LOCAL GOVERNMENT BORROWING IN POLAND
Since the mid-1990s, Polish local governments have increasingly used loans and bonds to fi nance their capital investments. By 2001, the total outstanding debt of the sector had risen to over USD 4.3 billion from virtually nothing in the early 1990s. Th is growth, while dominated by large cities, has included smaller towns and rural areas and, at least thus far, has been unaccompanied by signifi cant cases of fi nancial distress. Indeed, not only is the Polish municipal capital market among the most dynamic in the region, but it has clearly become a permanent and increasingly important component of the country’s local government fi nance system.
Nonetheless, the market is still in its infancy. Th e total outstanding debt of local governments remains less than 16% of their annual revenues. More importantly, most local governments continue to fi nance the vast majority of their investments on a pay-as-you-go basis with debt being used to fi nance less than 20% of their capital expenditures. Moreover, approximately half this debt comes from subsidized credit lines for the improvement of environmental infrastructure and thus is not strictly market-based.
At the same time, the market is fi lled with all sorts of anomalies, some of which are potentially dangerous. For example, the Polish bond market has grown rapidly over the last six years. Most of the issues, however, have been for less than a million dollars and have been purchased in their entirety by the underwriting bank. Similarly, the maturities of most municipal credits rarely exceed fi ve to seven years, and their interest rates are almost always variable. Th is is odd not only because infl ation has fallen dramatically over the last few years—and stayed relatively low—but because the national government has begun to issue fi xed-rate instruments with ten-year maturities that could and should serve as benchmarks for subsovereign lending.
Finally and most importantly, there are indications that over the last two years increasing numbers of local governments are using long-term debt to fi nance operating defi cits.1 Obviously, if this is the case it could lead to serious problems for the country in general and for the still immature municipal capital market in particular. In short, the development of local government borrowing in Poland has been both dynamic and promising, while at the same time fraught with all sorts of curious behaviors, regulatory weaknesses and potential dangers.
In the following, we attempt to explain both this dynamic growth and to analyze the outstanding structural weaknesses of the market. We will argue that the foundations of this growth lie above all in the essential soundness of the fi nances of Poland’s primary and most important tier of local government, the gminas (municipalities). At the same time, we will argue that most if not all of the most important threats to the market lie in the relative weakness of the two new levels of government that Poland created in 1999, the recent weakening of municipal fi nancial standing and the challenges posed by the absorption of EU funds.
2. STRUCTURE AND REGULATION OF POLISH LOCAL GOVERNMENTS
2.1 The Basic Structure of Subnational Governments
Poland now has a three-tier system of local government. Th e fi rst tier was created in 1990 and consists of 2,489 gminas or communal governments with an average of about 16,000 inhabitants. Th e boundaries of municipalities were basically inherited from the old regime and Polish reformers permitted the creation of new jurisdictions only under exceptional circumstances. As a result, Poland has managed to avoid the kind of jurisdictional fragmentation that has complicated the decentralization process in other countries of Central and Eastern Europe, and the vast majority of local governments are of reasonable size.
Municipalities are the most important level of local government in terms of functions and expenditures. Over the course of the decade, their responsibilities have been progressively expanded and there have been considerable shifts in the services that they provide as “own” and “delegated” functions.2
Municipalities are now responsible for pre-school and primary education, water and waste-water services, solid waste services, local roads, public housing, land-use and urban planning, some social welfare functions, some cultural functions and preventa-tive public health. Municipalities enjoy the presumppreventa-tive right to involve themselves
in the provision of any local public service not specifi cally assigned to other levels of government, and there are no hierarchical relations between Polish local governments.
Th ey can also establish special purpose associations to provide any of their service re-sponsibilities in common.3
County or powiat governments constitute the second tier of local government. Th ey took shape on an experimental basis during the mid-1990s and were made universal in 1999. Th ere are 381 counties, of which 66 are cities that have been granted county rights and responsibilities in addition to those they have as municipalities. Th ese include the 46 largest cities and 19 smaller towns that were granted county powers as compensation for their loss of status as provincial or regional capitals in 1999.
