DECENTRALISATION OF GOVERNMENT FINANCE IN TRANSITION COUNTRIES: The case-study of Croatia

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DECENTRALISATION OF GOVERNMENT FINANCE IN TRANSITION
COUNTRIES: The case-study of Croatia
by
Zdravko Petak
Visiting Scholar at the Workshop in
Political Theory and Policy Analysis
1. GENERAL TRENDS IN FINANCING LOCAL GOVERNMENTS IN TRANSITION COUNTRIES
Since begin of 1990s across the world countries have been faced with the challenges of
simultaneous globalization and decentralization. The requirements towards more decentralized forms
of governing have a point of departure in the necessity for more efficient delivery of various public
services. In order to accept these requirements many countries had started with decentralization of
their governing structures. That process became particularly strengthened in ex-socialist countries of
Central and Eastern Europe, as one of the main prerequisites for approaching their economies to
standards of market economy. From that reason the elaborations of possible trends in the process of
decentralization became the flourishing topic of research for many domestic and foreign social
science scholars and experts.
Several countries made significant progress towards more decentralized forms of governing
among foreign among former socialist states, but generally, that process is uneven among those
states (Dunn and Wetzel, 2000). Comparative analysis shows that Croatia does not belong to those
countries which more need for decentralization. Using two criteria – institutional development (derived
from two elements – government credibility and cumulative liberalization) and general physical and
demographic characteristics, Dunn and Wetzel constructed one kind of matrix that explain whether
one country has proclivity to more decentralized forms of governing or not. The group of countries
evaluated as pro-decentralized include Poland, Czech Republic, Hungary, Romania and Bulgaria.
Croatia was located in the group with Macedonia, Slovenia, Slovak Republic, which was labeled with
a less need for decentralization.
The second measure we could apply for evaluating the proclivity of one country towards more
decentralized forms of government is the sub-national share in general government expenditure (see
table 1). Taking this figure Croatia is located among the countries with the less sub-national share
among transitional countries. With the share of slightly over 10 percent of total consolidated
government consumption, the expenditures of the Croatian regional and municipal governing bodies
are bigger only than in Slovakia and Slovenia (those countries were also not located among the
countries with a high proclivity to decentralization).
There some reasonable explorations why Croatia passed into the group of countries with a
relatively high level of centralization. As indicated in several analysis (Bahl, 2000; Dunn and Wetzel,
2000), the proclivity to centralization rises with military conflicts at its own territory. Croatia passed a
severe period of such type of conflicts between 1991-1995, exactly in the period when some other
countries started with their reforms for more decentralized forms of governing. That time is lost for
Croatia. The question is now: are there real necessities for decentralization that will lead to
approximately same level of decentralization that Croatia (as a part of former Yugoslavia)
experienced prior 1991 events. Shortly speaking, that period of time could be labeled as deeply
developed self governing system, with a high responsibilities of a local governing bodies for various
forms of public services.
© 2002 Zdravko Petak

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Table 1: Sub-national Shares of General Government
Expenditures (percent)
ALBANIA 18.76
AZERBAIJAN 24.57
BELARUS 43.50
BULGARIA 18.72
CROATIA 13.47
CZECH REPUBLIC 21.69
ESTONIA 21.12
GEORGIA 28.80
HUNGARY 20.66
KAZAKHSTAN 45.45
KYRGYZ REPUBLIC 23.35
LATVIA 29.65
LITHUANIA 22.24
MOLDOVA 23.64
POLAND 38.87
ROMANIA 11.37
RUSSIAN FEDERATION 40.91
SLOVAKIA 7.35
SLOVENIA 11.46
TAJIKISTAN 31.33
UKRAINE 29.57
Source: Government Finance Statistics Yearbook.
Washington: IMF, 2001.

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The third measure for evaluating fiscal decentralization is expenditure side of transition countries
provided by functional classification (see table 2). The data indicates relatively high sub-national
shares in education, health, housing, recreation and culture, and transportation.
Table 2: Sub-national Shares of Total Government Spending by Functional Class (percent)
Public
Order &
Safety
Education Health Social
Security &
Welfare
Housing &
Communal
Amenities
Recreation
& Culture
Transportation &
Communication
ALBANIA - 80.19 29.91 19.08 31.77 34.03 6.76
AZERBAIJAN - 84.15 84.25 0.97 98.40 45.57 8.77
BELARUS 15.27 81.82 78.04 2.92 99.82 56.96 66.94
BULGARIA 2.17 59.53 44.11 8.30 68.95 26.69 12.19
CROATIA 2.29 16.70 0.95 0.95 49.57 58.38 27.30
CZECH REP. 17.20 17.22 5.98 8.03 68.47 61.89 46.53
ESTONIA 1.08 49.04 2.19 7.87 94.14 41.74 15.02
GEORGIA 15.05 79.32 48.75 7.33 91.51 54.21 25.59
HUNGARY 6.86 46.99 44.83 11.99 74.10 43.97 27.64
KAZAKSTAN 23.59 83.97 86.01 11.71 100.00 73.51 58.55
KYRGYZ RE. 4.56 40.38 40.14 9.10 27.71 25.77 0.64
LATVIA 5.93 72.47 4.25 5.66 79.64 50.23 24.49
LITHUANIA 3.02 72.62 0.67 9.46 99.95 39.06 9.34
MOLDOVA 15.58 72.92 63.18 1.99 99.30 46.65 20.62
POLAND 34.30 72.47 87.36 17.49 86.92 76.13 65.34
ROMANIA 4.80 9.23 0.36 2.97 83.01 34.74 17.55
RUSSIA 23.27 92.44 90.08 10.16 95.48 75.00 68.28
SLOVAKIA 5.69 2.40 0.26 0.49 56.74 27.00 18.78
SLOVENIA 5.88 23.92 1.61 1.14 77.64 45.33 23.10
TAJIKISTAN 6.06 84.52 79.31 5.94 82.90 24.96 32.15
UKRAINE 9.47 59.90 84.59 44.33 80.33 63.18 66.21
Source: Government Finance Statistics Yearbook.
Washington: IMF, 2001.

