Chapter 17

Fiscal federalism

Learning outcomes

• Explain why sub-national governments exist at all and compare the merits of fiscal decentralisation and centralisation

• Describe the Tiebout model• Describe the assignment of expenditure functions

and revenue sources (tax powers) to the national, provincial, and local spheres of government in South Africa

• Distinguish between tax competition and tax harmonisation.

Learning outcomes (continued)

• Explain the reasons for, and the nature of, intergovernmental grants

• List the types of intergovernmental grants• Explain the issues that surround borrowing powers

and debt management at sub-national level• Review the role of the South African Financial and

Fiscal Commission (FFC) in sharing revenue across the three spheres of government

• Discuss trends and issues in provincial and local government financing in South Africa.

Economic rationale for fiscal decentralisation• Sub-national government• Intergovernmental fiscal relations or fiscal

federalism• Spatial externalities• Public choice perspective on fiscal federalism.

The Tiebout model

Assumptions• All citizens are fully mobile• Individuals have full information about the local public goods offered by each jurisdiction• there is a large number of jurisdictions to choose from, spanning the full range of public good

combinations desired by• citizens• There are no geographic employment restrictions: people receive income from capital only

and are not tied to a• particular location through job or family ties• There are no spillovers across jurisdictions• There are no economies of scale in the production of public goods.

Just as the consumer may be visualised as walking to a private market place to buy his goods, we place him in the position of walking to a community where the prices (taxes) of community services are set. Both trips take the consumer to market. !ere is no way in which the consumer can avoid revealing his preferences in a spatial

economy.

Tiebout, 1956: 422

Reasons for fiscal centralisation

• Benefit or costs of a public service spill over to non residents

• Justification for centralised provision of public services– Transport systems– Water

• Lower administration and compliance costs.

Taxing and spending at sub-national levelThe assignment issue• Stabilisation function• Distribution function• Allocation function• Tax assignment• Expenditure assignment.

Tax competition vs tax harmonisation

Tax competition occurs when sub-national governments adjust (lower) their tax rates to attract mobile factors of production (notably capital)

from other jurisdictions.

Tax harmonisation occurs when sub-national governments coordinate their tax policies (for instance, by limiting the degree of

variation in tax rates levied, or by defining the tax bases in a uniform way).

Borrowing powers and debt management at sub-national level• Financial contagion• Moral hazard.

Unconditional non-matching grant

Conditional non-matching grant

Conditional matching grant (open ended)

Conditional matching grant (closed ended)

The rationale for intergovernmental grants• Fiscal imbalances• Minimum standards in public goods and services

provision• Compensation for benefits.

Intergovernmental issues in South Africa• Constitutional

– Expenditure assignment– Revenue assignment and borrowing powers

• Intergovernmental transfers and the Financial & Fiscal Commission (FFC)– Revenue sharing– Vertical division of revenue– Horizontal division of revenue

• Horizontal fiscal imbalances

• Provincial financing issues• Local government financing issues

– Urban economics.

Thank you.