Dr. Violeta Ruiz Almendral Fiscal Federalism Dr. Violeta Ruiz Almendral Professor of Tax and Finance Law Universidad Carlos III de Madrid, SPAIN Forum of Federations AMMAN, JORDAN- August 2007

Fiscal Federalism Introduction: the financing of a State. Inter-regional equity and equalization: vertical and horizontal fiscal imbalance. Revenues and expenditures in a federation: overview Types of revenues and their role: Taxation powers Borrowing powers Revenues from natural resources Spending power and the distribution of powers Management of the economy; the question of policy coordination

The financing of a State: revenues Taxes Democracy and taxation The role of taxes A brief history of taxation (as a main source of revenue, they are a XX century phenomenon?) Type of taxes Direct/indirect, personal/objective taxes. Custom duties, user fees, environmental taxes…

The financing of a State: revenues What to tax? Traditionally, three sources of tax revenues: Income Wealth Consumption New (relatively) sources: Environmental taxes User fees (public services, among other)

The financing of a State: revenues What taxes? INCOME: Personal Income Tax Corporation Income Tax Estate tax (“Death tax”) –also taxes Wealth- WEALTH: Property taxes CONSUMPTION: Sales taxes Value Added taxes (VAT) Excise OTHER TAXES: environmental taxes (Carbon Tax), Custom Duties…

The financing of a State: revenues Where to tax? (I) FUNCTIONS OF THE CENTER: Stabilization function Coordination Guarantee of minimun Solidarity (i.e. redistribution of income) TRADITIONAL CENTRAL TAXES: Income taxes Major consumption taxes (VAT) Excise Custom Duties

The financing of a State: revenues Where to tax? (II) FUNCTIONS OF SUBNATIONAL UNITS: Minimal financial autonomy Easy to establish taxes (political burden) Easy to collect taxes TRADITIONAL SUBNATIONAL TAXES: Sales taxes Wealth taxes (inmovable property)

Relevance of taxes in Europe (an example) Total taxes in relation to GNP Indirect taxes in relation to total revenues Direct taxes in relation to total revenues 1995 2002 2003 2000 EURO AREA 42.5 42.1 42.2 32.5 32.8 30.4 29.0 Germany 42.3 41.7 28.9 29.7 28.7 25.9 Spain 34.3 36.3 36.5 33.7 29.9 29.6 France 45.4 45.6 45.7 34.1 27.2 25.8 Ireland 35.2 29.8 31.2 41.4 41.1 39.5 U.K. 36.7 37.0 37.1 36.9 43.7 42.0 (*) No hay datos disponibles

The financing of a State: revenues Natural resources Relevant in Iraq (majority of public revenues) Problems: Unequaly distributed, Limited (?)

The financing of a State: revenues Public Debt Deficit financing; should be extraordinary Investment financing (the “golden rule”). Problems: Inter-generational equity, democratic constraints, risk assesment needed

The financing of a State: revenues Other revenues Public assets (i.e. companies…) Monopolies (i.e. Tobacco, Lottery, Oil and Gas…) Problems: Free competition, equality

Vertical fiscal imbalance What is Vertical Fiscal Imbalance? When does it arise? Why is it a problem? Possible solutions: Transfers (conditional/unconditional) Taxation powers (shared taxes, separated taxation systems…)

Horizontal fiscal imbalance What is horizontal fiscal imbalance? When does it arise? Why is it a problem? What are the solutions? Equalization formulas (additional problems: what should be included?) Coordination of revenues/expenditures

Revenues and expenditures of subnational units: overview Transfers Taxes Natural resources Debt (public/private) EXPENDITURES Budget powers Spending power Fiscal equilibrium

Revenues and expenditures of subnational units: overview What kind of revenue/expenditure system for subnational units? Total fiscal equivalence? (a myth) Fiscal equivalence “at the margin” Different starting points: the particularities of a “decentralization process”

Revenues and expenditures in a federation: the problem with transfers Essential: sufficiency of ressources No political autonomy without (certain) fiscal autonomy THE PROBLEMS: They may condition the subnational entities ‘Moral hazard’ problem: It is easier for governments to spend money when: (a) no political burden of having to raise it (b) Lack of accountability

Revenues and expenditures in a federation: the problem with transfers What kind of transfers? (I) Conditioned/unconditioned Grants (specific projects, region oriented) Lump sum agreements, based on objectives (i.e. minimum standards in Education, Health…) Based on need Assesing need as a problem Factors to take into account: geography, population (scattered, scarce –increasing or decreasing, ageing…)

