Why local tax incentives matter for cohesion policy

June 2026

Why should a municipality approve a wind farm, support a new industrial site or allocate land for thousands of new homes if most of the benefits flow elsewhere?

Europe’s municipalities are at the frontline of almost every major transition. They are expected to facilitate housing construction, support renewable energy deployment, enable industrial transformation, strengthen resilience to climate change, foster innovation, and adapt to demographic change. Yet municipalities often bear the political and administrative costs of these transitions while only partially benefiting from their economic gains.

A recent report from the Joint Research Centre (JRC) on local taxes and economic growth (Abre numa nova janela) offers an interesting perspective on this challenge. While the report focuses on municipal taxation, its broader message is about something more fundamental: incentives. If local governments are expected to actively support economic development and societal transitions, do they have sufficient incentives to do so?

This question is highly relevant for current debates on competitiveness, cohesion and the future of territorial governance in Europe.

Europe’s municipalities are anything but uniform

Any discussion about local incentives must start with recognising the remarkable diversity of municipalities across Europe.

European municipalities differ dramatically in size and population. Some countries, such as France, Germany and Czechia, have thousands of municipalities, many with only a few hundred inhabitants. Others, such as Ireland, Lithuania or Latvia, have comparatively few and much larger local authorities. Municipalities also differ in their territorial structures, administrative capacities and governance arrangements.

Perhaps even more importantly, municipalities differ in what they actually do. In some countries, local governments are responsible for education, healthcare and major infrastructure provision. In others, their responsibilities are more limited. Their financial resources and sources of income also vary considerably. Some rely heavily on locally generated revenues, while others depend largely on transfers from regional or national governments (see an earlier blog post on the role of local tax revenues for growth and cohesion (Abre numa nova janela)).

This diversity means there is no single European model of local governance. Yet it also offers the opportunity to see how different governance and fiscal systems influence development outcomes.

Local governance matters for economic growth

For many years, discussions on economic growth focused primarily on capital, labour, innovation and infrastructure. Increasingly, however, attention is turning towards institutions and governance.

The JRC report highlights a growing body of evidence suggesting that local governments play a far more significant role in economic development than is often recognised. Municipalities shape the conditions under which economic activity takes place. They decide on land use, manage permit procedures, invest in infrastructure, provide services, coordinate stakeholders and mediate conflicts around development.

In many cases, they also influence the quality of education, mobility, environmental management and public services that determine whether a place is attractive for businesses and residents alike.

Research increasingly shows that places with higher-quality local governance tend to perform better economically. Better governance is associated with higher productivity, stronger innovation performance and more favourable business environments. In other words, local governance quality is not simply a matter of administrative efficiency; it is becoming recognised as a key factor shaping territorial development.

Yet recognising the importance of local governance immediately raises another question: what motivates local governments to actively pursue development?

The missing piece: incentives

Supporting development is rarely cost-free. New housing developments often trigger opposition from existing residents. Renewable energy projects can generate local resistance. Industrial investments may create concerns about environmental impacts or quality of life. Even projects that contribute to national or European objectives frequently involve difficult negotiations at local level.

Municipalities therefore face a delicate balancing act between managing local concerns and supporting broader development goals.

The JRC report argues that incentives deserve much greater attention in this context. Local governments are more likely to invest time, resources and political capital in facilitating development when local communities can expect tangible benefits from successful outcomes.

This is where municipal revenue structures become relevant. If economic growth, employment creation or new investments generate additional resources that can be used to improve local services and infrastructure, municipalities may have stronger incentives to support development. If the benefits largely accrue elsewhere, local governments may have fewer reasons to actively engage.

The argument is not that municipalities act solely on financial motives. Rather, incentives help shape priorities and influence how local actors perceive the trade-offs associated with development.

Not all fiscal systems create the same incentives

Across Europe, municipalities are financed through very different combinations of local taxes, shared taxes, property taxes, grants, transfers and equalisation mechanisms.

These differences matter because they influence how strongly local revenues are linked to local economic performance.

In some systems, municipalities receive significant revenues from local economic activity, whether through local business taxes, shares of personal income tax or other locally linked sources. In others, municipal finances depend predominantly on transfers from higher levels of government. The Nordic countries, particularly Sweden and Denmark, have among highest realised revenue retention rates, with own-source tax revenues accounting for an average of more than 50%. By contrast, municipalities in Bulgaria and Spain have comparatively low fiscal autonomy and tax-setting powers.

Neither model is inherently right or wrong. Fiscal equalisation and redistribution remain essential to ensure that weaker territories can provide adequate services and maintain development opportunities. However, the report suggests that the balance between redistribution and incentives deserves greater attention.

The challenge is not simply how much funding local governments receive, but whether governance systems encourage municipalities to actively support economic development and societal transitions.

A territorial perspective on Europe’s transitions

This discussion becomes particularly relevant when viewed through the lens of Europe’s major transitions.

The green transition requires municipalities to host renewable energy installations, energy infrastructure and industrial transformation projects. The housing transition requires local authorities to accommodate new residential development despite increasing land-use pressures. The digital transition depends on investments in connectivity, skills and innovation ecosystems. Demographic change requires continuous adaptation of services and infrastructure.

In all these cases, municipalities are expected to contribute to objectives that extend far beyond their administrative boundaries.

Yet local governments often face immediate costs and political risks, while many of the benefits emerge at regional, national or European scales. For example, municipalities in Sweden may have limited direct fiscal incentives to approve onshore wind farms, as they often bear the political and administrative costs while most of the tax income goes to the national government. This creates a fundamental governance challenge: how can Europe ensure that local actors have sufficient incentives to actively contribute to collective goals?

The answer is unlikely to be found in fiscal policy alone. Administrative capacity, political leadership, institutional quality and local partnerships all matter. Nevertheless, the way resources and rewards are distributed across levels of government is an important part of the equation.

The challenge is not unique to any particular transition. It reflects a broader feature of multilevel governance in Europe. Municipalities are frequently asked to contribute to objectives that generate benefits far beyond their own boundaries, whether through hosting renewable energy infrastructure, accommodating housing growth, supporting industrial investments or adapting to demographic change. While the benefits of these developments often accrue at regional, national or European scales, the immediate costs, risks and political trade-offs are typically negotiated locally. This raises a broader question about the design of governance and funding systems: how can public policies ensure that local actors have both the capacity and the incentive to contribute to shared European objectives?

Towards an incentive-sensitive cohesion policy

If incentives matter for how municipalities engage with development and transitions, the question becomes whether European and national policy frameworks sufficiently recognise this dimension. This question is also relevant in the context of the proposed cash-for-reforms approach under future Cohesion Policy and the implementation of National and Regional Partnership Plans. This does not necessarily imply fiscal decentralisation or new local taxes. Incentives can take many forms. Cohesion policy could support reforms that strengthen the link between local development efforts and local benefits, improve municipal capacities to engage with economic transformation, or develop governance arrangements that reward municipalities for contributing to shared regional, national and European objectives. Capacity-building programmes, governance reforms and innovative funding mechanisms could all play a role in ensuring that local authorities become active partners in delivering strategic transitions.

Ultimately, competitiveness, cohesion and sustainability materialise in places. Municipalities are not simply implementing policies designed elsewhere; they actively shape the conditions under which development occurs. If Europe wants local authorities to become effective partners in delivering its long-term ambitions, future cohesion policy and National and Regional Partnership Plans may need to pay greater attention to whether governance arrangements create sufficient incentives for municipalities to support Europe’s strategic transitions.

by Kai Böhme

(Abre numa nova janela)