Sharing of natural resource revenues

1. Sharing of natural resource revenues Ehtisham Ahmad * * Based on work with Giorgio Brosio. The views in this presentation are personal and do not reflect those of the IMF, its management or Board of Directors.

2. Issues • Instruments choice: assignment of own-revenues from natural resources • Efficiency considerations • Accountability • Macroeconomic issues • What does experience show? • Political economy considerations • Transparency for good governance For discussion of Political Economy considerations see: Ehtisham Ahmad and Giorgio Brosio (eds), 2006, Handbook of Fiscal Federalism; and Ehtisham Ahmad and others: Emerging Issues in Fiscal Federalism (forthcoming) For transparency related issues: IMF, 2007, Guide on Resource Revenue Transparency

3. Stylized facts Characteristics of natural resource exploitation: • Huge geographic concentration of production; • Sparsely populated regions may exercise small weight in national politics; • Large disparities in per capita revenue of subnational units; • “Boomtowns” phenomenon; • Large, but unpredictable, fluctuations of price; • Growing demands from producing area to retain a (large) share of oil rent create pressures, rivalries and strain on national unity.

4. Instruments for sharing “economic rent” between levels of government • Separation of taxes: for example, royalties to subnational governments and income tax to central government, or vice versa; • Concurrence of taxes: each level of government levies taxes on oil rent (tax base sharing); • Revenue sharing: revenue is collected by one (usually, the central) government only and shared to other levels; • In kind sharing: contractors provide infrastructure to the producing areas; • Intergovernmental transfers.

5. Illustration of instruments for sharing rent • Separation of taxes: Ri= tiBi, where collection (or revenue), Ri, is equal to locally determined share, ti, of the locallydetermined tax base, Bi., i is region/state • Concurrence of taxes: Ri =(ti + li) Bi, where Ri are the total collections in jurisdiction i of the shared tax; liis the locally determined tax rate applied to the nationally determined tax base, Bi. Local revenue is ri = li Bi. • Tax revenue sharing: the tax bases, the tax rates and the revenue shares are determined by the central government and the revenue is allocated according to the principle of origin: ri = α t Bi; or, ri = α Ri.

6. Instruments for sharing rents from petroleum with subnational levels of government

7. Choice of Sharing Instruments Arguments against subnational taxation of oil rent: • Complexity of administration: collection by the most efficient means higher revenue; • Delays in revenue accruing to the center • Possible secessionist trends. Arguments in favor of subnational taxation of oil rent (the point of view of LGs): • Benefits associated with taxing power; • Direct control of revenue • North American models—USA and Canada.

8. Choice of Sharing Instruments Arguments against concurrent taxes • Vertical tax competition can lead to greater overall tax burden; • This applies especially to royalties. • Complexity in coordination and administration

9. Assignment of natural-resource revenue to subnational government Arguments against sub-national assignments (all natural resource revenues) • Inefficiency in geographical allocation of factors of production • location of firms in oil producing areas with no comparative advantage; • Inefficient spending due to limited absorption capacity • More resources than needed in Arauca (Colombia); Cajamarca (Peru) • Possibilities of sub-national corruption; • Volatility in prices: sub-national governments generally less able to absorb.

10. Assignment of some revenue to subnational government Arguments for assignment (of some revenues, e.g., production excises) • Localities should finance additional costs of investment in infrastructure. • Peak load pricing: expansion of capacity paid by those who use it • Compensation for environmental damage • Examine adequate instruments for these purposes.

11. Choice of sharing Instruments Revenue-sharing is most used : • Political-economy rationale—automatic sharing in national resources • But, difficult to agree on sharing percentage • Acheh discussion • Could enhance regional inequalities • Usually considered as part of a “package”

12. Revenue sharing: Alleviate or exacerbate political conflict? • Sharing the “pie” stokes conflict (Nigeria) • Symmetric and contract federalism: • construction of national infrastructure by resource-rich jurisdictions; • Sharing of revenues with all levels of governments (not only states/regions) • Districts/Municipalities may have different political objectives (Indonesia); • Central government could use intersecting policy instruments, • such as “trade and commerce” clause to build unity • Concurrent use of instruments, including redistributive transfers • Ensures that all regions and governments have stake in the union— • with federal management of natural resources

13. What is the experience?

14. Issues • What is the practice of sharing of oil-revenue rents in multi-level countries? • What do the numbers tell us? • How to ensure transparency and equitable distribution? • Political economy and maintenance of national unity

15. Instruments to collect natural resource economic rents • Instruments (as explained in the previous lecture) • Auctioning of exploration and exploitation rights • Government equity in projects • Production sharing • Taxes/royalties • The best strategy for the government depends on its degree of risk aversion. • Political economy constraints are important; and • A combination of instruments may be needed.

