Research

The influence of decentralized taxes and intergovernmental grants on local spending volatility

Authors:
To read the file of this research, you can request a copy directly from the authors.

Abstract

We study what affects the volatility of sub-central spending in 20 OECD countries. The evidence based on data from 1972 to 2007 shows that the volatility of intergovernmental grants from upper levels is positively associated with the volatility of local expenditure. On the contrary, the volatility of local tax revenues - mainly that of property taxes - exerts the opposite effect. Thus, making local governments rely more on grants than own taxes seems to adversely affect the stability of their spending, while allowing them to autonomously levy taxes on responsive tax bases provides incentives to smooth their expenditure.

No file available

Request Full-text Paper PDF

To read the file of this research,
you can request a copy directly from the authors.

Article
Full-text available
This paper offers a comprehensive and updated review of the effects of intergovernmental grants. We focus on the main findings in the existing literature on the effects of intergovernmental grants on tax policy and choices, expenditure decisions, fiscal stability and behavioral choices, and political economy. The intricate nature of the subject, intrinsically, does not allow for an all-inclusive survey, but we aim to provide a thorough examination and update of the most salient effects of intergovernmental grants, while indicating areas for further research.
Article
The changing situation in the world and fast arising threats and challenges stimulated investigations concerning the impact of different barriers on regional development and findings ways of their overcoming. The goal of the research is to identify and substantiate the dependence between indicators of social and economic development of the region and restrictive measures of international character. The empiric basis of the research is formed by expert method using binary logics of estimation and content-analysis; correlative-regressive analysis. In order to find a certain interconnection 184 indicators of Sevastopol strategic plan were studied. Results of the research showed that 51% (on average) of indicators of the strategic plan of social and economic development in Sevastopol depended directly or indirectly on restrictive measures of international character. The authors used statistic sampling of economic development indicators, which are affected most of all by restrictive measures of international character and plotted correlative-regressive models of the gross regional product dependence on the amount of investment in fixed capital; the amount of investment into fixed capital dependence on foreign trade turnover in the region. These models can be used to forecast strategic development of the region. The practical importance of the research is connected with elaborated forecast models as independent analytical tool for regional governance. The advanced approach to estimating social and economic development of the region in conditions of restrictive barriers of international character worked out on the basis of identifying factors influencing gross regional product and investment into fixed capital in the region can help accurately and truly estimate the impact of measures and tools of regional policy on social and economic development of the region in conditions of sanctions and restrictions.
Article
Full-text available
This paper assesses the effect of fiscal decentralization on government consumption volatility using data for 97 developed and developing countries from 1971 to 2010. The results suggest that a higher degree of fiscal decentralization leads to lower government consumption volatility. This result holds for the sub-sample of advanced economies, while it is not confirmed for those less-developed. This mechanism seems to work mainly through a lower volatility of the non-discretionary spending, which typically belongs to the central government’s policy. We also confirm existing findings according to which country size lowers government spending volatility. Thus, given a minimum level of development, fiscal decentralization reforms can reduce spending volatility by distributing power to sub-central governments, particularly in smaller countries which are usually more prone to volatility.
Article
Full-text available
In most states, the property tax departs markedly from the ideal of a low-rate, broad-based tax that treats various types of real property uniformly. Recently, many states have responded to rapidly rising residential property values with new constraints such as assessment caps. This paper will review property tax performance and analyze several arguments relating to alleged deficiencies of the property tax. The analysis suggests that the property tax has performed well by most measures and that it ranks high in terms of both stability and revenue elasticity. The restrictions and constraints imposed on the property tax are likely the result of the pursuit of political objectives by decision makers and not the result of structural problems with the tax itself.
Article
Full-text available
In this paper, we offer a comprehensive and updated review of the impact of fiscal decentralization on the economy, society and politics. Our first target is the examination of two crucial and yet unsolved issues in the empirical literature on decentralization: the proper measurement of decentralization itself and its potential endogeneity in econometric estimates. Then, we discuss the main existing findings on the effects of decentralization on a relevant list of socio-economic issues. The impact of fiscal decentralization reforms on political institutions and public policies is also considered. Complete answers on the impact of fiscal decentralization are not likely to be certain but, overall, there are reasons to be optimistic about the net positive result. Our survey by necessity has to be selective but it presents a balanced view of what is known and what is not yet known opening room for further research and practice on fiscal decentralization.
