March 24-26, 2003 Robert Ebel World Bank Institute Decentralization

1. Subnational Revenues & Intergovernmental RelationsDecentralization and Intergovernmental Fiscal Reform March 24-26, 2003 Robert EbelWorld Bank Institutewww.Decentralization.org

2. Organization of Remarks • Issues in Sequence • Assignment of Revenues Among Governments • Policy Framework/Key Principles • Fiscal Architecture • What is a Local Tax? • The Intergovernmental Menu • Linking Criteria with Assignment • Revenue Collection • Key Messages

3. Issues in Sequence • Finance Follows Function: Assign Expenditure Responsibility • Determine Revenue Authority… • ….And the “Fiscal Architecture” • “Own” Revenue Responsibilities at the Margin • Grants and Transfers • Borrowing and Debt • Monitoring and Reporting • Size and Structure of Local Government

4. Assignment of Revenues • Determination of which revenue sources should be assigned to subnational governments and how they are to be assigned • Includes taxes, other revenues, and intergovernmental aid • Concurrent with expenditure assignment

5. Policy Framework • Fiscal equivalence: Each government should finance its own expenditures out of its own revenues to the extent possible. • Subsidiarity in taxation: Assign to the lowest “tier” of government that can administer the tax and for which it is not inappropriate. • Need for mix of local taxes. • No one assignment fits all. • As external factors change, so may policy

6. Fiscal Architecture • Recognizing the “Architecture” of the Demographic, Economic and Institutional Setting • Matrix of Potential Revenue Sources (handout) • Similar Expenditure Needs Exercise

7. What is a “Local Tax” • Who determines whether the tax is to be imposed? • Who determines the nature of the tax base? • Who determines the tax base to which the rate is applied? • Who determines the tax rate applied to that base? • Who collects the revenue and enforces the tax? • Who receives the revenue? • Measurement matters

8. The Intergovernmental Menu Revenue Assignment • 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

9. Criteria & Scope for Local Taxation • Accountability and Transparency • Benefit/Tax-Price Link • Neutrality (Non-distortion) • Taxpayer Equity • Regional (Place) Equity • Reliability, Stability, Buoyancy/Elasticity • Administration and Compliance

10. Accountability: • Local politicians should be responsive to the expressed preferences of the citizens. Voice and participation becomes important. Do Elections Matter? And, need they be local? Implications of the Principle: • Local officials should have the power to determine their “own” tax rates. • What about tax base determination? • And, who should administer the tax base? • The burden of taxes should be borne by local citizens. • The question of “tax exporting”. • Information as key to accountability.

12. AccountabilityBenefits Received Benefit/Tax-Price Link To the extent possible taxes should function as a “price” for the benefits of public services that accrue to the tax payer/citizen — benefit areas (recall expenditure assignment) should be matched with financing areas. Implications • Taxes play a role similar to the quid-pro-quo of a market transaction • Adjust for local and regional variations in preferences for public goods(social welfare functions) • Spillovers (back to expenditure assignment, again) may call for (i) sub-municipal government (e.g., s.d.); (ii) local cooperation (Tripoli, Bangkok, Budapest); (iii) middle-tier governments; (iv) regional authorities. • Efficiency meets equity (rather than conflict)

14. AccountabilityBenefits – ReceivedNeutrality (Non-distortion) Non-DistortionTaxes should not unintentionally interfere with the private decisions of consumers, factor suppliers, and producers. That is they should be “neutral” Implications • The heart of “efficiency in taxation,” that is as difficult to achieve as it is identify Fiscal Architecture . But the guideline matters very much • Variability in rates should be allowed — this does not call for uniform rates • The key issue of price elasticity • Immobile tax bases rank high; “footloose” tax bases are a problem Interjurisdictional Tax Competition: Good or Bad? • Case for uniform tax bases: and watch out for quality of administration

15. AccountabilityBenefits – ReceivedNeutrality

16. AccountabilityBenefits – ReceivedNeutralityTaxpayer Equity Taxpayer Equity This requires that the burden be measured vis-à-vis some agreed upon common denominator of economic ability to pay and/or benefits received. The equity index should be based on economic criteria A Quick Agreement on Terminology Vertical Equity For Persons (Differential treatment of unequals) • Regressivity, progressivity, proportional • A presumptoin for proporitonal taxes • Should subnational units tax wealth” • Benefits taxes regardless of “gressivity (?) Horizontal Equity (Equal Treatment of Equals) • Individuals • Businesses

17. AccountabilityBenefits – ReceivedNeutrality (Non-Distortion)Taxpayer Equity … and Measurement • Individuals: Income and additions to wealth (broad vs. narrow income) • Businesses • Gross Product (if one can estimate it) • The Key issue of multi-jurisdictional apportionment

18. AccountabilityBenefits – ReceivedNeutrality (Non-Distortion)Taxpayer EquityRegional (Place ) Considerations Regional (Place) and Efficiency Local tax bases that are unevenly distributed across jurisdictions are not suited for regional use if they entail large regional inequities. Implications • This calls for good judgment: much is pinned on “what matters” for social fairness and national cohesion (from geographic distribution of natural resources to option demand) • This criterion may contradict the neutrality argument that views immobility of a tax base as efficiency enhancing • But, it is not-inconsistent with the benefits received argument

19. AccountabilityBenefits – ReceivedNeutrality (Non-Distortion)Taxpayer Equity Implications cont’d • Regulation and intergovernmental revenue sharing comes into play; intergovernmental structure and nation building • What about multinational natural resources? (common property problem)

20. AccountabilityBenefits – ReceivedNeutrality (Non-Distortion)Taxpayer EquityRegional EquityStability & Buoyancy Reliability, Stability, Buoyancy/Elasticity Question: what should be the elasticity: “Automatic” changes in Revenues = % Change in Yield Change in some economic base Implications • The tradeoff is evident; stability vs. buoyancy • Not to be confused with “adequacy” • Stability is conducive to competitiveness (private investment) • This topic also goes to the intergovernmental grant pool

21. AccountabilityBenefits – ReceivedNeutrality (Non-Distortion)Taxpayer EquityRegional EquityStability, Buoyancy

22. AccountabilityBenefits – ReceivedNeutrality (Non-Distortion)Taxpayer EquityRegional EquityStability, Buoyancy Administration & Compliance Administration and Compliance Taxes and tax systems should be transparently administered at low cost and without placing an undue burden on the taxpayer (business and individual) Implications • Keep it simple: especially locally • What may be optimal to the economist may simply not “work” • Citizens should have a tax system they can understand and control • “Achilles heel” of subnational Credit-Invoice VAT • Standardized Tax Bases • Cash Flow accounting may be preferable to accruals

23. AccountabilityBenefits – ReceivedNeutrality (Non-Distortion)Taxpayer EquityRegional EquityStabilityAdministration & Compliance Implications cont’d • Easily identifiable (“simple”) tax bases (e.g., turnover, head) may be in conflict with other criteria); but there are some consistencies as well • Complexity may foster corruption

24. Improving Revenue Collections • Contracting out local tax administration • The temptation of the octroi • Why focus on property taxes? • Improve collections of other taxes and fees • Enhance user charges and cost recovery

25. Key Messages • The Nature of “Own” Revenues • The Assignment Question • Then the Fiscal Architecture • Which Revenue Source and Why • Balancing the Policy tradeoffs • Administration