Executive summary

This 2016 edition of Fiscal Federalism seeks to analyse and propose reform options in the area of intergovernmental fiscal frameworks and sub-central public finance. The policy issues that it addresses are of a structural and macroeconomic nature, covering both the spending and the revenue sides of the budget. After an introductory chapter summarising trends and developments in decentralisation since 1995, the book goes on to examine:

  • fiscal constitutions and how they shape intergovernmental fiscal relations and outcomes;

  • the recurrent tax on immovable property and how it may underpin moves towards a more efficient, inclusive tax system;

  • how a shift from intergovernmental transfers to own taxation may help increase the accountability and efficiency of governments;

  • how sub-national governments should monitor and manage debt;

  • the spending power of sub-national governments.

Key findings and recommendations

  • Chapter 1, “A bird’s eye view of fiscal decentralisation”, is the introductory chapter to the 2016 edition of Fiscal Federalism. It finds that, although the OECD area is more decentralised than two decades ago, decentralisation has also become more unbalanced. While sub‐national jurisdictions account for 32% of government spending on average, only 15% of tax revenues accrue to them, which increases the importance of intergovernmental transfers. However, sub-central tax autonomy – the power to determine tax bases and rates – has also grown. Recurrent taxes on immovable property are on the rise and, more than 20 years on, have overtaken income taxes again as the biggest sub-national tax source. Sub-national governments are responsible for almost two-thirds of public investment – a share that has risen slightly over the last two decades, even defying the tight budget constraints after the 2008 crisis. While sub-national debt rose rapidly at that time, it is now generally evening out, although persistent rises in some countries’ levels of debt could be a cause for concern.

  • Chapter 2, “Fiscal constitutions”, compares the fiscal constitutions of 15 federal countries and the European Union. A fiscal constitution is the set of rules and frameworks which guide fiscal policy and are enshrined in a country’s fundamental laws. They govern sub‐national autonomy and responsibility, sub-national influence over federal fiscal policy, and intergovernmental budget frameworks. The chapter concludes that decentralisation hardly matters for such fiscal policy outcomes as deficits and debt. What does, though, is the coherence of institutional arrangements – i.e. the extent to which they fit together. To make fiscal constitutions more coherent, therefore, reform should seek to align sub-national tax and spending powers and strengthen sub-national budget constraints – by building insolvency frameworks, for example, or implementing good intergovernmental budget practices.

  • Chapter 3, “Reforming the recurrent tax on immovable property”, reviews property tax systems in OECD countries and suggests guidelines for reform. While the importance of property taxation began to decline in the early 1980s, it regained prominence in the wake of the 2008 crisis as it underwent reform. Immovable property tax is a good tax for funding local governments and among the least harmful to economic growth. It acts – albeit modestly – as an automatic stabiliser and can even be progressive. Yet it is unloved by voters and taxpayers because it is highly visible and not directly linked to ability to pay. To make property tax reform politically palatable, property taxation should cover all kinds of land, be based on regularly updated property values, and offer tax cuts to low-income groups. And it should rely on a good administrative and judicial framework. There is growing demand for a proper redesign of property taxation that is economically and fiscally successful.

  • Chapter 4, “Taxes versus grants: what revenue source for sub-national governments?” analyses trends and policy options in the composition of sub-national governments’ revenues. Many countries have decentralised spending responsibilities and widely fund them through intergovernmental transfers. While equal access to public services is the most common rationale for such grant systems, they are generally much larger than required by equalisation. Moreover, rather than smoothing out sub-central revenue fluctuations over the cycle, grants often tend to exacerbate them. Indeed, there is some evidence that they may widen rather than narrow economic disparities between jurisdictions in the long run. Governments seeking to make fiscal relations more efficient and inclusive should increase the share of sub-national governments in total tax revenue – e.g. by increasing property taxes or devolving some personal income taxation – and reduce and redesign the grant system to tie it more closely to actual sub-national needs.

  • Chapter 5, “Monitoring sub-central government debt: trends, challenges and practices”, examines how OECD countries monitor sub-central debt and makes a number of recommendations. As a result of the global financial crisis and ensuing stimulus packages, median sub-central government debt grew from 6% to 10% of GDP between 2007 and 2012. Mechanisms for monitoring sub-central debt have consequently come into the spotlight. The chapter explores those mechanisms that central governments in the OECD use to monitor sub-central debt and explains the chief challenges. It also surveys the main sub-central insolvency procedures. A well-functioning debt monitoring mechanism should ensure economic stability and sound fiscal management, be flexible enough to cope with unforeseen events, and safeguard sub-central financial capacity to deliver public services, particularly public investment. Monitoring mechanisms should also be carefully designed so as not to induce pro-cyclical policies.

  • Chapter 6, “The spending power of sub-central governments”, assesses the spending power of sub-central governments in a number of policy areas. Sub-national governments have limited discretionary powers over a range of budget items such as education, childcare, elderly care or transport. Traditional indicators – like the sub-central share of total government spending – may be misleading as they underestimate the impact of central government regulation on sub-central spending. Wide discrepancies between spending shares and spending power hint at opaque accountability in all tiers of government. Moreover, the more central government locks in sub-central spending, the more it has to help in the event of financial difficulty. Finally, in some instances low spending power undermines the ability of sub-central jurisdictions’ to meet fiscal targets. Reform should focus on devolving greater power to sub-national governments over their own spending.