Article
Full-text available
We evaluate the impact of political forces in the allocation of intergovernmental grants in Portugal, as it matured from a young to an established democracy. Using a large and unexplored dataset we show that political variables condition the granting system, and that their importance changed over time. While tactical manipulation in the distribution of grants among municipalities seems to exist only in the early years of democracy, opportunistic effects are stronger in the latter years. We argue that the latter effect is due to a change in the political environment and to the electorate's lack of information on intergovernmental grants.
Article
Full-text available
This paper reviews capital taxation issues in Italy based on a comprehensive definition encompassing taxes on income, transactions, and ownership. It discusses options to enhance the neutrality of the capital income tax system, followed by a detailed analysis of the property tax, the inheritance tax, and various transaction taxes. The paper also examines the case for replacing the set of existing taxes on financial and real assets with a single net wealth tax.
Article
Full-text available
Many countries are decentralizing in various ways. Decentralization is often intended at least partly to make government more efficient, flexible, and responsive. Many studies have evaluated the effects of decentralization on the provision of such services as health and education as well as on corruption, stability, and growth. Because what governments do and how well they do it is inseparably entangled with the question of how they are financed, this article outlines why and how a key element in a sound decentralization program should be to strengthen the linkage between local expenditures and local revenues—called here the Wicksellian Connection. Copyright © 2014 John Wiley & Sons, Ltd.
Article
Full-text available
This paper analyzes the impact of decentralization on overall fiscal performance in the European Union, taking into account fiscal institutional arrangements. We find that spending decentralization has been associated with sizably better fiscal performance, especially when transfer dependency of subnational governments is low. However, subnational fiscal rules do not seem to be associated with better performance.
Article
Full-text available
This essay contributes to second generation fiscal federalism (SGFF), which traces the implications of incentives created by political and fiscal institutions. The approach explores how various forms of fiscal federalism work in the presence of political officials who, rather than being benevolent social planners, face various forms of political incentives. The paper focuses on three sets of positive models: First, it explores self-enforcing federalism; that is, how federal systems are held together given various tendencies for federal systems to become centralized or fall apart. Second, it considers how specific political institutions, such as democracy, interact with decentralization. Finally, it studies various political impediments to economic growth, again highlighting the interaction with decentralization.
Article
Full-text available
This paper investigates the relationship between fiscal federalism and the sizes of local governments. While many empirical studies emphasized that grants encourage the growth of local public spending and local taxes constrain it, they are more silent regarding the effects of different types of tax autonomy. The paper addresses this issue by arguing that tax decentralization as organized on tax bases used only by local governments (tax-separation), rather than on tax-base sharing, would restrain local public expenditures. Using an unbalanced panel of OECD countries, the key finding is that only property taxes—mostly based on a “tax-separation” scheme—seem to favor smaller local governments. Thus, while tax decentralization is a necessary condition for limiting the growth of local governments, it does not appear sufficient, as tax-separation schemes among government levels would in fact be required.
Article
Full-text available
This paper extends the empirical literature about the effects of fiscal decentralization on the growth of government along three dimensions. It distinguishes between the effects of the level of decentralization from the way local governments finance their expenditures (common pool versus own resources); it uses a panel cointegration approach to separate the long run effects of decentralization from the short run dynamics; and it extends and revises the datasets generally used in these empirical analyses. The results show that the amount of revenue raised by sub-national governments leads to a long-term fall in the size of government but grants have the opposite effect. In addition, a greater decentralization of expenditure leads to greater overall spending. When the short-term is considered these influences work slowly, as the speed of adjustment towards the desired government size is relatively sluggish. In addition, in the short run, there is also a clear effect from the role of local revenue raising powers that stimulates the growth of government. These results appear robust to changes in the composition of the variables, countries and periods included the sample.
Article
Full-text available
Many countries have recently implemented fiscal decentralization reforms, assigning more functions and spending responsibilities to sub-national governments. In this paper we investigate the reasons behind the decentralization process of different categories of government expenditure (such as health, education, social security and welfare, housing, transports, public order) using IMF and OECD data for 21 developed countries over the period 1972-2006. We pay particular attention to the roles played by the taxing power of sub-national governments and by grants received from upper tiers of government. Then, we also study the determinants of the composition of local expenditure. Using a general-to-specific empirical approach, we adopt different models for each of the spending functions under analysis. This leads to a number of results, not yet reached in the existing literature, on the importance of tax decentralization, demographics, politics, and a number of other socio-economic variables.