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2. GENERAL OVERVIEW OF FINANCING LOCAL GOVERNMENTS IN CROATIA
2.1. Introductory explanations of the research objectives
Evaluation of the current system for financing local and regional self-government in Croatia is
based on the analysis of the financing model defined by the current law, and on the analysis of the
local governments as measured by indicators of the fiscal capacity of local government units
(counties, cities and communes) under the data for the years 1999 and 2000 respectively.
To obtain a comprehensive analysis of the current model of financing local units, it was necessary
to perform a number of empirical analyses:
- assessing the fiscal capacity of local units and defining indicators for the analysis of fiscal
capacity;
- determining the fiscal burden imposed by local units (the analysis of their own revenue
resources and revenues per capita, to establish whether there are any realistic opportunities (and
if any, what they are) for communes to levy new taxes or new tax rates to enlarge their sources of
financing as permitted by the state under current law);
- determining and evaluating the financial position of separate governing levels (central
government level, county level, city level and level of communes) in financing particular services,
with special reference to trends and the overall state of affairs;
- determining and evaluating the financial position of local units in areas of special state concern
(regions strongly damaged in the war);
- determining and evaluating the financial position of local units on islands (particular Croatian
problem);
- analyzing and evaluating the proportions of income allocated to local units under the provisions
and regulations of the current law for financing local units (with special reference to evaluate the
system, the criteria used for allocating funds (grants-in-aid, subsidies) to local units, and the
criteria for establishing the relative degree by which municipal revenues deviate from the state
and/or county average);
- analyzing the expenditure structure of local government budgets;
- analyzing and evaluating the system of fiscal equalization within the framework of the state fiscal
system (subsequent to its introduction, the system of fiscal equalization has been reduced to a
means of transferring funds to areas of special state concern due to war destruction);
- examining the problem of the distribution of fiscal power within the framework of the law relating
to competence by a level of fiscal authorities and resource allocation;
2.2. Approach to the analysis – methodological explanations
On the basis of the objectives set for the analysis of the state of affairs of the system of local
government financing in the Republic of Croatia, and taking into account the available fiscal statistical
data on public finances in Croatia for financing local units, two groups of indicators have been defined
- basic and supplementary indicators.
The basic indicators are following:
• Current revenues
• Current expenditures
• Ratio of current revenues to current expenditures
• Total revenues, including transfers
• Total revenues, excluding transfers
• Total expenditures
• Ratio of total revenues to total expenditures
• Capital expenditures
• Population (number of inhabitants)
• Current revenues per capita

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• Current expenditures per capita
• Total revenues per capita, including transfers
• Total revenues per capita, excluding financial transfers
• Ratio of employee costs to current revenues
The supplementary indicators are following:
1. Revenues per capita by county at the level of the Republic of Croatia
2. Revenues per capita by cities
3. Revenues per capita by communes
In selecting indicators for the analysis of fiscal capacity, the problem was the definition of fiscal
capacity. For the needs of empirical analysis, fiscal capacity has been defined in terms of:
• total budget revenues of a local unit, including transfers;
• total budget revenues of a local unit, excluding transfers;
• current budget revenues of a local unit;
The recent census for 2001 developed by the Central Bureau of Statistics was used for the analysis.
The available as of 31 March 2001, indicating that in Croatia live 4.3 millions of inhabitants. The
number of inhabitants could be also structured under the type of local government in which they live
(see table 3).
Table 3: Number of inhabitants living in a particular kind of local units
TOTAL POPULATION 4,381,352
Total population excluding Zagreb 3,611,294
Cities, including Zagreb 3,030,002
Cities, excluding Zagreb 2,259,944
Communes 1,351,350
Communes and cities in the areas of special
state concern 871,390
3. SERVICES PROVIDED BY LOCAL AND REGIONAL GOVERNMENTS
Table 4: Jurisdictions in providing services, by June 30, 2001
All municipalities Regional or
urban city
governments
Central
government
administration
Other government
format
I. EDUCATION
1. Pre-school X* X* X
2. Primary X X* X*
3. Secondary X X X*
4. Technical X X X*
5. Open universities X
II. SOCIAL WELFARE
1. Nurseries X X X
2. Kindergartens X* X* X
3. Welfare homes X X X
4. Personal services for elderly and handicapped X X X
5. Special services (families in crisis) X X X
6. Social housing X X X

