Finance in OECD Countries IMPORTANT

7/29/2019 Finance in OECD Countries IMPORTANT

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LOCAL GOVERNMENT FINANCE IN OECD COUNTRIES

Dr. Janice Caulfield

University of New South Wales

Paper presented to Local Government at the Millennium International SeminarFebruary 19

th, 2000, University of New South Wales.

In OECD countries there has been a growing mismatch between the functional competencies

and fiscal responsibility of local government. In all countries local authorities have broad land

planning and infrastructure provision powers and provide a wide range of local amenities.

Some have functional responsibility for important areas of public spending in education, health

and employment services. Continued population growth, especially in urban areas, has seen a

steady increase in demand for municipal services. While the last quarter of the Century has

witnessed measures of legislative and administrative decentralisation to meet these demands

(reforms which have tended to broaden the economic and social functions of local and

regional authorities), these measures have not been matched by a decentralisation of financial

control. Where financial decentralisation has occurred, it is generally the intermediate

governments that have benefitted, often in the name of new federalism (Owens and

Norregard, 1991). In those unitary countries without intermediate level governments such as

New Zealand and the United Kingdom, the problem of fiscal autonomy for local authorities

has not been given a high priority even by reforming governments (Martin, 1991), although

the issue was vigorously debated in the UK following the Blair governments Select

Committee report on local government finance[1]

. The phenomenon of inadequate growth in

local government revenue, and the subject of this paper, is common to many OECD countries.

This paper offers a comparative analysis of local government finance in OECD countries. Its

aims are twofold: one is to examine the problem of fiscal autonomy for local government2;

the other is to compare and contrast selected countries through a descriptive account of

patterns and trends in local financial arrangements. The fiscal autonomy of local governments

hinges on the degree of discretion or control available to them over their revenue source. Thus

the focus here is on revenue rather than expenditure data. Fiscal autonomy has been the

subject of long standing debate in the fiscal federalism literature where the problem of vertical

fiscal imbalance between the centre and the states has received much attention (Mathews,

1997; Watts, 1996). Vertical fiscal imbalance (VFI) exists where sub-national governments


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depend for their expenditure needs on transfers from higher levels of government. The key

argument in support of fiscal balance between revenue and expenditure powers (i.e.fiscal

autonomy) is that it increases the accountability and responsiveness of sub-central

governments. In the economic literature, it is generally agreed that fiscal decentralisationresults in a number of economic welfare gains, and that a willingness to mobilise local revenue

is the most allocative efficient way of organising public finance (Pola, 1996; OECD 1999).

The counter-economic argument, made in the 1950s in a climate of welfare economics (the

legacy of which continues to restrain local government fiscal autonomy), was that only central

governments could achieve local economic efficiency through policies of fiscal equalisation

and redistribution (Tiebout, 1956; Musgrave, 1973).

Diversity in Local Government Finance

The most striking feature of local government finance in OECD countries is the amount of

diversity that exists. There is wide variation in the proportion of local government spending

which is financed from revenue sources under local control. There are variations in the

numbers of local taxes, and in the extent to which particular tax bases are allocated to local

government. This diversity is explained, in part, by the fundamental differences in the context

and functions of local government in the different member states. The diversity of functions

reflect the balance between the choice and agency roles that local government can perform.

In the choice model, local governments may be seen as a means of allowing local communities

to make decisions which match their needs and preferences better than centralised decisions

could. In the agency model, local government is seen as a vehicle for the implementation of

policies and decisions of central government. In this case, central government will wish to see

a decision-making process which allows local discretion to be exercised only to the extent that

it does not conflict with the objectives of the centre (Smith, 1996). While local governments

universally combine elements of both roles, countries will tend more towards one or other of

these models. The diversity of contexts has to do with political culture and administrative

tradition, so that while some broad grouping of countries can be attempted, there is often as

much variation within these groupings as between them. Nonetheless for organising purposes

OECD countries can broadly be seen to fit into one of the following categories: i) Nordic

countries; ii) Anglo countries; iii) Continental countries (Franco and Prussian models); and iv)

Eastern countries (exemplified here by Japan but also including Turkey and Greece).

Overlaying this politico-regional grouping is the constitutional dimension where countries are


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classified as either federal or unitary. ( This latter categorisation has a number of problems,

discussed below).

