101799 MONTENEGRO: OPTIONS TO RESTORE FISCAL SUSTAINABILITY AND IMPROVE SPENDING EFFICIENCY AT SUBNATIONAL LEVEL November 2015 Acknowledgements This report is a product of the World Bank Technical Assistance for Montenegro, prepared as a background work for the Systematic Country Diagnostics for Montenegro. The report was based on the data provided by the Montenegrin Government from April to June 2015. The report was produced by a team composed of Juan Pradelli (Task Leader, Senior Economist), Rosanna Nitti (Senior Urban Specialist), David Waigwa Wachira (Economist), Nataša Obradović (Consultant), and Sanja Madžarević-Šujster (Sr. Country Economist). The team worked with the support of Gallina Vincelette (Program Leader), and under the supervision of Ivailo Izvorski (Practice Manager) and Tatiana Proskuryakova (Country Manager). The team met public officials and representatives of the numerous Government agencies and institutions, as well as some local government units, and is particularly grateful to the team in the Ministry of Finance that enabled the data collection and provided comments to the earlier draft. Disclaimer This report was produced by staff of the International Bank for Reconstruction and Development/The World Bank. The findings, interpretations, and conclusions expressed here do not necessarily reflect the views of the executive directors of the World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data reported here. The boundaries, colors, denominations, and other information shown on any maps herein do not imply any judgment on the part of the World Bank about the legal status of any territory or the endorsement or acceptance of the boundaries. The report was produced to provide advisory support for the Government of Montenegro but does not necessarily represent its views. 1 Table of Contents Executive Summary ...................................................................................................................................... 3 A. Introduction .......................................................................................................................................... 8 B. Revenues ............................................................................................................................................ 12 C. Expenditures ....................................................................................................................................... 17 D. Debt .................................................................................................................................................... 26 Tables Table 1. Local Government Units and Population Distribution ............................................................. 8 Table 2. Local Government Fiscal Performance .................................................................................... 10 Table 3. Budget Revenues ........................................................................................................................ 14 Table 4. Budget Expenditures .................................................................................................................. 19 Table 5. Municipal Debt, 2010-2014 ........................................................................................................ 27 Table 6. Municipal Debt, by municipality, 2014. ................................................................................... 27 Table 7. Public Finances - All municipalities ......................................................................................... 37 Table 8. Public Finances – Bijelo Polje ................................................................................................... 38 Table 9. Public Finances – Cetinje .......................................................................................................... 39 Table 10. Public Finances – Nikšić .......................................................................................................... 40 Figures Figure 1. Dependency Ratio, Percent of 15-64 ......................................................................................... 9 Figure 2. Active Population, Percent of Population ................................................................................. 9 Figure 3. Revenues and Spending per Capita (EUR) .............................................................................. 9 Figure 4. Budget Revenues ....................................................................................................................... 13 Figure 5. Budget Expenditures ................................................................................................................ 18 Figure 6. Municipal Employment, 2014. ................................................................................................. 20 Figure 7. Municipal Gross Salaries and Contributions (estimated accrual basis), 2014. ................... 20 Figure 8. Municipal Debt ......................................................................................................................... 27 Figure 9. Budget Expenditures 2007-14, Selected Municipalities (million euro) ................................ 33 Figure 10. Budget Revenues 2007-14, Selected Municipalities (million euro) ..................................... 34 2 Montenegro: Options to Restore Fiscal Sustainability and Improve Spending Efficiency at Subnational Level Executive Summary The World Bank prepared this Policy Note at the request of the Montenegrin Ministry of Finance (MOF) to formulate a diagnostic of the current situation of local self-governments in Montenegro—with a special focus on municipalities undergoing financial distress—and propose directions for policy and reform aimed at restoring fiscal sustainability and improving spending efficiency. The Policy Note intends to inform authorities on options to strengthen the financial stance of subnational entities, with special emphasis on distressed ones. The preparation of the Policy Note brought together the technical and institutional knowledge of the MOF, the Union of Municipalities, and the municipalities of Podgorica, Nikšić, Cetinje, Kotor, and Bijelo Polje, and the global experience of the World Bank in providing advice on subnational fiscal policy and public-finance management. A close collaboration between all these institutions permitted to hold valuable knowledge and information exchanges. The Policy Note focuses on options to strengthen the financial stance and spending efficiency of subnational entities—with special emphasis on distressed municipalities. In particular, the policy note focused on three aspects of local finances: (i) budget revenue sources and their adequacy to fund mandates and tasks; (ii) budget expenditures and employment in administration and municipal public companies; and (iii) budget-deficit financing using municipal debt, including bank loans for investment projects, bank loans for liquidity shortages, and arrears on salaries, taxes, and contributions due by municipalities as employers of public servants. Policy recommendations. The policy recommendations elaborated in the Policy Note are: 1. Broaden the tax bases of own-source revenues and introduce administrative measures to expand collection of real estate and other local taxes; 2. Condition the debt reprogramming agreements upon the adoption of measures aimed at staff rationalization, hiring freeze, and limitation on the growth of nominal wages. In addition, consider the merits and opportunities for merging utilities across smaller and distressed municipalities (or arrange for joint service delivery; e.g., water, garbage management, and road maintenance). 3. Financial restructuring of any type of debt should be accompanied with both revenue and expenditure measures. 4. To avoid reccurrence of the same issues in the future, and avoid moral hazard, local governments should also improve their public financial management (PFM) systems. In particular, they need to: a. Align the budget planning process with the central government budget calendar and introduce the medium-term budget planning based on the Macro and Fiscal Guidelines received from the MOF to inform their budget planning. Budget plans need to be made publicly available. b. Any budget revisions should be cleared and notified to the MOF, while the MOF needs to establish an early-alert system which would monitor the situation in all municipalities and identify risks in an early stage. 3 c. Budget execution data and reports need to be submitted to the MOF on time, but also made public. d. Immediately implement procedures in the financial management processes to record commitments and arrears. e. Fiscal Responsibility Act needs to be enforced at the level of local government as well. Municipalities cannot enter into debt arrangements without former approval of the MOF, as this is in open violation of the Fiscal Responsibility Law. f. The MOF/Tax Administration should be vigilant in collecting taxes and contributions from local governments. g. The National Audit Institution should be proactively scrutinizing municipal budgets and deviations from the sound budget management practices. Diagnostic. Montenegro, differently from other countries in the Balkans, is highly centralized and the municipalities have limited functional competences. Consequently, the share of LGUs spending in GDP was at 4.5 percent in 2014, which is less than 10 percent of the overall consolidated general government spending. The Law on Local Self Government stipulates the municipal tasks that include local road maintenance, water services, garbage collection and treatment, street lighting, greening, culture and sports. Municipalities do not have responsibilities to deliver education and health services, which constitute a large share of the local public activities and budgetary expenditures in other countries. It is therefore difficult to assess revenue gaps through an international benchmarking exercise comparing Montenegro against peer countries in terms of the types and shares of shared revenues, or the transfers per inhabitant. Similarly, no meaningful comparison in terms of number of public employees per inhabitant can be made in order to evaluate excess employment. Montenegro has a one-tier subnational government system--municipalities at the local level and no regional level, although the country has three distinguished areas as per the Law on Regional Development (North, Central and South/Adriatic regions) which are not administrative units. There are 23 municipalities, including the capital city, Podgorica. Their size varies considerably. One-sixth of municipalities have fewer than 5,000 citizens, while Montenegro has on average 30,000 inhabitants per LGU. However, in the Balkans, it has one of the largest concentration of citizens in the capital city Podgorica (30 percent). Northern municipalities, in particular, face significant challenges of depopulation, deindustrialization and fast ageing that all put pressure on fiscal and institutional ability to perform even the limited functions decentralized to them. Revenues. As a whole, Montenegrin municipalities largely rely on their own-source revenues to fund the local budget. Legislative changes introduced in recent years intended to improve the potential for raising own-source revenues (especially the real estate tax) and reduce distortions in the taxation of economic activities at local level (especially those induced by the charge for use of buildable land). Directions for policy and reform are: 1. Further strengthening of own-source revenues is necessary in all municipalities and would help improve financial sustainability in the long term. 2. Certain municipalities coping with severe structural problems (e.g., de-industrialization and scarcity of private-sector jobs, lack of business potential, shrinking economic activity and incomes, population migration) may need to be granted additional revenues or assets, possibly on a temporary basis and conditional upon commitments towards expenditure 4 rationalization (i.e., a balanced approach to fiscal consolidation that would include both revenue and spending measures). 3. Efforts and investments should then be undertaken to endow local tax-administration agencies with the human, technical, and administrative resources (and incentives) necessary to perform better and collect more local revenues. 4. Awareness should be raised among residents on the importance of paying real estate tax in order to support municipal development and service delivery. Expenditures. Some municipalities exhibit overstaffing and excessive payroll expenses because they have been acting as an ‘employer of last resort’ in a context of severe structural problems (e.g., de-industrialization and scarcity of private-sector jobs, lack of business potential, shrinking economic activity and incomes, population migration). Political patronage and cronyism may also be motives. Overstaffing and excessive payroll expenses are also the result of strategic behavior by local governments: it has been a deliberate policy of accumulating more expenditure commitments in relation to staff hiring than can be financed from expected revenues, in the hope of eventual financial relief from the Central Government. As a matter of fact, the Central Government has unofficially approved delay in payment of 100 percent of municipal social security contributions, then providing no incentive for local governments to economize on staff. Directions for policy and reform are: 1. Initiatives to rationalize staff headcount and reduce payroll expenses (in both its level and its rate of growth) are necessary in those municipalities to help restore financial sustainability in the long term. Actions along this avenue are the municipal staff rationalization plans launched in 2013—which eventually failed—and the new plans required by the MOF in 2015 as a condition to reprogram debts emerging from unpaid payroll tax and contributions. 2. The functional analysis of front and back office functions performed by municipalities and the identification of potential economies of scale that could be created through the implementation of shared services schemes are highly recommended given the comparatively limited size of a large number of municipalities. 3. Staff rationalization plans must be complemented with efforts to help create private- sector jobs in the local economy. Otherwise, it is very unlikely that public employees would exit their job positions—perhaps with the sole exception of those close to their retirement. The failure of plans launched in 2013 is certainly related to the lack of opportunities outside the public sector. Identification of opportunities for the outsourcing of existing services and back office functions to private providers through the concession and privatization of specific programs could also include the formation of small and micro enterprises by employees as part of the separation programs. 4. Efforts and investments should then be undertaken to endow those public employees offered an exit plan with new skills, realistic opportunities to work in the private sector, and financial support during the period in-between jobs. These conditions are necessary for them to accept the voluntary exit plans. In addition, opportunities for internal migration should be encouraged (e.g., information on nation-wide jobs opportunities, facilitation of daily or weekly commuting, credit facilities to buy housing for permanent residence in other districts). 