Step 9 - Agree on the financing of IMC

From Municipal Cooperation

Establishing IMC
PHASE 1: Initiating cooperation
PHASE 2: Establishing cooperation
PHASE 3: Implementing IMC
PHASE 4: Evaluating IMC

The financing of IMC is largely determined by the choice of the area of IMC, the type of financing that is most appropriate for the service and the legal form of cooperation. Western European practice reveals that the establishment and operation of IMC are often subsidized by the central government and that IMC often has privileged access to grant funding in specific service areas. The public law institution legal form is most likely to attract such subsidies and grants. Indeed, although the topic of the financing of IMC is presented here as a separate step, the initiators should seriously take this matter into account when discussing the areas of IMC and the legal form.

Municipal services, whether provided inter-municipally or not, rely on a standard range of revenue sources, such as:

  • user charges or fees levied on consumers of services;
  • local taxes, levied by municipalities and accruing to their budgets;
  • intergovernmental transfers consisting of general-purpose grants, earmarked grants or shares of specific national taxes;
  • fees paid for permits, licences and other administrative processes;
  • long-/medium-term loans to fund capital investment.

Broadly speaking, there are two categories of services provided under IMC:

  1. services for which consumers pay through user fees normally varying in scale according to the amount they consume;
  2. services financed from national or local levies whose bases (income, VAT, property value etc.) are not related directly to their personal consumption of a specific service

Services financed by user fees

Utilities are typical services for which consumers pay through user fees. This partly simplifies funding since the consumer charges can be credited directly to the IMC institution operating the service (a commercial company or an association of municipalities). The power to determine the tariff is usually vested in the cooperating municipalities. The cooperation agreement might delegate this right to the IMC institution. If it does not, changes in rates would have to be agreed by all the municipal councils, a majority of them, or councils representing the majority of people served, as appropriate.

Box 19: User fees

User fees are appropriate for funding municipal services where specific users can be identified and non-payers excluded. Most public utility services such as water supply, heating and energy are financed from user fees. Recreation is another service area that can apply user fees (swimming admissions, memberships and instruction). There are a number of services that are not suited for user fees and that should be financed from general taxes; these services have public goods characteristics. Examples include maintenance of local streets and roads, firefighting and police services. Solid waste collection and disposal is normally included in the base tax rate.

The concept of user fees is easy to understand but often difficult to implement. For instance, opposition can arise because user fees are alleged to be regressive since they absorb a higher percentage of lower-income individuals or households’ income when compared with higher-income individuals or households. Efficient user fees can be designed under a variety of circumstances – when economies of scale are present, when capacity constraints exist, when demand differs in peak and non-peak periods, when second-best considerations are prevalent and when externalities exist. The established approach is to apply marginal cost pricing or average cost pricing. The pricing of a service can also focus on economies of scale.

Source: Provincial Government of Nova Scotia (2006)

Consumers should be charged the full costs of service provision including operating and capital costs (repayment of loans used to finance the initial investment and depreciation). Where an IMC entity takes over a service with assets, their ownership should be transferred to it with the obligation to service any outstanding debt and provide for depreciation. An alternative is for the original owner to lease the assets to the IMC entity that would pay a rent covering debt service and depreciation.

In practice, investment costs are often not recovered through consumer charges; i.e. the provision of the service is subsidized, possibly because the consumers do not have the capacity to cover capital costs, consumption by low-income consumers is encouraged, or the public gains from consuming the service are considered very high. The subsidy is therefore covered by the taxpayers from general local or central government revenues.

Box 20: Loan finance

For major utilities such water supply, sewage treatment and landfill, loan finance may be important in providing initial investment capital. However, who the borrowers are may be an issue, be it

  • the IMC entity managing the service;
  • the IMC entity with municipal guarantees; or
  • the constituent municipalities.

