Comments on P. Smoke’s presentation

1. Comments on P. Smoke’s presentation Teresa Ter-Minassian

2. Overview • MAIN TAKE-AWAYS FROM PROF. SMOKE’S PRESENTATION • FOCUS ON RESULTS OF A STUDY OF SUB-NATIONAL TAXATION IN LATIN AMERICA

3. Main take-aways from Prof. Smoke’s presentation • There has to be an adequate ex-ante matching of sub-national revenues and spending responsibilities • The appropriate balance between own revenues and transfers is likely to vary across countries, over time, across levels of government and even across jurisdictions within each level • But, a meaningful degree of revenue autonomy is crucial to promote sub-national fiscal responsibility, political accountability and a linkage between benefits and cost of local goods and services • Appropriate sub-national tax handles have various desirable characteristics, but there are trade-offs among them, both on economic and political grounds. Therefore there is no one-size fits all prescription for the tax assignments • The design of inter-governmental transfers is crucial from macro-economic stability, equity and efficiency, and has also important implications for sub-national own tax efforts

4. A broad overview of sub-national revenues in Latin America • Vertical imbalances (gaps between sub-national own revenues and spending) differ significantly across the region, but tend to be large in the majority of countries • The imbalances vary significantly also within each level of government, reflecting both differences in tax capacities and efforts • Generally speaking, own revenues are more significant at the local than the regional level (with the notable exceptions of Brazil and Argentina) • There are also substantial differences across countries in the design of intergovernmental transfers systems

5. Different reform priorities • The diversity of sub-national revenue systems in the region implies different reform priorities • In some countries (most notably Mexico and Venezuela, less so in Bolivia, Colombia and Peru), an increase in sub-national own revenues is needed to raise the overall tax burden, and reduce dependence on revenues from non-renewable resources • In all countries (with the exception of Brazil at the state level) a reduction in vertical imbalances is needed to increase sub-national fiscal responsibility and political accountability • Sub-national tax reforms are needed in many countries to improve efficiency (for example, reduction of predatory tax competition under the state VAT in Brazil; reduction of cascading under the provincial transactions tax in Argentina; replacement of the informality-inducing payroll tax in Mexico)

6. Options to improve the performance of existing sub-national taxes • Elimination of widespread exemptions and incentives • In some cases, increases in tax rates • Improvements in sub-national tax administrations • Modernization of systems and procedures, with assistance from the central government, bilateral donors, and/or multilateral financial institutions • Modernization of property cadastres • Systematic exchange of information with national tax administration (example of Brazil)

7. Assignment of new tax handles • Regional PITs or regional surcharges on national PITs • Main obstacle is the poor state of personal income taxation in the region (too high thresholds, too steep progressivity of marginal tax rates, high degree of labor informality, exclusion of most non-labor incomes from the tax base) • Regional or local retail taxes • Main obstacles: regressivity (in a context of already high reliance on indirect taxation), and atomization of the retail sector • Regional VAT • Main obstacles: difficulties created by interstate trade • Sub-national excises (e.g. on oil, electricity, cell phones, tourism) • Good revenue-raising potential, but possible efficiency costs

8. Reform of transfers • Case studies provide reasonably robust evidence that the design of transfers affects the degree of sub-national revenue effort in the region • Adverse effects of discretionary transfers (and bailouts) on the effort (Argentina, Mexico) • Formula based transfers appear to affect positively own revenues in Peru and Colombia (probably because they boost sub-national incomes and thus own revenue bases) • Thus, transfer reform should concentrate on reducing discretionality, while increasing flexibility of formula-based transfers over the cycle. • There is also a need to refine existing equalization mechanisms in most countries of the region