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The text will be available in English on June 8th 2018.

Sharing Income Tax Revenues with Municipalities

The last decade was characterised by the reluctance of a number of Bulgarian governments to pursue their strategic commitment to fiscal decentralisation. The last meaningful steps towards higher financial independence of Bulgarian municipalities were taken in the distant 2007, when municipal councils were given the power to determine the size of local taxes and fees within a given range. The period that followed showed that this change was insufficient and has not led to a significant change in the structure of municipal budgets.

• Municipal budgets remain highly dependent on transfers from the central government. About 2/3 of municipal budget revenues come from such transfers, while capital expenditures are almost entirely dependent on EU funds.
• Independent fiscal policy is severely hampered by the lack of own revenues. The deteriorating condition of municipal budgets and the stipulations of the 2016 “Financial recovery procedure for municipalities with financial difficulties” have led to incentives to increase existing local taxes and have created prerequisites for growing political dependence through non-interest-bearing loans and their subsequent "forgiveness" by the Ministry of finance.
• The lack of own revenues limits the role of local democracies and deprives municipalities of the tools needed to form local policies. It is questionable whether the current system allows them to carry out long-term policies in the interest of their own citizens.

The Solution: Fiscal Decentralization

Fiscal decentralisation rests on two basic principles - "local self-government" and "subsidiarity". The first principle relates to the right and the ability of local authorities to manage and be responsible for a substantial part of local public affairs, while the second principle implies that problems are resolved as quickly, easily and efficiently as possible at the lowest possible level of governance.

A real change in the financial autonomy of the Bulgarian municipalities is only possible through the restructuring of the existing tax system. There is a wide consensus that a good first step towards fiscal decentralisation would be to share one-fifth of the revenue from personal income tax with municipalities. If we look at the 2018 budget, which foresees personal income tax revenues in the amount of BGN 3,372 million, the transfer of 1/5 of the proceeds would increase the own revenues of the municipalities by nearly BGN 675 million or by 30.4%.

Sharing income tax revenues with municipalities cannot and should not be approached as an isolated and unconditional shift in the structure of the tax system. In order for such a reform to succeed, additional steps must be taken, among which:

• Transition towards effective program-based budgeting procedures, which can lead to higher efficiency and transparency;
• Improved efficiency and transparency of local finances and the way in which municipal enterprises and municipal property are being managed;
• A reform in the administrative division of the country, which guarantees the long-term demographic and financial sustainability of municipalities.

The process of financial decentralisation also suggest a shift in the democratic model in the direction of increased political accountability at the local level and the active participation of civil society in the policy making process.

Sharing income tax revenues with municipalities (and eventually the delegation of the power to determine the actual tax rate within a given range) will lead to:

• Increased financial independence of municipalities and a better connection between local government revenues and the socio-economic processes at the local level;
• Reduced political dependence from the central government;
• Incentives for local governments to create and maintain a good business environment and to attract investment that can foster employment and, thus – municipal budget revenues;
• Restoring the lost link between taxation and political representation at local level and increasing the capacity of civil society to participate in the local policy debate;
• Creating conditions for real tax competition at the local level, especially when municipalities are given the right to determine the rate of the income tax within wider range.

The full text of the report is available in Bulgarian here.

| download full analysis [BG only] |

Is there convergence in the levels of economic development within the economic centres? This is the question that the Institute for market economics’ new study attempts to answer. It is based on the “Economic centres in Bulgaria” study, and aims at explaining the processes taking place within the individual centres. In the broadest sense, the study has three goals: to establish the fundamental differences in demographic and economic development between municipalities within and outside economic centres, to assess the potential for convergence in the levels of economic development within the individual economic centres, and finally to study whether such convergence is already taking place.

From the economic perspective, the study found that in the primary economic measures (production per capita, foreign direct investment and fixed assets expenditures, unemployment and salaries) municipalities in the periphery of economic centre resemble more those outside centres than their cores. In spite of that, the differences between peripheral municipalities and those outside centres are quite noticeable, which in turn means that there can be no doubts in the positive effects of the participation in economic centres on the peripheral municipalities.

