Local Governments Financing and Decentralization in

Local Governments Financing and Decentralization in Peru (Roles and Responsibilities)

Local Governments Financing and Decentralization in Peru (Roles and Responsibilities) Acronyms utilized: CG: Central Government, National Government RG: Regional Government LG: Local Government PPP: Public Private Partnership Official acronyms (Peru): CEPRI: Special Committee for the Promotion of Private Investment (Spanish initials) PROINVERSION: Private Investment Promotion Agency –Peru (National level of Government) EPS: Merit good services providers like water & sanitation, or electricity distribution (Spanish Initials) FONCOMUN: Fund for Municipal Compensation (Spanish initials) IGV: General Sales Tax (Spanish initials) IR: Income tax (Spanish initials). ISC: Selective tax on the consumption of special goods (Spanish initials) MEF: Ministry of Economy and Finances MML: Metropolitan Municipality of Lima MPA: Municipality of the Province of Arequipa MPT: Municipality of the Province of Trujillo PIP: Public Investment Project Official definitions (Peru): Public Investment Project (PIP): Intervention limited in time, which uses totally or partially public resources, to create, increase, improve, modernize or recover the productive capacity of goods and services, whose benefits are generated during the lifecycle of the project, independently from other projects (MEF, 2015, p 315). Nuevo Sol: National currency of the Republic of Peru (1 Nuevo Sol equals 0.29 US dollars, 1 Nuevo Sol equals 0.28 Euros) 1

Cesar E. Simborth, B. Arch, M.U.D.(Urban Design) Sustainable Transportation, Urban Design, http://www.c-sostenible.com/


Expenditure assignment in Peru According to (Muwonge, 2014), expenditure assignment consists on designating expenditure public responsibilities to the level of government that is closest to users, based on a “principle of subsidiarity”. Considerations of capacity to manage the functions, best use of economies of scale, and spillover effects should be taken into account (Muwonge, 2014). About, Peru, it is a unitary state composed of 24 regions, 196 provinces, and 1,854 districts (INEI, 2015). Peru’s urban population is above 78%, and all of its cities are administered by a Provincial and a number of District Municipal Local Governments, except for Lima, the capital, which is administered by a Metropolitan Municipal Local Government and 43 District LGs (INEI, 2015). We will only focus on the National–Local relation. Being the ones closest to citizens, LGs in Peru, have several expenditure responsibilities related to the provision of urban and rural infrastructure and services. They are detailed in the national “Organic Law of Municipalities, No. 27972” (Peru, 2003), summarized in columns C and D of Table 1. The CG has the obligation on the other hand, to design and supervise the national and sectoral policies, exercise functions, administer and regulate: external relations, defense, national taxation, marine regulation, national public services, national public infrastructure, among others established in the “Organic Law of the Executive Power, No. 29158” (Peru, 2007).

Revenue assignment in Peru According to (Muwonge, 2014), revenue assignment consists on defining what level of government would best finance expenditure functions in the context of fiscal decentralization. 1WB Ch1 As it is mandated by the national “Law of Municipal Taxation, Supreme Decree No. 156‐2004” (Peru, 2004), LGs are allowed to levy, collect and administer a specific group of taxes (See columns A and B from table 1), however they cannot set the tariffs, which are fixed by the CG in the same law. Municipalities can promote changes in tariffs through the parliament, and in the case of area/value based taxes (land, property), LGs can provide updates on their unitary values to the CG every year (Peru, 2004). Also, the same law mandates that LGs have the right to levy user charges to cover the costs of the different services they provide, and can raise special contributions (betterment charges) for specific local interventions in coordination with users (Peru, 2004). Merit good services like sanitation and electricity distribution can be provided indirectly through EPSs providers which can charge user fees to cover costs and generate profit (Peru, 2006). The “Law of the National Taxation System, Legislative Decree No. 771” (Peru, 1994), establishes which are the “taxes directly collected” by the CG (IGV, ISC, IR) or “ordinary revenue”. Additionally, the CG concentrates revenue from national service charges, Canon tax for extractive operations, donations and credit loans, all of which goes to a joint fund as it is stated in Law No. 30519 (Peru, 2016). The “Law of budget for the public sector for the fiscal year 2017, No. 30518” (Peru, 2016), defines the way in which it is redistributed to all levels of government (considering current, capital, and debt expenditure), and also provides the guidelines for LGs to elaborate their own annual budgets, resulting

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from the addition to their municipal revenue, of the redistributed ordinary revenue, and additional transfers (Peru, 2016). The latter will be explained in sub‐question “c”. LGs in Peru, can also increase their revenue by promoting PPP arrangements (Concession fees), and processing credit operations directly with national financiers, or with International financiers. For the latter, CG approval and guarantee is required, as it is stated in the “General Law for the System of National Debt, No. 28563” (Peru, 2005). Further details will be explained in sub‐question “d”.

