Decentralization and Intergovernmental Fiscal Reform

Global Experience and Framework for DecentralizationRoy Bahl Dean, and Professor of EconomicsGeorgia State University(rbahl@gsu.edu) Decentralization and Intergovernmental Fiscal Reform Sponsored by the Decentralization Thematic Group, PRMPS and WBI Washington, DC 29-31 March 2004

Why Decentralization • Economic Development • Elected Government • Inefficient Centralization • Uniformity Not Acceptable • Local Government Capacity • Autonomy v. Backdoor Approaches • Poor Service Delivery

The Arguments for Fiscal Decentralization • Moves Government closer to the People • Can improve Revenue Mobilization • Better Size Distribution of Cities

Can Local Governments Capture these Benefits? • Elected Councils • Chief Local Officers • Local Taxing Powers • Significant Expenditure Responsibility and Autonomy • Adequate Tax Administrative Capacity

The Arguments for Fiscal Centralization • Macroeconomic Control, Stabilization Policy • Direction of Investment in Social Overhead • Equalization Potential • Central Competence and Honesty • Reduces Central Bureaucratic Control

Do Countries Decentralize? • Empirical Evidence • Determinants • Industrialization • Economic Development • Size • Diversity • War

How To Do Decentralization 12 Rules For Implementation 8

Rules 1. Intergovernmental Fiscal Relations (Fiscal Decentralization) is a system, and all of the pieces must fit together.

What Is Fiscal Decentralization • Expenditure Assignment / Autonomy • Revenue Raising Powers • Borrowing Powers • Local Elected Councils • Civil Service Rules • Fiscal Relations Among Governments

Rules (Cont’d) 2. First, fix the assignment of expenditures, then assign revenues in amount that will correspond to the expenditure needs.

Rules (Cont’d) 3. Begin fiscal decentralization with a strong central ability to monitor.

Rules (Cont’d) 4. One system will not fit the urban and rural sectors.

Rules (Cont’d) 5. Accountability of local government officials requires significant local fiscal autonomy. Urban local governments must have some taxing powers.

What Is A Good Tax? • Adequate • Elastic • Equitable • Administratively Feasible • Neutral • Politically Acceptable

What Makes A Good Local Tax? • Adequate, Significant Revenue Yield • Stability of Revenue Yield • Correspondence Between Revenue Burden • Administrative Feasibility

How Should Revenues Be Assigned? • Value Added Tax • Foreign Trade Taxes • Business Income Tax • Individual Income Tax • Excises • Retail Sales Tax • Motor Vehicles • Property Tax • User Charges • Borrowing • Commercial Ventures

The Property Tax: Advantage • Revenue • Local Burden • Not Regressive • Benefit Tax • Land Use Effects • The Devil We Know

The Property Tax: Disadvantages • Little Revenue • Difficulty And Costly Administration • Judgmental Assessment • Tax On Unrealized Income • Visible • Difficult To Enforce

Rules (Cont’d) 6. The central government must honor its commitment to decentralization by following the rules it makes.

Rules (Cont’d) 7. Keep it simple. Precision in tax administration and grant distribution is probably not possible in most cases.

Rules (Cont’d) 8. Grants and shared taxes must play an important role in almost any decentralized fiscal system in a developing or transition country. Transfers may be designed as more centralized or more decentralized.

Rules (Cont’d) 9. There is an intraprovince dimension to intergovernmental fiscal relations and this should be taken into account in planning the system.

Rules (Cont’d) 10.Impose a hard budget constraint.

Rules (Cont’d) 11. Recognize that intergovernmental systems are always in transition, and plan for this.

Rules (Cont’d) 12. There must be a champion.

The Champions of Fiscal Decentralization 28

The Champions of Fiscal Decentralization (Cont’d) 29

Decentralization and Intergovernmental Fiscal Reform