Tax Assignments
Jorge Martinez-Vazquez
Georgia State University
Intergovernmental Fiscal Relations
DEFINITION OF REVENUE
ASSIGNMENT
 What taxes should be assigned to
different levels of government?
 How should these arrangements be
implemented?
Intergovernmental Fiscal Relations
Purposes of Tax Assignment

Provide subnational governments with
revenues they can control to implement
their expenditure responsibilities
(improved resource allocation)
Own taxes and levies
Shared taxes
Intergovernmental Fiscal Relations
Purposes of Tax Assignment(cont.)

Increase the accountability and responsibility
of subnational government officials to their
constituencies
 Subnational governments can significantly affect their total
revenues at the margin through their choices of taxes,
bases, or more preferably tax rates
 Subnational governments should operate with a hard budget
constraint. Revenue sharing and grants should be inframarginal funding. The expansion (or contraction) of the
budget should remain a subnational government
responsibility
Intergovernmental Fiscal Relations
Purposes of Tax Assignment(cont.)

Macroeconomic stabilization and
redistribution of income should be
generally left as responsibilities of the
central government
Intergovernmental Fiscal Relations
DESIRABLE FEATURES OF
SUBNATIONAL TAXES

Linkage between taxes and benefits
derived from local government services
(using the “benefit principle”)
 Employ user charges and fees whenever possible: for excludable
and individual benefits. (User charges act as quasi-prices by
rationing and signaling demand and they tend to be fair)
 For public services with generalized benefits use “consumption and
residence-based” taxes if benefits are provided to individuals and
“production and origin-based” taxes if benefits are provided to
businesses
Intergovernmental Fiscal Relations
DESIRABLE FEATURES OF
SUBNATIONAL TAXES(Cont.)

Administrative feasibility
Administration costs and compliance costs
(time and money employed to file taxes)
and political acceptability are taken into
account
Intergovernmental Fiscal Relations
DESIRABLE FEATURES OF
SUBNATIONAL TAXES(Cont.)

Revenue stability and revenue elasticity
Subnational governments typically cannot
run deficits and have more limited ability to
borrow. More unstable sources should be
assigned to the central government
Subnational revenues should increase with
income as much as the demand for
services
Intergovernmental Fiscal Relations
DESIRABLE FEATURES OF
SUBNATIONAL TAXES(Cont.)

Minimizing excess burdens and distortions in
the location of economic activity
 Unlike revenue burdens, excess burdens are
avoidable losses, which arise from people trying to
avoid taxes by working less, changing the level
and composition of consumption and investment,
etc.
 Taxes levied at the origin of production or source
of income tend to distort location more than taxes
on consumption or place of residence
Intergovernmental Fiscal Relations
DESIRABLE FEATURES OF
SUBNATIONAL TAXES(Cont.)

Controlling tax exporting (taxes are paid
by non-residents who derive no benefit)
Tax exporting can lead to over spending
It is unfair and undermines accountability
Intergovernmental Fiscal Relations
DESIRABLE FEATURES OF
SUBNATIONAL TAXES(Cont.)

Preventing predatory tax competition
 By jurisdictions that provide a haven to smugglers,
those that misstate residence, or practice profit
shifting through transfer pricing
 However, there is also “healthy” tax competition,
as when taxpayers relocate to enjoy a preferable
package of taxes and public services
Intergovernmental Fiscal Relations
THE CHOICE OF
SUBNATIONAL TAXES

There are hardly any taxes that comply
with all the desirable features for
subnational taxation

But clearly, there are better and worse
tax assignments
Intergovernmental Fiscal Relations
THE CHOICE OF
SUBNATIONAL TAXES(cont.)

At minimum tax assignments should
provide:
Autonomy at the margin
Stable assignments over time
Sufficient revenues for the wealthiest
subnational governments to be fiscally
autonomous
Intergovernmental Fiscal Relations
COMMON PROBLEMS WITH
REVENUE ASSIGNMENTS

Vertical imbalance (inadequate
correspondence between expenditure
responsibilities of subnational governments
and their assigned sources of revenue)
 Tax autonomy and increased use of subsidiarity in
taxation (taxes should be assigned to the lowest
level of government that can implement them) are
preferable to transfers
Intergovernmental Fiscal Relations
COMMON PROBLEMS WITH
REVENUE ASSIGNMENTS(cont.)

Lack of meaningful tax autonomy
Predominance of shared taxes and
transfers

Unstable Assignments
Assignments are decided in the annual
budget rather than stated in the laws and
fixed for a number of years
Intergovernmental Fiscal Relations
COMMON PROBLEMS WITH
REVENUE ASSIGNMENTS(cont.)

Wrong incentives and lack of uniformity: the
“regulation” of taxes
 Tax assignments are customized for each local
government to fit a “minimum budget”

Confused system resulting in the
misallocation of resources and significant
administration and compliance costs
Intergovernmental Fiscal Relations
COMMON PROBLEMS WITH
REVENUE ASSIGNMENTS(cont.)

Unfair apportionment of tax revenues
among subnational jurisdictions
The exclusive sharing of taxes on a
“derivation basis” (usually paid at the
headquarters of the firm) leads to the unfair
allocations of VAT and CIT revenues
Intergovernmental Fiscal Relations
COMMON PROBLEMS WITH
REVENUE ASSIGNMENTS(cont.)

Large horizontal disparities
The uneven distribution of tax bases
requires the introduction of equalization
grants
The problem is more acute with the sharing
of natural resource taxes
Intergovernmental Fiscal Relations
CHOICES IN PROVIDING TAX
AUTONOMY

Which taxes should subnational
governments be allowed to levy?
Closed lists are preferable to freedom to
legislate new taxes (less complexity, fewer
inequities and distortions)
Intergovernmental Fiscal Relations
CHOICES IN PROVIDING TAX
AUTONOMY(Cont.)

Discretion or not to modify tax bases
Discretion also leads to complexity and
inequities
Surcharges or taxes piggybacked on a
central government tax base are easier to
administer
Intergovernmental Fiscal Relations
CHOICES IN PROVIDING TAX
AUTONOMY(Cont.)

Discretion to set the tax rate is the
simplest and most effective form of tax
autonomy
National legislation can set, when
desirable, maximum and/or minimum rates
Intergovernmental Fiscal Relations
CHOICES IN PROVIDING TAX
AUTONOMY(Cont.)

Separate tax administrations for subnational
governments may be desirable but are not
always necessary if incentive compatible
arrangements between levels of government
are set in place

Tax sharing does not contribute to
subnational revenue autonomy
Intergovernmental Fiscal Relations
CHOOSING AMONG DIFFERENT TAXES
AT THE SUBNATIONAL LEVELS

Good choices for local (municipal)
governments
Fees and user charges
Real estate property tax
Betterment and improvement levies
Vehicle and transportation taxes
Piggyback flat rate personal income tax
Intergovernmental Fiscal Relations
CHOOSING AMONG DIFFERENT TAXES
AT THE SUBNATIONAL LEVELS (Cont.)

Good choices for regional governments
Piggyback flat rate personal income tax
Piggyback for selected excises
Business value tax (BVT) falling on wages
and profits
A regional VAT, if tax administration is
adequate, is superior to a retail sales tax.
Intergovernmental Fiscal Relations