5 Debt. Facing insufficient own-source revenues, overstaffing, and excessive payroll expenses, some municipalities incurred large borrowings through voluntary financing transactions (e.g., short-term bank loans providing liquidity) and forced financing transactions (e.g., arrears in the payment of salaries and related obligations for payroll tax and contributions), or became disproportionally dependent upon the Equalization Fund. Remedial actions taken in the past have been partially successful since the over-indebtedness problem still persists today. Anecdotal evidence suggest in the past the MOF had relaxed discipline—e.g., by implicitly allowing municipalities to delay payments of social security contributions—while some municipalities had contracted liabilities without requesting legal authorization from the MOF. Debt levels are now unsustainable, reportedly carrying very high interest rates (especially the short-term bank loans providing liquidity) and imposing a growing burden of debt services (interests plus amortizations) on the local budgets. Capital budgets are likely to take the hit if current expenditures are not rationalized and the debts are not restructured. Among stakeholders in Montenegro, there are different views on whether changes in legislation—particularly in Laws governing the revenues of local governments—would be necessary to cope with the financial distress observed in some municipalities. Some quarters, including the MOF, argue that the legal framework governing Montenegrin local finances is adequate and does not need overhaul; thus, the apparent deterioration of local finances in some municipalities has been the consequence of their mismanagement and policy mistakes in the past. Other stakeholders, e.g., the Union of Montenegrin Municipalities, make the case that legal reforms are required to strengthen the budget resources of local governments; in this regard, the current financial distress is attributed not only to mismanagement but also to past amendments to laws that reduced municipal revenues. Municipalities (reportedly, 14) and the MOF are entering into contracts that reprogram arrears on tax liabilities in exchange for plans to rationalize staff. As the municipalities’ staff rationalization plans are still under preparation, at this stage it is impossible to assess whether the proposed measures—impacting only the expenditure side—are sufficient to restore the financial sustainability and creditworthiness of the most distressed local governments.1 Directions for policy and reform are: 1. The roadmap to workout arrears on tax liabilities and rationalize staff provides an appropriate policy guidance for 2015. A similar roadmap should be established to workout other arrears and short-term bank loans providing liquidity. 2. Debt reprogramming contracts should be complemented with measures that seek to expand own-source revenues and to improve the operational effectiveness and efficiency of local governments beyond staff rationalization. Any support coming from the central government should come at a high price to municipalities mostly in terms of restraining their autonomy as a way to avoid creating undesired precedents and moral hazards. 3. With regard to the refinancing of municipalities short-term debts to commercial banks, one option to reduce costs would be for the central government to act as an agent on LGs behalf in the debt and cash market as a voluntary facility or even be obliged to use this 1 As of mid-November 2015, Cetinje, Bijelo Polje, Kolasin, Savnik, and Berane have submitted their plans to the MOF. 6 service, whilst being prohibited from direct bank financing for the duration of their restructuring or as part of their compact with the MoF. 7 A. Introduction 1. Montenegro, differently from other countries in the Balkans, is highly centralized and the municipalities have limited functional competences. The Law on Local Self Government stipulates the municipal tasks, including those of direct (or shared) concern for the local population and those devolved by laws and acts of the Government. Major mandated tasks include local road maintenance, water services, garbage collection and treatment, street lighting, greening, culture and sports. Notably, municipalities are not responsible for the delivery and financing of education, social welfare or health services. Consequently, the share of LGUs spending in GDP was at 4.5 percent in 2014, which is less than 10 percent of the overall consolidated general government spending. 2. Despite having a one-tier subnational government system, the population concentration in the capital is high. Montenegro has municipalities at the local level and no regional level, although the country has three distinguished areas as per the Law on Regional Development (North, Central and South/Adriatic regions) which are not administrative units. There are 23 municipalities, out of which two have not yet formed their basic institutions (for more than a year). Their size varies considerably. One-sixth of municipalities have fewer than 5,000 citizens, while Montenegro has on average 30,000 inhabitants per LGU. However, in the Balkans, it has one of the largest concentration of citizens in the capital city. Podgorica has most people, 30 percent of over 620 thousands Montenegrins live there. Table 1. Local Government Units and Population Distribution Number of Average population of LGUs below Capital city in Average density Population LGUs LGUs pop 5000 total (people/sq.km) Albania 4,202,098 385 10,915 41.0% 14.5% NA FBiH 2,337,660 80 29,221 13.8% 18.7% 268.75 BiH RS 1,433,038 63 22,747 25.4% 15.8% 63.42 Croatia 4,284,889 556 7,707 70.9% 18.4% 97.31 Kosovo 2,236,963 38 58,867 5.3% 11.4% 290.47 FYR of Macedonia 2,529,473 85 29,759 21.3% 25.0% 85.77 Montenegro 621,772 23 27,034 26.1% 30.0% 61.69 Serbia 7,748,519 170 45,580 0.6% 21.0% 395.22 Slovenia 2,063,077 212 9,731 51.9% 13.9% 101.8 Note: Montenegro, Croatia and Slovenia as of 2015. FBiH stands for Federation of BiH, while BiH RS stands for Republic of Srpska. Source: National statistical offices, World Bank (2013a), South East Europe Municipal Finance Review. 3. Increasing dependency ratios and low activity rates in some municipalities will continue to burden local finances. According to the census and administrative sources, between 2006 and 2011 the ratio of dependent age residents to prime working age residents in Pluzine increased by 5 percentage points, while Niksic, Podgorica and other Central municipalities experienced declines in dependency ratios. The Northern region will continue to underperform and become more dependent on pensions and social transfers, while the central and southern regions largely stand to benefit from improving demographic trends. Overall, the country also suffers from a large inactivity of population. In municipalities like Rozaje, Andrijevica and Plav, high dependency ratio is followed by the low activity rates of the working-age population thus further eroding the tax base of municipalities and creating pressures on fiscal sustainability of the local government units. 8 Figure 1. Dependency Ratio, Percent of Figure 2. Active Population, Percent of 15-64 Population Source: MONSTAT, EUROSTAT, World Bank staff calculations. 4. There are large observed differences of fiscal capacity across Montenegrin municipalities. While among the richest and the poorest municipality the revenue per capita difference is eightfold, the typology is not so straightforward. While the Southern region, on average, tends to have more fiscally abundant municipalities, while the Northern region the least fiscally strong municipalities, there are exceptions to this conclusion, like Figure 3. Revenues and Spending per Capita Pluzine, Savnik and Zabljak in the (EUR) North. Still, large differences in fiscal capacity likely leads to increasing inequality in terms of the public service delivery across regions which has been also demonstrated by the heterogeneity of social sector and infrastructure services outcomes. 5. The Law on Local Self Government Finances, together with special pieces of legislation introducing specific levies (e.g., Law on Local Communal Fees and Law on Real Estate Tax), delineate the Source: MOF, WB staff funding of municipal budgets. The local budget provides funding for municipal core functions. Four income sources are envisaged in the legislation: the own-source revenues (taxes, fees, and charges, levied by Local Governments), the shared revenues (levied by the Central Government), the Equalization Fund, and the conditional grants. In addition, municipalities are legally permitted to contract financial obligations—with prior authorization from the Ministry of Finance—and manage their assets— including the sale of their physical and financial property. 9 6. An effective exercise of local autonomy requires a strong financial standing in municipal administration. According to the Constitution, municipalities are autonomous entities. In practice, the principle of autonomy applies to local-budget decision-making provided that the expenditure commitments assumed by the local governments are consistent with the funding sources available to them. On the contrary, when a municipality is running financial distress because of its own financial mismanagement, the Central Government should assist it to preserve the delivery of essential services, and should also impose remedial actions that ultimately restrict local-budget autonomy. If the financial problems are observed in many municipalities, the necessity (and extent) of Central Government intervention mounts. 7. At present, some (not all) municipalities exhibit a fragile financial condition and unsustainable expenditures and debt. Overall, municipalities have generated a cash surplus over the last four years and have a low overall direct debt (4.8 percent of GDP). However, in parallel they generated additional 3.4 percent of GDP in arrears for taxes and to suppliers, while the debt of the local government-owned companies (which is mostly guaranteed by municipalities) has not been registered. In certain municipalities, unrealistic budgetary planning and large mismatches between spending commitments and fiscal capacity have led to financial distress. Legislative changes introduced in recent years intended to improve the potential for raising own-source revenues and to eliminate other traditional, distortionary local revenues; however, some municipalities have been unable (or unwilling) to strengthen their own sources of budgetary income. Overstaffing and excessive payroll expenses in local administrations and municipal public companies have revealed an implicit social safety net—implemented through the provision of public employment—as well as poor spending efficiency. Insufficient capacity to repay large arrears on tax liabilities and salaries and growing debts to banks and suppliers, have raised concerns about public finance sustainability and creditworthiness of some municipalities. Table 2. Local Government Fiscal Performance Local government, % of GDP 2006 2007 2008 2009 2010 2011 2012 2013 2014 Total revenues 5.6 8.0 8.4 6.3 5.7 4.9 5.7 5.9 6.1 Taxes 2.6 2.8 3.2 2.8 2.6 2.8 3.1 3.2 3.4 Personal Income Tax 1.0 0.8 1.0 0.9 0.8 1.0 0.9 0.8 0.9 Taxes on Property 0.8 0.7 0.9 0.5 0.4 0.4 0.4 0.4 0.4 Local Taxes 0.8 1.2 1.4 1.4 1.4 1.4 1.6 2.0 2.1 Duties 0.6 0.4 0.3 0.2 0.2 0.2 0.2 0.2 0.2 Fees 1.9 3.7 4.1 2.6 2.4 1.4 1.9 1.6 1.6 Other revenues 0.3 0.5 0.7 0.6 0.4 0.4 0.4 0.5 0.4 Total expenditures 5.7 7.8 9.3 7.5 6.8 4.4 5.0 4.4 4.5 Wage bill 1.1 1.2 1.3 1.4 1.0 1.0 1.0 1.1 1.1 Expenditures for supplies and services 0.7 0.8 0.8 0.7 0.6 0.5 0.5 0.4 0.4 Current maintenance 0.2 0.3 0.3 0.2 0.2 0.1 0.2 0.1 0.1 Interests 0.0 0.0 0.0 0.0 0.0 0.1 0.1 0.1 0.1 Transfers 0.4 1.0 0.8 1.0 0.9 0.8 1.0 1.0 1.0 Capital expenditures 2.6 3.9 5.3 3.8 2.7 1.6 1.5 1.4 1.4 Surplus/deficit -0.1 0.2 -0.8 -1.1 -1.1 0.5 0.7 1.6 1.6 Local government debt 4.8 Domestic 1.3 Foreign 3.5 Arrears 3.4 Source: MOF, WB staff calculations. 8. Remedial actions taken in the past have been only partially successful, so further substantive measures are necessary. The Government and the Ministry of Finance (MOF) led efforts to help municipalities putting their fiscal house in order, including initiatives to set up recovery plans, restructure debt towards the Central Government, and facilitate the sale of assets. 10 In April 2014, the Budget and Fiscal Responsibility Law mandated that municipality budgets cannot be approved without monitoring and endorsement by the MOF, thus seeking greater fiscal discipline, transparency, and accountability. As concerns persist, new initiatives are being explored, e.g., the Law on Salaries in the Public Sector (under preparation) to reform the civil- servant salary policy. 9. A roadmap to address arrears, overstaffing, and excessive payroll expenses provides policy guidance for 2015. In November 2014, policy discussions between the MOF, mayors, the Union of Municipalities, and the Tax Administration Unit, resulted in a roadmap to urgently address the arrears owed to the Central Government, banks and suppliers, as well as to proposals to remediate the problems of overstaffing and excessive payroll expenses. Some quarters assess the legal framework governing Montenegrin local finances as adequate, and attribute the the apparent deterioration of local finances in some municipalities to poor management and policy mistakes. Such conclusions were supported by the evidence whereby, given a common legal framework of universal application among local governments, a number of municipalities (e.g., Tivat, Plužine, Podgorica, Andrijevica, Kotor, Rožaje, Mojkovac) are actually performing well and not experiencing financial distress. Other quarters emphasize the necessity to amend laws regulating local finances to increase budget resources of municipalities, and argue that the structural heterogeneity among districts in Montenegro (where, for instance, Northern municipalities face legacy disruptions from transition, de-population, etc.) goes a long way in explaining why their fiscal performance differs even under a common legal framework and beyond the quality of their management. At any rate, there is a minimum consensus in that resolute action must be taken on reforming the operation and activities of distressed local governments, particularly seeking operational effectiveness and efficiency, in order to restore sustainability.2 10. At the request of the MOF, the World Bank prepared this Policy Note to formulate a diagnostic of the current situation of local self-governments in Montenegro—with a special focus on those municipalities in distress—and propose directions for policy and reform aimed at restoring fiscal sustainability and improving spending efficiency. The Policy Note intends to inform authorities on policy and reform options to strengthen the financial stance of subnational entities, with special emphasis on distressed municipalities. The preparation of the Policy Note brought together the technical and institutional knowledge of the MOF, the Union of Municipalities, and the municipalities of Podgorica, Nikšić, Cetinje, Kotor, and Bijelo Polje, and the global experience of the World Bank in providing advice on subnational fiscal policy and public-finance management. A close collaboration between these institutions permitted valuable knowledge and information exchanges. 2 Major milestones of the roadmap include: 1) formation of a working team involving the Ministry of Finance, the Union of Municipalities, and local self-governments, tasked with assessing the debt situation of each municipality with a view of exploring options for debt rescheduling as well as for municipal debt-assets swaps to relieve the burden of financial liabilities; 2) identification of tax liabilities as of end-2014; 3) initiation of legal measures against all local self-governments, public enterprises and institutions founded by municipalities, which pay wages without payroll taxes being settled; 4) initiation of actions to regularize the division of funds from the Equalisation Fund in 2015; 5) agreements to divide assets and staff between certain municipalities; 6) setting up the population registers in some municipalities to proceed with the division of personal income taxes among them; 7) local self- governments, public enterprises and institutions founded by municipalities, with registered surplus of staff, should downsize staff to meet the standards set in order to reduce payroll expense. 