On Thursday, February 5, during a meeting of the Advisory Council, a proposal by the Ministry of Finance (MoF) for a new local government finance equalization (LFE) model was constructively reviewed. The discussion with heads of local governments was attended by Minister of Finance Arvils Ašeradens and Minister for Smart Administration and Regional Development Raimonds Čudars. The meeting was held in implementation of the government’s mandate to prepare and submit a draft law for the improvement of the LFE system by March 1 of this year.
The proposal was developed in cooperation with stakeholders and is based on both current data and a multi-year analysis of trends in local government revenue and expenditure development. The goal of the MoF proposal is to improve the LFE system in a way that ensures stable and predictable financial resources for local governments to perform their statutory functions while simultaneously reducing the administrative burden.
The objective of local government finance equalization in Latvia, as in other European Union (EU) countries, is to provide local governments with resources to perform their functions at an equivalent and comparable level. It should be noted that LFE is not a regional development instrument, as other instruments are used for this purpose, including EU funds, loans, and public-private partnership projects.
The current LFE Law was adopted by the Saeima in 2015, and since then, as a result of economic development, population migration, administrative-territorial reform, and tax changes, the revenues of Riga and the Pierīga local governments have grown significantly faster than those of other municipalities. Simultaneously, the structure of local government budget expenditures has changed, necessitating a review of the LFE coefficient values established by law.
The LFE model proposed by the MoF provides solutions to address these challenges, and one of the most conceptually significant elements is the exclusion of real estate tax revenue from the LFE system, leaving it in full at the disposal of local governments. This approach, which gained support across all groups of local governments, strengthens the fiscal autonomy of municipalities and allows for a more direct link between tax payments and the development of the specific territory, while providing an opportunity for more targeted planning of infrastructure maintenance, improvement of the public environment, and investment attraction.
The proposed model also envisages a balanced distribution of personal income tax (PIT), allocating part of the revenue based on actual performance indicators, while including the other part in the LFE core funding and distributing it according to the average costs per equalization unit. Consequently, it is possible to move away from the current division of local governments into "payers" and "recipients" in the LFE model, replacing it with a unified, transparent, and systemically understandable approach to funding distribution. This strengthens the overall goal of the equalization system – to ensure equivalent access to basic services for all residents regardless of their place of residence.
Simultaneously, an improvement in PIT distribution is proposed, providing the possibility to perform the distribution not only by declared place of residence but also by the taxpayer’s place of work. This will promote entrepreneurship development in municipalities and allow the LFE system to better reflect real economic activity in the territories. The State Revenue Service has already commenced the necessary preparatory work for data accumulation.
A significant benefit of the proposal is a substantial reduction in the administrative burden. State funding for interest education and catering for students in grades 1–4 is being integrated into the LFE calculation. Simultaneously, changes in the criteria allow for the abolition of mutual settlements between local governments for educational services starting from Grade 1. This reduces the administrative burden associated with complex settlement procedures, makes the flow of funding simpler and more transparent, and allows local governments to focus more on service quality.
It should be noted that local governments primarily emphasize the need for additional state budget funding within the LFE system. Analyzing international indicators (EUROSTAT 2024 data) on local government revenue and expenditure relative to gross domestic product and their share in general government indicators, it is concluded that the funding level of Latvian local governments corresponds to EU indicators and exceeds the levels of the Baltic states, which have similar functions. Consequently, the question of increasing the additional LFE grant and its indexation is to be considered during the state budget preparation process, evaluating financial availability at all levels of government.