Counties are responsible for secondary education, local roads, a wide variety of inspection and permitting services, some land use planning, some cultural functions, local labor market policy, some social welfare functions, and the ownership and man-agement, but not the fi nancing, of primary health care institutions.
Th e creation of cities with county rights has separated substantial numbers of rural inhabitants from the infrastructure associated with county functions and created a number of problems with commuting—particularly for students in secondary education.
Similarly, it has left a substantial number of rural counties with very low revenues from shared taxes, and with important infrastructure defi cits, raising questions about their long term sustainability. Indeed, as we shall see, the fi scal weakness of counties may be creating problems for the operation of the subsovereign capital market.
With the establishment of counties in 1999, Poland also consolidated the number of regional (województwo) authorities from 49 to 16 while also extending self-government to this level of public administration. Self-governing regions, or Sejmiks, have been assigned select service responsibilities in secondary education, culture, roads and inspectorates.
More importantly, they are responsible for regional development planning.4 Th e Sejmiks share power at the regional level with nationally appointed governors (wojewoda) who, among other things, retain control over public safety functions and the disbursement of special purpose grants to subnational governments.
As can be seen from Table 2.1, municipalities are the most important level of local government and their expenditures account for almost 80% of all local government spending. Indeed, this share would be substantially higher if these fi gures included the expenditures of off -budget local government service providers.
As can be seen from Table 2.2 below, local governments are now responsible for more than 30% of all public expenditures and a remarkable 58% of all public investment spending. Moreover, while only 4% of national government expenditures are spent on investments, 13% of local government expenditures are devoted to capital improvements.
Indeed, as we shall see later, municipalities have been devoting a remarkable 20% of their total revenues to capital improvements.
Table 2.1
Shares of Local Government Expenditure (2001)
[PLN/m] Share [%]
Municipalities 38,568 46.6
Cities with county rights (big cities) 25,137 30.4
Counties 14,293 17.3
Regions 4,737 5.7
Total 82,734 100.0
Source: Ministry of Finance Reports.
In short, decentralization in Poland over the last decade has been both fast and profound.5 It has also been remarkably rational in the sense that basic public services have been assigned to levels of local government that are—in general—of suffi cient size and fi scal capacity to comfortably carry out their assigned responsibilities.
Table 2.2
Consolidated Public Expenditures by Level of Government (2000)
Public Expenditure All Levels [PLN/m]
National Government Local Governments [PLN/m] Share [%] [PLN/m] Share [%]
Total 343,570 236,711 68.9 106,859 31.1
Current 320,091 226,921 70.9 93,170 29.1
Capital 23,479 9,790 41.7 13,689 58.3
Capital expenditures as % of total 6,8% 4,1% 12,8%
Source: GUS Statistical Yearbook, 2001.
Th ese fi gures include the expenditures of the off -budget units of both national and local governments, according to IMF methodology (general government sector).
Hence the substantially higher total expenditure fi gures for local governments than those shown in Table 2.1.
Th is does not mean the system is perfect. Poland has a large number of relatively small gminas that do have trouble providing many services at acceptable standards. Similarly, there are probably too many counties, and the establishment of cities with county rights has placed many rural citizens in jurisdictions that lack the infrastructure necessary to
perform county functions. Th is has created a variety of transportation problems and has led to some disputes between local governments about how the costs of certain services should be paid for. Nonetheless, and in comparison with many countries of the region, it seems fair to say that Poland has done reasonably well in assigning service responsibilities to the appropriate levels of government.
Equally importantly, and as the investment levels of local governments suggest, Poland has also done a reasonably good job in creating an intergovernmental fi nance system that actually provides local governments with the revenues they need to meet the tasks they have been assigned.
2.2 Local Government Revenues
and the Intergovernmental Finance System
Local government revenues are regulated by the “Law on Local Government Revenues, 1999–2000.” Th is law was adopted with the creation of regions and counties in 1999 and was initially conceived as a temporary measure. Since 1999 the government has attempted to replace it with new legislation on at least two occasions, so far without success. Th e law preserved the previous legislation’s basic revenue categories for mu-nicipalities but extended most of them to counties and regions. Indeed, while there has been considerable adjustment of the shares and composition of the categories since the early 1990s, the basic structure of the law has remained relatively stable.