Article
Full-text available
Tax sharing and intergovernmental grants are two sub-central funding arrangements that are often difficult to disentangle. The dividing line is not drawn uniformly across OECD countries or across time, and rules established in National Accounts, Revenue Statistics and others give incomplete guidance. Moreover, tax sharing arrangements may differ according to how tax revenue is distributed across individual jurisdictions. In order to ensure that fiscal arrangements are recorded properly and on a comparable basis, a set of clear criteria to delineate them is required. This section presents the results of a test that was applied in order to find the dividing line a) between tax sharing and intergovernmental grants and b) between different categories of tax sharing. The test was performed using questionnaire responses and builds on earlier documents on the same topic presented to Fiscal Network Delegates in 2006 and 2008.
Article
Full-text available
The first fundamental step in the design of a system of intergovernmental fiscal relations should be a clear assignment of functional responsibilities among different levels of government. Instability and controversy in the practice of decentralized systems has followed when the law was silent or unclear about the competencies and expenditure obligations of different levels of government. A stable and meaningful decentralization requires an unambiguous and well defined institutional framework in the assignment of expenditure responsibilities among the different levels of government together with the sufficient budgetary autonomy to carry out the assigned responsibilities at each level of government. Designing the other important pieces of a system of decentralized finances, revenue assignments and transfers, in the absence of a clear expenditure assignment is to put the car before the horse. The decentralization movement in many countries of Latin America over the past decade made this fundamental mistake. Revenues were assigned to subnational governments and transfers put into place before it was decided what functional competencies would be transferred from the central government to subnational governments. These experiences led to weak decentralized systems and fiscally overburdened central governments, which in many cases continued to take on most expenditures responsibilities with fewer resources. The focus on the revenue side of decentralization and the neglect of a clearer assignment of expenditure responsibilities has also been a common theme of the decentralization process in countries in transition over the past five years.
Article
Full-text available
This article sets out a conceptual basis for measuring regional authority and engages basic measurement issues. Regional authority is disaggregated into two domains (self-rule and shared rule) and these are operationalised in eight dimensions. The article concludes by examining the robustness of this measure across alternative measurement assumptions.
Article
The difference and system generalized method-of-moments estimators, developed by Holtz-Eakin, Newey, and Rosen (1988, Econometrica 56: 1371–1395); Arellano and Bond (1991, Review of Economic Studies 58: 277–297); Arellano and Bover (1995, Journal of Econometrics 68: 29–51); and Blundell and Bond (1998, Journal of Econometrics 87: 115–143), are increasingly popular. Both are general estimators designed for situations with “small T, large N″ panels, meaning few time periods and many individuals; independent variables that are not strictly exogenous, meaning they are correlated with past and possibly current realizations of the error; fixed effects; and heteroskedasticity and autocorrelation within individuals. This pedagogic article first introduces linear generalized method of moments. Then it describes how limited time span and potential for fixed effects and endogenous regressors drive the design of the estimators of interest, offering Stata-based examples along the way. Next it describes how to apply these estimators with xtabond2. It also explains how to perform the Arellano–Bond test for autocorrelation in a panel after other Stata commands, using abar. The article concludes with some tips for proper use.
Article
Political parties and party systems exhibit widely varying degrees of nationalization, that is the extent to which a party receives similar levels of electoral support throughout the country. The level of party nationalization has a prominent effect on such important factors as the survival of democracy, the types of issues that dominate political competition, legislative behaviour and public policy. In spite of its importance, party nationalization has been neglected in the comparative politics literature. Our article makes two contributions. First, it provides a Measure of party and party system nationalization, based on the Gini coefficient, that is superior for comparative analysis to those employed to date. Second, it utilizes these measures to analyse nationalization in 17 democracies in the Americas, the first time nationalization has been examined empirically outside the advanced industrial democracies. The measure underscores the widely varying degrees in nationalization across party systems, within party systems over time, across parties within countries and within parties over time.
Article
This chapter presents a short overview of the transfer systems for municipalities in the Nordic countries. The level of redistribution between rich and poor units is examined, as well as what criteria are used in order to define differences in expenditure structures for service demand. To what extent are periphery-oriented and centre-oriented cost elements targetted in the system, and to what extent are regional policy elements explicitly taken into account? A tentative ranking of the Nordic countries is established along these lines. The chapter is based on a more detailed study financed by the Nordic Council of Ministries (Mønnesland, 2001) where the income systems are described in more detail. The conclusions drawn here will then have a more detailed base than illuminated in this chapter alone.
