Municipal Budgeting in the Faroe Islands: How Size and Financing Structure Affect Economic Sustainability

Abstract

This thesis examines how the structure of municipal finance and budget governance affects the economic capacity of municipalities on the Faroe Islands. In recent decades, Faroese municipalities have been assigned increasing responsibility for welfare services, including elderly care, while substantial differences persist in municipal size, tax bases, and administrative capacity. These structural differences raise questions about whether the current decentralized governance system provides sustainable economic conditions for all municipalities. The study analyzes how the Faroese municipal financing and budgeting model is organized and explores the economic challenges municipalities face in practice. The analysis draws on qualitative interviews with Faroese mayors combined with document analysis of policy reports, legislation, and economic assessments. The empirical findings are interpreted through theoretical perspectives from fiscal federalism, incremental budgeting, soft budget constraint theory, and research on intermunicipal cooperation.The analysis shows that differences in population size, demographic composition, and tax bases create unequal economic conditions across municipalities. Smaller municipalities appear particularly vulnerable to economic shocks, demographic ageing, and large investments. While intermunicipal cooperation can enhance administrative capacity, it may also generate coordination challenges and common-pool dynamics. Furthermore, the financing model for elderly care contributes to uneven financial pressures between municipalities. The thesis concludes that the current institutional framework may create long-term challenges for the sustainability of municipal welfare provision. Possible policy responses include adjustments to the financing model, stronger equalization mechanisms, or structural reforms aimed at ensuring more economically robust local governments.