Intergovernmental transfers Intergovernmental transfers are financial mechanisms to sort out vertical or horizontal imbalances, resulting from financial gaps after the assignment of expenditure responsibilities and revenue, in a context of evolving fiscal decentralization (Central to Local) within a country’s public administration system (Muwonge, 2014). They are important in dealing with fiscal imbalances since not all LGs within the same country may have the same tax base, service provision costs and demands, and users paying capacity. They can be determined based on: A fixed shared amount, a percentage of the LGs expenditure, or a population based criteria (Slack, 2009). According to Law No. 30518, the CG, collects the most robust revenue streams (national taxes and credits), and redistributes (crossed subsidy) a proportion of them, as a way to mitigate horizontal imbalances. LGs can use some of the intergovernmental transfers flexibly (for current or capital expenditure) according to their need prior “Municipal council approval” like the FONCOMUN (Law No. 22783, Peru, 2002), as well as have conditions on the use of others, like the Canon fund (Law No. 27506, Peru, 2001). The different types of CG‐LG intergovernmental transfers are detailed in column B, in Table 1. The main issue, however, seems to be that the overall proportion devolved to local governments falls too short. For fiscal year 2017 (Law No. 30518), approximately all LGs in Peru will be devolved, about 10% of the ordinary distribution (See table A), despite the fact that they administer the cities where above 78% of Peruvian population live (INEI, 2015). Table A. Percentage of fiscal devolution from ordinary transfers to different levels of government in Peru Source: Own elaboration. 2016 “A Large metropolis municipality like Lima, have investment programs on urban transportation public infrastructure valued on a few thousand millions of soles, while intermediate cities’ municipalities like Arequipa, or Trujillo, have programs valued on a few hundred millions of soles” (Huamanvilca, 2016). Ordinary transfers for Lima, Arequipa, and Trujillo are shown in table A (below), and it can be seen that large Municipalities like Lima, receive only a 1.48% of the LGs ordinary share, though it is home to about 30% of the national population (INEI, 2015). LGs are still highly dependent on conditional project based sectoral transfers, that are not always successful, due to bureaucracy time spent and political differences. Further details and the relation between the type of transfers and expenditure is presented in table 1. 3



Table B. Percentage of fiscal devolution from ordinary transfers to large Municipalities in Peru Source: Own elaboration based on MEF data. 2016

Access to capital markets According to the World Bank, it is fair that large infrastructure investments are long term funded by credits and capital markets, since that way future users can also contribute with its provision (Freire, 2014) for which LGs may need to have a good fiscal performance, or obtain CG guarantees (Slack, 2009). According to the Law No. 28563 “General Law for the National System of Debt” (Peru, 2005), LGs can follow special procedures in order to access to capital markets: ‐They can ask for loans to Private Financial Institutions (Banks), if there is lending capacity, a reliable credit record, and count with the approval of the Local Government Accountability Office. ‐They can benefit from loans from International Development Bank (International Cooperation) with the approval CG/MEF, and accountability of the competent sector. ‐According to the Legislative Decree No. 1224 “General framework for the promotion of private investment through PPPs in projects and assets” (Peru, 2015), municipalities can promote, and manage PPPs directly or indirectly by delegating the process to PROINVERSION, for the provision of infrastructure and services, involving the share of financing and risks. ‐The same regulatory framework, also allow municipalities to receive “Self‐financed unsolicited proposals” to finance capital expenditure on infrastructure and services. In order to do so, they establish a CEPRI to manage the process, and require that MEF approves the DBFOT contracts before they are signed. ‐ The same regulatory framework, allows LGS to receive co‐financed unsolicited proposals, to finance large infrastructure investment in cities and regions can also be presented. But the procedures is managed by the CG through PROINVERSION and the competent sector with the favorable opinion of the LG along the different project milestones. Further details and revenue coming from capital markets and expenditure is presented in table 1. 4



Table 1. Matrix of CG and LGs expenditure and revenue assignment, and responsibilities within the Public Sector of Peru. 2016 A) Who obtains? (Revenue)

B) Financing from where? (Revenue assignment)

LG

Operating (LG)

revenues

C) Of whom? D) Responsibilities / Functions (Expenditure (Is the expenditure assignment) responsibilit y)

User charges LG or Arbitrios (LTM DL 776).

