Case 3-4-1-8-09

In 2009, the state legislative body passed the 2009 Supplementary Budget Act and Related Acts Amendment Act (“Supplementary Budget Act”), which amended a series of statutes in order to limit the state budget deficit. The Tallinn City Council filed a petition with the Estonian Supreme Court, asking it to declare certain provisions of the Supplementary Budget Act (and its amendment of related acts such as the Income Tax Act, the Roads Act and the Occupational Health and Safety Act) unconstitutional; the Tallinn City Council argued that such provisions breached the constitutional guarantees related to funding and expenditures by local governments.

The Estonian Constitution provided a legal basis for local self-government, including funding guarantees for the performance of certain functions. Subsection 154 (1) of the Constitution created the right to sufficient funds for the performance of local government functions. This right included a right to stability of the system of funding these functions. When the local government was performing national duties, it was entitled to funding from the state budget to perform these functions under subsection 154 (2) of the Constitution.

The Talinn City Council argued that six statutory provisions were unconstitutional after the passage of the Supplementary Budget Act (violating, inter alia, the Constitutional principles and obligations of legal certainty, financial system stability, sufficient funding, preservation of Estonian culture and safeguarding persons’ fundamental rights, as well as various articles of the European Charter of Local Self-Government and other statutes): (1) the amount of income tax apportioned to local authorities was reduced with the amendment to Clause 5(1)1) of the Income Tax Act (“ITA”); (2) requirements and funding for performance of state-imposed duties under the Preschool Child Care Institutions Act, Youth Work Act, and Sports Act were reduced; (3) the minimum funding allotment under 16(3) of the Roads Act was removed; (4) state resources were not budgeted to cover the costs that local governments would incur due to the benefit payment requirements of the Occupational Health and Safety Act (“OHSA”); (5) local governments were prohibited from assuming debt obligations without Ministry of Finance approval under the Rural Municipality and City Budgets Act (“RMCBA”); and (6) subsection 16(4) of the BEF Regulation altered the use of funds for social benefit programs under the Social Welfare Act (“SWA”).

After ruling on the petition’s admissibility and setting out what were the constitutional financial guarantees for local authorities (namely, the right to independently organize all local issues, the right to be granted sufficient funds for the performance of local government functions, the right to the stability of the system of funding local government functions, and the limited right to assume debt obligations), the Court turned to a review of each of the statutory provisions raised by the City Council separately.

First, the Court considered the reduction in the local government’s income tax portion under the ITA. The Court noted that if the provision amending the ITA resulted in a situation where the funds earmarked for performance of local government functions were insufficient, such provision might violate the right to sufficient funding for the performance of local government functions. However, it was unclear whether the income tax revenue in question was used for the performance of local or national duties. The Court noted that subsections 154(1) and 154(2) of the Constitution created a right to funding for certain matters, but without clear record as to how these matters were funded the Court could not determine whether this threshold was met. To fulfill these constitutional guarantees, specific information as to the use of income tax revenue must be made available to the Court. Due to this ambiguity, the Court found this funding system to be unconstitutional. The Court did emphasize that the unconstitutionality of the system did not indicate that the reduction necessarily violated the local government’s right to sufficient funding for performance of its functions. Rather, this determination could not be made until information on the use of the funds became available.

While it was unclear whether the reduction in income taxes violated the sufficient funding right, the Court held such reduction did not violate the constitutional right to stability of the system of funding of local government functions. The Court determined that even though the change affected an important source of income for the locality in the middle of the budgetary year, the national goal of decreasing the state budget deficit was sufficiently compelling to justify the prejudice placed on local governments. Further, this goal was achieved through proportional and necessary means. Since the government had a compelling interest reached through the appropriate procedure, the limitation on funding was not a violation of the constitutional right to stability.

Next, the Court reviewed amendments to the Preschool Child Care Institutions Act, Youth Work Act, and Sports Act. The Supplementary Budget Act reduced the duties of local governments under these acts to ensure the goals of the acts would still be fulfilled despite funding reductions. The Court found these amendments were insufficient to alleviate the performance burdens placed on local governments and to achieve the necessary savings. Due to the illusory effect of these measures, the Court determined that they should not be factored into a future analysis of whether the state had violated its funding burden by amending the ITA.