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III. HEALTH SERVICES
1. Primary health care X X (CIHI)
2. Health protection X X X (CIHI)
3. Hospitals X X X (CIHI)
4. Public health X X X (CIHI)
IV. CULTURE, LEISURE, SPORTS
1. Theaters X X X
2. Museums X X X
3. Libraries X X X
4. Parks X
5. Sports, leisure X X X X (COC)
6. Technical culture X X X
7. Archives X X X X (CNA)
V. EOCONOMIC SERVICES
1. Water supply X
2. Sewage X
3. Electricity X (CEPI)
4. Gas X
5. District heatining X
VI. ENVIRONMENT, PUBLIC SANITATION
1. Refuse collection X
2. Refuse disposal X X X
3. Street cleansing X
4. Cemeteries X
5. Environmental protection X X X
VII. TRAFFIC, TRANSPORT
1. Roads X X X (CRA)
2. Public lighting X
3. Public transport X X X
VIII. URBAN DEVELOPMENT
1. Town planning X* X
2. Regional urban planning X X* X*
3. Local economic development X X
4. Tourism X X X (CTA)
IX. GENERAL ADMINISTRATION
1. Authoritative functions (licenses, etc.) X X* X*
2. Other state administrative matters (electoral
register, etc.)
X X
3. Police X
4. Fire brigades X X (CFPA)
5. Civil defense X
6. Consumer protection X X X*
* Marks dominant role of respective level of governance
CEPI Croatian Electric Power Industry

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CFPA Croatian Fire Protection Association
CIHI Croatian institute for Health Insurance
CNA Croatian National Archives
COC Croatian Olympic Committee
CRA Croatian Road Administration
CTA Croatian Tourist Association
4. ANALYSIS OF LOCAL GOVERNMENT BUDGETS
4.1. Analysis of local budget revenues
A basic indicator of the size and significance of local self-government is the relationship of its
revenues to total state GDP and its share in the total revenues of a consolidated general government.
The share of revenues of local budgets shows a slow tendency of increase in terms of both GDP
and consolidated general state revenues. In 1999 the proportion of local budget revenues within the
consolidated budget revenues of the state was 10.32% and the local component of GDP was 5.79%.
In 2000 their proportion of consolidated budget revenues was 11.07% and of GDP, 5.25%.
Taken as a whole, the major portion of the total revenues of municipalities, towns and counties is
current revenues (tax and non-tax revenues) which, in the revenue structure of 1999, accounted for
85% of revenues and, in 2000, even more, at 87%. Capital revenues in 1999 provided 7%, the same
as in 2000, while the share from transfers, which in 1999 was 8%, fell to 6% in 2000.
4.1.1. Tax revenues
Tax revenues in 1999 accounted for 55% of total revenues and in 2000 for 56% of total revenues.
The major part of the tax revenues of local self-government units comes from shared taxes (income
tax and profit tax) which together make up around 47% of all revenues in the two years observed
(income tax in 1999 amounted to 35% and in 2000 to 39%, whereas profit tax showed a decline from
12% to 8%).
At the level of local self-government, tax revenues in the budget revenue structure prevail in the
cities budgets where they make up more than half (60%) of total revenues; in the county budgets they
made up 57% in 1999 and 62% in 2000 of all revenues. In communes, however, such revenues
provide a little more than a third of their revenues, specifically 31% in 1999 and 34% in the year 2000.
Such an increase in tax revenues may be partly the result of the Law on Areas of Special State
Concern, the increase in tax rates (from 25% in 1999 to 32% in 2000) and improved tax collection
discipline.
The share of tax and municipal income tax (municipal income tax has not been separated for
reasons of a specific mode of presentation) in total revenues of communes was 20% in 1999 and
23% in 2000, in cities it was 39% in 1999 and 43% in 2000, and in counties it was 29% and 39% in
1999 and 2000 respectively, while in the City of Zagreb it was 50%.
Table 5: Budget revenues of communes, cities and counties in 1999
Type of revenue Total Communes Cities Counties
Total revenues 100.00 100.00 100.00 100.00
Tax revenues 55.19 31.41 59.49 49.75
Non-tax revenues 30.50 41.29 30.27 33.79
Capital revenues 6.62 7.85 6.92 0.21
Transfers 7.69 19.45 3.31 16.25
Source: Ministry of Finance of the Republic of Croatia

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Table 6: Budget revenues of communes, cities and counties in 2000
Type of revenue Total Communes Cities Counties
Total revenues 100.00 100.00 100.00 100.00
Tax revenues 55.69 34.09 59.50 55.13
Non-tax revenues 31.48 41.00 31.37 32.24
Capital revenues 6.68 10.34 6.57 0.64
Transfers 6.15 14.57 2.55 11.99
4.1.2. Transfers
Transfers or grants-in-aid as a proportion of total earned revenues in the year 1999 amounted to
8% for all communes, cities and counties combined, and in the year 2000 to 6%. These revenues are
a significant portion of county budgets and in the year 1999 such revenues amounted to 25%, while in
2000 they were 20%. For communes the share of financing provided by grants and financial support
amounted to 19% in 1999 and 15% in the year 2000, whereas in towns it was only 3% of budget
funds.
4.1.3. Other revenues
Studies dealing with local government finance use different terms for non-tax revenue, such as
genuine revenue or own revenues. For the needs of this analysis the term own revenues will mean
non-tax revenues plus own tax revenues.
Real estate tax includes revenues from tax on companies or company names, taxes on holiday
homes, and taxes on the use of public areas. Domestic taxes on goods and services include tax on
advertisements, expenditure tax, motor-vehicle tax, taxes on boats, and the like. These, for the most
part, are the taxes of local budgets.
One of the major indicators of the degree of independence of local self-government units is the
share of the unit’s own revenue in its local budget. Below are the allocations of shared taxes and own
tax revenues by different levels of government:
Table 7: Distribution of tax revenues
1999 2000
Cities/Communes Counties Cities/Communes Counties
Shared-tax
revenues 90.01 79.43
90.60
85.73
Own Tax
revenues 9.99 21.57 9.40 14.27
Source: Ministry of Finance of the Republic of Croatia
As data in table 7 shows, local taxes play a marginal role in the budgets of all local self-
government units and hence have a marginal impact on their financial power. Own tax revenues in
total tax revenues account for only 9-10% in the budgets of municipalities and towns, and make up
14-21% in county budgets. If non-tax revenues are added to the local tax revenues, which for the
most part consist of various local fees, user charges and rents, coming from the contributions for
various municipal services, use of maritime demesne, exploitation of mineral resources, the use of
power-generating plants, the use of public areas, local tourist taxes, fees from the sale of government
stamps, revenues from annual charges for concessions, exploitation of mineral and thermal waters

