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Roy Bahl and Richard M. Bird

This book draws on experiences in developing countries to bridge the gap between the conventional textbook treatment of fiscal decentralization and the actual practice of subnational government finance. The extensive literature about the theory and practice is surveyed and longstanding problems and new questions are addressed. It focuses on the key choices that must be made in decentralizing, on how economic and political factors shape the choices that countries make, and on how, by paying more attention to the need for a more comprehensive approach and the critical connections between different components of decentralization reform, everyone involved might get more for their money.
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Fiscal decentralization 101

Development from Below

Roy Bahl and Richard M. Bird

Fiscal decentralization is about how central governments empower subnational governments to service their populations and to pay for these services. This chapter provides an introductory overview of the main arguments of the book. We discuss why fiscal decentralization is often part of a country’s development policy, as well as the risks involved in giving local and regional governments more fiscal discretion. Here and throughout the book the discussion is based on theoretical arguments; our reading of the by now extensive research findings on many aspects of these issues; and our many years of observing how middle- and lower-income countries in all regions of the world operate. We conclude that while a few developing countries have turned theory into practice with good results, most have been proved unable to reap the potential benefits in practice so that, on balance, there is not much evidence of effective fiscal decentralization on the ground in most countries.

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Has decentralization worked?

Development from Below

Roy Bahl and Richard M. Bird

The focus in this chapter is on what the empirical evidence tells us about why countries have decentralized and what the impact of fiscal decentralization has been. We review why the data is limited, but nonetheless note that it suggests some conclusions about why some countries are more decentralized than others, and why decentralization is likely to be more fully developed in larger and higher-income countries than in smaller and poorer countries. However, when it comes to questions about the impact of fiscal decentralization on economic development, on the well-being of the population, and on the size and quality of government, the evidence gives no clear answers. Decentralization appears have had some positive impacts in some countries – but not always or everywhere. Experience to date suggests that there are some common traps and obstacles that lead to less favorable outcomes, and much of the rest of this book in effect suggests guidelines that countries wanting better outcomes should follow.

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Expenditure assignment and management

Development from Below

Roy Bahl and Richard M. Bird

This chapter focuses on expenditure assignment – the determination of the functions for which local governments are responsible, and the level of discretion they should have in deciding on their expenditure budgets. The analysis reviews both theory and practice with respect to ensuring that public expenditures are adequately controlled, accountable and efficient, and concludes that no country ever seems to get expenditure assignments completely right. While the reasons vary from country to country, they generally arise from the complex way economic concerns, public management and politics interact. The chapter concludes by setting out some principles that might guide how local governments can organize and manage the expenditures with which they are charged in ways more likely to realize the potential benefits of fiscal decentralization.

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Roy Bahl and Richard M. Bird

Local governments in developing countries are often responsible for providing much of a country’s public infrastructure. Given the usual magnitude of the infrastructure gap and the limited opportunities for capital financing available to local governments this situation may seriously hamper development. Although the relative advantage of delivering infrastructure services at the local level varies both with circumstances and the infrastructure concerned, there is often a strong case for unbundling responsibilities for these services by sub-function or by stages of the project cycle, with some responsibility falling to the local level. Alternative sources of infrastructure finance – local taxes, user charges, transfers, debt, public–private partnerships – are considered, especially common current practices and some successful experiences.

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Roy Bahl and Richard M. Bird

This chapter sets out a simple framework explaining why and how to impose a hard budget constraint on subnational governments; explores the opportunities for financing local budgets with local sources; and reviews practices in low- and middle-income countries. Noting that the scope of decentralized taxes is usually limited, we then review theoretical and other reasons for limiting the extent to which tax authority is assigned to local and regional governments. The merits of centralized vs decentralized tax administration are analyzed, as are some possible new candidates for subnational government taxes, with particular attention on some relatively successful experiences with broad-based sales taxes.

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Taxing land and property

Development from Below

Roy Bahl and Richard M. Bird

Theory suggests that taxes on real property are a good source of revenue for local governments. In practice, however, the annual property tax is not important in developing countries, for a variety of reasons explored in this chapter. The revenue performance of the property tax is weak because of overgenerous preferential treatments that erode the base, poor administration and low rates. There are wide variations in bases and rates, as the chapter discusses, but both valuation and collection are often weak. The chapter also discusses other ways to tax land and real property, including taxes on property transfers, and various ways of capturing increases in land values. It concludes with a discussion of reform options.

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Intergovernmental transfers

Development from Below

Roy Bahl and Richard M. Bird

This chapter reviews the dominance of intergovernmental fiscal transfers in financing local governments in developing countries. The rationales and objectives of such transfers are explored and the variations found in practice around the world analyzed. The architecture of transfer systems across countries is diverse, with each mixing shared taxes, conditional transfers and unconditional transfers in its own way. We discuss the evidence of the extent to which transfers appear to achieve their intended goals, and reforms that may improve these results. The evidence is decidedly mixed on whether transfers stimulate local revenue effort; but it does suggest that in most low- and middle-income countries they do little to equalize fiscal disparities. Most developing countries do not monitor their transfer systems regularly or in any depth, although a few have begun to do so in recent years.

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Financing metropolitan areas

Development from Below

Roy Bahl and Richard M. Bird

There is ample evidence that productivity and incomes increase with city size and density, and that city growth and national economic growth are strongly linked. Unfortunately, the fiscal framework in most developing countries limits the extent to which cities can meet expenditure needs or capture the revenue opportunities that accompany urbanization. This chapter lays out options for a better governance and financing model for big cities in the developing world. It considers how local governance may be structured within metropolitan areas; when and how more local autonomy in making expenditure decisions is possible; and the taxes and charges that might best support a more fiscally self-sufficient local governance structure, supporting the analysis with a review of the practice in metropolitan finance in some low-income countries.

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Giving decentralization a chance

Development from Below

Roy Bahl and Richard M. Bird

This concluding chapter argues that fiscal decentralization has had little chance to prove itself as a development strategy. Though only a few countries have reversed moves towards fiscal decentralization, almost none have done much to increase the fiscal autonomy of local governments. Decentralization may certainly give rise to problems, but for the most part those that have been observed in practice are due more to poor design and implementation than to any inherent flaw in the approach. The most important constraints impeding meaningful decentralization in many countries are the inadequacy of independent local government taxing powers and the failure to provide enough special arrangements for the financing and governance of large urban areas. The chapter concludes by suggesting some guidelines that may help countries to decentralize in a more effective and sustainable way.