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The Assignment of Revenues and Expenditures in Intergovernmental Fiscal

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 The Assignment of Revenues and Expenditures in Intergovernmental
Fiscal Relations*
By Charles E. McLure & Jorge Martinez-Vazquez

I. Introduction
Countries throughout the world are increasingly recognizing the benefits of fiscal
decentralization. In theory – if not always in fact – decentralization makes it possible for
people to have greater influence on the decisions of government that affect their lives. In
countries as varied as the republics of the former Soviet Union, the nations of Central and
Eastern Europe, South Africa, Australia, and various developing countries (e.g., Argentina,
Bolivia, and Colombia), many see decentralization as an important component of a strategy
designed to increase the political power of people, as expressed through local governments.1
Decentralization may, at the least, be important for political reasons, and it may also improve
the welfare of the populace.2

The first fundamental step in the design of a system of intergovernmental fiscal

relations should be a clear assignment of functional responsibilities among different levels of
government. Instability and controversy in the practice of decentralized systems has followed
when the law was silent or unclear about the competencies and expenditure obligations of
different levels of government. A stable and meaningful decentralization requires an
unambiguous and well defined institutional framework in the assignment of expenditure
responsibilities among the different levels of government together with the sufficient
budgetary autonomy to carry out the assigned responsibilities at each level of government.

Designing the other important pieces of a system of decentralized finances, revenue

assignments and transfers, in the absence of a clear expenditure assignment is to put the car
before the horse. The decentralization movement in many countries of Latin America over
the past decade made this fundamental mistake. Revenues were assigned to subnational
governments and transfers put into place before it was decided what functional competencies
would be transferred from the central government to subnational governments. These
experiences led to weak decentralized systems and fiscally overburdened central
governments, which in many cases continued to take on most expenditures responsibilities
with fewer resources. The focus on the revenue side of decentralization and the neglect of a
clearer assignment of expenditure responsibilities has also been a common theme of the
decentralization process in countries in transition over the past five years.

*
This report draws from "The Tax Assignment Problem: Conceptual and Administrative Considerations in
Achieving Subnational Fiscal Autonomy" by Charles E. McLure and "The Assignment of Expenditure
Responsibilities" by Jorge Martinez-Vazquez, papers prepared for the World Bank Institute's Decentralization
Homepage (www.worldbank.org/decentralization).
1
See Boadway (1997b) and Oates (1997) on Argentina, James (1992), Collins (1993), and Warren (1997) on
Australia, McLure (1993b) on Brazil, Wong (1993) and Bahl (forthcoming) on China, McLure (forthcoming, a)
on Kazakhstan, Wallich (1994) and McLure (1995b) on Russia, McLure (1995a) on South Africa, McLure
(1994a) and Martinez, McLure, and Wallace (1995) on Ukraine, Bird, Litvack, and Rao (1995) and McLure and
Martinez (forthcoming) on Vietnam, and Bird, Ebel, and Wallich (1995) on countries in transition from
socialism. Prud'homme (1995) provides a more extensive list of country studies.
2
For a more skeptical appraisal, see Prud'homme (1995). McLure (1995c) and Sewell (1996) question
Prud’homme’s analysis. See also Litvack, Ahmad, and Bird (1998).
 If fiscal decentralization is to be a reality, subnational governments must control their
"own" sources of revenue.3 Subnational governments that lack independent sources of
revenue can never truly enjoy fiscal autonomy; they may be – and probably are – under the
financial thumb of the central government.4 The question, then, is which revenue sources can
and should be assigned to subnational levels of government and how these assignments are to
be effected. This group of questions is commonly called "the tax assignment problem.”5
They are closely related to “the expenditure problem,” because of the importance of benefit
taxation in the finance of subnational government and the need to assure that subnational
governments have revenues that are adequate to finance the expenditures assigned to them.

In the second section of this report a general theory of public finance is reviewed in
other to give the theoretical background of the subject. Section III describes general
principals of expenditure assignment. Section IV discusses tax assignment problem and
concludes the report with some remarks.

II. Narrowing the Scope of Inquiry: Musgrave's Three-Function Framework

In his classic treatise, The Theory of Public Finance, Richard Musgrave (1959)
suggests that, for conceptual purposes, the functions of government should be separated into
three functions or "branches," macroeconomic stabilization, income redistribution, and
resource allocation.

The stabilization branch is to assure the achievement of high employment and price
stability, the distribution branch is to achieve an equitable distribution of income, and the
allocation branch is to see that resources are used efficiently.6

This conceptual division of the responsibilities of government allows us to narrow the

scope of inquiry into tax assignment, by indicating which of the three functions are most
appropriately assigned to various levels of government. The remainder of this section
focuses on the implications of the three-branch framework for the assignment of revenue
sources among levels of government, especially the assignment between the central
government and second-tier governments.7

3
The term “subnational” is used to describe all levels of government below the national level. “Second-tier” is
used for the highest level of subnational government-- the states of the United States, Australia, and Brazil, the
provinces of Argentina and Canada, the laender of Germany, and the oblasts of the new republics of the former
Soviet Union--and “local” is used for all governments below the second tier.
4
Much of the discussion of this paper is more appropriate for a federal system of government than for a unitary
system. None-the-less, interest in tax assignment is not confined to federations. It is necessary that, under
either system, the central government have a real commitment to devolution of power if tax assignment is to be
meaningful.
5
Musgrave (1983) asks, “Who Should Tax , Where, and What?” The tax assignment problem is part of a larger
set of questions that might be called “the revenue assignment problem." The latter includes the design of
intergovernmental grants and the framework for borrowing by subnational governments. I ignore these two
issues.
6
The stabilization branch would presumably be responsible for maintaining external balance (an acceptable
balance of trade under a regime of fixed exchange rates or a satisfactory exchange rate in a world of flexible
exchange rates). Policies for economic development or growth (reflected in the choice between present and
future consumption) might be assigned to the allocation branch, on the assumption that the stabilization branch
achieved its objectives.
7
See also Oates (1968), (1972), and (1994) and Musgrave (1983), especially pp. 10-17. Bird (1993a) provides
an extremely useful discussion of issues of fiscal decentralization.
A. Macroeconomic Stabilization
The stabilization function – the maintenance of high employment and price stability –
is ordinarily assigned to the central government.8 This is true for several reasons. First,
subnational governments commonly cannot much affect macroeconomic conditions within
their boundaries, and thus have little reason to try, because most of the effects of
macroeconomic policy attempted by subnational government will "leak" out of the area.9 A
simple Keynesian multiplier analysis can be used to illustrate the problem. Suppose that the
marginal propensity to consume is 0.6. An increase in central government expenditures of
$100 will have a second round impact of $60, a third round impact of $36, and a multiplier of
2.50. Suppose, by comparison, that the residents of a subnational government considering
the use of stabilization policy import half of their consumption from other areas. Even if all
the initial government spending of $100 is reflected in increased incomes within the
subnational jurisdiction--likely an unrealistic assumption--the second-round impact is only
$30 (50 percent of $60) and the third-round impact is only $9; the overall multiplier is only
1.43. Thus, the local multiplier effects beyond the first round are 150 percent of the initial
expenditure by the central government, but only 43 percent of the initial subnational
spending.

The second problem with subnational macroeconomic policy is the limited power to
borrow and the lack of the power to print money. Even if subnational governments had the
ability and incentive to attempt stabilization, they would have difficulty in engaging in the
deficit financing that is often required to implement expansionary policy, unless their
borrowing is supported by the central government. Where central governments do support
subnational borrowing, the result is commonly irresponsible behavior that threatens the
macroeconomic stability of the nation.

The taxes commonly thought to have the most powerful stabilizing effects are the
corporate income tax and the progressive individual income tax--the former because profits
fluctuate more than general economic conditions and the latter because of the stabilizing
effects of graduated rates (including tax-free amounts).10 This suggests that these two taxes
should be assigned to the central government. Note, however, that this reasoning does not
imply that subnational governments should not levy taxes on the income of individuals; such
taxes may have advantages that offset any disadvantage created by cyclical fluctuations in
revenues. Other considerations to be discussed below suggest that subnational governments
should rely heavily on corporate income taxes only if other suitable alternatives are not
available – and that access to revenues from these taxes should be made available to
subnational governments only subject to rigid controls.

Cyclical swings in revenues and expenditure requirements create problems even for
subnational governments that do not attempt to implement stabilization policies. If
subnational governments cannot much affect macroeconomic conditions nor easily adjust to
wide swings in revenues, it is appropriate for them to rely relatively heavily on revenue

8
Sewell (1996) suggests that there may be more latitude for subnational stabilization policy than in Musgrave’s
view.
9
Some may argue that no government can be effective in influencing macroeconomic conditions. This debate
need not divert our attention. If any macroeconomic policy is to be effective, it is more likely to be that of the
central government.
10
Progressive taxation takes a percentage of income that rises as income rises; regressive taxation takes a
percentage that falls. Proportionate taxation takes the same fraction of income at all income levels.
sources that are relatively insensitive to macroeconomic conditions. These include taxes on
consumption, such as general sales taxes, excises, and property taxes.11

B. Redistribution of Income
The distribution function is also commonly assigned primarily to the central level of
government. Again, this is true for several reasons. First, subnational attempts at
redistribution may not be successful, and they are likely to distort the geographic allocation
of economic resources. Progressive taxation intended to “soak the rich” may drive out capital
and high-income individuals. If this occurs, taxation that appears progressive may actually
be regressive. For example, the long-run incidence of property taxes levied on mobile capital
by one subnational jurisdiction may be on immobile factors, land and labor, rather than on the
owners of property.12

Corporation income taxes that are apportioned among subnational jurisdictions on the
basis of formulas may, in the first instance, burden whatever is in the formula, instead of
profits; see McLure (1981b). Thus a corporate income tax that is apportioned on the basis of
payroll, property and sales is equivalent to taxes on these three apportionment factors. The
portions that are equivalent to taxes on payrolls and sales are not likely to be progressive, and
even the portion that is equivalent to a tax on property may not be progressive, for reasons
noted in the previous paragraph.

The contrary problem occurs on the expenditure side: the payment of transfer
payments by subnational governments is likely to attract the poor. This may discourage use
of such policies.13

The theory just presented relies heavily on mobility of factors of production and of
people for its results. Mobility may, in fact, be less than commonly assumed, for a variety of
reasons. Most basically, models that assume mobility of people that have their intellectual
roots in the United States may be less applicable in other countries, where ties of family,
culture, and tradition are stronger. If subnational jurisdictions coincide with racial groupings,
redistributive policies are less likely to induce migration. Also, in countries in transition from
socialism (CITs) the fact that housing is not readily available and housing markets are less
well-developed limits mobility. Under these circumstances there may be more latitude for
subnational policies to redistribute income than in the Musgrave model.