As far as demography is concerned, the results of the study are much more ambiguous. Out of the main population dynamics indicators, a significant and unambiguous difference between municipalities in and out of economic centres can be seen only in mechanical growth. In municipalities outside of economic centres there are much more people permanently leaving compared to those settling in them; in the peripheries this ratio is lower, and in economic cores there are more people settling than ones leaving. This is a result of the possibility for daily committing from peripheral municipalities to a nearby economic core, where the better and better paying workplaces are located. In other words, the ability to commute daily to a nearby core means that people take the decision to move away permanently less frequently. This, in turn, keeps smaller and less economically developed settlements in the periphery of economic cores from depopulating. The very structure of the economies of the big groups of municipalities is different, primarily in the balance between agriculture, industry and high tech. While municipalities outside economic centres and those in the peripheries have a larger share of agriculture, most cores have and industrial profiles. High tech activities are almost exclusively located in the cores and are almost absent from other municipalities.

The assessment of the potential for convergence in the levels of economic development of municipalities met the IME analyst’s expectations. Municipalities who started the period between 2011 and 2015 from a lower level of economic development have been growing faster compared to those with better developed economies. It is interesting to note that this relationship is stronger for municipalities outside economic centres, compared to those in them.

When it comes to the convergence process, some economic centres do show convergence in the levels of economic development, i.e. a shortening of the distance between core and peripheral municipalities. This can be seen in the change of the standard deviation of production per capita and unemployment. In most centres there is a relatively even distribution of peripheral municipalities in groups that converge towards their respective cores and ones that lag behind. In other words, in many centres, especially larger ones, have two “tiers” of peripheral municipalities – one whose rate of economic development surpasses that of its core and is thus gradually approaching it, and one which is lagging behind.

The most optimistic result of the study is that in centres where the data allow for comparisons I the levels of household income, the average income in peripheral municipalities is approaching that of the cores. This is yet another confirmation that being a part of an economically strong centre provides a chance for faster development to economically weaker municipalities, and to better income of their population.

The complete analysis is available in Bulgarian.

Yavor Alexiev

In 2017 the Bulgarian labour market continued its expansion, and the improvement that took place in the last couple of years is becoming more visible on the regional level. According to the last annual data provided by the Employment agency (EA) there are 30 municipalities with unemployment below 5% (marked blue on the map) and 80 more with unemployment between 5 and 10 per cent. In 2013, in the heat of the labour market crisis the number of municipalities with such levels of unemployment were 3 and 43, respectively. Compact groups of low unemployment municipalities can be found in North Bulgaria, around Varna, as well as in the area around Troyan, Gabrovo and VelikoTarnovo, and in the South – around the capital, Plovdiv, Pazardzik, Burgas, Stara Zagora and Kazanlak.

Unemployment in the Bulgarian municipalities (2017 compared to 2013)

Source: EA, IME calculations

Municipal level data

Compared to 2016, unemployment has increased only in 4 municipalities – Brezovo (+6 percentage points), Bobovdol (+2.8 pr.p.), Lisichovo (+0.8 pr.p.) and Tryavna (+0.2 pr.p.). Despite the overall improvement, compact clusters of municipalities with high levels of unemployment (above 25%) still remain. A large part of North Bulgaria is still in the red, which is also true for the mixed-ethnicity regions as well as most municipalities along the Danube. In most cases, municipalities with high unemployment are either very far from the leading economic centres and the traditional flows of daily labour commuting, or have very low levels of education and training of the labour force. This combination of negative factors does provide for a near-future solution of their problems; it is more likely that the opposite is true, as the negligibly small effect of the overall economic growth on their local labour markets points to a long-term isolation from the processes taking place on the national level.

EA data also show that:

• Vidin is the only district centre where unemployment is still above 10% in 2017. Unemployment above 5% in North Bulgaria is observed in all North-Western district centres, as well as in Razgrad, Targovishte and Silistra;
• In South Bulgaria there are only four district centres with unemployment above 5% - Blagoevrgad (6.2%), Sliven (9.6%), Karzdali (5.8%) and Smolyan (6.3%);
• Most of the tourist municipalities achieve very good results – in 2017, unemployment in Bansko, Primorsko and Nesebar was below 5%, in Pomorie, Sozopol, Razlog and Chepelare – below 10%;
• Relatively low levels of unemployment are observed also in municipalities with large companies, such as Panagyurishte (7.3%), Etropole (7.8%) and Sopot (2.6%).

Structural issues

While the data provided by EA undoubtedly provides reason for optimism, some negative long-term trends can also be observed. The primary market in many districts still has difficulty providing such a number of workplaces as necessary to reduce unemployment faster and in a more noticeable way.

