ICELAND

Iceland is a constitutional republic with a parliamentary system. According to the 1944 Political Constitution, the head of state is the president, elected by direct popular vote for four-year terms, and the government is led by the prime minister, appointed by the president with the support of the parliament. The legislative power is vested in the unicameral parliament (Althingi) which is the oldest parliament in the world (it has existed since 930 a.d.) and whose 63 members are directly elected for four-year terms. The president is also vested with legislative power in the sense that he is empowered to sign bills into law, has veto power, and may send bills to the parliament.

Iceland is a unitary country with a single-tier of subnational governments, made up of municipalities. Article 78 of the 1944 Constitution forms the basis of the legal status of local authorities and their relationship with the central government. Alongside the Constitution, local autonomy is enshrined in the Local Government Act of 1998, amended several times in particular in 2011. Other specific regulations are the Local Government Elections Act (5/1998), and the Local Government Finance Act (4/1995).

The municipalities are governed by municipal councils that are directly elected every four years. The councils are named according to their size (city government, town government and parish councils). Local councils are composed of “aldermen” whose number varies depending on the population and are headed by a president (“oddviti” or “forseti” depending on the size of the municipality) elected by municipal council majority. The executive committee is the municipality's executive body and is composed of municipal council members designated by the council. It is in charge of the financial and administrative management of the municipality. Following elections, the municipal council may decide to appoint one of its members as mayor or may designate a non-political person to take on this role.

Through the 2011 revision of the Local Government Act, municipalities gained new responsibilities regarding service provision and support for disabled people. The law established new fiscal rules for municipalities together with enhanced arrangements for fiscal oversight of municipal finances and greater fiscal stability and new fora for central-local fiscal coordination. Other transfers are currently being discussed (e.g. elderly care, entire healthcare sector) but the main obstacle is the small size of many municipalities.

In 2015, the Act on Strategic Regional Plan and Regional Plans was passed to support regional development and increase consultation in regional affairs between ministries, within each region and between administrative levels. It established the procedures and ethos of Iceland Regional Plans of Action (RPA). The overall aim is to increase competitiveness, strengthen cultural foundations and promote community and regional development. Other objectives include streamlining communications between the government and municipalities and ensuring transparency in the allocation of public funds. The regional associations of local authorities are responsible for implementing the initiatives through five-year contracts with the government, under the supervision of the Iceland Regional Development Institute, and with joint funding from the municipalities, from the Ministry of Infrastructure and the Ministry of Culture and Business Affairs and other ministries.

TERRITORIAL ORGANISATION
MUNICIPAL LEVEL	INTERMEDIATE LEVEL	REGIONAL LEVEL	TOTAL NUMBER OF SNGs (2021)
69 municipalities (Sveitarfélög)
Average municipal size: 5 304 inhabitants
69			69

OVERALL DESCRIPTION: Iceland has a single tier of local government, made up of municipalities. Municipalities in Iceland date back to the 11th century. Following gradual mergers, the number of local authorities increased slowly until the middle of the 20th century when it reached a peak of 229, after which it decreased again, falling from 124 in 2000 to 69 as of January 2021. Municipalities had to negotiate the merger plans between themselves, to be approved by local referendums. There have been two main waves through two comprehensive local referendums on municipal amalgamations, the first time in 185 municipalities was in 1993 and the second time in 66 municipalities was in 2005. The main objective was to reach a sufficient size to be able to provide efficient and high-quality services.

MUNICIPAL LEVEL: As of 2021, the average size of municipalities is 5 345 inhabitants while the median size is 950 inhabitants. Around 84% of municipalities have fewer than 5 000 inhabitants and 68% less than 2 000 inhabitants. Eight municipalities have more than 10 000 inhabitants, including the three largest municipalities: Hafnarfjörður (29 687 inhabitants), Kópavogur (38 332) and Reykjavík (133 262). These three municipalities, together with another five neighbouring municipalities, form the Greater Reykjavík (“The Capital Region”), accounting for 60.7% of the national population. Municipalities in the urban area created an association in 1976 to cooperate in various fields such as waste policy, public transport and fire protection as well as defining the regional development programme.

HORIZONTAL COOPERATION: An evaluation of merger policy conducted in 2010 shifted focus from mergers and recommended the promotion of inter-municipal cooperation instead, considering that cost-efficiency, economies of scale and capacity could be gained by inter-municipal service or cooperation arrangements. Inter-municipal cooperation takes place on a regional basis through regional boards, regional federations, or economic development agencies that are co-owned by the municipalities (Local Government Act no. 45/1998). Following the decentralisation of social services for disabled people to municipalities, inter-municipal cooperation became compulsory for municipalities of fewer than 8 000 inhabitants. In total, 197 formal cooperation arrangements exist throughout the country and the average involvement of a municipality in a cooperation arrangement is 13.5, however varying significantly by region and municipality (6–23). By far the most frequent areas of cooperation are primary school and various social services.

