Anwar Shah, World Bank Lessons from International Practices of Intergovernmental Fiscal Transfers Anwar Shah, World Bank XVI Regional Seminar on Fiscal

Anwar Shah, World Bank

Lessons from International Practices of Intergovernmental

Fiscal Transfers Anwar Shah, World Bank

XVI Regional Seminar on Fiscal PolicyCEPAL/ECLAC, Santiago de Chile

January 26-29, 2004


Instruments of intergovernmental finance

• Unconditional vs conditional transfers– Unconditional: preserving local autonomy and enhancing inter-

jurisdictional equity– Conditional: providing incentives to undertake specific activities

• Conditional Transfers– matching vs non-matching– open-ended vs. closed-ended matching– Input based conditionality vs output based conditionality– Input based conditionality often intrusive and unproductive.

Output based conditionality can advance grantor’s objectives while preserving local autonomy


Perceptions on intergovernmental finance are generally negative

• Federal/Central : Giving money and power to sub-national governments is like giving whiskey and car keys to teenagers

• Provincial and Local : We need more grant monies to demonstrate that “money does not buy anything”.

• Citizens: The magical art of passing currency from one government to another and seeing it vanish in thin air.


Ironically these perceptions are well grounded in reality in LDCs

• Primary focus on dividing the spoils• Passing the buck transfers – revenue sharing with

multiple factors (Brazil, Argentina, India, RSA, Philippines and more)

• Asking for more trouble grants – deficit grants (Hungary, India, and more)

• Pork barrel transfers or political bribes (Brazil, India, Pakistan, USA)

• Command and control transfers (most countries) • Overall: Intergovernmental finance is the

dominant source of revenue but creates perverse incentives for fiscal management and accountability


No need to despair ….

As properly designed fiscal transfers can be part of the solution rather than part of the problem.


Governance Structure: 20th Versus 21st Century Unitary Centralized Center manages Bureaucratic Focused on inputs Command and control Internally dependent Closed and slow Intolerance of risk

Federal / confederal Globalized & localized Center leads Participatory Results matter Responsive and Accountable Competitive Open and quick Freedom to fail/ succeed


From Dividing the Spoils to Creating An Enabling Environment for Responsive

and Accountable Local Governance• Tax Decentralization

• Output based fiscal transfers – operating– capital

• Fiscal equalization transfers

• Responsible borrowing


Considerations in the Design of Fiscal Transfers

Consistency of design with a single objective Simple and transparent allocation criteria Create incentives for competitive service delivery and

support citizen-centered governance Provide incentives for fiscal prudence Ensure flexibility in use but accountability for results Stable and predictable Equitable ( entitlements vary inversely with fiscal capacity

and directly with fiscal needs) One size does not fit all – urban vs. rural, large vs. small Sunset clauses to ensure periodic review and

assessment


Objective Grant Design

Better Practices

Practices to Avoid

Fiscal Gap Reassign, tax base sharing

Canada Deficit grants, tax by tax sharing

Regional fiscal disparities

Fiscal capacity equalization

Australia, Canada, Germany, Denmark, ECA

General revenue sharing with multiple factors

Setting national minimum standard

Block transfers, conditions on service standards

Ex-Indonesian roads and education, Chile

Conditions on spending

Benefit spillovers Matching grant S. Africa teaching hospitals

Influencing local priorities

Open-ended matching

Canada social assistance

Ad hoc grants

Stabilization Capital grant with upkeep requirements

Political and policy risk guarantee

Stabilization without upkeep


Transfers to deal with fiscal gap Fiscal Gap: Structural imbalance as a result of a

mismatch between revenue means and expenditure needs.

Reasons:Inappropriate assign: ReassignLimited tax bases: Allow joint occupancy or tax decentralization.Tax competition: Federal collection and general (not on a tax-by-tax basis) revenue sharing.Tax room lacking: Tax abatement and tax base sharing (Canada ).

Practices to avoid: deficit grants; tax by tax sharing.


Transfers to set national minimum standards

Rationale: National economic union or internal common market

Redistributive role of the public sector and the national government

Design: conditional non-matching block transfers with conditions on standards of service and access.

Better practices: Indonesia roads and primary education grants; Colombia and Chile education transfers; Canada health and post-secondary education transfers.