In addition, 2017 EA data for the characteristics of the unemployed show that:

• 54.6% of the unemployed have no training and this share (available only on the district level) is the highest in Sliven (75.8%), Shumen (71.7%) andPazardzik (66.6%) and the lowest in the capital (23.4%), Gabrovo (28.2%) andPernik (40.2%);
• 27.8% of the unemployed have basic or no education, and this share is the highest in Sliven (52.7%), Shumen (44.2%) andYambol (43.8%), thelowest – inthe capital (4.4%), Gabrovo (6.7%) andSmolyan (11.3%);
• Unemployed for more than a year were 37% of registered in the labour offices, which is 4,5 percentage points below than the 2016 level. The most significant drop in long-term unemployment is in Gabrovo and Plovdiv, where the 2017 levels are respectively 17.3% and 28.3%. There are, however, districts where the relative share of the long-term unemployed is growing, and it reached 58% in Vidin, 56% in Montana and 48% in Silistra.

Following the above data, the claims that the labour offered in the economy does not meet the requirements of employers are far from surprising. In order to solve this issue, in the past months the government introduced changes aiming to reduce red tape in the process of hiring foreign workers – an important measure in support of the continued expansion of the labour market. The problems with the nature and quality of the active labour market policies however remains, as in 2018 the state continues to rely on subsidized labour rather than unemployed retraining and education. In addition, the effect of the record increase of the minimum wage on the poorest regions is yet to be assessed, and it appears that the debate around the mechanism for the setting of the minimum wage has died out.

Yavor Aleksiev

The annual NSI labour market data for 2017 confirm our preliminary observations[1] for continued improvement in large parts of the country. The annual average employment rate of the population aged 15-64 reached a record high of 66.9% and for the first time there are no districts in which this rate is below 55%.

In 2017 the difference between the capitol and the district with the lowest employment rate of the working population is 19 percentage points, compared to 24 percentage points in 2008 and 2009. Similar trends are also observed in regard to the economic activity and unemployment rates. The reduction of this spread is to be expected since the record high unemployment and almost non-existent unemployment in the capitol suggest that these indicators will change more slowly in future periods. At the same time the economic upturn is spreading out to smaller economic centres due to the lower price of labour, land, offices and other factors.

There is also a decrease in the standard deviation of the employment rate across Bulgarian districts – from 5.5 percentage points in 2016 to 5.1 percentage points in 2017, which is also the lowest value recorded under an economic turn since 2005. Lower values have been registered only during the labour market crisis in 2011-2014. Once again, these data show that the ongoing labour market development is more balanced than that in previous periods.

Despite these positive developments, some of the most persistent regional disparities are more visible than ever. The increase in the number of the employed in 2017 is concentrated primarily in the southern part of the country – for every four new jobs created there, there has been only one created in Northern Bulgaria. The largest increase in the number of people employed is observed in the district of Plovdiv (33 thousand people), followed by Stara Zagora and the capitol (16 thousand each); and the largest decline in registered in Haskovo (-2 thousand), Gabrovo (-1.5 thousand) and Vidin (-1.4 thousand). The employment rate of the population aged 15-64 has increased in almost all of the country’s 28 districts with the exception of Gabrovo and Vidin, in which there is a slight decline, as well as Varna Sliven and Haskovo, where the rate has remained unchanged.

Despite the relatively better 2017, it is obvious that the labour market in some regions of the country continues to struggle. Vidin, Montana, Lovech, Razgrad and Sliven are not only the districts in which the employment rate is traditionally lowest, but are also among the handful of districts that are yet to recover to their pr-crisis levels. We may also add Silistra to this group – although the 57% employment rate registered in 2017 is the highest ever for this district, it is still one oft he lowest in the country.

The map below illustrates this process since 2008. Although there are no longer districts in which the employment rate of the population aged 15-64 is below 55%, the general impression of a strong south and weak north remains valid. The data for the first two quarters of 2018 will show to what extend local economies in the poorer regions of the country have managed to deal with the record minimum wage hike as of January 2018.

Expectations for 2018

It is hardly surprising that by approaching EU-average economic activity and employment rations, the Bulgarian labour market has started to experience some well documented in other countries issues such as growing labour shortages. The recently adopted changes targeted at making the hiring of foreign workers easier are important, but insufficient to make a significant difference in the short term.

In 2018 we can expect an even stronger clash between the negative demographic trends, the problem with the qualification and skills of the unemployed (and of some of the employed) and the requirements of the labour market. The current period presents a rare chance for the Bulgarian government to put itself before the curve of labour market developments, by re-evaluating its active labour market policies (ALMPs). In light of the record high employment rate and existing labour shortages, policies targeted at direct job-creation are not only theoretically hard to justify, but can also be viewed as an instrument that hinders the long-term integration of the workers concerned in the real economy. The latter is an important prerequisite for obtaining skills that are valued by businesses and for creating a “qualification buffer” against future labour market shocks.