16. Tax instruments • Fixed fees • Specific (or, ad valorem) royalties • non-neutral but largely used • Income tax with-higher-than normal tax rate • Progressive income tax • Resource rent tax • almost neutral allows extraction of total rent

17. Instruments for sharing rents • Separation of (own) taxes • Concurrence of taxes (tax base sharing) • Revenue sharing • Intergovernmental transfers

19. Sharing of oil revenues • Considered, or adopted in many parts of the world (Nigeria, Indonesia, Sudan) • Political economy arguments widely used • Finance basic expenditures • “persuade” oil producing regions to stay in the federation—political economy • Could finance infrastructure in other regions: national cohesion

20. Revenue-sharing mechanisms • Oil revenue is collected centrally and redistributed according to a formula • Convenient way to transfer fiscal resources to subnational governments • Can be supplemented by transfers to address equalization concerns or special regional needs • But: • drawbacks for macroeconomic management, including volatility; and • May exacerbate tensions and conflict.

21. Difficulties with oil-revenue sharing • Volatility with respect to price (and production) changes • Difficulty in establishing a percentage • Indonesia and Nigeria • May generate unsustainable spending in upturns • Inadequate revenues for basic spending in downturns • Inefficiency in geographical allocation of factors of production • Location of firms with no comparative advantage

24. Assigning Revenue Bases • Assignment of specific oil revenue bases to subnational governments • Tax bases may be overlapping • Subnational governments are accountable • National equalization system may take oil revenue into account by not providing or limiting equalization transfers to oil-rich regions • Examples: Canada, United States

25. Assigning revenue bases (II) • Cover additional costs of investment in infrastructure: • expansion of capacity paid by beneficiaries • Compensation for environmental damage • environmental excise directly linked to production

26. An oil fund/ “Alaskan dividends” • Providing dividends to citizens directly • Idea of “dividends” appears politically appealing, especially if • Assets managed externally • BUT

27. “Alaskan fund/ dividends” • With significant deficits, diversion of oil revenues would exacerbate catastrophic fall of spending (e.g., proposals for Iraq) • especially with limitations on • Borrowing • Non-oil revenue sources • May lead to a reduction in needed investment or other priority public expenditures • Amounts to be distributed as dividends would be small (especially if there are considerable external debts)

28. “Alaskan fund/ dividends” (contd.) • May be difficult to target, • Political economy of by passing weak administration may not be effective— • Still need to be administered • Possibly weaker oversight of fund • May generate a parallel budget, with poor transparency and oversight • Would take years for the dividend to grow into any significant payments

29. Ensuring transparency • All revenues through central account of Treasury (TSA) • If stipulated; • Regional shares to regional TSAs from Central TSA • Transfer mechanisms clearly defined (discussed by Boadway) • If Stabilization Fund, all resources through budget, and no spending without appropriations • “Norwegian” model

30. Accountability and transparency • Financial management system design: • Transparency code • Penalties for misreporting and misuse • Probability of detection and oversight • Independent audit (EITI) • Information flows • Centrally determined formats for • Budget classification (GFS2001 and UN COFOG); • Tracking and reporting expenditures • Managing cash • Importance of Treasury Single Accounts • Setting up separate funds could weaken transparency # Not inconsistent with decentralized operations

31. Consistent reporting and transparency • Principles common to all level of governments and agencies • Need for timely and complete information on the finances of subnational governments, as well as of the center: • Including information on oil revenues • Assurance through improvement in reporting and audit mechanisms • Require work on the budget classification, common reporting formats

32. Macroeconomic considerations • Focus on non-oil revenues • Resources as wealth: consume revenues consistent with permanent income expectations • Ossowski and Barnett (2003) in Davis et al • Better position on the macroeconomic stance, risks and long-run sustainability • Evaluation of fiscal risks and contingent liabilities; • including from sub-national operations • PPPs: evaluate full costs and benefits

33. Do resource related Funds help? • Kuwait future generations; Iran • Preconditions important: • Clear operational rules and responsibilities • Presentation of fund operations to Legislature together with regular budget • No direct spending from the Fund (everything to be appropriated in the budget) • Activities reported to Parliament • Neither Kuwait not Iran meet these conditions

34. “Norwegian style” stabilization fund • Clear oversight of investments • Subject to strict reporting and audit • Prevents parallel budget arrangements • Transparent mechanisms, but difficult to replicate with weaker political systems

35. Conclusions • Various instruments available for “maximizing” the government’s take • Institutional arrangements vary—political economy driving factor • Efficiency, revenue and macroeconomic considerations important • Ensure transparency and good governance