11 11. Preliminary policy recommendations are summarized here and elaborated in the remainder of the Policy Note: (i) Broaden the tax bases of own-source revenues and introduce administrative measures to expand collection of real estate tax and other local taxes (Section B on Revenues); (ii) Condition the debt reprogramming agreements upon the adoption of measures aimed at staff rationalization, hiring freeze, and limitation on the growth of nominal wages (Section C on Expenditures); in addition, consider the merits and opportunities for merging utilities across smaller and distressed municipalities (or arrangements for joint service delivery); (iii) Financial restructuring of any type of debt should be accompanied with both revenue and expenditure measures (Section D on Debt). (iv) To avoid reccurrence of the same issues in the future, and avoid moral hazard, local governments should also improve their public financial management (PFM) systems. In particular, they need to: a. Align budget planning process with the central government budget calendar and introduce the medium-term budget planning based on the Macro and Fiscal Guidelines received from the MOF to inform their budget planning. Budget plans need to be made publicly available. b. Any budget revisions should be cleared and notified to the MOF, while the MOF needs to establish an early-alert system which would monitor the situation in all municipalities and identify risks in an early stage. c. Budget execution data and reports need to be submitted to the MOF on time, but also made public. d. Immediately implement procedures in the financial management processes to record commitments and arrears. e. Fiscal Responsibility Act needs to be enforced at the level of local government as well. Municipalities cannot enter into debt arrangements without former approval of the MOF, as this is in open violation of the Fiscal Responsibility Law. f. The MOF/Tax Administration should be vigilant in collecting taxes and contributions from local governments. g. The National Audit Institution should be proactively scrutinizing municipal budgets and deviations from the sound budget management practices. B. Revenues 12. As a whole, Montenegrin municipalities largely rely on their own-source revenues to fund the local budget (Figure 4 and Table 3). Own-source revenues provided resources in the order of € 120 million a year in 2012-14. Thus, own-source revenues account for nearly half of total budget revenues and 63 percent of the income sources—i.e., excluding financing transactions such as property sales and borrowing. Shared revenues, in turn, provided resources in the order of € 30-40 million in 2012-14, thus representing nearly one-sixth of total budget revenues and 20 percent of the income sources. Equalization Fund and grants are similar to shared revenues in terms of absolute size and weight. 12 Figure 4. Budget Revenues Budget Revenues 2007-14 (million euro) Composition of Budget Revenues 2007-14 (percent) Source: MOF 13. Legislative changes introduced in recent years intended to improve the potential for raising own-source revenues and mitigate distortions in the taxation of economic activities at local level. Legislative amendments since 2008 abolished or reduced traditional sources of local revenues, seeking to eliminate distortionary effects on economic activity as well as perceived abuses of taxation power by some municipal governments (who were taking advantage of inelastic tax bases).3 On the other hand, amendments aimed to increase the resources provided 3 Firstly, at aggregate level, the most significant reform was the abolition of the charge for use of buildable land since 2009, after this charge provided nearly € 30 million in 2008. Since municipal governments have extensive autonomy to determine it (e.g., there was no upper ceiling in the legislation), there was space for excessive taxation (e.g., some municipalities were charging very high levies on companies using public spaces for their production activities). Secondly, amendments to the Law on Local Communal Fees abolished a number of fees since 2008 (e.g., the use of facilities for power transmission, telecommunication facilities, TV and radio transmitters, and the use of the seashore for commercial purposes). Estimated revenue loss was around € 3 -5 million. Thirdly, amendments to the Law on Local Self Government Finances entering into force in 2011, eliminated a few taxes and charges (e.g., the consumption tax, the tax on the company name, the tax on games of chance and entertainment games, the fee for the use of passenger vehicles and trailers—or eco-charge), with an estimated revenue loss of € 6 million. Fourthly, amendments to the Law on Roads reduced the collection from charges for the use of municipal roads since 2010 — charges now must be approved by the Central Government, with an estimated revenue loss of € 3 -4 million. Fifthly, recent amendments to the Law on Spatial Development and Building of Structures envisage exempting the general- interest buildings, ancillary buildings, and prefabricated temporary structures, from the charge for provision of utilities at buildable land. Also, legislative changes introduced in 2009 shifted the time of collection from the beginning (building permit) to the end of the investment cycle (certificate of occupancy), but were subsequently reversed. The joint effect of these legislative reforms and the collapse of the real estate boom was eventually a reduction in collection from nearly € 66 million in 2009 to € 37 million in 2013. There are concerns that further limitation of these charges might be enacted, with the expectation that real estate tax can compensate for the revenue loss. The charge for provision of utilities at buildable land is paid by an investor for the provision of utility infrastructure to her buildings and structures. It intends to fund the real cost of developing land and making utility infrastructure available to an urban site, presumably on the basis of cost-recovery principles, and thus it is seen as a capital revenue (not current revenue). It is agreed in a contract concluded between the investor and the local government—with assent from the Central Government—and its purpose is strictly prescribed by the law. Substituting real estate tax for the charge for provision of utilities at buildable land raises complex issues: the charge 13 by the real estate tax, the shared revenues, and the Equalization Fund.4 Not surprisingly, it remains under dispute whether the net effect of all these legislative changed was an increase or a reduction in the municipalities’ fiscal capacity. Table 3. Budget Revenues Budget Revenues (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 305 348 280 238 210 214 236 230 Own Revenues 150 201 142 134 103 123 120 122 Surtax on Personal Income Tax (PIT) 15 19 16 15 15 15 18 18 Real property tax 14 16 21 25 30 36 39 41 Charge for provision of utilities at buildable land 73 93 66 65 35 50 37 38 Charge for use of buildable land 16 29 4 1 0 0 0 0 Other local taxes, fees, and charges 33 44 36 29 24 23 26 25 Shared Revenues 36 38 26 23 30 33 41 41 Personal Income Tax (PIT) 12 14 13 12 13 13 16 17 Charges for the use of assets and natural resources (concessions) 4 3 3 3 6 6 12 10 Property sale tax 20 19 9 8 10 11 11 12 Annual charge for vehicle registration 1 2 2 1 1 2 2 2 Equalization Fund and grants 17 28 28 22 29 29 41 36 Equalization Fund 11 21 19 17 23 23 24 29 Conditional Grants 2 2 1 0 2 3 5 3 Other transfers and grants 4 5 7 5 5 3 12 4 Financing Transactions 102 82 85 59 47 29 34 32 Sale of property 79 14 23 22 12 11 15 8 Loans 11 17 17 22 21 8 9 10 Carry-over from previous years 13 51 44 15 14 11 10 14 MEMO Composition of Budget Revenues (percent) Own Revenues 49 58 51 56 49 58 51 53 Shared Revenues 12 11 9 10 14 15 17 18 Equalization Fund and Grants 6 8 10 9 14 13 17 16 Financing Transactions 33 23 30 25 23 14 15 14 Composition of Budget Revenues Excluding Financing Transactions (percent) Own Revenues 74 75 72 75 63 67 60 61 Shared Revenues 18 14 13 13 19 18 20 20 Equalization Fund and Grants 8 10 14 12 18 16 20 18 Own Revenues + Shared Revenues + Equal.Fund (million Euro) 197 260 187 174 156 179 185 192 Source: MOF Directions for policy and reform 14. Further strengthening of own-source revenues—particularly the real estate tax—is necessary in all municipalities, and would help improve financial sustainability in the long term. The real estate tax is meant to be a cornerstone of own-source revenues. Its collection was actually expected to more than offset the downsizing of other traditional sources of local revenues. The tax compliance rate is high (80-90 percent) for real estate owned by corporations, arguably because municipalities have a handful of un-expensive administrative procedures available to enforce tax obligations (e.g., the possibility of blocking bank accounts and seeks for full cost-recovery and the real estate tax is alien to such concept; and transferring the cost of providing utility infrastructure to profit-making investors to other taxpayers (including households) is politically difficult and may not be deemed fair. 4 Firstly, the Law on Local Self Government Finances, amended on January 2011, raised the percentage of shared revenues accrued to municipalities (e.g., PIT share increased from 10 to 12 percent, with 16 percent for the Old Royal Capital and 13 percent for the Capital City; real estate turnover tax share increased from 50 to 80 percent; concession fee share increased from 30 to 70 percent, except for the use of ports —20 percent—and coastal zone— 50 percent). The Equalization Fund was also increased. Overall, these revenue items rose from € 45 million in 2010 to € 82 million in 2013. Secondly, the Law on Real Estate Tax, also amended on January 2011, increased the tax rates and coverage of the real estate tax, whose collection rose from € 25 million in 2010 to € 39 million in 2013. 14 transactions). On the other hand, the tax compliance rate is dismal (less than 50 percent) for real estate owned by households. Resident households are unwilling to pay real estate tax—in some cases, because of insufficient income or idle estate—and there are weak procedures to enforce tax obligations. In addition, illegal construction, primarily of household residences, has eroded the tax base for real estate tax. 15. Policy and reforms options to strengthen real estate tax collection include:  Enforce the legalization of irregular settlements—which is legally necessary and politically legitimate. A Bill Law on Legalization of Informal Buildings awaits parliamentary procedure since late 2012 and could provide a framework to address the issue of informal buildings. The Bill Law is aligned with the Law on Local Self- Government and the Law on Spatial Planning and Construction whereby municipalities are responsible for regulating construction land and creating conditions for construction activities. More importantly, the Law sets forth local fees to fund such responsibilities, e.g., the land development fee, the legalization fee, the fee for regional water supply system construction in the coastal municipalities, and penalties for violations on the Law.  Local tax administration units should take advantage of the centralization of cadaster information to better assess real-estate valuations and improve collection rates. The World Bank’s Land Administration and Management Project is currently providing support to the Real Estate Administration Department (READ) to centralize and upgrade the cadaster system. Thanks to this endeavor, the registration of a transaction, wherever it has happened, is immediately reflected in the system—a leap forward compared to the old, time-consuming practice of replicating the transaction in the central cadaster. In addition, all data can be accessed from any location in real time. Municipalities should then enhance their tax-administration performance using these innovations. For instance, they should work together with READ to establish an effective and efficient access to cadaster data for municipalities. This could be achieved through online services developed by READ, similarly to services being developed for notaries and geodetic companies. The municipalities could use the cadaster data to monitor real-estate transactions and valuations for taxation purposes, as well as to ensure consistency between the real estate turnover tax and the real estate tax.  Impose the legal obligation that no property sale (or related transaction) can be registered in cadasters unless all past tax obligations (including real estate tax) are settled.  Enforce registration of property in the cadaster, as tax-evading individuals or entities do not register in order to avoid paying the real estate turnover tax. In some instances, the local tax administration unit effectuates its own inspection of properties not registered in the cadaster and thus collects data.  For the future, introduction of ad-valorem real estate tax could be considered.  Efforts and investments should be undertaken to endow local tax-administration agencies with the human, technical, and administrative resources (and incentives) necessary to perform better and collect more local revenues. Local tax-administrations agencies in cooperation with the Tax Administration Unit should jointly make additional efforts to collect the estate-related taxes and PIT and surtax on PIT—which are perceived to be largely evaded. Information exchanges and technical assistance between tax administration units should be encouraged. 15  Awareness should be raised among residents on the importance of paying real estate tax in order to support municipal development and service delivery. 16. Certain well-known municipalities coping with severe structural problems (e.g., de- industrialization and scarcity of private-sector jobs, lack of business potential, shrinking economic activity and incomes, population migration) may need to be granted additional revenues or assets, possibly on a temporary basis and conditional upon commitments towards expenditure rationalization (i.e., a balanced approach to fiscal consolidation that would include both revenue and spending measures). Municipalities with serious structural problems to generate a viable local economy may be unable to raise real estate tax and other own-source revenues. Northern municipalities, for instance, experienced migration and this eroded their local tax bases. Municipalities facing structural issues must be identified on a case- by-case basis, and may need to be granted additional revenues or assets to help them restore financial sustainability (creditworthiness) and reduce the size and cost of borrowings. 17. Policy and reform options to strengthen revenues of distressed municipalities include, inter alia:  A special participation in concessions, over and above the statutory share granted by the Law. A transparent, publicly-available assessment of concession values should be mutually agreed between the municipality and the Concessions Commission. According to the Law on Concession Fees, the Commission keeps the registry of concession agreements. The records refer to concessionaire’s name, grantor`s name, subject of concession, date of concluding concession agreement, and concession period; but they do not contain information essential for monitoring the revenues calculated and collected. Anecdotal evidence suggests municipalities might receive less concession revenues— despite of the share being increased—because concession values are much lower than in the past.  