11
Property owners may have more difficulty in paying property taxes during times of economic stagnation than
those who pay taxes related to income or consumption. Whereas consumption can be reduced in order to reduce
the burden of taxes based on consumption, liability for property taxes is essentially independent of consumption
decisions in the short run. In addition, because of inertia in the assessment process, property taxes sometimes
tend to be relatively insensitive to secular trends in property values.
12
See Mieszkowski (1972). Note that this analysis of the incidence of a tax levied by one jurisdiction is
conducted holding the tax policy of other jurisdictions constant; see McLure (1977) and the discussion of
section III.
13
Sewell (1996) reviews evidence that subnational governments do, in fact, engage in income redistribution. It
should be noted that in Musgrave’s three-branch system, only transfers and taxes would be used to modify the
distribution of income; other types of expenditure policies would not be used. While tax policy can “level
down,” they cannot reduce poverty or “level up;” that must be done on the expenditure side. If problems of
implementation prevent use of transfers, as is common in LDCs, it may be appropriate to use expenditure
policy, related, for example, to health and education, to reduce poverty. Considerations discussed in the text
suggest that, while these may best be implemented locally, they should be financed nationally.
 Even if subnational taxation achieves some redistribution within a given subnational
jurisdiction, interpersonal inequalities may persist across jurisdictions. These can be
addressed only by national policies. In some cases it may be better to use intergovernmental
grants to address differences in average income levels in various subnational jurisdictions
than to use taxes and transfers to individuals.14 This possibility is not examined in detail
here, as such an examination is well beyond the scope of the present analysis; but Section IV
does note explicitly this advantage of one form of revenue assignment.

The tax instruments that are most commonly used in the attempt to reduce differences
in incomes are the corporate income tax and progressive individual income taxes. If, as
suggested, subnational use of these taxes is not likely of achieve the intended goals of income
redistribution, but distorts the geographical allocation of resources, the corporate income tax
and progressive individual income taxes should be assigned to the central government. As
with the assignment of the individual income tax to the central government for stabilization
purposes, this does not, however, mean that subnational governments should not use
proportionate taxes on the income of individuals.

C. Resource Allocation
The third function of governments is efficient allocation of resources. With respect to
resource allocation function, Musgrave argues that policies of subnational branches of
governments should be permitted to differ in order to reflect the preferences of their
residents. Decentralization of taxing and spending power allows subnational governments to
tailor schemes that match the demand of their constituency which will increase efficiency
ultimately because local governments have better information about their residents' needs
than the central government.

III. General Principles of Expenditure Assignments

Most countries in transition have been carrying out in one form or another
decentralization policies. But typically, there has been a lack of clearly designed
decentralization strategy. It has been quite common to give regional (when these exist) and
local governments autonomy to formulate budgets and spend their funds any way they wish.
This is a practice similar to that followed in decentralized government systems. But on the
other hand, the typical situation is for revenues and the overall level of the budget of
subnational governments to be determined by the central government as in a unitary state.
From a governance viewpoint, regional and local governments have autonomously elected
legislative powers but often the heads of the executive powers continue to be appointed by
the center, an institution associated with centralized unitary states. The present confusion in
institutions has led in many transition countries to an unwieldy mix of deconcentration and
decentralization of government activities. One way to examine the adequacy of expenditure
assignments is to analyze how well the actual assignment of responsibilities fits the
fundamental rules for the ideal assignment of responsibilities in a decentralized system of
government.

There is no absolute best way for deciding which level of government should be
responsible for particular public services. The adequacy of any assignment has to be judged
in terms of how well it achieves the goals or objectives set up by the government in its
decentralization strategy. The fact that it is up to the government to set these objectives

14
See Sewell (1996) and literature cited there.
should not be interpreted to mean that a murky assignment is acceptable. Clearly, without a
specific assignment of expenditure responsibilities it will not be possible to assess the
adequacy of the revenue and tax assignment to different levels of government, or the need
and effectiveness of a system of intergovernmental transfers. As we argued above,
expenditure assignment needs to be the first and fundamental step in the design of a
decentralized system of intergovernmental finances.

Commonly accepted objectives for fiscal decentralization include those of an efficient

allocation of resources via a responsive and accountable government, an equitable provision
of services to citizens in different jurisdictions, and preservation of macroeconomic stability
and promotion of economic growth (see Box 1).

The critical role of the efficiency criterion: The efficient provision of government
services requires that government satisfy the needs and preferences of taxpayers as well as
possible. This is best achieved by the “subsidiary” principle. Responsibility for the provision
of services should be at the lowest level of government compatible with the size of the
“benefit area” associated with those services. The benefit area for sanitation services is
clearly the local community, but for air traffic control the benefit area is the entire national
territory. Leaving the supply of public services with wider benefit areas to smaller units of
government is likely to result in the inefficient under-provision of services; e.g., a tertiary
hospital providing regional services is solely financed by a single municipality. Efficiency in
the provision of public services is enhanced if consumption benefits are linked to costs of
provision via fees, service charges, or local taxes.

The objectives of redistribution and stability best pursued by the central government:
Expenditures undertaken by government for equity or income equalization reasons, such as
social welfare or low income housing, is generally thought to be the domain of the central
government. Local or regional governments will not be able to sustain independent programs
of this nature because they will attract the needy from other areas while they will have to tax
their (potentially mobile) residents more heavily. While funding for these expenditures
should be a central government responsibility, implementation can very well be left to local
governments which may have informational and other comparative advantages. Expenditures
undertaken for the stabilization of the economy such as massive investment or unemployment
compensation are by their scale naturally ascribed to the central government.

No Single Best Assignment: The application of these rules largely facilitates the
assignment of expenditure responsibilities to different levels of government. However, the
rules do not always yield an unequivocal answer. Some public services, e.g., primary
education and primary health services, may be of a local nature by the size of their benefit
area, but because of their relevance in welfare and income redistribution they may also be
considered a responsibility of the central government. It is in this sense that it is not
meaningful to talk about the best assignment of expenditure responsibilities. What is
considered the best assignment is likely to change over time with changes in costs and
technological constraints, as well as changes in preferences. However, there is a need at any
given moment in time to have a concrete assignment of expenditure responsibilities among
the various assignments that could be considered optimal. Failure to have a concrete
assignment may lead to instability in intergovernmental relations and to the inefficient
provision of public services.
 Importance of a Clear and Stable Assignment: The lack of clear assignment of
expenditure responsibilities may be less burdensome in practical terms in centralized systems.
For example, under the Soviet Union, because all government budgets were integrated with
the federal budget, additional resources could be counted on when there was an unexpected
shortfall for subnational governments. As unitary systems become more decentralized, and
clearly in the case of federal systems, the failure to establish by law a clear assignment of
expenditure responsibilities for each government level can become a source of conflict
between the central and subnational governments and can lead to an inefficient provision of
public services. In situations where government budgets are tight, which is almost always, the
lack of clear assignments may lead to the underprovision of key public services.

Also important to note is that the lack of specific and clear assignments of expenditure
responsibilities necessarily conditions the adequacy of any tax revenue assignment and fiscal
equalization mechanism. Clearly, both systems can be inadequate for different expenditure
assignments and can easily become obsolete as soon as expenditure assignments are
significantly changed.

The experience of many economies in transition shows that without a specific

expenditure assignment, it is revenue availability that dictates the responsibilities of each
government level. This leads to institutional instability and again to an inefficient provision
of public services.

In the design of a decentralized system of intergovernmental finances, there is an

obvious need for a policy decision on concrete assignment of expenditure responsibilities
between the central government and the regions and between the regions and the local
governments. The explicit and systematized assignment of functions and expenditures to the
different levels of governments still needs to be a priority in transition countries’ strategy for
decentralization. A specific assignment protects subnational government budgets by making
the ad hoc transfer of responsibilities from the central government harder and by helping to
guarantee the continued provision of services. A specific and concrete assignment of
expenditure responsibilities, of course, should not detract from the flexibility needed to adapt
government budgets to major changes in policy.

3.1 Most Common Problems with Expenditure Assignments and the Need for Reform
Lack of Formal Assignment: A common problem in countries in transition is the lack
of a formal assignment of responsibilities. While a great deal of attention has been given to
issues of revenue sharing and government transfers in the first years of the transition, much
less attention has been given to the first logical first step in a system of intergovernmental
finances: an efficient and stable assignment of expenditure responsibilities to particular levels
of government. A formal assignment of responsibilities also contributes to the stability of the
system of intergovernmental finances. The experiences of countries such as Kazakhstan, the
Russian Federation, and Ukraine show how the lack of formal assignments may be a
destabilizing factor in intergovernmental relations. In these countries, early in the transition,
expenditure assignments had been continuously reworked by the central authorities simply
for fiscal convenience as a tool of fiscal deficit containment. It has been the lack of formal
assignment that has made this possible. From a fiscal management perspective, a formal
expenditure assignment also introduces an important element of certainty for budget planning
at all levels of government.
 Inefficient Assignments: A second common problem in the assignment of expenditure
responsibilities is the inefficiency of the assignments. First is the issue of capital expenditure
responsibilities. The problem in the early years of the transition, which has been slowly
solved, but also common to other countries, has been the assignment of all capital
expenditure responsibilities at the central level, independently of the level of government
responsible for the provision of the services associated with the capital infrastructure. This
assignment is guided either by the capacity to finance large projects or by the belief that only
central government officials are qualified to make capital investment decisions. However, the
full assignment of capital expenditure responsibilities is wrong. Given the importance of this
issue, it will be discussed separately below.

A second important set of problems comes from the assignment of expenditure

responsibilities for social protection and welfare to local governments. This is especially
wrong when the responsibility for funding is assigned to regional and local governments out
of general budgets. There is much less of a problem if social protection services are provided
by the subnational governments but financed by the central government. Local governments
may have a comparative advantage for the efficient delivery of these services, given their
proximity to local residents. But regional and local government financing responsibility for
these services runs against the ultimate objective of helping the most needy because the need
for social welfare and assistance is so much higher in poorer jurisdictions, which are at the
same time the least able to provide the necessary funds to cover social protection needs.

Other areas where there have been problems with expenditure assignments include the
responsibility for public utilities such as water and sewerage at the central level when these
services should be assigned at the subnational level. Ideally this type of service would be
provided by corporate entities dependent upon or regulated by subnational authorities and
with full-cost-recovery pricing. Another common problem has been the assignment of
responsibilities to subnational governments for national defense, which should be reassigned
to the central level.

Ambiguity in Certain Assignments: Despite the ambiguity in assignments, remarkably

few open conflicts or disputes have taken place between the central and subnational
governments in terms of assignment of expenditure responsibilities. From the operational
side, conflict and negotiations vary from country to country. For example, in the case of
Kazakstan, only three types of services were recently the object of negotiations among the
central and subnational governments: the maintenance of specialized education
establishments, certain defense expenditures, and transfers to low-income families.

Co-sharing of responsibilities: The actual assignment of functional responsibilities is

often quite different from what it appears to be in the “formal” assignment established by law
or practice. Take the case of education. Even though, in terms of actual expenditures going
through the budget, education would appear to be for the most part a local (or regional)
activity, many key decisions in educational policies are carried out at the central level in
many countries. More in particular the Ministry of Education may be responsible for the
construction of school buildings, curriculum design, teacher training, and design and
production of textbooks. Activities that are preserved at the local level may be the
recruitment and hiring of teachers. At times, the local government may be given the authority
for appointing principals, school inspectors and teaching specialists. However, even in these
cases local authority is limited because of the dual subordination of school officials to both
the Ministry of Education and to the subnational government. In many countries in transition,
even the head of the rayon administration is ultimately a central government appointee.
Similar issues to those in the education sector arise in other sectors such as health.

The co-sharing or fragmentation of responsibilities within a particular public service

has the disadvantage that it is likely to cause confusion leading to inefficiencies. In an ideal
world, all inputs for the delivery of a particular service would be simultaneously decided by
one single authority. With the fragmentation of duties within a service it is more likely that a
relative disproportion of funds will be spent on salaries and much less on other operation
expenditures; similarly, maintenance may be reduced to a minimum.

