Evaluation of incentive models for municipal finance

Abstract

According to Government’s outlines, cost savings of approximately one billion euros are targeted to be achieved from the duties and obligations of municipalities. One way to achieve savings could be an incentive scheme of municipal finances. This report analyses from the viewpoint of economics the risks associated with these types of incentive schemes and the properties of a functional incentive scheme.

A key message is that it is difficult to compare the performance of municipalities based on production of public services, since not all differences in terms of quality, needs and costs can be easily identified. Consequently incentive schemes based on measuring productive efficiency are problematic.

Instead, incentives for municipalities should be based on competition between municipalities in a way that strengthens the existing incentives of municipalities to improve their efficiency. Municipalities compete over residents by means of taxation and the level and quality of public services. One way to strengthen the incentives for efficiency is to reward municipalities for a positive net migration rate. When the analysis is based on migration, the benefit is that it in principle measures the comprehensive wellbeing of residents, avoiding any problems related to partial optimisation that are typical to incentive schemes. While a model based on net migration is not free of problems, it is simple and allows migration to be measured easily. But also in a model based on net migration, municipalities should only be compared with similar municipalities in order to enable fair competition and, therefore, creating incentives as well as possible.

This study is not intended to recommend any specific incentive scheme as such. Nonetheless, the report offers analytical views of the advantages and disadvantages of different models. When planning incentive schemes, practical challenges associated with them must be addressed as a poorly built incentive scheme may steer local government activities in an unwanted direction.

Publication Information

Kivinen, A., Kortelainen, M., Saastamoinen, A., Tukiainen, J., & Vartiainen, H. (2018), Arvioita kuntien käyttötalouden kannustinjärjestelmistä, Publications of the Government´s analysis, assessment and research
activities 49/2018.

• ISSN: 2342-6799
• ISBN: 978-952-287-597-6