The introduction of well-regulated communal fees. In this regard, a Law on Communal Services awaits parliamentary procedure since late 2011 and could provide financial solutions for local governments. The Law contains provisions on several areas: e.g., the identification of communal services and the minimum standards for service provision according to the local population’s specific needs; the establishment of organizational structures of communal-service providers, consistent with legal obligations governing the transformation of public utilities; the identification of holders of property rights over the communal infrastructure, in accordance with the Constitution of Montenegro and the Law on State Property. Relevant for the issue of strengthening local revenues, the Bill Law establishes principles of full cost-recovery to guide the determination of a communal service fee. It envisions the fee as a vehicle to fund the capital and maintenance expenses needed to provide these services—which today are financed by the local budgets’ current revenues. For practical purposes, the communal service fee could be a substitute for the charge for use of buildable land—eliminated in 2009.  The elimination of deferred payments on surtax on personal income tax. State authorities can approve deferred payment of the personal income tax—often aiming at promoting business investments—and this benefit simultaneously causes deferred payment of the respective surtax collected by municipalities without consent from the local government authorities. In cases where the loss of surtax receipts is significant, some compensation to local budgets should be envisaged, e.g., not extending automatically the deferred 16 payment to the surtax, or requiring a contractual agreement between the beneficiary of the deferred payment and the local government on how the surtax will be paid.  Increase the contribution of the Central Government budget to the Equalization Fund, which is actually distributed among the financially-distressed municipalities. For instance, allocate a share of revenue such as Value Added Tax or Corporate Income Tax to the Equalization Fund.5 18. At any rate, extraordinary revenues as those proposed above must be of a temporary nature and conditional upon undertaking expenditure adjustments . The merit and opportunity of introducing communal fees could be considered, taking on board their advantages (e.g., local governments know how to collect those levies and some have low collection costs) and disadvantages (e.g., local levies could lead to distortionary taxation and create legal uncertainties in the business environment). In any case, if new local fees are introduced to support municipal budgets, there must be legal provisions setting upper ceilings and other measures that prevent the excesses in local taxation seen in the past. C. Expenditures 19. Assessing the spending of local budgets is challenging because the cash-basis accounting hides the true extent of expenditure commitments—which would be fully revealed under an accrual-basis accounting. When expenditure commitments of a certain type go unpaid, arrears accumulate; and when arrears are eventually settled, the expenditure is recorded in the category ‘repayment of commitments from previous years’—and not in the original type of expenditure, thus making it impossible to monitor such type through time and across municipalities. 20. As a whole, since 2011 Montenegrin municipalities have spent € 200-215 million (on cash basis) but built a large volume of unpaid commitments and incurred into arrears (floating debt) (Figure 5 and Table 4). Payments of gross salaries and contributions were in the order of € 35 million in 2012-14, a figure that does not include the arrears in tax liabilities. Expenses in services and supplies were around €15 million, excluding arrears to suppliers. 5 The Equalization Fund is sourced from centrally-collected, shared revenues: 11 percent of personal income tax; 10 percent real estate turnover tax; 100 percent of annual charge for vehicle registration; 40 percent of the concessions on gambling. At the budget planning stage, the allocation to the Equalization Fund is determined on the basis of revenue forecasts in central and local budgets. The allocation is distributed through advanced payments (90 percent) and short-term, interest-free loans to meet liquidity needs (10 percent). When the actual revenue-collection figures are available by March of the following year, a net payment (or contribution) is made to settle any gap between budgeted and actual revenues. The Equalization Fund is distributed among all municipalities according to their fiscal capacity (60 percent) and budgetary needs (40 percent). The distribution criteria are set in the Law on Local Self- Government Financing. The fiscal capacity to be equalized refers to the per-capita revenues (both shared and own) with a rather nuanced methodology whereby the revenue items are equalized one-by-one and different benchmarks are used to determine the funds to be transferred (e.g., for the personal income tax, the per-capita subsidy is the difference between one municipality’s per-capita PIT and the national average per-capita PIT, while for the other shared-revenue items, the per-capita subsidy relies not on the national average but on the average of the sub-set of municipalities benefitting from the Equalization Fund —i.e., municipalities excluding Bar, Budva, Kotor, Plužine, Podgorica, Tivat, and Herceg Novi). The budgetary needs to be equalized are dealt with an equal subsidy to the sub- set of municipalities benefitting from the Equalization Fund (50 percent) and with a subsidy calculated on the basis of population and territory of the municipalities (50 percent). For the latter, the municipal wage bill (in gross terms) relative to population size and relative to territory size are used as proxies of budgetary needs. 17 Numerous transfers amounted to €34 million, of which nearly half were extended to municipal companies. The capital budget allocated €48 million to expenditures in local infrastructure, construction facilities, land development, and equipment. On average, in 2012-14, €46 million were paid to settle debts and spending commitments from previous years, thus indicating the large magnitude of arrears and short-term financing incurred by Montenegrin municipalities. Debt repayments related to securities and guarantees amounted to €10-18 million in 2012-14, with a persistent increase over time. Figure 5. Budget Expenditures Budget Expenditures 2007-14 (million euro) Composition of Budget Expenditures 2007-14 (percent) Source: MOF 21. In some (not all) municipalities, the local public sector is characterized by administrations and public enterprises that are overstaffed, and public services that appear inefficient. The common grounds of the discussion between the central and local governments have been the role and size of the municipal public sector, and its efficiency in delivering services. Policy makers in the local governments hereof face difficult challenges with no clear- cut solutions to address the conflicting pressures of public sector overstaffing—such as excessive payroll expenses and growing indebtedness—on the one hand, and, on the other, the local unemployment, the lack of employment opportunities in the private sector, and a declining local economy. 18 Table 4. Budget Expenditures Budget Expenditures (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 234 316 259 225 199 204 213 212 Gross salaries and contributions 32 42 41 33 33 33 36 37 Net salaries 18 26 27 25 27 26 25 26 Payroll tax 3 4 3 2 1 2 2 2 Contributions borne by the employee 5 6 6 4 3 4 6 6 Contributions borne by the employer 4 5 4 2 2 2 3 3 Municipal surcharge 0 1 0 0 0 0 0 0 Other personal income 6 7 6 6 7 3 2 2 Expenditures for supplies and services 21 24 20 18 16 17 15 14 Maintenance of infrastructure, buildings, and equipment 7 8 5 5 5 5 4 4 Interests 1 1 1 1 3 3 3 3 Rent 1 1 1 1 0 0 0 0 Subsidies 1 2 1 1 1 1 1 0 Other expenditures 2 1 1 1 1 1 1 3 Social security transfers (entitlements and redundancies) 0 4 1 0 1 0 0 0 Transfers 27 33 30 29 27 33 32 35 Transfers to public institutions 8 9 12 9 8 10 0 0 Transfers to NGO, political parties and associations 3 4 2 2 2 2 4 2 Transfers to individuals 3 4 3 3 3 3 6 9 Transfers to municipalities 1 6 1 1 1 1 0 0 Transfers to the central budget 0 0 0 0 0 1 3 3 Transfers to public companies 12 10 13 14 14 17 6 8 Other transfers 0 0 0 0 0 0 13 14 Capital expenditures 105 166 112 83 51 48 47 49 Expenditures for local infrastructure 51 95 55 59 33 33 34 34 Expenditures for construction facilities 19 28 24 14 10 7 5 9 Expenditures for land development 23 25 19 2 3 3 2 2 Equipment and other capital expenditures 12 19 15 8 5 5 6 4 Credits and loans 2 1 1 1 2 1 1 1 Debt repayment 22 20 37 43 50 55 67 59 Repayment of securities and guarantees 7 6 8 5 9 10 14 18 Repayment of commitments from previous years 15 14 29 37 41 44 53 41 Reserves 8 7 4 3 2 3 2 2 MEMO Composition of Budget Expenditures (percent) Gross salaries and contributions 14 13 16 15 16 16 17 17 Expenditures for supplies and services 9 8 8 8 8 8 7 7 Maintenance of infrastructure, buildings, and equipment 3 2 2 2 2 2 2 2 Transfers to municipal companies 5 3 5 6 7 8 9 10 Other current expenditure 11 12 11 11 13 12 10 11 Capital expenditures 45 53 43 37 26 24 22 23 Debt repayment 9 6 14 19 25 27 31 28 Other financing transactions 4 2 2 2 2 2 1 2 Composition of Current Budget Expenditures (i.e, excluding CAPEX, Debt Repayments, and Financing Transactions) (percent) Gross salaries and contributions 32 34 38 35 35 34 38 37 Expenditures for supplies and services 22 20 19 19 17 17 16 14 Maintenance of infrastructure, buildings, and equipment 8 6 5 5 5 5 4 4 Transfers to municipal companies 12 8 12 15 15 17 21 22 Other current expenditure 26 32 26 26 28 26 22 23 Budget Expenditures excluding Debt Repayments (million Euro) 213 296 223 182 149 150 146 153 Source: MOF 22. An intra-country comparison indicates that municipalities of similar size have very different employment levels, with some of them overstaffed despite similar statutory responsibilities (Figure 6). Some Montenegrin local governments—having autonomy to manage their staffing policy—built a bloated bureaucracy with no obvious additional tasks to perform relative to more conservative peers. For instance, Podgorica, a large municipality deemed to be prudently administered with a reasonable quantity of human resources, employs 4.6 staff per 1,000 inhabitants to work in the local administration and public institutions (i.e., excluding the local public companies). Bar, Bijelo Polje, and Nikšić, which are smaller than the Capital City but still large districts for Montenegrin standards, hire more public servants relative to their population: respectively, their ratios are 6.7, 9.1, and 9.5. The middle-size, efficient municipality of Herceg Novi employs 9.2 staff per 1,000 inhabitants, whereas peers like Pljevlja and Berane have ratios above 11. Finally, Rožaje, a small-middle municipality, hires 6.3 staff per 1,000 inhabitants, whereas comparable municipalities such as Danilovgrad, Ulcinj, and Kotor have ratios in the range 9-11, and peers like Budva and Cetinje are certainly overstaffed in 19 comparison. For even smaller municipalities, the analysis blurs because indivisibilities in the administrative organization of the public sector often lead to very high staff-to-population ratios. Figure 6. Municipal Employment, 2014. Note: Podgorica has 186,290 inhabitants and its bar reporting population is off-chart. Source: MOF and MONSTAT Figure 7. Municipal Gross Salaries and Contributions (estimated accrual basis), 2014. Left axis in euro; right axis in percent. Note: Accrual basis estimated assuming that net salaries were fully paid in 2014 and represented 60 percent of the gross salaries and contributions due. Source: MOF 23. Another comparison suggests that some municipalities have excessive payroll expenses that could absorb a large share of their recurrent revenues (excluding financing transactions) (Figure 7). Gross salaries and contributions per employee committed (not necessarily paid) by the local governments largel y differ, running from nearly €2,600 in Kolašin to €11,300 in Budva and €13,100 in Tivat. This heterogeneity reflects the autonomy of municipalities to manage their wage compensation policy as well as the country’s large regional disparities in terms of economic development and per-capita income. Overstaffing and generous wage compensation jointly result in excessive payroll expenses in local budgets. For instance, in 2014, the committed gross salaries and contributions (i.e., in accrual basis) were equivalent to 40-50 percent of the recurrent revenues in the municipalities of Šavnik, Plav, Danilovgrad, Ulcinj, and Herceg Novi. Cetinje was an extreme case as the commitments exceeded 100 percent 20 of those revenues; not surprisingly, contributions were not paid at all and even salaries were delayed.6 In 2014, ten municipalities did not have sufficient resources to live up to their commitments and eventually paid net salaries and only a fraction of their contributions due (sometimes a very small fraction, indeed): Bar, Berane, Bijelo Polje, Budva, Danilovgrad, Kolašin, Plav, Pljevlja, Ulcinj, and Cetinje. Surprisingly, Bar and Budva have relatively generous wage compensations compared to other districts; however, they seem to be unable to afford the high level of salaries committed to their staff. 24. Overstaffing and excessive payroll expenses are present in some municipalities and have been an important structural feature in Montenegro as a transition economy. Some (not all) municipalities exhibit overstaffing and excessive payroll expenses because they have been acting as an ‘employer of last resort’ in a context of severe structural problems (e.g., de- industrialization and scarcity of private-sector jobs, lack of business potential, shrinking economic activity and incomes, population migration). In part, high levels of public sector employment reflect the belief that the local government sector should be at the center of economic activity and have been an important feature for a decade now. Political patronage and cronyism may also be motives.7 25. Overstaffing and excessive payroll expenses are also the result of strategic behavior by local governments: a deliberate policy of accumulating more expenditure commitments in relation to staff hiring than can be financed from expected revenues, in the hope of eventual financial relief from the Central Government, ensured the process of delaying the payment of obligations related to staff. A significant problem in the country’s intergovernmental relations is the incentive it may provide to inefficiency in service delivery— and particularly to overstaffing—which is not originated in unfunded mandates. As a matter of fact, the Central Government has unofficially approved delay in payment of 100 percent of social security contributions, then providing no incentive to economize on staff. The result of which has led to overstaffing in most Montenegro municipalities and the reduction in funds to improve services to citizens. More recently, a tight fiscal straight jacket imposed by the Central Government has not been fully successful in preventing municipal arrears. 26. Municipalities have previously hidden overstaffing with creative measures . Employing staff on a short-term contractual basis (e.g., four-month contracts) did not imply any de facto rationalization because the short-term employees have their contracts renewed 6 The analysis of the wage bill through time is complicated because unpaid salaries at the end of the year are presented under outstanding liabilities or arrears, and when paid the next year, they are presented as repayment of commitments from previous years. 