On June 26, 2008, I took part in a Banque de France Workshop on the Impact of Decentralization on Public Finances in St. Germain-en-Laye, near Paris (Download Workshop_programm_decentralization.doc, Download List_of_participants.pdf). The Workshop looked at a number of critical issues related to decentralization, including the role of fiscal rules, the impact of decentralization on economic growth, and the pre-conditions for successful decentralization. It was attended by about 50 senior representatives of international organizations, central banks, the private sector, and academia. The discussions were opened by Mr. Ophele, Deputy Director General of Economic Studies and International Relations at the BdF and I was invited to take part in the concluding roundtable chaired by Mr. Franco of the Banca d’Italia.
Having been asked to be a little provocative, I observed in my presentation (integrating comments from Messrs. Keen and Norregaard of FAD) (Download Decentralization_and_tax_competition.ppt)that the bad things associated with decentralization and discussed in academic circles had not really happened (much) yet. For example:
- Empirical evidence showed that vertical tax rate competition had remained limited (although it existed, but only a little bit)
- As sub-National governments took over more responsibilities, the fiscal base had tended to remain stable (although even a very immobile base eventually became mobile).
I argued that the reason for which this had not happened was that the environment in which decentralization had taken place had been largely stable and predictable in the last decades.
Yet, I also argued that there was no reason to believe that vertical tax competition or a shrinking tax base (or something else) would not happen. In other words, vertical tax competition and vanishing tax bases could very well appear if the environment became more volatile. And there were many reasons to believe that there might be shocks just around the corner that could affect all levels of government (and hence the way decentralization was playing out), including:
- Ageing (and responsibility for health care and pensions);
- Environment (and water);
- Vanishing tax base (trade, difficulty to implement taxation at the source).
All of these shocks (and possibly others too) would trigger high fiscal costs, on a far bigger scale than those experienced in the rather mundane environment we have experienced so far, forcing new taxation measures, and inevitably triggering vertical tax competition and other problems.
As for the main sessions of the Workshop, this is what happened.
During the first session on decentralization and government behavior:
- There was a discussion on a “good” accounting rule for the states’ budget balances. The speaker proposed that the budgetary balance be given by “forecasted growth – 3%” (Hoorens, Dexia Bank), while the discussant argued for “forecasted growth – 0” (Langenus, Belgian National Bank);
- In an empirical OECD paper, it was shown that the fiscal autonomy of sub-central OECD governments was generally limited by high levels of earmarked grants and other factors. There was also little, if any, correlation between different possible autonomy indicators, such as revenue, tax autonomy, or intergovernmental grants (Blochliger, OECD, and Prof. King, Stirling University); and
- Two ECB staff argued that the degree of public spending decentralization in the EU, fiscal rules, and the electoral cycle impinged on a country’s fiscal position, but primary balances appeared to react to government indebtedness (Afonso and Hauptmeier).
The case of decentralization in EU countries was considered during the second session:
- According to a study by the BdF, while French municipalities appeared to be financially sound overall, an archaic taxation system and looming expenditure pressures (ageing) would require major reforms, possibly including a negotiated multi-annual target for local expenditure growth (Bouthevillain and Pavot); and
- A paper by two academics argued that Italy’s path to decentralization had become more difficult, as it was hampered by the diverging demands for autonomy of different regions. The constitutional conflict had now become more severe and the design of a system that would limit further demands for autonomy would be a major challenge (Bordignon and Cerniglia, University of Milan).
The impact of decentralization on fiscal outcomes was addressed in the third session:
- An empirical study showed that, contrary to the United States where both the federal and the state levels contributed to fiscal consolidation, lower tiers of governments did not assume much responsibility (if any) in debt consolidation in Germany (Claeys, Ramos, and Surinach, University of Barcelona);
- Two academics have shown that, for the EU as a whole, revenue decentralization reduced the size of the central government but increased that of subnational government, leaving the overall size largely unchanged, but there were significant differences within the EU (Cassette and Patty, University of Lille).