«Comparative Conclusions on Fiscal Federalism a n wa r s h a h 1 Fiscal federalism is concerned with the public finances of the various orders of ...»
on Fiscal Federalism
a n wa r s h a h 1
Fiscal federalism is concerned with the public finances of the various orders of government in a federal system. Federal countries differ a great
deal in their choices – specifically, how the division of fiscal powers is allocated among various orders and the associated fiscal arrangements.
Further, some aspects of fiscal arrangements, such as intergovernmental
fiscal transfers, resulting from these choices can be subject to periodic review (e.g., the five-year sunset clause in Canada) and redefinition in order to adapt to changing circumstances within and beyond nations.
Changes in these arrangements may also occur simply as a result of how various constitutional provisions and laws are interpreted by courts (as in Australia and the United States) or by various orders of government, as in all federal countries. In recent years, these choices have come under significant additional strain from the great changes arising from the information revolution and the emergence of a “borderless” world economy. This chapter reviews the practice of fiscal federalism in twelve case study countries and highlights the findings and lessons from these experiences.
Section 1 of this chapter provides a general discussion of the fiscal federalism features of selected federations. This is followed by comparative reflections on the division of fiscal powers in section 2. The allocation of spending and regulatory responsibilities is discussed, and attention is paid to issues in revenue-raising responsibilities, including the financing of capital investments. Issues in macroeconomic management and economic coordination are discussed in section 3. Section 4 highlights the practice of intergovernmental fiscal transfers and pays special attention to transfers whose purpose is to reduce regional fiscal disparities. A final section draws some general conclusions from these experiences.
Comparative Conclusions 371 1 s a l i e n t f e at u r e s o f s e l e c t e d f e d e r at i o n s The twelve federations (of these Spain and South Africa have unitary constitutions but are considered quasi-federations in practice) reviewed in this book represent a diverse sample in terms of demographics, level of economic development, affinity with stylized models of federalism, and features of fiscal federalism. In our sample, Switzerland is the smallest and the second richest federation with a population of 8 million and a per capita gdp of $37,465 (2002). India is the largest and poorest federation, with a population of 1.1 billion and a per capita gdp of $666 (2004) (see table 1). The sample federations also present diverse models of federalism. Australia, India, and Russia bear affinity to the layer-cake model of dual federalism, with a strong national-government role in the federal system. Under such a model, the responsibilities of the federal and state governments are distinct and separate, and there is a hierarchical relationship among the various orders of government, with the federal government at the apex. In India, the federal government has the residual powers and paramountcy on the shared rule, and it can even change state boundaries. Both Spain and Malaysia can be characterized as asymmetric layer-cake models of dual federalism. In Spain, Navarre and the Basque country and, to a lesser extent, the states of Sabah and Sarawak in Malaysia enjoy autonomous status and are treated more equally than are other constituent units of the federation. Canada, Switzerland, and the United States resemble the coordinate-authority model of dual federalism. Under the coordinate-authority model of dual federalism, states enjoy significant autonomy, and local governments are simply creatures of the states with a limited or no direct relationship with the federal government. Germany and South Africa embody features of cooperative federalism with interdependent (hierarchical) spheres of government, but in these countries the federal government assumes an almost exclusive role in legislative authority for policy and standards, and the intermediate order primarily acts as the implementing agent. Nigeria has a three-tier hierarchical system with a strong federal government.
Brazil, by contrast, presents itself as a cooperative-federalism model with three independent spheres of government. Brazil, India, Nigeria, and South Africa have constitutionally recognized local governments, whereas in all other federations local governments are creatures of the regional (province/state) governments.
Countries with a federal form of government vary considerably in terms of federal influence on state governments. Such influence is very strong in Australia, Germany, India, Malaysia, Nigeria, Russia, Spain, and South Africa; it is weak in Brazil, Canada, Switzerland, and the United Table 1 A comparison of selected fiscal systems
Note: * – constitutionally recognized fiscal tiers; lc – layer cake model; ca- coordinate authority model Source: Author’s impressions 374 Anwar Shah States. In the latter group of countries, federal influence over state expenditures is quite limited, and state governments have considerable authority to determine their own tax bases and tax rates (see tables 2 and 3). In centralized federations, conditional grants by the federal government play a large role in influencing the priorities of regional and local governments. In Australia, a centralized federation, the federal government is constitutionally required to follow regionally differentiated policies.
Federal countries also vary according to the process of provincial/ state influence on national policies. In some countries, there is a clear separation of national and state institutions (“executive” or “interstate” federalism) and the two levels interact through meetings of officials and ministers, as in Australia, Brazil, Canada, India, Malaysia, Nigeria, Spain, and Switzerland. In Germany and South Africa, state governments have a direct voice in national institutions; that is, in both these countries, state governments are represented in the second house of parliament – the Bundesrat in Germany and the Council of the Provinces in South Africa (“intrastate” federalism). This is to be expected in view of the primacy of national legislation in all functions and the need for state government inputs for such legislation in these countries. Such arrangements, however, limit the autonomy of both the federal and state governments in Germany, creating an indecision trap associated with this “spaghetti-bowl” politics, as suggested by Feld and von Hagen (see chapter on Germany). In Russia, the Federation Council (upper chamber), as envisaged by the Constitution, was expected to have the governor and the speaker of the legislature of each region represented in it. The Constitution has now been amended to have the one executive member nominated by the governor and the one legislative assembly member nominated by the legislative assembly of each region represented in the Federation Council, thereby weakening the regional influence at the centre. This comes in the wake of an important change in the election of governors – no longer directly elected but nominated by Russia’s president and appointed by the regional legislature. In Brazil, India, Malaysia, and the United States, regional and local coalitions play an important role in the second chamber of the national legislature. This role may not support the positions taken by states’ executives and therefore works to diffuse regional tensions. In Brazil, because all states have equal representation in the Senate, small states in the northeast have a disproportionate influence on the federal system. In Canada, the members of the second chamber are nominated by the prime minister; therefore, the Senate is considered to be more technocratic in its orientation as members are often appointed based upon recognition of their service achievements in government, politics, or business.
