Title page 1

Contents 2

Acknowledgments 6

Acronyms 7

Executive summary 8

Chapter 1. Local and regional government in Croatia - an overview 11

1.1. Overview of the territorial organization and main functions 11

1.2. Socio-economic context of LRGUs 21

Chapter 2. Subnational Government Expenditures in Croatia 26

2.1. Overview of Spending Trends and Drivers 26

2.2. Expenditures by economic classification 29

2.3. Expenditures by functional classification 34

Education 35

Health and social care 38

Chapter 3. Subnational Government Revenues and Debt in Croatia 44

3.1. Overview of Revenue Trends and Structure 44

3.2. LRGU revenues 49

Tax revenues 49

Non-tax revenues 55

Transfers 55

3.3. LRGU borrowings and debt 57

Chapter 4. Fiscal capacity 62

4.1. Fiscal capacity estimation in Croatia: is there room for improvement? 62

4.2. Scenario analysis for fiscal capacity calculations 67

4.3. Conclusions and recommendations 74

References 76

Annex 1: Additional tables 77

Annex 2: Additional figures 81

Annex 3: Government expenditures according to functional classification (COFOG) 88

Tables 4

Table 1. Responsibilities of local and regional government units in Croatia 17

Table 2. Sources of revenue at the LRGU level 19

Table 3. Components of current revenues suitable for the inclusion in fiscal capacity estimation, according to three step procedure 69

Table 4. Share of proposed additional revenues for fiscal capacity estimation in total revenues 69

Table 5. Additional revenues for fiscal capacity estimation - data issues 70

Table 6. Details of 5 simulation scenarios 70

Table 7. Summary of the scenario analysis results 71

Table 8. Gini coefficients for current fiscal capacity estimation framework and modifications presented in Scenarios 1 to 5 74

Figures 3

Figure 1. Subnational government in Croatia 13

Figure 2. Municipality size in the EU (2020) 14

Figure 3. Population change per city/municipality, in percent 15

Figure 4. Fiscal decentralization in the EU in 2023 21

Figure 5. GDP per capita per county, 2021 (EU27=100) 22

Figure 6. Index of Development 2024 25

Figure 7. Total LRGU expenditures, 2010-2023 27

Figure 8. Total LRGU expenditure 2010-2023 by LRGU tier (as % of GDP) 27

Figure 9. Total LRGU expenditure per capita in EUR (2022) 28

Figure 10. Total LRGU expenditure per capita vs Index of Development 28

Figure 11. Total LRGU expenditure per capita (2022), functional distribution 28

Figure 12. Total LRGU expenditure per capita (2022), economic distribution 28

Figure 13. LRGU expenditures by economic classification, as percent of GDP 30

Figure 14. Share of compensation of employees in total expenditures, 2023 30

Figure 15. Share of compensation of employees in total expenditures in 2023 vs Index of Development 30

Figure 16. Number of employees in LRGU bodies 31

Figure 17. Number of employees per 1000 inhabitants across regions, 2023 31

Figure 18. Compliance with wage restrictions according to the previous Law, 2023 31

Figure 19. Compliance with wage restrictions according to new provisions, 2023 31

Figure 20. Structure of material expenses, 2023 32

Figure 21. Structure of service costs, 2023 32

Figure 22. Distribution of user costs across LRGUs, 2023 32

Figure 23. Current and investment maintenance costs and investment expenditures, share in total expenditures, 2023 32

Figure 24. Structure of acquisition of non-financial assets, 2023 33

Figure 25. EU fund transfers, 2023 33

Figure 26. EU funds share in current revenues, 2023 33

Figure 27. EU funds (cumulative 2014-2023) and county level of development (2024) 34

Figure 28. Total LRGU expenditures by functions as a share of GDP 35

Figure 29. The share of pre-primary education spending in total expenditures of LRGU 36

Figure 30. Pre-primary education spending per child vs index of development 36

Figure 31. Primary and secondary education spending in total expenditures of LRGU 37

Figure 32. Primary and secondary education spending per pupil vs index of development 37

Figure 33. Share of transfers from central government equalization fund in total primary education spending in 2023 37

Figure 34. Share of transfers from central government equalization fund in total secondary education spending in 2023 37

Figure 35. Health expenditures, percent of total 38

Figure 36. Expenditures for social protection, in percent of total expenditures 38

Figure 37. Expenditures for social protection per capita vs Index of Development 39

Figure 38. Total revenues and main components 45

Figure 39. Structure of total revenues by LRGU level 45

Figure 40. Revenue structure, in % of total 48

Figure 41. Revenue structure by LRGU tier, in % of total 48

Figure 42. Revenue structure across different LRGUs, share in total, 2023 48

Figure 43. Revenues per capita excluding total grants, 2023 49

Figure 44. Index of Development, population change and change in revenues excluding total grants across counties (2023-2013) 49

