Tertiary education in the U.S. requires large investments that are risky, lumpy, and well-timed. Tertiary education is also heavily subsidized. By making the risk of human capital investment more acceptable, especially to low wealth households, subsidies may increase investment in human capital, lower long-run inequality, and reduce aggregate precautionary savings. However, subsidies also encourage more poorly prepared students to attend and are usually financed via distortionary taxes. In this paper, we find that observed collegiate subsidies improve welfare substantially relative to the fully decentralized (zero subsidy) outcome. We show that subsidies help smooth consumption, lower skill premia, increase interest rates as precautionary savings fall, lower the inequality of both consumption and wealth, increase intergenerational income mobility and raise welfare, even when financed by distortionary taxes.
Konstantin Sonin, Centre for Economic Policy Research (United Kingdom)
In a federal state, political leaders of constituent units might protect their enterprises from the federal center (e.g., allowing them not to pay federal taxes). The effectiveness of such protection depends crucially on the ability of local authorities to extract rents from enterprises. They can easily do so, if there are a small number of enterprises with large employment, and local monopolies can be effectively sustained. They cannot do it so easily if regional industry is competitive, political opposition is strong, and the federal center has enough means to enforce payment of taxes. We build a simple model to argue that it is the industrial structure of constituent units that determines political relations between them and the federal centre. The theory is supported by the recent experience of Russia, China, and Argentina.
Most economists agree that new investments in highways at this point in time in the United States have little impact on overall growth in output. New highways play a more important role in shifting economic activities among places, drawing jobs from other locations into the highway corridors, a phenomenon known as negative spillovers. The objective of this dissertation is two-fold, to examine the proposal to decentralize highway finance, which aims to solve the financial responsibility mismatch problem that stems from economic spillovers of highways, and to test the hypothesis of economic spillovers of highway investment at the metropolitan level. First, to better understand how spillovers influence the highway investment decision, the theoretical framework from the interjurisdictional tax competition literature is borrowed to model governments' investment behaviors. Numerical simulations show that decentralized local governments, which independently maximize output in their own jurisdiction, may engage in wasteful investments in highways with the presence of spillovers. Second, to shed more light on the spatial detail of economic spillovers, empirical tests of the spillover hypothesis are conducted at the metropolitan level, with census tracts as the unit of observation. The results of the quasi-experiment reveal census tract employment growth patterns that confirm the existence of negative spillovers caused by the opening of the Interstate 105 in 1993. The benefiting area, which grew substantially after the highway was opened, is limited to a long narrow corridor around the highway, while nearby locations outside the corridor experienced slow growth relative to the rest of the metropolitan area after controlling for various factors. Together, these results suggest that although negative spillovers are present at the metropolitan level, decentralizing highway finance may not be an effective policy to deal with the financial responsibility mismatch problem. Highway finance should remain centralized within metropolitan areas, and regional governing bodies should pay special attention to the distributional impact of highway projects.
Vertical fiscal imbalance, decentralized responsibility of spending with centralized financing, creates a common pool problem with spending pressure towards central funds. A model of decentralized government spending under vertical fiscal imbalance is developed, and the importance of national political characteristics for internalization of costs and spending level is investigated in an econometric analysis of Norway during 1880–1990. We argue that in a parliamentary democracy, the internalization of costs is influenced by the party fragmentation of parliament. This is confirmed by the econometric analysis using a Herfindahl index as a measure of fragmentation and political strength.
This paper studies optimal earnings taxation in a three period life cycle model where the taxes raised to finance an exogenous amount of public expenditure are allowed to be differentiated across ages. Agents choose their level of education when young and their age of retirement when old. We first look at the problem of optimal taxation when the young can borrow and then turn to the case where young face borrowing constraints. It is shown that, without borrowing constraints, a first best optimum can be decentralized by setting a zero tax rate in the third period and a first period tax lower than the second one.\nWith the borrowing constraint, the government may not be able restore intertemporal efficiency in which case a zero tax rate when old may not be optimal.