STATE TERRITORIAL ADMINISTRATION: There is no regional government in Iceland, but instead eight regional associations of municipalities, based on regional cooperation between local governments. They also serve as a central government deconcentrated body. These regional associations are in charge of preparing and implementing regional development plans for their regions, in line with the Iceland 2020 – Governmental policy statement for the economy and community, which provides guidance. This national strategy emphasises the need to strengthen municipalities, and proposes to grant a special status to Reykjavik City and the whole capital area. In some cases, the regional associations have also been entrusted with special tasks from municipalities (e.g. waste collection and management of school offices). Each region has a consultation forum that is directly involved in formulating and carrying out regional plans of actions, with representatives from municipalities, regional public institutions, the business sector, the cultural sector, academia and NGOs. The regional associations also allocate regional development funds.

Municipalities’ competences are not provided by a single Act, but rather by several sectoral laws. All municipalities have the same obligations regardless of their size (principle of uniformity). Compulsory tasks are entrusted to them by law (Article 7.1 of the Local Government Act), which mainly cover education, urban planning and environment, and social welfare.

In addition to these assigned responsibilities, municipalities can also undertake additional tasks in the interests of their communities, provided that these tasks are not assigned to others by law, as enacted in the general residual provision (general competences, Art. 7.3) and provided that they have the budget to support these functions.

The role of local authorities became more important and comprehensive in 1996, when they embraced primary schools and social services. Since 2011, municipalities have also taken over all services for disabled people. With this new competence came the requirement to have a population threshold of at least 8 000 inhabitants. Only six municipalities are administering this task by themselves whereas others are running it through inter-municipal co-operation projects (byggðasamlög) which may cover up to 13 municipalities.

Moreover, local governments own almost all of the geothermal power companies, which supply heating to most homes in Iceland and, on an increasing scale, provide electricity to the aluminium industry. Several local governments also own companies that manage harbours.

Main responsibility sectors and sub-sectors
SECTORS AND SUB-SECTORS	Municipal level
1. General public services (administration)	Internal administration; Issuing various licences for business; Building permits
2. Public order and safety	Fire brigade, rescue services
3. Economic affairs / transports	Street/road construction and maintenance; Public transport; Economic promotion and employment; Harbours
4. Environment protection	Waste collection and treatment; Wastewater; Environment protection; Public parks and open areas
5. Housing and community amenities	Water supply; Electricity; District heating; Town planning and building regulation; Social housing
6. Health	Monitoring of public and environmental health; Primary health services for the elderly
7. Culture & Recreation	Culture; Sports; Youth; Leisure; Public libraries; Museums
8. Education	Pre-schools; Primary and lower secondary schools; After school and summer holiday arrangements for children
9. Social Welfare	Care for disabled persons; Supplementary assistance to general pensions and income support programmes; Welfare services for the elderly; Child welfare; Youth support

Scope of fiscal data: municipalities, nursery schools, primary schools and senior residential institutions, as well as the Municipal Equalisation Fund

SNA 2008

Availability of fiscal data: High

Quality/reliability of fiscal data: High

GENERAL INTRODUCTION: Provisions regarding local finance come from the Local Government Act (Art. 3) and the Local Government Finance Act (Law 4 of 1995). Icelandic municipalities enjoy a significant degree of financial autonomy; however, their spending and revenue capacities are limited by the small size of most municipalities. The country was severely hit by the 2008 global financial crisis because of the bankruptcy of the banking system, which had a significant role in the national economy. It triggered a major economic downturn with high unemployment and inflation. The government had to turn to the International Monetary Fund (IMF) for a bailout. This economic crisis severely disrupted its public finances, and led to an increase in local government debt. The recent growth of the tourism sector created new opportunities for revitalising regional economies, but it also presents a new challenge to municipalities that lack the capacity and resources to provide the necessary services and infrastructure.

