The following OECD assessment and recommendations summarise Chapter 5 of the Economic Survey of Mexico 2005 published on 12 September 2005.
The division of powers and responsibilities between
levels of government is not ideal
Fiscal relations across levels of government are unbalanced: sub-national governments account for a high share of public spending and have significant autonomy in their borrowing, while their revenue-raising powers are both extremely limited and still under-exploited. The devolution of spending responsibilities has been rapid but incentives to improve efficiency are lacking. Sub-national governments are now managing core public spending programmes (most notably education and health care) but also have a role in infrastructure development and anti-poverty programmes. Interesting experimentation and innovations have emerged locally. In order to improve the outcomes of fiscal federalism, a national agreement defining spending responsibilities for each level of government is needed. This would help reducing overlaps of spending decisions. At the same time the quality of information on actual spending and outcomes should be improved, so as to enhance sub-national government accountability.
Sub-national governments’ share in general government revenues and expenditure
Per cent, 2003 (1)
Notes:
1. Or latest year available: 2000 for Japan, 2002 for Denmark and Mexico. Revenues include direct and indirect taxes as well as non-tax revenues received by regional and local governments and are expressed as a share of revenues received by the general government. Expenditure corresponds to total expenditure by regional and local governments expressed as a share of general government expenditure. Transfers between governments are netted out.
2. Mainland only. Data exclude revenues from oil production.
Source: OECD, National Accounts; Statistics Norway; Statistics Canada; US Bureau of Economic Analysis.
Financing of sub-national governments should be reformed,
to promote cost-effective public services and inter-regional equity
The current financing system of sub-national governments is characterised by: i) a very minor role of sub-national taxes; ii) a heavy reliance on earmarked grants; and iii) a revenue-sharing mechanism which embodies little redistribution across jurisdictions. Generous adjustments in federal transfers over recent years (associated with both the earmarked grant system and revenue-sharing arrangements) including the distribution of a sizeable part of oil excess revenues have reduced sub-national governments’ incentives to raise their own taxes, thus reducing their accountability. In this context, improving the fiscal “pact” would require:
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Raising the volume of sub-national governments’ own taxes. At the municipal level, this would require a better definition of property rights, updating land registers and improving administrative capabilities. At the state level, two options could be considered: further relying on a state surcharge over the federal personal income tax ("piggy-backing"), as allowed in 2005, or introducing a state VAT imposed on the same base as the federal VAT.
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Adjusting the earmarked grant system to promote cost-effective provision of, and equity in access to, public services across jurisdictions. Accountability should be strengthened and outcomes evaluation should be reflected in allocation criteria. The formulae used to allocate money across sub-national governments are largely based on historical costs and actual facilities: they should be changed to reflect objective needs criteria (such as in the education sector, using the number of school-age children instead of the number of schools and teachers). At the same time, it should be made possible to carry over some part of unspent earmarked grants, in particular those for infrastructure.
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Limiting federal transfers to encourage sub-national governments to fully use their taxing powers. In this context, it would be desirable to set a prudent path for federal transfers over the medium term and to increase their predictability by smoothing the impact of cyclical developments and/or oil price fluctuations so as to avoid temporary revenue increases from translating into recurrent sub-national government spending.
All levels of government and the Congress face risks in this process. If the status quo is modified, many sub-national governments could see a reduction in revenues while increasing their own fiscal revenues will have a political cost. Also, the great heterogeneity in socioeconomic conditions between and within states complicates the negotiation process. In consequence, an objective and constructive dialogue must take place in order to come to a sustainable and efficient agreement.
Sub-national financial resources
At 2003 prices, million of pesos
1. Before 1995 data are not available.
Source: CEFP, Indicadores de Finanzas Públicas por Entidad Federativa, 1980-2002; INEGI, Finanzas Públicas Estatales y Municipales de México 1999-2002.
Mechanisms conducive to fiscal sustainability at the
sub-national level need to be strengthened
Although sub-national debt is still generally low, fiscal sustainability is not assured in the longer term. The quality of public finance data is poor and implicit liabilities may be high. Under the new scheme the sub-national governments can use federal transfers as guarantee for the lenders. It would be desirable to set a limit on the extent to which federal transfers can be used as a guarantee. Improving the consistency and coverage of public finance data is also required for financial markets to play an effective role. Although it may be legally and politically difficult to impose fiscal rules on sub-national governments, their use should be promoted.
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For further information please contact the Mexico Desk at the OECD Economics Department at webmaster@oecd.org. The OECD Secretariat's report was prepared by Bénédicte Larre, Stéphanie Guichard and Isabelle Joumard under the supervision of Nicholas Vanston.
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