12 Local Taxation in an International Perspective

Ehtisham Ahmad, Vito Tanzi, and Qiang Gao
Published Date:
September 1995
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Giorgio Brosio*

Local taxes enhance the autonomy of local governments and their accountability. The joint effect is to enable citizens to influence the quantity and the mix of services provided by local governments and the mix of taxes needed to finance them. In particular, accountability requires that the cost of providing local public services should be passed on to citizens who utilize them through taxes and user charges. This process is facilitated when local governments have tax autonomy, that is, when they have their own taxes and are able to fix their tax rates with reference to their financing needs.

Pros and Cons of Local Taxation

All over the world, the funding of local governments has become increasingly difficult in the last decades. There are good reasons for this phenomenon. First of all, the revenue needs of local governments have increased faster than those of the central governments. One has to remember the spread of urbanization and the rapid increase of costs associated with the provision of urban services. Second, technical progress in transport and communications has constantly increased the mobility of both persons and goods.

This higher mobility produces in turn two main effects on local taxes. First, it allows “tax exporting,” that is, it allows a local government to shift the tax burden from its citizens to those of other local jurisdictions. This takes place, for example, when a local government is allowed to tax a natural resource that is sold outside its jurisdiction, or when a city government imposes a parking fee only on cars coming from other jurisdictions. Tax exporting is not only unfair but also inefficient. Local governments tend to increase excessively their tax revenues when the tax burden can be exported to other areas.

The second effect refers to “tax competition.” Citizens can react to high local taxes by moving to another jurisdiction with lower taxes. In turn, local governments can use tax reductions to attract persons and firms from other jurisdictions. Tax competition is not necessarily evil. It is surely not evil from the point of view of the taxpayers, but it does constrain the choices of local governments regarding their tax instruments. The joint effect of tax exporting and tax competition has been to reduce the number of local taxes that can be administered by local governments without creating too many problems and conflicts.

The problem of funding local governments has been compounded by the growing spatial unevenness of economic growth that has exacerbated differences among local jurisdictions about their tax bases and thus their ability to finance expenditures. These differences have been used as an argument against a too large local tax autonomy; that is, local taxes may produce horizontal inequity. This happens because rich areas are able to finance a higher level of local services than poor areas, even by imposing a lower tax burden on their residents. Moreover, in some countries, the centralization of tax instruments has been considered beneficial from many points of view, like stabilization and economic growth policies.

Finally, some experts (see, for example, Groenewegen (1990)) argue that tax administration is both harder and costlier when performed by lower levels of governments. Empirical evidence does not completely support these claims. It is clear, however, that the broad-based taxes (on income or consumption expenditure, for example) that represent the pillars of modern tax systems can be better administered at the central level.

In most countries, some of these problems have been solved by reducing the role of local taxes and by increasing the share of grants from the central government in the revenues of local governments. Furthermore, local governments have increasingly relied, for their own financing, on nontax sources of revenue, primarily user charges and fees.

It is important to stress, however, that in recent years many countries have tried to reverse the trend toward tax centralization, partly as an attempt to trim their central budget deficit and partly to achieve a greater degree of efficiency in the operation of local governments. New taxes have been created, and the role of old ones has been expanded, as we shall see in the next sections.

The last remark is that practically all the problems mentioned here tend to decrease with the increase in the geographic size of local jurisdictions. For example, the problems tend to become less acute—if not disappear—when passing from local governments to regions or to states in federal countries. In fact, in Europe, some countries (e.g., the United Kingdom and Belgium) have proceeded in the last two decades to merge their small local governments, thus creating more viable units of government. Such changes were also important from the point of view of tax assignments and administration.

The Tax Assignment Problem

At the theoretical level the problems associated with the size and capacity of local governments have been taken into account in the literature on tax assignment. Musgrave (1983) has used equity and efficiency criteria to formulate the following broad principles:

  • taxes suitable for economic stabilization should be the responsibility of the central government;

  • taxes with a high redistributive potential should be also central;

  • tax bases that are highly unequally distributed among jurisdictions should be left to the central government;

  • taxes on mobile factors and goods are best administered by central governments;

  • taxes on immobile (or scarcely mobile) factors and goods should be the responsibility of local governments; and

  • taxes and user charges based on the benefit principle can be appropriately used at all levels of governments, but are especially suitable for assignment to the local level, inasmuch as they are able to capture the benefits of local expenditures.

