Analysis: Improving municipal services requires additional sources of income

According to Märt Masso, an expert at the Foresight Centre, a recent analysis shows that there is a strong correlation between the municipalities’ income and the quality of services. “If a municipality’s per capita income increases by 10%, the quality of services improves by approximately 4%,” said Masso. “At the same time, this means that in order to increase the quality and availability of services, real sources of additional revenue are needed – be it a larger share of income tax or an increase in local taxes.”

According to 2023 data, on a 9-point scale, the quality of municipal services in 18 areas ranged from 1.8 to 5.87, so the average is merely 4.02 points. A higher quality of services can be enjoyed in wealthier municipalities, meaning it is predominantly linked to higher income per capita.

The analysis reveals that revenue growth similar to previous years is not sufficient to noticeably improve the quality of services. Especially since the municipalities are already using their resources efficiently. According to the Foresight Centre’s forecast, municipalities’ revenues will grow by 10% in the next 2-3 years, but considering the municipalities’ increased loan obligations, this pace of growth will only exacerbate their financial difficulties.

In order to improve the quality of services by 4%, the municipalities’ income tax revenues would need to be increased by approximately 1.2 times, for example, by increasing their share in personal income tax from the current 71% to 83%. Alternatively, a nearly fivefold increase in local tax revenue would yield the same result.

“The future of municipalities’ financing requires clear choices,” said Masso. “Either the municipalities’ share of the existing tax revenues should be increased or more possibilities for the municipalities to impose the taxes themselves must be provided. In both cases, the impact of the tax burden on both residents and businesses needs to be considered.” He added that, on a more optimistic note, there is also hope for innovations that would help each euro lead to more service improvement than before.

The Foresight Centre notes that understanding the correlation between the quality of services and the financing of municipalities is increasingly important. Improving the availability and quality of public services requires the state to make a strategic choice: either increase the municipalities’ revenue base to ensure better funding for their existing duties or reduce the municipalities’ responsibilities, while focusing on improving the quality of services in the remaining areas.

The results of the analysis are given at the Foresight Centre’s short report ‘Prospects for Strengthening the Revenue Base of Municipalities and Developing Services’ (in Estonian), which is part of the Foresight Centre’s research stream ‘The Future of Spatio-temporal Accessibility of Public Services’. The purpose of the research stream is to map the availability of public services now and in the future and discern the most suitable future models of service provision.