Objective: The objective of this review is to highlight strategic directions and actions that would strengthen the operational and financial performance of the local government sector, and in particular the municipalities. The Government’s current reform proposals are focused on the provisions developed in the draft Public Administration Law. The draft law proposes an increase in central government funding for the local authorities. These increases would have to be put in perspective of the overall macroeconomic and fiscal constraints as well as current absorptive capacity in the municipalities. This report outlines strategic directions and actions that are designed as a comprehensive reform program for the municipal sector.
Rapid Urbanization: Currently, about 65% of the population lives in urban areas and it is expected that this percentage will increase to between 75% and 85% before it stabilizes. The urban population has grown by 4.4% per year during the last fifty years compared to an average national population growth of 2.3% in the same period. Although the pressures related to urbanization have been high, Turkey has been able to provide urban services to its citizens. Overall coverage of transport, water, and solid waste management is high, and on a per capita basis municipal expenditure has increased over time.
Need for a Strategy: In the past urbanization related demands were met by assigning basic responsibilities for service delivery to the municipalities. The central government was the main source of financing, and to ensure proper use of resources a number of oversight and control measures were put in place. While this strategy worked in the past, it is now becoming increasingly difficult for the central government to oversee the 3,200 municipalities in the country. Thus, while the municipal sector is functional, the current strategy does not adequately address increasing urbanization demands for the following reasons:
Fiscal pressures rule out the past practice of meeting the growing service demands through increased allocations from the central budget. The public sector’s share of GDP is high and this is especially relevant for municipal investments which have been dependent on the central government through the Treasury guarantee scheme and heavily subsidized borrowing through Iller Bank.
The system of local transfers and borrowing does not provide incentives for financial discipline. There is limited support to improve financial accountability at the local level, although financial accounting and management reforms have been mandated for the whole public sector and measures are being taken in the central agencies on this matter. The reforms include a new procurement law, new accounting standards and budget classification system, and new measures for internal control and audit. A major training and extension effort is needed to implement these reforms in the local authorities.
Large shares of central government funding for both operational and capital expenses at the local level have caused a split in the responsibility for taxation (by the center) and usage of resources (by the municipalities), thus reducing local accountability. Also, continued reliance on traditional administrative control has become increasingly ineffective to oversee, influence, and guide Turkey’s large and growing urban sector and economy.
The role of the private sector in the delivery and financing of urban services is minimal, excepting urban transport, due to the perceived high political risks and lack of a supporting regulatory framework. With greater involvement of the private sector, the service efficiency would increase and fiscal pressures would decrease.
Significant investments (tentatively estimated at US$20 billion) are needed for Turkey to meet EU standards in the areas of water, wastewater and solid waste. Reforms are needed to ensure that municipalities and their utilities can raise the required financing and manage their assets in an economic manner.
The Economy and the Municipal Sector:The size of the municipal sector is currently about 4% of the GNP. While there is little room for growth in the short term, sector growth in the long run may be possible provided there is a reduction in fiscal pressures and a shift from central government to local government responsibilities. The reforms proposed for the municipal sector are also linked to the financial sector. Long-term domestic loans are not available today and the high cost of borrowings from external sources, without State guarantees, limits debt financing by the municipalities. This in turn affects investment financing since municipalities on average use as much as 1/3 of their current revenues to fund capital costs.
Overall Approach Towards the Reform:Reforms in the municipal sector cover many areas and a strategic approach should be taken by identifying the type of reform, defining the role of various agencies, and outlining a schedule. A key factor in designing the reforms would be differences in the size, economic conditions, and institutional capacity of the municipalities. The proposed improvements may vary between municipalities and would be linked to their size and capacity. This review suggests municipal sector improvements in the following two broad categories:
Public Sector Reform: With the objective to create a system for sustainable delivery of urban services, reforms would center around the passage and implementation of the Public Administration Law covering three broad areas: central government oversight functions, central government transfers, and locally raised revenues. Particular emphasis would be placed on local implementation of the recently adopted public sector legislation and measures related to financial accountability, budget classification and control, and public procurement; and
Municipal Borrowing Reform: Reforms would focus on re-establishing local financial discipline, addressing the issue of municipal arrears, and the operations of Iller Bank to help establish a sustainable system of central government support for local investments. In the long term, an appropriate legal and regulatory framework should be established to facilitate the use of commercial funding for municipal investment. Before such financial intermediation takes place, several conditions would need to be met including an increase in financial discipline at the municipal level and an improved macroeconomic climate with room for expanded public lending.
