Framework for Local Revenue Mobilization Innovations in Local Revenue Course June 2003 Dana Weist PRMPS

2 Policy Framework  Fiscal equivalence: To greatest extent possible, each government should finance its own expenditures out of its own revenues  Subsidiarity: Assign to lowest “tier” of government that can administer tax, and for which it is not inappropriate  Need for mix of local taxes and revenues  No one assignment fits all  As external factors change, so may policy

3  Demographic, economic and institutional setting  Matrix of potential revenue sources  Similar expenditure needs exercise Fiscal Architecture

4 What is a “Local” Tax?  Who determines whether the tax is imposed?  Who determines the tax base?  Who determines the tax rate applied to that base?  Who collects the revenue and enforces the tax?  Who receives the revenue?

5 Criteria for Local Taxation  Accountability and transparency  Benefit/tax-price link  Neutrality (non-distortion)  Taxpayer equity  Regional (place) equity  Reliability, stability, buoyancy/elasticity  Administration and compliance

6 Accountability Criterion  Local politicians should be responsive to expressed preferences of citizens Implications:  Local officials should have power to determine their “own” tax rates –Who should determine tax base? –Who should administer tax base?  Tax burdens should be borne by local citizens  Information as key to accountability

7 Accountability Favors What Ranks Poorly Local personal income User Charges General Business taxes (GR, VAT, Company Profits Visitor (e.g., tourist) taxes Accountability Options

8 Benefit/Tax-Price Link  To extent possible, taxes should function as a “price” for benefits of public services that accrue to taxpayer/citizen Implications  Taxes play a similar role to prices in market transaction  Adjust for local and regional variations in preferences for public goods (social welfare functions)  Spillovers may call for (i) sub-municipal government; (ii) local cooperation; (iii) middle-tier governments; (iv) regional authorities  Efficiency meets equity (rather than conflict)

9 Benefits Received Favors What Ranks Poorly Whenever possible charge Visitor Taxes Business Taxes Non resident based personal income tax Benefits-Received Options

10 Non-Distortion Criterion  Taxes should not unintentionally interfere with private decisions of consumers, factor suppliers, and producers; they should be “neutral” Implications  Heart of “efficiency in taxation,” difficult to achieve  Variability in tax rates possible  Key issue: price elasticity  Immobile tax bases rank high; “footloose” tax bases are a problem  Interjurisdictional tax competition: good or bad?  Case for uniform tax bases, and watch out for quality of administration

11 Non-Distortion Options Non-Distortion FavorsWhat Ranks Poorly Local real estate tax generally Land value tax plus charges User charges Resident based PIT Sumptuary taxes Some general business taxes Taxation of “bads” Poll taxes Non-resident based PIT Gross receipts taxes Severance taxes (keep in mind rate matters)

12 Taxpayer Equity Criterion  Tax burden must be measured by some measure of economic ability to pay and/or benefits received Terminology  Vertical equity (Differential treatment of unequals) –Regressivity, progressivity, proportionality  Horizontal equity (Equal treatment of equals) –Individuals vs. businesses  Measurement –Individuals: Income and additions to wealth (broad vs. narrow income) –Businesses Gross Product (if can be estimated) Multi-jurisdictional apportionment complicated

13 Taxpayer Equity Options Taxpayer Equity Favors What Ranks Poorly Resident Personal Income Tax Ad valorem property taxes Poll Taxes Area-based property taxes Gross Receipts taxes

14 Regional (Place) Equity Criterion  Local tax bases that are unevenly distributed across jurisdictions are not suited for regional use if they entail large regional inequities Implications  Requires good judgment: much is pinned on “what matters” for social fairness and national cohesion  Not-inconsistent with benefits-received argument  Regulation and intergovernmental revenue sharing come into play; intergovernmental structure and nation building  What about multinational natural resources?

15 “Place” Equity Options Place Equity FavorsWhat Ranks Poorly Central taxation of natural resources; multi or supranational Local severance taxes Wealth taxes may fit here

16 Reliability/Stability/Buoyancy/Elasticity  What should be the elasticity: “Automatic” changes in Revenues = % Change in Yield Change in some economic base Implications  Obvious tradeoff: stability vs. buoyancy  Not to be confused with “adequacy”  Stability is conducive to competitiveness  Also relevant for intergovernmental grant pool

17 Stable vs. Buoyant Options Stable Revenue Bases Buoyant Revenue Bases Ad valorem property tax (distinguish between land and improvement components) Area-based property tax Proportional Rate PIT VAT Some excises PIT Corporate Profits Tax (CIT) Gross Receipts Some excises

18 Administration and Compliance  Taxes/tax systems should be transparently administered, at low cost, and without placing an undue burden on taxpayers Implications  Keep it simple: especially locally –What is optimal to economists may not “work” –Citizens should be able to understand and control their tax system  Standardized tax bases  Cash flow accounting may be preferable to accruals  Complexity may foster corruption

19 Administration/Compliance Options What WorksWhat Ranks Poorly Piggyback PIT Excise and retail sales taxes Turnover taxes Wage tax Some user charges Multi-rate taxes Lots of exemptions, deductions, incentive packages to businesses Property tax

20 Choosing Local Taxes  Few taxes comply with all desirable features for local taxation  Tradeoffs are inevitable  But clearly, there are better and worse tax and revenue assignments

21 Choice of Subnational Taxes  At a minimum, tax assignments should provide: –Autonomy at the margin –Stability over time –Sufficient revenues for the wealthiest local governments to be fiscally autonomous  Design of local taxes has repercussions on tax administration

22 Promoting Tax Autonomy  Closed list  Discretion to set tax rate  Separate tax administrations not necessary with incentive compatible arrangements

23 “Good” Local Taxes  Municipal governments –Fees and user charges –Land/property taxes –Business registration –Vehicle fees and transportation taxes –Piggyback, flat-rate personal income tax

24 “Good” Local Taxes (Cont.)  Regional/provincial governments –Piggyback, flat-rate personal income tax –Piggyback for selected excise taxes –Business value tax falling on wages and profits

25 Property Tax: Advantages  Revenue  Local burden  Not regressive  Benefit tax  Land use effects  The “devil we know”

26 Property Tax: Disadvantages  Little revenue  Difficult and costly administration  Judgmental assessment  Tax on unrealized income  Visible  Difficult to enforce

27 Local Income Tax: Advantages  Generally meets area-correspondence test  Revenue productive  Not regressive  Piggyback administration

28 Local Income Tax: Disadvantages  Competition with central government  Inter-regional tax competition  Income distribution objectives  Administration  Equalization

29 User Charges: Theory  Excellent source of local revenue –Economically efficient –Fair and equitable  Common notion: “whenever possible, charge”

30 User Charges: Practice  Not used as extensively as they should be  Seldom well-designed  Too often, local user charges are –Inefficient –Inequitable –Costly to administer  Excessive focus on revenue with limited attention on design  Seldom politically popular, especially if imposed for a service that was previously under-priced

31 Design and Implementation  Impose charges only where it pays to do so – especially public utilities such as water and electricity  Design charges efficiently  Ensure public acceptance of charges, e.g. through attention to distributional aspects  Avoid “nuisance” charges

32 Summary  No one mix of revenues nor magic bullet  Fiscal architecture may clarify options  Assess tradeoffs in choosing among options  Devil is in detail: design matters  Don’t forget administration and compliance – simplicity and transparency