1 Local Revenue Sources Nick Devas International Development Department School of Public Policy University of Birmingham August 2005

2 Local Revenue Sources 1.Why do we need local own revenues? 2.Division of revenues between centre and local 3.Forms of shared revenues 4.Criteria for assessing local revenue sources 5.Suitable local revenue sources

3 1. Why Local Own Revenues? Local (political) choice Allocative efficiency: –choices reflect local needs and preferences –facing voters with the true costs of their choices –‘Fiscal Federalism’, subsidiarity –Public Choice theory Local accountability Ability to use local tax regime to attract investment – but how realistic?

4 But: Biggest and best taxes collected centrally: –administrative convenience –equity between taxpayers –neutrality LGs left with relatively small, inefficient, inequitable taxes Some regions have v.small tax bases Thus revenue sharing / transfers required

5 So: Need to identify and assign suitable local taxes / revenues Need to improve local revenue administration But pursuing poor people for small amounts is neither efficient nor equitable So, accept that some regions will remain heavily dependent on central transfers Design transfers to provide for (some) local choice, and to build local accountability

6 2. Division of Revenues between Centre and Local Resources to match functions Range of LG functions varies between countries, but often substantial Centre collects most revenues, for good, practical reasons But resources do not “belong” to centre – so should be shared between levels Limited scope for local taxes

7 Intergovernmental Transfers Transfers to address imbalances between functions & resources: –‘vertical imbalance’ between tiers –‘horizontal imbalance’ between LGs (Re)assignment of tax sources, where possible / appropriate Tax-base sharing (surcharging) Revenue sharing Block (general) grants Specific (conditional) grants

8 Design of IG Transfers Distribution of resources between levels to reflect relative expenditure responsibilities But how measured? Complexity in multi-tier system Equitable distribution between LGs based on –relative expenditure needs –relative fiscal capacity Local discretion vs. central control Importance of stability, predictability, transparency of allocations Use of performance conditions

9 3. Shared vs. Own Sources a) Own sources: Local choice, local needs, accountability But in practice often constrained by CG Limited local own sources b) Tax-Base Sharing (Surcharging): Tax-base defined by CG Revenue collected by CG and/or LG Local choice of tax rate (within limits) Local expenditure choice Approximates to local taxation

10 Shared vs. Own Sources (cont.) c) Revenue sharing CG decides tax base and tax rate CG collects (but LG may assist – partnership) CG decides allocation to LGs (by origin or formula) Local choice about expenditure d) Block grants CG decides amount and allocation (equalisation) Local choice about expenditure (but may be limits) e) Specific grants CG decides amounts and allocation CG decides expenditure pattern Some local choice about expenditure details

11 4. Criteria for Local Revenues a) Yield –substantial –stable, predictable –elasticity (inflation, pop.growth, real incomes) –low collection cost b) Equity –liability clear not arbitrary –horizontal equity –vertical equity –benefit principle of equity

12 Criteria for Local Revenues (cont.) c) Neutrality –minimising distortions to relative prices –not creating undesirable incentives / disincentives d) Administrative practicality –ability to identify, assess and enforce –considering limited staff capacity e) Political acceptability –visibility of tax payment

13 Criteria for Local Revenues (cont.) f) Suitability as a local tax Is it clear which LG should receive the tax? (property tax vs. income tax) Is point of tax collection the same as point of final tax incidence? (property tax vs. VAT) Is tax liability confined to that LG. or will the tax be “exported” to people in other jurisdictions? (profits tax) Is it possible to have local discretion over tax rate? Do differences in local tax rates cause locational distortions? Effect on inter-regional equity: can all LGs benefit from the tax?

14 Criteria for Local Revenues (cont.) Conclusion: No (local) tax is perfect Conflicts between criteria Aim to have a set of local taxes which is least damaging Ideally 2-5 local taxes –not depend on one (UK!) –not multiple, overlapping taxes

15 5. Typical Local Taxes Principal local tax bases Property (land, buildings) Personal incomes Economic activity (businesses, sales) Motor vehicles / fuel

16 Property Taxation Most common local tax (urban buildings & land, but also rural land in some countries) Substantial, stable, predictable Immovable, so cannot be disguised Relatively equitable Reasonably neutral Easily assigned to right LG Can have local discretion over tax rates

17 But: Large administrative task Inelastic unless property revalued or tax rates increased Highly visible, so politically sensitive Real value of PT revenues has declined Taxes on Increased Urban Land Value Various possibilities To capture windfall gains To finance urban infrastructure But complexity, administrative constraints Equity issues

18 Local Taxes on Personal Incomes Quite common in developed countries But not in developing countries –limited formal sector employment –concentrated in capital city / major urban centres –revenue sharing form national income tax more suitable (by origin or by formula) –Graduated Personal Tax in Uganda

19 Local Taxes on Economic Activity Local sales / turnover taxes (states in India) –but overlap with VAT –problems of assessment / collection Local services taxes (Brazil, Philippines) –but overlap with VAT –problems of assessment / collection Local payroll taxes (Hungary) –overlap with national social security taxes –small formal sector employment in LDCs –discourage employment

20 Local Taxes on Economic Activity (cont.) Business licences (Africa) –limited potential (but SBP in Kenya) –problems of assessment and equity –disincentive effects Local produce taxes (Africa, Indonesia) –problems of assessment, collection, evasion –disincentives to production / marketing Taxes on local resource extraction –building materials, natural resources –legitimate recompense for resource depletion –problems of assessment, collection, evasion

21 Local Taxes on Economic Activity (cont.) Taxes on tourism / entertainments –potential in cities / tourist areas only Octroi (India: tax on goods entering municipality) –major revenue source for some municipalities –highly distorting of economic activity / transport –now largely abolished Taxes on utility bills: electricity, telephone –easily & cheaply assessed / collected through utility company –reasonably equitable –but economically distorting if rates is high

22 Local Taxes on Motor Vehicles / Fuel Annual vehicle licences –reasonably equitable –but CGs unwilling to surrender revenue Fuel tax –desirable incentive effect –best as a shared tax collected thru’ oil companies Car parking charges –effectively a tax, in major urban centres Road tolls (on ordinary roads) –but cause disruption to transport & trade

23 Other Local Taxes Tax on advertisement signs Tax on cattle –but problems of acceptability, assessment, enforcement Tax on bicycles / carts –regressive and difficult to enforce

24 Charges for Services For service where benefits are mainly private Full cost recovery (or marginal cost pricing) But costs/difficulties of measurement/collection Subsidies where significant public benefits Cross-subsidies may be possible to ensure poor are served But subsidies often benefit mainly the better off or those allocating the subsidised service Investing to increase access to services often more important for poor than subsidies