Intergovernmental Transfers and GrantsLocal governments in most OECD countries rely on intergovernmental transfers for a

substantial percentage of their revenues. The constitutional basis on which the transfers to

local government are determined varies; some member states (such as Germany) provide such

transfers through stable tax-sharing arrangements, while others allocate grants on the basis of

discretionary choices by central government (Smith, 1996). Intergovernmental transfers

constitute at least 30 per cent of local budgets in many countries and in some (UK, the

Netherlands, Ireland) more than 70 per cent (OECD, 1997). Central governments becameincreasingly involved in the financing of sub-national governments during the 1960s and 70s,

initially as a response to growing demands for government services at the local and regional

levels and then, in their efforts to confront the problem of growing regional and metropolitan

disparities in the 1980s and 90s , through strategies offiscal equalisation (Caulfield, 1997).

In the current period of financial austerity at the national level, it is now clear these past

interventions have placed sub-national governments in a tenuous position. Not only have sub-

national governments expanded their policy arenas and service provisions but they are now

having to find new ways to fund programs in the face of cut backs in grants from central

government. Discretionary transfers are a mixed blessing. Faced with restrictive tax policies,

local governments rely on central government grants to meet their expenditure shortfalls.

Moreover, grants are less politically painful forms of revenue raising, and many local

communities depend on their equalising or redistributive effects. The implications for local

autonomy will depend on three factors. First, the proportion that grants represent in the total

revenue budget of local governments; second, the form in which the grant is given, as a

specific purpose or general grant; and third, the formula used for distributing the grant.

Beginning in the late 1980s, special-purpose grants became the object of critical examination

in some countries. The conclusion was that not only did they violate the right of local self-

determination, but they led to the inefficient use of local resources (Netherlands Scientific

Council Report, 1990). Indeed, an OECD survey in 1983 supported the argument in favour of

fiscal autonomy by showing that in countries where local government was not responsible for

tax decisions, local expenditures increased more rapidly. The trend in government financial


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transfers away from specific purpose payments and towards block grants has been a general

one in most Member countries. The question is whether the current preference of central

governments for general grants is more closely related to their efforts to rein in levels of local

expenditure, than to any real commitment to local autonomy.

The Data

The analysis which follows uses as its base data OECD country statistics which are collected

in an annual publication of the OECD[3]

. The main aggregate indicator used by the OECD is

the tax-to-GDP ratio, showing the share of tax revenues in Gross Domestic Product[4]

.

Sources of revenue are divided into three categories; (i) tax, (ii) non-tax, and (iii) grants.

There are two major problems with the data as it is currently calculated. One is the standardclassification of revenue where the assumption has been that the tax share of local government

revenue is a measure of its fiscal autonomy. The tax classification, however, takes no account

of local government discretion over locally raised taxes, so that even where local government

receives a larger share of total tax revenues of general government, this cannot be taken to

mean greater fiscal independence from central government. For example, while Norway and

Finland had roughly the same percentage share of general government tax revenue in 1995 (at

20 and 22 percent respectively) local government in Finland can set its own tax rate whereas

Norway must accept a centrally determined revenue split.

A recent project of the OECDs Working Party on Tax Policy Analysis has developed a

framework for further classification of revenue data based on degrees of autonomy of local

taxation arrangements. The new classification (still being developed) takes account of a

countrys institutional arrangements which give more or less control to local authorities (see

Appendix).

The combination of all government units operating in a country is typically called general

government, consisting of four sub-sectors:

i) federal, central or national government;

ii) state, provincial, cantonal, or regional governments when they exist within a country;

iii) local governments including municipalities, school boards, etc.; and

iv) any supranational authorities exercising taxation and public expenditure functions

within the national territory(OECD, 1999).


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This leads to the second problem with the OECD revenue data which classifies sub-national

government revenue as either state or local according to a countrys constitution as federal or

unitary. Thus, while there is a break down for federal countries between their respective sub-

national government revenues, there is no similar break down for unitary countries eventhough many of these have intermediate and multiple levels of government. The revenue data

from unitary countries with cantonal or regional governments is classified by the OECD as

local, even though these intermediate units of government may exercise a competence

independently of central government. The OECD in its turn takes this classificatory system

from the International Monetary Fund which probably has less interest in the institutional

diversity of government and its ramifications for fiscal policy.

Local Government Finance Compared

The following analysis reveals first and foremost the diversity that exists between countries.

Yet despite this diversity, some common themes and generalisations can be made, especially

about the directions of change in local government finance. These themes indicate what may

be some key problems for local government autonomy. However, at this stage of the

research, the data is indicative only and more detailed country studies will be needed before

any firm conclusions can be drawn[5]

.