Subnational government expenditure by economic classification
2020	Dollars PPP / inhabitant	% GDP	% general government	% subnational government
Total expenditure	8115	14.7%	29.1%	100.0%
Inc. current expenditure	7234	13.1%	28.3%	89.1%
Compensation of employees	3886	7.0%	43.8%	47.9%
Intermediate consumption	2607	4.7%	45.2%	32.1%
Social expenditure	227	0.4%	3.6%	2.8%
Subsidies and current transfers	292	0.5%	12.4%	3.6%
Financial charges	222	0.4%	10.0%	2.7%
Others	0	0.0%	0.0%	0.0%
Incl. capital expenditure	881	1.6%	37.3%	10.9%
Capital transfers	80	0.1%	26.9%	1.0%
Direct investment (or GFCF)	801	1.5%	38.8%	9.9%

EXPENDITURE: The level of local expenditure in GDP and total public spending in Iceland is below the OECD average, amounting to 14.7% of GDP and 28.3% of public spending in 2020. Icelandic local authorities are one of the biggest employers in the country. The share of staff expenditure in subnational government expenditure is above the OECD average (34.4%), the subnational government staff spending in public staff spending is below the OECD average (61.2%), and below the average for OECD unitary countries (41.4%). Administrative costs tend to weigh more on the smallest municipalities due to their prevalence. Overall, current expenditure accounted for around 89.1% of subnational government expenditure in 2020.

DIRECT INVESTMENT: Before the economic and financial crisis of 2008, many municipalities had been investing in infrastructure as a way to attract new companies and inhabitants. After the crisis, direct investment at the national and local levels slumped, and as of 2020 the share of subnational governments in total public investment remained below the OECD average (38.8% in Iceland versus 54.6% in the OECD). Investment levels started to recover at the national level in 2015, mainly in the transport sector. Besides, the rise of tourism in the country incurred rising spending pressures, in particular regarding the upgrade and expansion of infrastructure, creating particular difficulties for local governments. Local governments can undertake development projects in combination with the Icelandic Regional Development Institute in the tourism sector.

PPP´s are not used at the municipal level, and they are still rare overall. The central government has used PPP´s in case of major transport projects, such as the Hvalfjardar tunnel near Reykjavik, the capital city.

Subnational government expenditure by functional classification
2019	Dollars PPP / inhabitant	% GDP	% general government	% subnational government
Total expenditure by economic function	7945	13.2%	-	100.0%
1. General public services	739	1.2%	15.3%	9.3%
2. Defence	0	0.0%	0.0%	0.0%
3. Security and public order	75	0.1%	8.4%	0.9%
4. Economic affairs/transports	863	1.4%	28.8%	10.9%
5. Environmental protection	137	0.2%	36.8%	1.7%
6. Housing and community amenities	253	0.4%	75.9%	3.2%
7. Health	52	0.1%	0.8%	0.7%
8. Recreation, culture and religion	1202	2.0%	65.9%	15.1%
9. Education	2736	4.6%	64.8%	34.4%
10. Social protection	1887	3.1%	18.0%	23.7%

Local authorities’ spending in Iceland is particularly concentrated in the fields of education, social protection and recreation, culture and religion, which overall constituted 73.3% of subnational government spending in 2019. The largest area of local spending is education, with a share of subnational government spending and GDP higher than the average for OECD countries (24.3%). Municipalities are responsible for both current and capital expenditure, including teacher salaries, from pre-schools through lower secondary education, while the central government runs upper secondary schools and universities. Social welfare is also an important spending category, which represents a larger share than in the OECD countries (14.1%), since subnational governments have been devolved functions relative to the care of the disabled, and are responsible for a part of general pensions schemes and income support programmes (for instance, for people whose unemployment benefits expire). Besides, municipalities’ expenditure in housing and community amenities and recreation and culture account for 75.9% and 65.9% of general government expenditure (respectively). On the other hand, municipalities play a very minor role in the health sector, which remains a centralised function.

Subnational government revenue by category
2020	Dollars PPP / inhabitant	% GDP	% general government	% subnational government
Total revenue	7601	13.8%	32.9%	100.0%
Tax revenue	5922	10.7%	32.5%	77.9%
Grants and subsidies	766	1.4%	-	10.1%
Tariffs and fees	647	1.2%	-	8.5%
Income from assets	265	0.5%	-	3.5%
Other revenues	0	0.0%	-	0.0%

OVERALL DESCRIPTION: Iceland has the highest share of tax revenues in subnational government revenue among all OECD countries, the OECD average being 42.4%. Consequently, Iceland also has the lowest share of intergovernmental transfers (10.1% vs 41.2% in the OECD on average). Tariffs and fees account for a small portion of subnational government revenue compared to the OECD average (13.3%). Nevertheless, subnational government revenue, which accounts for 13.8% of the GDP and 32.9% of public revenue, remains below the OECD average (respectively 17.1% and 36.6%).