Practices to avoid: Conditional transfers with conditions on spending; ad hoc grants.


An Example: Education grant to encourage competition and innovation

Allocation basis to state/local governments: Population aged 5-17

Distribution basis to providers: Equal per pupil to both public and private schools

Conditions: Universal access to primary and secondary education. Private school access to poor on merit. Improvements in achievement scores and graduation rates. No conditions on the use of funds

Penalties: Public censure, reduction of grants funds and termination

Incentives: Retention of savings


Indonesia - Specific Purpose Transfers to Local Governments (now defunct)

L2. District/Town Road Improvement GrantLength of roadsConditionDensityUnit cost

L3. Primary School GrantSchool age children (ages 7-12)Needs for facilities


Federal financing of health care in Canada

Per capita transfers tied to rate of growth of GDP (plus transfer of tax points - for health and post secondary education in 1977,13.5% points of PIT and 1% point of CIT)

Conditions: (1) Universality (2) Portability (3) Public insurance but public/private provision (4) Opting in and out (5) No extra billingPenalties:Threat of discontinuation for breach of the conditions (1)- (4)

above.Dollar for dollar reduction for breach of the condition (5).Sunset clause: Parliamentary review every 5 years.


Fiscal Equalization Transfers: Rationale

• Political : Large regional fiscal disparities can be politically divisive. May even create threat of secession. Fiscal equalization grants to create a sense of political unity

• Makes it possible for all citizens to be treated alike regardless of the places of residence. Thereby advances social justice ( fiscal equity) and efficiency in market resource allocation (fiscal efficiency).




Transfers to reduce regional fiscal disparities

Design: General non-matching fiscal capacity equalization transfers.

Better practices: Fiscal equalization programs (sources of data: CGC, Finance Canada, Lotz, Shah & Spahn)

Paternal: Australia (fiscal capacity plus fiscal needs) and Canada (fiscal capacity only)

Solidarity, Fraternal or Robin Hood: Germany (fiscal capacity), Sweden, Denmark

Practices to avoid: General revenue sharing with multiple factors e.g. practices in Brazil, India and South Africa.


Fiscal Equalization Program

Australia Canada Germany

Legal Status

Law Constitution Constitution

Paternal or

Solidarity

Paternal Paternal Solidarity

Total Pool determination

Ad hoc Formula Formula

Allocation Formula Formula Formula Fiscal capacity equalization

Yes, RTS Yes, RTS Yes, RTS


Fiscal Equalization Program

Australia Canada Germany

Fiscal Need

EqualizationYes, RES No No

Program Complexity

High Low Medium

Political Consensus

No Yes May be ?

Who recommends

Independent agency

Intergov. Committees

Bundesrat

Dispute resolution

Supreme court

Supreme Court

Constitutional court


A Representative Tax System approach to fiscal capacity equalization

Equalization from revenenue source i =National Per capita State’saverage base in — own basetax ratei all statesi per capitai

=Per capita Per capitapotential standardizedrevenue in — revenue inAll states (i) state A (i)


A Representative Expenditure System approach to Fiscal Need Equalization

Equalization entitlement from expenditure category iEQUALSPer capita potential expenditure of State A for category i

based upon own need factors if it had national average fiscal capacity

MINUSPer capita potential expenditure of State A on expenditure

category i if it had national average need factors and national average fiscal capacity


Federal Fiscal Equalization Program of Canada is enshrined in the constitution

______________________________________

Canada Constitution Act 1982, Article 36.(2)Parliament and the Government of Canada are

committed to the principle of making equalization; payments to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of services at reasonably comparable levels of taxation.



Table 4 - Government Secondary Education Factors - 1995-96

Disability Factors NSW Vic Qld WA SA Tas ACT NT

Dispersion 0.9973 0.9921 1.0093 1.0106 0.9972 0.9952 0.9885 1.0710

Grade Cost 1.0014 1.0028 0.9966 0.9950 0.9992 0.9998 1.0016 0.9979

Input Costs 1.0120 0.9950 0.9860 1.0030 0.9910 0.9900 1.0080 1.0340

Relevant Population 0.9749 0.8874 1.0983 1.1639 0.9679 1.1422 0.9750 1.2226

Administrative Scale 0.9946 0.9946 0.9946 1.0065 1.0105 1.0304 1.0463 1.1139

Service Delivery Scale 0.9922 0.9906 1.0031 1.0153 1.0166 1.0380 0.9714 1.1141

Vandalism & Security 1.0023 1.0023 0.9973 0.9973 0.9973 0.9923 0.9923 0.9923

Cross-border 0.9965 1.0001 1.0001 1.0001 1.0001 1.0001 1.0660 1.0001

Category Disability 0.9692 0.8658 1.0815 1.1941 0.9772 1.1917 1.0440 1.6605

An Example of Expenditure Need Determination in Australia: Secondary Education Expenditure Need Factors