On the other hand, in reality the co-sharing of responsibilities for a single service may
be inescapable. This may be the case for example for education where national governments
may take on the responsibility for higher education while subnational governments take on
the responsibility for primary and secondary education. Co-sharing of responsibilities may
also take place within a particular function. Thus, for example, while subnational
governments are responsible for primary and secondary education, curricula and textbook
production may be carried out by the national government.

Co-sharing of responsibilities may not be a problem when particular functions and

tasks in a common area are clearly assigned to different levels of government. However, it is
a common practice to leave responsibilities unclear when they are assigned to more than one
level of government. These are the so called common competencies or functions which often
has led to conflicts in service approach and to less than adequate coverage. In difficult fiscal
conditions, spending less or even withdrawing from common competencies is more
defensible for both central and subnational governments.

3.2 Examples of Current Assignment of Expenditure Functions

The assignment of responsibilities among the three levels of government for a variety
of countries are summarized in the tables attached to these notes. The most important feature
in this table is the variety of expenditure assignment across countries. This variety reflects
both different approaches to decentralization, as in federal and more decentralized countries,
and unitary and more centralized countries.

In those transition countries that were a part of the Soviet Union (the CITs) the
current assignments tend to agree in many ways with the principles of expenditure
assignment in public finance, which are reviewed below. In these countries in particular there
is a broad correspondence between the geographical dimension of benefits from a particular
service and the level of government responsible for its provision. Most often, by and large,
the functions allocated to the central government have a national dimension. These include
defense and internal security, the justice system, foreign relations, and research. Some of the
expenditures with macroeconomic and redistribution implications such as pensions and
unemployment compensation are also the responsibility of the central government. These are
financed by extra-budgetary funds. Correspondingly, most of the expenditure responsibilities
of subnational governments involve services with regional or local “benefit areas” such as
tertiary hospitals, primary education, fire protection, or sanitation. However, appearances are
misleading and many of these countries have several important problems in expenditure
assignments.
 The shares of subnational governments in the consolidated budget have remained
constant in some cases (e.g., Russia and the Baltic states) but have fluctuated significantly in
other countries (for example Ukraine and Kazakhstan). These fluctuations reflect both the
additional shifting of expenditure responsibilities to subnational governments and the relative
budgetary priority given by the government to services provided at the central and
subnational levels. Instability is also a characteristic of fundamental changes in decentralized
systems. For example, in the face of shrinking real resources accruing to the public sector,
tough decisions had to be made regarding priorities for public expenditures in countries in
transition.

A significant feature of expenditure assignments is that the functions and the relative
expenditure shares of subnational governments vary significantly from country to country
and they reflect tradition and inertia as much or more than best principles. For example, a
peculiarity of CIT countries is that subnational governments finance most social welfare or
social protection expenditures. This goes against bets principles and the practice of most
other countries. On the other hand, another predominant characteristic of CIS countries is the
concentration of education and health expenditures at the subnational level is shared with
many other countries, specially in the case of education.

3.3 General Recommendations for reform in Expenditure Assignments

Establishment of a formal assignment of expenditure responsibilities: Expenditure
responsibilities should be specified in the law. Some countries do so in the Constitution but
many others do so in particular laws such as the law on the budgetary system or the law on
subnational budget and self-government. The latter is the preferred alternative because
changing the Constitution is much harder, and it should be expected that as technology and
conditions change in a country there will be a need to change expenditure assignments.

Reassignment of selected expenditure responsibilities: The central government should

assume full financial responsibility for social welfare expenditures when these are assigned at
the subnational level. Delivery of these services can still be performed via local governments
on a reimbursement basis, a grant program, or another of several means. The central
government should also assume 100 percent responsibility for expenditures in national
defense, including the national guard. Finally, subnational governments should assume
responsibility for public utilities.

Reassignment of Capital Investment Responsibilities: Responsibilities for capital

infrastructure should be placed at the level of government responsible for the delivery of the
specific services including the operation and maintenance of those facilities. This will
encourage a more efficient use of resources. Only those capital infrastructure facilities
actually desired by subnational governments will be built and subnational governments will
have an interest in maintaining and repairing the capital infrastructure.

Facilitating capital investment at the subnational level: All types of subnational

borrowing should be closely regulated by the central authorities. Besides enforcing the debt
limits established by the law, there should be a certification process of the conditions for any
bond issues. The central government as a general policy should not act as guarantor of
regional and local government debt issues. Special circumstances such as the borrowing in
foreign currency from international lending institutions which may require central
government guarantees should be handled directly by the Ministry of Finance. In these cases,
the central government should institute mechanisms to ensure repayment by the local
government. Borrowing by local governments to invest in commercial operations should be
especially discouraged.

Subnational development funding: There is considerable merit to the establishment of

a subnational development fund to promote lending to subnational governments for long-term
capital investment. This may be the only effective way to allow small local governments to
fulfill their capital investment responsibilities. Other sources of financing include local bond
issues. Both should be encouraged. However, direct access to capital markets by subnational
governments is premature and will take time to develop.

Designing a development fund: The desirable structure for the subnational

development fund is that of an autonomous institution that takes direct and final
responsibility for borrowing and investment projects. The bulk of funds for this institution
should come from direct bond issues in the capital market. The central and local governments
could contribute initial capital shares. The institution should be managed by independent
professionals who answer to a managing board composed of central and local government
representatives.

Bond issuance Local governments should be allowed to issue non-guaranteed or

limited liability debt for investment in public utilities. These “revenue bonds” will be repaid
from revenue proceeds associated with tariffs set at full cost-recovery levels.

Establishment of a coordinated national policy to facilitate the divestiture of social

responsibilities by state enterprises: Lessons learned from other countries in this area should
be helpful in developing national programs to deal with this problem. The multiple strategy
should contain a combination of policies including complete privatization and absorption into
subnational budgets accompanied by rationalization, greater efficiency and cost recovery
measures. The central government should provide adequate budgetary adjustments at the
subnational level for these new responsibilities.

The need to address minimum standards: Central governments should consider

introducing policies that guarantee desired minimum levels of provision for certain services
at the local level. National standards can be enforced in several ways such as enticing local
governments with a matching grant program. But national standards may also be enforced by
denying full receipt of block grant money unless certain minimum expenditures and
provisions established by the central government are met. Programs in which national
standards may be required include not only social welfare but also education, health,
sanitation, and the environment. But restrictions should be imposed sparingly to protect local
autonomy which, in general, is very desirable.

The need for sectoral policies in key areas: Clearly the priority for public
expenditures in most countries should remain in investment in human resources through good
levels of education and health, and strengthening the safety net so that in effect there is less
friction to the readjustment in the economy. However, there are also significant changes that
need to be made in these sectors to increase the efficiency of operations. Several measures in
key sectors will also help increase the efficiency of public expenditures. However, all these
measures should be considered within the context of well defined sectoral policy objectives
now lacking in many transition countries. For this reason governments should proceed with
comprehensive reviews of the housing, education, health, and social welfare sectors.
IV. Realizing the Political Benefits of Tax Assignment
The allocation function in Musgrave's three-branch system involves the provision and
financing of public services.15 To the extent possible, services provided by government
should be financed by user charges and fees; this is both fair and efficient, in the sense of
encouraging responsible use of the nation's economic resources. An approach that allow
beneficiaries to pay for identifiable public services that might otherwise not be provided,
often by self assessment by a group of beneficiaries, is called betterment levies, valorización,
or special levies.

Where strict compliance with the dictations of benefit finance is not feasible, because
of the difficulty or undesirability of exclusion from the benefits of public spending, the
principle is, none-the-less, instructive.16 For both equity and efficiency, tax payments should
reflect costs and benefits of public services, to the extent possible. Among the best examples
of benefit-related taxes are those levied on motor vehicles and motor fuels and used for the
construction and maintenance of roads and highways.
Each level of government should be assigned taxes that are related to the benefits of
its spending. Thus, the proper assignment of taxes that are related to benefits depends on the
assignment of expenditure functions. The central government should be responsible for
expenditures having benefits that extend across subnational boundaries or that are
characterized by economies of scale not realized at the subnational level. Subnational
government comes into its own in the provision of goods and services characterized by
limited economies of scale and limited spillovers of benefits to other jurisdictions.

User charges, fees, and taxes related to the benefits of public spending are likely to be
regressive, or at most proportionate to income; they are not likely to reduce the inequality in
the pre-tax distribution of income.17 According to the Musgrave three-branch view of
government, this is not a defect, since income redistribution lodged in the central
government, where it can be implemented most effectively, is available to offset the
regressivity of benefit-related taxes, including those of subnational governments.

The above discussion of tax assignment in the allocation branch focused on the
economic benefits of tax assignment – the resource allocation benefits of relating taxes to
benefits paid. There is also a political dimension to the issue that needs to be discussed
briefly.18 It is useful to divide the discussion of the political benefits of tax assignment into
the related topics of a) subnational sovereignty and b) accountability and c) tax competition.

15
Although not explicitly included in Musgrave’s analysis, avoidance of tax-induced misallocation of resources
seems to fall naturally within the allocation branch. This would presumably be a responsibility of all levels of
government.
16
Public finance of activities can be justified where there is inability of exclusion and/or lack of rivalry in
consumption; see Musgrave (1959). Even if exclusion is technically possible, it may be inefficient to exclude
potential consumers from services characterized by non-rivalry in consumption.
17
This statement is incomplete, if income distribution is seen in terms of the distribution of welfare, instead of
the only the distribution of income, and if the benefits of public spending, as well as tax burdens, are considered.
Taxes related closely to marginal benefits may finance expenditures that involve substantial inframarginal
benefits. These inframarginal benefits may have special value to low-income families. Obvious examples
include the provision of safe drinking water. Many consumers would probably consider themselves better off if
they had access to safe water, even if they had to pay for it. The problem is often access, not cost.
18
This is not to suggest that the economic and political aspects can be neatly identified and separated; they are
inextricably intertwined.
a. Subnational Sovereignty
A rational assignment of taxing powers helps provide each level of government
control over its fiscal destiny.19 In particular, it allows choice in the level of public spending
at each level by government. To do this, tax assignment should exhibit the following
characteristics. (Of course, a rational system also has other desirable features; these are
described in subsequent sections.)

Own revenues: First, subnational governments must have enough “own” revenues to
finance the services they provide. If a subnational government legislates and collects its own
taxes, protected by meaningful constitutional safeguards of its right to do so, it clearly has a
source of own revenues. Even if such a government must rely on grants from a higher-level
government, it may reasonably be considered to have own revenues, provided the grants are
determined in an objective way and are guaranteed by the constitution or legislation of long-
standing. By comparison, own revenues may not exist in any real sense, if grants are made at
the sole discretion of the higher government, perhaps on an ad hoc, arbitrary, and
unpredictable basis, and even well into the fiscal year and subject to renegotiation.20
Between these extremes lies a variety of arrangements that provide more or less complete
subnational ownership of revenues. Shared taxes and tax surcharges collected by higher level
governments might properly be seen as own revenues; but where there is substantial risk that
the higher level government collecting the revenues will not remit them to the subnational
government, effective ownership is reduced.

