Decentralization and Reform in Latin America

Decentralization and Reform in Latin America

Improving Intergovernmental Relations

Edited by Giorgio Brosio and Juan P. Jiménez

Decentralisation and Reform in Latin America analyses the process of intergovernmental reform in Latin America in the last two decades and presents a number of emerging issues. These include the impacts of decentralization and the response of countries in the region to challenge such as social cohesion, interregional and interpersonal disparities, the assignment of social and infrastructure expenditure, macrofinancial shocks, fiscal rules and the sharing of natural resources revenue. The main aim of the book is to assess the effective working of decentralized arrangements and institutions, with a view of suggesting corrections and reforms where the system is not working according to expectations.

Chapter 8: Intergovernmental transfers in subnational finances

Fernando Rezende and João Veloso

Subjects: development studies, development economics, economics and finance, development economics, public finance

Extract

Over time, fiscal decentralization in Latin America has been accompanied by the growing importance of intergovernmental transfers in subnational finances. There are three main explanations for this: first, the impact of global markets and technological advances on the mobility of the tax base traditionally tapped into at the subnational level, which has imposed additional constraints on the decentralization of tax powers; second, the increasing role played by provincial and local governments with regard to the provision of urban and social services, as well as in public investments that are essential to promote economic development and improve social well-being, such as education, health and urban infrastructure; and third, a rise in costs to fulfill subnational governments’ responsibilities, which reflect societies’ demands for a higher standard in the provision of public services together with the need to apply costly solutions to tackle urban and social problems in a highly dense and unequal environment. The outcome of contradictory moves – greater spending responsibilities in a context of higher producing costs and less room for raising own revenues through taxes – is an increasing financial gap. Furthermore, when regional and social disparities are high, as is the case in most Latin American countries, huge differences arise with respect to the financial gap faced by distinct jurisdictions (the so-called ‘horizontal disparities’); that is, it is not possible to deal properly with this situation by attempting to bypass the limitations to raising taxes at the subnational level. Reliance on transfers is indispensable, besides being necessary, even though it leaves subnational governments vulnerable to external events, such as cuts induced by macroeconomic fiscal adjustment needs, the impact of an economic downturn on budgetary receipts, the likelihood of restrictions being imposed on the use of transfer-originated resources, and the fact that central government financial authorities prefer to raise taxes not included in the transfer system.

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