Tax Assignments Jorge Martinez-Vazquez Georgia State University

1
Tax AssignmentsJorge Martinez-VazquezGeorgia
State University

• Intergovernmental Fiscal Relations

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DEFINITION OF REVENUE ASSIGNMENT

• What taxes should be assigned to different levels
  of government?
• How should these arrangements be implemented?

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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)

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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

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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

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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

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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

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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.