Marginal revenues: Even if subnational governments have own revenues, they may
not be able to affect the amount of revenue they receive. This is true, for example, if the
central government shares revenues from certain taxes with subnational governments. In
such a case, the own revenues of subnational governments are not marginal revenues.21 By
comparison, if subnational governments legislate and implement their own taxes – or even if
they are allowed to impose surcharges on the taxes levied by the central government at rates
they choose, they can affect the amount of revenues they receive. This distinction is crucial,
because subnational governments must be assigned sources of marginal own revenues--own

19
A rational assignment of taxing powers is necessary, but it is not sufficient. As noted below, an otherwise
rational system of tax assignment may produce patterns of vertical imbalance and horizontal disparities that are
unacceptable. Moreover, subnational governments may lack fiscal sovereignty, even if they are assigned taxes
that, at first glance, seem adequate. In principle, subnational governments may have substantial discretion over
how they spend revenues raised through taxes they legislate and implement, tax surcharges, and shared taxes.
(Of course, at any particular time, expenditures may be largely "uncontrollable," because of prior commitments.)
But the central government may mandate spending by subnational governments, or it may provide grant funds
that can be spent only for very narrowly specified purposes. In either case, there may be little subnational
autonomy. Between these two extremes is a spectrum of discretion in the use of funds. The more discretion, the
more fiscal autonomy a subnational government has. Mandated spending is ignored in what follows.
20
It is difficult for a subnational government to exercise fiscal autonomy if it cannot predict its revenues with an
acceptable degree of certainty. Revenues may be unpredictable for any number of reasons. First, they may
depend on economic conditions, as well as the state of taxpayer compliance and tax administration, whether
from taxes legislated and implemented by subnational governments or from taxes imposed by the national
government. Second, funds from grants are unpredictable if they are provided on an ad hoc basis. By
comparison, grants based on population and specified in advance are predictable, at least in principle. While it
is more or less inevitable that subnational governments experience the first type of predictability (that resulting
from variability in economic conditions and the success of enforcement), they should not be forced to
experience the second (ad hoc adjustments in grants). The second type of variability can be reduced through the
process of tax assignment. See also the discussion of macroeconomic stabilization below.
21
This terminology is not totally satisfactory; revenues provided by the central government may be incremental,
but not the result of actions taken by the subnational government.
revenues whose level they can control--if they are to be truly autonomous. Only by choosing
to pay higher or lower taxes can residents of subnational jurisdictions choose the level of
public services they want. An important prerequisite for the exercise of subnational fiscal
autonomy is thus the ability to choose tax rates.

Subsidiarity in taxation: It is commonly accepted that expenditure responsibility

should be assigned to the lowest level of government that simultaneously reflects the
geographic scope of benefits of public services and achieves economies of scale; this is
commonly called the principle of subsidiarity. A similar principle can be evoked in the area
of tax assignment: a given tax should be assigned to the lowest level of government that can
implement it (or for which it can be implemented) and for which it is not inappropriate.22
Compliance with this principle is important to minimize the tendency towards vertical
imbalance, which exists because subnational governments have difficulty implementing
many taxes, but higher levels of government can implement almost any tax that a lower level
of government can implement

b. Accountability and Tax Competition

The fact that subnational governments enjoy sovereignty does not mean that they are
accountable. Even in a democracy, the political forces that support accountability commonly
encounter self-interested politicians and entrenched bureaucracies that may blunt these
forces.24 In less democratic societies, people may have even less power, because their leaders
are less accountable to them. Rational tax assignment may help to increase accountability.
In this regard, tax competition between subnational jurisdictions deserves special mention.
Although sometimes thought to be an unmitigated evil, tax competition can have positive
effects. Just as competition in the marketplace protects consumers from the rapaciousness of
business, so tax competition protects citizens from the rapaciousness of politicians and
bureaucrats. It helps assure that taxpayers are getting what they pay for.25

Tax competition takes several forms. In its most effective form, high-income
individuals and investors controlling the capital needed for economic development threaten to
leave--or take their money from--jurisdictions where taxes exceed the value of the benefits of
government spending--or never to come or invest there.26 This helps assure that the

22
Similarly, Musgrave (1983, p. 11) notes that the assignment rules he suggests “place narrower constraints on
the lower levels of government, so that the latter might be accorded prior claim on the use of taxes suitable to
them.” The notion of subsidiarity in taxation was introduced to the EU with the Maastricht Treaty amendments
to the Treaty of Rome (Article 3B). Subsidiarity requires that Member States should be able to determine their
own fiscal policies unless those policies have negative spill-over effects on the entire Union. The Commission
of the European Communities (1991, p. 7) explained that subsidiary requires that “Member States should remain
free to determine their tax arrangements, except where these would lead to major distortions.” See also McLure
and Weiner (forthcoming).
24
The literature of “public choice” deals with such issues. It is well beyond the scope of this paper. See,
however, Brennan and Buchanan (1980).
25
Brennan and Buchanan (1983) provide a strong argument for tax competition. See also McLure (1986). This
is only part of the story, although an important part. Because those who enjoy public goods cannot be excluded
from enjoying the benefits, they have little incentive the reveal their preferences for such goods. There is thus a
tendency to under-provision of public goods that may be aggravated by tax competition. See Gordon (1983) for
a theoretical analysis of the inefficiencies that can result from decentralization, including tax competition.
Benefit taxation helps to combat this source of market failure. See also Wildasin (1986). Tax competition
makes it difficult for subnational governments to tax mobile factors--capital and highly educated or skilled
labor--and thus to engage in progressive taxation.
26
Even where factors of production are not mobile, tax competition may have a beneficial effect, by making
over-taxed industries uncompetitive. In this case the result may be disinvestment and unemployment, instead of
composition of government spending, as well as the level, is appropriate. The pressure
exerted by potential investors is likely to be extremely important in developed countries
(LDCs) and countries in transition from socialism (CITs), both of which seek foreign
investment.27

c. More on the Role of Benefit Taxation

Many services provided by governments, including subnational governments, produce
what may be described as "generalized benefits," benefits that cannot be closely related to
taxes on the beneficiaries. While generalized benefits may not be conducive to the use of
charges and fees, or even taxes closely related to benefits, such as taxes on motor transport,
they can be related in a general way to taxes payed.28 Thus, for example, the general benefits
of government spending may be thought to be loosely related to income or to private
consumption. Unless there is some reason to believe that benefits rise more or less rapidly
than income or consumption, it may be reasonable simply to rely on flat-rate taxes on income
or consumption for the finance of such services.29

At the subnational level, an additional inquiry is necessary when people do not work
where they live (or if they do not invest their savings where they live): whether production or
consumption (income earned or income spent) is the better measure of generalized benefits.30
If benefits of public spending are more closely related to production or the earning of income
than to consumption or the spending of income, origin-based taxes on value added and
payroll taxes levied where employment occurs would be superior to destination-based value
added taxes, retail sales taxes, and residence-based income taxes as measures of benefits
received.31

migration of capital and labor. This, too, may have political costs. Of course, it is difficult to imagine a
contemporary setting in which capital is not mobile. Thus the model implicit in the text is generally more
relevant.
27
This pressure is strongest for investors from countries taxing only foreign-source income. It is diminished to
the extent the home countries of investors provide foreign tax credits for source-country taxes, unless taxpayers
have excess (unused) foreign tax credits. See Slemrod (1995) for a masterful exposition of this complicated
topic.
28
The world-wide trend of privatizing activities formerly provided by government and financed by taxes not
closely related to benefits suggests that the latitude for benefit-related charges is probably greater than
traditionally thought. In making such a statement one must be careful to distinguish between services that are
now provided privately but financed publicly from general revenues, those that are now provided and financed
privately, and those that are still provided publicly but financed on a basis related to benefits.
29
Whether income or consumption is the better measure of benefits is, of course, an important question, but not
central to the present discussion. In many countries consumption does not differ much from income, especially
labor income, except at the very top of the income distribution.
30
This issue arises most commonly and most conspicuously in the case of workers commuting across the
boundaries between jurisdictions. It also arises when workers spend long periods in employment away from
home, as in much of Sub-Saharan Africa. It is quite possible in such a case that three jurisdictions might
reasonably make claims to revenues from taxes on the earnings of such workers: the jurisdiction of residence of
the employee, the jurisdiction of employment, and the jurisdiction where the employee's family lives. The last
arguably has the greatest claim to tax revenues, because of the expense of education and health care for the
family.
31
Under a destination-based VAT, tax is applied to the goods imported into the taxing jurisdiction and exports
from the jurisdiction occur tax-free. Under an origin-principle VAT, exports are subject to tax, and tax is
applied only to the value that is added after importation. The retail-sales tax is inherently a destination-based
tax, except to the extent that it is applied to sales to businesses producing for export. For further elaboration, see
McLure (1987).
 In principle, this is an empirical issue, though a difficult one, given the inherent
difficulty of relating benefits of public spending to private actions. Yet a priori reasoning
suggests that consumption (the spending of income) is probably more closely related to the
benefits of public spending than is production (the earning of income). For example,
education for one’s children is provided where one lives, not where one works; the same is
predominantly true of health care. The implications of this reasoning concerning generalized
benefits of public services for the problem of tax assignment are clear: in principle,
residence-based income taxes are probably superior to employment-based payroll taxes, and
destination (consumption)-based sales taxes are better than origin (production)-based ones.
If, as seems likely, production is more mobile than the residence of households, the use of
origin-based taxes that do not reflect the generalized benefits of public spending are more
likely to distort the location of economic activity than are residence-based taxes. Moreover,
as noted below, they are likely to contribute to horizontal fiscal disparities.

4.1 Alternative Methods of Revenue Assignment

A variety of methods of assigning revenues to subnational governments can be
distinguished. These methods differ in the degree of fiscal autonomy they provide
subnational governments, their ease of compliance and administration, the fairness and
neutrality they are likely to produce, and the degree of interjurisdictional redistribution they
can accommodate. In discussing these alternatives, it is convenient to distinguish four
features: (a) which level of government chooses the taxes from which subnational
governments receive revenues, (b) which defines the tax base(s), (c) which sets the tax
rate(s), and (d) which administers the tax(es). From the viewpoint of subnational fiscal
sovereignty, the capacity to set rates is clearly the most important of these; it is what allows
subnational governments to choose the level of public services. Subnational governments
clearly cannot be allowed total discretion in the choice of the taxes they will levy; for
example, they should not be allowed to levy import duties on international trade or trade
between subnational jurisdictions or to impose taxes likely to be exported in large part.
Excessive subnational latitude in the choice of tax bases and in tax administration can create
unacceptable complexity and administrative burdens, as well as inequities and distortions in
the allocation of resources.