These general principles can be translated into more detailed tax policy recommendations (see also Box 1 on local autonomy):

  • the personal income tax and the corporation income tax should be assigned to the central government, the former for the redistribution and stabilization reasons already given, and both for discouraging the interjurisdictional mobility of factors of production;

  • broad-based consumption taxes should be treated differently according to how they are levied: sales taxes levied at the manufacturing stage should be given to the upper tier of government and to subordinate levels of government only where geographical areas are large (as in the case of the states and provinces in the United States and Canada); sales taxes levied at the retail stage can be given to local governments insofar as it is possible to restrict the tax to residents;

  • selective excise taxes should be assigned to the central government if they fall on goods (to avoid tax exporting) or to local authorities if they fall on services (since much smaller tax exporting is assumed for them);

  • land and property taxes are the most suitable for lower tiers of government, especially when they are imposed on residential property that is the least mobile; taxing commercial and industrial property, on the other hand, allows the possibility of exporting the burden and makes the property a less suitable tax base for local governments;

  • benefit taxes, license fees, and user charges have an important role to play at the local level.

Box 1.Local Taxes Ranked According to Degree of Autonomy They Provide to Local Governments

Own taxesThe base and the rates of tax are under local control. In other words, local governments can control the burden they impose on their citizens.
Overlapping taxesThe base is determined at the national level, but the rates are decided locally.
Shared taxesThe base and the rate are decided nationwide. No possibility of controlling locally the burden of the taxes. Local governments may, however, bargain with the central government the amount of the revenue they receive. Furthermore, as for the other taxes, they can stimulate with their policies the growth of the base of the taxes.

Structure of Local Taxation

Industrial Countries

As for the industrial countries, no common pattern exists in the structure of their local tax revenues (see also Owens (1992) and Brosio and Pola (1989)). In fact we can single out three modes, or groups of countries (see Table 1). The countries in the first group rely for more than two thirds of their local tax revenue on income taxes, on both individuals and companies. This is the case in the Scandinavian countries, Switzerland, Belgium, and Germany.(Belgium and Germany are examined further in Table 2.) Japan is also close to this pattern, as the share of income taxes is approaching the percentage mentioned above. The prevalence in subnational revenue of taxes on property characterizes the second group, that is, formed by the United Kingdom and its former colonies. Countries in the third group show no predominance of a single tax, but rather a large variety of solutions to the problem of raising local tax revenues. Consumption taxes are not the single revenue source in any country of the subnational level, but in most federal countries general consumption taxes (namely, value-added tax and sales taxes) are important sources of revenue for state governments.

Table 1.Tax Revenues from the Main State and Local Taxes as Percentage of Total Tax Revenues of State and Local Governments, Selected Countries
Income and ProfitsPropertyGeneral ConsumptionSpecific Goods

& Services
United States
New Zealand
United Kingdom
Source: International Monetary Fund.
Source: International Monetary Fund.
Table 2.Two Cases of Tax-Sharing Systems: A “Classical” One, Germany, and a New One, Belgium
Shares of Revenue Attributed to



(In percent)
Personal income tax42.542.1515
Capital income tax50.050.00
Corporate income tax50.050.00
Personal income tax67.232.80
Tax on property sales58.641.40

The present structure seems to reflect only partially the criteria suggested by the theory. This is because of the importance of the income and profit taxes. At a closer look, however, the gap between practice and theory becomes much narrower. First, many countries, like Germany, Denmark, Austria, and Spain, adopt a tax-sharing arrangement for their income taxes. Under such arrangement, state and local governments are automatically attributed a fixed percentage of the overall income tax receipts within the country. The division of these receipts between individual units is usually made on the basis of the division of the tax base between these units. This implies that state and local governments have no autonomy in the administration of the tax; that becomes close to a general (block) grant. Second, in the other countries (the only exception is Switzerland), lower levels of government use a single, proportional, rate. The rate usually varies throughout the country but within limits. This allows local authorities to reduce the potential for competition between themselves, and the disparities in revenue capacity of the various units. In addition, the taxable income is determined with uniform rules all over the country (again the exception is Switzerland). The main advantages of income taxes from the point of view of their use by local government stem from the fact that their tax base is both wide and buoyant.