‐Execute current operational expenditure. ‐Provide local public services (Operate and maintain): Parks and green areas, public space cleaning, solid waste collection, public safety, civic registration. (LOM 27972). ‐Physical planning of the territory in the district, province, or metropolis. ‐Environmental protection: Plans, and creation of protected areas (LOM 27972). ‐Administrative services, licenses and permits (industrial, commercial), and public parking (LTM DL 776). EPS providers Operating revenues User fees Public local ‐Water and sanitation (LGSS, (LG Indirect (EPS) companies, or 26338). provision). Private ‐Electricity distribution (LCE, concessions 25884). (LG Indirect provision). LG Operating revenues ‐Taxes: LG ‐‐Execute current operational (LG) Property, expenditure (% Depends on their Property annual budget). transfer, ‐Execute capital expenditure. Vehicular, ‐Provide public services: Urban Public paid and Rural infrastructure, Urban events (LTM DL mobility and public 776). transportation, parks, recreation ‐Users and culture, others not covered contributions by the RG or NC (LOM 27972). (Betterment charges). LG Intergovernmental ‐General Sales LG transfers (CG) Tax (IGV) ‐Selective tax on the consumption of special goods (ISC)

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LG

Unconditional (CG)

LG

Unconditional equalization (CG) Conditional non‐ matching (CG)

LG

LG (two‐ tiered negotiation) LG

LG

LG asks NG

‐ Income tax ‐Ordinary resources (DL 771,1993) (LPSP 30518, 2017) ‐Ordinary Resources ‐FONCOMUN (LTM DL 776). ‐Ordinary Resources Canon tax for private natural resources extractive operations in the locality (LC 27506, 2001)

Conditional matching ‐Direct project (CG) based sectoral transfers Private capital as part of a PPP arrangement: Concessions, Auto/Co‐ financed non solicited proposals. (PI ‐ DL 1224, 2015) Borrowing / Credit operations with National entities (LSNE 28563, 2012).

LG

LG LG

LG

LG / NG

‐Formulate and implement infrastructure PIPs and services (capital expenditure). ‐Implement a specific PIP. ‐Plan, appraise, and promote the Implementation of a specific PIP. LG / NG

LG (Private Banks or Financiers) Borrowing / Conditional credit operations NG on behalf with international entities (LSNE 28563, of LG 2012). (International Development Banks) Source: Own elaboration based on the revision of the cited documentation. 2016

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Reference List Freire, M. E., 2014. Managing external resources. In: C. Faracque-Vitovic and M. Kopanyi eds., 2014. Municipal finances : a handbook for local governments. Washington: World Bank. pp. 325-378. Huamanvilca, M., 2016. Interview about critic aspects of fiscal distribution in Peru by Director of Budget and Planning in the Municipality of the Province of Arequipa. By C. Simborth [phone] 21-12-201, 14:30. Muwonge, A. and Ebel, R. D. 2014. Intergovernmental finances in a decentralized world. In: C. Faracque-Vitovic and M. Kopanyi eds., 2014. Municipal finances : a handbook for local governments. Washington: World Bank. pp. 139. Perú INEI, Estado de la población peruana en el 2015. Lima, 2015. Perú, Ley Orgánica de Municipalidades No. 279722. Lima. 2003. Perú, Ley Orgánica del Poder Ejecutivo No. 29158. Lima. 2007 Perú, Ley de Tributación Municipal, DS 156-2004. Lima. 2004 Perú, Ley-General-de-Servicios-de-Saneamiento. No. 26338. 2006 Perú, Ley del Sistema Nacional de Tributacion DL 771. Lima 1994 Perú, Ley de presupuesto para el sector público en el año fiscal 2017 No. 30518. Lima. 2016 Perú, Ley General del Sistema Nacional de Endeudamiento No. 28563. Lima. 2005 Perú, Ley del Canon No. 27506. Lima. 2001 Perú, Ley General de Promoción de la Inversión Privada en Asociaciones Publico Privadas, proyectos y activos LD 1224. 2015. Slack, E., 2009. Municipal borrowing and access to the capital market. Municipal borrowing and access to the capital market. 2009. Guide to municipal finance. Nairobi: United Nations Human Settlements Programme (UNHabitat). pp. 65-70.

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