The Supplementary Budget Act also altered 16(3) of the Roads Act, which outlined the method for determining the minimum level of funding that local governments must allocate for the management of roads. According to the Tallinn City Council, the reduction of state funding for roads should have been accompanied by a reduction in local authorities’ obligations because subsection 154(2) of the Constitution required full funding of national duties imposed on local governments. The Court rejected this argument, noting that maintenance of local roads was a local government function, not an imposed national duty, and thus the local government was not entitled to full funding by the state. Even though such maintenance was not a national duty, the Court found that the change in funding did prejudice the local government’s right to stability of funding. By removing funding, local authorities had lost certainty as to their ability to plan of performance of local government activities.  However, due to the same justifications for limiting income tax revenue (i.e., the need to reduce the state budget expenditure), the Court did not find this prejudice unconstitutional.

The Tallinn City Council also asserted that the burden to pay employee benefits under OHSA violated the right to full funding for the performance of national duties. Paying these benefits would increase local government costs, which the state did not provide funding to cover. Despite this increase in costs, the Court found that OHSA did not violate subsection 154(1) or (2) of the Constitution. Although the amended provisions of OHSA increased the costs of performance of local functions without providing local authorities with the funds for such performance, because OHSA did not regulate the funding of local functions, the constitutional right was violated not by OHSA itself (as the legislation increasing the cost of the performance of such local functions), but rather by the legislation regulating funding of local functions. Moreover, the funding guarantee of this provision was narrowly construed to only include state (not local) measures that directly interfered with local authorities’ goals. The Court determined that the requirements of OHSA did not do this and thus local governments were not entitled for state funding for benefits given to employees performing local government functions.

To further the economic stability of Estonia, the state legislature had prohibited local governments from incurring debt obligations without the Ministry of Finance’s approval. To obtain this approval, the locality must fulfill a GDP requirement and the debt could only be used for certain purposes. The Court found that, while these requirements did prejudice the right to municipal self-administration and financial guarantees of local authorities, the restrictions were constitutionally acceptable because they were established in accordance with procedural requirements and were in furtherance of a legitimate government goal.

Lastly, the Court found the change in social benefit funding allocation under subsection 16(4) of the BEF Regulation was constitutional. The Tallinn City Council argued that the surplus funds from social benefit allocations were to be used for local functions as understood under subsection 42(4)(stipulating that funds should be allocated from state budgets to municipal budgets for the payment of social benefits) of the SWA and requiring their use for future national duties was a violation of constitutional guarantees of self-government. The Court rejected this claim because the funds were being transferred to the next year for the same purpose, i.e. payment of subsistence benefits. Since the funds had a specific purpose, the Court determined that they were not surplus funds as defined by SWA and thus the BEF Regulation did not infringe upon local authorities’ rights.

” The right and duty to independently decide and organise local issues based on law, including to decide how to spend the money allocated for resolution of local issues, can be exercised by a local authority only if it has enough money. Therefore the right to municipal self-administration specified in clause 154 (1) of the Constitution essentially presupposes that local authorities be granted the right to sufficient funds for performance of local government functions. Thereby, in accordance with the said right, sufficient funding of the local government functions arising from law as well as of other local government functions not provided by law must be ensured in accordance with the said right.” Paragraph 55.

“As mentioned, the right to sufficient funds for performance of local functions requires that the system of funding local government functions provide local authorities with sufficient revenue for performance of local functions at least to the minimum extent required. At the same time the said right does not protect a local authority against the existing funding system becoming less favourable, if as a result thereof the funding of the local authority's own functions does not become insufficient. The right to sufficient funds for performance of local government functions does not include the right according to which the level of funding of local functions once achieved can never be reduced.” Paragraph 68.

“The Supreme Court en banc has previously found regarding the stability of the funding system that the stability of the system of financing local authorities is an important value. A stable and foreseeable financing system allows local authorities to draft more accurate development plan and implement them more effectively (see judgment of the Supreme Court en banc of 19 April 2004 in Case No. 3-3-1-46-03 , point 25). A stable funding system is inevitable for independent decision-making on and arrangement of any and all local issues. Unstable funding may subtly deprive local authorities of their independence. Therefore local authorities need to be able to act in reasonable expectations that the regulation established for funding their functions remains stable and it is not suddenly made less favourable to local authorities, especially in the middle of the budgetary year.” Paragraph 79.

“The right to sufficient funds for performance of local government functions has been violated if funds for performance of local functions at the minimum level required are not granted to a local authority (see point 65 above). In order to identify whether reduction of an accrual of a local authority violates the right to sufficient funds, it is necessary first to know whether the money accruing from the source has been earmarked for performance of local or national functions. The given right may be violated by reduction of the funds earmarked for performance of local functions. Neither the Income Tax Act nor any other legislation specifies what portion of the income tax accruing to a local authority is to be used for performance of local government functions and what part of the income tax portion must be used for performance of national duties. Based on the legislation in force one can but presume that local authorities have to finance the decision-making on and arrangement of local issues as well as performance of national duties from the income tax portion to an unspecified extent.  In addition, in order to identify a violation it must be found out whether after reduction of the funds the funding of local government functions in the specific local authority falls below the minimum level required.” Paragraphs 89-90.

