Executive summary

This volume of Fiscal Federalism surveys recent trends and policies in intergovernmental fiscal relations and subnational government, as countries emerge from the Coronavirus crisis. The chapters draw insights into good practices in fiscal federalism and how to resolve policy-making trade-offs, while delving into more detailed examinations of:

  • the design of fiscal equalisation systems

  • subnational tax and spending autonomy

  • public sector performance across levels of government

  • digitalisation challenges and opportunities

  • subnational accounting and insolvency frameworks

  • funding and financing of local government public investment

  • early lessons from the COVID-19 crisis for intergovernmental fiscal relations.

Chapter 1, “Synthesising good practices in fiscal federalism”, examines the design of intergovernmental fiscal relations, including how tax and spending powers are assigned to promote sustainable and inclusive economic growth. Decentralisation can enable subnational governments to provide better public services for households and firms, while it can also make intergovernmental frameworks more complex, harming equity. The challenges of fiscal federalism are multi-faceted and involve difficult trade-offs. This synthesis chapter consolidates much of the OECD’s work on fiscal federalism over the past 15 years, with a particular focus on OECD economic surveys. The chapter identifies a range of good practices in the design of country policies and institutions related to strengthening fiscal capacity, delineating responsibilities across levels of government and improving intergovernmental co-ordination.

Chapter 2, “Evaluating fiscal equalisation: finding the right balance” examines the transfer of financial resources to and between subnational governments with the aim of mitigating regional differences in fiscal capacity and expenditure needs. However, the determination of fiscal capacity and expenditure needs is not a straightforward task. OECD countries use widely varying mechanism design approaches in their equalisation systems. This chapter compares national approaches, covering the three modes of fiscal equalisation: pure revenue equalisation, revenue/cost equalisation and gap-filling equalisation, describing the distinct impacts of each approach on subnational revenue disparities. A clear inverse relationship emerges between the size of the cost-equalising component within a system and the percentage change in subnational per capita revenue disparities after equalising transfers are applied, although no significant relationship emerges between equalisation and regional convergence.

Chapter 3, “Twenty years of tax autonomy across levels of government: measurement and applications”, overviews the Fiscal Network’s assessment of sub-central government tax autonomy in OECD countries. This chapter first provides an overview of the methodology used to characterise tax autonomy. After summarising the widespread use of the tax autonomy results by researchers addressing a range of policy issues, the chapter highlights recent trends in sub-central government revenues and presents the results of the latest survey of tax autonomy, completed in 2020. Using the OECD’s tax autonomy methodology, the chapter then assesses local government tax autonomy in the 50 US states. The analysis reveals that US local governments have somewhat more tax autonomy than local governments in the average OECD country. The chapter also includes refinements of the tax autonomy methodology.

Chapter 4, “Spending autonomy and public sector performance across levels of government”, presents new measures of subnational spending autonomy across key sectors of local government service delivery, which allows the analysis of alternative arrangements on outcomes. Differences in spending autonomy across sectors and countries may have important consequences for intergovernmental fiscal relations. Yet the share of subnational expenditure often does not reflect the true degree of decision-making authority. The chapter then examines how the performance of the public sector can be strengthened through the assignment of responsibilities at the most effective level of government for their delivery, focusing on health care. Performance monitoring and evaluation systems are also illustrated that can enable the benchmarking of public services to promote learning about good policy practices.

Chapter 5, “Digitalisation challenges and opportunities for subnational governments”, looks at these issues in the areas of tax and expenditure policy, service delivery and fiscal-financial management, as well as regulatory practices and policies. However, governments – especially subnational ones – often also face shortages of skills, equipment and physical infrastructure, while having to address emerging challenges in cyber security risk management and data protection. The digital transformation calls for co-operation among the different layers of administration in support of effective and efficient digitalisation of subnational governments. This chapter reviews and discusses these opportunities and challenges.

Chapter 6, “Can subnational accounting give an early warning of fiscal risks?” reviews the early detection of state and local fiscal problems in order to resolve them quickly before they turn into crises. A survey was undertaken to investigate the quality of subnational accounting, as well as the use of subnational accounts by national governments that monitor subnational finances. The results show that in many countries subnational accounting has characteristics that should help in the early detection of fiscal problems, including the use of accrual accounts. Many national governments use a wide range of indicators from the accounts to monitor the financial health of subnational governments. However, there is room for progress including in the monitoring of non-financial assets and reporting of currently off-balance sheet liabilities.

Chapter 7, “Insolvency frameworks for state and local governments” can stipulate rules and procedures to resolve debt in a prompt and orderly way. Such frameworks may serve to facilitate debt restructuring and the fiscal recovery even of subnational entities. They may help prevent subnational governments from sliding into insolvency. This chapter identifies the benefits of setting up an insolvency framework for subnational governments, complementing existing budget rules and procedures. It analyses different design options of subnational insolvency frameworks by drawing on existing regimes for municipalities in Colombia, Hungary, South Africa, Switzerland and the United States as well as proposals for sovereign bankruptcy procedures in the literature. The chapter also explores the main challenges for implementing subnational insolvency regimes and presents possible solutions.

Chapter 8, “Funding and financing of local government public investment” offers a framework to analyse the key factors which affect the capacity of local governments to fund and finance public investment. The bulk of government investment is done at the local level in OECD countries, representing on average 41% of total public investment. Most studies on subnational government debt focus on the regional or state level, and very few studies analyse public investment specifically by local governments. This chapter aims at filling this gap, presenting a framework to analyse the key factors that matter, and illustrates the framework with five country examples: Denmark, Finland, Ireland, Netherlands and New Zealand.

Chapter 9, “Intergovernmental fiscal relations and the COVID-19 crisis: early lessons”, analyses the responses countries have taken through the channel of intergovernmental relations to tackle the pandemic at different stages of the crisis, highlighting lessons learnt. With all levels of government involved in handling the COVID-19 outbreak, intergovernmental relations have had a crucial role to play in designing and implementing an effective response to the crisis. Moreover, not only have intergovernmental relations shaped the response to the crisis, but the crisis is also shaping the future of intergovernmental relations. As the world economy and societies are going through radical changes due to the pandemic, fiscal federalism may have to adapt to the post-crisis period, when there are higher regional inequalities and greater interdependence between central and subnational policies.

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