Transcript Lectures on Selected Topics in Public Finance

Intergovernmental Finance:
Lessons from International
Practices
Anwar Shah, World Bank
[email protected]
International Seminar on Tax Reform and
Fiscal Federalism, Brasilia, 5-6 March, 2008
Perceptions on intergovernmental
finance are generally negative
• Federal/Central View: Giving money and
power to sub-national governments is like
giving whiskey and car keys to teenagers.
• Provincial and Local View: We need
more grant monies to demonstrate that
“money does not buy anything”.
• Citizens: The magical art of passing
money from one government to another
and seeing it vanish in thin air.
Perceptions about intergovernmental finance:
Perspectives of The Australian Premiers’
Conference
Ironically these perceptions are
well grounded in reality
• Primary focus on dividing the pie
• Passing the buck transfers – revenue sharing with
multiple factors that work at cross purposes (Argentina,
India, RSA, Philippines and more)
• Asking for more trouble grants – deficit grants (China,
Hungary, India, and more)
• Pork barrel transfers or political bribes/ favors
(Germany, India, Mexico, Pakistan, USA e.g. $200m
bridge to nowhere in Alaska )
• Command and control transfers (most countries)
• Overall: Intergovernmental finance is the dominant
source of revenue but creates perverse incentives
for fiscal management and accountability
No need to despair ….
• As properly designed fiscal transfers can
be part of the solution rather than part of
the problem.
• Intergovernmental finance can be an
important tool in securing economic union;
fostering results based accountability to
citizens; facilitating a competitive edge in a
globalized and localized world and
advancing local governments’ lead role in
local economic development and network
governance at the local level.
Guidelines for Intergovernmental
Finance
 Clarity in objectives, consistency of design with objectives and
singular focus
 Simplicity, objectivity and transparency of allocation criteria
 Incentives for fiscal prudence and competitive service delivery and
results based accountability to citizens
 Autonomy: Independence in designing programs and flexibility in
use of resources
 Revenue Adequacy and responsiveness
 Predictability
 Fairness: entitlements vary inversely with fiscal capacity and
directly with fiscal needs; one size does not fit all – urban vs. rural,
large vs. small
 Affordability
 Review :Sunset clauses to ensure periodic review and assessment
Objective
Grant
Design
Better Practices Practices
to Avoid
Bridging
vertical fiscal
gaps
Reassign, tax
base sharing
Canada
Deficit grants,
(China), tax by tax
sharing (China, India
pre-2000)
Reducing
regional fiscal
disparities
(equalization)
Fiscal
capacity
equalization
(FCE)
Fiscal capacity
equalization with an
explicit standard as in
Canada, Germany,
Denmark
General revenue
sharing with
multiple factors,
(Brazil, India)
Fiscal equalization
with a fixed pool as
in Australia, China
Setting national
minimum
standard
Output based
transfers,
conditions on
service standards
Conditional
capital grants –
matching inverse
with fiscal
capacity
Roads and primary education
(ex-Indonesia), Education
(Canada, Chile, Brazil,
Colombia); Health (Canada)
School construction.
(Indonesia, pre-2000)
Federal highways grants to
states (USA)
Conditions on
spending (e.g. USA:
Bridge to nowhere in
Alaska)
Capital grants with no
matching and no
future upkeep
requirements
Transfers to deal with vertical
fiscal gaps

Fiscal Gap: Structural imbalance as a result of a
mismatch between revenue means and expenditure
needs.
Sources of Fiscal Gap and Possible Solutions:
Inappropriate assign: Reassign taxing and spending
powers
Limited tax bases: Allow joint occupancy or tax
decentralization.
Tax room lacking: Tax abatement and tax base sharing
(Canada, Denmark, Sweden ).
Tax competition: Federal collection and general (not on
a tax-by-tax basis) revenue sharing.
Practices to avoid: deficit grants; tax by tax sharing.
REVENUE SHARING
•
MERITS
–
–
–
–
•
Efficiency gains of centralized tax administration
Simple and transparent division of fiscal pie
State and local expenditure autonomy preserved
Possible to incorporate factors to accomplish grantor objectives
DRAWBACKS
– Lack of political and fiscal accountability if little discretion of revenue raising at
the margin
– States and local government have no discretion over the total amount
– Growth in state and local funding dependent on growth in federal revenues and
not on own expenditure needs
– States and locals exposed to risks with changes in federal tax base or collection
– Specific revenue sharing for individual taxes on narrow bases such as income
and payroll taxes, not desirable due to perverse incentives
– Revenue sharing with multiple factors that work at cross purposes introduces
complexity and lack of clarity in impact
– Tax effort provisions can introduce inequity
– Equal per jurisdiction component, if significant, can create incentives for breakup
of existing jurisdictions
Transfers to set national
minimum standards
 Rationale:
 National economic union or internal common market
 Redistributive role of the public sector and the national
government
 Design: conditional non-matching block transfers with
conditions on standards of service and access.