Institutional Responsibilities: A number of agencies would be involved in the implementation of these reforms – including the Ministry of Interior, Treasury, Ministry of Finance, Ministry of public works, State Planning Organization, and the Association of Municipalities. For public sector reforms, it would be logical for the Ministry of Interior to be the lead agency. For municipal borrowing reform, Treasury should take the lead role given their close link to macroeconomic issues and the financial sector.
Municipal Responsibilities and Institutions: The core municipality responsibilities are: a) transportation which includes urban road construction and maintenance, and public transportation; b) water and wastewater services; and c) solid waste management. The municipalities are also responsible for land use planning and development, management of the environment, and conservation of natural and cultural/historical assets. The services are provided either by municipalities or through municipal enterprises. In addition, there are municipal enterprises that run commercial operations that are not directly connected to the core services. This review proposes that the municipalities disengage themselves from commercial operations that may attract the private sector.
Municipal Revenues and Expenditure: Municipal accounts are kept on a cash basis. Cash inflow for the municipalities is as follows: central government transfers – 50%; local revenue generation – 39%; borrowings – 11%. On cash outflow the breakdown is (2000): current expenditure – 43%; investment expenditure - 25%; and transfers – 32%. The cash outflow has traditionally been higher than the cash inflow and the deficit has been financed through debts held by the State. The current outstanding municipal debt to the State is around US$ 5.1 billion and it corresponds to about one year of municipal revenues. Due to statistical uncertainties, it is not clear whether information on revenues and expenditures captures all municipal activities, i.e. commercial and enterprise activities, and as a result it is difficult to determine the effectiveness of the use of funds compared to services delivered. A stronger local financial management system is needed to provide accurate information to guide the development of policies and to support day-to-day management decisions.
Central Government Oversight: The central government exercises considerable control over Turkey’s municipalities mainly through the Ministry of Interior and the provincial and district governors. The central government oversight relies largely on ex-ante controls and emphasizes the center’s obligation to ensure compliance with laws. The control measures fall under three categories – administrative, budgetary, and financial. As evidenced by the increasing financial arrears, the traditional reliance on ex-ante controls has become increasingly ineffective as the urban economies have become too large and complex for the center to control directly. Further, the oversight system is not outcome oriented and fails to provide information about municipal performance and actual service delivery. Reforms proposed to improving the central government’s oversight functions include:
Technical Assistance and Training. Training and advisory support should be provided to improve financial and operational performance. On the financial side, efforts should focus on local implementation of already legislated reforms that cover the entire public sector related to financial accountability and control, budget classifications and public procurement.
Increase performance monitoring. To this end, the Government has started a pilot project that will benchmark operational and financial performance across many municipalities. Development of the pilot is being supported by a grant from the Bank’s Institutional Development Fund (IDF).
Reduce administrative control. This would include increased local control over taxes and fees, modification or elimination of cumbersome administrative procedures that lead to delays, and replacement of the existing system of central government authorization for staffing decisions with increased authority at the local level.
Introduce a participatory budgeting process. International experience shows that the accountability of municipalities increases if citizens are involved in planning and budgeting processes. Increased accountability leads to better governance at the local level. This type of budgeting process could be considered in the medium to long term.