Local governments have four basic types of revenues: shared-taxes, conditional grants (dotacja), non-conditional fi scal transfers (subwencja) and own revenues. Own revenues include income from user fees and charges, from the sale or rental of municipal property, and from “own” taxes.
Th e category of user fees and charges consists of fees for classic urban services like water supply and treatment, public transport and solid waste collection and disposal, as well as stamp duties on offi cial documents, fees for the sale of real estate, and fees for the exploitation of mineral rights. In many areas, however, the ability of local governments to set user fees and charges is constrained by the national government. For example, the rates for stamp duties, transaction fees and exploitation rights are set by the Ministry of Finance. As a result, local governments’ ability to generate additional revenues by raising local fees and user charges is fairly limited.
Municipalities, unlike counties and regions, have the right to impose “own taxes”6 on real estate, agricultural and forestry activities, small businesses (an octroi)7 and dogs.
With the exception of the tax on dogs, however, the Ministry of Finance determines both the base and maximum rates of these taxes. Th e most important own tax is the real estate tax. Th is is a fl at, per square meter charge on land and buildings.8 Meanwhile, agricultural and forestry taxes are based on the average price of expected per hectare
yields of particular types of land. As a result, municipalities have no true own taxes of any signifi cance and their capacity to generate additional revenues is based primarily on the sale or rental of municipal property.9
Table 2.3
Structure of Municipal Revenues [%] (1991–2001)
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Total revenue 100 100 100 100 100 100 100 100 100 100 100
Own-revenues:
of which10
45.5 47.3 46.5 40.3 40.1 35.0 35.3 33.5 37.1 36.6 37.5 Real estate tax 15.3 16.4 14.8 13.4 14.1 11.4 11.2 11.3 11.7 12.3 14.8
Transport tax 1.1 3.5 3.3 2.8 3.0 2.7 2.9 0.8 0.7 0.7 0.8
Agricultural tax 3.9 2.7 3.8 2.8 2.6 2.2 2.0 1.8 2.3 2.0 2.1
Stamp fees 4.6 5.3 5.0 4.0 3.7 3.4 3.3 3.4 4.3 3.8 1.1
Asset sales NA NA NA 3.0 3.1 3.6 4.0 4.1 7.8 7.9 4.8
Shared taxes 28.9 22.2 25.4 23.1 23.1 24.5 24.3 24.7 17.7 15.9 14.6
of which CIT 0.0 2.6 3.6 2.5 2.3 1.8 1.8 1.7 1.4 1.6 1.1
PIT 0.0 19.6 21.8 20.6 20.7 22.7 22.4 23.0 16.3 14.3 13.5
Grants 12.0 18.8 16.7 21.6 20.6 13.9 14.1 14.3 11.6 13.7 11.7
of which Delegated 10.8 16.3 13.1 18.4 13.7 7.3 7.5 7.4 7.1 7.2 7.0
Own 1.2 2.5 3.6 3.2 4.2 4.8 4.8 5.0 2.9 4.4 2.8
General subsidy 13.5 11.7 11.4 14.9 15.2 25.3 24.1 25.4 33.6 33.8 36.2 Source: GUS Statistical Yearbooks.
Between 1991 and 1993 other income included income from asset sales and rentals.
In 1991 and 1992 it also included surpluses from the previous year. Of other income, the most important categories are the small business tax, the forest tax and the mineral exploitation tax.
As can be seen from Table 2.3, the most important own revenues have consistently been the real-estate tax, followed by stamp taxes and asset sales.11 Here, it is worth noting that the share of revenues coming from asset sales has increased over time, indicat-ing just how much property was assigned to gminas. Municipalities now derive about a third of their income from “own” revenues, down from 45% at the beginning of the decade.