Taxes on immovable property are the second most important source of tax revenues for local governments (see also Box 2). Many reasons explain the use of these taxes by local governments. Although property taxes are predominantly local, subnational governments do not have complete discretion about them. Central governments tend to intervene in the specification of the assessment procedures and in setting limits on the tax rates that can be levied. For example, only in Sweden and the United Kingdom (although not in the last period in the 1980s in which the tax was in existence) were there no limitations on the rates, as in most parts of the United States (where the tax is governed by the individual states). The central government is usually also involved in the administration of taxes, because of the strict connection between these taxes and other important taxes, such as death, income, and capital transfer taxes.

The share of property taxation in total revenues has slightly decreased over the period considered in Table 1. The role of property taxes in financing local government has been subjected to conflicting trends. Some countries have decided that property taxes should be eliminated or substantially reduced. The United Kingdom replaced the local property tax (“the rates”) with a poll tax, in order to increase the accountability of local governments (see Box 3). The experiment showed big flaws (see Smith (1991)), and the government was induced to revert to a new form of property taxation. Ireland abandoned its property tax in 1978, but for different reasons that were connected with the deemed insufficient equity of the tax. The tax was abandoned for only five years, however; Ireland reverted thereafter to the same kind of taxation, by introducing a tax on imputed income from residential property. In Switzerland some cantons, which are responsible for local taxes, as in every federal system, abolished the property tax during the early 1980s because of its high costs, especially when compared with its yield.

Box 2.Four Main Types of Property Taxation

  • Annual or rental value of property. In this system, the base is defined as the expected or notional value of the property. (Examples are the former British tax and the taxes still used in the former British colonies.) There are usually wide divergences between assessed values and the net market rent because of (1) legal deductions in annual value, (2) rent controls, and (3) assessment difficulties. The rates applied are in some cases flat, in others, progressive with respect to property value (especially in developing countries).

  • Capital values of land and improvements. The tax base is defined as the assessed value of land and improvements. In theory, this value should be equal to the full market price. In practice, however, it is generally lower than that because of infrequent assessment and poor assessment practices. The rates applied are generally flat. This version of the tax is more difficult to administer than the former one. In fact, in the capital value type, higher levels of government are frequently involved in the assessment process both in developed and developing countries, whereas the annual type is usually administered by local governments only.

  • Site value of the land. This is a special version of the former type: only the value of the land is taxed. The main attraction of this tax is its potential for improving the efficiency of land use. More precisely, since only the land is taxed the owner has no disincentive to developing the land to its most efficient use. This tax has been used in a number of developing countries (like Jamaica and Kenya) and in some parts of Australia, New Zealand, and South Africa. The tax has two main disadvantages. The first is the usual assessment problem, due in this case to the paucity of sales of vacant land, which imposes a need to evaluate the total property value and then deduct from it the value of improvements. The second is the restriction of the tax base when only the site value is considered.

  • Capital gains on property. Increased value may be taxed on an accrual or realization basis. This second choice is better suited to individuals. The base of this tax is lower than that of the other types.

Mediterranean countries, on the contrary, have shown a growing interest toward property taxes as a source of revenue. Spain has given more autonomy over the tax rate to its local authorities. Portugal decided to introduce a new property tax that is destined to become the pillar of its local taxation. Greece is also in the process of decentralizing and raising existing taxes on property. Italy introduced in 1991 a property tax (ISI, imposta straordinaria sugli immobili) as a national source of revenue. From 1994 it became a true local tax, as its revenue and the power to fix rates were completely devolved to local authorities, whereas the administration continued with the central government.

