From Fiscal Constitution to Tax and Expenditure Assignment

Some time ago, the great international expert Anwar Shah pointed to the importance of what he called the ‘fiscal constitution’. It is obvious he did not intend to play down national constitutions: he observed only that the more modest concept of ‘fiscal constitution’, besides adhering to the provisions of the former, incorporates other, more specific, concepts and practices that have become the authentic references for understanding how fiscal issues actually play out in federal countries (Shah 2007).

This is an important idea. Recent studies allow us to highlight some of the key components of such fiscal constitutions, with a particular initial focus on the essential features of multilevel finance^[58]—tax assignment, expenditure assignment and mechanisms for making intergovernmental transfers. Among these features are the criteria for determining which of them correspond or can be assigned to the constituent units and which to the federal government, criteria that are also applied to the functions which generate public spending. The vertical imbalances (systematic gaps between the own-source revenues and expenditure responsibilities assigned) that usually appear open the way for the establishment of mechanisms to transfer resources to reduce or elimi­nate such disequilibria.

There are other important features, some of them linked to mechanisms for policy development and decision making. In federal countries, the process of decision making known as ‘co-determination’ is particularly important. Co­determination involves the actions of other actors like the judiciary (in partic­ular the Supreme Court) or the Senate. The former plays a central role in the formulation of revenue doctrines and in balancing the interests of territorial jurisdictions and those of the nation. The Senate, as the second chamber in federations, can also play a fundamental role, to the extent it represents and defends the true interests of the provinces or states as original constituent units (OCDE 2016).

Kenneth Wheare (1964) drew a particularly emphatic and prescriptive pic­ture of the fiscal capacity of the members of a federation. The states must have sufficient revenues to enable them to act independently in their governmental activities. This perception in the matter of revenues is also reflected in percep­tions of transfers (where they are needed). In this case, Wheare would point out that any such transfers would have to be granted free from any condition: that is to say, not subject or linked to any particular purpose, available to help meet the goals that the state governments themselves set. Wheare was writing in strong defence against quite insistent claims that federal systems face very strong forces pushing them ultimately towards unification; he insisted instead that federal systems posess a robust framework for a lasting existence, in which these financial principles play an importantrole.^[59]

Over time, notwithstanding the originating principle of clear ‘separation’, we also see the development of a ‘cooperative’ and ‘consensual’ view of the relationship among federal actors. In particular, some have pointed out the fre­quent utilization of federal spending power in cooperative/consensual federal frameworks. In brief, the spending power exercised by the federal government

table 10.1 Tax Assignment in an Idealized Federal Context

implies the imposition of its own priorities on the provinces, states, cantons, lander or similar sub-national units, and on the municipal or communal levels (as minor sub-national units). This is true, too, in the fiscal field (Bird 2011).

The prescriptions of Wheare and others, based on a strict federal constitu­tional order in its ‘financial side’, could be included in what is called the ‘fed­eral finance approach’, which can be contrasted with the contributions of fis­cal economists adhering to the theoretical approach of ‘fiscal federalism’ (Bird and Chen 1998), focusing on capacity to consider and respond to the concep­tual standards of efficiency, equity and administrability.

From Charles Tiebout’s (1956) seminal contribution, and its emphasis on the possibility of ‘voting with one’s feet’, to the rationalized approach elabo­rated by the Musgraves (Musgrave and Musgrave 1992) and others, a frame­work (see Table 10.1) was developed according to which the main taxes should be assigned to the national government, while those that are related to land or local in nature should be assigned to intermediate and local governments (Due and Friedlaender 1981). In practice, this implies that personal income tax, corporate taxes and the main sales taxes should all be levied by central govern­ments, leaving intermediate and local government finances resting essentially on property taxes and other minor or less profitable taxing options. As a result, federal arrangements can adopt a variety of different forms: a strict separation of revenue sources, some concurrency, and mechanisms for revenue sharing or ‘piggy backing’.^[60]

Beneath this approach lies the principle that reserves the important func­tions of stabilizing macroeconomics and redistribution of personal incomes to the federal government, assuming that they are inappropriate to the sub­national orbit. The latter must limit its activities to the allocative side of policies of a more restricted territorial scope.^[61] This leads to an unbalanced distribution of fiscal power, generally in favour of the national government. It does, however, provide an important safety-valve for states and municipal­ities, in the form of the ability to levy supplementary rates on taxes legislated federally.

Recent contributions to the literature generally agree on this approach, but add a moderate role for excise taxes, and distinguish various types of taxation on sales, as well as logically insisting on the concept of administrative feasibil­ity for the design and levying of certain taxes (McLure 2000). This is important, because it defines how fiscal constitutions can be designed to grant certain taxing powers to each governmental level—that is to say, the gross distribu­tion of law-making capacities in taxation matters. In practice, federal financial regimes exhibit a variety of options (Bird and Vaillancourt 1998). Moroeover, specific prescriptions as to the exercise of taxation powers could be introduced or established at more detailed level or in a complementary form.

This approach, in other words, implies the existence of a tax autonomy that is regulated or circumvented in some way. The line between the imposition of constraints and ‘tax harmonization’^[62] as a necessary phenomenon is some­times unclear and not fully defined. Tax harmonization, as a technical objec­tive in systems with a large number of taxing authorities acting in an economic or fiscal union, can take a variety of different forms, as the experience of the European Union shows.^[63] Tax autonomy is analysed in the literature in terms of how strictly the parameters for the exercise of freedom to tax are set for that level. Table 10.2 outlines possible arrangements, illustrating the different degrees of tax autonomy under consideration.

It is clear that only the first option entails a full degree of tax autonomy. All the others involve some type of control or limitation imposed by other levels table 10.2 Classification of Tax Powers at the Sub-Central Government (scg) Level

a. 1 The recipient scg sets the tax rate and any tax reliefs without needing to consult a higher-level government.

a. 2 The recipient scg sets the rate and any reliefs after consulting a higher-

level government.

b. 1 The recipient scg sets the tax rate, and a higher-level government sets

no upper or lower limits on the rate chosen.

b. 2 The recipient scg sets the tax rate, and a higher-level government sets

upper and/or lower limits on the rate chosen.

c. 1 The recipient scg sets tax reliefs—but it sets tax allowances only.

c. 2 The recipient scg sets tax reliefs—but it sets tax credits only.

c. 3 The recipient scg sets tax reliefs—and it sets both tax allowances and

tax credits.

d. 1 There is a tax-sharing arrangement in which the scg s determine the

revenue split.

d. 2 There is a tax-sharing arrangement in which the revenue split can be changed only with the consent of scg s.

d.3 There is a tax-sharing arrangement in which the revenue split is determined by legislation, and which may be changed unilaterally by a higher-level government, but less frequently than once a year.

d.4 There is a tax-sharing arrangement in which the revenue split is determined annually by a higher-level government.

e Other cases in which the central government sets the rate and base of the scg tax.

f None of the above categories applies

the actual degree of autonomy sub-national levels have in the exercise of their designated taxation powers.

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