1. Dr. Violeta Ruiz Almendral
Fiscal Federalism
Dr. Violeta Ruiz Almendral
Professor of Tax and Finance Law
Universidad Carlos III de Madrid, SPAIN
Forum of Federations
AMMAN, JORDAN- August 2007

2. Fiscal Federalism Introduction: the financing of a State.
Inter-regional equity and equalization: vertical and horizontal fiscal imbalance.
Revenues and expenditures in a federation: overview
Types of revenues and their role:
Taxation powers
Borrowing powers
Revenues from natural resources
Spending power and the distribution of powers
Management of the economy; the question of policy coordination

3. The financing of a State: revenues
Taxes
Democracy and taxation
The role of taxes
A brief history of taxation (as a main source of revenue, they are a XX century phenomenon?)
Type of taxes
Direct/indirect, personal/objective taxes.
Custom duties, user fees, environmental taxes…

4. The financing of a State: revenues
What to tax?
Traditionally, three sources of tax revenues:
Income
Wealth
Consumption
New (relatively) sources:
Environmental taxes
User fees (public services, among other)

5. The financing of a State: revenues
What taxes?
INCOME:
Personal Income Tax
Corporation Income Tax
Estate tax (“Death tax”) –also taxes Wealth-
WEALTH:
Property taxes
CONSUMPTION:
Sales taxes
Value Added taxes (VAT)
Excise
OTHER TAXES: environmental taxes (Carbon Tax), Custom Duties…

6. The financing of a State: revenues
Where to tax? (I)
FUNCTIONS OF THE CENTER:
Stabilization function
Coordination
Guarantee of minimun Solidarity (i.e. redistribution of income)
TRADITIONAL CENTRAL TAXES:
Income taxes
Major consumption taxes (VAT)
Excise
Custom Duties

7. The financing of a State: revenues
Where to tax? (II)
FUNCTIONS OF SUBNATIONAL UNITS:
Minimal financial autonomy
Easy to establish taxes (political burden)
Easy to collect taxes
TRADITIONAL SUBNATIONAL TAXES:
Sales taxes
Wealth taxes (inmovable property)

8. Relevance of taxes in Europe (an example)
Total taxes in relation to GNP
Indirect taxes in relation to total revenues
Direct taxes in relation to total revenues
1995
2002
2003
2000
EURO AREA
42.5
42.1
42.2
32.5
32.8
30.4
29.0
Germany
42.3
41.7
28.9
29.7
28.7
25.9
Spain
34.3
36.3
36.5
33.7
29.9
29.6
France
45.4
45.6
45.7
34.1
27.2
25.8
Ireland
35.2
29.8
31.2
41.4
41.1
39.5
U.K.
36.7
37.0
37.1
36.9
43.7
42.0
(*) No hay datos disponibles

9. The financing of a State: revenues
Natural resources
Relevant in Iraq (majority of public revenues)
Problems: Unequaly distributed, Limited (?)

10. The financing of a State: revenues
Public Debt
Deficit financing; should be extraordinary
Investment financing (the “golden rule”).
Problems: Inter-generational equity, democratic constraints, risk assesment needed

11. The financing of a State: revenues
Other revenues
Public assets (i.e. companies…)
Monopolies (i.e. Tobacco, Lottery, Oil and Gas…)
Problems: Free competition, equality

12. Vertical fiscal imbalance
What is Vertical Fiscal Imbalance?
When does it arise?
Why is it a problem?
Possible solutions:
Transfers (conditional/unconditional)
Taxation powers (shared taxes, separated taxation systems…)

13. Horizontal fiscal imbalance
What is horizontal fiscal imbalance?
When does it arise?
Why is it a problem?
What are the solutions?
Equalization formulas (additional problems: what should be included?)
Coordination of revenues/expenditures

14. Revenues and expenditures of subnational units: overview
Transfers
Taxes
Natural resources
Debt (public/private)
EXPENDITURES
Budget powers
Spending power
Fiscal equilibrium

15. Revenues and expenditures of subnational units: overview
What kind of revenue/expenditure system for subnational units?
Total fiscal equivalence? (a myth)
Fiscal equivalence “at the margin”
Different starting points: the particularities of a “decentralization process”

16. Revenues and expenditures in a federation: the problem with transfers
Essential: sufficiency of ressources
No political autonomy without (certain) fiscal autonomy
THE PROBLEMS:
They may condition the subnational entities
‘Moral hazard’ problem: It is easier for governments to spend money when:
(a) no political burden of having to raise it
(b) Lack of accountability

17. Revenues and expenditures in a federation: the problem with transfers
What kind of transfers? (I)
Conditioned/unconditioned
Grants (specific projects, region oriented)
Lump sum agreements, based on objectives (i.e. minimum standards in Education, Health…)
Based on need
Assesing need as a problem
Factors to take into account: geography, population (scattered, scarce –increasing or decreasing, ageing…)