7 As indicated in the interviews, the current situation is the result of the period of economic transition and a political situation that overloaded decisions that were not rational from an economic point of view, but from a social one: primarily assuming a large number of employees from the private sector due to the declining economy and failing businesses. In addition, a change of government at the local level also meant a change of employees. The economic situation saw the municipalities as the only employer in order to pursue social policy. Large bankruptcy proceedings have been initiated for the companies that used to operate and employ significant number of workers who then ended up at the unemployment bureau. The towns were under enormous pressure for employment and operated like social welfare institutions wherein a large number of people were employed. In cases like Nikšić, with a local economy struggling to cope with large firms closing their commercial activities and lack of business opportunities, the local government had to step in to absorb excess labor and mitigate disruptions to the fabric social. Similar conditions are thought to prevail in Northern and lagging municipalities. This is certainly a development challenge that is just reflected in local public finances. 21 recurrently. Transfers of employees from the municipal administration to the local public companies also intended to hide overstaffing. Transfers are less likely now because local public companies cannot continue absorbing employees, and because the MOF now monitors information on the number of employees in both the municipality and the local public companies. 27. Local governments are continuing to add jobs, as the municipal staff rationalization plans launched in 2013 eventually failed and re-hiring have been observed. It appears that the sequence of the adjustment process has negatively affected the performance of important parts of the public sector. Re-hires indicate a poorly handled downsizing process. In the best case, they imply that workers who were essential to the operation of their structured units were mistakenly considered redundant. In the worst case, they suggest that workers who had no intention to leave the public sector were able to cash in golden handshakes. It is difficult to believe that downsizing projects that were characterized by substantial re-hiring did a good job at reallocating workers across sectors. Ceteris paribus, a high percentage of displaced workers re- hired can therefore be seen as an indication of low economic returns to downsizing.8 28. The strategy for public administration reform in 2011-2016, including a plan for the internal reorganization of the public sector adopted in 2013, has not achieved its commendable objectives. The strategy documents envisioned the internal reorganization of the public sector of local governments, and one salient objective was to reduce the number of employees within the public administration. Such reduction would take place in two phases. The first phase was supposed to be implemented in July, 2013 and cover the period 2014-2015, targeting a 5 percent reduction in each year. The annual report prepared for 2014 provided unfavorable data and information: instead of reductions, there was an increase of 1,217 employees in 2014. Although the importance of these documents cannot be exaggerated, they contain no enforcement measures for local governments. Given the legally-granted local autonomy, the Central Government and the MOF have no mechanism available to oblige local governments with respect to their internal organization—which they enact as their own discretion. 29. Staff rationalization plans proposed in 2013 also failed due to lack of incentives and structural labor-market issues. Beyond the lack of enforcement mechanisms, other important reasons for which the 2013 plans were not achieved concern incentives and labor-market issues. Employment exit proposals were voluntary—in line with the labor regulations—and only a handful of staff close to retirement age accepted the proposed early-retirement package. The remaining staff rationally preferred to maintain their public jobs in a context of lack of employment opportunities in the private sector. This factor was particularly relevant in municipalities facing severe structural problems in their local economies. 8 Under the Law on Local Government Finance (Art 59a), municipalities that face liquidity problems for more than 90 days are required to prepare rehabilitation plans (with a program of measures to overcome financial difficulties including the reduction of employment, etc.); after which, they may have been issued approval by MOF to exceed the 10 percent debt ceiling (Art 64). Reportedly, the state provided co-financing for the social plans. On the basis of these agreements, municipalities were obliged to submit their budgets and procurement plans for approval, along with the reduction of employees. The municipalities have largely not complied. For example, Municipality of Berane laid off 150 persons. The state provided about 3,000 Euro for each person. However, the subsequent report received from the municipality indicated that the number of employees actually increased by 100, meaning that some may have been rehired. 22 Directions for policy and reform 30. Three fundamental directions for policy and reform should be pursued: (i) to increase average productivity in the public sector by reducing overstaffing; (ii) to generate fiscal savings directly through a smaller (or slowly growing) wage bill as well as indirectly by stemming efficiency losses; and (iii) to promote dynamic, job-creating private sector activity to absorb labor leaving the public sector. 31. The debt reprogramming contracts signed between MOF and the municipalities offers a window of opportunity to demand local governments to undertake an internal reorganization consistent with the employment-reduction plans submitted in 2013, or even with new plans. Since the debt reprogramming represents a contractual relationship, a municipality’s failure to comply with the proposed staff rationalization plan can lead to the immediate termination of the contract and the loss of financial advantages emanating from the reprogramming. This was the only way for the Central Government and the MOF to engineer an enforcement mechanism. 32. The staff rationalization plans required by the MOF as part of the debt reprogramming contracts are an important step forward. Staff rationalization will reduce local government expenditures and thus improve the financial position. The recommended measures focus on the following:  Municipalities should sign a clause agreeing not to hire any additional employees, or, at a minimum, to hire new employees only with the explicit consent from the MOF.  Municipalities should sign a clause agreeing on the rationalization of the number of employees. A realistic plan must be formulated to reduce the number of employees by an X percent each year, for a period of 3-5 years. Reportedly, Bijelo Polje plans to reduce 30 percent of its staff in a 3-year period, aiming at saving €1.3 million. Cetinje intends to reduce 200 staff and thus achieve savings of €1.5 million, but without specifying a timeline.  Complementing the plans to reduce staff, the municipalities should commit to gradually reduce the personnel expenses as a share of own revenues, preferably setting annual targets to be monitored by the MOF.  The functional analysis of front and back office functions performed by municipalities and the identification of potential economies of scale that could be created through the implementation of shared services schemes are highly recommended given the comparatively limited size of a large number of municipalities  The MOF should put in place a monitoring mechanism tracking both new job positions in local governments as well as the staff departures.  Municipalities announce a public call for consensual termination of employment that is followed by a certain social program or severance payment. Without a likely private- sector job, a social program, or a severance payment, the consensual termination may be an acceptable option for those people who are close to retirement, but not for those who are at the peak of their careers.  Municipalities should consider measures and incentives for local businesses to increase employment, particularly the SMEs using labor-intensive technologies (e.g., services). For instance, some municipalities established business zones to encourage investors to hire people. Within these zones, the entrepreneurs are exempted for paying taxes and 23 charges for the certain period of time (e.g. three years) with the condition to expand their business to more than five employees. The municipalities also need to avoid providing unjustified subsidies through limiting its tax base. 33. The law does not permit the laying off of public employees and the forced pension retirement, and so voluntary exits and severance packages are the only options to reduce overstaffing. Under the relevant legislation in Montenegro, the conditions for retirement have become more rigid—at the age of 67 or after 40 years of work—and the municipal authorities cannot force anyone into retirement before the statutory, minimum retirement age is reached. Thus, the space to reduce staff through early retirement is limited. The law does not permit the laying off of public employees and then voluntary exits and severance packages should be offered. Reportedly, voluntary exits are rare exceptions, though. 34. Voluntary departure schemes are probably feasible options to consider; however, they have pros and cons. This mechanism uses an arbitrary rule typically based on seniority and current earnings so that the workers to be let go are offered higher compensation packages, the longer their tenure in the local administration. For instance, separated workers receive two years of salary, or one month of salary per year of service, or some other combination of these of these seniority and current earnings variables. This mechanism helps by-pass the legal obstacles where outright layoffs are not allowed. This ‘buying out’ scheme greatly minimizes political costs. However, two common problems have diminished the effectiveness of this mechanism: (i) wrongful targeting, as sometimes only the best public-sector workers leave because they are the ones who have the best prospects in the private sector; and (ii) overpayment or underpayment, as the resulting compensation amount may bear little relation with the loss experienced as a result of separation (of course, some severance pay packages may be so unattractive that no public sector worker would leave, whereas others may represent such a windfall that everybody, including workers with low productivity, would take them). Too often, severance pay is offered indiscriminately: some public sector employees take the package, others stay, and only later do governments see who they've got left. The sequence should be reversed: firstly, identify the services to cut and the overstaffed jobs; secondly, offer severance pay to those targeted to leave.9 35. Funding generous severance payments will probably require to take on additional municipal debt, or to receive additional transfers from the Central Government. These financial costs, however, should be seen as improving (not deteriorating) the long-term financial viability of distressed municipalities. An abrupt staff reduction will burden the Montenegro social welfare funds. The Rehabilitation Plans of Cetinje and Bijelo Polje, for instance, estimate 9 Other schemes may also be considered, but seem less likely to be adopted. After a voluntary program is carried out, any remaining redundant staff may still need to be laid off against their will, through an involuntary retrenchment scheme. This involves offering severance payments to encourage redundant workers to quit, thus overcoming their resistance to downsizing, restructuring, or privatization. This option may entail involuntary ‘soft’ separations under the strict enforcement of mandatory retirement rules or the enforcement of legal or contractual provisions dealing with under-performing employees (e.g., ghost workers), or ‘hard’ separations such as layoffs. Similar to the voluntary case, a rule of thumb involving salary and perhaps seniority in the public sector is used to calculate the compensation package. Even less likely options are contracting-out schemes—whereby activities previously executed within the local administration (or local public company) are contracted out to private cooperatives established by former enterprise employees —and employment ownership in privatizations—where shares are reserved for employees in the to-be-privatized enterprises, thus giving them a direct stake in the performance and profits of the companies. 24 that € 2 million and €1 million, respectively, are necessary to fund appropriate severance payments. 36. On policy options to rationalize public employment and reallocate workers from the public to the private sector, the challenges are likely to arise with the incentive framework necessary to achieve an effective transfer of labor. There is a strong economic rationale to reallocate underutilized, or redundant, workers from public jobs to more productive activities in the private sector, namely to increase efficiency and overall economic output. The task of reducing the size and improving the efficiency of an overstaffed public sector would also help cut fiscal deficits. Nevertheless, eliminating public sector jobs is universally unpopular and likely to generate political opposition, implying that effective downsizing measures must address political economy constraints as well. The challenge lies in designing appropriate methods to rationalize public employment, and establishing a supportive incentive framework. 37. The Law on Salaries in the Public Sector (under preparation) to reform the civil- servant salary policy can be instrumental to the containment of excessive payroll expenses . Salaries at the local level differ from one municipality to another and also to the Central Government. The Government needs to deal with salaries in a systemic manner under the Law on Salaries in the Public Sector, now being under preparation, in order to introduce principles linking the level of salaries to fiscal parameters. Some options to consider include:  The Law could stipulate wage scales (with a minimum floor and a maximum ceiling) for specific grades and job descriptions. This would facilitate ‘standardizing’ labor costs.  The wage scales should accommodate differences in the cost of living across regions, and could be indexed—fiscal situation permitting—to reflect overall increases in the cost of living. Other variations in economic life that stem from differences in municipalities’ size, geographic position, special administrative status, and political structure, could also be considered.  Notably, to incentivize performance, compensations above the maximum ceiling of the scales (e.g., annual bonuses or special allowances) could be permitted if and only if there is strong evidence that the recurrent revenues of the municipality are sufficient to fund the additional wage compensation; thus, these exceptions to the wage scales should be approved on a case-by-case basis—preferably involving the MOF. In addition, the performance should be monitored and audited ex post. 38. Local governments should undertake a rational internal reorganization of tasks and resources, in order to identify areas of potential spending efficiency gains. The local governments should consider taking the following steps:  Review the staffing and administrative expenditure pattern of the municipal departments and local public enterprises, in order to identify opportunities to reduce of their functions, activities, administrative structure, and levels of staffing. The functional review exercise aims to enhance the efficiency of service delivery.  