Independent subnational legislation and administration provides subnational

governments the most fiscal autonomy. Under this approach subnational governments
choose the taxes they levy, define the tax base(s), set the tax rate(s), and administer the
tax(es).56 This is the approach followed in the United States; subject only to very general
constitutional limitations (e.g., due process and non-interference with interstate and
international commerce) and almost no statutory limitations, the states can do virtually
anything they want in these four areas.57

Carried to the extreme, this approach is vulnerable to inconsistency, duplication of

effort, and excessive complexity of compliance and administration. These problems can
occur if different jurisdictions choose radically different taxes (e.g., if some levy retail sales
taxes, but others levy value added taxes), define their tax bases in different ways (as in the
56
Subnational constitutions or laws may limit any of these, as in the United States. If such limitations are
sufficiently restrictive, it may make little sense to speak of subnational discretion in the affected areas. But self-
imposed restrictions in constitutions of subnational governments are different from restrictions imposed from
above by law or as part of a national constitution.
57
Duncan and McLure (1997) describes the American system of tax assignment. Local governments, being
legally dependent on the states, generally do not have the same degree of fiscal sovereignty.
case of the state corporate income taxes and retail sales taxes in the United States), or
administer the same taxes in different ways. Inequities and economic distortions can also
occur if the tax systems of various subnational governments do not mesh, resulting in gaps or
overlaps in taxation. Within limits, these problems – which differ in importance from tax to
tax – can and should be tolerated in the interest of gaining the benefits of decentralized
government. But serious complexities, inequities, and distortions can and should be avoided.
This objective can be achieved, without greatly compromising the fiscal autonomy of
subnational governments, through intergovernmental compacts among subnational
governments or the imposition of uniform ground-rules by a higher level of government, for
example, rules for the definition and division of the corporate income tax base.58
Alternatively, subnational surcharges on national taxes can be employed.

Subnational surcharges provide most of the important fiscal autonomy of independent

subnational legislation and administration, without the inequities, distortions, complexities,
and problems of compliance and administration just described. Under this approach a higher
level of government defines the tax base and collects both its own tax and surcharges set by
subnational governments.59 This approach ideally avoids the problems that occur when
different subnational jurisdictions define the tax base in conflicting ways, use different
apportionment formulas, and administer the tax in different ways. Because of their power to
set surcharge rates, subnational governments retain the most important attribute of fiscal
sovereignty in the tax field; the ability to define the tax base and administer taxes are much
less important.

There is no reason, in principle, that the tax rate of the central government cannot be
zero for a particular tax; in such a case the central government would simply administer the
tax of subnational governments, thereby assuring uniformity and avoiding duplication of
effort. There is, however, a problem of providing incentives for the central government to
collect a tax that it does not keep – and, indeed, of trusting it not to keep the revenues it
ostensibly collects for subnational governments. These problems exist in any system of
surcharges.

58
In 1957 in the United States, the National Conference of Commissioners on Uniform State Laws prepared a
model statute, the Uniform Division of Income for Tax Purposes Act (UDITPA), and urged its adoption by
states imposing corporate income taxes. Since then more than 25 states – of the 45 that impose corporate
income taxes – have adopted UDITPA, some with important modifications. Because UDITPA does not cover
all aspects of corporate income taxation, there would be substantially differences in state laws, even if all states
were to adopt it.
The situation is even worse in the sales tax area, where each of the 46 states (including the District of Columbia)
defines the tax base as it wishes. Because of the complexity of state sales and use taxes, the U.S. Supreme Court
has ruled that the states cannot require a mail-order vendor to collect use taxes unless the vendor has a physical
presence in a state. In order to simplify their systems, in hopes of gaining an agreement under which mail-order
vendors and their equivalents in electronic commerce would voluntarily collect use tax, the states are
considering adopting uniform definitions of products, so that a given state’s sales and use tax base could be
defined simply by choosing whether or not to tax given identically defined products. See McLure (1998b).
59
It is sometimes suggested (commonly where the national government is considering levying a type of tax
already imposed by subnational governments) that subnational governments could administer national
surcharges on their taxes. Although similar system is employed successfully in some countries (the
administration of the national VAT by the German laender and the VAT of the Canadian government by the
province of Quebec being the best-known examples), it does not seem to deserve serious consideration in most.
Aside from the need to harmonize tax bases and administration in all jurisdictions, subnational governments can
have an incentive to be lax in administering taxes that raise money, at least in part, for the national government
at the expense of local taxpayers.
 Surcharges should, of course, be limited to that portion of the tax base reasonably
deemed to arise in, or be attributed to, the taxing jurisdiction. This objective is relatively
easy to implement for some taxes (e.g., payroll taxes). In some (e.g., company income taxes)
it may be necessary to use formulas to divide the tax base among subnational jurisdictions.

Subnational surcharges appear to be the most appropriate means of providing

subnational governments with own marginal revenues in many countries, especially LDCs
and CITs, where administrative resources are scarce. While some Canadian provinces (the
largest and wealthiest) implement their own individual and corporate income taxes, others
rely on surcharges on the national taxes. In both cases tax bases and apportionment formulas
are quite similar, if not identical.

Tax sharing is generally much less attractive than subnational surcharges. Under this
approach subnational governments receive fixed fractions of revenues from particular
national taxes originating within their boundaries; commonly the sharing rates are uniform
across jurisdictions (though not across taxes), but this is not necessarily the case. As with
surcharges, formulas may be needed to determine the deemed origin of tax revenues. In
many less developed countries (LDCs) and countries in transition (CITs) the data needed to
share revenues (e.g., data on consumption, by subnational jurisdiction, needed to divide
revenues from the VAT) may not exist or may not be reliable.

This approach also avoids the problems that arise from extreme subnational
independence in tax policy. But it does so in a way that severely restricts fiscal autonomy of
subnational governments. Individual subnational governments have autonomy over how to
spend a given amount of revenue, but not the power to alter the amount of revenue they
receive from shared taxes; thus they cannot control the level of public spending. (While all
subnational governments, acting as a group, can attempt to affect their share of revenues from
these taxes, no subnational government, acting unilaterally, can hope to do so. The
harmonized sales tax employed in several of the maritime provinces of Canada, which
combines federal and provincial VATs, illustrates the problem. All of the provinces that
participate in the scheme must implicitly adopt the same VAT rate. In Germany the central
and subnational governments engage in an annual struggle over the split of revenues from
certain taxes. )

Revenue sharing assigns revenues of higher levels of government to lower levels of

government on the basis of formulas. Though the origin of revenues can be reflected in such
formulas, it is more common for formulas to be based, inter alia, on population, tax capacity
(inversely), or measures of need, such as per capita income. Since revenue sharing is not
based on the origin of revenues, this approach offers an alternative that does not exist (or
exists only in attenuated form) under the three methods of revenue assignment just discussed:
redistribution of fiscal resources between jurisdictions. By comparison, under the previous
three approaches, revenues flow to the jurisdiction where economic activities occur; thus
there is no redistribution of income between subnational jurisdictions. (A minor qualification
should be made in the case of tax sharing; sharing rates could be set at higher levels for poor
jurisdictions than for more affluent ones. It is more convenient to classify that approach as
revenue sharing, rather than tax sharing.)

Since subnational governments need to exercise little or no independent fiscal effort

in order to receive funds from revenue sharing, this is generally not a source of marginal own
funds. The only fiscal autonomy lies in how to spend the money. (These statements should
be qualified by noting that revenue sharing formulas sometime contain a measure of "own tax
effort." Of course, if subnational governments are to be able to exert tax effort, meaningful
marginal sources of revenues--and the latitude to use them as they wish--must be assigned to
them.)

In summary, it appears that subnational surcharges generally dominate both

independent subnational taxation (legislation and administration) and tax sharing as means of
providing subnational governments with fiscal autonomy in the tax area; this is especially
true in LDCs and CITs, where the resources needed for compliance and administration are
quite scarce. Surcharges provide almost as much fiscal autonomy as independent taxation,
but are much simpler. They provide more autonomy than tax sharing, and are scarcely more
complicated. None of these provides for redistribution among subnational jurisdictions; for
that, some form of revenue sharing (or grants) is needed.

Transition from tax sharing, which is now found in many countries, to a system of
surcharges, in which subnational governments choose tax rates, could be achieved as follows.
First, tax sharing rates could be made uniform, if uniformity does not now exist. (It might
also be necessary to rationalize the basis of tax sharing, if the present basis makes no sense,
as when excises are shared with the jurisdiction of origin, instead of he jurisdiction of
destination, as in much of the former Soviet Union.) Then tax sharing could be converted to
a uniform-rate subnational surcharge on the national tax. Finally, subnational governments
could be given authority to decide surcharge rates.

4.2 Vertical Imbalance and Horizontal Disparities

A system of tax assignment designed in accord with the principles outlined above
may produce vertical imbalance in the revenues available to various levels of government or
horizontal fiscal disparities among governments at a given level.88

a. Vertical Fiscal Imbalance

Vertical fiscal imbalance is likely because many of the taxes that, from a conceptual
point of view, are appropriately assigned to subnational governments cannot easily be
administered in a way that implements this assignment. It is especially difficult to find taxes
that can be implemented in a way that provides subnational governments with marginal
sources of own revenues.89 As noted earlier, neither revenue sharing nor tax sharing provides
marginal sources of own revenues for subnational governments.

The likelihood of vertical fiscal imbalance explains the earlier emphasis on

subsidiarity in taxation: the view that subnational governments should generally be assigned
any tax that they can administer (or that can be administered for it) that is not inappropriate
for their use. Also, it explains why many nations may need to assign the corporation income
tax to subnational governments, despite the manifest disadvantages of such an assignment.
Box 1 illustrates the results of alternative choices in tax assignment. Whereas the Canadian
88
See Bird (1993).
89
The version of this paper delivered at the Vienna Workshop in March 1998 contained the following sentence:
“The most obvious example of this problem is the value added tax; while a VAT can provide revenues that can
be shared with subnational governments on the basis of a formula, it cannot very well form the basis of tax
surcharges or even tax sharing based on the origin of revenues (and even less can it be administered by
subnational governments acting independently).” The omission of this sentence from the present draft indicates
the change in the author’s thinking since the Vienna Workshop--and the importance he ascribes to the dual
VAT. For further discussion, see the paper by McLure at www.decentralization.org.
provinces and the states of the United States are fiscally quite strong, the Australian states
and the provinces of South Africa are fiscally weak.

b. Horizontal Fiscal Disparities

Even if tax assignment follows the principles outlined here, horizontal fiscal
disparities are likely, unless taxable capacity is evenly distributed across subnational
jurisdictions.90 Unequal fiscal capacity generally occurs where income levels are quite
different. Inequalities in income levels make it difficult for poor jurisdictions to collect as
much tax revenue as their more affluent counterparts from income and sales taxes. But
particular industrial structures and tax assignments can create or aggravate horizontal
disparities. The assignment of taxes on important and geographically concentrated natural
resources to subnational governments is perhaps the most obvious example of this
phenomenon. The assignment of the corporate income tax to subnational governments can
have a similar effect, especially if the tax base is apportioned primarily on the basis of origin-
related factors such as payrolls and property. Including destination-based factors in the
apportionment formula may help to offset this tendency.