An optimal linear world income tax that maximizes a border-neutral social welfare function provides a drastic reduction in world consumption inequality, dropping the Gini coefficient from 0.69 to 0.25. In contrast, an optimal decentralized (i.e., within countries) redistribution has a miniscule effect on world income inequality. Thus, the traditional public finance concern about the excess burden of redistribution cannot explain why there is so little world redistribution.
We provide a model incorporating features of local public finance in Japan, including close fiscal ties between different levels of government as well as bureaucratic determinations of intergovernmental transfers. The discretionary nature of transfers softens local budgets ex post, which exerts perverse incentive effects on local governments ex ante. Fiscal decentralization that assigns more revenue responsibility to the local level serves to counteract this moral hazard incentive. The emphasis is on the endogenous nature of regional fiscal capacities at the local level. Fiscal devolution motivates local jurisdictions to become fiscally independent wherever possible.
In this paper we analyze the optimal degree of centralization for the supply of public goods. We identify the reliance on an exclusion mechanism as a central feature of the decentralized provision of public goods. An exclusion mechanism induces a contest between users of the public goods who want to free ride and the providers who want to exclude free riding. This contest explains the costs of decentralization. A centralized contribution does not rely on an exclusion mechanism to finance the public goods but on taxation which induces different types of transaction costs. A comparison of the relevant distortions explains the optimal degree of centralization of the supply of public goods.
Musgravian" externalities, formulated and illustrated by Musgrave in a 1966 paper on "social goods" are seen in this paper as one form of the interactions that occur between the components of a federation.The original formal apparatus is first exposed briefly.In that context, it is then considered whether and how alternative forms of federal structures are likely to achieve efficiency.Following suggestions from the literature, three such forms are dealt with: "planned", "cooperative" and "majority rule" federalisms.Next, the relevance of non cooperative equilibria is examined, in the light of an interpretation of them as "fall back" positions when disagreement occurs among members of a federation.Finally, the question is evoked of what economics and public finance may have to say on the limits to institutional decentralization, i.e. on the choice between federal, confederal and secessional structures.
The Indonesian authorities are exploring options for the establishment of subnational government endowment funds and the Ministry of Finance (MoF) has drafted regulations in that context. However, the motivations and objective for establishing an endowment fund at the subnational level diverge across various stakeholders. Clarity of the objectives and purpose of the endowment fund will be critical for informing features of its architecture, and the endowment fund should be aligned with the national fiscal policy objectives. Establishing such funds at a time of fiscal deficit entails a “borrowing-to-save” approach which is not optimal from a fiscal policy perspective. Currently, there is a misalignment between the design of inflow and outflow rules, the endowment fund’s objectives, and the fiscal/economic context. In addition, the current draft MoF regulations restrict the investment policy to conform with the law on decentralization enacted in 2022. This report emphasizes that regardless of the structure of the endowment fund, it needs to be fully integrated within the budget. The report also provides recommendations on assessing the full cost of the subnational government endowment fund, its design and implementation, and provides suggestions to improve the draft MoF regulations.
