Lessons from International Practices of …siteresources.worldbank.org/PSGLP/Resources/AnwarShahPPTEN.pdfLessons from International Practices of Intergovernmental Fiscal Transfers

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Anwar Shah, World Bank

Lessons from International Practices of Intergovernmental Fiscal TransfersAnwar Shah*

July 2004Language: English

Prepared for the program on:

Fiscal Management For Better Governance:

Learning from Each Other

A Joint Program of the Ministry of Finance, China, the Canadian Agency for International Development and the World Bank Institute

Web: www.worldbank.org/wbi

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* The author is a Lead Economist and Program Leader on Public Sector Finance of World Bank Institute. This presentation was made at the International Seminar on Intergovernmental Finance System, held in Chongqing, China, July 4-9, 2004. The seminar is one of series of events organized under the program, ‘Fiscal Management for Better Governance’. The program is directed by Dr. Anwar Shah ([email protected]), Lead Economist and Program Leader on Public Sector Governance, World Bank Institute, 1818 H Street, NW, Washington, DC 20433, USA. For further information, please contact Chunli Shen ([email protected]).


Lessons from International Practices of Intergovernmental

Fiscal Transfers Anwar Shah, World Bank

International Seminar on Intergovernmental Finance

Chongqing, China, July 4-10, 2004


Outline• A taxonomy of grant instruments• A stylized view of intergovernmental finance in

developing countries• Grant objectives and design considerations• Grants to deal with fiscal gap• National minimum standards grants• Fiscal equalization grants• Institutions of IGFR• Lessons


Imperatives in Sub-national Finance

• Growing demand for services and seriously deficient infrastructure and some regions being left behind

• Greater potential for expenditure decentralization than for tax decentralization

• Access to inadequate tax bases• Limited potential for user charges for education, health and social

services • Access to credit is curtailed.• Intergovernmental finance is the dominant

source of revenue (60% in LDCs and 33% in OECD) and its design has implications for efficiency and equity in public service provision.

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Instruments of intergovernmental finance

• Unconditional vs conditional transfers– Unconditional: preserving local autonomy and enhancing inter-

jurisdictional equity– Conditional: providing incentives to undertake specific activities

• Conditional Transfers– matching vs non-matching– open-ended vs. closed-ended matching– Input based conditionality vs output based conditionality– Input based conditionality often intrusive and unproductive.

Output based conditionality can advance grantor’s objectives while preserving local autonomy


Perceptions on intergovernmental finance are generally negative

• Federal/Central View: Giving money and power to sub-national governments is like giving whiskey and car keys to teenagers.

• Provincial and Local View: We need more grant monies to demonstrate that “money does not buy anything”.

• Citizens: The magical art of passing money from one government to another and seeing it vanish in thin air.


Ironically these perceptions are well grounded in reality in LDCs

• Primary focus on dividing the spoils• Passing the buck transfers – revenue sharing with

multiple factors (Brazil, Argentina, India, RSA, Philippines and more)

• Asking for more trouble grants – deficit grants (Hungary, India, and more)

• Pork barrel transfers or political bribes (Brazil, India, Pakistan, USA)

• Command and control transfers (most countries) • Overall: Intergovernmental finance is the

dominant source of revenue but creates perverse incentives for fiscal management and accountability


No need to despair ….

As properly designed fiscal transfers can be part of the solution rather than part of the problem.

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Governance Structure: 20th Versus 21st Century

UnitaryCentralizedCenter managesBureaucraticFocused on inputsCommand and controlInternally dependentClosed and slowIntolerance of risk

Federal / confederalGlobalized & localizedCenter leadsParticipatoryResults matter Responsive and AccountableCompetitiveOpen and quickFreedom to fail/ succeed


From Dividing the Spoils to Creating An Enabling Environment for Responsive

and Accountable Local Governance• Tax Decentralization• Output based fiscal transfers

– operating– capital

• Fiscal equalization transfers• Responsible borrowing


Considerations in the Design of Fiscal Transfers

Consistency of design with a single objectiveSimple and transparent allocation criteria Create incentives for competitive service delivery and support citizen-centered governanceProvide incentives for fiscal prudenceEnsure flexibility in use but accountability for resultsStable and predictableEquitable ( entitlements vary inversely with fiscal capacity and directly with fiscal needs)One size does not fit all – urban vs. rural, large vs. small Sunset clauses to ensure periodic review and assessment


Practices to Avoid

Better Practices

Grant Design

Objective

Deficit grants, tax by tax sharing

CanadaReassign, tax base sharing

Fiscal Gap

Stabilization without upkeep

Political and policy risk guarantee

Capital grant with upkeep requirements

Stabilization

Ad hoc grantsCanada social assistance

Open-ended matching

Influencing local priorities

S. Africa teaching hospitals

Matching grantBenefit spillovers

Conditions on spending

Ex-Indo. roads and education, Chile, Brazil

Block transfers, conditions on service standards

Setting national minimum standard

General revenue sharing with multiple factors

Australia, Canada, Germany, Denmark, ECA

Fiscal capacity equalization

Regional fiscal disparities

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Transfers to deal with fiscal gapFiscal Gap: Structural imbalance as a result of a mismatch between revenue means and expenditure needs.