Concepts such as “VET and lifelong learning” still lack concrete substance and should be put at the centre of the policy debate and the Government’s ALMPs, or we may once again wake up to find that unemployment has surged to the surprise of politicians.

Efforts should also be targeted at general optimization of Bulgaria’s labour market legislation, so that part-time work and flexible employment practices become more popular.

And, frankly speaking, 32 years later – is it time for a new Labour Code?

The English version of “Regional Profiles: Indicators of Development 2017” was presented on March 13th 2018 at a dedicated round table discussion attended by representatives of foreign embassies, chambers of commerce and industry and international organisations, among other distinguished guests.

download the full study | browse the district profiles | download the presentation [1] [2]

The presentation was focused on the following topics:

• Economic expansion: which parts of the country grow robustly and which lag behind;
• Labour markets: is labour shortage the only game in town;
• Education: what is education quality in the regions and is there a feedback loop to labour market performance;
• Local taxes: are tax hikes trendy among local authorities.

The IME also presented the country’s leading economic centres – a pilot research effort, made public just a few weeks ago. The study came out of the team’s desire to draw an economic map of the country based entirely on natural economic processes. The analysis highlights the strongest nuclei of the national economy and their pertaining peripheries.

Yavor Aleksiev

Recent Eurostat data show that the gap between the poorest and richest regions in EU countries is still considerable. In the 2007-2016 period, this gap increased in 12 countries, including Bulgaria, and declined in 9. In almost all cases "convergence" was achieved because the poorest regions have caught up, but because of a decline in the relative wealth of the richest one. The indicator used by European statistics for this comparison is GDP per capita, expressed in terms of purchasing power standard (PPS).

Figure 1 shows the differences in the development of the richest and poorest regions in each member state (as % of the EU average), which has more than one such region within Europe.

Figure 1: Per capita GDP (PPS) as % of EU average, 2016

Source: Eurostat, IME calculations (* Data for the richest region in the UK show the average for all five London regions.)

It is clear that Bulgaria is far from being among the countries with the greatest unevenness in the development of the regions. At the same time, Bulgaria, Croatia and Greece, which has seriously deteriorated in recent years, are the only countries in which the richest region has lower welfare than the EU average.

Change over the last decade

The analysis of the wealth gap in the richest and poorest regions in European countries over the last decade shows that the countries in which disparities decrease between 2007 and 2016 are nine, and we can conditionally divide them into three groups :

• Countries in which differences are shrinking because of declining relative development in the richest region and increasing development in the poorest (Austria , Germany and Portugal);
• Countries in which differences are declining, but there is a decline in the relative development in both the richest and the poorest regions (Belgium, Finland, Spain, the UK and Greece);
• The only country that has managed to achieve some, albeit minimal, upward development of its poorest and richest region, that has lead to more cohesion, is Hungary.

In the vast majority of Member States, the gap between the poorest and the richest regions is widening. We can define four groups here:

• Countries in which both the richest and the poorest regions have increased their relative development, but the differences are getting bigger due to faster growth of the rich regions - Denmark , Poland , Romania and Bulgaria;
• Countries in which both in the richest and the poorest regions are losing ground compared to average EU levels, but the negative processes are more pronounced in poor regions, so the gap is widening - the Netherlands , Sweden and Croatia;
• Countries in which the differences are growing due to an increase in the relative level of development in the richest region and a decline in the poorest - Ireland, France and Italy;
• Countries in which the poorest region stagnates and the richest improves its relative level of development - the Czech Republic and Slovakia.

Focus on Bulgaria

Between 2007 and 2016 GDP per capita, expressed in PPS, in the poorest Bulgarian region (Northwest Bulgaria) has increased only slightly - from 27% to 29% of the EU average. For the same period, the increase in Southwest Bulgaria is from 67% to 78% and the average for the country has increased from 40% to 49%. Thus, our country remains last in terms both of the relative prosperity of its poorest region and that of its national values. In 2007, the poorest Romanian region (Northeast) had the same level of development as Northwest Bulgaria. In the following period, however, the increase in this region of our northern neighbour is from 27% to 36% of the EU average compared to the 29% for Northwest Bulgaria.

Of course, some of the observed differences are a consequence of the peculiarities of the administrative divisions of EU countries, as the capitals of many of them are separate statistical regions.