Revenues and expenditures in a federation: the problem with transfers What kind of transfers? (II) Based on “fiscal effort” Representative tax system Other resources Equalization formulas Establishing of a solidarity measure What’s the limit? Horizontal vs. Vertical equalization systems

Revenues and expenditures in a federation: the problem with transfers Who designs transfers? Zero sum game: Multilateral vs Bilateral Agreement Political Bargaining (different political weights of regions) Transparency, accountability: solid statistical data, importance of institutions (i.e. a Senate or territorial chamber)

Revenues and expenditures in a federation: the problem with subnational taxing powers They are necessary: “No representation without taxation” (=some taxation powers are essential to political autonomy) Fiscal competition, always a bad idea? Horizontal fiscal imbalance

Revenues and expenditures in a federation: the problem with subnational taxing powers What kind of taxes? Subnational taxes Shared taxes Type of taxes: Direct/indirect (personal-objective) The role of “user fees”

Revenues and expenditures in a federation: the problem with subnational Taxing Powers Total Fiscal responsibility or fiscal equivalence every tier raises their own taxes for their own expenditures. Total equivalence. Fiscal responsibility ‘at the margin’, Giving sub-national tiers of government responsibility to obtain monies in addition to what they obtain in the form of transfers. In practice, a mix of transfers and taxes.

Revenues and expenditures in a federation: the problem with Natural resources Different types of ressources, different problems: Sun & Beach: tourism (over explotation) Oil and Gas: energy (pollution, limited…) Timber, coal, …

Revenues and expenditures in a federation: the problem with borrowing powers Borrowing powers as an attractive source of revenue: Fast liquidity No (obvious) political burden Reasons to limit borrowing powers of subnational units Over-endebtment Financial Stability General coordination of economy in jeopardy

Revenues and expenditures in a federation: the role of Spending power Spending as a way to implement policies The expanding nature of the spending power of the center (the “Commerce clause”, the “coordination of the economy..) Limitation of expenditures: the “stability contraints”

Fiscal Provisions in the Iraqi Constitution Article (24): The state shall guarantee the freedom of movement for workers,goods and Iraqi capital between the regions and the provinces. This shall be regulated by law. THEREFORE: Coordination of taxation powers, to avoid fiscal frontiers…

Fiscal Provisions in the Iraqi Constitution Article (28): 1st - Taxes and fees shall not be imposed, amended, collected or eliminated except by law. 2nd - Low-income people should be exempted from taxes in a way that guarantees maintaining the minimum level necessary for a living. This shall be regulated by law THEREFORE: Need for subnational parliaments (rule of law) Coordination of taxation powers (to ensure 28.2)

Fiscal Provisions in the Iraqi Constitution Article (108): The federal authorities will have the following exclusive powers: 1st - drawing up foreign policy, diplomatic representation, negotiating international accords and agreements, negotiating and signing debt agreements, drawing up foreign sovereign economic and trade policies. 3rd - drawing up financial and customs policy, issuing currency, organizing trade policy among regions and provinces in Iraq, setting the general budget for the nation, drawing up currency policies and establishing and administering a central bank. THEREFORE: Custom Duties must remain at the center Limitation of borrowing powers

Fiscal Provisions in the Iraqi Constitution Article (109): Oil and gas is the property of all the Iraqi people in all the regions and provinces. Article (110): 1st - The federal government will administer oil and gas extracted from current fields in cooperation with the governments of the producing regions and provinces on condition that the revenues will be distributed fairly in a manner compatible with the demographical distribution all over the country. A quota should be defined for a specified time for affected regions that were deprived in an unfair way by the former regime or later on, in a way to ensure balanced development in different parts of the country. This should be regulated by law. THEREFORE: Equalization of natural resources Redistribution of revenues (via the taxation system, excess profit tax, local taxes…)

Fiscal Provisions in the Iraqi Constitution (116) 4th - A fair share of the revenues collected federally is designated to regions, in a way that suffices their duties and obligations, taking into consideration the (region's) resources and needs. Article (128): 1st - The revenues of the region are made up of its designated share from the state budget and from the region's local resources. THEREFORE: Transfers based on need

Fiscal Provisions in the Iraqi Constitution Article (128): 2nd - The Cabinet of the region prepares the annual budget for the region and the final expense account, and a law is issued for them by the National Council for the Region. The Cabinet presents a copy of the region's general budget and the final expense account to the federal finance ministry, after they are approved by the National Council for the region.