Reasons:Inappropriate assign: ReassignLimited tax bases: Allow joint occupancy or tax decentralization.Tax competition: Federal collection and general (not on a tax-by-tax basis) revenue sharing.Tax room lacking: Tax abatement and tax base sharing (Canada ).

Practices to avoid: deficit grants; tax by tax sharing.


Transfers to set national minimum standards

Rationale:National economic union or internal common marketRedistributive role of the public sector and the national government

Design: conditional non-matching block transfers with conditions on standards of service and access.Better practices: Indonesia roads and primary education grants; Brazil health transfers, Colombia and Chile education transfers; Canada health and post-secondary education transfers.Practices to avoid: Conditional transfers with conditions on spending; ad hoc grants.


An Example: Education grant to encourage competition and innovation

Allocation basis to state/local governments: Population aged 5-17Distribution basis to providers: Equal per pupil to both public and private schoolsConditions: Universal access to primary and secondary education. Private school access to poor on merit. Improvements in achievement scores and graduation rates. No conditions on the use of fundsPenalties: Public censure, reduction of grants funds and terminationIncentives: Retention of savings


Health grantAllocation basis: Weighted population by age class with higher weights for ages 0-5 and 65+

Distribution: Patient use

Conditions: Minimum standards of services and access to health care

Penalties: Reduction of grant funds

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Indonesia - Specific Purpose Transfers to Local Governments (now defunct)

L2. District/Town Road Improvement GrantLength of roadsConditionDensityUnit cost

L3. Primary School GrantSchool age children (ages 7-12)Needs for facilities


Federal financing of health care in Canada

Per capita transfers tied to rate of growth of GDP (plus transfer of tax points - for health and post secondary education in 1977,13.5% points of PIT and 1% point of CIT)

Conditions:(1) Universality(2) Portability(3) Public insurance but public/private provision(4) Opting in and out(5) No extra billing

Penalties:Threat of discontinuation for breach of the conditions (1)- (4)

above.Dollar for dollar reduction for breach of the condition (5).Sunset clause: Parliamentary review every 5 years.


International practices in transfers to reduce regional fiscal disparities

Design: General non-matching fiscal capacity equalization transfers.

Better practices: Fiscal equalization programs (sources of data: CGC, Finance Canada, Lotz, Shah & Spahn)

Paternal: Australia (fiscal capacity plus fiscal needs) and Canada (fiscal capacity only)

Solidarity, Fraternal or Robin Hood: Germany (fiscal capacity),Sweden, Denmark

Practices to avoid: General revenue sharing with multiple factors e.g. practices in Brazil, India and South Africa.


Influencing local prioritiesDesign: Open-ended matching transfers (with matching rate to vary inversely with fiscal capacity).

Better practices: Matching transfers for social assistance in Canada.

Practices to avoid: Ad hoc grants.

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To compensate for benefit spillovers

Design: Open-ended matching transfers with matching rate consistent with spillout of benefits.

Better practices: RSA grant for teaching hospitals.

Practices to avoid: Closed-ended matching transfers.


Regional stabilizationDesign: Capital grants provided maintenance possible.

Better practices: Limit use of capital grants and encourage private sector participation by providing political and policy risk guarantee.

Practices to avoid: Stabilization grants with no future upkeep requirements.


Capital grantsSpecial issues in the use of capital transfers to finance infrastructure investments.Merits:

Finance large infrastructure projectsVisibleNo long-term commitment by donors

Demerits:Capital biasFungibilityDistort local prioritiesUndermine local autonomy


Improving capital grantsLimit their useRequire maintenance plan and user charge policyMatching rate inversely related to fiscal capacitySelection of recipients based on need and capacity factors and project evaluationTechnical assistanceMonitoring, inspections, audit, and evaluationsRequire survey of condition of existing network for assessment of future needs

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Fiscal Transfers: Negative Lessons or Practices to Avoid

• General revenue sharing with multiple factors

• Deficit grants• Fiscal Effort Provisions• Input or process based or ad hoc grants• Capital grants without assurance for

upkeep• Negotiated or discretionary transfers


Fiscal Transfers: Positive Lessons or Practices to Strive For

• K.I.S. (keep it simple)• Focus on single objective• Introduce sunset clause• Output based conditional transfers with citizens’

evaluations• Fiscal capacity equalization to a defined

standard• Political consensus on the standard of

equalization• Institutional arrangements for broad based

consultation

Documents

Lessons from International Practices of …siteresources.worldbank.org/PSGLP/Resources/AnwarShahPPTEN.pdfLessons from International Practices of Intergovernmental Fiscal Transfers