Local Government Total Revenue (tax, non-tax and grants) as a percentage of GDP for the

years 1980 and 1995.

Denmarks local government has the largest income to GDP followed closely by the other

Scandinavian countries, Sweden, Norway and Finland. These countries local authorities are,

of course, responsible for major areas of public spending such as health and education,

typically provided by state governments in federal countries, and central governments in other

unitary countries. The financially poorest of thefederal countries are Mexico and Australia.

New Zealand fares marginally better than Australia, but as the third poorest ofunitary

countries after Greece and Turkey, indicates New Zealands strong centralist regime. The next

poorest group of unitary country local governments is Japan, Luxembourg, Iceland and

France. The Netherlands, Ireland and the UK are financially stronger; but what is significant

here is that when compared to the 1980 data, it is these latter three countries (together with

New Zealand) that have lost ground in the 15 year period. Sweden, and to a lesser extent

Denmark, also suffered a decline in revenue over the period.


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There were marginal increases in most federal country local government revenues over the

period, while Finland, Spain, Italy, France and Norway made more substantial gains[6]

.

Local Government Own Source and Total Revenue, 1995 (as % of GDP)

By comparing own source revenue to total revenue we can see the degree of local

government dependence on higher levels of government. In light of the above discussion on

intergovernmental grants, this is an important comparison for what it says about local

government autonomy. Countries most heavily reliant on grants are the Netherlands, the UK,

Ireland, Spain and Italy where more than 70 per cent of total local revenue comes in this form.

(As newly regionalised countries, Spain and Italy are in a sense special cases). Belgium,

Canada, and Denmark depend for approximately half their revenues on grants, whereas for

Norway, Luxembourg and the USA grant income is around 30 percent. Australia, Austria,

New Zealand and Iceland receive less than 20 per cent of their revenues in grants.

LOCAL GOVERNMENT TOTAL REVENUE, 1980 AND 1995 ( % OF GDP)

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

AUS

AUT

BEL

CAN

DEU

SWZ

USA

DEN

FIN

FRA

IRL

ISL

ITA

JAP

LUX

NLD

NZL

NOR

ESP

SWE

UKD

COUNTRY

PERCENTAG

1980

1995


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Main Taxes as a % of Total Local Tax Revenues, 1997

There are two main sources of local government tax; these are the income tax and the

property tax, but there is a wide range of taxes used by many countries, from use tax to goods

and services tax to payroll tax. The income (and profit tax) is, taken overall, the mostimportant tax for local government in the OECD at an average of 41 per cent. This tax takes

a number of forms including tax sharing arrangements with higher levels of government

(Germany); separate tax rates but a central tax system (Belgium); separate rate and allowance

structures (Sweden); and separate tax systems (Switzerland). The property tax dominates the

Anglo speaking countries; Australia, for example, is 100 per cent reliant on the property tax.

In equity terms, it is seen as a regressive tax in that higher income households pay relatively

less tax than lower income households. The advantage of an income tax over the property taxis seen to be its relative progressivity (OECD, 1983). British experience, however, might

suggest that a property tax has more to commend it than, for example, a flat rate poll tax

which is equally regressive and has resulted in a complex system of rebates (Travers, 1989;

Bird and Slack, 1991). In fiscal autonomy terms the property tax has proved to be the most

controversial largely because of its inflexibility. It is a highly visible tax and therefore resistant

to growth[7]

. Large fluctuations in property values can occur and hence, as a source of income

for local governments, it is unpredictable. Moreover, it is subject to central governmentcontrols in the form of rate capping. Countries with the most diverse tax bases (and therefore

LOCAL OWN SOURCE AND TOTAL REVENUE, 1995 ( % OF GDP)

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

AUS

AUT

BEL

CAN

DEU

SWZ

USA

CHE

DEN

FIN

FRA

IRL

ISL

ITA

LUX

NLD

NZL

NOR

ESP

SWE

TUR

UKD

COUNTRY

PERCENTAGE

OWN

SOURCE REV

TOTAL

REVENUE


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the greatest flexibility) are Austria, Japan and Spain, where these countries have between six

and seven different tax bases to draw on.

