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A lifeline for municipalities in times of coronavirus

A lifeline for municipalities in times of coronavirus

Municipalities are experiencing severe economic effects from the coronavirus crisis. Their financial distress requires a long-term solution to deal with these financial problems.

Just like the private sector, the public sector is experiencing severe economic effects from the coronavirus pandemic. Dutch municipalities are increasingly in dire financial straits since the coronavirus crisis has caused both a drop in their income and a rise in their expenditure. The Minister of Internal Affairs – recognising this problem – announced that municipalities would be assisted with various support measures. In her letter of 26 October 2020, the minister stated that the financial position of municipalities still has her attention. However, a long-term solution to the financial distress that the crisis is causing municipalities remains to be found. Does the so-called ‘Article 12 allowance’ offer a way out, and if not, how can municipalities combat their financial problems?

A perfect storm?

Municipalities are not just countering the negative effects of the coronavirus crisis. The financial situation shows that even before this crisis, the social domain for which municipalities bare increasing responsibilities had already led to a deficit in the annual accounts and higher taxes in a majority of municipalities. In response, municipalities have been forced to implement cutbacks in their budgets. The coronavirus crisis is exacerbating the financial situation of municipalities across the country. Among other things, the measures to combat the virus have led to a drop in tax revenues because of lower income from tourist and parking taxes. Furthermore, many tax payments have been suspended. After all, local entrepreneurs and citizens are unable to meet their tax obligations due to a drop in their income. At the same time, municipal expenditure is increasing due to necessary and unforeseen spending. They have had to step in with emergency funds to support distressed entities, including associations and institutions in the cultural and sports sector. Municipalities are required to ensure that national coronavirus measures are implemented, including the maintenance of public order, traffic measures, and the facilitation of educational accommodation.

This has resulted in unprecedented budgetary overspending by municipalities, while budgets were already under pressure. It has created a storm that is probably too difficult for municipalities to weather on their own. The primary legal and policy mechanisms for such overspending are clear: increase local taxes and reduce spending. However, the uncertainties of these times remain high as it is not yet clear how soon coronavirus measures can be withdrawn and how the economy will respond.

As a result, the national government has agreed to 'realistically compensate' municipalities. This agreement includes, first and foremost, that municipalities should not be put in a worse position than they already are. That is why, in May and September 2020, the government put in place two support measures. The financial support offsets the additional cost for municipalities. However, this only covers their short-term costs. The Minister of Internal Affairs has not yet shown what specific steps will be taken to assist financially distressed municipalities. In the absence of such steps, another course of action is necessary. We will discuss two main avenues: applying for Article 12 allowances on the one hand and resorting to bankruptcy proceedings on the other hand. Nevertheless, in case a sustainable solution is not found, several additional support measures will be necessary in the long run.

Article 12 allowances: Not the ultimate remedy

One solution may be found within the current framework of budget rules for municipalities. Municipalities receive an annual payment from the national government out of the municipal fund. The specific amount is determined in accordance with criteria laid down in the Financiële-verhoudingswet (Financial Relations Act, Fvw). If this payment turns out to be insufficient, municipalities can apply for an additional allowance based on Article 12. A municipality is eligible for such an allowance when its general sources are significantly and structurally insufficient.

Does the ‘Article 12 allowance’ provide a suitable long-term solution for municipalities in financial distress? Probably not. This relates to the design of the Financial Relations Act. Article 12 allowances are paid from the overall municipal fund and, as such, any allowances paid are at the expense of what other municipalities will receive annually. This means that additional allowances for municipalities could, under the current circumstances, cause financial shortages in other municipalities.

However, a proposal to revise the Financial Relations Act was consulted at the beginning of this year. Importantly, it regards a recalibration of the municipal fund. Among other things, parts of the municipal fund intended for the social domain, will be better distributed. The recalibration concerns a redistribution of the resources, but explicitly not an expansion of the total amount available in the fund. One of the main reasons for this is that municipalities increasingly differ from one another. This recalibration is intended to counteract the structural deficits of municipalities but stems from pre-coronavirus times. It is therefore unlikely that the radical financial consequences of the crisis can be resolved with this recalibration.

Option of limited resort: Bankruptcy

In very extreme cases, where municipalities are hit so hard by the coronavirus crisis without any real solution, could bankruptcy be an option? The fact that municipalities can theoretically be declared bankrupt has been stated in parliamentary history. However, in recent history this has never occurred. After all, the societal impact of a failed municipality would be substantial. A bankruptcy would formally regard only the property law matters of a municipality. From a practical perspective, this is not so simple. The municipality in question would retain its public law powers and duties, but without control and access to its assets to carry out any activities. In order to prevent municipalities from being threatened with bankruptcy due to the current pandemic, it is important that the provincial and national government also closely monitor their financial well-being and step in when necessary.

A lifeline for municipalities

The loss of income and the high expenditure caused by the pandemic is leading to financial distress in municipalities. As a result, the government has taken support measures on two occasions. Continuing to allocate support measures may help temporarily, but it does not seem to be a long-term solution. Article 12 allowances will also not provide long-term relief for municipalities from their financial distress, as these are financed from the municipal fund on which the annual payments of all municipalities depend. The envisaged recalibration of the municipal fund may offer a better distribution among municipalities, but it does not seem to be an appropriate means to counteract the financial slump.

Prior to the coronavirus crisis, municipalities were already experiencing financial problems, especially concerning the social domain. The crisis has exacerbated their situation severely. But this is no quick sprint; this more like a marathon, and therefore requires long-term solutions. A revision of the Financial Relations Act may offer a possible solution. However, this would only be realistic if this considers an expansion of the total municipal fund, resulting in more available resources for municipalities and taking into account their pre-coronavirus situation. If worst comes to worst, municipalities may formally go bankrupt. Given their public duties, the societal consequences are far from desirable.

A better solution – in case no sustainable funding is assured – would be to reconsider legislation concerning bankruptcy procedures specifically for municipalities. For example, should restructuring proceedings be available to municipalities where they can act as debtor in possession? This could ensure that they can continue to carry out their public duties during a period of restructuring, where they would otherwise be forced to go bankrupt and be divested in favour of an insolvency practitioner. Such procedures are not as novel as they may seem. They are already in place, for instance, in the United States as laid down in the Chapter 9 of the US Bankruptcy Act. Though this would be a big step to take, these difficult times do show that public entities may also face financial distress and should not be left without access to a solid lifeline.

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