18. Revenues and expenditures in a federation: the problem with transfers
What kind of transfers? (II)
Based on “fiscal effort”
Representative tax system
Other resources
Equalization formulas
Establishing of a solidarity measure
What’s the limit?
Horizontal vs. Vertical equalization systems

19. Revenues and expenditures in a federation: the problem with transfers
Who designs transfers?
Zero sum game: Multilateral vs Bilateral Agreement
Political Bargaining (different political weights of regions)
Transparency, accountability: solid statistical data, importance of institutions (i.e. a Senate or territorial chamber)

20. Revenues and expenditures in a federation: the problem with subnational taxing powers
They are necessary: “No representation without taxation” (=some taxation powers are essential to political autonomy)
Fiscal competition, always a bad idea?
Horizontal fiscal imbalance

21. Revenues and expenditures in a federation: the problem with subnational taxing powers
What kind of taxes?
Subnational taxes
Shared taxes
Type of taxes: Direct/indirect (personal-objective)
The role of “user fees”

22. Revenues and expenditures in a federation: the problem with subnational Taxing Powers
Total Fiscal responsibility or fiscal equivalence
every tier raises their own taxes for their own expenditures. Total equivalence.
Fiscal responsibility ‘at the margin’,
Giving sub-national tiers of government responsibility to obtain monies in addition to what they obtain in the form of transfers. In practice, a mix of transfers and taxes.

23. Revenues and expenditures in a federation: the problem with Natural resources
Different types of ressources, different problems:
Sun & Beach: tourism (over explotation)
Oil and Gas: energy (pollution, limited…)
Timber, coal, …

24. Revenues and expenditures in a federation: the problem with borrowing powers
Borrowing powers as an attractive source of revenue:
Fast liquidity
No (obvious) political burden
Reasons to limit borrowing powers of subnational units
Over-endebtment
Financial Stability
General coordination of economy in jeopardy

25. Revenues and expenditures in a federation: the role of Spending power
Spending as a way to implement policies
The expanding nature of the spending power of the center (the “Commerce clause”, the “coordination of the economy..)
Limitation of expenditures: the “stability contraints”

26. Fiscal Provisions in the Iraqi Constitution
Article (24): The state shall guarantee the freedom of movement for workers,goods and Iraqi capital between the regions and the provinces. This shall be regulated by law.
THEREFORE:
Coordination of taxation powers, to avoid fiscal frontiers…

27. Fiscal Provisions in the Iraqi Constitution
Article (28): 1st - Taxes and fees shall not be imposed, amended, collected or eliminated except by law. 2nd - Low-income people should be exempted from taxes in a way that guarantees maintaining the minimum level necessary for a living. This shall be regulated by law
THEREFORE:
Need for subnational parliaments (rule of law)
Coordination of taxation powers (to ensure 28.2)

28. Fiscal Provisions in the Iraqi Constitution
Article (108): The federal authorities will have the following exclusive powers:
1st - drawing up foreign policy, diplomatic representation, negotiating international accords and agreements, negotiating and signing debt agreements, drawing up foreign sovereign economic and trade policies.
3rd - drawing up financial and customs policy, issuing currency, organizing trade policy among regions and provinces in Iraq, setting the general budget for the nation, drawing up currency policies and establishing and administering a central bank.
THEREFORE:
Custom Duties must remain at the center
Limitation of borrowing powers

29. Fiscal Provisions in the Iraqi Constitution
Article (109): Oil and gas is the property of all the Iraqi people in all the regions and provinces.
Article (110): 1st - The federal government will administer oil and gas extracted from current fields in cooperation with the governments of the producing regions and provinces on condition that the revenues will be distributed fairly in a manner compatible with the demographical distribution all over the country. A quota should be defined for a specified time for affected regions that were deprived in an unfair way by the former regime or later on, in a way to ensure balanced development in different parts of the country. This should be regulated by law.
THEREFORE:
Equalization of natural resources
Redistribution of revenues (via the taxation system, excess profit tax, local taxes…)

30. Fiscal Provisions in the Iraqi Constitution
(116) 4th - A fair share of the revenues collected federally is designated to regions, in a way that suffices their duties and obligations, taking into consideration the (region's) resources and needs.
Article (128): 1st - The revenues of the region are made up of its designated share from the state budget and from the region's local resources.
THEREFORE:
Transfers based on need

31. Fiscal Provisions in the Iraqi Constitution
Article (128): 2nd - The Cabinet of the region prepares the annual budget for the region and the final expense account, and a law is issued for them by the National Council for the Region. The Cabinet presents a copy of the region's general budget and the final expense account to the federal finance ministry, after they are approved by the National Council for the region.