Who among the above has legal power to borrow is obviously a determining factor. Another is the legal ownership of the assets financed by the loan. The form of security is also important; if loans are secured by the assets themselves, their owner would be expected to guarantee the loan, but it could be the operator if the security consists of a lien on the consumer charges. A further possibility is that investment costs are covered by loan, but lenders insist on the constituent municipalities guaranteeing repayment. Finally, the inter-municipal body may have no power to borrow and the municipalities have to do so instead..

Should user fees be uniform throughout the area served by IMC? The costs of providing the service are likely to vary between localities. Public transport routes will cost more per passenger mile to outlying areas if buses travel half empty. Water will cost more to pump to hilly areas. Arguments of social justice or political compromise may require everyone to pay the same amount, but economic rationale requires user fees to be related to costs incurred. The selection between average prices with internal cross-subsidization or user charges reflecting the differences in direct costs is a political decision that the IMC entity or the individual municipal councils have to take.

Another typical IMC area is the provision of administrative services through IMC offices. In this case, the financing of the activities comes directly from the public through charges related to the issuance of building permits, trade licences and civil registrations, etc. If these services are subsidized, then some of the funding will originate from the general budgets of the IMC partners, as further discussed below.

Services financed by taxpayers from local and central government revenues

In cases where some or all the costs of a municipal service cannot be supported by user fees, the resources for IMC generally come from local government revenues and/or central government revenues (intergovernmental transfers to municipalities in the form of grants). Financing arrangements for the provision of educational and health services such as schools or hospitals attract considerable financing from local and national general revenues. IMC institutions set up to coordinate local economic development planning, tourism development or environment protection would normally be funded by contributions from the budgets of the partner municipalities.

In some countries, IMC agencies are allowed by law to levy local taxes themselves. Most notably, in France, the communautés urbaines may impose an additional rate on the standard municipal taxes on business and property. The French example of assigning the main municipal business tax to the city-wide communautés urbaines is a way of redistributing its revenue from the municipalities, where the companies are largely located, to the larger urban economy, from which their revenues are generated.

The major issue in IMC is how the contributions from local and shares of national taxes are apportioned between the constituent municipalities. When a programme is to be jointly funded, the municipalities should agree which of the following choices is the fairest. Often a combination is selected to balance between differing opinions on what is fair.

Equal shares: A joint programme can be established where each municipality pays an equal share. This approach is best suited to situations where the participating municipalities are approximately the same size and receive approximately equal benefits from the joint programme. Equal shares are often used as the way of allocating overhead costs of a programme, such as advertising costs for joint purchasing or administrative costs.

Population: Each municipality's cost share for a joint activity can be based on population. The municipality's share is equal to its percentage of the total population of the participating municipalities. This approach is most appropriate when the general population of each municipality is served evenly by the programme. If all citizens benefit, then all citizens should share in the cost through their taxes.

Fiscal capacity: Fiscal capacity can be used as a basis for the allocation of each municipality’s share of the cost of IMC. Shares are deemed fairly allocated if they approximate the relative fiscal resources of each municipality. As with population, shares on this basis will tend to be large for the more developed municipalities and small for the rural ones.

Extent of use by citizens: In programmes where the direct beneficiaries of an IMC can be identified, municipal shares can be allocated in proportion to the number of these users residing in each participating jurisdiction. In each of these cases, the number of users of the service can be identified for each participating municipality and municipal shares of the IMC costs allocated on the same basis. Paying on the basis of use is very popular but it is limited to the programmes where direct users can be identified by municipality of residence. Even in this case, individual municipalities may argue that per capita user costs are not uniform. The costs of supplying services to outlying or sparsely populated areas may be greater. Wealthier areas may be in a better position to contribute more, leading to some differential based on per capita revenues. Again, these are political decisions that must be taken by the IMC partners. The apportionment of costs may be defined in the IMC agreement or in the legislation governing IMC arrangements. In some countries such as France, the state (the prefect) has the power to adjudicate.