Framework for Local Revenue Mobilization

1. Framework for Local Revenue Mobilization Innovations in Local Revenue Course 23-24 June 2003 Dana WeistPRMPS (dweist@worldbank.org)

2. Policy Framework • Fiscal equivalence: To greatest extent possible, each government should finance its own expenditures out of its own revenues • Subsidiarity: Assign to lowest “tier” of government that can administer tax, and for which it is not inappropriate • Need for mix of local taxes and revenues • No one assignment fits all • As external factors change, so may policy

3. Fiscal Architecture • Demographic, economic and institutional setting • Matrix of potential revenue sources • Similar expenditure needs exercise

4. What is a “Local” Tax? • Who determines whether the tax is imposed? • Who determines the tax base? • Who determines the tax rate applied to that base? • Who collects the revenue and enforces the tax? • Who receives the revenue?

5. Criteria for Local Taxation • Accountability and transparency • Benefit/tax-price link • Neutrality (non-distortion) • Taxpayer equity • Regional (place) equity • Reliability, stability, buoyancy/elasticity • Administration and compliance

6. Accountability Criterion • Local politicians should be responsive to expressed preferences of citizens Implications: • Local officials should have power to determine their “own” tax rates • Who should determine tax base? • Who should administer tax base? • Tax burdens should be borne by local citizens • Information as key to accountability

7. Accountability Options

8. Benefit/Tax-Price Link • To extent possible, taxes should function as a “price” for benefits of public services that accrue to taxpayer/citizen Implications • Taxes play a similar role to prices in market transaction • Adjust for local and regional variations in preferences for public goods (social welfare functions) • Spillovers may call for (i) sub-municipal government; (ii) local cooperation; (iii) middle-tier governments; (iv) regional authorities • Efficiency meets equity (rather than conflict)

9. Benefits-Received Options

10. Non-Distortion Criterion • Taxes should not unintentionally interfere with private decisions of consumers, factor suppliers, and producers; they should be “neutral” Implications • Heart of “efficiency in taxation,” difficult to achieve • Variability in tax rates possible • Key issue: price elasticity • Immobile tax bases rank high; “footloose” tax bases are a problem • Interjurisdictional tax competition: good or bad? • Case for uniform tax bases, and watch out for quality of administration

11. Non-Distortion Options

12. Taxpayer Equity Criterion • Tax burden must be measured by some measure of economic ability to pay and/or benefits received Terminology • Vertical equity (Differential treatment of unequals) • Regressivity, progressivity, proportionality • Horizontal equity (Equal treatment of equals) • Individuals vs. businesses • Measurement • Individuals: Income and additions to wealth (broad vs. narrow income) • Businesses • Gross Product (if can be estimated) • Multi-jurisdictional apportionment complicated

13. Taxpayer Equity Options

14. Regional (Place) Equity Criterion • Local tax bases that are unevenly distributed across jurisdictions are not suited for regional use if they entail large regional inequities Implications • Requires good judgment: much is pinned on “what matters” for social fairness and national cohesion • Not-inconsistent with benefits-received argument • Regulation and intergovernmental revenue sharing come into play; intergovernmental structure and nation building • What about multinational natural resources?

15. “Place” Equity Options

16. Reliability/Stability/Buoyancy/Elasticity • What should be the elasticity: “Automatic” changes in Revenues = % Change in Yield Change in some economic base Implications • Obvious tradeoff: stability vs. buoyancy • Not to be confused with “adequacy” • Stability is conducive to competitiveness • Also relevant for intergovernmental grant pool

17. Stable vs. Buoyant Options

18. Administration and Compliance • Taxes/tax systems should be transparently administered, at low cost, and without placing an undue burden on taxpayers Implications • Keep it simple: especially locally • What is optimal to economists may not “work” • Citizens should be able to understand and control their tax system • Standardized tax bases • Cash flow accounting may be preferable to accruals • Complexity may foster corruption

19. Administration/Compliance Options

20. Choosing Local Taxes • Few taxes comply with all desirable features for local taxation • Tradeoffs are inevitable • But clearly, there are better and worse tax and revenue assignments

21. Choice of Subnational Taxes • At a minimum, tax assignments should provide: • Autonomy at the margin • Stability over time • Sufficient revenues for the wealthiest local governments to be fiscally autonomous • Design of local taxes has repercussions on tax administration

22. Promoting Tax Autonomy • Closed list • Discretion to set tax rate • Separate tax administrations not necessary with incentive compatible arrangements

23. “Good” Local Taxes • Municipal governments • Fees and user charges • Land/property taxes • Business registration • Vehicle fees and transportation taxes • Piggyback, flat-rate personal income tax

24. “Good” Local Taxes (Cont.) • Regional/provincial governments • Piggyback, flat-rate personal income tax • Piggyback for selected excise taxes • Business value tax falling on wages and profits

25. Property Tax: Advantages • Revenue • Local burden • Not regressive • Benefit tax • Land use effects • The “devil we know”

26. Property Tax: Disadvantages • Little revenue • Difficult and costly administration • Judgmental assessment • Tax on unrealized income • Visible • Difficult to enforce

27. Local Income Tax: Advantages • Generally meets area-correspondence test • Revenue productive • Not regressive • Piggyback administration

28. Local Income Tax: Disadvantages • Competition with central government • Inter-regional tax competition • Income distribution objectives • Administration • Equalization

29. User Charges: Theory • Excellent source of local revenue • Economically efficient • Fair and equitable • Common notion: “whenever possible, charge”

30. User Charges: Practice • Not used as extensively as they should be • Seldom well-designed • Too often, local user charges are • Inefficient • Inequitable • Costly to administer • Excessive focus on revenue with limited attention on design • Seldom politically popular, especially if imposed for a service that was previously under-priced

31. Design and Implementation • Impose charges only where it pays to do so – especially public utilities such as water and electricity • Design charges efficiently • Ensure public acceptance of charges, e.g. through attention to distributional aspects • Avoid “nuisance” charges

32. Summary • No one mix of revenues nor magic bullet • Fiscal architecture may clarify options • Assess tradeoffs in choosing among options • Devil is in detail: design matters • Don’t forget administration and compliance – simplicity and transparency