All local governments receive revenues from shared personal income taxes (PIT), and municipalities and regions are also entitled to shares of corporate income taxes (CIT). Between 1992 and 1998 shared taxes consistently represented 23% to 25% of all municipal revenues. Currently, municipalities receive 27.6% of the PIT taxes paid by residents of their jurisdictions, and 5% of the CIT taxes paid by fi rms doing business in their jurisdictions.12
Th e Law on Local Government Revenues also guarantees all local governments a block grant, known as the general subsidy (subwencja ogolna). Th e composition of the general subsidy has evolved over the course of the decade and now includes three basic components for all levels of local government: an equalization component, a component for roads and, most importantly, an education component. For municipalities, the equalization component of the subsidy is provided to local governments whose per capita revenues are at least 15% below the national average. Th ese local governments receive 90% of the diff erence between their per capita revenues and 85% of the national average.13 Th e operation of the Polish equalization system has helped ensure that even fi scally weak jurisdictions have the fi nancial means to meet their basic service responsibilities. It has also helped rural jurisdictions make use of debt fi nance and to extend investment borrowing well beyond the larger cities.
In this context, it is also important to understand how the education component of the general subsidy works. Th is component is the largest element of the general subsidy and for both rural gminas and counties often represents their single most important source of revenue. Th e funds available for the component are set by the Law on Local Government Revenues and must equal 12.8% of state budget revenues.14 Th ese funds are allocated to local governments on the basis of a formula determined by the Ministry of Education, and approved by the Ministry of Finance.
In 1999, the government substantially increased teachers’ pay without accordingly increasing the sum of funds to be allocated to local governments through the education subvention. Th is produced an immediate crisis in local government fi nances that resulted in a partial correction of the subvention by the national government. Nonetheless, the costs of the wage hikes lowered the disposable resources of local governments and probably constituted the single most important reason for the decline in municipal investment spending after 1999.
Finally, the Law on Local Government Revenues states that local governments can receive earmarked grants for the execution of their own functions and for functions delegated or commissioned to them by the national government. Earmarked grants now account for a relatively modest 14% of municipal revenues, a fair share of which go for investments. As a result, municipalities can be said to have very signifi cant expenditure authority since more than 85% of their total revenues are freely disposable.
Until 1999, allocation of these earmarked grants was not subject to objective criteria. Instead, decisions were made by state-appointed governors on a discretionary
basis. Th eir decisions, however, were subject to review by the Regional Parliaments (Sejmik Samorządowy).15 Despite the absence of objective criteria for the allocation of these funds, a signifi cant share fl owed to rural gminas with weak fi scal capacities.16 Th is helped at least some rural jurisdictions to use debt to fi nance investments without getting into fi nancial trouble.
Despite the limited tax powers of municipalities, and the constant shifts in the way all forms of state transfers have been calculated (shared taxes, earmarked grants and the general subsidy), municipal revenues have been remarkably stable and robust.
Indeed, municipalities have been able to devote more than 20% of their income to investments, as can be seen from Table 2.4. In fact, the equalization system (and the nature of the education subvention) has made this true for all types of municipalities.
Nonetheless, it is important to note that investment spending has fallen in both real and nominal terms since 1999, mostly because of the problems with the education subvention described above.
Table 2.4
Municipal Investments as a Share of Revenues and GDP [PLN/m] (1994–2001)
1994 1995 1996 1997 1998 1999 2000 2001
Total Municipal Revenues 14,808 1999 30,956 39,518 46,119 51,742 56,350 60,954 Investment Expenditures 3,364 4,657 7,056 9,681 10,937 10,637 11,176 11,210 Investment Expenditures
as % of revenues
22.7 23.3 22.8 24.5 23.7 20.2 19.8 18.4
Municipal investment as % of GDP
1.6 1.5 1.8 2.1 2.0 1.7 1.6 1.5
Source: Ministry of Finance.
Th is high rate of investment suggests that the intergovernmental fi nance system has generally provided municipalities with revenues adequate to meet their responsibilities.
After all, no other economic actor on the Polish scene—meaning households, fi rms and the central government—has had similar levels of freely disposable income. Th is is not to say that the intergovernmental fi nance system has been perfectly aligned or stable. It is to say, however, that the system has been suffi ciently predictable and robust to make the prudent use of debt fi nance possible for both urban and rural jurisdictions. Indeed, there is little question that the general stability and robustness of municipal revenues in Poland is exceptional for the region.