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etc., and capital revenues, then the share is substantially higher and accounts for approximately 40%
for the budget revenues of communes and cities or 55% and 46% respectively for the county budgets.
However, these are the revenues that may be used only for the purpose for which they have been
levied.
The financial reports of local units show that non-tax revenues in communes account for a major
part of revenues, in contrast to other local units, and in 2000 make up around 41% of the total budget
revenues; in cities, non-tax revenues account for 31% of total revenues and approximately equal
percentage in counties (32%).
Generally, the system of financing local governments in Croatia is highly rely on share taxes, as
actually one form of transfers, because the local governing units have little power to choose the tax
rate or the tax base (Bahl, 2000). Out of any discussion is that own local taxes do not have any
significant impact in the budget at any level of local self-government.
4.2. Structure of expenditure of local self-government units
In the structure of the total expenditures of local and regional self-government units it can be seen
that current expenditures are on the. In 1999 the share of current expenditures was 68% and in 2000
it was 73%. A major portion of current expenditure is accounted for by the purchase of goods and
services, capital expenditures and the costs for employees.
The costs for salaries and contributions of employees account on average for 22% of all
expenditures at the level of the Republic of Croatia. However, in some local units that figure is much
higher and takes away a extremely high portion of the total budget.
An analysis of the share of these costs provided from current revenues of municipalities in the
year 2000 shows that 34 % of communes spend over 50% of their current revenues (total tax and
non-tax revenues) on salaries of their own administration. There are also 17 communes that spend
over 100% of their current revenues on that expenditure item. In the case of cities situation is little
better. Analysis shows that only 11% of cities spend on that item 50% of their current revenues.
4.3. Analysis of the fiscal capacity of local budgets
An analysis of the fiscal capacity of the units of local self-government and administration was
carried out using several indicators to obtain reliable information on the real situation of the system of
financing local self-government.
Proceeding from the data from the Central Bureau of Statistics (population census of 31 March
2001 – preliminary unofficial data) regarding the population of the Republic of Croatia and actual
revenues in counties, municipalities and towns (excluding the City of Zagreb) in the years 1999 and
2000, within the total actual revenues in 1999 and 2000 (in line with the Law on Financing) average
government revenues per capita were computed in accordance with the Law on Financing (Article 49)
and 75 % of average revenue per capita.
Average actual total revenues, including financial support, amounted to HRK 1,480 per capita in
1999, and excluding financial support they amounted to only HRK 1,302. In the year 2000 they were
HRK 1,467. The highest revenues were earned in the County of Istria, to the amount of HRK 2,685 in
1999 and HRK 3,167 in 2000, which is twice the state average or 4.5 times the revenues of the
Vukovar-Srijem County whose per capita revenues were the lowest, being only HRK 603 in 1999 and
785 in 2000.
Unequal economic power is one of the very important factors and/or reasons for unequal growth
of revenues per capita and for the creation of ever growing differences among counties. In addition to
unequal economic power some other factors are responsible for such a situation: the growth of the
unofficial (grey) economy, tax benefits and exemptions in the areas of special state concern, etc.
Twelve counties earned the average of government revenues in 1999 per capita. Out of 20
counties, 8 counties earned below the government average in 1999. In the year 2000 thirteen
counties earned the average government revenues, while seven were below 75% of the government
average.
The analysis of fiscal capacity of local self-government units for the period 1999-2000 shows the
following.

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At the level of the total budget of local self-government units in the Republic of Croatia:
- The average revenue per capita, including financial support but excluding the City of Zagreb,
amounted to HRK 1,480 in 1999 and HRK 1,615 in 2000;
- The average revenue per capita, excluding financial support and the City of Zagreb, amounted
to HRK 1,302 in 1999 and in 2000 it amounted to HRK 1,467;
- 75% of the average revenues per capita, without financial support and excluding the City of
Zagreb, in 1999 amounted to HRK 976 and HRK 1,101 in 2000;
- 50% of the average revenues per capita without financial support amounted to HRK 651 in 1999
and HRK 734 in the year 2000;
- The ratio of current revenue/current expenditure in 1999 was 1.11 and in 2000 it was 1.16;
- The ratio of total revenues/total expenditures in 1999 was 0.94 and in 2000 it was 0.91;
- The population was 3,611.924;
- The average current revenue per capita earned in 1999 was HRK 1,185 and in 2000 it was HRK
1,323;
- The average current expenditure per capita in 1999 was HRK 1,072 and in 2000 it was HRK
1,135;
- Average capital expenditure per capita in 1999 was HRK 479 and in 2000 it was HRK 455.
Cities with a population over 40,000
• In total there are 13 towns, excluding Zagreb.
• The average revenue per capita with financial support amounts to HRK 1,717 or without
financial support, HRK 1,694.
• The current revenue/current expenditure ratio is 1.17.
• Total revenues/total expenditures ratio is 0.92.
• The population is 999,846.
• Average current revenue per capita amounts to HRK 1,533.
• Average current expenditure per capita amounts to HRK 1,315.
• Average capital expenditure per capita amounts to HRK 531.
Cities – Total
• 122 cities altogether, excluding the City of Zagreb.
• Average revenue per capita, including financial support, amounts to HRK 1,487 and excluding
financial support, HRK 1,393.
• The current revenue/current expenditure ratio is 1.12.
• Total revenues/total expenditures ratio is 0.92.
• The population is 2,259,994.
• Average current revenues per capita is HRK 1,256.
• Average current expenditure per capita is HRK 1,122.
• Average capital expenditures per capita amount to HRK 472.
Communes and cities on the islands
• Average revenue per capita, including financial support, amounts to HRK 2,365.
• The current -revenue/current expenditure ratio is 1.01.
• Current revenue per capita is HRK 1,670.
• Current expenditure per capita is HRK 1,451.
• The population is 109,446.

