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FINANCING BASIC SERVICES24 The financing role of local governments takes different forms, depending on the extent of decentralization, their resources, and whether they are the organizing authority for services. This section explores the financing of basic services, tariffs and affordability, and investment mechanisms, as well as how these affect the governance of basic services.
Basic services and public funding Since the 2000s, there has been a move away from the idea of ‘full cost recovery’ through user tariffs to the concept of Sustainable Cost Recovery (SCR), which relies on a combination of tariffs, taxes and transfers (the 3Ts).25 SCR also implies the use of the 3Ts to attract loans, bonds or equity for investment in extending or maintaining services. While the 3Ts are the main sources of financing, repayable sources can play a crucial role in upfront investment by extending repayments over the financing period. Three main characteristics of sustainable cost recovery have been identified:26 a mix of the 3Ts to finance recurrent and
capital costs and leverage other financing; predictability of public subsidies to facil-
itate investment (planning); tariffs that are affordable to all while en-
suring financial sustainability. Sustainable financing requires that sectors are not treated in silos. Cross-subsidization is vital to bridge geographical inequalities and implement inter-sectoral equalization (where the profits from one service are used to finance deficits in others).
Central governments remain a major source of financing for basic services, but local governments are providing an increasing proportion in high- and middle-income countries. SCR implies that public spending will complement revenues from tariffs, particularly (but not only) in lower-middleand low-income countries, where affordability is a significant constraint. For example, while tariffs make up 90% of revenue to the water sector in France, they account for just 40% in Korea, and 10% in Egypt.27 Donor contributions can be an important source of investment capital in low-income countries (equivalent to 1% of GDP in seven countries).28 The European chapter discusses a range of ways of financing services: full cost recovery through tariffs (i.e. water in Denmark); financing solely through taxation (i.e. water and sanitation in Ireland); a mix of subsidies for various service providers (i.e. transport in France and Germany); geographical, social or sectoral cross-subsidies; co-financing by national, regional and local public authorities; and European or international funds. Combinations of these models can make it difficult to uncover the “true costs” of service provision. Few countries recover all water service costs through tariffs, and investment is mainly financed by public subsidies (local, national or international). Public transport is also heavily subsidized (by municipal and intermediary government budgets, national grants, and commercial sources). While progress has been made in tariff collection and financing in Latin America, subsidies from local, intermediate and central governments continue to be vital. In most cases, profits from water utilities are insufficient for effective operation, particularly for infrastructure investment. Most countries use tax subsidies and national grants
For more on financing, see Appendix to this report by Claude de Miras, Institut de Recherche pour le Développement (France). 24
‘Tariffs’ are fees paid by service users, ‘taxes’ refer to funds channelled to basic services by central, regional and local governments, and ‘transfers’ refer to funds from international donors and charitable foundations. Transfers include grants and concessional loans, such as those given by the World Bank, which include a grant element in the form of a subsidized interest rate or a grace period. OECD (2009). 25
26
Winpenny (2002)
OECD (2009). See also Annex I. However, even in France, public funds represent around 88% of public investment in water sector. Pezon (2009).cited in D. Hall and E. Lobina (March 2012), Financing water and sanitation: public realities, PSI-PSIRU, www.psiru.org 27
28
OECD (2009).