The distribution of competencies between the different levels of a federal system may have remarkable effects on economic growth, because mainly the regions of a country contribute to national economic development. Thus, a governments economic policy is reasonably shaped along regional lines. The theoretical discussion in economics focuses however on the efficiency aspects of a decentralized provision and financing of public services; rarely the argument is raised that decentralization or federalism increases growth through a higher ability of the political system to innovate and to carry out reforms. After a discussion of the theoretical arguments on federalism and growth, we address the empirical question in this paper how important the assignment of decision making competencies and the design of fiscal federalism are for economic development. Finally, on the basis of existing theoretical and empirical studies on economic growth and federalism, open questions and possible ways of answering them are presented.
This note presents the methodology and \n findings of a field study on the financing needs of \n Madagascar's communes-the country's lowest but \n most institutionally advanced level of subnational \n government. Following a first round of municipal elections \n in 1995, more than 1,500 communes are now formally \n responsible for maintaining basic administrative services \n and social and economic infrastructure, including local \n waste disposal and sanitation. In addition, communes are \n responsible for identifying and coordinating local \n investments and for supporting implementation of the \n national Poverty Reduction Strategy at the local level. To \n finance these activities, communes receive population-based \n transfers and small conditional transfers, and can collect \n revenue from property, market, and consumption taxes as well \n as user charges. Yet little is known about how much these \n fiscal assignments satisfy local needs. As part of its \n policy dialogue with the government of Madagascar, the World \n Bank is engaged in extensive research that includes \n geographic mapping of social spending and a review of \n opportunities and obstacles to fiscal and sectoral \n decentralization. This research generated the following \n analysis of local and cross-sectoral service needs and \n available financing.
Die Kompetenzverteilung zwischen den verschiedenen Gebietskörperschaftsebenen eines föderativen Staates kann sich erheblich auf das Wirtschaftswachstum auswirken, da es insbesondere die Regionen eines Landes sind, die zu seiner gesamten wirtschaftlichen Entwicklung beitragen. Dies legt einen regionalen Zuschnitt der staatlichen Wirtschaftspolitik nahe. Aus ökonomischer Sicht wird in der theoretischen Diskussion hingegen vornehmlich auf die Effizienzaspekte einer dezentralen Bereitstellung und die Finanzierung öffentlicher Leistungen abgehoben. Selten findet sich das Argument, dass Dezentralität oder Föderalismus – vermittelt über eine höhere Innovationsund Reformfähigkeit des politischen Systems – zu einer Steigerung des Wachstums führen. Nach einer Diskussion der theoretischen Überlegungen zu Föderalismus und Wachstum wenden wir uns in diesem Beitrag der empirischen Frage zu, welche Bedeutung die Zuordnung von Entscheidungskompetenzen und die institutionelle Ausgestaltung des fiskalischen Föderalismus für die wirtschaftliche Entwicklung eines Landes haben. Auf Basis der bisher existierenden theoretischen und empirischen Studien zu Wirtschaftswachstum und Föderalismus werden offene Fragen und mögliche Ansätze zu ihrer Beantwortung formuliert. <bold>Abstract</bold> The assignment of competencies in a federal state can have a strong impact on economic growth, because the regions of a country particularly contribute to its total economic development. Hence, public policy should be tailored to regional needs. Public economists however mainly focus on the efficiency of decentralized public goods provision and financing; seldom arguments concerning political innovation due to a decentralized experimentation of policies and its impact on economic growth are considered. After a discussion of theoretical arguments on federalism and economic growth, the empirical question is addressed in this paper whether the assignment of autonomy and the institutional design of fiscal federalism influence economic development of a country. On this basis, open question and potential routes of research are formulated.
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.
This paper assesses the impact on local government budget of the rearrangement of central-local fiscal relationship under proposal in Japan, or the so-called Trinity Reform, where it is proposed that some of the tax base be handed from the central to the local governments, in conjunction with drastic cut in both transfer of the tax revenue and a collection of subsidies. The tool used for this objective is the Nagoya City University Econometric Model (NCUEi 2003) whose core system has been duly modified to simulate proposals, and also to investigate the performance of the local economy under the strain of declining and aging population. The object case taken up in this paper is Nagoya City.The model is characterized by the market adjustment of the regional total demandsupply balance, where the age distribution of the population is incorporated so as to assess the impact of the demographic change both on the total demand and productive capacity. The forecast and simulations show that while the abovementioned Reform generates persistent unfavorable impact to the local government, the dominant negative impact comes from the demographic change, in terms of the primary balance of Nagoya City. Unless proper measures are to be taken, the simulations indicate, the local government's fiscal soundness will hardly be maintained under the two major pressures, one from the fiscal decentralization as represented in the subsidy cut-cum-tax base transfer and the other from the demographic change. The simulation of the abovementioned reform reveals that it definitely worsens the primary balance of the locality, and implies that practically an additional transfer of consumption tax must accompany this reform, even for one of the most favorable localities like Nagoya where its major industrial sectors, or the automobile-industry-led industries in this case, are steadily growing. The implication will be obvious for localities where economy is less favorable.