Review the existing arrangements for re-deployment and re-training of surplus staff to ensure that any additional manpower for new areas of municipal activities are met by re- deployment (not by new hiring).  To mitigate the problems of politicization of staff decisions, a clear-cut demarcation line should be drawn between positions expected to be filled by political appointees—which 25 should not be permanent contracts—and the positions for professional civil servants— which may be long-term jobs and always subject to a merit-based recruiting process.  Conduct internal reorganization to foster responsible and efficient local public administration that will be at the service of citizens and businesses.  Segment the activities of public companies in order to separate those that are profitable from those that are not. The former should be subject either to remediation plans or to corporate dissolution with outsourcing of services to private companies or to public companies operating in other municipalities. 39. Local governments should also improve their public financial management (PFM) systems. Weaknesses in PFM systems have to be addressed. For instance, on orderliness of the budget process, certain municipalities are delayed in submitting budget execution data and reports to the MOF. There is evidence of municipalities enacting budget revisions and final statements way beyond the due date, and approving expenditures which exceed budget appropriations. Worse, there are examples of municipalities entering into debt arrangements without former approval of the MOF, in open violation of the Fiscal Responsibility Law. Municipal PFM needs to be strengthened and further scrutinized by both the MOF and the National Audit Institution. 40. Staff rationalization plans must be complemented with efforts to help creating private-sector jobs in the local economy. Options should be explored to promote the creation of private-sector jobs in the local economy, in order to incentivize staff to leave their (secured, stable) public jobs. Inter alia, options might include:  Centers for employment and re-training programs.  Financial support for an extended period of time, preferably conditional upon prove of active job search.  Facilitation of daily or weekly commuting between municipalities with and without employment potential, i.e., encouragement of internal migration, at least of a temporary nature, taking advantage that Montenegro is a small country.  Efforts and investments should then be undertaken to endow those public employees offered an exit plan with new skills, realistic opportunities to work in the private sector, and financial support during the period in-between jobs. These are necessary for them to accept the voluntary exit plans. D. Debt 41. Municipal debt is small relative to the total public debt in Montenegro, but some municipalities are particularly over-indebted and their growing arrears indicate a serious financial distress (Figure 8, Table 5 and Table 6). Municipal debt as of end-2014 amounted to € 286 million, of which bank liabilities were € 167 million and arrears were € 119 million. Financing transactions, such as borrowings, arrears, and sales of assets, provided funding in a context of decreasing above-the-line revenues. Financial distress is particularly acute in a handful of cases: almost all arrears at subnational level corresponds to 11 municipalities, namely Danilovgrad, Plav, Kolašin, Pljevlja, Ulcinj, Berane, Cetinje, Bar, Bijelo Polje, Nikšić, and Budva. Nikšić and Budva had the largest absolute amount of indebtedness (€ 15 million and € 33 million, respectively), whereas Kolašin and Ulcinj had the largest amount of debt relative to revenues excluding financing transactions (above 200 percent in both cases). 26 Figure 8. Municipal Debt Debt 2010-14 (percent of budget revenues) Composition of Debt in 2014 (percent of budget rev.) Table 5. Municipal Debt, 2010-2014 Indicators Total Bank MEMO: Total Debt Total Arrears Total Debt as Debt (% of Budget (% of budget (% of budget Year of end-year Bank Debt Arrears budget revenues, revenues, revenues, revenues, excluding (million euro) excluding excluding excluding financing financing financing financing transactions transactions) transactions) transactions) (million euro) 2010 183.3 88.3 95.0 102.5 49.4 53.1 178.8 2011 215.3 116.7 98.6 132.4 71.8 60.6 162.6 2012 225.2 115.4 109.8 121.9 62.5 59.4 184.7 2013 287.4 170.6 116.8 142.3 84.5 57.8 201.9 2014 286.2 166.9 119.2 143.9 84.0 60.0 198.8 Table 6. Municipal Debt, by municipality, 2014. Bank Debt Arrears Indicators Total Debt Total Bank Total Arrears MEMO: Liabilities Total Debt as (% of 2014 Debt (% of (% of 2014 Budget for gross Liabilities Liabilities Municipality of end-2014 Liabilities budget 2014 budget budget revenues, Total Bank Total salaries & for other for loans Other Domestic Foreign for capital revenues, revenues, revenues, excluding (million euro) Debt Arrears contributions current (liquidity liabilities expenditures excluding excluding excluding financing charged to expenditures shortages) financing financing financing transactions employer transactions) transactions) transactions) (million euro) Andrijevica 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4.1 4.1 0.0 1.2 Bar 14.8 4.1 0.1 4.0 10.7 2.9 0.7 1.5 3.3 2.3 122.2 34.0 88.2 12.1 Berane 13.3 3.5 2.8 0.8 9.8 7.7 1.1 0.8 0.1 0.0 224.7 59.7 165.1 5.9 Bijelo Polje 18.5 7.6 6.9 0.8 10.9 6.7 1.0 1.7 0.9 0.6 192.6 79.1 113.5 9.6 Budva 99.1 65.9 7.5 58.4 33.1 4.4 7.3 17.4 1.3 2.7 309.8 206.2 103.6 32.0 Cetinje 14.2 4.0 4.0 0.0 10.2 6.6 1.7 0.4 1.0 0.5 219.0 61.4 157.5 6.5 Danilovgrad 4.2 1.4 0.7 0.7 2.8 2.5 0.3 0.0 0.0 0.0 139.7 46.9 92.8 3.0 Gusinje 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Herceg Novi 10.3 8.6 0.8 7.8 1.7 0.3 1.2 0.0 0.0 0.1 76.9 64.5 12.4 13.3 Kolašin 8.1 3.8 3.4 0.4 4.3 1.5 1.2 0.3 1.2 0.2 375.8 174.8 201.0 2.2 Kotor 4.4 3.9 0.4 3.5 0.5 0.3 0.0 0.0 0.0 0.2 34.5 30.8 3.7 12.7 Mojkovac 0.8 0.3 0.3 0.0 0.5 0.1 0.3 0.0 0.0 0.1 38.0 14.4 23.6 2.0 Nikšić 33.7 18.5 5.9 12.6 15.3 2.5 1.3 1.0 9.3 1.2 185.8 101.7 84.1 18.2 Petnjica 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 15.6 0.0 15.6 0.2 Plav 3.7 0.9 0.9 0.0 2.8 1.3 0.2 0.1 1.2 0.1 171.9 41.3 130.6 2.2 Plužine 0.5 0.5 0.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 21.8 20.9 0.9 2.3 Pljevlja 14.1 7.3 5.8 1.5 6.8 3.0 1.9 1.1 0.1 0.7 151.1 78.6 72.6 9.3 Podgorica 26.1 26.1 0.6 25.5 0.0 0.0 0.0 0.0 0.0 0.0 58.7 58.7 0.0 44.5 Rožaje 1.6 1.6 0.5 1.1 0.0 0.0 0.0 0.0 0.0 0.0 37.8 37.8 0.0 4.2 Šavnik 0.7 0.2 0.2 0.0 0.4 0.4 0.0 0.0 0.0 0.0 61.5 21.8 39.7 1.1 Tivat 4.2 4.2 0.0 4.2 0.0 0.0 0.0 0.0 0.0 0.0 40.1 39.8 0.3 10.4 Ulcinj 13.4 4.2 3.6 0.7 9.2 3.4 1.0 0.1 4.5 0.2 301.1 95.2 205.9 4.5 Žabljak 0.4 0.2 0.2 0.0 0.2 0.1 0.0 0.0 0.0 0.0 27.9 13.3 14.5 1.4 TOTAL 286.1 166.9 45.0 122.0 119.2 43.7 19.2 24.6 22.8 8.9 198.8 Source: MOF 42. Facing insufficient own-source revenues, overstaffing, and excessive payroll expenses, certain municipalities either became disproportionally dependent upon the Equalization the Fund or resorted largely to borrowings and arrears (e.g., voluntary 27 financing such as Bank loans providing liquidity, or forced financing such as arrears in the payment of salaries and related obligations for payroll tax and contributions). Since the beginning of the global crisis, the mismatches between fiscal capacity and spending commitments in certain municipalities led to transfer-dependence and over-indebtedness. Liquidity shortages were covered by contracting short-term bank loans (i.e., loans not tied to investment projects) and by incurring arrears in the payment of salaries, related tax liabilities, and supplies. Currently, in these municipalities, the levels of debt are unsustainable (i.e., the debt burden is disproportionate relative to the repayment capacity associated to the available revenue sources) and the interest bill is a growing drainage of local budget resources. The interest rates on short-term bank loans are very high—probably reflecting both the credit risk and the inelastic demand for financing by municipalities. 43. The repayment of debts and spending commitments from previous years (e.g., arrears) is ballooning and crowds out the capital budget. Overall, the repayment of debts and spending commitments from previous years (e.g., arrears) absorbed 19 percent of the local budget in 2010 and up to 28 percent in 2014. Concomitantly, the capital expenditure decreased from 37 percent of the local budget in 2010 to 23 percent in 2014, to a large extent crowded out by the debt repayments. Anecdotal evidence suggests that some municipalities have made remarkable efforts to repay their liabilities without any restructuring, but often at the expense of the capital projects and maintenance standards. Even basic services (e.g., road maintenance and garbage treatment) are falling below acceptable, minimum levels of execution. To be sure, arrears are a manifestation of the inability to fund current expenses—including gross salaries. Therefore, the capital budget would probably be further contracted unless current expenditures be rationalized and the outstanding debts be restructured. 44. Fiscal rules imposing constraints on local finances are difficult to monitor and subject to manipulation, and thus have not prevented over-indebtedness in some municipalities. The Law on Local Self Government Finances establishes fiscal rules aimed at strengthening discipline at the budget planning stage, e.g., Article 41 stipulates that current expenditures and debt repayments (i.e., principal) must be financed from current revenues, and Article 64 establishes that debt payments (i.e., interest and principal), payments under leasing contracts, repayment of commitments from previous years, and any other debt obligations, must not exceed 10 percent of the realized current revenues in the previous year. Optimistic revenue forecasts often allow complying with the fiscal rules at the budget planning stage (ex ante). Large breaches are observed later, at the execution stage (ex post), as collected revenues fall short of expected ones.10 Thus, regardless of their good intentions, the existing fiscal rules have not prevented some municipalities from borrowing excessively.11 10 MOF argues that local revenue forecasts are of poor quality, with systematic overestimation of one-off revenues raised through sales of land, building permits, and charges for provision of utilities at buildable land. Overestimation may result from outright manipulation of forecasts in order to comply with the fiscal rules, or from deals between local governments and real-estate investors that eventually break apart—e.g., Bar and Budva tried to sell the land of Kraljicina Plaza but the initiative eventually failed and the expected revenues did not materialize. MOF finds it difficult to make an independent assessment of the local revenue forecasts because it lacks relevant information such as the applications for building permits. 11 MOF or a dedicated agency should be able to undertake local-finance forecasts independently, so as to assess the realism of the forecasts prepared by the municipalities themselves. 28 45. Remedial actions taken in the past have been partially successful since the over- indebtedness problem persists. The Government and the MOF led efforts to help municipalities put their fiscal house in order. In 2010, 12 municipalities restructured tax and non-tax debts for a period of five years, and formulated recovery plans. In 2013, initiatives were launched to set up new recovery plans, restructure debt towards the Central Government, and facilitate the sale of assets.12 In April 2014, the Budget and Fiscal Responsibility Law mandated that local budgets cannot be approved without monitoring and endorsement by the MOF, thus seeking greater fiscal discipline, transparency, and accountability. Nevertheless, the MOF has to be mindful of the local autonomy and cannot impose changes on the proposed budget. It was only through specific contracts agreed between the Central Government and a local government that the former could condition financial assistance to the later upon the adoption of fiscal consolidation measures (e.g., in the debt reprogramming contracts signed in 2010). 46. A roadmap to workout arrears and rationalize staff provides policy guidance for 2015. In November 2014, policy discussions between the MOF, mayors, the Union of Municipalities, and the Tax Administration Unit, resulted in a roadmap to urgently address the arrears owed to the Central Government, banks and suppliers, and to decisively remediate the problems of overstaffing and excessive payroll expenses. Complementary issues were explored, e.g., the Law on Salaries in the Public Sector (under preparation) to address civil-servant salary policy and tie the level of salaries to fiscal parameters. 47. The proposed roadmap is shaped by the view that the legal framework governing Montenegrin local finances is adequate. Evidence indicates that, given a common legal framework of universal application among local governments, a number of municipalities (e.g., Tivat, Plužine, Podgorica, Andrijevica, Kotor, Rožaje, Mojkovac) are actually performing well and do not experience financial stress. On the other hand, resolute action must be taken on reforming operation and activities of other local governments—particularly seeking operational effectiveness and efficiency—in order to restore their financial sustainability. In this regard, the November 2014 policy discussions concluded that the single most prominent problem in most municipalities is the substantial amount of arrears, owed to the Central Government, banks and suppliers, followed by the problems of overstaffing and excessive payroll expenses. 48. Municipalities (reportedly, 14) and the MOF are entering into contracts that reprogram arrears on tax liabilities in exchange for plans to rationalize staff . These arrangements are an important step forward. Tax debt is envisaged to be repaid within 20 years (or 5 years for Bar and Budva), with annuities being smaller in the first year of implementation to provide some room for the municipalities to adjust, and gradually increasing over time. Reprogramming arrears would normalize obligations because municipalities are requested to pay their salaries in gross amounts (i.e., inclusive of social security contributions and payroll tax) starting January 2015; with enforcement powers granted to the Tax Administration Unit. This is a commendable action from the perspective of financial planning, accountability, and transparency.13 Provided that staff rationalization is achieved despite of the structural difficulties 12 Asset sales to repay tax arrears were quite limited in terms of volume. The Tax Administration Unit is of the view that the properties offered by the municipalities are of little value for private investors. 13 Municipal public companies also incurred into arrears on tax liabilities. Reportedly, the MOF cannot enter agreements with these companies because they are unable to guarantee their debt repayments. Instead, the MOF signs a contract with the municipalities owing them. If municipalities fail to repay their debts in accordance with the 29 highlighted earlier in this note, the expected reduction in municipal spending should help improving the financial position going forward. Directions for policy and reform 49. Debt reprogramming contracts might be complemented with measures that seek to expand own-source revenues. Measures to bring more revenues to local budgets should complement the provisions aimed at reducing staff and payroll expenses (See Annex 2 of this study). Revenue measures were suggested earlier in this note (e.g., broaden bases for real estate tax by legalizing irregular settlements, supporting local tax administration units). 