Decentralization in Ukraine is already an economic success

Article by: Anna Harus, Oleg Nivievskyi

New amalgamated communities that were formed by the decentralization reform in Ukraine have shown remarkable economic success in only two years. Citizens now see what their taxes are being spent on and local governments have the incentive to improve the local business climate, and this can become the foundation of a new social contract in Ukraine, write Anna Harus and Oleg Nivievskyi for Vox Ukraine. Here is an abridged version of their article “In Unity There Is Strength: The Effect of the Decentralization Reform on Local Budgets in Ukraine.”

Decentralization in Ukraine implies two important results for long-term economic growth: (1) more local taxes being paid and (2) reduction of expenditures on local government.

Decentralization reform in Ukraine commenced in 2014. The success of the reform in achieving the declared goal was discussed mainly in the discourse of improving the quality of public services provided in amalgamated villages and cities.

However, a crucial aspect is almost completely ignored in research and public debates: the reform impact on the economy.

In order to estimate the net economic effect of the reform, the authors analyzed the types of local budget revenues and expenditures whose change may consistently be tracked both before and after the reform.

After amalgamations, the existing ATCs were able to increase net tax revenues from several types of local taxes (e.g. single tax on individuals and on legal entities, real estate rent, tourist fee).

We assume that granting local governments with a bigger authority as well as state transfers to exercise this authority has allowed them to invest a lot in community development. Accordingly, local residents saw on what their taxes paid were spent and became more willing to pay them. Local governments have also been given incentives to improve the local business climate in order to collect more taxes and thus have more funds for local development.

The amalgamation of local communities resulted in an increase in revenues from real estate tax by +121.7% and from tourist fee by +8.8% (per capita). As a result of amalgamations, there was also an increase in revenues from the single tax on individuals by +5.4% and from the single tax on legal entities by +23.4% (per capita).

Local expenditures had grown faster after the formation of an ATC, namely – per capita expenditures on roads management, housing and public utilities, sports events and facilities, leisure clubs, libraries, museums and exhibitions.

But development expenditures grew even faster. In general, territorial consolidation has led to a two-fold increase in development expenditures (+437.1%) compared to an increase in consumption expenditures (+198.9%) per capita. This means that after the formation of an ATC, local authorities spend more on long-term development, restoration and reconstruction programs than on incidentals (street lighting, utilities and energy bills, purchase of small inventory, etc.).

Before the reform, development expenditures were 3-4.5 times smaller than consumption expenditures:

Average per capita expenditures on development and consumption by year across Amalgamated territorial communities (ATC) and non-ATC communities. Image: VoxUkraine

Simultaneously, ATCs have spent less on local bureaucracy. This may indicate the effect of economies of scale, as there are fewer people working in the local government bodies of ATCs than there were cumulatively in the local government bodies of the villages that consolidated into an ATC:

Average share of local government expenditures in total expenditures by year across ATC and non-ATC communities. Image: VoxUkraine

Thus, already in the first two years, the reform achieved the expected results.

In amalgamated communities, tax revenues increased and administrative costs decreased compared to the non-amalgamated ones.

The final stage of the reform is currently underway, but it ignores the interests of the main actors in this process, i.e. local communities, with plans being made for the compulsory amalgamations of local communities that have not yet consolidated

To cherish the achievements of the decentralization reform, in particular the trust from the local business, now the most important on the agenda is to maintain the independence of the ATCs from the newly formed rayon administration and leave the money to local communities, at the grass-roots level.

If part of the ATC income, which has been preserved and spent locally for 4-5 years, is taken away in favor of the rayon budget by a directive order, this will lead to a loss of trust from local businesses, and their willingness to pay taxes in benefit of their community will decrease. This is why all 60% of PIT and other taxes paid according to the Budget Code must remain in ATC’s budgets.

Authors — Anna Harus, Researcher at Kyiv School of Economics, Oleg Nivievskyi, Kyiv School of Economics.

Read the full research here.

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