Central Government Transfers: Central government transfers to municipalities amount to about 2% of GNP and represent 50% of the municipal revenues. The transfers take place through three mechanisms: 6% of national taxes are distributed to the municipalities based on population levels (55% of transfers); 4.1% of taxes collected within the province of a metropolitan municipality are transferred back to the metropolitan municipality (30% of transfers) and; transfers through special government programs (15% of transfers). The transfer system has many appealing features as it is simple and objective and provides stability and predictability in municipal revenues. The transfer system also results in a modest form of equalization. However, the large share of central transfers de-links taxation and spending, weakening taxpayer accountability. Further, the transfers are not linked to actual service levels and extra transfers to the metropolitan municipalities foster preferential treatment of these urban areas. Also, the equalization scheme is merely a by-product of the proposed transfer scheme. Reforms related to improving the transfer system could include:
Reduce dependence on transfers. Larger cities should be allowed to levy additional taxes, linked to centrally defined taxes, such as income tax. Thus increased revenues would be generated through locally controlled taxes and fees rather than through increases in the central transfers.
Link transfers to service. Central transfers could be linked to some degree to the level of service actually provided by the municipalities. This would create an incentive for the municipalities to be more service oriented. A sanction mechanism should be established and enforced in case of inadequate performance.
Review of the equalization mechanism. In the short to medium term it is unlikely that the equalization system would be amended since the current system is functional and allows a modest level of transfer from richer to poorer municipalities. However, in the longer term, as infrastructure needs of the larger cities are met, institutional capacity of the municipalities is increased and a benchmarking system is in place, amendments to the equalization program should be considered to establish clear objectives for the equalization scheme and to assist the smaller and the poorer municipalities.
Municipal Revenues: Revenues raised locally correspond to 39% of total municipal revenues (about US$72 per urban citizen) although the tax rates and fees are almost exclusively centrally determined. About one third of municipal revenues originate from local taxes and fees while as much as two-thirds are generated from various business and enterprise activities. Locally raised revenues are centrally controlled and to a large extent are generated by commercial activities. While there are many taxes, the collection rates are low and the proliferation of local taxes and fees makes them costly to administer. There are rigid controls imposed by the central government to adjust local revenues and often these taxes and duties do not keep pace with inflation. The absence of a tourist tax also imposes a burden on residents of tourist areas who have to pay for the infrastructure that is designed for both residents and tourists. Also, the reliance on revenues from businesses and enterprises suggests that municipal activities may enter in commercial areas and crowd out private sector activities, and there is a mismatch between the source and use of funds for municipal services. A number of measures to improve municipal revenues are suggested:
Local tax reform. A thorough review of the existing local taxes and fees should be conducted with the objective to consolidate taxes, introduce tourist tax, increase control for the local authorities to set rates, and convert the environmental cleansing tax into a fee based service.
Improve financial management and collection. As responsibilities of local authorities towards generating local revenues increase, it is important to strengthen the local financial management systems and bring them in line with recent legislation and on-going reform efforts. This will help to keep track of resources, monitor service levels, and show the deficiencies in tax collection that in turn should help to increase the collection rate. The system should also be made compliant with EU standards.
Involve the private sector. Municipalities should disengage themselves from commercial activities that could crowd out the private sector. The municipalities should focus on the core services (transport, water, wastewater, solid waste management, and land use planning and development) where efforts to introduce the private sector should be made.
Municipal Borrowing: The poor credit record of municipalities remains a fundamental problem for the development of the sector. The total outstanding municipal debt to the State is around US$ 5.1 billion and an estimated 85% of this debt is not being serviced. Almost 90% of the debt is related to State support for investments – Treasury guarantees or loans from Iller Bank. The rest of the debt reflects outstanding payments to public institutions. The combination of municipalities’ poor credit history, perceived high local political risks, and non-availability of long term funds have not allowed the municipalities to access private capital for investments. Municipalities have only been able to access funds from Iller Bank and loans from International Financial Institutions, backed by a Treasury guarantee. A new Debt Law was passed in 2002 regulating public borrowing. Under this law, to apply for a Treasury guarantee, municipalities must clear outstanding obligations to the central government and justification for the investments must be provided through feasibility studies. It is too early to determine the effects of this new law but proper implementation would signal a shift from past practices. To further support the implementation of the Debt Law, legislation related to public sector financial management and procurement, and to improve the creditworthiness of municipalities, a number of proposals are suggested in this review:
Increase automatic sanctions. Mechanisms to impose stiffer and automatic sanctions against municipalities that do not service their debt should be considered. By making the sanctions automatic and not discretionary, greater incentives would be created for the municipalities to honor their debt obligations.
