UNDP Training Programme: Decentralisation and Local Governance (RBEC) Fiscal Decentralisation Nick Devas IDD, School of Public Policy June 2007

Fiscal Decentralisation: Principles  Resources follow function  Criteria for allocating functions  Criteria for allocating resources  Balanced budgets, based on realistic revenue forecasts and rules about borrowing  Scope for improved performance: revenue mobilisation and expenditure management

Assignment of Functions  CG: broad policy, performance targets, monitoring  LG: local priorities and implementation  Sectors with local diversity, limited spillovers and modest economies of scale  Sectors not requiring uniform national standards  Local capacity constraints  Problem of small size  Divisions within multi-tier system

Resource Assignment  Central governments collect main revenues – for good efficiency, equity and administrative reasons  SNGs/LGs usually have limited revenue sources: criteria for assignment  Vertical balance  Redistributing centrally collected resources: –revenue sharing –grants –horizontal balance / equalisation

Criteria for Assigning Local Taxes  Yield: adequacy, stability, elasticity  Low collection costs  Equity: vertical, horizontal  Neutrality: effect on relative prices & incentives  Administrative capacity  Political acceptability: visibility  Ease of assigning revenue to right LG  Tax burden falls in residents, not exported  Not creating inter-regional distortions  Scope for local choice about tax rate  Resource for all LGs

Local Taxes: Conclusions  No local tax is perfect: criteria conflict  Best ones may overlap with central taxes  More than one local tax but not too many  Central prescription of tax objects / tax base  Some local choice over tax rates (but limits?)  Assessment centrally or locally  Local collection  Local choice about use of revenue

Typical Local Taxes  Property taxes (land, buildings, transfers)  Vehicle taxes (annual, transfer)  Business taxes (but problems of assessment and conflict with national taxes)  Income tax: but best as share of central tax  Tourism, hotels, entertainments  Electricity consumption  Others: advertisements, bicycles, alcohol

Improving Local Tax Performance  Property tax: valuation basis (rather than size) and updating valuations  Updating tax registers  Increasing tax rates in line with inflation  Simplified collection systems  More effective enforcement measures  Proper accounting and record keeping  Balance between effectiveness (more revenue) and efficiency (less cost)

Charging for Local Services  For services where benefits are private  Charges to reflect true cost (marginal pricing)  But difficulties of correct pricing, measurement and collection  Subsidised charges (or free provision): –where public benefits are large –for poor (if poor are only/main beneficiaries) –but income subsidies may be better –scope for internal cross-subsidies? –free or subsidised provision may mean no service or inadequate service

Revenue Sharing  National tax revenues may be shared: –by origin: incentive to support tax collection but reinforces inter-LG inequalities, plus problem of assignment to right LG (e.g. VAT) –by formula: redistributive but little incentive  High sharing ratios may reduce CG incentive to improve collection performance  Surcharging on national tax base (tax-base sharing): like local tax but problems of assignment to right LG and inter-LG equity

Intergovernmental Grants  Specific grants: to ensure national priorities  Matching grants: a form of specific grant that encourages LG contribution  Block / General grants: LGs have choice; main means of equalisation (horizontal balance)  Grant formulae to take account of: –relative expenditure needs (various factors) –relative local resource capacity

Grant Formulae  Expenditure needs factors: which ones?  Local revenue capacity: how to assess?  Other factors: regional cost variations, poverty factor, performance related factors  Data availability and reliability (for all LGs)  Incentive / disincentive effects  Simplicity vs. accuracy/equity  Transparency and public trust

Capital Financing and Borrowing  Asset sales  Borrowing –sources, financial institutions –borrowing capacity –municipal bonds  Leasing, deferred purchase  Public-private partnerships: various forms  Community contributions

Closing the Fiscal Gap  Increased efficiency in resource use  Alternative ways to deliver services, e.g. contracting out, privatisation, community provision  Improving revenue collection performance  Improving financial management –financial information systems –accounting systems –auditing: internal. external –budget centres with devolved responsibilities  Use of performance indicators, targets  Public accountability