Where tax assignment does not follow the principles set forth here, horizontal
disparities may be even worse. One of the most egregious cases involves the assignment of
excise taxes to the jurisdiction where production or importation occurs, instead of the
jurisdiction of consumption. The combination of an origin-based VAT, differentiation of
production on a geographic basis, and exemptions for food can also produce horizontal
disparities. Finally, as noted above, the combination of triangular trade and an origin-based
VAT can cause horizontal disparities.

c. A Caveat on the Design of Intergovernmental Grants

At the end of the day, it is likely that, in many countries, taxes reasonably assigned to
subnational governments will not be adequate to finance the provision of services assigned to
those governments or that they will result in horizontal fiscal disparities. If so, it may be
desirable to use grants from higher level governments to compensate for vertical fiscal
imbalance or to offset horizontal fiscal disparities. While a complete discussion of the design
of such grants is beyond the scope of this paper, one point deserves emphasis. Grants
intended to offset vertical imbalance or horizontal disparities should provide infra-marginal
funding for subnational governments, so as not affect the marginal decisions of those
governments regarding the choice between public and private spending.91 It is especially
important that subnational governments not be penalized for raising additional revenues, by
reducing grants.92
90
This discussion is limited to horizontal disparities that occur even if taxes are assigned in a rational manner.
Disparities are even more likely if tax assignments are not rational, as when excises are assigned to the
subnational jurisdictions where importation and production occurs.
91
Grants may be appropriate because of interjurisdictional spillovers of benefits of services provided by
subnational governments. By their nature this type of grant should be designed to change the terms on which
private income can be exchanged for public services characterized by spillovers (and, indeed, the terms of the
trade-off between these and other public expenditures).
92
Section 227 of the Constitution of South Africa reflects this thinking; it provides (Paragraph 2): “Additional
revenue raised by provinces or municipalities may not be deducted from their share of revenue raised nationally,
or from other allocations made to them out of national government revenue. Equally, there is no obligation on
the national government to compensate provinces or municipalities that do not raise revenue commensurate with
their fiscal capacity and tax base.”
Some favor including provisions in grants that reward greater subnational tax effort. This policy is unattractive,
unless there are reasons to believe that the choices of subnational governments are being artificially constrained
4.3 Concluding Remarks: Tax Competition Revisited
The discussion flowing through this paper indicates the difficulty of achieving fiscal
autonomy of subnational governments, especially in LDCs and CITs, and highlights a
problem. On the one hand, subnational governments need the ability to vary tax rates, in
order to exercise fiscal autonomy and engage in healthy tax competition. On the other hand,
it may be difficult to vary many of the most important tax rates, without inducing taxpayers
to take steps that would artificially minimize their tax burdens, at the expense of revenues in
the high-tax jurisdiction. This may be true of the individual income tax (to the extent people
do not work where they live), sales taxes (because of cross-border shopping), certain excises
(because of smuggling and cross-border shopping), and corporate income taxes based on
separate accounting (because of manipulation of transfer prices). It is possible to vary rates
of subnational surcharges on corporate income, if the tax base is apportioned on the basis of a
formula. But excessive variation of rates of business taxes, origin-based sales taxes, and
source-based income taxes not matched by differences in benefits provided to taxpayers is
likely to distort the location of business. This suggests the need to rely as heavily as possible
on fees, charges, and taxes that can be linked closely to the benefits of public services,
destination-based sales taxes, and residence-based income taxes.

It is useful to distinguish between healthy tax competition and what might be called
predatory tax competition. In healthy tax competition there is pressure for taxes to be no
higher than justified by the benefits of public spending. Pressure for responsible taxation
comes from those who threaten (perhaps implicitly) to migrate from jurisdictions where taxes
exceed the benefits of public activities. The only way to avoid the taxes is to leave the
jurisdiction and cease consuming the services it provides. There is relatively little reason for
taxes to fall below benefits in this model.

Predatory tax competition is very different. It is not necessary for taxpayers to leave
the jurisdiction and forego benefits of public spending in order to benefit from smuggling,
cross-border shopping, false statements of residence, or manipulation of transfer pricing; they
can stay in the high-tax jurisdiction, but not pay its taxes. Pressure for tax reduction comes,
in part, not from healthy tax competition, but from predatory behavior of jurisdictions that
can finance their public services, with little cost to their own residents, by providing a haven
for residents of other jurisdictions who would engage in smuggling, cross-border shopping,
misstatement of residence, or shifting of corporate income. This type of tax competition is
potentially destructive, instead of healthy. Rather than being welcomed, like healthy tax
competition, it should be suppressed. Use of formula apportionment minimizes the
possibility of manipulating transfer prices to shift corporate income between jurisdictions.
The other forms of abuse just described are more difficult to prevent.

to suboptimal levels. Even then, it seems more appropriate to remove the obstacles than to reward tax effort, per
se.
Box 1: Some Principles for Expenditure Assignment
There is no one best way for deciding which level of government should be responsible for the provision of
particular government services. The adequacy of any assignment has to be judged in terms of how well it
achieves the goals or objectives set up by the central government in its decentralization strategy.
Commonly accepted objectives of fiscal decentralization include an efficient allocation of resources via a
responsive and accountable government, an equitable provision of services to citizens in different
jurisdictions, and macroeconomic stability and economic growth. These objectives are also incorporated in
the European Charter of Self-Government.
An efficient provision of government services requires that government satisfy the needs and preferences
of taxpayers as closely as possible. This is best achieved by keeping the provision of services at the lowest
level of government compatible with the size of "benefit area" associated with those services. For example,
the benefit area for sanitation services is clearly the local community, but for air traffic control the benefit
area is the entire national territory. Assigning public services with wider benefit areas to smaller units of
government is likely to result in the inefficient underprovision of services; e.g., a tertiary hospital
providing regional services is financed only by a single municipality, with other municipalities free-riding.
Efficiency in the provision of public services is enhanced if consumption benefits are linked to costs of
provision via fees, service charges, or local taxes.
Expenditures undertaken by government for equity or income equalization reasons, such as social welfare
or low-income housing, are generally thought to be the domain of the central government. The general
belief is that local or regional governments would not be able to sustain independent programs of this
nature, because they would attract the needy from other areas while requiring that they tax their
(potentially mobile) residents more heavily. While funding for these expenditures should be a central
government responsibility, implementation can be left to local government, which may have informational
and other comparative advantages. To the extent that mobility of households is limited, local governments
may be effectively able to carry their own redistributional policies.
Expenditures undertaken for the stabilization and growth of the economy, such as public investment
projects or unemployment compensation, are by their scale naturally assigned to the central government.
The application of these rules largely facilitates the assignment of expenditure responsibilities to different
levels of government. However, the rules are unlikely to yield a unique answer in every situation. Some
public services, e.g., primary education and primary health services, may be of a local nature by the size of
their benefit areas. But because of their relevance to welfare and income redistribution, they may also be
considered a responsibility of the central government.
The objectives are not all attainable at the same time. The pursuit of greater efficiency and autonomy may
be achieved at the cost of a sacrifice in the equality of service levels. It is for this reason that we cannot
speak of a "best expenditure assignment." The government's strategy and priorities would assign different
weights to the objectives of efficiency, equity, and stability. In addition, what is considered the best
assignment is likely to change over time with changes in costs and technological constraints, as well as
changes in preferences. However, there is a need at all times to have a concrete and clear assignment of
expenditure responsibilities that could be considered preferable among the alternative assignments. Failure
to have a concrete assignment may lead to instability in intergovernmental relations and to the inefficient
provision of public services. Without an explicit assignment of expenditure responsibilities it will be much
harder to reach consensus and stability in the assignment of tax revenues and to arrive at a workable
system of equalization transfers.
 Table 1: Fiscal Autonomy in Subcentral Governments
Own taxes Base and rate under local control
Overlapping taxes Nationwide tax base, but rates under local control
Nontax revenues Fees and charges. Generally, the central government specifies
where such charges can be levied and the provisions that govern
their calculation.
Shared taxes Nationwide base and rates, but within a fixed proportion of the tax
revenue (on a tax-by-tax basis or on the basis of a "pool" of
different tax sources) being allocated to the subcentral government
in question, based on (1) the revenue accruing within each
jurisdiction (also called the derivation principle) or (2) other
criteria, typically population, expenditure needs, and/or tax
capacity.
General purpose grant Subcentral government share is fixed by central government
(usually with a redistributive element), but the former is free to
determine how the grant should be spent; the amounts received by
individual authorities may depend on their efforts.

Specific grants The absolute amount of the grant may be determined by central
government or it may be "open-ended" (that is, depend on the
expenditure levels decided by lower levels of government), but in
either case central government specifies the expenditure programs
for which the funds should be spent.
Source: Anwar Shah, The Reform of Intergovernmental Fiscal Relations In Developing & Emerging Market
Economies, Policy and Research Series No. 23, World Bank, 1994.
 Table 2: Conceptual Basis of Expenditure Assignment

