Front Matter

Front Matter

Editor(s):
Teresa Ter-Minassian
Published Date:
September 1997
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    Fiscal Federalism in Theory and Practice

    Teresa Ter-Minassian

    Editor

    International Monetary Fund

    Washington • 1997

    © 1997 International Monetary Fund

    Design and production: IMF Graphics Section

    Cataloging-in-Publication Data

    Fiscal federalism in theory and practice / Teresa Ter-Minassian, editor. — Washington : International Monetary Fund, 1997.

    p. cm.

    Papers prepared by the staff of the International Monetary Fund.

    ISBN 1-55775-663-5

    1. Intergovernmental fiscal relations. 2. Finance, Public. 1. Ter-Minassian, Teresa. II. International Monetary Fund.

    HJ197.F57 1997

    Price: $35.00

    Address orders to:

    External Relations Department, Publication Services

    International Monetary Fund, Washington D.C. 20431

    Telephone: (202) 623-7430; Telefax: (202) 623-7201

    E-mail: publications@imf.org

    Internet: http://www.imf.org

    Foreword

    A few years ago, when Teresa Ter-Minassian first approached me with the idea that the staff of the Fiscal Affairs Department could produce, over the medium run, a book containing a number of country studies dealing with the prevailing fiscal arrangements between national governments and subnational governments or jurisdictions, my reaction was not enthusiastic. The department was very busy with many activities, some new ones, and its staff was greatly overworked. It did not seem wise to add to its work, especially to deal with an area that was not at the forefront of policymakers’ or economists’ interests. It was only her insistence that made me agree. She pointed out that while there was much information on the fiscal arrangements of a few industrial countries, little was known about most of the developing ones.

    Over the following years, staff of the Fiscal Affairs Department prepared papers on a large number of countries and also on a few analytical topics on fiscal federalism. These papers were for the most part written by economists operationally engaged in the IMF’s country work. These individuals had, thus, the benefit of access to current information and to the countries’ experts, but, at the beginning, they did not have particular knowledge of issues related to fiscal federalism. Most studies had to be revised more than once because either the situation in some of the countries was changing rapidly or, with the passing of time, the authors acquired much greater sophistication in the subject and thus felt that they could improve the studies, or they realized that some of their earlier analyses or conclusions were wrong. Over this period, the combined knowledge that the Fiscal Affairs Department had of issues and practices related to fiscal federalism and fiscal decentralization grew significantly, owing to both the preparation of the studies and the technical assistance missions undertaken at the request of country authorities. These requests, rare in the past, have become progressively more frequent. This book thus represents the result of much collective thinking by the staff of the department on the design of intergovernmental fiscal relations. Given the IMF’s basic mandate, its emphasis is on the impact of those relations on macroeconomic management.

    Since the time when Teresa Ter-Minassian first proposed the project, fiscal federalism has become a hot political issue in many countries and has attracted the attention of an increasing number of economists. Developments in the European Union and in countries such as Argentina, Brazil, Canada, China, India, Italy, Russia, and others have made policymakers and experts pay close attention to the arrangements in fiscal relations between the national government and the local governments that exist not only in federal but also in unitary countries. The increased attention also reflects a recent trend that favors greater fiscal decentralization in public spending. And decentralization requires a rethinking of the roles and responsibilities of various levels of government in relation to the traditional policy objectives of allocation, stabilization, and redistribution.

    The studies contained in this book show the great variety of experiences ranging from those of highly centralized countries, where most spending and taxing decisions are made at the national or central level, to those of decentralized countries (such as Brazil, Canada, and the United States) where local jurisdictions have considerable power in these decisions.

    Existing intergovernmental fiscal arrangements are generally not the product of detailed analytical studies by economists or political scientists but are the result of historical developments or even of historical accidents. It is unlikely that the same arrangements would be chosen if today the countries had the freedom to start from scratch. However, changing in a substantive way arrangements that are often specified in the countries’ constitutions or in their laws is very difficult, even when there are grounds to believe that some changes would be highly beneficial. In some cases, the existing arrangements have created (or have contributed to) political problems and economic difficulties. Arrangements that might have made sense in the past may be less adequate in a world in which economic conditions and technology are changing rapidly. For example, the assignment of particular tax bases (such as property, sales, and incomes) to different levels of government may create macroeconomic and allocational difficulties when some bases tend to grow faster than others and when some expenditure responsibilities have a different dynamic. These difficulties may also be connected with the impact of tax competition on tax revenues. Therefore, subnational jurisdictions may end up with spending responsibilities that exceed the available resources and may be tempted to rely excessively on borrowing.

    Fiscal federalism and fiscal decentralization give rise to many difficult issues and questions. Some are related to the allocation of resources, some to stabilization, and some to income or resource redistribution. Many of these are discussed in the various papers. A few are mentioned below.

    It has often been argued that a decentralized fiscal arrangement improves the allocation of resources because the decentralization of fiscal decisions implies that the package of spending and taxing tends to better reflect the wishes of the local voters. This, however, may be true only under certain circumstances. For example, voters don’t normally vote with their feet as assumed in many studies done by U.S. economists.