Box 3.The “Failed Revolution” of the British Poll Tax

  • The main goals of the tax were to increase the accountability of local governments by (1) ensuring that all citizens who vote for local government services contribute to their costs; and (2) establishing a clear link between changes in local expenditure and changes in local tax bills.

  • Structure of the tax. Every adult (aged 18 or over) was subject to the tax. The average liability in 1990 was £252 (approximately $400). Persons with very low incomes received a subsidy of up to 80 percent of the poll tax.

  • Implementation problems. There were high administration costs due to the registration of residents, who exhibited a high mobility, and the huge expenses for recovering unpaid debts.

  • Political difficulties. Strong resistance to the tax from citizens, especially low-income persons, who perceived the tax as inequitable.

Of the remaining taxes administered by local governments, one has to mention local business taxes (see Bennett (1987) and Pola (1991)). Under this heading is included a wide range of taxes that allow local governments to generate revenues from economic activities located within their jurisdiction. Business taxes are widely used in socialist countries. In Western Europe, there are three main versions of these taxes:; (1) special taxes on inputs to a firm, like the French Taxe professionnelle, or on a combination of inputs, profits, and income, like the German Gewerbe Steuer, (2) taxes on profits, or income of professionals, like those administered in Switzerland, and (3) taxes on property used by business as a factor of production. In addition, businesses contribute to local revenues by paying fees and user charges that play a very important role in some cases.

Special taxes on inputs to a firm are an instrument for taxing business activities, and are being increasingly used in a number of countries. Germany and France are the most important cases, but similar taxes are now levied in Italy and Spain. These taxes have various bases. In the French version, the base is composed of two elements: (1) the rental value of fixed business assets and (2) one eighth of salaries and wages. According to French experts (see Gilbert and Guengant (1991)), the burden of this tax varies considerably among various activities and among jurisdictions. As for the former, capital-intensive firms are generally more burdened than labor intensive ones. The tax provides, however, a substantial share of local tax revenues, due to its wide coverage.

The base of the German tax is also very complex, even if it has been simplified recently by excluding, among other things, the payroll component. It is levied on business profits, plus 50 percent of interest paid on long-term debt and capital stock, plus 50 percent of long-term debt. The tax plays a very important role in the financing of German local governments, contributing more than 40 percent of their total tax revenue. Moreover, it gives flexibility to local governments’ fiscal policies, since rates are fixed locally.1 Negative features of the tax include its sensitivity to the general economic cycle and the extraordinarily large disparities in tax potential between various areas, which are corrected by means of equalization grants.

The Spanish tax that was reformed in 1992 (IAE, Impuesto sobre Actividades Económicas) is a kind of license tax, that is, a flat tax on businesses that varies according to different activities and sectors. The tax also takes into account the surface area of business premises. Its most attractive features are its simplicity of administration and its wide coverage, which ensure a potentially substantial revenue. It is clearly a kind of tax that is well suited to developing countries. Italy has had a local business tax since 1988; like the Spanish tax, the tax base also takes account of the surface area of business premises and is weighted according to the taxpayer’s income.

Business taxes offer local authorities the possibility of weighing the burden imposed on their residents against that imposed on economic activities, that is, balancing the revenue potential of cities with a high concentration of business activities and that take benefit from this tax with that of cities that are predominantly residential and that benefit mostly from using local taxes on income or sales. Moreover, these taxes are perceived by local governments as an instrument for fostering local economic growth through tax incentives. Central governments are obviously more cautious in this respect, fearing the effects of fierce competition among local jurisdictions. In fact, in unitary states, the tax base, the main criterion for the administration, and ceilings on tax rates are specified at the central level.