Figure 45. Tax structure across LRGUs, 2023 51

Figure 46. Distribution of PIT per capita across LRGUs, 2023 51

Figure 47. Change in PIT revenues across different LRGUs after PIT legislation changes, 2018 51

Figure 48. PIT revenues, 2023 51

Figure 49. Surtax revenues and regions' development index 52

Figure 50. Surtax rate and LRGUs fiscal balance (EU funds included) 52

Figure 51. Revenues from real estate transfer tax across different regions 54

Figure 52. Revenues from tax on holiday homes 54

Figure 53. Utility fee 55

Figure 54. Utility contribution 55

Figure 55. Share of transfers for decentralized functions in current revenues across LRGUs, 2023 56

Figure 56. Transfers for decentralized functions by county and level of development 56

Figure 57. Transfers and PIT revenues for decentralized functions 56

Figure 58. Transfers from the budget by type of grant, 2023 57

Figure 59. Other transfers by county level of development, 2023 57

Figure 60. LRGU budget balance 58

Figure 61. LRGU debt 58

Figure 62. Operating ratio before interest 61

Figure 63. Operating ratio before interest excluding EU funds 61

Figure 64. Net operating surplus 61

Figure 65. Net operating surplus excluding EU funds 61

Figure 66. Debt service ratio 61

Figure 67. Allocated equalization transfers per capita, in relation to economic development 63

Figure 68. Current LRGUs' revenues before and after equalization transfers, per capita, in EUR, 2018-2023 avg 63

Figure 69. PIT revenues per capita, 2018-2023 average 64

Figure 70. Other revenues per capita, 2018-2023 average 64

Figure 71. Correlation between other revenues and fiscal equalization fund, per capita EUR, only for LRGUs entitled to equalization, 2018-2023 average 66

Figure 72. Distribution of other revenues per capita, 2018-2023 average 66

Figure 73. Differences in equalization transfer mechanism for cities and municipalities, Scenario 5 compared to the current equalization system 72

Figure 74. Differences in equalization transfer mechanism for counties, Scenario 5 compared to the current equalization system 72

Figure 75. Intensity of change in fiscal transfers in Scenario 5 compared to the current fiscal capacity estimation, in per capita terms 73

Figure 76. Allocated equalization transfers per capita in Scenario 5, in relation to economic development 73

Boxes 5

Box 1. Decentralized functions in Croatia 16

Box 2. Taxes as a source of revenues for LRGUs in Croatia 18

Box 3. Financing of subnational government in OECD countries 19

Box 4. Index of Development 23

Box 5. Efficiency of LRGU spending in Croatia 39

Box 6. Tax reform in 2024 and 2025 52

Box 7. Fiscal capacity estimation - a theoretical consideration 65

Box 8. The fiscal equalization system in Croatia 66

Box Tables 23

Table B1. Number of LRGUs classified into underdeveloped and developed areas based on the index of development over time 23

Table B2. Input-output indicators 40

Table B3. Changes in the taxation of income 53

Box Figures 40

Figure B1. Secondary education outcomes, 2022 40

Figure B2. Health care outcome, 2019 40

Figure B3. Efficiency scores for LRGU spending on secondary education 41

Figure B4. Efficiency scores for LRGU spending on health 42

Figure B5. Efficiency scores for LRGU spending on infrastructure 43

Figure B6. Change in tax burden from PIT, % of total 53

Figure B7. Change in tax burden from taxation of vacation homes, % of total 53

Figure B8. LRGUs' fiscal capacity and actually allocated equalization transfer, in relation to the reference value used in the fiscal capacity estimation,... 67

Annex Tables 77

Table A1. International experience in responsibilities across subnational government levels 77

Table A2. Sources of tax revenue (besides PIT) at LRGU level in 2024 78

Table A3. PIT revenue and other revenues as share in current revenues excluding transfers and per capita amounts, 2018-2023 average 80

Annex Figures 81

Figure A1. Employment rate per city/municipality (population 15+) 81

Figure A2. Unemployment rate per city/municipality (population 15+) 81

Figure A3. Aging index per city/municipality (2021) 81

Figure A4. Share of population with tertiary education per city/municipality (20-64) 81

Figure A5. Subnational Government Expenditures by Economic Classification, 2023 82

Figure A6. Subnational Government Expenditures by Functional Classification, 2023 83

Figure A7. Children in formal childcare by age group and duration (% over the population of each age group) in 2022 84

Figure A8. Coverage of children aged 0-6 by kindergartens in 2021 84

Figure A9. Share of PIT in current revenues excluding transfers, 2018-2023 average 85

Figure A10. Share of other revenues in current revenues excluding transfers, 2018-2023 average 85

Figure A11. Summary of changes in equalization fund, Scenarios 1-4 in comparison to current equalization system, cities and municipalities 86

Figure A12. Summary of changes in equalization fund, Scenarios 1-4 in comparison to current equalization system, counties 87