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Measuring Fiscal Decentralisation
Concepts and Policies
This book deals with two issues. The first concerns the various measurement of fiscal decentralization in general and their usefulness for policy analysis. The second and more specific issue concerns the taxonomy of intergovernmental grants and the limits of the current classifications.
Chapter 1. Measuring decentralisation: The OECD fiscal decentralisation database
Fiscal decentralisation is notoriously difficult to measure. The common indicators such as the share of sub-central in general government spending or revenue often provide an imprecise or even misleading picture of intergovernmental fiscal frameworks. Since discretion over the budget is a central aspect of fiscal autonomy, the OECD has developed a more refined set of decentralisation indicators over the last decade. This chapter first presents the indicator on sub-central tax revenue autonomy, followed by the indicators which reflect the restrictions attached to intergovernmental grants. The third section establishes the criteria that should help find the dividing line between tax sharing and intergovernmental grants, two fiscal arrangements that are often difficult to disentangle. For illustrative purposes, results are presented for the year 2005. Finally, the results of a pilot study developing a set of spending power – or spending autonomy – indicators for a few OECD member countries are presented.
Chapter 2. On grant policy and the OECD-taxonomy of grants
The chapter addresses two issues. One is to explain why earmarking, so much criticised, still is so much used. The second is to examine whether international grant statistics compare the degrees of local autonomy in a correct way. The distinction between earmarked and non-earmarked grants is the basic feature of the OECD classification of grants. The drivers of earmarking are listed. Among these are the desire of the centre to implement merit wants, and the demand for precise compensation for the costs of new local competences. Next a number of problems in the OECD classification of grants is described. Among these are the unclear treatment of tax sharing revenues, the negative correlation between earmarking and regulation, the need for a grey zone between earmarking and non-earmarking, and the – in some cases large – grants for agent functions. The chapter ends with a summary of issues for improvements of the OECD statistics.
Chapter 3. Measurement of decentralisation: How should we categorise tax sharing?
The empirical studies of the economic effects on fiscal decentralisation depend critically on the correct measurement of decentralisation. And yet the various decentralisation measures conventionally used by researchers do not reflect the complex nature of sub-central fiscal frameworks. In particular, the sub-central share of revenue suffers from the fact that revenue arrangements in many countries consist of tax sharing, with or without in-equalisation. To overcome this problem, the OECD (2009) has developed a set of criteria that identify two types of tax sharing: one with strict tax base proportionality and the other without it. However, this definition still needs further refinement since it does not capture the different degrees of fiscal equalisation embedded in tax sharing arrangements. This chapter suggests a refinement of the tax sharing definition that captures the degree of (inverse) proportionality between local tax base and revenue from tax sharing.
Chapter 4. The role of decentralisation indicators in empirical research
This chapter examines the role of decentralisation indicators and their use for empirical research. The chapter reviews first the conventional approach for capturing the degree of fiscal decentralisation. Second, in order to capture the effects of fiscal decentralisation in empirical research, the data and estimation issues are discussed. Third, the construction of indicators to capture the degree of fiscal decentralisation should be informed by recent incentive theory. Even if a transfer is a lump sum, incentive effects may still exist. The concept of the soft budget constraint is useful for understanding the incentive structure behind lump sum transfers. The design and the timing of transfers are important. If the transfer is designed and allocated ex post after local government has undertaken specific actions, the transfer should not be regarded as a lump sum transfer ex post. The theoretical models suggest that a taxonomy of transfers is complicated and indicators of fiscal decentralisation should be carefully designed.
Chapter 5. Measuring the extent of fiscal decentralisation: An application to the United States
The goal of this chapter is to develop a taxonomy of decentralisation measures and how they are related to each other. In addition to introducing a common language for the different strands of literature, this taxonomy is instrumental for studying the outcomes of decentralisation. Using cross-state data from the United States, we show that aggregating distinct dimensions of fiscal decentralisation into a single indicator inevitably leads to a loss of information in the form of lower explanatory power. We conclude that the distinct aspects of decentralisation should enter regression analyses separately, in the most flexible functional form possible. In particular, we find that revenue autonomy is virtually orthogonal to the subnational share of revenues and expenditures, suggesting that it carries additional information. In this chapter we show also how the conventional measures of decentralisation can be modified to account for the differing dependence on external grants.
Chapter 6. Measuring decentralisation of public sector activities: Conceptual issues and the case of Germany
This chapter examines conceptual problems related to standard revenue and expenditure measures to assess government decentralisation. While the refinement of the revenue metric as proposed by the OECD comes close to expressing the degree of sub-central tax autonomy, there are still problems to be resolved for assessing tax sharing. Suitable expenditure-oriented decentralisation measures are more difficult to construct. Not only can central mandates or conditions imposed on funding limit the degree of fiscal autonomy of sub-central governments; it is also relevant to evaluate to which extent such constraints are binding for sub-central governments. The problems related to fiscal decentralisation measures are then discussed by looking at the German federal arrangements, which have raised some controversies in the past. Fiscal measures alone may fall short in defining the degree of decentralisation in a country. A more comprehensive approach is needed. The chapter concludes with an outline of a more differentiated composite decentralisation index.
Chapter 7. Taxonomy of grants and local taxes: The Norwegian case
The chapter discusses a taxonomy of grants and local taxes based on the Norwegian institutional context. A main issue is whether the major local tax, the personal income tax, should be classified as a tax with local discretion or a tax sharing arrangement. Although local governments can formally set tax rates below the upper limit, it would give a more correct picture of the Norwegian system if the local income tax was classified as a tax sharing arrangement. The taxonomy of grants is less problematic, but some earmarked grants constitute a grey zone in the sense that they work as non-earmarked grants. In addition, the VAT compensation scheme should be classified as a non-earmarked grant.
Chapter 8. Measuring decentralisation: The challenge of the Danish story
The OECD has done path breaking work in developing indicators of local autonomy. The work begun in the late 1990s on a taxonomy of local taxing power seems especially promising. In contrast to measures of local shares of total expenditure and revenue it focuses on the discretion enjoyed by local authorities. This is at the heart of the theoretical concepts of local autonomy, authority or decentralisation. It is therefore recommendable to continue the OECD work on establishing a cross-national dataset on local taxing power. But there is still work ahead before this particular indicator is completely satisfactory. The Danish experience shows how difficult it is to make a correct coding of individual countries. It is not enough to focus on official rules in national tax codes. At least in Denmark, these rules are nested in informal institutions and supplemented by other formal rules that make the formal tax codes grossly misleading.
Chapter 9. From transfers to tax "co-occupation": The Italian reform of intergovernmental finance
This chapter provides insights into the current reform of intergovernmental fiscal relations in Italy. The most relevant change is the abolition of transfers as an ordinary means of sub-central government finance, except for equalisation. Since the room for autonomous local taxes is quite narrow, transfers will be mainly replaced by different forms of “co-occupation” of central taxes. Using the OECD taxonomy of tax autonomy, we show that the effective increase in “infra-marginal” tax autonomy of sub-central governments brought about by the reform will be quite modest. At the margin, however, where autonomy really matters, there could be enough room for effective discretion. The main problem is that both the central and the sub-central governments fear tax power decentralisation. The former because it feels that, at least in the transition period, the electorate might not properly distinguish the different fiscal responsibilities; the latter because they would prefer not to tax their electorate.
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