1 fiscal federalism dr. violeta ruiz almendral professor of tax and finance law universidad carlos...

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Fiscal Federalism

Dr. Violeta Ruiz AlmendralProfessor of Tax and Finance Law

Universidad Carlos III de Madrid, SPAIN

Forum of FederationsAMMAN, JORDAN- August 2007

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Fiscal Federalism

1. Introduction: the financing of a State.2. Inter-regional equity and equalization: vertical and

horizontal fiscal imbalance.3. Revenues and expenditures in a federation: overview4. Types of revenues and their role:

– Taxation powers– Borrowing powers– Revenues from natural resources

5. Spending power and the distribution of powers6. Management of the economy; the question of policy

coordination

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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…

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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)

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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…

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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

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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)

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Relevance of taxes in Europe (an example)

Total taxes in relation to GNPIndirect taxes in relation to

total revenuesDirect taxes in relation to

total revenues

1995 2002 2003 2000 2003 2000 2003

EURO AREA 42.5 42.1 42.2 32.5 32.8 30.4 29.0

Germany 42.3 41.7 41.7 28.9 29.7 28.7 25.9

Spain 34.3 36.3 36.5 33.7 33.7 29.9 29.6

France 45.4 45.6 45.7 34.3 34.1 27.2 25.8

Ireland 35.2 29.8 31.2 41.7 41.4 41.1 39.5

U.K. 36.7 37.0 37.1 37.0 36.9 43.7 42.0

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The financing of a State: revenues

• Natural resources – Relevant in Iraq (majority of public revenues)– Problems: Unequaly distributed, Limited (?)

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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

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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

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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…)

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• 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

Horizontal fiscal imbalance

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Revenues and expenditures of subnational units: overview

REVENUES

• Transfers• Taxes• Natural resources• Debt (public/private)

EXPENDITURES• Budget powers• Spending power• Fiscal equilibrium

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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”

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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

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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…)

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• 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

Revenues and expenditures in a federation: the problem with transfers

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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)

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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

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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”

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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.

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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, …

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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

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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”

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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…

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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)

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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

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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…)

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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

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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.