    An important question relates to the assignment of tax revenue. Should the local jurisdictions have tax bases or tax revenue assigned to them? If tax bases, which ones? And what are the implications of these decisions for tax administration and for tax competition? If tax revenue, how should the allocation be made? On the basis of sharing of total tax revenue or of the revenue of particular taxes? What about arrangements that allow differentiated sharing of different taxes rather than tax revenue? To what extent do these arrangements compromise tax policy because of the incentives they create that makes some taxes preferable to others?

    If a country is large, such as Brazil, it is likely that some areas will be more developed than others. If local jurisdictions must rely on their own revenue sources, the poorer jurisdictions will have less resources than the richer ones. Therefore, they will not be able to finance services at the same level as the richer jurisdictions. Should a country accept this differentiation in the quality of services? If not, there is a need for the transfer of resources from rich to poor jurisdictions. How will this be accomplished? By what method? And how much will be transferred? Very difficult issues arise in this context. Of course, the more centralized a country, the greater can be the role of the central government in implicitly redistributing income by providing services of equal quality. Some of the papers address this question.

    Finally, some literature going back a few decades deals with the implications of decentralization for stabilization. Those who wrote on these issues in earlier years maintained that stabilization was the responsibility of the national government and could be pursued better in centralized countries, because a national government would have more of an incentive, and more efficient policy tools, for pursuing a stabilizing policy. In more recent years, however, the focus in stabilization policy has changed from pursuing countercyclical, Keynesian fiscal policy to one of bringing equilibrium to the fiscal accounts that have become structurally unbalanced. In this connection, some have maintained that a decentralized fiscal arrangement makes it more difficult to correct the structural imbalance, especially when the local governments have access to borrowing and can put political pressures on the national government to bail them out when they run into difficulties. This is an aspect that attracts considerable attention in the studies.

    The book is made up of 7 issue-related chapters, which deal with some of the conceptual or theoretical underpinnings, and 21 case studies. The case studies represent a wealth of information on many countries of which little was available in the literature. It is hoped that the book will not only help the staff of the IMF in its operational work but that it will also be useful to the many policymakers who are contemplating reforms or are concerned about these issues.

    This project was supervised by Teresa Ter-Minassian, who spent many hours reading manuscripts, advising and encouraging authors, and writing her own chapters. Given the fact that both she and the other authors were very busy with their normal work, it was a great achievement to have taken this project to completion and to have created such a useful and interesting book. It is my hope that this book will improve in some way the policymaking in many countries. As it represents much collective thinking by the staff of the Fiscal Affairs Department, it is fair that the whole department should share in the responsibility of any remaining errors.

    In conclusion, I wish to express my deep gratitude to all those who participated in this creation, and especially to Teresa Ter-Minassian for her remarkable management of a difficult enterprise.

    Vito Tanzi

    Director

    Fiscal Affairs Department

    Preface

    This book presents a collection of essays on the principal theoretical and institutional aspects of intergovernmental fiscal relations, prepared mainly by staff of the Fiscal Affairs Department of the IMF. The literature on intergovernmental fiscal relations has been expanding rapidly in recent years, in line with a growing worldwide trend toward fiscal decentralization. The book is intended to contribute to this evolving body of knowledge by providing an overview of the current thinking in the literature on these issues (the theory of fiscal federalism) and the current status of intergovernmental fiscal relations in a broad range of industrial, developing, and transition economies (the practice of fiscal federalism). As a reflection of the IMF’s focus on macroeconomic issues, the book emphasizes the macroeconomic dimensions of intergovernmental fiscal relations, an area that until recently had been relatively neglected in the fiscal federalism literature.

    Given its coverage and focus, the book should prove especially useful to policymakers and academic scholars who wish to know about best and worst practices in intergovernmental fiscal relations across a broad range of different countries and to draw relevant lessons from these experiences.

    As the Director of the Fiscal Affairs Department, Vito Tanzi, observes in the Foreword, the book is very much a collective effort of the department and has benefited greatly from the dialogue on fiscal federalism issues that over the last few years the staff of the department has carried out with policymakers in many IMF member countries. It has also benefited from the contributions of a number of authors who were associated with the department when the papers were prepared, Juan Amieva-Huerta, Giorgio Brosio, Nicoletta Emiliani, Sergio Lugaresi, and Paul Bernd Spahn, and from comments by colleagues in other departments of the IMF.

    Special thanks are due to Esha Ray of the External Relations Department, who provided editorial assistance and coordinated the publication process, and to Champa Nguyen and Meike Gretemann of the Fiscal Affairs Department, Lilián Martínez of the Western Hemisphere Department, and Alicia Etchebarne-Bourdin of the External Relations Department, who provided technical support in the production of the book.

    The views expressed are those of the authors and do not necessarily reflect those of the IMF.

    Teresa Ter-Minassian

    Contents

    The following symbols have been used throughout this publication:

    … to indicate that data are not available;

    — to indicate that the figure is zero or less than half the final digit shown, or that the item does not exist;

    – between years or months (e.g., 1995–96 or January–June) to indicate the years or months covered, including the beginning and ending years or months; and

    / between years (e.g., 1996/97) to indicate a fiscal (financial) year.

    “Billion” means a thousand million.

    Minor discrepancies between constituent figures and totals are due to rounding. The term “country,” as used in this publication, does not in all cases refer to a territorial entity that is a state as understood by international law and practice; the term also covers some territorial entities that are not states, but for which statistical data are maintained and provided internationally on a separate and independent basis.

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