Article
This article uses cross-national data to examine the effects of fiscal and political institutions on the fiscal performance of subnational governments. Long-term balanced budgets among subnational governments are found when either (1) the center imposes borrowing restrictions or (2) subnational governments have both wide-ranging taxing and borrowing autonomy. Large and persistent aggregate deficits occur when subnational governments are simultaneously dependent on intergovernmental transfers and free to borrow- a combination found most frequently among constituent units in federations. Time-series cross-section analysis reveals that as countries increase their reliance on intergovernmental transfers over time, subnational and overall fiscal performance decline, especially when subnational governments have easy access to credit. These findings illuminate a key dilemma of fiscal federalism and a more precise notion of its dangers: When constitutionally or politically constrained central governments take on heavy cofinancing obligations, they often cannot credibly commit to ignore the fiscal problems of lower-level governments.
Article
The tax on immovable property has been characterized as probably the most unpopular among tax instruments, in part because it is salient and hard to avoid. But economists continue to emphasize the virtues of the property tax owing to its relatively low efficieny costs, benign impact on growth, and high score on fairness. It is, therefore, generally considered to be underutilized in most countries. This paper takes stock of the arguments for using real property taxation, and presents an updated data-set for high-and middle income countries to illustrate its use. It also reflects the renewed and widespread interest in property tax reform globally, and discusses the many policy and administrative issues that must be carefully considered as prerequisites for successful property tax reform.
Article
Most of the empirical analysis explores the relationship between fiscal decentralization and economic growth within a constitutional void. This paper investigates the connection between fiscal decentralization and income growth across different institutional settings in 20 OECD countries over the period 1973-2007. We find that the pro-growth effects of tax decentralization depend critically on the nature of the administrative institutions and political system in place: fiscal decentralization leads to higher (lower) rates of economic growth when coupled with high (low) administrative and high (low) political decentralization. This provides evidence of institutional complementarities at work, as well as new insights on how local tax structures should be designed and combined with administrative and political settings to support economic growth.
Article
This paper investigates whether emerging market countries can implement monetary policies to cope with financial crises as advanced countries did during the recent global crisis—injecting significant amounts of money into the financial system without facing major short-run adverse macroeconomic repercussions. Using panel data techniques, the paper analyzes episodes of financial turmoil in 16 Latin American countries during 1995–2007. The results show that developing and emerging market countries should be cautious because injecting money on a large scale into the financial system may fuel further macroeconomic instability, increasing the chances of simultaneous currency crises.
Article
This work provides empirical evidence for a sizeable, statistically significant negative impact of the quality of fiscal institutions on public spending volatility for a panel of 25 EU countries over the 1980-2007 period. The dependent variable is the volatility of discretionary fiscal policy, which does not represent reactions to changes in economic conditions. Our baseline results thus give support to the strengthening of institutions to deal with excessive levels of discretion volatility, as more checks and balances make it harder for governments to change fiscal policy for reasons unrelated to the current state of the economy. Our results also show that bigger countries and bigger governments have less public spending volatility. In contrast to previous studies, the political factors do not seem to play a role, with the exception of the Herfindahl index, which suggests that high concentration of parliamentary seats in a few parties would increase public spending volatility.
Book
The chapters in this book explore in detail the choices regarding both the structure and administration of the property tax, drawing on the extensive knowledge the authors have acquired in studying property taxes around the world. The chapters provide a wide-ranging treatment of the design choices and administrative tasks, both in terms of the breadth of design options and administrative tasks covered and the depth of the discussion. The authors describe the range of design choices, discuss the associated issues and the advantages and disadvantages for each, and present the criteria to help choose among the options.