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• Capital expenditures per capita amount to HRK 905.
• The total number of self-government units is 44 (2 cities and 32 communes).
Communes in the area of special central-government concern
• The total revenues/expenditures ratio is 1.00.
• Current revenue per capita is HRK 343; current expenditures per capita HRK 567.
• There are 81 communes of special state concern.
• Capital expenditures per capita amount to HRK 228.
• Capital revenues per capita, including financial support, are HRK 818.
• Capital revenues per capita, excluding financial support, amount to HRK 394.
• There is a population of 246,257 inhabitants.
Cities in the area of special government concern
Indicators of fiscal capacity in towns located in areas of special government concern show different
tendencies.
• The current revenues/current expenditures ratio is 0.98.
• Total revenues/total expenditures ratio is 0.94.
• Total revenue per capita, excluding financial support, amounts to HRK 1,098.
• Total revenue per capita, including financial support, amounts to HRK 1,300
• Average current revenue per capita is HRK 1,010 and current expenditure per capita HRK
1,029.
• Average capital expenditures per capita amounts to HRK 351.
• The population in the 28 towns is 625,133.
A major handicap in monitoring the fiscal capacity of local and regional self-government units is
inefficiency in supervising the execution of the budget. While formally the supervising bodies for the
execution of the budget are in place, the supervision is reduced primarily to the control of the
accuracy of entering individual items in the books and does not control the budget contents. Hence
the representative and executive bodies of local and regional self-government should improve their
control mechanisms, and the Ministry of Finance should pay greater attention to the budgets, in
particular when considering the requests for grants.
4.4. Transfers
The financing of public needs has been planned in such a manner that grants are given
exclusively as a support to the economically weaker local self-government units. However due to the
war hostilities in Croatia, such grants go only to the areas of special government concern and are not
given as funds for financing specific levels of public needs in all local self-government units.
Regarding financial equalization, the Law regulates that:
♦ In a county where the per capita revenues of the county, communes or cities are below the
average of the Republic, excluding the City of Zagreb, the Republic shall allocate a grant from the
State Budget up to 75%. The grant may not be awarded to a county where the rate of surtax on
income tax is lower than 1% and the rates and the level of taxes are lower than the highest rates
or amount of taxes as regulated by law.
♦ In a city or a communes in a region where the revenues of communes or cities with an
average tax load are below the county average per capita, with the exception of towns with a
population over 40,000, the county shall award a grant from the county budget to cover the
difference between actual revenue per capita and 75% of the county average revenue per capita.
The grant may not be awarded to a commune or a city where the rate of surtax on income tax is
lower than 1% and the rates of local taxes are lower than the highest rates or amount of taxes as
regulated by law.

