Intergovernmental Transfers

1. Intergovernmental Transfers Anwar Shah, World Bank

2. Relevance • Dominant source of subnational revenues in many countries. • Design matters for efficiency and equity. • Grant design must be consistent with grant objectives.

3. Importance of transfers • Dominant source of revenue for subnational governments in some countries: South Africa 85% Indonesia 72% Provinces 72% Local 85% Nigeria 67% to 95% Mexico 70% to 90% (poorer states) Pakistan 82% to 99% • Design of transfers matter for efficiency and equity and fiscal discipline.

4. Grant types Non-matching transfers: • Selective (conditional) • General (unconditional) Selective matching transfers • Open-ended • Closed-ended Conceptual impacts • General non-matching • higher welfare • Selective matching open-ended • higher expend. stimulation

5. LDCs Passing the buck transfers (Brazil, India, South African revenue sharing) Pork barrel transfers (Brazil and Pakistan) Asking for more trouble (deficit grants and bailouts) DCs Conditional transfers Equalization transfers Grants in LDCs vs DCs

6. Criteria for design of transfers • Autonomy • Revenue adequacy • Equity • Predictability • Efficiency • Simplicity • Incentive • Safeguard of grantor’s objectives

7. Objective To bridge fiscal gap To reduce regional fiscal disparities Setting national minimum standards Influencing local priorities To compensate for benefit spillover Regional stabilization Design Reassignment, tax abatement, tax base sharing Fiscal capacity equalization Conditional block transfers Open-ended matching transfers Open-ended matching transfers Capital grants with upkeep requirement Economic rationale of intergovernmental transfers

8. Transfers: Lessons • Grant design must conform to objectives. Main Arguments and Grant Design • Fiscal Gap: Structural imbalance as a result of a mismatch between revenue means and expenditure needs.

9. ...Fiscal gap Reasons: Inappropriate assign: Reassign Limited 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 and Brazil).

10. To bridge fiscal gap • Design: (a) Reassign (b) tax abatement(c) tax base sharing. • Better practices: Tax abatement in Canada; tax base sharing in Brazil, Canada, and Pakistan. • Practices to avoid: deficit grants; tax by tax sharing.

11. Special issues in state-local transfers • Principal-agent relationship • Pass-thru of federal transfers from states desirable due to better access to data. • Considerations in unconditional grant design: • Classification by population size, municipality type, and urban/rural • Equal per municipality component • Equal per capita component • Service area component • Fiscal capacity component • Considerations in conditional transfers • Simple objectively verifiable indicators of need

12. Indonesia -- General Purpose Transfers 1. Provincial Development Grant • Equal per province (85%) • Area (15%) 2. District Development Grant • Per capita with a floor 3. Village Development Grant • Equal per village 4. Less Development Village Grant • Per capita

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

14. Education grant • Allocation basis: Population aged 5-17 • Distribution: Equal per pupil to both public and private schools • Conditions: Universal access to primary and secondary education • Penalties: Public censure, reduction of grants funds • Incentives: Retention of savings

15. Health grant • Allocation 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

16. Indonesia - Specific Purpose Transfers to Provinces P1. SDO - Subsidy for Autonomous Regions • Public sector wages P2. Provincial Road Improvement Grant • Length of road • Condition of road • Unit cost of construction and maintenance P3. Reforestation and Regreening

17. Indonesia - Specific Purpose Transfers to Local Governments L1. SDO - Subsidy for Autonomous Regions • Public sector wages L2. District/Town Road Improvement Grant • Length of roads • Condition • Density • Unit cost

18. ...Transfers to Local Governments L3. Primary School Grant • School age children (ages 7-12) • Needs for facilities L4. Health Grant • Need for medicine, health centres, and personnel L5. Reforestation Grant • Project review

19. Federal financing and health care in Canada Per capita transfers tied to rate of growth of GDP 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 1-4. Dollar for dollar reduction for 5. Sunset clause: Parliamentary review every 5 years.

20. Influencing local priorities • Design: 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.

21. 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.

22. Regional stabilization • Design: 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.

23. Capital grants Special issues in the use of capital transfers to finance infrastructure investments. Merits: • Finance large infrastructure projects • Visible • No long-term commitment by donors Demerits: • Capital bias • Fungibility • Distort local priorities • Undermine local autonomy

24. Improving capital grants • Limit their use • Require maintenance plan and user charge policy • Matching rate inversely related to fiscal capacity • Selection of recipients based on need and capacity factors and project evaluation • Technical assistance • Monitoring, inspections, audit, and evaluations • Require survey of condition of existing network for assessment of future needs

25. To reduce regional fiscal disparities • Design: General non-matching fiscal capacity equalization transfers. • Better practices: Fiscal equalization programs of Australia, Canada, and Germany. • Practices to avoid: General revenue sharing with multiple factors.

26. Fiscal equalization transfers REGIONAL FISCAL INEQUITY AND NATIONAL FISCAL INEFFICIENCY ARGUMENT DIFFERENCES IN NET FISCAL BENEFITS ACROSS STATES (NFBS) Reasons: a. Differences in access to source-based taxes such as resource revenues and CIT. b. Per capita incomes differs differential access to PIT and sales tax.

27. c. Fiscal needs different: Proportion of old, young, incidence of disease, terrain factors, etc. Total Income = Private Income + NFBs Individuals with identical incomes in two states: Rich Poor Private income 10,000 10,000 Tax paid 5,000 5,000 Per capita exp. 10,000 5,000 NFB 5,000 0 Total income 15,000 10,000 • Fiscally induced migration to RICH state. • Inefficient and inequitable resource allocation.

28. Grants rationale Solution: • Fiscal equalization transfers to eliminate NFBs • Allow replication of financial structure of an unitary state while having decentralized decision making. • Equity and efficiency considerations coincide. Design of FETs: • Must be inframarginal, i.e., no incentive to change fiscal effort to exploit the system.