Carlos Eduardo Frickmann Young, Carlos A. Roncisvalle
The objective of this study is to examine the evolution and characteristics of the financing for the nvironment in Brazil, in order to identify the advances and retreats after the Rio 92 Conference. Brazil has a very decentralized administration, composed of three independent levels of public administration: the federal government, 27 state governments, and more than 5000 municipios, " or municipalities; all of them with specific environmental institutions. However, at the time of the completion of this report, there were no indicators that aggregate information from these different institutional levels for the 1992-2001 period.(1) Thus, this study was a first effort to generate this kind of figures. Given the very short time for its completion, the main priority was to identify the resource flows from the federal government and some selected states. Efforts to estimate spending on pollution control and other environmental activities by the private sector were also made. In addition, the issue of funding sources is also discussed. Despite many methodological problems involved in the elaboration of these indicators, it was possible to identify trends and conclusions for environmental spending. At the federal government level, it was estimated that environmental expenditures were between 0.4% and 1% of the federal spending. Another important finding was that, although there was an official commitment to increase efforts in this area after the Rio 92 Conference, the overall federal government expenditures in environmental issues did not increase during the 1993-2000 period. Moreover, a matter of concern was the declining quality of this spending, with fewer resources directed to end-activities and more money diverted to means-expenditures. An important cause of this was the increasing share of debt related expenditures (interests and amortization) in the total budget. On the other hand, investments suffered cutbacks, particularly in the more recent period, and the expenditures in personnel fell systematically by 25% in constant prices during the second half of the nineties. Environmental projects are the most important single element in international cooperation agreements. However, the flow of foreign resources presented a declining trend since 1994, oscillating between 6% and 17% of total expenditures. Most of these resources come from external credit operations (loans), which means that in the long term, they represent an extra pressure of financial expenses in the budget. The proportion of international donations/total expenditures in 2000 fell to the lowest level in the series (2.0%), clearly indicating the decline of international support for environmental projects in Brazil. Results for the 1996-98 period show that, if sanitation costs are included (an overestimate since it also considers water supply), environmental expenditures are relatively more important for local governments: around 9% of the total public spending in the sample of municipios considered. State governments are in the second position, spending around 1.5% of their budget on environmental issues, in contrast to the less than 1% of the federal government. For this reason, there remains a clear need to generate better aggregate figures for the states and municipios for the whole period. The methodologies used for public budgeting and expenditure control vary widely, making it very hard to supply compatible aggregate numbers. In the three states where longer time series were estimated (São Paulo, Paraná and Rio Grande do Sul), there was no consistent trend of increasing expenditures on environmental objectives. Another gap that needs to be fulfilled refers to the private sector environmental spending. There were positive signals which indicated that the private sector is getting more concerned with the environmental issues, particularly those agents that have interests/responsibilities at the international level. It was calculated that the environmental spending of the industry sector was around R$ 160 million per year, slightly less than 1% of its value added. Although it is expected that this number will increase in the future, it is considerably lower than the public sector spending on environmental issues. It is very difficult to aggregate all these figures, but assuming for the year 2000 that the public spending on environmental issues was of 1.5% of the total, the public environmental spending would be of 0.33% of GDP, and an annual expenditure per capita of R$ 22.9 per capita (US$ 9.2 per capita). If the estimated industrial environmental spending (R$ 160 million) is added, the total spending becomes R$ 4.1 billion (0.34% of GDP), or R$ 23.9 per capita (US$ 9.6 per capita). Most of the funding for environmental projects comes from the government (mainly federal, through BNDES), international development agencies, or from companies' own resources. The private financial sector has a minor role on the financing of environmental expenditures but, gain, there are signals of positive changes, with the creation of innovative private funds specialized in environmentally friendly projects that combine financial and "green" interests as an example. The consolidation of economic instruments in international environmental agreements, particularly the Kyoto Protocol on greenhouse gases emissions, may accelerate this new financial market. Another potential source of funding for environmental projects is connected to the implementation of economic instruments in the environmental management system. Command-andcontrol procedures, such as licensing and emission standards, largely dominate the environmental regulation in Brazil. However, some interesting experiences, such as the "green" tax rebound (ICMS verde) and the recent changes in the water resources policy adopting the user/polluter-pays principle, indicate that the role of economic instruments will increase and, consequently, that there is potential for developing self-sustained financial mechanisms to sponsor environmental expenditures. (1) After the completion of this research, the Brazilian Institute of Geography and Statistics (IBGE) published estimates of public spending for the 1996-98 period (IBGE 2001). Whenever relevant, these figures were also added to the analysis, but with an alert that they were obtained using different methodological procedures."
