Fiscal Decentralization and Accountability
Jean-Paul Faguet
London School of Economics and Political Science & IPD
Outline
1. Definition/concept of fiscal decentralization
2. Intergovernmental (fiscal) relations
3. How to assign public services to different levels of government
4. Taxation at different levels of government
5. Intergovernmental transfers
6. Fiscal hierarchy vs. polycentrism
7. Political decentralization  accountable & responsive
government
8. When and why does decentralization fail?
9. Decentralization, conflict and political (in)stability
1.
The Concept of Fiscal Decentralization
Financial aspects of devolution to regional and local government.
Also called “fiscal federalism”.
Two interrelated issues:
1. Who taxes and spends? Division of spending responsibilities
and revenue sources between levels of government (national,
regional, local etc).
2. What is taxed and spent on? Discretion given to regional and
local governments to determine expenditures and revenues
(both in aggregate and detail).
2.
The Importance of Intergovernmental Relations
Decentralization does not eliminate central government
responsibility, rather changes it:
Direct provision of public service  Cost sharing, regulation,
monitoring, etc.
“Decentralized” public services = overlapping responsibilities
amongst 2+ levels of government.
Ex: Education – Local provision & regulation, Central
finance, Central standards for pricing and provision.
 Requires local and central governments to find a way to
work together.
 This is Intergovernmental Relations (IGR).
Key Educational Decisions and Responsibilities
GROUP
Organization
Personnel
Planning
Resources
DECISIONS
Level of decentralization
Choose textbooks
Determine teaching methods
Hire / fire school director
Recruit / hire teachers
Set or argument teacher pay
Set performance exams
Determine expenditures
Allocate personnel budget
Allocate non-personnel budget
N = national, R = regional, L = local, S = school.
Source: Winkler and Gershberg (1999).
ARG
R
S
S
R
R
R
N
R
R
R
CHILE
L
S
S
L
L
L
N
N, L
L
L
EL SAL
S
S
S
S
S
N
N
N
N
S
MEX
R
N
S
R
R
N
N
R
R
R
Q.1 What levels take decisions in
Afghanistan?
• Education?
• Health?
• Water &
Sanitation?
• Agriculture?
3. Assigning Services to Different Levels of Government
Which public services should be devolved?
• Geographically specific – low externalities/spillovers
• Heterogeneous demand
• Local information important for production (local info
expensive/hard to obtain)
• Low economies of scale
Broad principle of government design:
Encompassing principle: Assignment of governmental
responsibility should encompass relevant externalities.
 National externalities and public goods are best dealt
with by national governments, local externalities and
public goods by local governments.
Oates’ (1972) Decentralization Theorem.
Local government should be responsible for all
forms of spending which do not inflict an
externality on other jurisdictions. The level and
type of such spending can be tailored to the
desires of the local residents.
E.g.
• trash collection
• fire services
Arguably few externalities.
But: Actual political jurisdictions will never
adequately encompass all the relevant
externalities, and hence there will always be the
need for intergovernmental cooperation
Decentralized Taxation Systems
1.
2.
3.
4.
5.
Five basic guidelines for designing revenue
systems.
Local taxes should be as neutral as possible 
Not distort economic behaviour.
Benefits and costs of local taxes should be clear
to citizens.
Incidence of local taxes should be equitable.
Administration and compliance costs should be
kept low  No complex taxes to local
governments.
Avoid mobile tax bases.
Four most common local taxes:
• Property: Easy to identify and assess. Linked to local
prosperity and hence local policy.  Provide LG
accountability to taxpayers
• Income: Large source of LG revenues in Europe, but
much less common in LDCs.
• Sales tax: e.g. VAT, Sales tax.
• User charges: E.g. Housing rents, water and heating
charges, public transport fares.
Q.2 What taxes do LGs in Afghanistan
levy?
•
•
•
•
•
•
Property?
Sales?
Income?
Royalties?
User fees?
Other?
5. Intergovernmental Transfers
Different forms:
1) Shares of national taxes distributed either
a) by formula (e.g. per capita), or
b) by origin (i.e. to the local government where they are collected).
2) Grants/subventions which are either
a) targeted to support specific expenditures (e.g. education), or
b) untargeted and used at discretion of LGs (e.g. block grants).
Targeted grants – for expenditures favoured by national government.
Tax sharing and block grants usually have two main purposes, vertical and
horizontal equalisation.
Vertical equalisation:
closing the gap between the cost of services devolved
to local governments and their local revenues.
Horizontal equalisation: closing the gap between rich and poor districts’
revenues (per capita).
An effective transfer system should satisfy
several criteria:
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•
•
•
Revenue adequacy: LGs should have sufficient resources to
carry out devolved responsibilities.
Local tax effort and expenditure control: Ensuring sufficient
tax efforts by local authorities. Don’t encourage fiscal deficits.
Equity: Transfers should increase with local fiscal needs and
decrease with local fiscal capacity.
