Tax Assignments Jorge Martinez-Vazquez Georgia State University

1. Tax AssignmentsJorge Martinez-VazquezGeorgia State University Intergovernmental Fiscal Relations

2. DEFINITION OF REVENUE ASSIGNMENT • What taxes should be assigned to different levels of government? • How should these arrangements be implemented? Intergovernmental Fiscal Relations

3. Purposes of Tax Assignment • Provide subnational governments with revenues they can control to implement their expenditure responsibilities (improved resource allocation) • Own taxes and levies • Shared taxes Intergovernmental Fiscal Relations

4. Purposes of Tax Assignment(cont.) • Increase the accountability and responsibility of subnational government officials to their constituencies • Subnational governments can significantly affect their total revenues at the margin through their choices of taxes, bases, or more preferably tax rates • Subnational governments should operate with a hard budget constraint. Revenue sharing and grants should be infra-marginal funding. The expansion (or contraction) of the budget should remain a subnational government responsibility Intergovernmental Fiscal Relations

5. Purposes of Tax Assignment(cont.) • Macroeconomic stabilization and redistribution of income should be generally left as responsibilities of the central government Intergovernmental Fiscal Relations

6. DESIRABLE FEATURES OF SUBNATIONAL TAXES • Linkage between taxes and benefits derived from local government services (using the “benefit principle”) • Employ user charges and fees whenever possible: for excludable and individual benefits. (User charges act as quasi-prices by rationing and signaling demand and they tend to be fair) • For public services with generalized benefits use “consumption and residence-based” taxes if benefits are provided to individuals and “production and origin-based” taxes if benefits are provided to businesses Intergovernmental Fiscal Relations

7. DESIRABLE FEATURES OF SUBNATIONAL TAXES(Cont.) • Administrative feasibility • Administration costs and compliance costs (time and money employed to file taxes) and political acceptability are taken into account Intergovernmental Fiscal Relations

8. DESIRABLE FEATURES OF SUBNATIONAL TAXES(Cont.) • Revenue stability and revenue elasticity • Subnational governments typically cannot run deficits and have more limited ability to borrow. More unstable sources should be assigned to the central government • Subnational revenues should increase with income as much as the demand for services Intergovernmental Fiscal Relations

9. DESIRABLE FEATURES OF SUBNATIONAL TAXES(Cont.) • Minimizing excess burdens and distortions in the location of economic activity • Unlike revenue burdens, excess burdens are avoidable losses, which arise from people trying to avoid taxes by working less, changing the level and composition of consumption and investment, etc. • Taxes levied at the origin of production or source of income tend to distort location more than taxes on consumption or place of residence Intergovernmental Fiscal Relations

10. DESIRABLE FEATURES OF SUBNATIONAL TAXES(Cont.) • Controlling tax exporting (taxes are paid by non-residents who derive no benefit) • Tax exporting can lead to over spending • It is unfair and undermines accountability Intergovernmental Fiscal Relations

11. DESIRABLE FEATURES OF SUBNATIONAL TAXES(Cont.) • Preventing predatory tax competition • By jurisdictions that provide a haven to smugglers, those that misstate residence, or practice profit shifting through transfer pricing • However, there is also “healthy” tax competition, as when taxpayers relocate to enjoy a preferable package of taxes and public services Intergovernmental Fiscal Relations

12. THE CHOICE OF SUBNATIONAL TAXES • There are hardly any taxes that comply with all the desirable features for subnational taxation • But clearly, there are better and worse tax assignments Intergovernmental Fiscal Relations

13. THE CHOICE OF SUBNATIONAL TAXES(cont.) • At minimum tax assignments should provide: • Autonomy at the margin • Stable assignments over time • Sufficient revenues for the wealthiest subnational governments to be fiscally autonomous Intergovernmental Fiscal Relations

14. COMMON PROBLEMS WITH REVENUE ASSIGNMENTS • Vertical imbalance (inadequate correspondence between expenditure responsibilities of subnational governments and their assigned sources of revenue) • Tax autonomy and increased use of subsidiarity in taxation (taxes should be assigned to the lowest level of government that can implement them) are preferable to transfers Intergovernmental Fiscal Relations

15. COMMON PROBLEMS WITH REVENUE ASSIGNMENTS(cont.) • Lack of meaningful tax autonomy • Predominance of shared taxes and transfers • Unstable Assignments • Assignments are decided in the annual budget rather than stated in the laws and fixed for a number of years Intergovernmental Fiscal Relations

16. COMMON PROBLEMS WITH REVENUE ASSIGNMENTS(cont.) • Wrong incentives and lack of uniformity: the “regulation” of taxes • Tax assignments are customized for each local government to fit a “minimum budget” • Confused system resulting in the misallocation of resources and significant administration and compliance costs Intergovernmental Fiscal Relations

17. COMMON PROBLEMS WITH REVENUE ASSIGNMENTS(cont.) • Unfair apportionment of tax revenues among subnational jurisdictions • The exclusive sharing of taxes on a “derivation basis” (usually paid at the headquarters of the firm) leads to the unfair allocations of VAT and CIT revenues Intergovernmental Fiscal Relations

18. COMMON PROBLEMS WITH REVENUE ASSIGNMENTS(cont.) • Large horizontal disparities • The uneven distribution of tax bases requires the introduction of equalization grants • The problem is more acute with the sharing of natural resource taxes Intergovernmental Fiscal Relations

19. CHOICES IN PROVIDING TAX AUTONOMY • Which taxes should subnational governments be allowed to levy? • Closed lists are preferable to freedom to legislate new taxes (less complexity, fewer inequities and distortions) Intergovernmental Fiscal Relations

20. CHOICES IN PROVIDING TAX AUTONOMY(Cont.) • Discretion or not to modify tax bases • Discretion also leads to complexity and inequities • Surcharges or taxes piggybacked on a central government tax base are easier to administer Intergovernmental Fiscal Relations

21. CHOICES IN PROVIDING TAX AUTONOMY(Cont.) • Discretion to set the tax rate is the simplest and most effective form of tax autonomy • National legislation can set, when desirable, maximum and/or minimum rates Intergovernmental Fiscal Relations

22. CHOICES IN PROVIDING TAX AUTONOMY(Cont.) • Separate tax administrations for subnational governments may be desirable but are not always necessary if incentive compatible arrangements between levels of government are set in place • Tax sharing does not contribute to subnational revenue autonomy Intergovernmental Fiscal Relations

23. CHOOSING AMONG DIFFERENT TAXES AT THE SUBNATIONAL LEVELS • Good choices for local (municipal) governments • Fees and user charges • Real estate property tax • Betterment and improvement levies • Vehicle and transportation taxes • Piggyback flat rate personal income tax Intergovernmental Fiscal Relations

24. CHOOSING AMONG DIFFERENT TAXES AT THE SUBNATIONAL LEVELS (Cont.) • Good choices for regional governments • Piggyback flat rate personal income tax • Piggyback for selected excises • Business value tax (BVT) falling on wages and profits • A regional VAT, if tax administration is adequate, is superior to a retail sales tax. Intergovernmental Fiscal Relations