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Croatia Subnational Public Finance Review Summary

Core Content

This report provides an in-depth analysis of the fiscal and financial developments of subnational government units (LRGUs) in Croatia, focusing on expenditure, revenue, and debt trends. It aims to support policy reform to improve public service delivery and promote balanced regional development. The report covers 576 LRGUs, including 21 counties and 555 municipalities and cities.

Main Functions of LRGUs

LRGUs are responsible for a wide range of public services not assigned to the national government, including:

• Housing and spatial/urban planning
• Communal services
• Pre-primary, primary, and secondary education
• Culture and recreation
• Local transport
• Civil protection
• Waste management and water/sewerage services

Additionally, since 2001, LRGUs have taken on significant responsibilities for financing and providing services such as health care, education, social care, and fire protection.

Fiscal Capacity and Disparities

Croatia's fiscal capacity estimation is based solely on personal income tax (PIT) revenue potential, which may lead to biased results. There is a high share of other revenues (e.g., property taxes, sales taxes, administrative fees) that are not included in the estimation, which could result in equalization transfers favoring wealthier LRGUs.

LRGUs exhibit significant disparities in fiscal capacity. More developed regions tend to have higher per capita spending, particularly in education, health, and social protection, while less developed regions focus more on administrative costs. These disparities create an adverse feedback loop, where less developed regions struggle to provide quality public services.

Revenue Trends and Structure

LRGUs rely on a mix of tax and non-tax revenues, as well as transfers from the central government. Key revenue sources include:

• Personal Income Tax (PIT): A major component of LRGU revenues, with significant variation in per capita amounts and shares in total current revenues.
• EU Funds: A critical source of revenue, especially for less developed regions. They constitute a large share of current revenues for some LRGUs.
• Equalization Transfers: Aim to reduce fiscal imbalances by providing funds based on the tax revenue generating capacity per inhabitant. These transfers are negatively correlated with the level of development, but there are persistent disparities and outliers.

Expenditure Trends and Drivers

Total LRGU expenditures have increased over time, with variations in per capita spending and functional distribution. Key expenditure areas include:

• Education: Spending per child varies significantly with development levels. Wealthier regions achieve higher standards.
• Health and Social Care: Expenditures are a major share of total spending, with some regions relying heavily on central government transfers to cover costs.
• Administrative Costs: A significant portion of expenditures in less developed regions is spent on employee compensation and operational expenses.

Fiscal Equalization System

The fiscal equalization system in Croatia aims to reduce disparities in public service provision. However, the current system is based on a limited scope of revenue sources and may not be fully effective. The report suggests that expanding the scope of revenue sources for fiscal capacity estimation could improve the efficiency of the system, but it would require better data collection and more comprehensive criteria for inclusion.

Recommendations and Scenario Analysis

• Expand Revenue Sources: Include other revenue streams such as property taxes, sales taxes, and administrative fees in fiscal capacity estimation to ensure a more accurate and equitable distribution of equalization transfers.
• Improve Data Collection: Establish a detailed database and regular data collection on tax bases, rates, and fees to enable better revenue potential estimation.
• Adjust Equalization Formula: Incorporate a fiscal needs component into the formula to account for the potential of LRGUs to deliver public services.
• Gradual Implementation: Any reform should be well-prepared and implemented gradually to allow LRGUs to adjust to new financial arrangements.

Scenario analysis indicates that broadening the scope of fiscal capacity estimation could reallocate around a quarter of equalization funds, potentially increasing equality in income per capita (as shown by a decrease in the Gini coefficient). However, it may not necessarily increase the revenues for less developed regions, suggesting the need for a more detailed analysis of development needs.

Key Figures and Tables

• Figure 1: Subnational government structure in Croatia

• Figure 2: Municipality size in the EU (2020)

• Figure 3: Population change per city/municipality

• Figure 4: Fiscal decentralization in the EU (2023)

• Figure 5: GDP per capita per county (2021)

• Figure 6: Index of Development (2024)

• Figure 7-12: Expenditure trends and distribution

• Figure 13-38: Revenue trends and distribution

• Figure 39-42: Revenue structure by LRGU tier and region

• Figure 43-48: PIT revenues and surtaxes

• Figure 49-56: Equalization transfers and fiscal capacity

• Figure 57-67: Scenario analysis and fiscal capacity estimation

• Table 1: Responsibilities of local and regional government units

• Table 2: Sources of revenue at the LRGU level

• Table 3-8: Components of fiscal capacity estimation and scenario analysis results

Conclusion

Croatia's subnational governments face significant challenges due to administrative fragmentation and disparities in fiscal capacity. The current fiscal equalization system is not fully effective in addressing these disparities, and reforms are needed to ensure more equitable and efficient distribution of resources. Improving data collection and expanding the scope of fiscal capacity estimation are critical steps towards achieving this goal.