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The reform of fiscal systems in developing and emerging market economies : a federalism perspective

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  • Boadway, Robin
  • Roberts, Sandra
  • Shah, Anwar

Abstract

The authors review experiences with fiscal federalism in industrial countries and present a framework for a reform of fiscal systems in developing and transition economies. They indicate how the benefits of decentralized decisionmaking in a federal system can be achieved in a manner consistent with the objectives of national efficiency and equity. The following are their suggestions. Decentralization can be made compatible with national objectives through conditional grants, regulation, or coordinated decisionmaking. The federal government should assume primary responsibility for providing national public goods and services, for efficiency of the internal common market, for redistributive equity, for external relations, and for macroeconomic policy. State governments should be responsible for subnational public goods and services, for the delivery of quasi-private goods and services, (such as education, health, and social insurance), for fiscal equity among municipalities, and for overseeing local government decisionmaking. Local governments should be responsible for purely local services. Where jurisdiction for a public service is shared, the roles of the various levels of government should be clarified. Accountability should be hierarchical, with the federal government responsible for overall policy and standards, and lower levels of government with the actual delivery of services and infrastructure. In some cases, asymmetric decentralization may be the preferred option, especially where jurisdictions differ greatly in size and population. Efficiency and equity must be considered in assigning taxes. Efficiency considerations suggest centralizing taxes applied on more mobile bases (such as taxes on capital income and on trade). Equity considerations suggest centralizing progressive income taxes and transfers to persons as well as taxes on wealth and wealth transfer and on resource rents. States could use excise taxes or general sales taxes if levied on a single-stage basis; if a multistage sales tax is used, it is best administered centrally. States could also obtain revenues from piggy-backing on the federal income tax provided a harmonized system is maintained. Municipalities should use property taxes, user fees, and licenses. Tax and expenditures assignment must be supplemented by a system of fiscal transfers, both because the desirability of greater decentralization of expenditures than of taxes will give rise to fiscal imbalances and because transfers are a necessary instrument for achieving efficiency and equity in a decentralized federation. In a decentralized federation, fiscal inefficiencies and fiscal inequities will occur because states will not deliver comparable sets of services at comparable tax rates. Eliminating these differential net fiscal benefits requires a set of equalizing unconditional transfers, possibly combined with a more general revenue-sharing scheme. Matching conditional grants are useful for internalizing the spillover of benefits from state public spending to residents of neighboring states. More important is the use of federal-state conditional grants as a means for the federal government to achieve national efficiency and equity objectives while allowing public service delivery to be decentralized. In transition economies, framework laws on property rights, corporate legal ownership and control bankruptcy, and financial accounting and control are not fully developed. This should be a high priority. The lack of local administrative experience, institutions, and competence should not be used as an excuse for not decentralizing responsibilities. If necessary, transitional funding and training should be provided.

Suggested Citation

  • Boadway, Robin & Roberts, Sandra & Shah, Anwar, 1994. "The reform of fiscal systems in developing and emerging market economies : a federalism perspective," Policy Research Working Paper Series 1259, The World Bank.
    • Handle: RePEc:wbk:wbrwps:1259
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    References listed on IDEAS

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    1. Flatters, Frank & Henderson, Vernon & Mieszkowski, Peter, 1974. "Public goods, efficiency, and regional fiscal equalization," Journal of Public Economics, Elsevier, vol. 3(2), pages 99-112, May.
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    3. Shah, Anwar, 1991. "Perspectives on the design of intergovernmental fiscal relations," Policy Research Working Paper Series 726, The World Bank.
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    Cited by:

    1. Iregui, Ana Maria, 2005. "Decentralised provision of quasi-private goods: The case of Colombia," Economic Modelling, Elsevier, vol. 22(4), pages 683-706, July.
    2. Jorge Martinez-Vazquez & François Vaillancourt, 2011. "An Overview of the Main Obstacles to Decentralization," Chapters, in: Jorge Martinez-Vazquez & François Vaillancourt (ed.), Decentralization in Developing Countries, chapter 1, Edward Elgar Publishing.
    3. Kim, Aehyung, 2008. "Decentralization and the provision of public services : framework and implementation," Policy Research Working Paper Series 4503, The World Bank.
    4. de Mello, Luiz Jr, 2000. "Fiscal Decentralization and Intergovernmental Fiscal Relations: A Cross-Country Analysis," World Development, Elsevier, vol. 28(2), pages 365-380, February.
    5. Huther, Jeff & Shah, Anwar, 1998. "Applying a simple measure of good governance to the debate on fiscal decentralization," Policy Research Working Paper Series 1894, The World Bank.
    6. Sato, Motohiro, 2003. "Tax competition, rent-seeking and fiscal decentralization," European Economic Review, Elsevier, vol. 47(1), pages 19-40, February.
    7. Celina Souza, 1996. "Redemocratization and Decentralization in Brazil: The Strength of the Member States," Development and Change, International Institute of Social Studies, vol. 27(3), pages 529-555, July.
    8. Shah, Anwar, 1998. "Balance, accountability, and responsiveness : lessons about decentralization," Policy Research Working Paper Series 2021, The World Bank.
    9. Osvaldo Larrañaga, 1996. "Descentralización y Equidad: El Caso de los Servicios Sociales en Chile," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 33(100), pages 345-365.
    10. Abdul Jalil, Ahmad Zafarullah, 2009. "Decentralization, Subnational Governments' Behaviour and Macroeconomic Instability: The Case of Malaysia," MPRA Paper 19071, University Library of Munich, Germany.
    11. Boadway, Robin & Roberts, Sandra & Shah, Anwar, 1994. "Fiscal federalism : dimensions of tax reform in developing countries," Policy Research Working Paper Series 1385, The World Bank.
    12. Shah, Anwar, 2005. "Fiscal decentralization and fiscal performance," Policy Research Working Paper Series 3786, The World Bank.

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