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Equalization FormulaEqualization Formula

Ministry of Finance of GeorgiaMinistry of Finance of GeorgiaBudget DepartmentBudget Department

TbilisiTbilisiOctober 18, 2007October 18, 2007

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IntroductionIntroduction

Current PositionCurrent Position Previous PositionPrevious Position ReasonReason

During Formula development process I During Formula development process I used to be the Budget Director at the used to be the Budget Director at the Ministry of Finance of Georgia; the Ministry of Finance of Georgia; the formula was prepared under my direct formula was prepared under my direct leadershipleadership

A local consultant was hired to develop the A local consultant was hired to develop the formula.formula.

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Purpose of PresentationPurpose of Presentation Review of the reforms implemented for Review of the reforms implemented for

decentralizing local self-governance in decentralizing local self-governance in GeorgiaGeorgia

Organic Law on Self-Governance (1997)Organic Law on Self-Governance (1997) Elections for the self-governance units (1998)Elections for the self-governance units (1998) Establishment of the 1072 self-governance unitsEstablishment of the 1072 self-governance units

Amendments into the Organic Law on Self-Amendments into the Organic Law on Self-Governance Governance

Creating 69 Self-Governance units from 1072Creating 69 Self-Governance units from 1072

IntroductionIntroduction

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Self-Governance

Unit

SELF-GOVERNNACE

SELF-GOVERNNACE

SELF-GOVERNNACE

SELF-GOVERNNACE

SELF-GOVERNNACE

SELF-GOVERNNACE

SELF-GOVERNNACE

SELF-GOVERNNACE

GOVERNANCE

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IntroductionIntroduction

OutcomeOutcome Increase in RevenueIncrease in Revenue Revenue Simplifying hiring of the more Revenue Simplifying hiring of the more

skilled staffskilled staff Increasing the degree of independence for Increasing the degree of independence for

self-governance unitsself-governance units Law on the Budgets of the Self-Law on the Budgets of the Self-

Governance UnitsGovernance Units Budget authoritiesBudget authorities Types of the transferTypes of the transfer Equalization transfer formulaEqualization transfer formula

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Need for New Equalization Need for New Equalization FormulaFormula

Existing formula did not meet Existing formula did not meet the requirementsthe requirements

Amendments in legislation Amendments in legislation Average income declineAverage income declineDid not cover all of the Did not cover all of the

municipalitiesmunicipalities

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Goal of the New Goal of the New Equalization FormulaEqualization Formula

Equal financial capacityEqual financial capacity SimplicitySimplicity Inability to manipulate dataInability to manipulate data ComprehensivenessComprehensiveness

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Equalization FormulaEqualization Formula

Ti=(E-R)*KTi=(E-R)*K

wherewhere::TiTi – – shows equalization transfer for local shows equalization transfer for local municipalitymunicipality E E – – shows budget expenditures of local shows budget expenditures of local municipality municipality RR _ _ shows revenues of local municipalityshows revenues of local municipalityKK – – is coefficient of supportis coefficient of support

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Expenditure CalculationExpenditure Calculation

E=E=∑ Cn*Pn∑ Cn*Pn or or CC11*P*P11+ C+ C22*P*P22+ C+ C33*P*P33+ + CC44*P*P4 4 + C+ C55*P*P5 5 + C+ C66*P*P66

E (expenditure) = the sum total derived from the E (expenditure) = the sum total derived from the multiplication of the multiplication of the

statistical data (statistical data (CnCn) and equalization coeficient () and equalization coeficient (PnPn))wherewhere::

CCnn i.ei.e ( (CC11 C C22 C C33 C C44 C C55 C C66 ) ) – – is a statistical indicator of local self-governing unit is a statistical indicator of local self-governing unit (population, pre-school age children, area, number of youth under 7-18, (population, pre-school age children, area, number of youth under 7-18, status of the capital, roads of local importance)status of the capital, roads of local importance) ;;

PPnn i.ei.e Pn (PPn (P11,P,P22,P,P33,P,P44,P,P55,P,P66.) – .) – Equalization coefficients, which represent Equalization coefficients, which represent interconnection between each category of expense (function) and interconnection between each category of expense (function) and statistical indicator. Amount of equalization coefficient is calculated statistical indicator. Amount of equalization coefficient is calculated through regression analysis, which is then approved by the order of the through regression analysis, which is then approved by the order of the Minister of Finance for the long-term period (3-4 years); this coefficient is Minister of Finance for the long-term period (3-4 years); this coefficient is the same for all self-governing units and increases annually consistent the same for all self-governing units and increases annually consistent with the Consumer Price Index (CPI) identified in the Basic Data and with the Consumer Price Index (CPI) identified in the Basic Data and Direction paper (BDD)Direction paper (BDD)

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Calculation of Equalization Calculation of Equalization CoefficientCoefficient

– State service of common purpose

– Defense – Public order and security– Other expenses

– Education

– Economy – Environment protection– Housing communal

services

– Recreation, culture and religion

– Health protection– Social Provision

Economic Economic activityactivity

Health and Health and Social Social

InsuranceInsurance

Administration

CultureCulture

Education

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Calculation of Equalization Calculation of Equalization CoefficientCoefficient

AdministrationAdministration EducationEducation CultureCulture Economic Economic activityactivity

Population Number of pre-school age children

Population Population Length of the Length of the roadsroads

Area Number of Number of youth under youth under 7-18 Status 7-18 Status

of the capitalof the capital

Status of the Status of the capitalcapital

Status of the

capital

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Calculation of Equalization Calculation of Equalization CoefficientCoefficient

Calculating average costCalculating average cost Calculating average expense Calculating average expense

indicator based on the forecast indicator based on the forecast expenses of the basic (present) year expenses of the basic (present) year and actual expenses of the previous and actual expenses of the previous two years.two years.