98 92 99109

101109

93

274

75

100

125

150

175

200

225

250

275

NSW VIC Qld WA SA Tas ACT NT

106

96 98

113

88

77

92

104

50

75

100

125

NSW VIC Qld WA SA Tas ACT NT

Figure 4 – Australia - Relative Revenue Raising Capacity Ratios - 1995-96

Figure 3 - Australia - Relative Cost of Service Provision Ratios - 1995-96

Anwar Shah, World BankThe World Bank TW URD

Germany : How does theFinanzausgleich work ?

Germany : How does theFinanzausgleich work ?

• A fiscal capacity yardstick is defined per capita (national average with modifications)

• Each State’s fiscal capacity per capita is measured against this yardstick

• ‘Poor’ States obtain 95 % of fiscal yardstick

• ‘Rich’ States pay in progressive steps

• The Finanzausgleich is a pure horizontal clearing mechanism

Anwar Shah, World BankT h e W o r ld B a n k T W U R D

H o w d o e s th e F in a n z a u s g le i c hw o r k ? ( 2 )

H o w d o e s th e F in a n z a u s g le i c hw o r k ? ( 2 )

' M a r g in a l le v y ' o n S ta te f is c a l c a p a c ity in e x c e s s o f a v e r a g e f is c a l c a p a c ity

0 2 0 4 0 6 0 8 0

1 0 0

1 0 3

1 0 6

1 0 9

1 1 2

1 1 5

1 1 8

M a r g i n a l r a te i n p e r c e n t

S ta te p e r c a p i ta f i sc a l

c a p a c i ty r e l a t i v e to

a v e r a g e p e r c a p i ta

f i sc a l c a p a c i ty

S ta te p e r c a p i ta f i sc a l

c a p a c i ty r e l a t i v e to

a v e r a g e p e r c a p i ta

f i sc a l c a p a c i ty


„Effectiveness“ of the Finanzausgleich

1999


Denmark: Equalization models and standards

Equalization type

Counties Metropolitan areas

Local Govts.

Fiscal capacity

85% Robin Hood

90% Robin Hood

50% central grant

Fiscal Needs

85% Robin Hood

60% Robin Hood

35% Robin Hood


Institutional Arrangements for Fiscal Transfers

• Intergovernmental committees: Canada, Germany (with strong role of Bundesrat)

• Independent grant commissions: Australia (permanent secretariat), India (limited duration) and South Africa (permanent)

• Intergovernmental cum civil society commissions: Pakistan (limited duration)


Fiscal Equalization Grants: Some Lessons

• Fiscal capacity equalization with an explicit standard is desirable and do-able in most countries.

• Fiscal need equalization is much more complex – desirable but may not be worth doing. Rough justice may be better than precise justice.

• For local equalization – one size does not fit all.• Important to have societal consensus on the standard of

equalization• Must have a sunset clause and provision for a review

and renewal• Institutional arrangements for a continuous review and

periodic revision


Negative Lessons: Practices to Avoid

• General revenue sharing with multiple factors

• Deficit grants

• Fiscal Effort Provisions

• Input or process based or ad hoc grants

• Capital grants without assurance for upkeep

• Negotiated or discretionary transfers


Positive Lessons: Practices to Strive For

• K.I.S. (keep it simple)• Focus on single objective• Introduce sunset clause• Output based conditional transfers with citizens’

evaluations• Fiscal capacity equalization to a defined

standard• Political consensus on the standard of

equalization• Institutional arrangements for broad based

consultation

Documents

Anwar Shah, World Bank Lessons from International Practices of Intergovernmental Fiscal Transfers Anwar Shah, World Bank XVI Regional Seminar on Fiscal