Table 2 Fiscal decentralization to provinces/states
In some federal countries, constitutional provisions require all legislation to recognize that ultimate power rests with the people. For example, all legislation in Canada must conform to the Canadian Charter of Rights.
In Switzerland, a confederation by law but a federal country in practice, direct-democracy provisions empower citizens to hold government to account (e.g., all major legislative changes require approval by referendum).
In Malaysia, the Clients’ Charter empowers citizens to hold governments to account in the event specified public service standards are not met.
Regional income disparities, however, are significant in most of the case study countries. These disparities are the largest for South Africa and the smallest for the United States.
The constitutional division of power on the spending and regulatory responsibilities in the case study countries generally conforms to the subsidiarity principle. India, Malaysia, and South Africa are the exceptions, where, responding to historical legacies, a dominant federal role was carved out by the constitution and, in the case of India, further cemented by a centrally appointed unified civil service. The practice in most federal countries, as a result of historical, cultural, and institutional factors and legal-judicial interpretations varies widely, and most federal countries, with the exception of Canada, have allowed a wider federal role than originally envisaged by the framers of the constitution. The original federal role was largely limited to services of national scope such as “peace, order and good government.” This role was later expanded due to wars and judicial interpretation of the constitution, as in Australia and the United States; threats of secession, as in India and Russia; issues in combating terrorism and promoting racial equality, as in the United States;
natural-resource management and environmental protection, as in Brazil, Nigeria, and the United States; debt management and fiscal discipline, as in Brazil; protection of the indigenous majority, as in Malaysia;
or, more commonly, federal use of regulatory or spending powers in order to achieve national objectives in securing a common economic union, as in most of the case study countries. The use of federal regulatory powers often results in unfunded or underfunded mandates, whereas the use of conditional matching grants can lead to fiscal stress for regional and local governments.
The overall role of the intermediate orders of government is the strongest in Switzerland and Canada; fairly strong in the United States, Brazil, and Australia; and relatively weak in other federations, with the weakest
Comparative Conclusions 379Figure 1 Subnational expenditure as a% of total government expenditure Sources: Various chapters in this volume; Government Finance Statistics Yearbook (various issues) Washington, dc: International Monetary Fund.
being in South Africa. However, this role remains large in all the case study countries with regard to the delivery of social and infrastructure services, with the exceptions of Malaysia and South Africa, where such services are centralized. In Canada, provinces have a role in immigration policy and in regulating securities and labour markets, thus creating the potential for inefficiencies in the internal common market.
Local government responsibilities are extensive in Switzerland, the United States, Brazil, and Canada; quite restricted in Spain, India, Russia and Malaysia; and highly constrained in Australia (see figure 1). In Spain, basic education and basic health care are intermediate-order responsibilities. In Russia, several local services, such as public transit, roads, and fire prevention, are regional government functions, whereas local police protection and local tax collection are federal responsibilities. In Australia, local governments play an insignificant role in public service delivery and are primarily responsible for property-oriented services such as garbage collection and street maintenance and cleaning.
380 Anwar Shah Overall, with the exception of Spain, Brazil, Australia, and Malaysia, subnational expenditures in the case study countries account for 50 percent or more of consolidated public expenditures, with state and local governments in Switzerland and Canada accounting for more than 60 percent of such expenditures (see Figure 1).
Shared rule is sometimes a source of confusion and conflict. In Canada, the provinces have attempted to limit the federal spending power in social services by entering into a social union framework agreement with the federal government. In Germany, where the intertwining of federal and state powers is an issue, the Federalism Reform Act, 2006, limits federal laws requiring the consent of the Bundesrat (second chamber) to specified areas and also gives states flexibility to deviate from a federal law in its implementation. In Switzerland, ambiguity with regard to shared rule is avoided by having intergovernmental agreements and contracts. In the United States, Russia, and South Africa, unfunded or underfunded federal mandates represent sources of concern for state (province/region) governments.
Allocation of taxing Powers
Taxing powers (tax base and rate determination and tax collection) are highly centralized (75 percent or more central revenues) in Malaysia, South Africa, and Australia; centralized (60 percent to 75 percent of revenues collected by the centre) in Brazil, India, Russia, and the United States; highly decentralized in Switzerland (37 percent of total revenues collected by the centre); and decentralized (40 per cent to 50 percent at the centre) in Canada and Nigeria. Other countries fall in the intermediate range. In Russia, the centralization of tax administration has resulted in a weaker effort in collecting state (regional) and local taxes.