local governments do not define which public infrastructure the fee is supposed tomaintain, nor do they define how much they are actually paying to maintain publicinfrastructure. As a result, the fee cannot be understood as a payment for a particular typeof service. This is true despite the fact that some local governments have developed verycomplicated point systems that seem to “scientifically” allocate these costs acrossdifferent types of users because none of the systems defines which costs are in fact beingcharged for. The rate schedules that most local governments use to set the fee clearly discriminateagainst businesses. In all of the local governments I examined, 70 to 80 percent of the feecomes from legal entities, 3 and while it is true that some businesses impose highermaintenance costs on public infrastructure than households, it is certainly not the casethat 70 percent of these costs are related to business activities. Many local governments impose lower fees on businesses that typically “use” moreinfrastructure (e.g. manufacturers) than on those that use less (e.g. commercial enterprises1See article 27 of The Law on Urban Construction Land, 2001 Jugoslovenski pregled, 2001, and article 77 of theLaw on Construction and Planning. Article 17 of the Law on Local Government Finance however, allows localgovernments to use “type of activity” as a basis for distinguishing rates for all communal fees.2It seems that legislators called the land use fee a fee and not a tax because they felt it was inappropriate to allowthe taxation of state-owned land. See Boris Begović, Boško Mijatović, and Marko Paunović, “The Reform of UrbanLand Finances,” Center for Liberal Democratic Studies, 2006.3It should be noted that unlike with the property tax, the Serbian Chart of Accounts does not distinguish between theland use fee derived from businesses and the land use fee derived from individuals. To the degree that the feeremains a part of the Serbian system of public revenues, this oversight should be corrected.IDG Working Paper 2009-034

and service providers). Here, in other words, the fee blatantly leaves behind any logic of auser charge and is instead being imposed on the basis of what local policymakers thinkthe market can bear 4 .In short and in practice, the fee is really a badly constructed tax on businesses that shouldeventually be eliminated. Or put another way, the fee should be replaced by the greater use oftwo different local government revenues. On the one hand, the general purpose, quasi-taxcharacter of the fee should simply be folded into the property tax. On the other hand, its quasifee character should be expressed in higher utility charges so that providers of public services—such as water and solid waste companies—cover more of their costs out of revenues that aredirectly related to how much of a given service particular users consume.There are similar conceptual and practical problems with the land development fee. The landdevelopment fee is a one-time charge that local governments are allowed to impose on investorsfor constructing or improving residential buildings or business premises5 . In 2007, the landdevelopment fee constituted 13.2 percent of all local government revenues and was the singlemost important source of own revenue. The significance of the fee, however, differs greatlyacross jurisdictions. In the four big cities it constituted 20 percent of all revenues, while in allother municipalities it constituted only 4 percent of local government revenue or less than theexisting share of the property tax.Like the land use fee, local governments typically differentiate the fee on the basis of both thelocation of the investment and its purpose, though in practice they tend to use a much shorter listof purposes to differentiate the land development fee than they do for the land use fee.Nonetheless, and like the land use fee, the land development fee is not really a fee. It is called afee because it is supposed to represent a calculation of the costs that local governments havealready incurred to build municipal infrastructure. There is, however, no reasonable way toprice—or for that matter apportion—the historical costs of all infrastructure that localgovernments have built over the last 50 years.Equally important, the fee is not related to the costs of any new infrastructure that might benecessary to service the new development. On the contrary, investors are expected to carry thesecosts themselves, either in the form of hook-up charges paid directly to utilities or by fixingroads and other public amenities on their own. 6 Thus the land development fee is essentially atax on new investment dressed up as a fee for old investment.More recently, however, and at least in Belgrade, it has become a way for local governments tocapture the market value of unused construction land at the moment when they lease out state4Similar points are made in Begović, Mijatović, and Paunović, op. cit.5It is worth adding that the fee is imposed simply if the purpose of building is changed from residential to commercialuse.6Some local governments are willing to negotiate the fee downward if the investment is particularly attractive and theinvestor must make significant additional payments for hook-up charges.IDG Working Paper 2009-035

owned property to third parties. Thus, Belgrade has ceased calculating the fee as a chargeindependent of the lease fee for a state-owned property, and instead establishes the value of bothin a single auction procedure.Strangely however, the city then calls this value the development fee, when in fact it is reallymuch closer to the market value of the lease fee which by law must be established throughauctions. As a result of this “accounting” practice, Belgrade reported more than 13 billion dinarsin revenue from the land development fee in 2007 but only 150 million dinars in revenue fromthe land lease fee. Or put another way, the land development fee accounted for more than 20percent of the city’s total revenue while the land lease fee amounted for less than 0.2 percent.This situation in Belgrade has profound implications for how the business development feeshould be thought about. The first implication is simply that 70 percent of all local governmentincome from the land development fee is coming out of Belgrade and that everywhere outside ofthe capital—including in the other cities—the importance of the fee as a local governmentrevenue source is much closer to 4 percent than it is to 13 percent.The second implication is that at least with respect to the amount of the fee that is coming fromnew investment in unused construction land—certainly the major source of the fee in alljurisdictions outside of the capital and perhaps in Belgrade itself—local governments couldcapture the current value of the land almost entirely through the prices they receive throughauctions for the lease fee. Or put another way, current lease prices are now being discounted byinvestors by the amount they are expecting to pay in the land development fee. As such, simplyeliminating the fee is likely to result in auction prices for leases increasing substantially, amovement that would undoubtedly be even more pronounced if instead of auctioning off leases,local governments were auctioning off ownership rights.As a tax on new investment, the land development fee, like the land use fee, should eventually beeliminated and its revenue raising role replaced by two different instruments. First, particularinvestments that create measurable needs for new public infrastructure—such as new roads, newschools, or additional capacity in the water and sewage system—should be calculated separatelyand imposed on individual investors as forward-looking impact fees. 7Developing sound methodologies for the calculation of impact fees, however, is not a simplebusiness, and bad methodologies can result in charges that are as opaque and discriminatory asthe current development fee. Worse, it may take a number of years before Serbian municipalities(and their utilities) have the information systems and the cost data necessary to constructreasonable and equitable impact fees. 87In fact, investments that place additional burdens on network infrastructure such as water and sewage systems areoften charged for as a special part of a hook-up fee. In other words, one part of the fee is calculated on the basis ofthe additional piping and metering that must be built to service the site; and another part of the fee is based on theshare of the additional capacity the investment will use.8The MEGA program is currently investigating how to construct a reasonable impact fee that might be calculated inSerbia today.IDG Working Paper 2009-036

Second, the role of the land development fee as badly constructed business tax should bereplaced by a fiscal instrument that more equitably shares the costs of building and maintainingpublic infrastructure between businesses and residents. And here again, the basic answer lies inmaking more effective use of the property tax.Before turning to the property tax, however, it is important to understand how these fees havebeen administered in Serbia. Until recently, these fees have almost everywhere beenadministered by Land or Construction Directorates. The Construction Directorates are publicutilities founded and owned by local governments and ultimately responsible to them. But

Land Lease Fee 742143 153 3,337,582,471 2.2 Land Development Fee 742253 20,228,014,920 13.1 Income from sale of goods and services other 742 1,140,009,741 0.7 Total Local Government Own Revenues 54,870,693,724 35.6 A. The Land Use and Land Development Fees The land use and the land development fees deserve special attention because they are .

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