Responsibility for
Policy, Standards & Provisional,
Expenditure Category Comments
Oversight Administration
Defense F F Benefits and costs are national in scope
Foreign Affairs F F Benefits and costs are national in scope
International Trade F F Benefits and costs are national in scope
Monetary Policy,
F F Benefits and costs are national in scope
currency & Banking
Interstate Commerce F F Benefits and costs are national in scope
Transfer Payments to
F F Redistribution
Persons
Subsidies to Business
F F Regional development, industrial policy
and Industry
Immigration F F Benefits and costs are national in scope
Unemployment
F F Benefits and costs are national in scope
Insurance
Airlines and Railways F F Benefits and costs are national in scope
Fiscal Policy F, S F,S,L Coordination is possible
Regulation F F,S,L Internal common market
Natural Resources F F,S,L Promotes common market
Environment Benefits and costs may be national,
F,S,L S,L
regional or local in scope
Industry & Agriculture F,S,L S,L Significant interjurisdictional spillovers
Education F,S,L S,L Transfers in kind
Health F,S,L S,L Transfers in kind
Social Welfare F,S,L S,L Transfers in kind
Police S,L S,L Primarily local benefits
Water, Sewage & Refuse L L Primarily local benefits
Fire Protection L L Primarily local benefits
Parks and Recreation Primarily local responsibility, but
F,S,L F,S,L national and provincial governments
may establish own parks
Highways
Interstate F S,L Internal common market
Provincial S S,L Provincial benefits and costs
Interregional S S,L Interregional benefits and costs
Local L L Local benefits and costs
Spending Power Fiscal transfers to advance own
F,S F,S
objectives
Note: F is federal responsibility; S is state or provincial responsibility; and L is local responsibility
Source: Anwar Shah, The Reform of Intergovernmental Fiscal Relations In Developing & Emerging Market Economies,
Policy and Research Series No. 23, World Bank, 1994.
 Table 3.1: Expenditure Assignment to Subnational Authorities
Country
Expenditure Category Bulgaria CSFR Hungary Poland Romania Russia
Defense No No No local No No Military housing
responsibility
Justice/Internal Security Security of farming -- Enforcement of rights No Public security is --
estates of national and ethnic provided by local
minorities branches of the
Ministry of the
Interior
Foreign Economic No -- -- -- -- --
Relations
Education All expenditures Partial responsibility Primary and Kindergarten and None Several special
(capital and current) un the Czech secondary only, pre-elementary vocational schools.
of primary and Republic including day care schools only Wages, operation,
secondary schools. and high schools construction and
Some kindergartens maintenance of all
and technical & primary and secondary
vocational schools schools. Local
enterprises build some
facilities
Culture and Parks No -- Supporting cultural -- Overlapping Some museums with
activities responsibility for oblast significance. All
cultural activities recurrent expenditures
of all sport and park
facilities and all other
cultural facilities.
Health Tertiary care and No Basic health and No None Paramedics, medicine,
psychiatric hospitals. social service primary health clinics.
Polyclinics. Some Secondary and tertiary
primary care ad drugs hospitals, veteran
hospitals, diagnostic
centers, and special
service hospitals
Roads Improve traffic No Maintenance of local Only local or urban Maintenance Maintenance of oblast,
safety. Maintenance public roads roads/streets rayon and city and
of III and IV class commercial roads
roads and urban
streets
Public Transportation All modes of city Urban transport only Local mass transport Construction and Public transport Most public
transportation maintenance of investment transportation facilities,
bridges including subway
 Country
Expenditure Category Bulgaria CSFR Hungary Poland Romania Russia
Fire protection Most fire protection No Local fire protection -- None Most fire protection
services services
Libraries Local libraries No -- Partial responsibility No (books purchased Special library services
through the budget of at the oblast level and
the Ministry of most local library
Culture) services at the rayon
level
Police services Sofia has a signed No -- -- -- Road (traffic) police
contract with the
National Militia.
Other municipalities
get the service free
Sanitation (garbage -- -- Garbage collection Ownership and -- Part of garbage
collection) provision of cold collection at both oblast
water at all levels and rayon levels
Sewage Garbage collection -- Garbage collection Ownership and Sewage collection Most operational
and sanitation and settlement provision of sewage expenditures at the
cleaning rayon level
Public utilities (gas, Water supply -- Water management Supply street lighting District heating and Subsidies to households
electricity and water) infrastructure and maintenance of water (not enterprises) at the
public cemeteries rayon level
Housing Management of -- Housing management Shared responsibility Housing services Maintenance is the
common pastures and responsibility of the
other municipal level of government or
property. Financing, enterprise owning the
building and housing. Capital
subsidizing for expenditures are
residential housing included unless
otherwise noted.
Price and other Mass transport and Direct subsidies to Rent subsidies Rents Energy subsidies to For fuels, mass transport
subsidies drugs. Subsidy to agricultural households and and food such as bread,
inter-village bus cooperatives, and public transport milk and medicines at
service within subsidies to the rayon level. Also,
municipalities. enterprises that are rent subsidies
Heating subsidy since not involves in
1992. production of local
public goods
 Country
Expenditure Category Bulgaria CSFR Hungary Poland Romania Russia
Social Welfare Homeless, disabled -- Social care facilities -- -- Part oblast government
and orphans such as old age and responsibility, and the
handicapped homes rayon level,
management of
programs funded by
upper level governments
New public enterprises Can establish new Can establish new Can establish new Can establish new Can establish new Capacity to invest in
(productive sectors) domestic joint domestic joint domestic joint domestic joint domestic joint joint ventures (keeps
ventures ventures ventures ventures ventures 50% of privatization
proceeds if rayon
subordination). At the
rayon level this also
includes 10% of any
other subordination
Environment Measures to improve -- Protection of the -- -- Responsible for local
and rehabilitate the environment environmental
environment problems, e.g.
preservation of forests
State-owned enterprises -- Major local Major local Local ownership Local ownership “Group C” enterprises,
ownership ownership responsibilities responsibilities e.g. local light industry,
responsibilities responsibilities housing construction
and food industry.
Rayon responsibility
exists only if the
enterprise is transferred
to the local level
Source: Jorge Martinez-Vazquez, The Assignment of Expenditure Responsibilities, Paper presented in Intergovernmental Fiscal Relations and Local Financial Management
Course, Chiang Mai, Thailand, February 2-March 5, 1999
.
 Table 3.1a: Expenditure Assignment to Subnational Authorities (updated)
Country
Expenditure Category Estonia Latvia Lithuania Ukraine
Primary and secondary schools, Primary and secondary schools, Primary, secondary and vocational
Education Primary and secondary schooling
except teachers’ wages except teachers’ wages schools
Polyclinics, municipal hospitals Tertiary care, polyclinics, Primary health case, ambulance Health clinics, hospitals and
Health
and primary care medicine and some primary care services paramedics
Temporary social benefits , day
Care for elderly and other social Responsibility for homeless, Child and family allowances,
Social Security care, care for elderly, homeless
assistance disabled and orphans other social protection
and handicapped
Municipal police and FIRE
Police and Fire No Municipal police Local police and fire service
protection
Housing maintenance and Financing, building, maintenance Rental and sale of municipal Maintenance and small scale
Housing
communal services and subsidies housing stock building
Some public transportation
Public Transportation Local public transportation City transportation Local public transportation
facilities
Maintenance of local networks
Roads Maintenance and construction Urban and rural roads Maintenance of roads
and town streets
Garbage collection and street Garbage collection and street Garbage collection, street cleaning
Sanitation Garbage collection
cleaning cleaning and parks
Water, sewage and some district Sewage and subsidies to
Public utilities Water and sewage Water, sewage and heating
hearing households
 Table 4: Allocation of Social Functions to Subnational Government in Selected Countries

United
Austria Belgium Denmark France Germany Ireland Italy Luxembourg Netherlands Norway Sweden Switzerland Turkey
Kingdom
Preschool
R,L L L L L R,L L
education
Primary
and
R,L R,L L R,L R,L L R,L L L L L R,L L
secondary
education
Vocational
and
R R,L R,L R,L L L R,L L R,L R L
technical
training
Higher
R,L R R,L R L
education
Adult
L L L L R,L R L R,L R,L R,L L
education
Hospitals R,L R,L R L,D R,L R,P,L L R,L R,L R R,L R,L
Personal
R,L L R,L L R,L R,P,L L L L R R R
health
Family
welfare R,L R,L L L,D R,L R,L L L L R,L L L
services
Welfare
R,L L L L L R,L L L L L R,L R,L L
homes
Housing R,L L L R,L L R,L L R,L L L L L L
Refuse
collection
L L L L L L L L L L L R,L L L
and
disposal
District
L L L L L L L L R,L R,L L
heating
Water
L L L L L L R,P,L L R,L L R,L R,L L
supply
Note: R = state, regional government; D = departments in France; L = local government; P = provinces in Italy
Source: Jorge Martinez-Vazquez, The Assignment of Expenditure Responsibilities, Paper presented in Intergovernmental Fiscal Relations and Local Financial Management
Course, Chiang Mai, Thailand, February 2- March 5, 1999.
 Table 5: Assignment of Local Public Services to Municipal and Regional/Metropolitan Governments
Allocation criteria for public vs. private
Allocation criteria for provision
production
Public Service Economies Economies Benefit- Political Consumer Economic Composite Efficiency Equity Composite
of scale of scope cost proximity sovereignty evaluation
spillout of sectoral
choices
Fire fighting L L L L L M L P G P
Police protection L L L L L M L P G G
Refuse collection L L L L L M L P P P
Neighborhood parks L L L L L M L P G G
Street maintenance L L L L L M L P P P
Traffic management L M L L L M L P P P
Local transit service L M L L L M L P P P
Local libraries L L L L L M L G G G
Primary education L L M M L M M P G P,G
Secondary education L L M M L M M P G P,G
Public transport M M M L,M M M M P.G G P.G
Water supply M M M L,M M M M P G P.G
Sewage disposal M M M M M M M P,G P.G P.G
Refuse disposal M M M M M M M P P P
Public health M M M M M M M G G G
Hospitals M M M M M M M P,G G P,G
Electric power M M M M M M M P P P
Air/water pollution M M M M M M M G G G
Special police M M M M M M M G G G
Regional parks M M M L,M M M M G G G
Regional planning M M M L,M M M M G G G
Note: L = local government; M = regional/metropolitan government; P = private sector; G = public sector
Source: Anwar Shah, The Reform of Intergovernmental Fiscal Relations In Developing & Emerging Market Economies, Policy and Research Series No. 23, World Bank,
1994.
 Table 6: Magnitude of General Government Expenditures and Portion Administered by Each Level of Government1
(average of latest three years available)
Total Government
Education Health Social Security and Welfare
Expenditures3
Ending Social Security
Country Total Education Health Central State Local Central State Local Central State Local Central State Local
Year and Welfare
(in % of GDP) (in % of general government)
Argentina2 1987 33.2 4.0 1.1 9.1 60.3 39.7 33.3 66.7 24.4 75.6 89.4 10.6
Australia 1987 39.1 5.5 5.5 9.6 52.9 40.4 6.8 8.5 91.3 0.2 43.5 55.6 0.9 92.8 6.2 1.0
Austria 1987 70.4 13.7 16.9
Belgium 1987 56.7 85.9 11.9
Bolivia 1986 11.1 85.9 10.6 3.4
Brazil 1987 34.1 65.8 24.5 9.6
Canada 1987 46.0 5.8 6.0 12.3 41.3 40.3 18.4 4.8 34.5 60.7 2.6 89.5 7.9 65.8 31.3 2.9
Chile 1987 32.3 4.9 1.9 8.8 93.8 6.2 81.7 18.3 98.1 1.9 100.0
Colombia 1984 18.0 5.5 1.3 3.2 67.4 23.9 8.7 55.5 39.2 5.3 49.0 40.2 10.8 90.0 7.8 2.2
Denmark 1986 57.6 7.1 5.2 23.1 44.9 52.9 46.8 53.2 7.1 92.9 26.1 73.9
Finland 1987 43.0 54.7 45.3
France 1985 49.3 4.6 8.3 20.9 82.2 16.5 75.3 24.7 97.0 3.0 91.8 8.2
Germany 1983 50.2 4.2 8.0 21.2 58.7 21.5 17.9 1.0 73.8 25.2 74.4 11.2 14.4 79.0 10.9 10.1
Hungary 1988 64.5 5.7 4.2 18.1 77.8 22.2 20.0 80.0 39.2 60.8 95.7 4.3
India2 1986 22.6 3.4 0.9 2.3 47.5 52.5 9.0 90.1 30.2 69.8 0.0 100.0
Indonesia2 1988 22.8 3.1 0.5 0.4 88.7 11.3 65.3 34.7 72.8 27.2 0.0 100.0
Ireland 1987 55.8 72.5 27.5
Israel 1986 62.9 5.3 2.0 10.0 90.8 9.2 67.2 32.8 97.0 3.0 94.9 5.1
Kenya 1984 29.3 5.2 2.1 1.4 94.3 5.7 94.0 6.0 91.9 8.1 75.9 24.1
Luxembourg 1987 39.1 4.4 0.7 21.3 81.3 15.9 74.1 25.9 92.0 8.0 97.4 2.6
Malawi 1984 29.1 3.7 2.2 0.6 93.7 6.3 98.7 1.3 82.9 17.1 100.0 0.0
Mexico 1984 30.2 90.1 7.6 2.3
Netherlands 1988 59.2 70.1 29.9
New Zealand 1981 43.2 86.9 13.1
Norway 1986 47.2 66.4 33.6
Pakistan 1979 26.1 68.2 28.3 3.5
Paraguay 1984 11.3 95.1 4.9
Poland 1988 48.1 71.1 28.9
Romania 1985 32.3 2.1 2.1 8.9 77.0 23.0 28.0 72.0 10.3 89.7 99.3 0.7q
South Africa 1986 33.3 74.8 12.5 12.7
Spain 1986 38.2 78.8 9.9 11.3
Sweden 1987 61.6 59.8 40.2
Switzerland 1984 37.4 5.3 5.9 13.9 47.5 28.3 24.2 6.2 57.5 36.3 45.5 32.1 22.4 88.5 5.6 5.9
Thailand 1982 21.2 4.1 1.1 1.2 92.3 7.7 94.8 5.2 93.5 6.5 97.4 2.6
Tunisia 1982 34.0 5.1 2.5 4.7 94.6 5.4 100.0 100.0 100.0
United
1987 44.8 5.1 5.1 14.3 70.9 27.2 12.7 87.3 100.0 84.0 16.0
Kingdom
United States 1987 37.1 5.1 4.3 9.0 60.3 17.3 22.4 4.2 24.5 71.3 50.5 33.8 15.7 78.0 14.6 7.4
Yugoslavia 1987 25.3 3.2 4.2 7.8 23.2 31.4 45.4 0.0 0.0 100.0 0.0 0.0 100.0 7.3 75.9 16.8
Zimbabwe 1986 45.0 8.3 2.6 3.0 75.8 24.2 60.2 39.8 86.6 13.4 100.0 0.0
1
Excluding intergovernmental grants.
2
Data for general government do not include local government.
3
Includes supranational authorities share of general government expenditures in Belgium (2.2%), Denmark (2.2%), France (1.4%), Germany (1.8%), Luxembourg (2.7%) and United Kingdom (1.9%).
Source: Levin (1990), based on International Monetary Fund, Government Finance Statistics Yearbook, Vol. 13 (Washington, DC: IMF, 1989)
 Table 6a: Magnitude of General Government Expenditures and Portion Administered by Each Level of Government
(average of latest three years available, updated)