Local Government Tax Revenue as a % of GDP 1975, 1985 and 1997

Tax as a source of income for local government in many OECD countries has steadily declined

since 1975, most notably in those countries heavily reliant on property tax, and in most federal

countries. Britain suffered the biggest losses as a direct result of central government policies

under the Thatcher government. But Norway too has lost ground. Growth in tax over the

period has occurred in other Nordic and Continental countries and in Japan. As a proportion

of general tax revenue, however, Japan has lost ground to central government, as has Finland.

Indeed, most countries have reduced their share of tax at the local government level. The

notable exceptions are Denmark, France, the Netherlands, Iceland, Italy and Spain.

MAIN TAXES AS A % OF TOTAL LOCAL TAX REVENUES, 1997

0%

20%

40%

60%

80%

100%

AUS

AUT

BEL

CAN

DEU

SWZ

USA

DEN

FINFRA

ISL ITA JAP

LUX

NLD

NZL

NOR

ESP

SWE

UKD

COUNTRY

PERCENTAG

OTHER TAXES

TAXES ON USE

SPE GOODS &

SERV

GENERAL TAXES

PROPERTY

PAYROLL

INCOME & PROFIT


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LOCAL GOVERNMENT TAX REVENUE AS A % OF GDP 1975, 1985 AND 1997

0

2

4

6

8

10

12

14

16

18

AUS

AUT

BEL

CAN

DEUSW

ZUSA

DEN

FIN FRA IR

LISL ITA JA

PLUX

NLD

NZL

NOR

ESP

SWE

UKD

COUNTRY

PERCENTAGE

1975

1985

1997

LOCAL GOVERNMENT TAX REVENUE AS A % OF GENERAL TAX REVENUE

1975, 1985 AND 1997

0

5

10

15

20

25

30

35

AUS

AUT

BEL

CAN

DEU

SWZ

USA

DNK

FIN

FRA

ISL

IRL

ITA

JPN

LUX

NLD

NZL

NOR

ESP

SWE

UKD

COUNTRY

PERCENTAG

1975

1985

1997


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Local Government Own Source and Tax Revenue, 1995 as a % of GDP

A comparison of own source (ie. local tax andnon-tax sources of revenue) with tax only

reveals some important differences and patterns among countries. Japan is the only country

whose own source income is 100 per cent dependent on tax. Most countries rely for theirown source revenue on a mixture of taxes andfees and charges (or non-tax). Countries

which rely most heavily on non-tax forms of income are the Netherlands, UK, Ireland,

Austria, Germany, Switzerland and Finland. The downward trend in tax revenue has been

partly ameliorated by a substantial shift to non-tax revenue such as user charges. This is

especially the case in federal countries. In North America( and increasingly in Australia), user

charges are viewed as highly efficient and politically acceptable (Bird & Slack, 1991; Kincaid,

1991). Unless they are pure public goods or the policy intention is redistributive, there is thepresumption that local public services should be charged for. To this extent local governments

in these countries have demonstrated residual powers of local autonomy (Pierre, 1990). Non-

tax revenue has less appeal in unitary countries which showed variable results. The exceptions

are Finland where non-tax as a revenue source more than doubled between 1980 to 1995. In

Norway, the Netherlands, France, Spain and Luxembourg there was growth, but in the UK

there was a marked decline as there was in Iceland, Sweden and New Zealand. Privatisation of

local government enterprises has been an important contributing factor to the decline in non-

tax revenue in the UK and New Zealand (Stoker, 1999; Martin, 1991).


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Local Government Fiscal Autonomy

Historically, the size of a local governments tax share has been seen as a measure of its fiscal

autonomy. However, the OECD now recognises that fiscal autonomy is a more complex

matter. According to its Working Party on Tax Policy Analysis, fiscal autonomy is greatest if

sub-central governments are free to determine both the taxable base and the rates of a

particular tax, without any aggregate limits on revenues, base or rate enforced by the central

government[8]

. In Table 1 of the working partys report Taxing Powers of State and Local

Government, 1999 (see Appendix), revenues are organised by degree of tax autonomy usingeight categories as follows

[9].

a) sub-central government sets tax rate and tax base

b) sub-central government sets tax rate only

c) sub-central government sets tax base only

d) tax sharing arrangements

i) SCG determines revenue-split

ii) revenue-split can only be changed with consent of SCGiii) revenue-split fixed in legislation, may unilaterally be changed by central

government

iv) revenue-split determined by central government as part of the annual budget

process

e) central government sets rate and base of sub-central government tax[10]

