Principles of Revenue Assignment

Principles of Revenue Assignment
Introduction
Purposes of Revenue Assignments
Criteria of Revenue Assignments
Revenue Assignments methods
Common problems of revenue assignments
Desirable features of subnational taxes
Revenue Assignment - Principals

Introduction
 Revenue assignments are necessary as
there is need for expenditure assignments
to improve service delivery
 Revenue assignment is one of the four
pillars of fiscal decentralization
 Fiscal decentralization is one of the three
dimensions of decentralization
 Decentralization is a world wide
phenomenon going on in every country

Definition - Decentralization
 Decentralization is the transfer of authority and
responsibility for public functions from central
government to subordinate or quasi-
independent organizations or the private sector
 Decentralization is of the empowerment of
people by the empowerment of their local
governments
 Two issues/questions/problems -
◦ what public function should be assigned and to
which level of government.
◦ how subnational governments are to be financed

Dimensions of decentralization
Political
Empowerment
Administrative
(Regulatory)
Empowerment
Fiscal
Empowerment

Definition – Fiscal Decentralization
 Fiscal decentralization studies the fiscal
aspects of how public goods and services
are or could be provided and financed by
regional and local governments in a
devolved system of government.
 Fiscal decentralization has the potential to
reduce accountability by breaking the
links between the levels of taxation and
expenditure.

Four Pillars of Fiscal Decentralization
SNG Structure/Political & Administrative Decentralization
Expenditure
Assignment
Sub
national
Debt
and
Borrowings
Intergovernmental
Fiscal
Transfer
Revenue
Assignment
Fiscal Decentralization

Revenue Assignment - Introduction
▪ Which revenue sources (taxes) can and
should be assigned to different levels of
government? - depends partly on the mix of
various taxes used in the country overall
▪ How should these arrangements be
implemented?
 At minimum revenue assignment should
provide:
➢Autonomy at the margin
➢Stable assignments over time
➢Sufficient revenues for the wealthiest subnational
governments to be fiscally autonomous

Revenue Assignment - Introduction
▪ Two basic principles
• Sub-national units should be allowed to
finance locally-provided services
(benefiting local residents) by using “Own-
source” revenues;
• Where possible, sub-national revenue
should be collected only from local
residents in relation to the benefits they
receive from local services

Categories of Financial Sources for
Subnational Government
 Revenues
◦ Tax revenues
◦ Non-tax revenues (charges, income from property, etc)
 Intergovernmental grants
◦ General purpose grants
◦ Conditional grants
◦ Matching grants
 Other sources
◦ Credits
◦ Revenues from privatization

Purposes of Tax Assignment
 Fiscal Autonomy
◦ There must be enough own revenues
◦ Revenues must be marginal
◦ The principle of subsidiarity in taxation
 Accountability and responsibility increase
◦ Internal and external audit
◦ Public control
 Resource allocation
◦ Provision of public (social) goods
◦ Benefit principle of taxation
◦ Externalities

Purposes of Tax Assignment(cont.)
 Macroeconomic stabilization and
redistribution of income should be
generally left as responsibilities of the
central government
 Beggar-thy-neighbour redistributive
policies may result if redistributive equity
is handed over to subnational government

 Increase the accountability and responsibility
of subnational government officials to their
constituencies
➢Subnational governments can significantly affect
their total revenues at the margin through their
choices of taxes, bases, or more preferably tax rates
➢Subnational governments should operate with a
hard budget constraint. Revenue sharing and grants
should be infra-marginal funding.The expansion (or
contraction) of the budget should remain a
subnational government responsibility

 Resource Allocation
◦ Provide subnational governments with
revenues they can control to implement their
expenditure responsibilities (improved
resource allocation)
➢Own taxes and levies
➢Shared taxes

Choices in providing Tax Autonomy
 Which taxes should subnational governments
be allowed to levy?
➢Closed lists are preferable to freedom to legislate
new taxes (less complexity, fewer inequities and
distortions)
 Should there be a discretion to modify or not
to modify tax bases
➢Discretion also leads to complexity and inequities
➢Surcharges or taxes piggybacked on a central
government tax base are easier to administer

Choices in providing Tax Autonomy
(Cont.)
 Discretion to set the tax rate is the
simplest and most effective form of tax
autonomy
➢National legislation can set, when desirable,
maximum and/or minimum rates
 Separate tax administrations for
subnational governments may be desirable
but are not always necessary if incentive
compatible arrangements between levels
of government are set in place

Revenue Assignments - Introduction
 For efficiency, it may be desirable to
assess the base of a tax centrally and even
to have it collected by the central
government; but for accountability it is
critical that the local authorities are
responsible (perhaps within limits) for
setting the tax rate

Choosing Among Different Taxes At
The Subnational Levels
 Good choices for local (municipal)
governments
➢Fees and user charges
➢Real estate property tax
➢Betterment and improvement levies
➢Vehicle and transportation taxes
➢Piggyback flat rate personal income tax

Choosing Among DifferentTaxes At The
Subnational Levels(Cont.)
 Good choices for regional governments
➢Piggyback flat rate personal income tax
➢Piggyback for selected excises
➢Business value tax (BVT) falling on wages and
profits
➢A regionalVAT, if tax administration is
adequate, is superior to a retail sales tax.

