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
Anwar Shah, World Bank
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
Anwar Shah, World Bank
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.
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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
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No need to despair ….
As properly designed fiscal transfers can be part of the solution rather than part of the problem.
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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
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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
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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
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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
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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.
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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.
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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
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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
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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.
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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).
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Anwar Shah, World Bank
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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.
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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
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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
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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)
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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
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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.
Anwar Shah, World Bank
Anwar Shah, World Bank
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
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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
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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
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„Effectiveness“ of the Finanzausgleich
1999
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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
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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)
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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
Anwar Shah, World Bank
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
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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