Transparency and stability: Formula should be announced
and localities should be able to forecast own revenues in order
to prepare budgets. Formula should be stable, allowing longterm local planning.
Intergovernmental transfer systems in many countries, e.g.
Latin America, are far from satisfying such criteria. There are
often open channels for “moving money around”  fiscal
irresponsibility, uncertainty and instability.
6. Fiscal Hierarchy vs. Polycentrism
Simple hierarchy
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Polycentrism
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7. Decentralization must be tied to political
accountability if it is to enhance
accountability and responsiveness.
• Otherwise a country is likely to see modest
improvements in public information in
exchange for higher public overheads
 But not necessarily any accountability
improvements.
Q.3 When and Why Does
Decentralization Fail?
• 80-100% of world’s countries are
decentralizing over the past 25 years.
• But very little evidence of success, either
specific (e.g. education, sewerage) or
general.
• Why?
8. When and Why Does
Decentralization Fail?
Why So Much Centralization?
Why Does Decentralization Fail?
• Central Govt has power to make the rules of the game
• CG is staffed by people who live in the capital, who benefit from public
goods available there.
• Residents of c appropriate any surplus not allocated to the periphery 
Residual authority  Capital city is selfish
• CG gains from convincing as many districts as possible to cooperate with
its plans.
 This combination of incentives generates a game in which c offers districts
the minimum necessary to ensure cooperation of the largest number. This
maximizes its own allocation of resources.
Simple Solution – by analogy with the Ultimatum Game:
• An economist gives Sam 100 x £1 coins, and instructs her to
offer Paul any amount between £0 and £100. If he accepts, each
keeps their share. If he rejects the offer, the economist takes all
£100 back. What amount will Sam offer?
 Now apply this logic to Central-Local Government Relations.
Implications
• In a context of strong central government and weak
countervailing powers brought about by a weak institutional
framework, self-interested central government will
systematically under-invest in the periphery.
Is this what most of the world’s developing countries look like?
Why So Much Centralization?
 Because it is in the interests of those who live in the capital. They
benefit directly from a highly centralized government with weak
constitutional guarantees for lower-level districts. And they make
the laws of the land.
 Once central provision of a given service is established, the
center’s incentive is to renege on initial promises and drive local
allocations lower. Thus the center beggars the periphery, not
once but continually.
Why Does Decentralization So Often Fail?
 B/c few reforms are seriously pursued. Those charged with
implementing reform – CG bureaucrats – have little interest in
succeeding. They benefit from the residual power they hold, and
do not want to see it, or resources, dispersed.
 Instead, decentralization becomes one more policy promise on
which the center reneges. And the old pattern of central
accumulation continues.
9. Decentralization, Conflict & Political Instability
Decentralization decreased centrifugal forces in and helped integrate:
• Bolivia – Story of reform…
•
Belgium
• Spain
•
Switzerland
• UK
•
India
• Indonesia
Could decentralization help/have helped in:
• Turkey
• Serbia (Kosovo-Montenegro)
• Czechoslovakia
• Sudan
???
• Afghanistan ???
Decentralization and Violence in Colombia
• Colombian decentralization was designed to increase the responsiveness of
the state, and “drain the swamp” of public support for guerrillas &
paramilitaries.
• Decentralization improved quality of, and access to, public services
throughout Colombia.
Empirical evidence is contradictory
• Cohen (1997), Hechter (2000) and Saideman et al
(2002) find that federal countries experience more
protest but fewer violent rebellions. Can
federalism redirect or moderate tensions that
might lead to instability?
• Hug (2005) argues federalism is endogenous to
ethnic conflict, and finds federal countries suffer
more rebellions.
• Brancati (2005), Hegre and Sambanis (2005), and
Treisman (2007)  Results are mixed
Decentralization and School Enrollment
Index of Public and Private School Enrollment
1.5
Public
Private
Total
Enrollment Index
1.4
1.3
1.2
1.1
1
0.9
0.8
1994
1995
1996
1997
1998
1999
Year
2000
2001
2002
2003
2004
Health Insurance Coverage Rate by Region
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
19 9 5
19 9 6
Andina
19 9 7
19 9 8
Caribe
19 9 9
2000
Oriental
2001
2002
Pacifica
2003
2004
But…
Decentralization provided pots of money that guerrillas and
para’s could capture. They did so, using these localities as bases
of finance and operations.
Did D cause Bolivia’s political party system to collapse?
Probably.
• New class of politician arose in LGs – from local civil society &
private sector
• New parties/movements arose nationally – MAS, many local
“partiditos”
• Stable system of political party competition and alternation in
power collapsed.
• Composition of Congress 50% new actors
• Composition of Constitutional Convention 80% new actors
Group Exercise (15’)
Drawing on your experience -- Is fiscal
decentralization likely to spur peacebuilding
or aggravate tensions in Afghanistan?
Thank you