50. A debt reprogramming contract would provide stronger incentives to a municipality if it involves new cash flows. By envisaging revenue measures that do provide new cash, the contracts could further strengthen the financial position, give stronger incentives to proceed with staff rationalization, and mitigate the impact of fiscal consolidation on capital and maintenance expenses. The case for providing new cash flows is reinforced by the need to fund severance payments and normalize the payment of gross salaries. 51. Debt reprogramming contracts could be complemented with measures that aim at improving the operational effectiveness and efficiency of local governments. Any support coming from the central government should come at a high price to municipalities mostly in terms of restraining their autonomy as a way to avoid creating undesired precedents and moral hazards. Measures to boost cost-effectiveness of service delivery, especially with regard to municipal companies, could be envisaged in the contracts. For instance, contracts could require the merging of operations (and even joint ownership) of utilities across small municipalities, in order to rationalize the cost of service provision by exploiting economies of scale. Montenegro could consider the successful experience of OECD countries in improving operational effectiveness and efficiency of municipal companies by merging them or arranging joint delivery of services (see Annex 1 of this study). 52. In those municipalities undergoing financial stress, bank loans should be also reprogrammed—reducing interest costs and lengthening maturities—in the context of a fiscal consolidation plan. Loans for investment financing and liquidity provision extended by commercial banks should be also restructured. Reportedly, some loans carry high interest rates and have short maturities, thus absorbing substantial budget resources and posing liquidity risks. With regard to the refinancing of municipalities short-term debts to commercial banks, one option that the government might consider to reduce costs would be for the central government to act as an agent on LGs’ behalf in the debt and cash market as a voluntary facility or even be obliged to use this service, whilst being prohibited from direct bank financing for the duration of their restructuring or as part of their compact with the MoF. At least, debt reprogramming contracts signed between municipalities and commercial banks should be monitored by the MOF and complement the fiscal consolidation plans envisaged in the reprogramming of tax debts. Bank debt reprogramming must be designed in such a way that budget costs are reduced all along the life of the financial obligation, i.e., reprogramming must not be a purely rescheduling exercise. Lower interest rates, longer maturities, and grace periods should be granted. Guarantees contract, the Tax Administration Unit will undertake measures such as blocking accounts and withholding the transfer of shared revenues. 30 could be offered in order to reduce solvency risk and ensure direct payments to banks, which would justify the reduction in budget costs. 31 Annex 1. Incentives to Support Joint Service Delivery and Amalgamation of Municipal Companies 1. Montenegro has comparatively low numbers of inhabitants per local government compared to other EU countries, and a large concentration of citizens in the capital city14. The current fragmentation of local governments makes it hard to serve citizens effectively and limits the capacity to manage financial and human resources. Addressing the optimal territorial organization and functional decentralization, including service-delivery responsibilities of municipal companies, should be a priority for Montenegro. 2. Service delivery is hampered by excessive fragmentation. The small size of most Montenegrin municipalities and their markets for public services provided by municipal companies raises the question of whether the scale of administrative overhead and public services is efficient, or, at a minimum, if there is room to improve efficiency. Admittedly, it is quite difficult to discern a precise relationship between local government’s size and efficiency; nevertheless, empirical research shows that efficiency begins to drop off significantly below 5,000 inhabitants15. Montenegro has several municipalities below that size. Having too many subnational entities, or at least too many that are too small to be viable, Montenegro should seriously explore introducing incentives for municipalities to coordinate over service provision, and perhaps even to amalgamate voluntarily. 3. OECD countries have several approaches to encourage coordination or amalgamation between local governments, always seeking to reap economies of scale, internalize spillover effects, and use better their indivisible physical assets involved in service delivery16. In Finland, to promote voluntary municipal amalgamation, grants were offered to merging municipalities, whose amount depended on the number and size of municipalities being merged and on the size of the municipality created after the amalgamation. France has promoted coordination by recognizing inter- communal structures as legal entities and giving them partial subsidies. In Turkey and Japan, municipalities may join forces in formal associations to perform joint tasks such as school management and waste disposal. While amalgamation is a politically complex endeavor, coordination might be technically feasible. Policy tools to encourage coordination include: progressively increasing grants (i.e., bigger entities obtain larger grants); threshold requirements for investment grants (i.e., soft financing is provided only to 14 World Bank (2013); South East Europe Municipal Finance Review: Local Government Finance in the Western Balkans; Report No. 82649-ECA 15 Fox, W. and T. Gurley (2006); “Will Consolidation Improve Sub -National Governments?�; World Bank Policy Research Working Papers 16 OECD (2006), Efficiency of Sub-central Spending 32 entities that serve a population exceeding a minimum size); and one-off and formula-based compensations that put weight on the size of the population served. Annex 2. Preliminary Assessment of Highly-Indebted Municipalities 1. Some municipalities are particularly over-indebted and their growing arrears indicate a serious financial distress. Financial distress is particularly acute in a handful of cases: almost all arrears at subnational level corresponds to 11 municipalities, namely Danilovgrad, Plav, Kolašin, Pljevlja, Ulcinj, Berane, Cetinje, Bar, Bijelo Polje, Nikšić, and Budva. Nikšić and Budva had the largest absolute amount of indebtedness (€ 15 million and € 33 million, respectively), whereas Kolašin and Ulcinj had the largest amount of debt relative to revenues excluding financing transactions (above 200 percent in both cases). 2. Bijelo Polje, Cetinje, and Nikšić are representative of the group of highly-indebted Montenegrin municipalities. Their poor performance in terms of budget and debt outcomes is apparent when confronting these municipalities against the whole universe of local governments used as a benchmark. Figure 9. Budget Expenditures 2007-14, Selected Municipalities (million euro) All municipalities (benchmark) Bijelo Polje Cetinje Nikšić 3. The highly-indebted municipalities have resisted to embark in a fiscal consolidation effort comparable to those undertaken by their peers in the last few years. By and large, Montenegrin municipalities severely contracted total budget expenditures (including debt repayments) during the global crisis in 2009, and further adjusted downwards in 2010-14 (Figure 9). For all municipalities, the average annual budget expenditure in 2013-14 was 23 percent 33 lower than the average in 2007-08 (i.e., in the pre-crisis years for which data are available), thus revealing a significant consolidation and downsizing of municipal spending. In the highly- indebted local governments, however, the budget contraction was milder, or even the municipal spending increased. For Cetinje and Nikšić, the reduction in the average annual budget expenditure in 2013-14 vis-à-vis the pre-crisis level was 6 percent and 13 percent, respectively. And for Bijelo Polje, there was an increase of 20 percent. 4. The highly-indebted municipalities have suffered disproportionately from the losses of own-source and shared revenues caused by legislative amendments and the fallout of the global crisis. A combination of legislative amendments since 2008 and the fallout of the global crisis—most notably, the prick of the real-estate boom—negatively affected own-source and shared revenues of Montenegrin municipalities (Figure 10). Overall, the average annual budget revenues from own and shared sources in 2013-14 was 24 percent lower than the average in 2007-08. Not surprisingly, it is a widespread opinion among municipal officials that the net effect of the legislative amendments since 2008 was negative for the local finances. Furthermore, some highly-indebted local governments have lost a substantial amount of revenues: for Cetinje and Nikšić, the reduction in the average annual budget revenues from own and shared sources in 2013-14 vis-à-vis the pre-crisis level was nearly 45 percent. Figure 10. Budget Revenues 2007-14, Selected Municipalities (million euro) All municipalities (benchmark) Bijelo Polje Cetinje Nikšić 5. With a weakening fiscal capacity, the highly-indebted municipalities have become largely dependent on borrowings (including arrears) and the Equalization Fund to fund their budgets. Facing a collapse in own-source and shared revenues and being unwilling to 34 curtail expenditures—in some cases because of structural disruptions in the local economy— some municipalities resorted to debt financing and transfers from the Central Government through the Equalization Fund. Thus, liabilities soared and local autonomy was de facto weakened because of financial dependency. In 2013-14, on average, one-half of Nikšić’s budget revenues came from borrowings and the Equalization Fund. The shares were even higher in Bijelo Polje’s (two-thirds) and in Cetinje (three-quarters). For practical purposes, therefore, these municipalities depend on both the banks and the Central Government to operate. 6. Restoring sustainability of public finances in highly-indebted municipalities requires a major budget consolidation. A back-of-envelope calculation suggests highly- indebted municipalities should undertake a major adjustment in their (above-the-line) budget balance in order to reduce their liabilities to a sustainable level in the medium-term.17 The analysis calculates the annual (above-the-line) budget surplus that municipalities must achieve in order to gradually reduce the debt-to-revenue ratio from the 2014 level to 100 percent in the next five years (i.e., in 2015-19), assuming the (above-the-line) revenues remain constant at the 2014 level. 7. Bijelo Polje, having a total debt of € 18.5 million at end-2014 and thus a debt-to-revenue ratio of 193 percent, must achieve an annual (above-the-line) budget surplus of € 1.8 million in 2015-19 to bring the debt-to-revenue ratio down to 100 percent by 2019. In 2012-14, on average, the officially-reported annual (above-the-line) budget surplus was € 2 million. But the officially- reported (above-the-line) expenditures are on cash basis and do not include expenses incurred but unpaid—which are recorded below-the-line subsequently, when payments are made, in the item repayment of commitments from previous years. If an estimate of expenditures on accrual basis is used, instead, the annual (above-the-line) budget was roughly balanced in 2012-14, on average.18 Therefore, Bijelo Polje would need to undertake significant effort to generate a budget surplus of € 1.8 million per year in 2015-19. Such an effort involves raising more revenues, reducing expenditures, or both. And it exceeds the € 1.3 million savings expected from reducing redundant employees, as proposed in Bijelo Polje’s Rehabilitation Plan. 8. Cetinje, with a total debt of € 14.2 million at end-2014 and thus a debt-to-revenue ratio of 219 percent, must achieve an annual (above-the-line) budget surplus of € 1.5 million in 2015- 19 to bring the debt-to-revenue ratio down to 100 percent by 2019. In 2012-14, on average, the officially-reported cash-basis annual (above-the-line) budget deficit was € 4.1 million, and the 17 The above-the-line revenues are all revenue items with the exception of financing transactions such as sale of property, loans, and carry-over from previous years. The above-the line expenditures are all spending items with the exception of debt repayments and reserves. The above-the-line budget balance is the difference between above-the- line revenues and expenditures. 18 The estimated accrual-basis expenditures adjust upwards the officially-reported cash-basis expenditures, as follows: (i) the payroll tax and contributions—which often went unpaid, partially or totally—are increased so that they represent two-thirds of the net salaries actually paid —which is a conservative assumption because sometimes even the net salaries went partially unpaid as well; (ii) the expenditures in supplies and services in 2012-14 are increased in proportion to the stock of liabilities for other current expenditures reported at end-2014—in particular, one-third of the end-2014 stock of liabilities for other current expenditures is added to the officially-reported annual expenditures in supplies and services, under the assumption that unpaid expenses basically happened in 2012-14; (iii) the municipal transfers in 2012-14 are increased in proportion to the stock of liabilities for transfers to institutions, individuals, and NGOs reported at end-2014—as explained in point (ii); and (iv) the capital expenditures in 2012-14 are increased in proportion to the stock of liabilities for capital expenditures reported at end-2014—as explained in point (ii). 35 estimated accrual-basis figure was € 4.9 million. Cetinje would then be in a particularly challenging condition if it seeks to achieve a budget surplus of € 1.5 million per year in 2015-19. The magnitude of the adjustment is such that it seems impossible to undertake it without revenue measures. Furthermore, the adjustment is much larger than the € 1.5 million savings expected from reducing 200 staff, as proposed in Cetinje’s Rehabilitation Plan. 9. Nikšić, having a total debt of € 33.7 million at end-2014 and thus a debt-to-revenue ratio of 186 percent, must achieve an annual (above-the-line) budget surplus of € 3.1 million in 2015- 19 to bring the debt-to-revenue ratio down to 100 percent by 2019. In 2012-14, on average, the officially-reported cash-basis annual (above-the-line) budget surplus was € 6 million, and the estimated accrual-basis figure was € 4.1 million. These surpluses, however, resulted from large transfers from the Equalization Fund and some generous grants and donations received in 2013. As such a substantial financial support may not be forthcoming in the next few years, Nikšić will also find it challenging to generate a budget surplus of € 3.1 million per year in 2015-19. 