 Better practices: Indonesia roads and primary
education grants (now defunct); Brazil health transfers,
Colombia and Chile education transfers; Canada
health and post-secondary education transfers.
 Practices to avoid: Conditional transfers with
conditions on spending; ad hoc grants.
An example : An Output based ( performance oriented)
education grant to set national minimum standards and
encourage competition and innovation and citizen
empowerment
• Allocation basis among local governments: school
age children (ages 6-17)
• Distribution to providers: equal per pupil to both
government and private schools
• Conditions: Universal access to all, private school
admissions on merit regardless of parents’ income,
improvements in school achievement scores, graduation
and drop out rates, no condition on spending
• Penalties: public censure, reduction of grant funds
• Incentives for cost efficiency: retention of savings
• Built-in bottom up results based accountability:
competition with voice and exit options as parental
choice of school determines school grant.
Challenge: Bridging Economic Divide within
Nations
China (1999)
India (1997)
Brazil (1997)
France (1995-97)
Theil index (T)
Italy (1995-97)
Weighted gini index
(Gw )
Spain (1995-97)
Relative m ean Deviation
(Rw )
Form er West Germ any (1995-97)
Weighed coefficient
of variation (CVw )
United Kingdom (1995-97)
Canada (1998)
United States (1997)
Australia (2002-2003)
0
0.2
0.4
0.6
0.8
1
Inequality Measures
Source: Shankar and Shah. 2001. “Bridging the Economic Divide within Nations”. Policy Research Working Paper 2717.
Washington, D.C.: The World Bank.
Fiscal Equalization Transfers:
Why?
• Political : Large regional fiscal disparities can be
politically divisive. May even create threat of secession.
Fiscal equalization grants to create a sense of political
unity
• Fiscal efficiency and fiscal equity: Makes it possible
for all citizens to be treated alike by the public sector
regardless of the places of residence. Thereby advances
social justice ( fiscal equity) and efficiency in market
resource allocation (fiscal efficiency).
• Securing a Common Economic Union: Fiscal
equalization transfers help create a level playing field for
fiscally disadvantaged states and regions to integrate
with the national economy.
•
International practices in transfers to
reduce regional fiscal disparities
 Design: General non-matching fiscal capacity equalization
transfers.
 Better practices: Fiscal equalization programs (sources of data:
CGC, Morris, Finance Canada, Dafflon, Lotz, Shah, Spahn &
Werner)
 Paternal: Australia (fiscal capacity plus fiscal needs) and
Canada (fiscal capacity only)
 Solidarity, Fraternal or Robin Hood: Germany (fiscal capacity)
 Mixed: Switzerland, Sweden, Denmark
 Practices to avoid: General revenue sharing with multiple factors
e.g. practices in Brazil, India and South Africa.
Equalization programs are concerned with inter-jurisdictional
equity (horizontal fiscal equity) not with with interpersonal equity
(vertical equity)
• Australia: capacity to provide services at the same
standard with same revenue effort and same operational
efficiency
• Canada: “reasonably comparable levels of public
services at reasonably comparable levels of taxation
across provinces”
• Germany: “to equalize the differences in financial
capacity of states”
• Switzerland: “to provide minimum acceptable levels of
certain public services without much heavier tax burdens
in some cantons than others”.
Fiscal
Equalization
Program
Australia
Canada Germany
Switzerland
Legal Status
Federal
Law
Constitution
Constitution
Paternal or
Solidarity
Paternal
Paternal Solidarity
Mixed
Total Pool
determination
Ad hoc
Formula Formula
Ad hoc
Allocation
Formula
Formula Formula
Formula
Fiscal
capacity
equalization
Yes, RTS
Yes,
RTS
Yes, major
macro tax
bases
Constitution
Yes, Actual
Revenues
Fiscal
Equalization
Program
Australia
Canada
Germany
Switzerland
Fiscal Need
Equalization
Yes
No
No (only
some
pop size
and density)
Program
Complexity
High
Low
Low
Medium
Political
Consensus
No?
Yes (?)
Yes (?)
Yes
Who
recommends
Independent
agency
Intergov.
Committee
s
Solidarity
pact II
Federal
Government
Sunset clause
no
Yes (5
years)
no
no
Dispute
resolution
Supreme
court
Supreme
Court
Constitution
al court
Supreme court
Germany – Fiscal Equalization
in 3 stages
• Stage 1: Equal per capita distribution of 75% of
States’ share of VAT revenues (47.8% of total) to
all 16 states and remaining 25% as supplement
to financially weak states.
• Stage 2: Formal Fiscal Equalization Program
through Solidarity Pact II – Rich states
contribute to the pool through a progressive tax
(45 –72.5% rate) and poor states receive
progressive subsidy from the pool.
