Framework for Local Revenue Mobilization

Innovations in Local Revenue Course

23-24 June 2003

Dana WeistPRMPS

(dweist@worldbank.org)

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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

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Demographic, economic and institutional setting

Matrix of potential revenue sources

Similar expenditure needs exercise

Fiscal Architecture

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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?

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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

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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

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Accountability Favors

What Ranks Poorly

Local personal income

User Charges

General Business taxes

(GR, VAT, Company Profits

Visitor (e.g., tourist) taxes

Accountability Options

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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)

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Benefits Received Favors

What Ranks Poorly

Whenever possible charge

Visitor Taxes

Business Taxes

Non resident based personal income tax

Benefits-Received Options

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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

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Non-Distortion Options

Non-Distortion Favors What 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)

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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

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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

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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?

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“Place” Equity Options

Place Equity Favors What Ranks PoorlyCentral taxation of natural resources; multi or supranational

Local severance taxes

Wealth taxes may fit here

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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

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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

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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

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Administration/Compliance Options

What Works What 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

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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

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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

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Promoting Tax Autonomy

Closed list Discretion to set tax rate Separate tax administrations not

necessary with incentive compatible arrangements

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“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

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“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

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

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Property Tax: Disadvantages

Little revenue Difficult and costly administration Judgmental assessment Tax on unrealized income Visible Difficult to enforce

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Local Income Tax: Advantages

Generally meets area-correspondence test

Revenue productive Not regressive Piggyback administration

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Local Income Tax: Disadvantages

Competition with central government Inter-regional tax competition Income distribution objectives Administration Equalization

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User Charges: Theory

Excellent source of local revenue – Economically efficient– Fair and equitable

Common notion: “whenever possible, charge”

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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

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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

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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