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Decentralization and Tax Competition

Decentralization and Tax Competition. Luc Leruth Offices in Europe, IMF. Decentralization in a Principal-Agent context.

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Decentralization and Tax Competition

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  1. Decentralization and Tax Competition Luc Leruth Offices in Europe, IMF

  2. Decentralization in a Principal-Agent context • The National Government (the Principal) has devolved responsibility for collecting certain taxes (and expenditures) to sub-National Governments (the Agents) – Sometimes (US) it is the opposite!; • Hopefully, it devolved those taxes that the agents are best placed to collect (it knows better); • But the Principal wants to check (to gather information), … • To avoid pitfalls (like excessive borrowing leading to bail-outs), … • And perhaps to punish (through lower transfers).

  3. The good things about it • Decentralization tends to be more efficient; • It induces responsible behavior; • It increases the information flows (better accounting), especially with piggy-backing; But one should not expect a fully efficient outcome as controls entail costs.

  4. The less good things • Increased decentralization has tied up the hands of all levels of government, thus limiting their room for maneuver; • It has led to the occasional abuse by the center (devolving a white elephant or either level of government breaking the contract); • It has forced bail-outs on national governments who had promised not to offer any. This is part of the price to pay for the increased efficiency generated by a principal-agent relationship.

  5. The bad things that have not happened (yet) • Empirical evidence shows that vertical tax rate competition has remained limited (although it exists); • As sub-National governments took over more responsibilities, the fiscal base has tended to remain stable (although an immobile base can eventually become mobile). This partly reflects that the environment in which decentralization has taken place was largely stable and predictable. It may not hold in a more volatile environment with shocks that could affect any level of government.

  6. One example: Nigeria • The economy (and the budget) rely on oil; • Vertically sharing resources is a hard task (especially when the price of oil is low); • Abuja is affected by brownouts every day (so who is responsible?); • Competition for capturing oil resources at all levels leads to difficulties.

  7. In more developed countries The environment can also be affected by shocks that can affect all levels of government, including • Ageing (and responsibility for health care and pensions); • Environment (and water); • Vanishing tax base (trade, difficulty to implement taxation at the source); • Any crisis that would affect the contract between the levels of government and force a change. These could trigger high fiscal costs, on a far bigger scale that the rather mundane environment we have experienced so far, force new taxation measures, and inevitably trigger vertical tax competition.

  8. All doom and Gloom? Thank you?

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