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In the past few years it has not been possible to implement these provisions for all the counties.
Grants were awarded to counties according to the capability of the State Budget and also directly to
communes and cities in areas of special government concern. In 1999, current grants of HRK 372
million were given, and HRK 270 million in 2000.
The State Budget, in addition to current grants, also provides funds for a number of capital
projects undertaken by local self-government units – in 1999 HRK 133 million were allocated and in
2000 HRK 130 million. Further, counties provide from their budgets financial support to communes or
cities within their region.
5. CENTRAL GOVERNMENT DECENTRALIZATION POLICY
Trying to provide a suitable framework for developing local governance, national government
started with the so-called “First stage of decentralization” by July 1, 2001. Government actually
changed particular parts of several laws in the fields of primary and secondary education, social
security, primary health care and county hospitals, broadening responsibilities of cities and counties in
providing the above mentioned services.
In the course of the first stage of decentralization, the central government handed over its portion
of income tax used for functions transferred to the local level in order not to interfere with the rights
the units are entitled to, pursuant to previous laws and so that the transferred obligations would not
jeopardize the functioning of local units.
The functions of all the units whose fiscal capacity is inadequate will be assumed by counties.
This also holds true for cities and communes in the areas of special state concern as regulated under
the Law on areas of special state concern, which stipulates that income tax and profit tax earned in
the territory of the units shall be transferred to the units until the year 2005. The impact of this Law on
areas of special state concern will be seen during the coming period. During the past two years this
impact has not been visible (revenues of local governing units in that area is relatively low in relation
to national average).
To recognize that the first stage of the decentralization of the financing system is only the first of a
number of steps that need to be taken in the field of financing the state, regional and local levels of
power in the Republic of Croatia. To pass amendments to laws to ensure further implementation of
the decentralization process of public spending, along with efficient and economic operations and
increased responsibility for exercising the obligations undertaken. Decentralization implies not only
the physical and functional transfer of revenues and tasks from the state to the local level but also the
responsibility of local authorities for the execution of the whole process. It is worth noting that a
limiting factor of the whole process is human resources and human resources management at a local
level.
In other words, it is essential to ensure not only the exercise of delegated functions but also to try,
during the first stage of decentralization of education, primary health care, and social services, to
improve the delegated functions, because it is the local units themselves that can best assess their
needs and find satisfactory solutions. In line with this, it is of paramount importance to increase
control over the mode of exercising public spending transferred from the State Budget to local self-
government units, paying much more attention than has been given up to now to the planning,
preparation and development of local budgets and to implementation analyses at the level of local
and regional self-government units.
To continuously monitor and analyze the implementation of the measures proposed. The Law on
Financing stipulates the functions that will be delegated to a local level (Article 45) and that they be
financed from an additional share of income tax or financial equalization support when the resources
from the additional share are insufficient (Article 45 a). In this way, “certainty” regarding the financing
of delegated functions during the first stage of decentralization has been ensured and the manner of
accessing supplementary funds and the execution of obligations or transfers to the end users, as well
as their obligation to report on how the resources are spent, has been regulated under the regulation.
Due to a number observations and following the measures proposed in the framework of the first
stage of decentralisation in Croatia, which started with the change of the legal framework in the area
of financing communes, cities and counties, some time will be required to monitor the results of the
measures proposed. To assess the impact of the measures and to make appropriate adjustments on

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the basis of the results of at least two years, it is essential to monitor over a period of at least three
consecutive years the situation in the area of financing local and regional self-government.
The suggested model of financing local and regional self-government is an interim model which
would be used during the first stage of decentralization. A "final model” of financing would be
developed/suggested on the basis of the monitoring, analysis and evaluation of the achievement of
the fiscal capacity of local units during a three-year fiscal period, and within the framework of a
regional development strategy.
The assumptions for a financing model area:
- local units during a three-year period will achieve sufficient fiscal capacity to finance the
activities for which they have been established;
- local units are ranked according to their fiscal capacity (basic and supplementary indicators
from the analysis for the years 1999 and 2000 are suggested as criteria for ascertaining the rank
of each local commune/city/county unit);
- a certain weighting of the ranking position of a local unit (according to fiscal capacity)
reflecting broader criteria (social, traffic, ecological, demographic, political, cultural, historical etc.),
for an assessment on whether a local unit meets the criteria for establishment and/or whether the
current units are able to finance functions and activities for which they have been established in
compliance with the law;
- during the planning and development of local unit budgets for a coming fiscal year, the rank of
each local unit will be one of the criteria used in determining the amount of resources to be
allocated in view of the requests for planned capital investment;
- the rank of a local unit will be one of the criteria for the allocation of additional funds from the
State Budget aimed primarily at financing development;
- public debate involving representative bodies of local units, the Government and the
Parliament, leading to a political consensus on the part of all interested parties, which, by
amending the Law on Financing Local and Regional Self- Government, will integrate these criteria
into law;
- the actual results over a period of three years will be the basis for issuing a decision on the
status of a local unit and on whether or not it may be an independent unit;
- the ranking of each local unit showing the results in the previous fiscal year will also be the
basis for amendments in effective legislation, provided that during public debate the
representative bodies of the units of local and regional self-government assess this as essential
for amending the law.
The problem of financing municipalities, towns and counties is a complex one, requiring
continuous monitoring and analysis, ongoing adjustments and suggestions for new/further
investigation. The definition of a rank-list and indicators of fiscal capacity as criteria for assessing the
level of economic strength of any local unit will at the same time have an impact on the economic
development of local units, will improve the responsibility of public services for their own development
and will contribute to the overall development of democracy.
6. DECENTRALIZATION POLICY MEASURES PROPOSED BY INDEPENDENT INSTITUTIONS
AND RESEARCHERS
Independent institutions dealing with the decentralization issues in Croatia include actually four
important actors. At the first place there is strong NGO institution, The Croatian Law Centre (CLC),
as a branch of Open Society Institute in Croatia. Dozens of social scientists and experts from various
fields, varying from cultural policy to health care are included in expert teams of the Centre. Except
CLC, there are exist two independent institutions, making research and/or training in the field of local
governing. The one is the Urban Institute in Zagreb, working there since 2001. The other is the
Institute for Public Finance, also in Zagreb. These two institutions continuously produce research

