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«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 ...»

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Vertical fiscal gaps, at least at the conceptual level, are largely a non-issue in Canada, the United States, and Switzerland because state governments have sufficient fiscal powers to overcome such gaps. In Canada, the federal government used tax abatement as well as incentives for tax-base sharing to overcome such a gap in the past. These vertical gaps represent a significant issue in the remaining case study countries as they have centralized tax administration and constrained state and local taxing powers. To overcome such gaps, general revenue sharing, with a multitude of equalization

Comparative Conclusions 389

components, is being used in Brazil, India, Malaysia, and Nigeria. Ironically, in India such revenue sharing uses 1971 population data as the basis for allocating finds among states; in Brazil, state and municipal coefficients are frozen at 1988 levels. Tax-base sharing and tax-by-tax sharing is used in Germany; fiscal need equalization grants are used in Australia, Russia, and Spain (mostly historical expenditures). For most countries in our sample, fiscal transfers reverse the fiscal position of the federal government from surplus to deficit (see table 4).

Bridging the fiscal divide within nations

The fiscal divide within nations represents an important element of the economic divide within nations. Such a divide is a matter of concern in all the case study countries, with the important exception of the United States. In Canada, such a divide is accentuated by provincial ownership of natural resources and soaring oil and gas prices. Fiscal equalization programs, with the objective of enabling constituent units to provide reasonably comparable levels of public services at reasonably comparable levels of taxation, are frequently advocated to overcome such a divide. Such programs are expected to foster goods and factor mobility and help secure a common economic union.

Among the case study countries, Australia, Canada, Germany, Malaysia, Russia, Spain, and Switzerland attempt to address regional fiscal disparities through a program of fiscal equalization. In the United States, there is no federal program because factor mobility has served to bridge fiscal and economic differences to a great extent, although such differences within states remain a matter of policy concern. And, for that reason, state education finance typically uses equalization principles. In Canada, such a program is enshrined in the Canadian Constitution and is termed “the glue that holds the federation together.” Such programs in the case study countries are federally financed, with the exception of Germany and Switzerland. In Germany, wealthy states make progressive contributions to the equalization pool, and the poor states receive from this pool. In Switzerland, the new equalization program, effective in 2008, has a mixed pool of contributions from the federal government and wealthier cantons. In Russia, equalization programs conducted by regions for local equalization use the mixed approach.

All the case study countries with an equalization program have some focus on fiscal-capacity equalization. Australia, in addition, has a comprehensive approach to fiscal-need equalization. Spain equalizes fiscal need based on historical expenditures, and both Russia and Malaysia consider partial equalization of expenditure needs based on selected need indicators. The Canadian and German equalization programs use an explicit fiscal-capacity 390 Anwar Shah standard of equalization that determines both the total pool as well as allocations across constituent units. Such a principled approach to equalization is desirable as it results in greater transparency and objectivity in allocating equalization payments. All other programs utilize a fixed pool but use allocation formulae to determine allocation across units.

The equity and efficiency implications of equalization programs are a source of continuing debate in most federal countries. In Australia, the complexity introduced by expenditure-needs compensation is an important source of discontent with the existing formula. In Canada, provincial ownership of natural resources is a major source of provincial fiscal disparities, and the treatment of natural-resource revenues in the equalization program remains contentious. In Germany, the applications of overly progressive equalization formulae result in a reversal of fortunes for some rich jurisdictions. Some rich Länder in Germany have, in the past, taken this matter to the Constitutional Court to limit their contributions to the equalization pool. In Spain, the asymmetric treatment of autonomous communities (charter regime) and the rest of the regions (common regime) for equalization purposes is a continuing source of contention. In Brazil, India, Malaysia, Nigeria, Russia, and South Africa, much controversy and debate is generated by the equity and efficiency impacts of existing programs.

In Nigeria, arbitrary use of the Federation Account (resource revenue pool) to retire federal debt and revenue-sharing formula components, especially the 13 percent share for derivation component, are sources of concern (especially for the Niger delta region).

Institutional Approaches to the Design and Practice of Equalization Transfers The case study countries use diverse approaches to institutional arrangements for equalization transfers. These diverse arrangements have been designed to suit the contexts of individual countries. In Spain, Switzerland, Malaysia, Russia, and South Africa, the federal ministry of finance or treasury is responsible for decisions on the total pool and allocation among constituent units. In Brazil, the total pool is determined by the Constitution, and the federal Senate determines the allocation for state and local governments. In Australia, India, and Nigeria (semi-independent), independent grant commissions are entrusted with making recommendations on the formula for allocating such transfers, whereas the total pool is predetermined by legislation. In Canada, intergovernmental forums make the initial determination. These decisions are then endorsed and legislated by the federal Parliament and implemented by the federal Ministry of Finance. In Germany, a federal compact determines the allocation, which is legislated by the federal government and implemented by the Ministry of Finance.