Recent developments in local taxation include various new kinds of taxes. Of special interest is the reliance on utility charges to tax publicly provided goods. Italy, for example, introduced in the mid-1980s a local tax on electricity consumption. Electricity is sold by a national public monopoly. The local tax is in addition to the nationwide fixed price. The tax has three distinct advantages (the same arguments may apply to telephone bills and even water bills): first, electricity consumption is a proxy indicator of income; second, the costs of administering such a tax are low; and third, the tax can be tailored to local jurisdictions of every size (even to the sub-units of a city).

A second important example of new forms of taxation, or of revitalization of old ones, is the special charge levied on the financing of urban infrastructure. In some cases (e.g., the Canadian “development charges” or the American “impact or development fees”), they are imposed on developers and are based on the costs of the project. In other cases, a tax is imposed on the increased value of property attributable to public investment projects. This kind of taxation is discussed more broadly in the next section, in reference to the valorization tax.

A final point is the increased reliance on charges and fees. A number of services that are provided at the local level (among the most costly are public transportation and kindergartens) can be charged individually, which helps increase the efficiency of their provision. It does so by stimulating consumers to express their dissatisfaction with what they receive. In addition, charges and fees are potentially a substantial source of revenue.

Developing Countries

A few remarks are in order with respect to developing countries. The first concerns the scope of responsibilities left to local governments. For both political and economic reasons, fiscal decentralization is generally less significant in developing countries than in the developed ones. Of course, cities (especially the big ones) in the developing world present even greater expenditure and revenue needs than those of the industrial countries, but, in general, subnational governments account for a lower share of all government expenditures, and local taxes play a lesser role—always with respect to developed countries—in financing local expenditures. In fact, in recent decades some government functions have shifted to higher levels of government. Quite often this shift has taken place through the creation of special national agencies charged with the provision of urban services.

On the revenue side, central governments have pre-empted the use of most, if not all, of the more productive taxes, such as broadly based income and sales taxes. Local governments have thus been forced to accept what was left, which, in most cases, is inappropriate for their rapidly rising financing needs. The structure of local taxation in developing countries presents a very wide variety of situations (see Bahl and Linn (1990) and Shah (1991)). Some examples of the existing problems include the following. The property tax in some countries (Brazil, India, Indonesia) is administered, exclusively by the central government, or jointly with local governments. Some countries still rely on excises—clearly not the best choice from the efficiency point of view—for the funding of their local governments (e.g., Argentina and Bangladesh). There are even a few cases (e.g., in some Indian states) where taxes on intermunicipal trade are administered by the local authorities.2 Also the business tax continues to be used in some countries, such as Colombia, where administration poses difficulties.

In general, developing countries encounter bigger difficulties in the administration of local taxes than the developed ones. Second, mobility is a source of lesser concern in such countries. Both these factors help us to understand why developing countries still rely on traditional taxes.

Experts have suggested various ways of widening the range of tax instruments suited to cope with the financing of local expenditure in developing countries, especially in urban areas where problems and financial needs are concentrated. The suggestions include property taxation, which is already levied in a number of countries, as well as, valorization and automotive taxes (discussed below).

The valorization tax, which has been tried in Colombia (see Bird (1992)), consists of utilizing the rapid rise in property values produced by public investment projects to finance their costs by taxing the increase in value. It is not only a benefit tax but a truly earmarked tax in the sense that (1) its product is reserved for financing a specific expenditure, and (2) its tax base is derived from the realization of this expenditure. It presents some advantages with respect to the other types of property taxation mentioned above, namely, the tax on capital values of land and improvements, and with respect to the capital gains tax on increments in site values. As we saw, the assessment of the tax on capital values is difficult and the revenue it produces lags behind in respect to the public infrastructure expenditures. The same problem applies to the capital gains tax; that is, the payment is usually made only when the increment in value is realized by sale. This contrasts with the valorization tax where the payment is secured during, or even before, the investment is made, and the tax recovers only those benefits from public investment that enhance the value of the land.

The administration of the tax, however, presents some difficulties, which can be solved by appropriate skills and procedures. The Colombian experiment suggests that the tax requires the following: (1) careful study of the projects to determine those that will create an increase in site value at least equal to the cost of the projects; (2) careful costing of projects; (3) freedom to establish formulas for apportioning the tax among property owners; (4) prompt construction of projects; and (5) prompt collection of all taxes assessed on the property owners during the execution of the project.