TAX REVENUE: There is no tax sharing arrangement in Iceland and all municipal tax revenues come from own-source taxation. They are derived primarily from the municipal personal income tax (PIT), which represented 80.4% of municipal tax revenue in 2020, i.e. 62.6% of total municipal revenue and 8.6% of GDP. The PIT is levied by both central and local governments, the latter receiving a little more than half of total PIT receipts. The municipal PIT corresponds to a flat percentage of total taxable income, which varies slightly across municipalities. The municipal income tax withheld at source is 14.45% but the actual rate varies from 12.44% to 14.52% in the final assessment, based on the decision of each municipality (Art. 23 of the Law 4/1995).

The second source of local tax revenue is the property tax on residential and commercial buildings, which represented 19.6% of subnational government tax revenue and 15.3% of subnational government total revenue in 2020. The tax rate varies (up to 1.65%), depending on the municipality and the type of property (Art. 3, Law 4/1995). The municipal property tax rate for residential housing (A-tax) is limited by the central government at 0.5%, and that on commercial premises (C-tax) at 1.32%. Local authorities are authorised to levy a special A and C tax of 25%. From 2006 to present, government buildings like schools and hospitals pay a rate of 1.32% for the property tax (B-tax). Overall, the property tax amounted to 1.7% of GDP, well above the OECD average (1.0% in 2020). There is also several small taxes on the use of goods and provision of services activities that account for 2% of subnational government tax revenue.

GRANTS AND SUBSIDIES: Transfers mostly come from the Municipal Equalization Fund, established in 1937 and regulated by the Law 4 of 1995. This Fund has gradually expanded in the 1990s and more recently when subnational governments took on greater spending responsibilities regarding elementary schools and care for persons with a disability. The main role of the Equalisation Fund is to equalise municipal tax revenue so they can all provide services to their inhabitants. The central government contributes to the Fund through an annual contribution corresponding to 2.12% of its total tax revenues and 0.264% of the previous year’s PIT base. Local governments also contribute 0.77% of their PIT base (earmarked for elementary school expenditure) and 0.95% of the PIT base (earmarked for disabled expenditure). Fund revenues are then shared among the municipalities based on a complex formula that takes municipal expenditure and resources into account. The Fund is managed by the Minister of the Interior, assisted by a seven-member advisory committee appointed for a period of four years by the Association of Local Authorities and the Minister of the Interior. Recent discussions tended to promote a reform of the Icelandic equalisation scheme in order to promote further mergers and inter-municipal cooperation across municipalities, to enhance the efficiency of local policies. In 2020, 88.8% of grants were current grants, while 11.2% were capital grants.

OTHER REVENUE: Subnational governments have considerable autonomy in setting local fees and charges. They have their own business operations and institutions responsible for providing public services, such as water, electricity and heating utilities. Additionally, they receive revenue from sewage disposal fees, rental fees, license fees. A new parking fee to be levied outside urban areas was recently introduced to match increased expenditures for municipalities. However, the share of user charges and fees is below the OECD average. Property income includes revenues from rents and sales of assets as well as revenues from local public companies (dividends). It accounted for 3.5% of their revenue. In the aftermath of the 2008 banking crisis, a small group of municipalities sold all their properties, such as school buildings, and rented them back through contracts.

Subnational government fiscal rules and debt
2020	Dollars PPP / inh.	% GDP	% general government debt	% SNG debt	% SNG financial debt
Total outstanding debt	7601	13.8%	12.1%	100.0%	-
Financial debt	3999	7.2%	9.4%	52.6%	100.00%
Currency and deposits	0.00	-	-	0.00%	0.00%
Bonds / debt securities	0.00	-	-	0.00%	0.00%
Loans	3998.95	-	-	52.61%	100.00%
Insurance pensions	1978.98	-	-	26.04%	-
Other accounts payable	1622.66	-	-	21.35%	-

FISCAL RULES: In 2011, the Local Government Act 138/2011 introduced a budget and debt rule. For current operations, it obliges municipalities to balance their revenue and expenditure over a three-year period. Since 2011, local governments are also monitored by an independent external body, the Municipal Fiscal Oversight Committee (MFOC), which classifies them into one of three categories depending on their compliance with these fiscal rules. Municipalities that do not comply with the rules may be sanctioned, its fiscal powers may be suspended by the Minister of Local Governments and vested in a financial management board. The new law on public finance (Public Finance Act, Law 123/2015, 28 December 2015) also includes relevant provisions for local government. It provides - for the first time - new rules on fiscal strategy, including both the State and the municipalities, based on a “Fiscal Strategy Plan”.