Methods of Revenue Assignment
 Independent subnational tax legislation and
administration
 Tax base or tax rate establishment
 Subnational surcharge
 Tax sharing
 Revenue sharing: intergovernmental
transfers
High fiscal autonomy
Low fiscal autonomy

Methods of Revenue Assignment (cont.)
 Independent subnational tax legislation and
administration
◦ free introduction of regional and local taxes
◦ close list of subnational taxes
 Tax base or tax rate establishment
◦ should central government set tax base and tax rate bounds
◦ At what level set extra tax rate to the federal taxes
◦ Flat extra rate or progressive
 Tax Sharing
◦ does not contribute to subnational revenue autonomy

21
Shared Tax vs.Tax Surcharges
 Shared tax
◦ Could distort fiscal (tax) policy of the central
government
◦ Benefit principle violation
◦ Region discretion if different shares is used
◦ Negative incentives could occur
◦ Lack of most listed above drawbacks
◦ Induce tax competition

Tax Sharing : Statutory division of
federal tax among government levels
Federal
budget
Regional
budget
Local
Budget
? ? ?
Revenue from
particular tax

TAX SHARING: uniform fraction
60% 60% 60% 60%
60%
Province A Province B Province C Province D Province F
Total tax 100%
Uniform tax shares

TAX SHARING: different fraction
Total tax 100%
60% 40% 60% 75%
80%
Different tax shares

TAX SHARING: Pool-tax
Accumulated share of tax 50%
Distribution by formula (per capita)
Total tax 100%

Common Problems with Revenue
Assignments
 Vertical imbalance (inadequate correspondence
between expenditure responsibilities of
subnational governments and their assigned
sources of revenue)
➢Tax autonomy and increased use of subsidiarity in
taxation (taxes should be assigned to the lowest level
of government that can implement them) are
preferable to transfers
➢Inadequate revenue/ productivity of tax
assigned to subnational governments

Assignments(cont.)
 Lack of meaningful tax autonomy
➢Predominance of shared taxes and transfers
 Unstable Assignments
➢Assignments are decided in the annual budget
rather than stated in the laws and fixed for a
number of years

Assignments(cont.)
 Wrong incentives and lack of uniformity: the
“regulation” of taxes
➢Tax assignments are customized for each local
government to fit a “minimum budget”
 Confused system resulting in the misallocation
of resources and significant administration and
compliance costs

Assignments(cont.)
 Unfair apportionment of tax revenues
among subnational jurisdictions
➢The exclusive sharing of taxes on a “derivation
basis” (usually paid at the headquarters of the
firm) leads to the unfair allocations ofVAT and
CIT revenues
 Large horizontal disparities
➢The uneven distribution of tax bases requires the
introduction of equalization grants
➢The problem is more acute with the sharing of
natural resource taxes

Desirable Attributes of Subnational
Taxes (Revenue Assignments)
 There are hardly any taxes that comply
with all the desirable features for
subnational taxation
 But clearly, there are better and worse
tax assignments

 Linkage between taxes and benefits
derived from local government services
(using the “benefit principle”)
➢Employ user charges and fees whenever possible: for
excludable and individual benefits. (User charges act
as quasi-prices by rationing and signaling demand and
they tend to be fair)
➢For public services with generalized benefits use
“consumption and residence-based” taxes if benefits
are provided to individuals and “production and
origin-based” taxes if benefits are provided to
businesses

 Revenue stability and revenue elasticity
➢Subnational governments typically cannot run
deficits and have more limited ability to
borrow. More unstable sources should be
assigned to the central government
➢Subnational revenues should increase with
income as much as the demand for services

 Minimizing excess burdens and distortions
in the location of economic activity
➢Unlike revenue burdens, excess burdens are
avoidable losses, which arise from people trying
to avoid taxes by working less, changing the level
and composition of consumption and
investment, etc.
➢Taxes levied at the origin of production or
source of income tend to distort location more
than taxes on consumption or place of residence

 Controlling tax exporting (taxes are paid
by non-residents who derive no benefit)
➢Tax exporting can lead to over spending
➢It is unfair and undermines accountability
 To control tax exporting
➢Use taxes on local consumption and place of
residence
➢Taxes with immobile base and with evenly
distributed tax base

 Preventing predatory tax competition
➢Efficiency of internal common market is must
➢By jurisdictions that provide a haven to
smugglers, those that misstate residence, or
practice profit shifting through transfer pricing
➢However, there is also “healthy” tax competition,
as when taxpayers relocate to enjoy a preferable
package of taxes and public services
 Administrative feasibility
➢Administration costs and compliance costs (time
and money employed to file taxes) and political
acceptability are taken into account

Principles of Revenue Assignment

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