Taxes related to motor vehicle ownership and use, such as automotive taxes, constitute another potentially important source of revenue for local governments that is often neglected in developing countries. There are three main arguments in favor of this kind of taxation (see Bahl and Linn (1992) and also Box 4).

  • it is a rapidly growing tax base;

  • it allows local governments to match the costs on local governments due to automobile use; and

  • it helps to control automobile use and the social costs produced.

Automotive taxes are also appealing from the equity point of view. In fact, they may improve the distribution of income.


Local taxes are a powerful instrument for accountability of local governments. Their use is subjected to increasing constraints, however, owing to the high mobility of persons and goods and to the unevenness of spatial growth, which enhances differences among local governments in their taxing power. Great care has thus to be exerted, when thinking about possible reforms of local tax systems, in the choice of proper taxes. Analysis of the existing tax systems shows that most industrial countries rely alternatively for the financing of their local governments on two kinds of taxes, namely, the personal income tax and the property business tax. The personal income tax is very attractive from the local government’s point of view. Its potential revenue is large and buoyant. Some provisions have to be made, however, in order to face some of the problems created by their use at the local level, like the disparities in their potential and their procyclical character.

Some countries that have used the property tax for a long period, like the United Kingdom and Ireland, tried to replace the tax with other instruments but have reverted to it subsequently. Many Mediterranean countries have recently decided to increase their reliance on this kind of tax for financing their local governments.

Some attention has been devoted to business taxes, which are still (or even increasingly) popular in continental Europe, as a way to balance tax revenues coming from individuals with those levied on businesses. This balancing allows equalization of the tax potential of residential areas with that of industrial and tertiary areas. While implementation may pose difficulties in developing countries, such taxes may be thought of as a proxy for the use of local services by businesses.

Box 4.Four Main Forms of Automotive Taxation for Local Governments

  • Fuel taxes. Fuel taxes consist of levying an additional fuel tax over and above the national tax accruing to the central government. Local fuel taxes may be used for controlling congestion costs, that is, for restricting vehicle use on congested streets. Their main advantages, however, reside in their considerable revenue potential, even by applying moderate rates and the moderate cost of administering them, especially if the production and distribution of fuel is made by a government-owned company, as is the most frequent case in developing countries.

  • Taxes on sales and transfers of motor vehicles. In many developed countries this kind of automotive taxation takes place through stamp and registration taxes that are administered mainly at the central level. One may conceive of local governments utilizing this tax base. The revenue potential is substantial but clearly lower than that of the third form of taxation.

  • Annual license taxes. These are taxes levied annually on the ownership or on the use of motor vehicles. Even with moderate rates, these taxes may substantially contribute to the financing of local governments.1 They require careful administration, however, in order to avoid evasion.

  • Congestion taxes. This fourth category consists of a variety of instruments, like area- and time-specific taxes designed to address congestion problems. Parking fees and tolls form part of this category, but the revenue potential is clearly smaller than that of the preceding ones.

For example, Bahl and Linn (1992), p.202 show that in Jakarta the motor vehicle license tax accounted for approximately 33 percent of all local taxes for fiscal year 1986.

Less uniformity in local taxation is shown by developing countries, which are usually; more centralized than the industrial ones. Revenue needs of local governments are extremely high, especially in the large cities. Their satisfaction requires, among other things, modernization, if not simply the creation, of a local tax system. This paper has stressed the potential of property taxes and automotive taxes for local revenues.

For both industrial and developing countries—and for countries that are presently engaged in the transition from socialist to market economies—user charges and fees are an extremely productive source of revenue and an efficient one. One can observe an increased reliance on them in a number of countries.


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University of Torino, Italy.

Most of the other sources of revenue for subnational governments in Germany are shared taxes.

This is the case of the octroi, a tax levied on goods entering a city for the purpose of local processing or final consumption. It may curtail domestic trade and surely increase the price of “locally imported” goods.

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