36 Table 7. Public Finances - All municipalities Budget Revenues (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 305 348 280 238 210 214 236 230 Own Revenues 150 201 142 134 103 123 120 122 Surtax on Personal Income Tax (PIT) 15 19 16 15 15 15 18 18 Real property tax 14 16 21 25 30 36 39 41 Charge for provision of utilities at buildable land 73 93 66 65 35 50 37 38 Charge for use of buildable land 16 29 4 1 0 0 0 0 Other local taxes, fees, and charges 33 44 36 29 24 23 26 25 Shared Revenues 36 38 26 23 30 33 41 41 Personal Income Tax (PIT) 12 14 13 12 13 13 16 17 Charges for the use of assets and natural resources (concessions) 4 3 3 3 6 6 12 10 Property sale tax 20 19 9 8 10 11 11 12 Annual charge for vehicle registration 1 2 2 1 1 2 2 2 Equalization Fund and grants 17 28 28 22 29 29 41 36 Equalization Fund 11 21 19 17 23 23 24 29 Conditional Grants 2 2 1 0 2 3 5 3 Other transfers and grants 4 5 7 5 5 3 12 4 Financing Transactions 102 82 85 59 47 29 34 32 Sale of property 79 14 23 22 12 11 15 8 Loans 11 17 17 22 21 8 9 10 Carry-over from previous years 13 51 44 15 14 11 10 14 Budget Expenditures (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 234 316 259 225 199 204 213 212 Gross salaries and contributions 32 42 41 33 33 33 36 37 Net salaries 18 26 27 25 27 26 25 26 Payroll tax 3 4 3 2 1 2 2 2 Contributions borne by the employee 5 6 6 4 3 4 6 6 Contributions borne by the employer 4 5 4 2 2 2 3 3 Municipal surcharge 0 1 0 0 0 0 0 0 Other personal income 6 7 6 6 7 3 2 2 Expenditures for supplies and services 21 24 20 18 16 17 15 14 Maintenance of infrastructure, buildings, and equipment 7 8 5 5 5 5 4 4 Interests 1 1 1 1 3 3 3 3 Rent 1 1 1 1 0 0 0 0 Subsidies 1 2 1 1 1 1 1 0 Other expenditures 2 1 1 1 1 1 1 3 Social security transfers (entitlements and redundancies) 0 4 1 0 1 0 0 0 Transfers 27 33 30 29 27 33 32 35 Transfers to public institutions 8 9 12 9 8 10 0 0 Transfers to NGO, political parties and associations 3 4 2 2 2 2 4 2 Transfers to individuals 3 4 3 3 3 3 6 9 Transfers to municipalities 1 6 1 1 1 1 0 0 Transfers to the central budget 0 0 0 0 0 1 3 3 Transfers to public companies 12 10 13 14 14 17 6 8 Other transfers 0 0 0 0 0 0 13 14 Capital expenditures 105 166 112 83 51 48 47 49 Expenditures for local infrastructure 51 95 55 59 33 33 34 34 Expenditures for construction facilities 19 28 24 14 10 7 5 9 Expenditures for land development 23 25 19 2 3 3 2 2 Equipment and other capital expenditures 12 19 15 8 5 5 6 4 Credits and loans 2 1 1 1 2 1 1 1 Debt repayment 22 20 37 43 50 55 67 59 Repayment of securities and guarantees 7 6 8 5 9 10 14 18 Repayment of commitments from previous years 15 14 29 37 41 44 53 41 Reserves 8 7 4 3 2 3 2 2 Debt (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 286 Banks 167 Domestic debt 45 Foreign debt 122 Arrears 119 Liabilities for current expenditures 64 Liabilities for gross salaries & contributions charged to employer 44 Liabilities for other personal receipts 1 Liabilities for other current expenditures 19 Liabilities under social welfare transfers 0 Liabilities for transfers to institutions, individuals, NGOs 8 Liabilities for capital expenditures 25 Liabilities under loans and borrowings 23 Liabilities for reserves 0 MEMO Total Debt (% of budget revenues, excluding financing transactions) 144 Total Bank Debt (% of budget revenues, excluding financing transactions) 84 Total Arrears (% of budget revenues, excluding financing transactions) 60 37 Table 8. Public Finances – Bijelo Polje Budget Revenues (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 6.4 10.3 13.3 9.3 9.6 10.0 9.9 9.7 Own Revenues 2.9 4.0 3.2 2.7 2.3 2.3 2.3 1.9 Surtax on Personal Income Tax (PIT) 0.4 0.6 0.5 0.5 0.4 0.5 0.5 0.5 Real property tax 0.3 0.3 0.4 0.3 0.4 0.5 0.4 0.5 Charge for provision of utilities at buildable land 0.2 0.3 0.2 0.2 0.3 0.4 0.4 0.4 Charge for use of buildable land 0.4 0.6 0.0 0.0 0.0 0.0 0.0 0.0 Other local taxes, fees, and charges 1.7 2.1 2.1 1.7 1.1 1.0 0.9 0.5 Shared Revenues 0.6 0.8 0.6 0.6 0.8 1.1 1.1 1.2 Personal Income Tax (PIT) 0.3 0.4 0.4 0.3 0.4 0.5 0.6 0.6 Charges for the use of assets and natural resources (concessions) 0.0 0.1 0.1 0.1 0.2 0.3 0.4 0.4 Property sale tax 0.2 0.2 0.1 0.1 0.1 0.2 0.1 0.1 Annual charge for vehicle registration 0.1 0.1 0.1 0.1 0.0 0.1 0.0 0.1 Equalization Fund and grants 2.2 4.2 6.5 4.0 4.5 4.8 5.2 6.5 Equalization Fund 1.8 4.0 3.3 4.0 3.8 4.5 4.3 5.8 Conditional Grants 0.3 0.0 0.1 0.0 0.0 0.0 0.0 0.0 Other transfers and grants 0.1 0.2 3.1 0.0 0.7 0.3 0.9 0.7 Financing Transactions 0.7 1.4 3.0 2.0 2.0 1.8 1.4 0.0 Sale of property 0.1 0.0 0.0 0.0 1.1 0.1 0.8 0.0 Loans 0.5 1.2 2.9 2.0 0.5 0.4 0.0 0.0 Carry-over from previous years 0.1 0.1 0.0 0.0 0.4 1.3 0.5 0.0 Budget Expenditures (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 6.0 10.3 13.2 8.9 8.2 9.4 9.9 9.6 Gross salaries and contributions 1.2 1.9 1.8 0.8 1.2 1.4 1.3 1.2 Net salaries 0.7 1.1 1.3 0.8 1.2 1.4 1.3 1.2 Payroll tax 0.1 0.2 0.1 0.0 0.0 0.0 0.0 0.0 Contributions borne by the employee 0.2 0.3 0.4 0.0 0.0 0.0 0.0 0.0 Contributions borne by the employer 0.2 0.3 0.0 0.0 0.0 0.0 0.0 0.0 Municipal surcharge 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other personal income 0.2 0.3 0.2 0.1 0.1 0.2 0.1 0.0 Expenditures for supplies and services 0.5 0.5 0.6 0.5 0.5 0.4 0.3 0.4 Maintenance of infrastructure, buildings, and equipment 0.0 0.0 0.0 0.0 0.5 0.6 0.6 0.4 Interests 0.0 0.0 0.0 0.0 0.0 0.0 0.4 0.2 Rent 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Subsidies 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.1 Other expenditures 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 Social security transfers (entitlements and redundancies) 0.1 0.1 0.4 0.1 0.1 0.1 0.2 0.1 Transfers 1.2 1.6 1.7 1.7 1.6 1.9 1.6 1.6 Transfers to public institutions 1.0 1.4 1.5 1.4 1.3 1.7 0.0 0.0 Transfers to NGO, political parties and associations 0.1 0.1 0.1 0.2 0.2 0.2 0.3 0.2 Transfers to individuals 0.0 0.1 0.1 0.1 0.1 0.1 0.9 0.8 Transfers to municipalities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Transfers to the central budget 0.0 0.0 0.0 0.0 0.0 0.0 0.2 0.6 Transfers to public companies 0.0 0.0 0.0 0.0 0.0 0.0 0.2 0.0 Other transfers 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Capital expenditures 2.0 4.9 5.9 4.1 1.7 2.3 2.5 2.3 Expenditures for local infrastructure 1.2 3.8 4.9 3.1 1.4 1.9 1.7 2.2 Expenditures for construction facilities 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.1 Expenditures for land development 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Equipment and other capital expenditures 0.8 1.1 1.0 1.0 0.4 0.4 0.6 0.1 Credits and loans 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Debt repayment 0.6 0.7 2.3 1.4 2.3 2.3 2.7 3.1 Repayment of securities and guarantees 0.1 0.0 1.5 0.7 0.8 1.0 0.6 0.9 Repayment of commitments from previous years 0.5 0.6 0.8 0.7 1.5 1.3 2.1 2.2 Reserves 0.2 0.2 0.2 0.2 0.1 0.2 0.1 0.1 Debt (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 18.5 Banks 7.6 Domestic debt 6.9 Foreign debt 0.8 Arrears 10.9 Liabilities for current expenditures 7.7 Liabilities for gross salaries & contributions charged to employer 6.7 Liabilities for other personal receipts 0.0 Liabilities for other current expenditures 1.0 Liabilities under social welfare transfers 0.0 Liabilities for transfers to institutions, individuals, NGOs 0.6 Liabilities for capital expenditures 1.7 Liabilities under loans and borrowings 0.9 Liabilities for reserves 0.0 MEMO Total Debt (% of budget revenues, excluding financing transactions) 192.6 Total Bank Debt (% of budget revenues, excluding financing transactions) 79.1 Total Arrears (% of budget revenues, excluding financing transactions) 113.5 38 Table 9. Public Finances – Cetinje Budget Revenues (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 5.0 6.6 5.2 4.1 7.2 7.6 8.1 8.0 Own Revenues 3.1 3.5 2.5 1.8 1.4 2.0 1.3 1.6 Surtax on Personal Income Tax (PIT) 0.3 0.4 0.3 0.3 0.3 0.3 0.3 0.4 Real property tax 0.3 0.2 0.1 0.1 0.3 0.3 0.3 0.3 Charge for provision of utilities at buildable land 0.1 0.2 0.2 0.1 0.0 0.1 0.1 0.1 Charge for use of buildable land 0.8 0.2 0.0 0.1 0.0 0.0 0.0 0.0 Other local taxes, fees, and charges 1.6 2.4 1.8 1.1 0.8 1.3 0.6 0.7 Shared Revenues 0.6 0.7 0.4 0.4 0.5 0.6 0.7 0.7 Personal Income Tax (PIT) 0.4 0.4 0.3 0.3 0.3 0.4 0.5 0.5 Charges for the use of assets and natural resources (concessions) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Property sale tax 0.1 0.2 0.0 0.1 0.1 0.1 0.1 0.1 Annual charge for vehicle registration 0.0 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Equalization Fund and grants 1.1 1.6 1.6 1.1 2.7 3.4 4.5 4.2 Equalization Fund 0.6 1.0 1.2 0.7 1.5 1.6 2.0 3.5 Conditional Grants 0.0 0.1 0.3 0.0 0.8 1.7 1.7 0.7 Other transfers and grants 0.5 0.5 0.2 0.4 0.4 0.0 0.8 0.0 Financing Transactions 0.3 0.9 0.7 0.7 2.6 1.6 1.5 1.6 Sale of property 0.1 0.6 0.0 0.0 0.0 0.0 0.0 0.3 Loans 0.1 0.3 0.6 0.0 2.0 1.1 0.8 1.3 Carry-over from previous years 0.0 0.0 0.0 0.7 0.5 0.6 0.7 0.0 Budget Expenditures (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 16.1 17.7 10.1 10.8 10.0 10.9 18.0 13.7 Gross salaries and contributions 1.9 2.5 2.8 2.5 2.1 2.6 3.0 3.0 Net salaries 1.1 1.4 1.7 1.6 1.7 1.8 1.7 1.7 Payroll tax 0.2 0.3 0.3 0.2 0.1 0.2 0.3 0.3 Contributions borne by the employee 0.3 0.4 0.4 0.5 0.2 0.4 0.6 0.7 Contributions borne by the employer 0.3 0.3 0.3 0.2 0.1 0.2 0.3 0.3 Municipal surcharge 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other personal income 0.4 0.4 0.3 0.3 0.2 0.2 0.2 0.2 Expenditures for supplies and services 1.4 2.0 1.3 1.0 0.9 1.1 1.0 1.1 Maintenance of infrastructure, buildings, and equipment 2.2 2.2 2.1 1.7 1.3 1.5 1.7 2.0 Interests 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Rent 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Subsidies 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other expenditures 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.1 Social security transfers (entitlements and redundancies) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Transfers 1.4 1.5 1.0 0.8 0.8 1.1 1.0 1.3 Transfers to public institutions 0.5 0.7 0.6 0.4 0.4 0.5 0.0 0.0 Transfers to NGO, political parties and associations 0.5 0.6 0.3 0.2 0.1 0.3 0.0 0.2 Transfers to individuals 0.4 0.2 0.2 0.1 0.2 0.2 0.6 0.7 Transfers to municipalities 0.0 0.0 0.0 0.0 0.1 0.1 0.0 0.0 Transfers to the central budget 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.3 Transfers to public companies 0.0 0.0 0.0 0.2 0.0 0.0 0.1 0.1 Other transfers 0.0 0.0 0.0 0.0 0.0 0.0 0.4 0.0 Capital expenditures 7.9 6.9 1.7 1.8 0.4 1.1 4.5 2.1 Expenditures for local infrastructure 2.1 4.9 1.5 0.7 0.3 0.9 4.2 1.9 Expenditures for construction facilities 4.3 0.6 0.0 0.0 0.0 0.1 0.1 0.0 Expenditures for land development 0.0 0.5 0.1 0.8 0.1 0.0 0.0 0.0 Equipment and other capital expenditures 1.4 1.0 0.0 0.3 0.0 0.1 0.2 0.2 Credits and loans 0.3 0.0 0.0 0.2 0.9 0.6 0.7 1.1 Debt repayment 0.3 1.6 0.8 2.3 3.4 2.7 5.8 2.7 Repayment of securities and guarantees 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Repayment of commitments from previous years 0.3 1.6 0.8 2.3 3.4 2.7 5.8 2.7 Reserves 0.2 0.5 0.2 0.1 0.1 0.1 0.1 0.2 Debt (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 14.2 Banks 4.0 Domestic debt 4.0 Foreign debt 0.0 Arrears 10.2 Liabilities for current expenditures 8.4 Liabilities for gross salaries & contributions charged to employer 6.6 Liabilities for other personal receipts 0.1 Liabilities for other current expenditures 1.7 Liabilities under social welfare transfers 0.0 Liabilities for transfers to institutions, individuals, NGOs 0.4 Liabilities for capital expenditures 0.4 Liabilities under loans and borrowings 1.0 Liabilities for reserves 0.0 MEMO Total Debt (% of budget revenues, excluding financing transactions) 219.0 Total Bank Debt (% of budget revenues, excluding financing transactions) 61.4 Total Arrears (% of budget revenues, excluding financing transactions) 157.5 39 Table 10. Public Finances – Nikšić Budget Revenues (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 23.7 25.5 16.5 15.4 17.8 15.4 23.6 23.4 Own Revenues 14.8 21.0 7.8 7.3 6.9 7.4 9.1 8.5 Surtax on Personal Income Tax (PIT) 1.6 1.9 1.4 1.1 1.2 1.0 1.6 1.3 Real property tax 1.6 1.3 2.9 3.4 3.8 4.7 4.3 3.4 Charge for provision of utilities at buildable land 6.5 2.2 1.1 1.8 1.0 1.1 1.0 1.8 Charge for use of buildable land 3.3 13.9 0.9 0.1 0.0 0.0 0.0 0.0 Other local taxes, fees, and charges 1.8 1.6 1.4 1.0 1.0 0.6 2.2 2.1 Shared Revenues 2.5 2.2 2.0 1.2 2.0 2.3 2.4 3.2 Personal Income Tax (PIT) 1.6 1.4 1.2 0.8 1.2 1.2 1.4 1.6 Charges for the use of assets and natural resources (concessions) 0.4 0.2 0.4 0.1 0.4 0.3 0.4 0.5 Property sale tax 0.3 0.4 0.3 0.2 0.3 0.6 0.2 0.4 Annual charge for vehicle registration 0.1 0.2 0.2 0.0 0.2 0.3 0.5 0.7 Equalization Fund and grants 1.1 1.8 2.4 2.1 3.8 4.0 8.3 6.4 Equalization Fund 0.9 1.6 1.9 2.0 3.3 3.9 4.6 6.1 Conditional Grants 0.0 0.0 0.1 0.0 0.4 0.0 0.0 0.0 Other transfers and grants 0.2 0.1 0.5 0.1 0.1 0.1 3.8 0.3 Financing Transactions 5.3 0.5 4.4 4.7 5.1 1.7 3.8 5.3 Sale of property 0.0 0.0 0.0 0.6 0.0 0.1 0.1 0.2 Loans 5.3 0.5 4.1 4.0 5.1 1.6 3.6 4.8 Carry-over from previous years 0.0 0.0 0.2 0.1 0.0 0.0 0.1 0.3 Budget Expenditures (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 23.7 25.3 16.3 15.8 17.8 15.2 19.8 22.6 Gross salaries and contributions 2.8 3.7 2.5 2.2 1.7 1.5 2.1 4.3 Net salaries 1.6 2.6 1.8 2.2 1.7 1.5 1.8 2.8 Payroll tax 0.3 0.3 0.1 0.0 0.0 0.0 0.1 0.3 Contributions borne by the employee 0.5 0.5 0.3 0.0 0.0 0.0 0.2 0.8 Contributions borne by the employer 0.4 0.4 0.2 0.0 0.0 0.0 0.1 0.4 Municipal surcharge 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.0 Other personal income 0.8 1.1 0.5 0.8 2.2 0.1 0.0 0.1 Expenditures for supplies and services 1.8 2.9 2.6 2.2 2.1 1.4 1.4 1.0 Maintenance of infrastructure, buildings, and equipment 0.9 1.8 1.0 0.2 0.1 0.3 0.0 0.1 Interests 0.3 0.2 0.2 0.2 0.9 1.0 0.6 0.7 Rent 0.1 0.2 0.1 0.2 0.1 0.1 0.2 0.2 Subsidies 0.0 0.1 0.1 0.2 0.1 0.1 0.0 0.0 Other expenditures 0.0 0.0 0.0 0.0 0.0 0.0 0.1 0.1 Social security transfers (entitlements and redundancies) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Transfers 3.5 5.8 2.0 1.5 1.1 1.2 1.2 2.7 Transfers to public institutions 0.2 0.7 0.6 0.3 0.2 0.4 0.0 0.0 Transfers to NGO, political parties and associations 0.2 0.3 0.1 0.1 0.1 0.1 0.1 0.1 Transfers to individuals 0.6 0.5 0.2 0.3 0.1 0.2 0.2 0.4 Transfers to municipalities 0.0 4.2 0.0 0.0 0.0 0.0 0.0 0.0 Transfers to the central budget 0.0 0.0 0.0 0.0 0.0 0.0 0.3 0.1 Transfers to public companies 2.6 0.0 1.1 0.8 0.7 0.5 0.6 1.2 Other transfers 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.8 Capital expenditures 0.8 3.0 1.3 1.7 2.5 2.6 4.7 5.8 Expenditures for local infrastructure 0.5 2.1 0.9 1.1 0.0 2.4 4.2 5.5 Expenditures for construction facilities 0.3 0.6 0.3 0.4 2.4 0.0 0.2 0.1 Expenditures for land development 0.0 0.3 0.0 0.0 0.0 0.0 0.0 0.0 Equipment and other capital expenditures 0.1 0.0 0.2 0.2 0.1 0.2 0.3 0.3 Credits and loans 0.0 0.0 0.0 0.0 0.1 0.0 0.0 0.1 Debt repayment 7.4 3.3 4.6 5.8 6.6 5.9 9.1 6.9 Repayment of securities and guarantees 3.9 1.5 1.9 0.3 1.4 2.0 2.3 2.5 Repayment of commitments from previous years 3.5 1.8 2.7 5.4 5.1 3.9 6.8 4.4 Reserves 5.1 3.1 1.4 0.8 0.4 1.2 0.3 0.7 Debt (Million Euro) 2007 2008 2009 2010 2011 2012 2013 2014 TOTAL 33.7 Banks 18.5 Domestic debt 5.9 Foreign debt 12.6 Arrears 15.3 Liabilities for current expenditures 3.8 Liabilities for gross salaries & contributions charged to employer 2.5 Liabilities for other personal receipts 0.1 Liabilities for other current expenditures 1.3 Liabilities under social welfare transfers 0.0 Liabilities for transfers to institutions, individuals, NGOs 1.0 Liabilities for capital expenditures 1.0 Liabilities under loans and borrowings 9.3 Liabilities for reserves 0.1 MEMO Total Debt (% of budget revenues, excluding financing transactions) 185.8 Total Bank Debt (% of budget revenues, excluding financing transactions) 101.7 Total Arrears (% of budget revenues, excluding financing transactions) 84.1 40