DEBT: As a result of the investments made in the pre-crisis years, many municipalities had sizeable debt denominated in foreign currencies that were indexed to inflation. When the króna collapsed in 2008, local debt exploded, burdening them financially. The share of the municipal debt in the total public debt is 12.1% in 2020. Still, fiscal policy has made significant progress in reducing public debt. In 2001, the Local Government Act also introduced a debt rule, limiting total subnational government debt and liabilities to 150% of total revenue. Local governments above the limit are required to bring the debt ratio under this benchmark within a period of ten years. Local governments with total debt exceeding 250% of revenue are prohibited from raising new debt except for refinancing. In 2020, the local debt level was below the OECD average both regarding the share of GDP (27.9%) and public debt (20.2%). Total outstanding debt is composed of financial debt (65%), insurance pensions (21%) and other accounts payable (14%). Financial debt comprises loans for 52.6%. The Municipality Credit Iceland (MCI) is a capital loan fund owned by the local authorities, providing between 25% and 30% of the financing needs of Iceland’s municipalities. Municipality Credit Iceland Green Bond Framework provides financing to projects that fulfil the set green/sustainability criteria.

TERRITORIAL MANAGEMENT OF THE CRISIS: The main bodies of the health system responsible for policy, financing, planning and regulation are Parliament, the ministries of Welfare and Finance, and a mix of public and private service providers, although publicly provided care is predominant. The Ministry of Welfare has major policy-making and executive authority, and its agencies are responsible for health policy, administration and supervision. Though the country is divided into seven regions for health-care organization purposes, these regions have no administrative authority or separate revenue streams. The national health insurance system is financed through the annual national budget.

While all government departments played a role in responding to the COVID-19 pandemic, the main responsibility rested with the Ministry of Health and the Ministry of Justice. The National Response Plan for Global Pandemics was activated and implemented jointly by the Civil Protection Department of the Icelandic Police and the Chief Epidemiologist under the authority of the Minister of Health. While coordinated nationwide, the responses were decentralised to the regional police and health authorities around the country, who activated local crisis coordination centres to coordinate and manage responses at the local level

EMERGENCY MEASURES TO COPE WITH THE CRISIS AT THE DIFFERENT LEVELS OF GOVERNMENT: Since the beginning of the COVID-19 crisis, municipalities aimed to support households and local business with various measures. For instance, the due dates for real estate taxes were postponed, and municipalities temporarily reduced tariffs and certain fees. This support was primarily directed at unemployed individuals and their families. The municipal maintenance work was increased as much as possible, and sewerage construction was started with support from the state. Municipalities offered up to 1000 jobs in entrepreneurship projects in collaboration with Unemployment Insurance Fund. Special care was taken to ensure that new jobs are suitable for women and people of foreign origin.

IMPACTS OF THE CRISIS ON SUBNATIONAL GOVERNMENT FINANCE: Municipal revenue was affected significantly by falling tax revenue. In 2020, a government working group predicted a significant decrease in the income of most municipalities, and a resulting negative impact on their financial position, amounting to a total of just over ISK 33 billion. The combined operating results of all municipalities was expected to be ISK 26.6 billion lower than was expected in the 2020 budgets. Increased municipal investments were expected to amount to just over ISK 6.5 billion. The combined effect would therefore be just over ISK 33 billion. In comparison, the total expenditure of the municipalities in 2019 was just over ISK 390 billion. The effect therefore amounts to 8.5% of total municipal expenditure from 2019, or about 1.1% of GDP in the same year.

ECONOMIC AND SOCIAL STIMULUS PLANS: Main measures to restart the economy include public investment, tax incentives for real estate improvement and innovation, temporary tax relief for the tourism sector, a domestic travel gift, and marketing efforts to encourage tourism in Iceland. Parliament also approved temporary rules for financial restructuring of companies. A number of supporting fiscal measures were extended beyond their original sunset clauses. The 2021 budget and accompanying medium-term fiscal strategy plan envisage continued fiscal support and a gradual reduction in the general government deficit.

Discretionary fiscal measures amounted to around 9% of 2020 GDP in 2020-21, while the automatic stabilisers (declining tax revenues, unemployment benefits) contributed another 8%. The government also embarked on a five-year investment programme focusing on infrastructure, research and development of around 0.5% of GDP annually. The government issued few guarantees, helping to keep contingent liabilities under control.

The regional associations of municipalities were encouraged to emphasise tourism-related projects and tourism in the local area. Municipalities, institutions, funds and companies increased their counter-contributions to action plan projects related to the promotion of tourism.