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materials dealing with the local government decentralization policy. Finally, the last actor is the
Associations of Croatian Cities that proposed (in cooperation with the Urban Institute) completely
new Law, regulating the status of regional and local governing units.
6.1. Administrative decentralization or decentralization of government decision-making
Revenues for units of local and regional self-government are collected in conformity with the law,
according to the budget plan and to the functions executed as prescribed by law. When establishing a
new unit, it is essential that financing resources be determined and that the normal functioning of the
local unit be possible from the funds collected from its own resources.
The indicators obtained by empirical analysis and the correlation of current revenues (for the
purpose of this analysis these revenues will be regarded as own revenues and they will be the
minimum necessary for establishing a unit) and current expenditures (which include the basic
functions the unit is supposed to execute), show to what extent each local unit covers its current
expenditures and whether it is capable of redirecting funds to capital investment if it collects any
additional resources.
The analysis has taken into account that during the past several years local self-government units
have been subjected to various additional financial obligations following from new legislation, without
any additional financing resources being provided therefore (for example, the Law on Fire-Fighting,
the Law on Natural Disasters, the Law on Water Management, etc.).
The analysis of fiscal capacity by counties shows that in a great number of units the total
revenues per capita including financial support are below the state average. An additional analysis
excluding financial support was carried out to see how much money would be needed if counties were
provided with financial support up to 75% of the state average.
6.2. The number of local government units
To undertake a review of the current number of units in the system of local and regional self-
government relative to their fiscal capacity, as measured by the following indicators: revenues per
capita; ratio of current revenues to current expenditures and ratio of employee salaries costs to
current revenues.
6.3. Definition of local government responsibilities
One of the most recommendation, particularly in the CLC, is that system must clear enumerate
basic (obligatory) and additional (discretionary or non-obligatory) responsibilities that will be provided
by local governments. In CLC exists even a special expert team dedicated to propose the above
mentioned list (Kopric, 2002). Definition of basic responsibilities (basic functions) for the central state,
regional (counties) and local levels of governing (cities and communes), as well as definition of the
respective sources of funds for financing basic functions is required in their recommendations.
To clearly separate/demarcate the boundaries between the affairs of state administration and
those of local authorities. For example, prior to the decision to decentralize some public functions
(education, primary health care, social services), which has been effective since 1 July 2001, the
execution of these functions was within the competence of a county and was financed through the
State Budget. After the Law on Financing came into effect, the functions have continued to be
executed by county offices, and only in part by local authorities, which means that local units are not
yet organized in such a way as to be able to exercise these tasks on the ground, since the law does
not clearly regulate who will exercise the functions, when they will exercise them and in what
timeframe, and who will provide the resources for employees (currently, the employees exercising
these functions continue to be paid from the State Budget). Deficiencies relating to the said
weaknesses in the effective law on local and regional self-government should be amended.
Therefore, amendments to the relevant legislation are proposed.

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6.4. Minimal requirements for establishing new local government units
To establish a procedure to ensure that when a new unit of local and/or regional self-government
is established, a minimum requirement is met relating to the earning of revenues to cover the basic
(obligatory) functions of local self-government.
The minimum requirement relating to revenues earned in units of local and/or regional self-
government should be defined by the Ministry of Finance at the time of proposing the State Budget for
a new fiscal year and submitted to the Croatian Parliament to be enacted with the “budget package”.
It has been proposed that, upon the proposal of the Ministry of Justice, Administration and Local
Self-Government, and subject to prior consent by the Ministry of Finance, a unit of local self-
government that for three consecutive years has not met the requirement to earn revenues to cover
basic (obligatory) functions be merged with another unit of local self-government within the county so
as to ensure sufficient earnings for the coverage of basic functions.
6.5. Decrease the contribution of Central government in shared-taxes
To gradually decrease the contribution of the State in the allocation of shared revenues, actually
means expansion of the portion of shared-taxes dedicated to local government units.
6.6. Improving financial management in local governments units
To improve the collection of current local revenues which will, along with the increased investment
funds, instead of just increasing current expenditures, improve economic development and the overall
progress of a region.
6.7. Diminishing the costs in capital expenditures
Capital revenues in the revenues of local units account for a relatively small portion. Most of the
funds for financing capital projects come from the State Budget. The funds for current expenditures
and capital projects at the level of municipalities and towns are also provided by counties in their
budgets as a form of assistance and support, depending on circumstances.
To facilitate the financing of capital expenditures: to enable two or more units of local and/or
regional self-government to join together to earn higher revenues to provide for investments in joint
capital projects and hence to ensure a higher level of financial capability. That measure was strongly
proposed by some members of the CLC expert teams, but in the same time several researchers
pointed out that such type of recommendation will be convicted to a complete failure without a prior
simulation research. The idea of compulsory merging two or more communes if they do not receive
sufficient revenues for running some capital infrastructure programs is too simplistic and against the
logic of self-governance.
To provide public services, specifically those relating to utility services, jointly for the needs of
several units.
To arrange for an increase in investment funds, and not of funds for current expenditure, in the
budgets of local and self-government units, by pooling the resources of several units.
6.8. Privatization of local government companies
Carrying out the privatization of public services within the local government units is at the absolute
begin in Croatia. There are some plans to privatize transport companies or gas-utility companies, but
such policies did not put in effect.
6.9. Areas of special central government concern and local governments on islands
While there is a system of financial support in the communes on the islands, the present analysis
of fiscal capacities of island communes shows that fiscal capacity measured by the indicator revenues
without financial support per capita is much higher than the state average, which suggests that no
support is necessary for quite a number of communes on the islands. On the other hand, if a criterion