• Stage 3: Federal Supplementary grants
Compensation of marginal tax revenue
Solidarity Pact II -2005 German Equalization Program
Marginal compensation in percent
100
80
60
40
20
0
-20
-40
before Solidarity Pact II
-60
after Solidarity Pact II
-80
-100
80
82
84
86
88
90
92
94
96
98
100 102
104 106 108
Relative financial position in percent
110
112
114
116
118
120
The equalizing impact of
distribution of VAT revenues
Revenue per capita relative to average
HH
HE
BAY
BW
NRW
HB
SH
RP
after VAT-distribucion
NDS
before VAT-distribucion
BE
SAAR
BRG
SACH
THUE
M-V
S-A
0
0,2
0,4
0,6
0,8
1
1,2
1,4
1,6
1,8
2
„Effectiveness“ of
Finanzausgleich
Per capita revenue before and after
Finanzausgleich relative to average
HE
BW
BAY
HH
NRW
SH
RP
NDS
SAAR
BRG
S-A
after horizontal grants
before horizontal grants
SACH
THUE
M-V
HB
BE
0
0,2
0,4
0,6
0,8
1
1,2
1,4
Denmark: Equalization models and
standards for central-local transfers
Equalization
type
Counties
Fiscal
capacity
85% Robin 90% Robin 50%
Hood
Hood
central
grant
85% Robin 60% Robin 35% Robin
Hood
Hood
Hood
Fiscal
Needs
Metropolitan
areas
Local
Govts.
Fiscal Equalization Grants: Some Lessons
from International Experiences
• Equalization formula must determine both the pool and allocations.
• Fiscal capacity equalization with an explicit standard is desirable
and do-able in most countries.
• Fiscal need equalization is much more complex – desirable but may
not be worth doing. Rough justice may be better than precise justice.
• Output based transfers offers a promising alternative for fiscal need
compensation. Enhance results based accountability.
• Equalization transfers must not be looked at in isolation of the
broader fiscal system especially conditional transfers.
• For local equalization – one size does not fit all.
• Important to have societal consensus on the standard of
equalization
• Must have a sunset clause and provision for a review and renewal
• Institutional arrangements for a continuous review and periodic
revision require serious thoughts as independent grants commission
typically recommend more complex formulae.
Alternate Institutional
Arrangements for ET
•
•
•
•
•
Central government agency
Intergovernmental Forums
Intergovernmental cum civil society forums
Sub-national government forums
Independent agency model – reporting to
executive – permanent or periodic
• Independent agency model reporting to
legislature
• Legislature itself
Institutional Choices: Intergovernmental Forums
vs Independent Grant Commissions
Criteron
Forum
Commission
Transactions Costs:
Participation and monitoring costs Low to Medium
Low to high
Legislative and executive
costs
High
High
Agency Costs
Low
High
Uncertainty costs
Low
Medium
Political Compact
Yes
No
Durability of compact
Yes
NA
Pool determined by standard
Yes?
No
Allocation by standard
Yes
No
Stability of allocation criteria
Yes
May be?
Potential outcomes:
Fiscal Transfers: Negative Lessons
or Practices to Avoid
•
•
•
•
•
•
•
•
General revenue sharing with multiple factors
Tax by tax sharing for taxes with narrow bases
Deficit grants
Fiscal Effort Provisions
Input or process based or ad hoc grants
Capital grants without assurance for upkeep
Negotiated or discretionary transfers
One size fits all
Avoid Conditional transfers with conditions on spending as
they impair recipient’s autonomy without furthering
grantor’s objectives
Fiscal Transfers: Positive Lessons
or Practices to Strive For
•
•
•
•
•
K.I.S.S. (keep it simple, sir)
Focus on single objective
Introduce sunset clause
Tax base sharing
Output based conditional transfers with citizens’
evaluations
• Fiscal capacity equalization to a defined standard
• Political consensus on the standard of equalization
• Institutional arrangements for broad based consultation
Traditional conditional grants versus
Output-based grants
Criteron
Traditional conditional
grant
Output-based grant
Objective
Spending levels
Quality and access to public
services
Design
Complex
Simple and transparent
Eligibility
Government
Service providers (govt. and
beyond government)
Conditions
Inputs
Outputs
Allocation
Project proposal
Service population
Compliance
Inspections and audits
Client feedback.
Comparison with base year.
Penalties
Audit observations
Public censure, voice and exit
Managerial
flexibility
None
Absolute
LG Autonomy
Little
High
Transparency
Little
High
Focus
Internal
External
Accountability
Top down input based
Bottom up, results based
From Dividing the Pie to Creating An
Enabling Environment for Responsive
and Accountable State-Local Governance
• Tax Decentralization and Tax Base
Sharing
• Output based fiscal transfers
– operating
– capital
• Fiscal equalization transfers
• Responsible borrowing
References
• Boadway , Robin and Anwar Shah, editors
(2007). Intergovernmental Fiscal
Transfers: Principles and Practice.
Washington, DC: World Bank
• Boadway, Robin and Anwar Shah
(forthcoming, 2008), Fiscal Federalism.
London and New York : Cambridge
University Press.