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| HOME > Courses > Fiscal Decentralization > Basic Approaches |
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What Are the Basic Approaches to Fiscal Decentralization? 1.33 Countries do not follow the same path to fiscal decentralization. What they have in common is that they begin by assigning certain functions to sub-national governments. Sometimes this assignment is clear, and sometimes it is quite murky; sometimes it involves major expenditure responsibilities and sometimes it does not. The biggest difference in the approach to decentralization, however, comes on the revenue side. Taxes may be assigned to sub-national governments and may be controlled by those governments, or revenues may be declared as central and shared with the lower levels. The former we call "the revenue assignment approach" and the latter we call "the revenue-sharing approach." 1.34 The assignment approach gives defined expenditure responsibilities and financing powers to sub-national governments. The idea is to define a sphere of financing that "belongs" to the local governments, and then to give them significant autonomy in carrying out these duties and structuring their financing. 1.35 There are gradations of the assignment approach, depending on how much power is given to the local governments. For example, the federal government in the United States grants significant autonomy and responsibilities to its state governments, including the power to levy taxes against all major tax bases. A broad range of social service and infrastructure responsibility is assigned to the states. 1.36 In developing and transition countries, more modest revenue autonomy and responsibility is assigned to sub-national governments. Expenditure assignment often involves mostly housekeeping functions for local governments, and very minor local taxing powers. Typically, the functions involved would include markets, refuse collection, street maintenance, recreation, fire protection, and general maintenance of government. The taxes assigned are usually a plethora of nuisance taxes and licenses, and perhaps a property tax. 1.37 Some developing and transition countries do devolve more important functions to the local governments. These include primary education, clinics and basic health care, public utilities and transportation, and at the regional government level, hospitals and universities. In such cases, the financing powers given in developing countries may include some significant non-property tax, such as a tax on payrolls, business assets, some form of a sales tax, or a tax on automobile use. 1.38 The assignment approach works best when there is an approximate correspondence between the expenditure responsibility and the revenue-raising powers, i.e., local government services are locally financed. Intergovernmental grants should then be used to pick up the needs related to equalization and to assure proper investment in government services with significant externalities. In practice, intergovernmental transfers often play more of a role in the financing of local governments. 1.39 The United States is a good example of how the assignment system can work. The United States Constitution places few restrictions on states operations, but otherwise they have freedom to do as they will. In other words, they are assigned all functions that do not violate the Constitution, and they may levy any tax that does not restrict interstate commerce. States have imposed on themselves a constraint that they may not run deficits and determine the rights and powers of their constituent local units. Grants, mainly for externalities and equalization, account for about 20 percent of state and local government expenditures. 1.40 The other approach to fiscal decentralization is the sharing approach. In this case, revenues are mostly central and are shared with sub-national governments. Typically, sub-national governments have little power to choose the tax rate or the tax base. Local governments finance their services largely though intergovernmental transfers. The extent to which this approach leads to any significant degree of fiscal decentralization depends on the importance of expenditure functions that are given to local governments, and to the nature of the intergovernmental transfer system. 1.41 Revenue-sharing can be structured in many ways. Most commonly, the taxes are all formally central and are then shared either on a derivation basis (origin of collection) or as a grant distributed across local governments on some basis such as formula or cost reimbursement. Another version is a piggyback where locals are allowed to add a rate on to the central tax, and receive the full amount raised from the piggyback. 1.42 Tax sharing is widely practiced among developing and transition countries. There seems to be no rhyme nor reason to the choices made as to which tax base to share, as is indicated by the following examples:
1.43 The transition countries also have fiscal decentralization as part of their development plans. The approach is more akin to revenue-sharing than revenue assignment. Typically, all taxes are central, and typically there is sharing of the major taxes on a derivation basis. Local governments may have a claim on the revenues from a tax collected within their boundaries, but they may not change the rate or base of the tax. The tax sharing therefore, is really a form of intergovernmental transfer, where the local government has little formal say in the amount raised (Bahl, 1994). Still this may constitute a form of fiscal decentralization because the sub-national government has discretion in how it may spend these "unconditional" grants. 1.44 There is some indication that transition countries are moving toward the assignment system, and there is some evidence of the beginnings of a piggyback approach. Consider the following examples:
1.45 A feature of decentralization in transition countries that is not often found in other countries is the use of "backdoor" approaches to local government autonomy. Usually because the tax administration service has divided loyalties between the center and local levels, and because the enterprises still have ties to the government, and because tax sharing provides a natural inducement for local government "cheating", local governments often hive off resources from the sharing pool. They do this by providing tax exonerations to enterprises, by moving money into extrabudgetary funds which are not part of the sharing pool, and by encouraging lax administration. The result is a greater retention of revenues at the local level via these backdoor approaches to federalism. This is a major weakness of the sharing approach in the transition countries (Bahl, forthcoming, and Martinez-Vazquez and McNab, 1997). 1.46 Transition countries are in many ways less decentralized than most countries in the world. Among the considerations that lead to less decentralization are the following:
The Revenue Instruments
for Fiscal Decentralization
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Fiscal Decentralization
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