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for awarding support also involved population density and development, the picture would be
completely different. Therefore, the development and revival of the islands should be accomplished
through targeted projects and capital construction in order to retain population on the islands, thus
reducing the future spending of general funds.
If only the first stage of decentralization is considered, the results indicate that expenditures on
the islands are much higher in comparison with other parts of the country, both because of population
density and age structure.
A special method of financing, as indicated by analysis, should be used in the present stage of
development, not only in areas of special state concern and in communes on the islands, but also in
some parts of other counties.
7. CONCLUDING REMARKS
7.1. General
In order to continue the decentralization process through a number of stages, a thorough analysis
of the “First phase of decentralization” is the first prerequisite (see Antic, 2001). Since decentralization
means the transfer of power, responsibility and resources from the state level to the local level, during
the further implementation of the process at a local level it is essential:
- to ensure responsibility and transparency at all levels of administration and to provide a
transparent definition of roles at different administration levels;
- to maintain the independence of local administrations both in the exercise of functions and in
earning revenues, in connection with which it is most important to “ensure approximately the
same opportunities for the provision of services to all citizens”. This will be feasible through
financial equalization provided in the concept of fiscal decentralization;
- to regulate and define standards (in the first stage, state-run services regulate the norms for
local administration, a task that should normally be done by the local administration; in addition,
the central administration should not have a direct impact on local administration in areas of local
responsibility or competence).
Concerning changes in the territorial organization of local and regional authorities in the Republic of
Croatia, a dual approach should be applied:
1. one relating to the current territorial organization, and
2. one relating to requests for establishing new local and regional units.
From the viewpoint of its economic efficiency, the present organization of local and regional self-
government is inadequate, a fact which has been substantiated by the data obtained from analyzing
the budgets. Reducing the autonomy of local units by forcing association with neighboring communes
or cities is not a solution that would gain much support in public. Hence it is necessary to establish a
transitional period (e.g. three years) during which the units would be encouraged to improve their
economic strength by, for example, negotiating with neighboring communes or cities for the joint
provision of utility services or the like. If they fail to improve their economic strength during the term
required, they will be formally associated with another local unit.
The decision to establish a new local unit should include analytical arguments regarding the
capacity of the local unit to function independently. The analytical argumentation would involve the
development of:
- a list of the new infrastructure base available to the unit (schools, general practitioners’
surgeries, homes for the elderly and the infirm, theatres, museums…);
- budget projections for a three-year period;
- a plan of activities with accompanying financing resources for a three-year period.

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On the basis of such information it might be ascertained whether a local unit is capable of carrying out
its obligations and in what way.
It is suggested that a new article be inserted into the Law on the Territory of Counties, Towns and
Municipalities in the Republic of Croatia to define the conditions according to which a new local or
regional unit could be established.
7.2. Open questions
7.2.1. Establishing regions
What is the role of a region? In other words, what functions are to be undertaken by regions (or
what functions should be delegated to them)? This is a complex issue which might be resolved in the
following manner:
- First, specific expert groups need to give answers to questions ranging from territorial
decentralization to specific activities.
- Next, the expert team on Financing Local Self-Government will have to evaluate the financial
implications of the concept.
- Finally, debates will follow on how to resolve the actual and projected shortage of funds through
a regional concept. In other words, how to obtain the funds for financing the functions of the new
organization. Particularly for tactical and political reasons, the proposal to abolish counties would
have to be delayed, notwithstanding their inefficiency, and so the decision on the model would not
mean just the transfer of the county resources to new regions.
7.2.2. The role of local neighbourhood communities
The issue of the re-establishment of local communities has also been raised, since it is claimed
that during their existence such communities proved to be a good solution and was a concept closest
to the idea of direct democracy (it should be added – to a limited extent). Specifically, local
communities may respond promptly to an issue relating to a relatively small number of citizens
affected by the same problem, thus eliminating sluggishness in the perception and formulation of a
response, characteristic of a large, bureaucratic system at higher levels of a territorial organisation.
Here again, as in the case of the much more ambitious project of regions, the question is how to
secure funds. Formerly, a significant source of funds for local communities was provided through a
local voluntary tax. If local communities are to be re-established, the question concerning the source
of funds should be thoroughly aired. A key issue might be - would a local voluntary tax be a form of
self-assessment, that is a public revenue (once voted it will be valid for all citizens and will be
collected, if necessary, by force) or would a local voluntary tax be a contractual obligation relating to
private law (obligatory only for those who contract to pay a local voluntary tax and not obligatory for
those who refuse to do so).
7.2.3. The status of Zagreb metropolitan area and the status of large cities
Current solution that the City of Zagreb has dual status, as a City and County is far from
satisfactory solution.
Further tasks:
- To establish criteria for determining which cities in the territory of Croatia (out of 122 towns)
would be categorized as “large towns” and which would thus have a special position, together
with the City of Zagreb, in the system of financing. Possible criteria might be: the number of
inhabitants, the area a town spread out, the type and volume of activities the inhabitants are
engaged in, etc.
- To investigate what size of town ensures the optimal conditions for the living and work of its
citizens.

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- To define the tasks currently within the competence of towns as well as those that should
be in their competence. In particular, the needs of the citizens in modern towns should be
investigated, as well as the way modern towns can solve the problem of financing.
- To investigate the cost effectiveness of individual fiscal and non-fiscal revenues in the
capital and in some other large Croatian cities. To suggest measures which would improve the
cost effectiveness of some city revenues (e.g. measures that would make a city area more
attractive for residence, consumption, entertainment etc.).
- To propose a financing model for the City of Zagreb and other “large cities” in the Republic
of Croatia.
7.3. Conclusion
A model for financing local and regional self-government might include four levels of organization:
regions, counties, cities/communes and local communities (neighborhood communities), each of
which would require its own financial resources. Even if the level of local communities appears to be
relatively undemanding with regard to financing, a regional level will need a rather large amount of
resources. The satisfaction of these needs requires very serious consideration and it might be
achieved only through the interaction of all interested groups – teams, where those involved in any
public services (education, health care, social services) should be the first to give an outline of the
model.

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