Finding the correlation by Finding the correlation by individual function between individual function between average expenses and statistical average expenses and statistical indicators through regression indicators through regression

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Equalization CoefficientEqualization CoefficientEqualization Schedule for Expenditures

0.0

1,000.0

2,000.0

3,000.0

4,000.0

5,000.0

6,000.0

7,000.0

8,000.0

0.0 20.0 40.0 60.0 80.0 100.0 120.0 140.0 160.0 180.0 200.0

Number of Population

Sta

te S

erv

ice o

f Com

mon P

urp

ose

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Calculation of Equalization Calculation of Equalization CoefficientCoefficient

Coefficient Name Administration

Economic activity and housing communal services

Recreation, culture and religion

Education In total

P1 Population 20.9620 10.3326 31.2946

P2 Area 0.07990.0799

P3Length of the road 39.7289

39.7289

P4

Number of youth under 7-18

7.6866 7.6866

P5

Number of pre-school age children

104.0022 104.0022

P6Status of the capital

1,724.0300 22,249.1040 23,973.1323,973.13

3939

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Calculating BudgetCalculating Budget Expenditures Expenditures of Municipalitiesof Municipalities

Name of the Statistical indicatorEqualization

CoefficientCalculated

Cost

Population C1 122.1 P1 31.2946 C1*P1 3,821.1

Area C2 16.7 P2 0.0799 C2*P2 1.3

Length of Road C3 104.1 P3 39.7289 C3*P3 4,137.4

Number of youth under 7-18 C4 24.5 P4 7.6866 C4*P4 188.4

Number of pre-school age children C5 8.2 P5 104.0022 C5*P5 854.3

Status of the capital C6 1.0 P6 23,973.1339 C6*P6 23,973.1

Total Sum           32,975.6

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Revenues of Local MunicipalitiesRevenues of Local Municipalities

R - revenues of local municipality (property tax, non-tax R - revenues of local municipality (property tax, non-tax revenues, capital revenues). Revenues for each district are revenues, capital revenues). Revenues for each district are calculated according to the tendency (“TREND”) of current calculated according to the tendency (“TREND”) of current year forecast and previous three year actual indicators. Excel year forecast and previous three year actual indicators. Excel function “TREND” had been used for calculation of revenuesfunction “TREND” had been used for calculation of revenues..

R=TREND(2004w, 2005w,2006w,2007w)= 15,995.2

Calculating revenuesCalculating revenues

RevenuesRevenues 20042004 20052005 20062006 20072007 20082008

BatumiBatumi 1,317.3 1,317.3 4,649.1 4,649.1 6,191.0 6,191.0 13,558.3 13,558.3 15,995.215,995.2

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Support CoefficientSupport Coefficient

At the following stage, amount of At the following stage, amount of equalization transfer of the budget equalization transfer of the budget of each local municipality is of each local municipality is calculated. This transfer is received calculated. This transfer is received via multiplying the difference via multiplying the difference between the expenses and the between the expenses and the revenues of the same municipality revenues of the same municipality by the coefficient of support (K), by the coefficient of support (K), which is approved by the which is approved by the government of Georgia for 4 yearsgovernment of Georgia for 4 years..

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Calculating equalization transfer Calculating equalization transfer for Batumifor Batumi

Calculating revenuesCalculating revenues

Statistical indicators Amount Equalization coefficients Amount of expenses

Population (thousand men) C1 122.1 P1 - 31.2946 3821.1

Area per capita (m2) C2 16.7 P2 - 0.0799 1.3

Length of the roads (kl) C3 104.14* P3 - 39.7289 4137.4

Number of youth under 7-18 (thousand men) C4 24.51

P4 - 7.6866 188.4

Pre-school age children (thousand men) C5 8.21 P5 - 104.0022 853.9

Status of the capital C6 1.0 P6 - 23,973.1339 23, 973.1

Total - E 32,975.2

Note* - length of road = (127*0.9)*0.9 + (127*0.1)*0.1

R=TREND(2004w, 2005w,2006w,2007w)= 15,995.2,If K=0.6Then T=(E-R)*K=(32975.2-15995.2)*0.6=10188.0

RevenuesRevenues 20042004 20052005 20062006 20072007 20082008

BatumiBatumi 1,317.3 1,317.3 4,649.1 4,649.1 6,191.0 6,191.0 13,558.3 13,558.3 15,995.215,995.2

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Issues Encountered in Issues Encountered in TransitionTransition

Calculated transfers were not Calculated transfers were not sufficient to offset loss of income taxsufficient to offset loss of income tax

Status of the Capital should be revisedStatus of the Capital should be revised Use indicators that have stronger Use indicators that have stronger

coefficient (with higher correlation coefficient (with higher correlation coefficient)coefficient)

One Time Revenue fluctuation One Time Revenue fluctuation (including capital revenues)(including capital revenues)

Tie transfer pool to GDP, VAT an etcTie transfer pool to GDP, VAT an etc..

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Having been discussed with Having been discussed with Parliament and Government Parliament and Government the Formula was approved by the Formula was approved by the “law on self-governance the “law on self-governance unit” and Instructions for unit” and Instructions for transfer calculation was transfer calculation was approved by the Order of the approved by the Order of the MinisterMinister

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Thank You for Your Thank You for Your Attention!Attention!