“The legislature has not established a system of funding of local authorities that complies with subsection 154 (1) and the second sentence of subsection 154 (2) of the Constitution (see points 89-90 above). Therefore the Court en banc cannot evaluate in the present case whether the City of Tallinn or another local authority has, following the reduction of the income tax portion accruing to local authorities, enough money for performance of the local functions at the minimum level required, i.e. whether local authorities' right to sufficient funds has been violated by reduction of the income tax portion or not. Also, the legislation in force does not allow for evaluating in the present case whether the performance of the national duties imposed on local authorities by law has been fully funded also after reduction of the income tax portion. 93. The aforementioned means that the existing system of funding local authorities must, to the extent that it does not allow for evaluating the constitutionality of the provision amending clause 5 (1) 1) of the ITA, be declared unconstitutional.” Paragraphs 92-93.

“The Court en banc explained above that the right to the stability of the funding system protects local authorities against major unexpected adverse amendment of the legislation regulation the funding of local government functions to the detriment of local authorities, especially in the middle of the budgetary year. Adverse amendment means, above all, reduction of the funding. The right to the stability of the funding system also requires that if the state does decide to make the legislation regulating funding considerably more unfavourable, the state must, based on the substance of the amendment, grant local authorities a sufficient period for adaptation to the new regulation.” Paragraph 100.

“The Court en banc notes that the purpose of the provision amending clause 5 (1) 1) of the ITA is to decrease the state budget deficit; more precisely, to compensate for the loss of planned revenue arising from the economic recession and to decelerate the decrease of the level of public services provided by the state. . . . The Court en banc finds that the purpose specified in the previous point is constitutional and thus it may justify the limitation of the constitutional guarantees of the local self-government. The prerequisite thereby is, obviously, that the reduction of the income tax portion of local authorities is suitable, necessary and proportional (see also point 64 above) as a measure of cutting the state's expenditure.” Paragraph 105-106.

“The Court en banc does not find that the uncertainty caused in the system of funding of local government functions, considering its scope, would clearly outweigh the importance of reducing the state budget deficit. Therefore it cannot be found that the said provision is clearly disproportionate as a measure for cutting the state's expenditure.” Paragraph 129.

“In the opinion of the Court en banc sections 81 and § 281 of the RMCBA were established in line with the competence, procedural and formal requirements. In point 103 the Court en banc found that the requirements of subsection 116 (2) of the Constitution were not violated upon adoption of the Supplementary Budget Act (incl. the provisions under observation in this point). According to the Court en banc, the provisions establishing restrictions on assumption of obligations are also formally constitutional in other respects.” Paragraph 139.

“[T]he explanatory memorandum of the Supplementary Budget Act notes that the restrictions of assumption of debt obligations have been established to prevent the insolvency and excessive debt burden of local authorities. In other words, they have been established in order to prevent a situation where the costs of repayment of debt obligations account for such a portion of the revenue of local authorities, that it starts adversely impacting the performance of the functions of the local authorities, incl. the obligation arising from § 14 of the Constitution to uphold fundamental rights and freedoms. 144. According to the Court en banc, it is legitimate to strive for these goals.” Paragraphs 143-144

“ Considering the aforementioned, the Court en banc is of the opinion that the need to achieve the goals of §§ 8 1 and 281 of the RMCBA is currently more important than granting local authorities the right to assume debt obligations to the extent available before the provisions entered into force. Therefore these provisions do not violate the right to assume debt obligations arising from subsection 154 (1) of the Constitution.” Paragraph 151.

“The Court en banc finds that the contested part of the BEF Regulation does not prejudice the constitutional guarantees of local self-government. The petitioner’s view that the BEF Regulation has, disregarding the second sentence of subsection 154 (2) of the Constitution, imposed on it the obligation to pay state social benefits out of the funds earmarked for payment of local government social benefits and provision of local government social services, is wrong, relying on the wrong interpretation of the term "surplus of funds" used in subsection 42 (4) of the SWA. Not the outstanding balance of funds of previous years' subsistence benefits unused by the end of the budgetary year – as indicated in subsection 16 (4) of the BEF Regulation – but the outstanding balance of the subsistence benefit funds planned in the budget of the current year must be treated as the “surplus of funds” for the purposes of subsection 42 (4) of the SWA.” Paragraph 169.