State wants to redirect funds from wealthy municipalities to rural areas

Unrenovated and abandoned apartment buildings in Järva municipality.
Unrenovated and abandoned apartment buildings in Järva municipality. Source: Olev Kenk/ERR

The state wants to redistribute tax revenues to assist less prosperous municipalities. The municipalities in the golden circle, such as Tartu, Tallinn and Harju County, would receive less money, while the municipalities in rural areas would receive more. Local governments are not enthusiastic about this proposal.

Next year, according to a proposal prepared by the Ministry of Finance, the procedure for distributing funds to local governments will change. The new system will provide municipalities with 3 percent of the state pension, as opposed to the current 1.88 percent.

In addition, the income tax rate decrease from 11.96 percent to 11.76 percent. This is the exact opposite of the Riigokogu's December decision that, beginning on January 1 municipalities will receive 12,06 percent of personal income tax.

As pension income rises, cities and towns with an aging population and young residents, who have relocated there, will receive more funding. However, this initiative will adversely affect municipalities with a higher proportion of working-age residents, such as Tallinn and the suburbs of the capital. And this loss is significant: with the adjustments to the income tax and the so-called equalization fund, Tallinn, for example, would receive almost €7 million less than it does now.

This is termed the "harmonizing effect" in the proposal. The difference, €11.1 million, would be transferred to the local government equalization fund, i.e. redistribution of income tax between the wealthiest and the poorest.

Such a redistribution of funds is necessary because there is no money in the state budget to support the less well-off local authorities, but they need additional funds because the VAT will increase from 20 percent to 22 percent next year. This will have a significant impact on local governments.

Minister of Regional Affairs Madis Kallas (SDE) told ERR that additional funding for local municipalities is currently impossible due to the state budget deficit, so a budget-neutral model was proposed.

"This seems to be the best way to support, in particular, those local governments where the number of people of working age has decreased significantly and so tax revenues have decreased as well," Kallas said.

The revenue base of municipalities outside of Harju County is projected to increase by nine million, according to the calculations. However, next year's tax changes will have a negative impact of five million. As the coalition delays on the tax changes, the figures remain provisional and have not been accurately calculated. Municipalities were given a few days to reach consensus on this particular draft.

The leader of the Association of Estonian Cities and Municipalities, Veiko Luhalaid, said that this is the third draft in a row that has been granted a few days for approval, and that municipalities and towns are frustrated.

"This is obviously not enough time to conduct an analysis or consult with members; members do not have time to send us their analyses so that we can arrive at a meaningful desicion. This leaves us with an unpleasant aftertaste," Luhalaid said.

Aimur Liiva, the mayor of the municipality of Kiili in Harju County, said that since the governing coalition has already decided on the tax changes, requesting feedback is rather formal. "However, this is clearly a poor practice. The draft was received on Friday evening, and the deadline for a response is Tuesday," he said.

Neither wealthier nor less well-to do municipalities agree with the proposal

Kiili municipality is one of the most affluent in Estonia, with the highest average income and one of the youngest populations. According to the Ministry of Finance's calculations, the redistribution of the income tax would have a -1.6 percent negative impact on the municipality, which equates to €190,000.

Liiva said that it implies that they must leave some projects undone and, in general, redirecting money leaves a bad impression.

"As you know, those who are being taken away live in areas with a severe lack of nursery and school places. The cost of nursery is the municipality's greatest expense. We have never built a spa or a concert venue, nor have we ever built a center or a retreat. All of our surplus monies have gone into the construction of schools and infrastructure. Nothing will be accomplished if you remove €190,000 from the budget. Most likely, the roads will suffer as we continue to build kindergarten and school facilities for four children," Liiva said.

Liiva said it is evident that action must be taken to reduce regional disparities, but redistribution of tax revenue will not make a significant difference. "Will this proposal be of any help at all? Rather, it appears to be a spark in the pan; something exists for a short time. The situation is unlikely to improve on a long term," he said.

Karel Tolp, mayor of the North-Sakala rural municipality, which is facing bankruptcy, told ERR that taking from one to give to another raises concerns as a solution and that such a move in rural areas does not address fundamental issues.

"If we use our municipality as an example, we receive a 1,4 percent increase, or €107,000. Is that even sufficient to have a significant effect? The disparity becomes staggering when we consider how much more money is available in Tallinn, Tartu, and the surrounding area. In and of itself, attempting to lessen this disparity is admirable, but in the big scheme of things, it is akin to checking a box and saying "done." However, this has little effect on the discrepancy between municipalities. We are still unable to provide the same services as cities, and we are unable to prevent people from migrating to cities. It should be done in a different way," Tolp said.

Tolp added that the additional €100,000 would not even be sufficient to fill the vacant municipal support positions.

A tax increase erodes positive change

Luhalaid, the leader of the Association of Estonian Cities and Municipalities, said the increase in money from pension fund is positive because it accounts for out-migration from municipalities, but that the remainder of the planned tax changes will significantly reduce the projected revenue.

"According to our calculations, the re-distributive effect, which appears positive in this draft, is essentially nullified by the increase in the income tax and VAT rates. I am reticent to assert that these rural municipalities will profit. When the remainder of the tax package is implemented we will see how well they function together. Currently, however, there is a feeling that it is not a very beneficial change," Luhalaid said.

He added that the finance ministry did not have sufficient time to conduct a more thorough analysis of the effects.

"The ministry has not been able to analyze at this level and to have a complete picture of what this will entail for all municipalities," Luhalaid added.

Tolp suggested that the government should consider instituting tax breaks to attract more business and employment to rural areas.

"The question is why do people leave? In reality, living in the countryside is in many ways superior to metropolitan life. But if we do not have employment possibilities... Probably, there should be significant tax differences between these areas," he said.

In a sparsely populated country like Estonia, it is difficult and expensive to sustain settlement everywhere, the mayor of the Kiili municipality said.

"There are few realistic alternatives. Even Norway, with its oil wealth, has struggled to keep people in sparsely populated areas; urbanization continues. This is where progress is taking us, and there is nothing we can do about it," Liiv said.


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Editor: Kristina Kersa

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