Fernando Filgueira, Herman Kamil, Fernando Lorenzo, Juan Andrés Moraes · 5 authors
This paper analyzes the reasons behind Central Government (CG) bailouts of Subnational Governments (SNGs) in the case of Uruguay. We argued that Uruguay represents a good example of the risks of fiscal decentralization, in the context of adjustment policies, and when SNGs` responsibilities and resources have not been carefully defined. We show that, in unitary countries where SNGs lack the opportunities to misbehave that they have in federal countries (e. g. , public debt issuance, international borrowing), SNG officials find ways to finance deficits through non-compliance with politically contestable obligations. In particular, SNGs in Uruguay finance their deficits by accumulating debts with other government agencies and obtaining discretionary transfers from the CG. Through statistical analyses we show that debts and deficits are mainly related to vertical fiscal imbalances and economic conditions in the SN jurisdictions. Yet, the analysis of recent bailout episodes suggests that institutions and political factors play a role (i. e. , they are important ex-post factors). This implies that bailouts have been more than simple compensations for structural imbalances, thus creating opportunities for strategic behavior on the part of SNG authorities (partly confirmed by the disparate fiscal performance of Montevideo vis-à-vis the rest of the country).
Teresa García-Milá, Timothy J. Goodspeed, Therese J. McGuire
As part of a process of democratization, many countries spanning Europe, Latin Amertica, Africa, and Asia are reorganizing their governments bydevolving fiscal responsibility and authority to newly empowered regionaland local governments. Although decentralization in each country proceedsdifferently, a common element tends to be an initially heavy relianceon central government grants to fund regional spending. We develop atheoretical model of regional borrowing decisions in which the incentivesfor regional borrowing depend crucially on how the regions expect thefederal system of finance to evolve. We examine the implications of themodel using data on Spanish regions for the period 1984-1995 and findevidence that regions may be borrowing inefficiently in response toincentives imbedded in the Spanish system of fiscal decentralization.
Based on cross-country data for up to 78 countries, this paper shows that fiscal decentralization-the assignment of expenditure and revenue mobilization functions to subnational levels of government-is associated with various indicators of governance, such as corruption, rule of law, and government effectiveness. Unlike previous studies in the decentralization/governance literature, which focus primarily on expenditure-based measures of decentralization, the results reported in this paper show that the relationship between decentralization and governance depends on how subnational expenditures are financed. The higher the share in total subnational revenues of nontax revenues and grants and transfers from higher levels of government, the stronger the association between decentralization and governance.
This paper analyzes financial dual track in China. We show that the co-existence of a soft-budget track (under centralized financing) and a hard-budget track (under decentralized financing) can be strictly more efficient than the two pure cases. Our argument is as follows. First, a hard budget constraint alone is not sufficient to induce sound firm performances, positive incentives in terms of firms' profitability are needed as well. Second, for an economy such as China where many firms are hopeless money losers, there is pecuniary externality in financing. That is, the total number of firms financed into operation in the economy can affect the profitability of all firms. This paper offers a number of examples of such externality. In such an economy, centralized financing helps internalize the externality, improving firms' profitability, and yet it leads to a soft budget constraint. Under decentralized financing, budget constraint is hard, but firms suffer from low profitability. A financial dual track does better: the existence of the soft-budget sector improves profitability, enhancing the disciplinary effect in the hard-budget sector. Based on this analysis, the paper sheds light on the complementary relation between soft budget constraint syndrome in the state sector and the remarkable growth of the non-state sector in China
The author studies the \n allocation-between a central government and a local \n authority--of responsibility for planning, financing, and \n operations for the delivery of health services, in the \n context of an incomplete contracts model. In this model, \n inputs are required of both the central government and local \n authorities but they are unable to write down, and commit \n to, a complete and binding contract describing the actions \n both should take. The model is meant to capture the tradeoff \n between central and local authority in decisions about both \n financing and the provision of services. Each party provides \n a specific input--for example, the central government \n establishes a drug procurement system while the local \n authority designs and implements an incentive scheme to get \n doctors to carry out their responsibilities appropriately. \n The responsibility for delivery of services is identified \n with the ownership of essential infrastructure, such as the \n clinic or hospital. The author finds that to maximize the \n joint surplus of the two public bodies: Ownership of the \n facility should be given to the party that most values the \n well-being of local residents. (This way, if ex post \n bargaining breaks down, each still enjoys some benefits from \n the other's actions.) Financing authority and \n responsibility for delivering services should be negatively \n correlated. Generally it is optimal to allocate tax \n authority to the party that values the residents' \n well-being less--in other words, separate spending \n responsibility (ownership) from financing authority. A \n heavier financing burden (access to a small and inefficient \n tax base) has the same incentive effect as asset ownership: \n It increases the return to effort. If transferring ownership \n of the physical asset is costly (because the party that \n builds the asset has an inherent advantage in operating \n it-that is, there is some human capital embodiment), it may \n be optimal for the party with the higher construction costs \n to have planning authority. Somewhat paradoxically, the \n greater the costs of transferring assets from one party to \n the other, the more likely that ownership of the facilities \n and their provision should be separated.
