Lessons from International Practices of Intergovernmental Fiscal Transfers

1. Anwar Shah, World Bank Lessons from International Practices of Intergovernmental Fiscal Transfers Anwar Shah, World Bank ashah@worldbank.org, International Conference on Fiscal Decentralization Islamabad, Pakistan, May 3-4, 2006

2. Anwar Shah, World Bank Outline A stylized view of intergovernmental finance in developing countries Grant objectives and design considerations Grants to deal with fiscal gap National minimum standards grants: education, health, infrastructure The practice of fiscal equalization grants Lessons

3. Anwar Shah, World Bank 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.

4. Anwar Shah, World Bank Ironically these perceptions are well grounded in reality in LDCs Primary focus on dividing the spoils Passing the buck transfers – revenue sharing with multiple factors (Brazil, Argentina, Philippines and more) Asking for more trouble grants – deficit grants (Hungary, South Africa, China and more) Pork barrel transfers or political bribes (USA ) Command and control transfers (most countries) Overall: Intergovernmental finance is the dominant source of revenue but creates perverse incentives for fiscal management and accountability

5. Anwar Shah, World Bank No need to despair …. As properly designed fiscal transfers can be part of the solution rather than part of the problem.

6. Anwar Shah, World Bank

7. Anwar Shah, World Bank Transfers to deal with fiscal gap Fiscal Gap: Structural imbalance as a result of a mismatch between revenue means and expenditure needs. Reasons: Inappropriate assign: Reassign Limited tax bases: Allow joint occupancy or tax decentralization. Tax competition: Federal collection and general (not on a tax-by-tax basis) revenue sharing. Tax room lacking: Tax abatement and tax base sharing (Canada ). Practices to avoid: deficit grants; tax by tax sharing.

8. Anwar Shah, World Bank 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; 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.

9. Anwar Shah, World Bank An example : A performance oriented education grant to set national minimum standards and encourage competition and innovation 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

10. Anwar Shah, World Bank Indonesia - Specific Purpose Transfers to Local Governments (now defunct) L2. District/Town Road Improvement Grant Length of roads Condition Density Unit cost L3. Primary School Grant School age children (ages 7-12) Needs for facilities

11. Anwar Shah, World Bank Health Care Finance in Canada Health care a provincial matter according to the constitution Federal “spending power” through fiscal transfers help create federal-provincial cooperation and uniform standards of access and care throughout Canada.

12. Anwar Shah, World Bank Federal financing of health care and Social Services in Canada – Canada Health Transfer (CHT) and Social Services Transfer (CST) Equal Per capita cash transfers (plus transfer of tax points - for health and social services and post secondary education in 1977,13.5% points of PIT and 1% point of CIT) Conditions for health care transfer (CHT): (1) Universality (2) Portability (3) Public insurance but public/private provision (4) Opting in and out (5) No extra billing Conditions for CST: All Canadians treated alike for welfare programs. Penalties: Threat of discontinuation for breach of the conditions (1)- (4) above. Dollar for dollar reduction for breach of the condition (5). Sunset clause: Parliamentary review every 5 years.

13. Anwar Shah, World Bank Fiscal Transfers for School Finance Marrying Equity with Performance Orientation: Taxpayer exercised option in Canada Vouchers for schools in Chile and State of Michigan, USA Equity based allocation: four stylized models of states’ transfers to school boards in the USA

14. Anwar Shah, World Bank School Finance in the USA Full state finance: Hawaii, Idaho, Washington ( In NH: only 9%) Block grant (Flat grant): Equal per capita or per student. Sometimes indexed to population, GDP, inflation growth rates (2 states – Delaware and North Carolina) Equalization grants Foundation grants: Grant varies inversely with the fiscal capacity of a school board (42 states– 22 with mini.tax rate) Percentage equalization grant: a matching-cum-equalization grant for school spending (1 state – Rhode Island) District power equalization grant: incentives for increased tax effort embodied in an equalization grant. (2 states – Indiana and Washington)

15. Anwar Shah, 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). But with full capitalization – case weaker as you pay more for private services (housing) and less for public services in richer states and vice versa in poorer states. Hence a matter of political taste (USA perspective) but USA has strong emphasis on equalization in state-local education transfers

16. Anwar Shah, World Bank