Comparative Conclusions 391

While, on an a priori basis, no one institutional arrangement is preferable to another, experience has shown that independent grant commissions typically opt for greater complexity in designing such transfers, leading to much acrimony and debate. Leaving these decisions to the federal government alone, however, makes such transfers vulnerable to the whims of the regime in power. Intergovernmental forums offer a second-best alternative by having all relevant stakeholders involved in the decisions on such transfers.

Setting national minimum standards through output-based fiscal transfers Setting national minimum standards in regional-local services serves both efficiency (creating an internal common market) and equity (treating all citizens equally regardless of their place of residence). Such standards can be attained by conditional non-matching grants, in which the conditions reflect national output-based efficiency and equity concerns and there is a financial penalty associated with failure to comply with any of the conditions. Conditions are thus imposed not on the specific use of grant funds but on the attainment of standards in quality, access, and level of services. Such outputbased grants do not affect state-local government incentives for cost efficiency, but they do encourage compliance with nationally specified standards for access, quality, and level of services. Properly designed conditional nonmatching output-based transfers can create incentives for innovative and competitive approaches to improved service delivery and results-based accountability in the public sector. Input-based grants fail to create such an accountability environment. Although output-based (performance-oriented) grants are best suited to the grantor’s objectives and are simpler to administer than are traditional input-based conditional transfers, they are rarely practised in the sample federal countries. Prominent notable exceptions are education and health finance in Brazil, Canada, and South Africa, and highway finance in the United States. The reasons have to do with the incentives faced by politicians and bureaucrats. Such grants empower clients while weakening the sphere for opportunism and pork-barrel politics. The incentives they create strengthen the accountability of political and bureaucratic elites to citizens and weaken their ability to peddle influence and build bureaucratic empires. Their focus on value for money exposes corruption, inefficiency, and waste. Not surprisingly, this type of grant is opposed by potential losers.

In most of the case study countries, with a few notable exceptions, federal conditional grants use input-based conditionality. Such conditionality impairs state and local autonomy and is a source of conflict. Growing use of such grants is a matter of state and local concern in Australia, Germany, Spain, and Russia. Vertical fiscal gaps – differences between the revenue share and expenditure share before fiscal transfers – are 392 Anwar Shah very large for provinces in South Africa and states in Australia and India, but these are eliminated by fiscal transfers.

In Brazil and Canada, and to a limited extent in South Africa, education and health transfers focus on output and access-based conditionality. In the Unites States, federal fiscal transfers to state and local governments, with the important exception of highway grants, were in the past predominantly input-based conditional grant programs, although since the 1990s, an emphasis on shifting federal grants towards performance-based criteria is slowly emerging.

5 lessons learned and concluding remarks The following lessons emerge from these diverse experiences.

• Clarity in responsibilities but periodic joint review is key to the successful working of the fiscal system. As Rudyard Kipling once said, there are 160 ways to design fiscal tiers, and every one of them is right. What matters is that constitutional and legal systems and institutions must provide for mechanisms to build societal consensus for new compacts in view of changing circumstances and be amenable to timely adjustments to implement such compacts.

Asymmetric federalism arising from symmetric and uniform principles • leads to amicable and sustainable outcomes.

Finance should follow function to strengthen responsiveness and ac countability to taxpayers.

Fiscal rules accompanied by “gate keeper” intergovernmental commit tees provide a useful framework for fiscal discipline and fiscal policy coordination.

To ensure fiscal discipline, all governments must be made to face the fi nancial consequences of their decisions.

Securing a common economic union through unimpeded goods and • factor mobility and national minimum standards for social services and infrastructure is the best guarantee for political and economic stability and regional convergence in the long run.

Institutional arrangements for managing intergovernmental conflicts • play an important role in the smooth working of a federal system.

Properly designed intergovernmental transfers can strengthen results based accountability and also enhance competition for the supply of public goods, fiscal harmonization, state and local government accountability, and regional equity. Manna-from-heaven transfers or bilaterally negotiated transfers can build transfer dependencies that cause the slow economic strangulation of fiscally disadvantaged regions. All transfers must be open for periodic reviews.

Comparative Conclusions 393

• Societal norms and consensus on the roles of the various orders of government and limits to their authority are vital for the success of decentralized decision making. In the absence of such norms and consensus, direct central controls do not work, and intergovernmental gaming leads to dysfunctional constitutions. Direct-democracy provisions can be helpful in restraining governments.

• A clients’ charter with specified standards of services and feedback and redress mechanisms can help strengthen government accountability to citizens.

In conclusion, the federal countries examined in this volume have shown a remarkable ability to adapt and to meet emerging challenges in fiscal federalism. While the challenges they face may be very similar, the solutions they discover and adopt are often unique and local. This represents a remarkable attestation to the triumph of the spirit of federalism in its never-ending quest for balance and excellence in responsive, responsible, and accountable governance. The long march to attain new heights in inclusive governance continues.

–  –  –

1 The author is grateful to Professor John Kincaid for helpful comments.

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