The chief of the ruling Saenuri Party has triggered a debate on local government finances by suggesting the need to introduce a municipal bankruptcy system as a means of curbing local government debt.
In his New Year’s news conference Tuesday, Hwang Woo-yea said his party would consider instituting a bankruptcy system for local governments to prevent them from borrowing excessively to finance ill-advised projects.
A municipal bankruptcy system is designed to salvage local governments that cannot function normally due to heavy debts. Under the system, a local government would be declared bankrupt when its debt reaches a certain level. Then the central government would resolve its debts, but deprive it of its autonomy, including budget authority, and force it to undergo tough restructuring.
At the moment, no local government is on the brink of bankruptcy. But in recent years, a growing number have gotten themselves into financial difficulties by rushing into risky development projects or wasting money on populist events.
Taebaek City of Gangwon Province is a case in point. The former coal-mining town has incurred 140 billion won in debt by investing in a resort development project. Its debt-to-budget ratio now stands at 102 percent, the highest among local governments.
The aggregate debt of local governments topped 100 trillion won last year. On top of that, public corporations run by municipalities have 72 trillion won in liabilities. If these corporations go belly up, the governments that created them have to pay back their debt.
Against this backdrop, the Saenuri leader called for efforts to put the brakes on provincial government debt. He said the introduction of a municipal bankruptcy system would make local governments more responsible for their finances.
Hwang’s proposal was met with harsh criticism from provincial governments. They argued the central government should first find ways to bolster their finances before talking about disciplining them.
They pointed to the low fiscal self-reliance ratio of local governments. The average ratio of the 17 provinces and big cities barely exceeds 50 percent, with five of them below 30 percent.
The low fiscal independence of local governments is attributable to the small share of local taxes in the total tax revenue. So they say that the central government should take bold steps toward fiscal decentralization if it wants to hold them accountable for their finances.
This argument has a valid point. Nevertheless, it would still be good to have a municipal bankruptcy system in place as the possibility of local governments becoming insolvent cannot be ruled out.
The existence of such a system could also serve as a check on spendthrift local governments. There should be some kind of institutional arrangement to prevent local politicians from bringing their municipalities to financial ruin by pursuing self-serving projects.