Unfortunately, however, the picture with respect to the revenue adequacy and ex-penditure authority of Poland’s counties and regions is less clear, particularly for counties.
As can be seen from Table 2.5, neither level of government has signifi cant own revenues,
and for both, close to 50% of income is derived from earmarked grants. Moreover, and particularly for counties, the percentage of revenue derived from shared taxes—income that (all things being equal) can be expected to grow with the economy—is small.
Table 2.5
Revenues of Counties and Regions in 2001
County Region
[PLN/m] Share [%] [PLN/m] Share [%]
1. Own revenues 1,029.9 7.3 84.2 1.8
1.1 Income from assets 162.8 1.2 28.3 0.6
2. Shared taxes 181.2 1.3 558.6 11.6
2.1 PIT 181.2 1.3 69.0 1.5
2.2 CIT — — 462.6 10.1
3. Earmarked grants 6,459.5 45.1 2,401.5 52.2
3.1 For own tasks 2,249.1 16.0 1,074.7 23.4
3.2 For delegated tasks 3,932.7 28.0 1,082.6 23.5
4. General subsidy 6,503.9 46.3 1,582.2 34.4
Total 14,041.1 100.0 4,599.5 100.0
Source: Ministry of Finance Report.
Th us, the revenue base of both these new levels of government is considerably weaker than that of municipalities. Only 6.5% of counties’ expenditures went to investments, raising serious questions about the adequacy of their revenues. Th e situation for regions on this score is better, and a robust 30% of their expenditures went to investments in 1999.
2.3 The Regulation of Local Government Budgeting, Borrowing, Financial Reporting and Accounting
Alongside the Law on Local Government of 1990 and the Law on Local Government Revenues of 1998, the fi nancial management of municipalities, counties and regions are regulated by a number of other pieces of legislation. Th e most important of these are the Public Finance Law, the Law on Regional Accounting Offi ces and the Ministry of Finance’s Ordinance on the Classifi cation of Budgetary Revenue and Expenditures.
In the following, we discuss the most important aspects of these laws and the regulatory system they create.
2.3.1 Th e Regulation of Local Government Budgeting and Borrowing
In Poland, a single legislative act—the Law on Public Finance of 199817—governs the constitution, execution and control of both the national budget and the budgets of local governments. Th e law defi nes both the state budget and local budgets as annual, unitary (jednolity) constructs (Misiąg, 1996). Th e principle of unitary budgets means that all revenues must fl ow into the general budget, and that no revenues may be segregated for specifi c purposes.18 Among other things, this makes it impossible for local governments to formally separate their operating revenues and expenditures from their capital revenues and expenditures, or to dedicate specifi c revenue streams to particular expenditure items.19
Similarly, the principle of annual budgets means that budgets are conceived of as one-year fi nancial plans, and that all appropriations lapse at the end of the year. As a result, multi-year fi nancial obligations are subject to political risk and it is unclear whether it is legally possible to create so-called sinking funds dedicated to the repayment of future debt liabilities (Spoff ord, 1997). To reduce these risks, and to encourage long-term fi nancial planning at the local level, the law contains provisions that allow but do not require local governments to include in their budgets appendices that defi ne multi-year investment plans.
It remains unclear, however, whether these appendices really make possible legally binding, multi-year appropriations because the appendices can be changed by a normal budget resolution (Article 110, Law on Public Finance, Spoff ord, 1997). Moreover, while many municipalities have indeed begun to attach such appendices to their budgets, the treatment of them remains rather formalistic.
Th e Law states that the total expenditures contained in a budget defi ne the maximum expenditures a government can incur in given year. Th e Law also requires that expenditures be broken down into operating expenditures, capital expenditures and debt service payments (Article 28, Law on Public Finance). As a result, it is relatively easy for local governments to say how much they spend on investments from their general budgets every year. Nonetheless, being able to determine annual investment expenditure is not the same thing as having clearly separated operating and capital budgets. In fact, the way the law defi nes budget defi cits, having both a surplus and revenues from asset sales impedes a clear determination of how investments and operating expenditures are in fact being funded.
First, the law states that planned expenditures can exceed planned revenues, but that the budget resolution must indicate how the resulting “defi cit” is to be funded