Benchmark performance. The monitoring system that is being developed through the Bank’s IDF grant will be the basis for determining the performance of municipalities. The system will monitor both financial performance and quality of service. The results will be publicly available and such a system should contribute to local authorities being more fiscally responsible.
Credit Culture Enhancement. As loan funds would have to be increasingly passed on to the municipalities with no government subsidies or guarantees, changes would be necessary in the borrowing practices of the municipalities. The changes would be supported by technical assistance on budgeting methods, financial control, auditing and disclosure standards, and developing municipal credit records.
Provide Technical Assistance. Assistance should be provided to the municipalities on investment planning, asset management, financial management, and project appraisal and implementation techniques.
Reforming the System for Municipal Borrowing: Initially, reform efforts should focus on establishing financial discipline and setting the incentives for municipal borrowing. In the medium term, reforms should ensure that the borrowing system enables municipalities to access funds including potential assistance from the EU. In the longer run, mechanisms should be developed to prepare municipalities for accessing commercial credit. There is extensive international experience to draw up on for all phases of the reform work.
Iller Bank Reform: Reform of Iller Bank would be a key component to improve the function of the current municipal borrowing system. Initially, efforts should focus on improving the credit culture in the municipalities. A detailed reform program should be outlined focusing on increasing financial discipline and improving practices in borrowing and selection of investments. The quality of local investments would have to be improved by rationalizing the process by which budgetary and other funds are transferred to municipalities. Iller Bank reforms would entail setting clear objectives for the bank, establishing independent day-to-day operations, achieving self-financing, and being less reliant on the government. Turkey’s Eighth Five Year Plan also supports the continuation of Iller Bank as a development and an investment bank. At a later stage, after financial discipline is restored, Iller Bank could play a role in financial intermediation.
Phased Approach: The reforms would also have to be carried out in a phased manner with benchmarks to determine progress. In Phase 1, the focus would be to identify reforms and review the existing situation in detail, initiate monitoring of municipal operations in a comprehensive manner and adopt the bill on Public Administration with appropriate provisions. In Phase 2, the focus would be to implement the selected reforms, including the legislation under the Public Administration Law. During Phase 3, the stress would be on performance monitoring and enforcement of reforms. In this phase, review of municipal functions to determine whether the municipalities should be responsible for social services – health education, social protection – should be carried out. Review of the equalization method should also be performed at this stage. Success in meeting the objectives in each phase would be determined through progress made in meeting pre-established benchmarks.
Possible Role of the World Bank:The Bank has assisted Turkey in the municipal sector by financing a number of water and wastewater projects. Through an IDF grant, the Bank is currently assisting the Government to develop a performance benchmarking system to track the operations in pilot municipalities. The Bank is also assisting the Government to address the current reform needs in public sector management and the financial sector. Given this background the Bank could assist with the proposed reforms in a number of ways including: a) advisory role on various aspects of local government administration, including international perspective; b) public sector reform support such as strengthening governance at the local level, increasing financial accountability, and introducing a framework for budget planning along the lines of ongoing reforms in central government; c) assist in introducing the private sector for delivery of services; d) assist in the reform of Iller Bank and re-establishment of financial discipline in municipal borrowing; and e) possible use of the Bank’s guarantee instrument to raise capital for the municipal sector by the financial intermediary or to cover the risks of an operator that may provide municipal services.