Article
This article examines whether the efficiency gains accompanying fiscal decentralization generate higher growth in more decentralized economies, applying pooled‐mean group techniques to a panel dataset of 23 Organization for Economic Co‐operation and Development (OECD) countries, 1972–2005. We find that spending decentralization has tended to be associated with lower economic growth while revenue decentralization has been associated with higher growth. Since OECD countries are substantially more spending than revenue decentralized, this is consistent with Oates' (1972) hypothesis that maximum efficiency gains require a close match between spending and revenue decentralization. It suggests reducing expenditure decentralization, and simultaneously increasing the fraction financed locally, would be growth‐enhancing. (JEL E62, H71, H72)
Article
Because of the manner in which it is normally paid, the property tax is almost certainly the most salient major tax in the U.S. The property tax is also the least popular tax and the only major tax whose revenues have declined as a share of income. We hypothesize that high salience explains the unpopularity of the property tax, the level of the property tax, and prevalence of property tax revolts. To identify variation in the salience of the property tax over local jurisdictions and over time, we exploit conditionally random variation in tax escrow. Tax escrow is a method of paying the property tax that makes it much less salient--as we demonstrate using survey evidence. We find that areas in which the property tax is less salient are areas in which property taxes are higher and property tax revolts are less likely to occur. We present several specification tests, including spatial correlation tests and instruments based on bank branches, that suggest that our results are valid. An implication of our results is that voters facing a non-benevolent government may wish to keep taxes' salience high even if, as a result, they hate their salient taxes.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
Article
This article offers an empirical answer to the question of which institutional arrangements can help to keep the accounts of sub-national governments in balance. I take into consideration the autonomy that these governments have in raising their revenues and fiscal rules as formulated in law or constitutions. The former works as an implicit constraint since governments with more autonomy might assume higher responsibility for accumulated deficits. The latter works as a direct explicit constraint on sub-national borrowing, but might be subject to endogeneity through preferences for fiscal responsibility. This potential source of bias is taken into account by using IV techniques for fiscal rules. Results from my original dataset, covering full information for 14 years of all EU15 countries, show that the effectiveness of tools depends critically on the federal background. Fiscal rules work in unitary countries, while higher tax autonomy yields lower deficits in federations.
Article
Normative principles provide a relatively clear set of rules for the balance between grants and taxes (box 1 reviews the normative theory), but in practice a variety of types of tax-grant systems are observed in OECD countries, which do not all follow these rules. According to the theory, own-taxes should be the primary revenue source (technically for the last dollar of spending), while transfers should only be used as a supplementary revenue source to correct for externalities, act as an insurance buffer, or redistribute resources between regions (see OECD 2006a, 2006b). Besides, the theory wants tax bases for sub-national governments to be confined to immobile resources such as land and user fees. In practice, transfers often represent a large proportion of sub-national governments’ revenues, and many countries use income taxes instead of property taxes at the sub-national level.
Article
Regional Studies. This paper explores the relationship between fiscal federalism, understood as institutionalized regional economic self-rule, and convergence in regional per capita incomes. The principal economic argument against fiscal federalism is that, unless paired with generous equalization grants, it will enhance regional inequalities by reducing inter-regional redistribution. Does the evidence support this claim? Multilevel spatial regressions on primary sub-national jurisdictions in twenty-five Organisation for Economic Co-operation and Development (OECD) countries show that lower-income regions tend to catch up with higher-income regions only when they enjoy substantial economic powers. Indeed, there is more convergence across member states of the European Union than across regions within almost any of the European Union member states. Fiscal federalism may pose less serious tradeoffs than commonly assumed.
Article
While revenue sharing is not likely to eliminate state and local taxation since the tax effort factor subsidizes increased governmental growth, it does tend to eliminate what Madison saw as a distinctive feature of the U.S. form of government, a compound republic. This essay has discussed why local and state officials have conceded the principles of a compound republic to a monopoly form of government. Federal, state and local officials find it to their advantages to collude and operate in a monopoly environment rather than in a competitive environment.
Article
Rodriguez-Pose A. and Gill N. (2005) On the 'economic dividend' of devolution, Regional Studies 39 , 405-420. Recent political and academic discourse about devolution has tended to stress the economic advantages of the transfer of power from national to subnational institutions. This 'economic dividend' arises through devolved administrations' ability to tailor policies to local needs, generate innovation in service provision through inter-territorial competition, and stimulate participation and accountability by reducing the distance between those in power and their electorates. This paper, however, outlines two related caveats. First, there are many forces that accompany devolution and work in an opposite direction. Devolved governmental systems may carry negative implications in terms of national economic efficiency and equity as well as through the imposition of significant institutional burdens. Second, the economic gains, as well as the downsides, that devolution may engender are contingent, to some extent, upon which governmental tier is dominating, organizing, propagating and driving the devolutionary effort.