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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?. Purposes of Tax Assignment.

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Tax assignments jorge martinez vazquez georgia state university l.jpg

Tax AssignmentsJorge Martinez-VazquezGeorgia State University

Intergovernmental Fiscal Relations


Definition of revenue assignment l.jpg
DEFINITION OF REVENUE ASSIGNMENT

  • What taxes should be assigned to different levels of government?

  • How should these arrangements be implemented?

Intergovernmental Fiscal Relations


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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


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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 infra-marginal funding. The expansion (or contraction) of the budget should remain a subnational government responsibility

Intergovernmental Fiscal Relations


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Purposes of Tax Assignment(cont.)

  • Macroeconomic stabilization and redistribution of income should be generally left as responsibilities of the central government

Intergovernmental Fiscal Relations


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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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


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