Decentralization is commonly championed as a means for achieving equity. To date, however, there has been little discussion of the mechanisms underlying this relationship, and several of the few empirical investigations that have addressed the topic have found the converse; that decentralization has exacerbated inequalities. This article examines the performance and equity in financing of the Honduras Ministry of Health's (MOH) decentralized user fee system. The MOH of Honduras established a national user fee policy in 1989. It provided a framework of rules and regulations and decentralized administration of the system to the regional offices. A survey conducted under the auspices of this study provided detailed information about the structures and operations of MOH user fee systems. The survey revealed that the systems vary markedly by region, creating horizontal inequities, and that they have numerous other shortcomings. The average price of a consultation is low, US dollars 0.16, and revenues have consistently equalled just 2% of MOH expenditures. The systems' administrative costs are equal to 67% of their revenues. Eliminating the user fee systems in all but the national and regional hospitals would actually save money and/or enable the MOH to provide more care. Average consultation prices are highest in health posts, intermediate in centres and lowest in the national hospitals, thereby encouraging the inappropriate use of the MOH's pyramidal referral system and fostering MOH inefficiency. Fee levels and exemption practices are horizontally and vertically inequitable. The likelihood of paying for an ambulatory visit is highest at a health post, 89%, and lowest at a hospital, 49%. Individuals from the poorest one-fifth of households are the most likely to have to pay for care. Honduras' experience demonstrates that a decentralized user fee system is not necessarily equitable, and that, more generally, the gains that can be realized from decentralizing user fee systems are not automatic. They must be anticipated, planned for and cultivated by a well-designed and well-implemented initiative that is not a single, one-time event, but rather a dynamic, on-going enterprise.
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.
Bob Searle, Jun Ma, Stefano Piperno, Ehtisham Ahmad
Intergovernmental equalization grants have been described as “the glue that holds a nation together.” Getting the grants system right is critical to countries as they decentralize. This paper illustrates general principles with an example based on Indonesia in 2000. A general grant should be used to supplement own revenues and to finance local service provision where there are no central mandates. The special needs of backward regions would be better provided for by specific grants. Specific grants need to be taken into account in the general grants scheme.
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.
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.
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).
The decentralisation of educational administration in Indonesia has recently been the focus of much interest throughout the Asia-Pacific region. With its massive population and multi-ethnic social background, Indonesia serves as an interesting example when considering the real impact of decentralized systems on the financing of Junior Secondary Education in developing countries. In this paper, first, the decentralisation scheme and the current financial budgeting system at the school level of junior secondary education in Indonesia are outlined. Second, a quantitative analysis of the unit cost among provinces, districts and schools is detailed. Finally, policy tasks for the further development of decentralised administration will be identified. Even under the former centralised regime, each school or district was operating in a varied way, while it is also true that the process of this diversified financial budgeting was not always a strategic one.
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.
The paper provides information and analysis in support of the Bank's subnational development strategy (GN-2026). The strategy will guide future Bank operations in support of decentralization to address the complex issues countries are facing in their efforts to promote the socioeconomic development in subnational territories. The document is divided in three sections: the first section provides an overview of the decentralization process in Latin America and the Caribbean and sets the stage for an analysis of the key isuues that need to be addresses by the Bank when supporting the decentralization process in the region; the next chapter discusses the challenges confronted by subnational governments. The development of subnational governments is key to improving well-being. The next section focuses on the structure of intergovernmental relations and concludes that a well-designed structure provides subnational governments with incentives to efficiently allocate resources to the most socially profitable uses. The next chapter discusses the governance issues involved in decentralization, while the next section concentrates on the institucional aspects of the institucional aspects of decentralization and concludes that the Bank should emphasize the need for subnational governments to have sufficient institutional capacity at socially acceptable levels of performance. Finally, the last chapter discusses the variety of issues related to financing subnational governments and recommends that the Bank stress the paramount importance of sufficient sources of financing for ensuing good subnational government performance.
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
After the 1988 Constitution, as a consequence of an unplanned decentralization process, the increase of social expenditures by local governments has contributed to aggravate the financial situation of these governments. This aggravation poses a serious problem to the financing of social policies, thus threatening their future implementation and implying the worsening of social inequalities. This paper discusses the decentralization process of public policies and the federative equilibrium in Brazil.
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.