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Edited by Serdar Yilmaz and Farah Zahir

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Serdar Yilmaz and Farah Zahir

The book presents a rich and illuminating research and comparison between the mature federal systems and the maturing federations in the world. At the outset, the book describes the interplay of various forces and conditions including the geography, demography, political and economic systems that impact relationships between the various tiers of government. Then it analyses the application of the theory in mature, evolving and unitary federations.

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Roy W. Bahl Jr

Countries structure their intergovernmental transfers in many different ways, depending on the objectives they wish to achieve and on how they decide to use expenditure and revenue assignments in their intergovernmental fiscal systems. The basic building blocks of the architecture of intergovernmental transfers are vertical sharing, which addresses the vertical fiscal imbalance in the system, and horizontal distribution, which addresses the reduction in fiscal disparities. The industrial countries reviewed in this volume do a good job with applying best international practices to produce reasonably efficient and equitable systems, but low- and middle-income countries are more burdened by resource constraints and weak databases to support their systems.

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Serdar Yilmaz and Farah Zahir

The design of intergovernmental transfers has a huge bearing on the efficiency and equity of public service provision as they play a prominent role in financing subnational governments across the world. In the first-generation theory (FGT) of fiscal federalism, they are viewed as economic policy tools to correct imperfections. The FGT assumed that decision makers are benevolent actors who would intervene to provide public goods efficiently. On the other hand, the recently emerged second generation theory (SGT) of fiscal federalism focuses on the political economy implications of transfers and pays attention to the institutional and political incentives that induce or constrain the behaviour of politicians. The SGT sees intergovernmental transfers as a potential tempting target for rent-seeking politics. This chapter summarizes the main arguments of both theories and provides examples from federations.

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Bernard Dafflon and François Vaillancourt

The objective of this chapter is to present the main issues associated with equalization in such a way that one can more easily compare the fundamental architecture of equalization between countries. This chapter first highlights milestone contributions to the political economy of interregional solidarity then distinguishes between interregional disparities (equalizable) and differences (not equalizable). It then introduces the notion of first- and second-generation equalization models: they differ in their treatment of expenditure needs. First generation equalization either ignored expenditure needs or mixed revenue and expenditure needs in one formula. Second generation equalization addresses revenue and expenditure needs equalization explicitly yet in complementary fashion. The chapter then presents a comprehensive and coherent listing of the key issues in equalization policy followed by a synoptical table linking possible determinants of disparities to revenue, needs and cost differences. It shows that high unit costs for public services is often linked to high revenue potential.

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Paul B. Spahn

The German federation possesses three levels of government: the federation, the states and local governments. Each level of government is autonomous as to their expenditures of the budget, and administrative responsibilities for financing each respective outlay function are linked – with some exceptions. However, lower tiers of government possess practically no significant own taxes – except for some local taxes. Tax legislation is uniform throughout the nation. In matters of taxation the states can only co-decide conjointly with the federal parliament (Bundestag) through their second chamber (Bundesrat) whose members are not elected but representatives of state governments. Although the German equalization system is under continuous political stress and is criticized as being overly generous, with negative incentive effects, it is unlikely to change significantly given the institutional setup where the majority of states are at the receiving end of the scheme. The pending reform of 2020 has brought about only marginal changes.

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Howard A. Chernick

Federal grants to states and localities comprised 17 per cent of all federal spending in 2017, and 33 per cent of state general revenues. The share of funds that ultimately go to individuals, mainly for healthcare, has increased, while the share for capital expenditures has diminished sharply. Unlike most federalist countries, the US does not use untied grants for fiscal equalization. Instead, the US relies on categorical grants, with income-related matching and maintenance of effort requirements, to incentivize states and their localities to provide certain merit goods to the poor, and to enhance capital stocks. Interstate differences in redistribution remain substantial. Education funding is primarily a local responsibility, but almost half of revenues come from state aid. The equalizing effect of state aid has increased over time. Intergovernmental grants are important tools of countercyclical fiscal policy. Overall, grants are roughly additive to own revenues, though displacement or supplementation varies by grant type.

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Marcelin Joanis and François Vaillancourt

This chapter presents the key aspects of Canadian fiscal federalism with particular attention given to the treatment of natural resource rents. The case of Canada is of interest to scholars given that it is one of the oldest federations with important vertical and horizontal fiscal imbalance. The chapter is divided into three parts. The first one presents briefly the Canadian provinces in terms of their demography and economy. It then presents in some detail the key transfers in place. The second part presents the debate on fiscal imbalance that occurred in the first decade of this century. The third part focuses on three natural resource issues in Canada: the treatment of natural resource rents – earned (petroleum and gas) and dissipated (hydro rent) – in equalization; the debates around the building of pipelines; and the interaction between federal carbon taxation and provincial carbon policies (cap and trade, regulation, taxation).

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Bernard Dafflon

Introduced in 2008 after ten years of contentious discussions between the federal government and cantons, the actual equalization policy in Switzerland presents several specificities detailed in this chapter. Its ambition is reducing disparities both in the cantons’ tax raising capacities and their expenditure needs simultaneously. Revenue equalization is based on a representative tax system (RTS) applied to the federal direct tax base in the cantons. Expenditure needs are estimated differently for two different groups of cantons: one for urban cantons using socio-demographic variables and the other for mountainous areas using geo-topographic variables. The complexity of the equalization formula raises the following questions: which explanatory variables should be used for which functions? How to measure needs? How much equalization is acceptable? Who pays for what? This chapter shows that in modelling an equalization policy, it is possible to reach sustainable political compromise and practical solutions even if statistical information is not available and it is difficult to quantify certain factors.

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Bob Searle

This chapter examines intergovernmental fiscal relations as it is practised in Australia. It discusses the level of vertical fiscal imbalance (VFI) and how that has increased over time, and the mechanisms through which VFI is overcome. It also shows how those mechanisms have reduced the autonomy of the states and how this has resulted largely from Commonwealth government actions and a single clause in the Australian Constitution. The system of achieving horizontal fiscal equality for the states is described, as are the changes to that system since the late 1970s. The administrative structures within which intergovernmental fiscal relations operates are outlined. In each of these discussions, areas where further change might be considered are identified. It is concluded, however, that major change is unlikely in the foreseeable future.