Stan Chervin, Kelly D. Edmiston, Matthew N. Murray
Decentralized systems of government finance give rise to fiscal disparities due to interjurisdictional variations in tax bases and expenditure needs. Intergovernmental aid is used to address such disparities. This article explores changes in local tax capacity and intergovernmental aid resulting from urban shopping malls that extract retail sales and sales tax revenue away from surrounding areas, especially rural counties. A model is developed and estimated to determine the impact of urban malls on local government sales tax bases, controlling for sales tax rate differentials and other factors. The results reveal a 15.9% decline in the sales tax base for counties in close proximity to two newmalls. The analysis is extended to examine impacts of changing local tax capacity on state education aid. Based on the programconsidered here, less than 20% of the loss in own-source revenue is recovered through increased aid.
Guillém López i Casasnovas, Esther Martínez Garcia
The authors analyse the magnitude and composition of the fiscal imbalance between Catalonia and the Spanish Central government for 1995-1998, and its evolution since 1986. A flow approach is adopted, whereas the usual incidence hypothesis is followed in alloating tax revenues. The results show a rather stable net contribution of Catalonia to the Spanish Central government in 1998 of 1.3 trillion pesetas (8.37% of Catalan GDP). Calalonia participated in 19.60 % of Central government revenues, but received only 15.03% of expenditures. Catalan population is 15.5% of the Spanish total. Overall, in 1994 constant terms, the evolution of the per capita imbalance rises from 117,133 PTAs. in 1986, to 192,294 PTAs. in 1998. The authors also introduce an explicit way to deal with the effects of Central government budget deficits on fiscal revenues, in computing the financial distortions of the political and economic central role of Madrid, different tax compliance among regions, the impact of inflation differentials, and the evaluation of the social security flows on regional imbalances. In general, the authors favour an estimation of the amount of revenues at the disposal of Catalonia in order to finance its own expenditure, without the mediation of the Central government, but maintaining a single Spanish fiscal system. This approach may force the contribution of Catalonia as any other region to finance the joint expenditures of the Central government, and/or to finance its owm public sector, but in a rather more dear way. As a result, with regard to the financial decentralization system, territorial solidarity and social cohesion is enhanced, at the same time that autonomy and self-governance,
in a better way than it is today.
This short note provides a framework for looking at public sector governance and productivity improvements. It argues that the role of government in enhancing productivity growth is two-fold. First, government should provide an environment that is conducive in improving total factor productivity in private sector production. Second, government should work to increase the productivity of the public sector itself. In terms of providing the appropriate economic setting that is favorable to private-sector-led development, government needs (1) to provide the macroeconomic and the microeconomic environment that will establish incentives for firms/individuals to act in accordance with the invisible hand had there been no market imperfection, (2) to provide the institutional infrastructure (i.e., property rights, law and order, rules and even application and enforcement of the same) that markets need to work efficiently; and (3) to ensure the financing/provision of adequate basic health care and education, and basic physical infrastructure (World Bank 1992). In particular, the instruments that government may use in this regard are include (1) direct government interventions in the product markets as defined by the regulatory structure in strategic sectors, and (2) economy-wide policies like financial liberalization, trade liberalization, and foreign investments liberalization. On the other hand, (1) budget reform (2) the installation of a system of performance measurement and incentive in the public sector, (3) the re-engineering of the bureaucracy, (4) the combating of corruption, and (5) decentralization are the key features of a program that will increase the productivity of government operations.