Total Government
Education Health Social Security and Welfare
Expenditure
Ending Social Security
Country Total Education Health Central State Local Central State Local Central State Local Central State Local
Year and Welfare
(in % of GDP) (in % of general government)
Argentina1 1997 26.3 4.0 1.9 8.8 58.9 41.1 22.1 77.9 20.1 79.9 93.0 7.0
Australia 1998 42.4 5.4 6.8 9.8 59.9 34.8 5.3 35.4 64.4 0.2 52.7 46.7 0.6 90.8 7.7 1.5
Austria 1997 74.0 53.9 33.3 12.8
Belgium 1997 53.5 89.1 10.9
Bolivia 1998 32.2 7.6 1.9 5.6 69.1 18.8 12.1 55.5 41.0 3.5 42.2 49.6 8.2 95.2 4.0 0.8
Canada 1995 60.9 10.5 8.1 17.3 41.8 42.5 15.7 8.1 53.0 38.9 15.0 83.7 1.3 64.2 31.7 4.1
Chile 1998 23.1 91.5 8.5
Denmark 1995 75.1 7.6 5.4 36.5 56.3 43.7 52.2 47.8 7.9 92.1 48.8 51.2
Finland 1997 62.8 62.4 37.6
France 1993 55.0 5.1 8.3 20.9 82.3 17.7 62.2 37.8 97.3 2.7 92.0 8.0
Germany 1996 58.1 4.4 8.8 21.9 59.2 24.1 16.7 2.6 69.1 28.3 71.8 12.8 15.4 78.0 11.1 10.9
Hungary 1998 56.3 7.2 4.6 15.4 76.6 23.4 51.9 48.1 52.0 48.0 90.2 9.8
India1 1996 27.0 3.1 0.8 53.8 46.2 9.5 90.5 26.5 73.5
Indonesia1,2 1993 19.6 2.5 0.6 88.0 12.0 67.1 32.9 78.1 21.9 100
Ireland 1996 49.7 6.4 11.2 11.1 74.9 25.1 77.0 23.0 51.0 49.0 92.3 7.7
Israel 1996 42.9 6.9 3.6 9.5 85.9 14.1 72.8 27.2 98.6 1.4 94.0 6.0
Kenya 1994 30.8 5.5 1.7 96.0 4.0 97.9 2.1 92.2 7.8 61.7 38.3
Luxembourg 1995 49.1 5.0 1.0 22.0 84.3 15.7 75.8 24.2 97.8 2.2 97.7 2.3
Mexico 1997 22.1 71.9 23.8 4.3
Netherlands 1997 63.5 17.9 7.4 21.5 76.6 23.4 85.1 14.9 94.9 5.1 84.4 15.6
New Zealand 1998 36.4 89.4 10.6
Norway 1997 55.2 6.7 7.0 17.2 67.1 32.9 38.8 61.2 22.4 77.6 81.3 18.7
Paraguay 1993 13.2 1.2 0.9 2.0 97.9 2.1 98.5 1.5 94.8 5.2 99.8 0.2
Poland 1998 48.6 5.6 6.7 20.3 79.6 20.4 42.9 57.1 92.5 7.5 95.7 4.3
Romania 1997 36.3 3.5 2.8 9.9 87.5 12.5 86.9 13.1 80.5 19.5 97.7 2.3
South Africa 1996 47.4 63.0 29.2 7.8
Spain 1996 53.3 4.3 5.6 15.2 69.4 18.7 11.9 34.3 59.4 6.3 37.7 59.3 3.0 94.6 3.5 1.9
Sweden 1998 67.7 65.5 34.5
Switzerland 1997 52.5 6.9 9.8 17.0 52.3 27.7 20.0 9.8 54.9 35.3 55.7 25.0 19.3 79.0 12.9 8.1
Thailand 1996 15.8 3.2 1.2 0.5 91.9 8.1 96.0 4.0 92.9 7.1 96.1 3.9
Tunisia 1996
United
1998 50.6 4.7 5.8 18.0 78.0 22.0 33.2 66.8 100.0 79.7 20.3
Kingdom
United States 1997 43.2 7.6 7.7 9.1 53.7 25.3 20.9 5.3 43.3 51.4 56.6 32.7 10.7 70.6 21.2 8.2
1
Data for general government do not include local government.
2
Expenditure of Indonesian central government on social security and welfare began in 1994
Source: International Monetary Fund, Government Finance Statistics Yearbook, Vol. 23 (Washington, DC: IMF, 1999)
 Table 7: Conceptual Basis of Tax Assignment
Determination of
Collection and
Type of Tax Base Rate Comments
administration
Customs F F F International trade taxes
Corporate income F F F Mobile factor, stabilization tool
Resource taxes, resource rent
F F F Highly unequally distributed tax bases
(profits, income) tax
Royalties, fees, charges,
Benefit taxes / charges for state-local
severance taxes, production, S,L S,L S,L
services
output and property taxes
Conservation charges S,L S,L S,L To preserve local environment
Personal income F F,S,L F Redistributive, mobile factor
Wealth taxes (taxes on capital
wealth, wealth transfers, F F,S F Redistributive
inheritances, and bequests)
Benefit charge, e.g. social security
Payroll F,S F,S F,S
coverage
Border tax adjustment possible under
Multistage sales taxes (VAT) F F F federal assignments, potential
stabilization tools
Single-stage sales taxes (manufacturer, wholesale, retail)
Option A S S,L S,L Higher compliance cost
Option B F S F Harmonized, lower compliance cost
“Sin” taxes
Excises on alcohol and
F F F Health care shared responsibility
tobacco
Betting, gambling S,L S,L S,L State and local responsibility
Lotteries S,L S,L S,L State and local responsibility
Race tracks S,L S,L S,L State and local responsibility
Taxation of “bads”
Carbon F F F To combat global/national pollution
Pollution impact may be national,
BTU taxes F,S,L F,S,L F,S,L
regional or local
Tolls on federal/provincial or local
Motor fuels F,S,L F,S,L F,S,L
roads
To deal with interstate, intermunicipal
Effluent charges F,S,L F,S,L F,S,L
or local pollution issues
Tolls on federal/provincial or local
Congestion tolls F,S,L F,S,L F,S,L
roads
Parking fees L L L To control local congestion
Motor vehicles
Registratio, transfer taxes and
S S S State responsibility
annual fees
Driver’s licences and fees S S S State responsibility
Business taxes S S S Benefit tax
Excises S,L S,L S,L Residence-based taxes
Completely immobile factor, benefit
Property S L L
tax
Completely immobile factor, benefit
Land S L L
tax
Frontage, betterment S,L L L Cost recovery
Poll F,S,L F,S,L F,S,L Payment for services
User charges F,S,L F,S,L F,S,L Payment for services rendered
Note: F = federal responsibility; S = state or provincial responsibility; L = local responsibility
Source: Anwar Shah, The Reform of Intergovernmental Relations in Developing and Emerging Countries, Policy Research Paper No. 23, World
Bank, 1994
 Table 8: Tax Revenue Attributable to Each Level of Government
(in % of general government)
Domestic Taxes on
Total Tax Revenue Taxes on Income Taxes on Property
Goods and Services
Country Year C S L C S L C S L C S L
Netherlands 1988 97.8 0.8 100.0 100.0 99.4
Paraguay 1987 97.6 2.4
Indonesia 1988 97.3 2.7 100.0 55.4 44.6 95.4 4.6
Chile 1987 96.5 3.5 100.0 100.0 95.5 4.5
Kenya 1986 96.4 3.6 100.0 1.4 98.6 97.6 2.4
Zimbabwe 1986 96.3 3.7 100.0 12.3 87.7 98.3 1.7
Ireland 1987 96.0 2.3 100.0 42.9 57.1 98.7
Malawi 1984 95.9 4.1 99.7 0.3 1.9 98.1 99.8 0.2
Israel 1986 95.5 4.5 100.0 22.9 77.1 100.0
Thailand 1988 95.0 5.0 100.0 58.8 41.2 92.8 7.2
South Africa 1986 94.4 1.5 4.1 100.0 27.7 72.3 95.6 4.4
Belgium 1987 93.5 5.0 90.0 10.0 100.0 95.9 3.3
New Zealand 1981 93.5 6.5 100.0 17.9 82.1 98.8 1.2
Luxembourg 1987 93.3 6.2 87.6 12.4 92.0 8.0 99.2 0.7
Hungary 1988 91.7 8.8 73.6 26.8 55.5 45.5 99.2 0.8
France 1988 90.0 9.2
United 1987 88.1 10.7 100.0 17.0 83.0 99.8
Kingdom
Spain 1986 87.7 3.3 9.0 84.3 1.2 14.4 56.7 23.9 19.4 76.1 7.4 16.5
Mexico 1984 84.6 12.7 2.7 98.2 1.6 0.2 8.7 52.4 38.9 99.4 0.3 0.3
Australia 1987 81.1 15.3 3.6 100.0 4.9 4.9 49.2 46.0 75.6 24.4
Norway 1986 80.9 19.1 57.1 42.9 40.6 59.4 99.8 0.2
Poland 1988 80.9 19.1 79.6 20.4 50.8 49.2 89.2 10.8
Columbia 1984 80.3 13.3 6.3 100.0 9.5 90.5 70.0 30.0
Bolivia 1986 78.6 18.4 3.0 99.2 0.8 60.1 36.2 3.7
Sweden 1987 77.7 32.6 33.2 66.8 100.0 100.0
Pakistan 1979 76.9 18.5 4.6
Finland 1987 76.0 25.3
Austria 1987 75.8 11.5 12.7 58.0 22.6 19.4 52.1 4.3 43.6 71.3 13.1 15.6
Brazil 1987 71.4 26.6 1.9 100.0 2.8 51.9 45.3 43.7 53.4 2.8
Denmark 1987 71.2 28.8 54.0 43.0 57.0 43.0 99.4 0.1
Germany 1988 69.8 21.7 7.6 39.4 40.5 20.1 5.2 54.5 40.3 69.9 29.4 0.1
India 1986 67.2 32.8 100.0 39.0 67.0 51.9 48.1
United States 1987 66.7 20.6 12.8 81.6 16.8 1.7 5.6 7.2 87.1 17.1 68.0 14.9
Switzerland 1987 60.5 22.8 16.7 22.8 42.2 35.0 32.6 42.2 25.2 87.7 11.8 0.5
Canada 1988 50.8 40.0 9.2 63.5 36.5 16.1 83.9 38.7 60.8 0.5
Note: C = central government; S = state government; L = local government. Figures are the average of the last three years
available.
Source: Levin (1991)
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