By way of example, we see in Table 1 (Appendix) that New Zealands local government shareof general government tax at 5 per cent is very much lower than Norways which in 1995

,

0.0

5.0

10.0

15.0

20.0

25.0

AUS

AUT

BEL

CAN

DEU

USA

DEN

FIN

FRA

IRL

ISL

ITA

JAP

LUX

NLD

NZL

NOR

ESP

SWE

UKD

COUNTRY

PER

CENTAG

TAXREVEN

OWN

SOURC

REV


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accounted for 20 per cent of total taxes, and yet New Zealands level of autonomy is much

greater because it has discretion over both the tax rate and base, whereas Norway has

effectively no fiscal discretion. It can be concluded therefore that countries that have both

attributes, that is where local government has a relatively large share of national taxationtogether with high fiscal discretion over that share, have more autonomy. These countries

include Sweden, Switzerland and Japan.

Conclusion

From the foregoing analysis we see a great deal of diversity in local government financial

arrangements around the world. The data shows variations along a number of dimensions.

These include whether a country is unitary or federal, whether its tax base is primarilyproperty or income; its level of dependence on intergovernmental transfers, and its

discretionary powers over taxation. The overall picture at the end of the millenium is one of

fiscal constraint either through reductions in grants or loss of tax revenue and in two cases,

Britain and New Zealand, a decline in non-tax revenue as services in these countries have been

progressively privatised. Countries especially affected by a loss in taxation are those

dependent on the property tax. These mostly Anglo countries have been subject to various

central government intrusions such as rate-capping or, even more extreme, central government

take-overs as happened in Britain with the business tax. A partial solution for many countries

(except New Zealand and Britain which have lost trading enterprises) has been to turn to non-

tax sources such as user charges to balance their budgets. Central-local decentralisation then

must be seen as only partial and ultimately unsatisfactory as long as functional responsibilities

continue to be devolved without an appropriate devolution of fiscal autonomy for local

governments.

.

[1]The Environment, Transport and Regional Affairs Committees Report Local Government

Finance (1999). See also Modern Local Government, In Touch with the People the White

Paper, British Government, July, 1998.


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2

This paper does not enter into theoretical debates on local autonomy which have been more

than adequately covered by Harold Wolman and Michael Goldsmith (1992) and Desmond

King (1987,1990)

[3]OECD. Organisation for Economic Cooperation and Development (1999)Revenue

Statistics, 1965/1998. A problem for this paper has been the availability of recent data. Themost recent collected data is for 1997 but here it is only tax revenue that is available. Data

which includes other sources of income i.e. non-tax and grants is available only for 1995.

[4]As a comparative measure there are some limitations on the tax-to-GDP ratio including, for

example, the extent to which countries engage in tax expenditures rather than direct

government spending; differences in the measurement of GDP between countries; and the

economic cycle.

[5]The OECD has 28 member countries and growing. Some new members may not be

represented in the data because of data gaps from earlier years. The most recent data available

is for 1997 but is restricted to tax revenue. Where grants and non-tax revenues are included,

the most recent data available is for 1995.

[6]Italy and Spain are special cases because of their recently introduced regional governments.

[7]A good example of this resistance is the celebrated case of Proposition 13 in the State of

California. See OSullivan et.al. 1995.

[8]OECD (1999) Taxing Powers of State and Local Government Tax Policy Studies No. 1.

[9]The Working Party acknowledges that the classification is still not as finely tuned as it

might be. For example, while the (a) classification indicates the greatest level of autonomy,

even this does not take account of a central governments ability to impose a limit on total

revenues to be raised from own taxes. Nor does it take account of central governments not

infrequent restriction on the band width or range of rates that a local government (otherwise

free to set the rate) can establish.

[10]The table shows a predominance of type (b) tax; that is, where SCGs set tax rates only.This category averages approximately 9 per cent of total taxes of general government which is

exactly half the sub-central government share of total tax. The most important tax base for

this predominant category (b) is income and profits tax (OECD, 1999).

REFERENCES

Bird, R. and E. Slack (1991) Financing Local Government in OECD Countries: the Role of

Local Taxes and User Charges in J. Owens and G. Panella (eds.)Local Government: an

International Perspective (North Holland: Amsterdam)

Caulfield, Janice (1997) Finance, Taxation and Equity within Metropolitan Areas. Paper

presented to the OECD/Sweden Workshop Governing Metropolitan Areas: Institutions,

Finance and Partnerships. Stockholm, 4-6 June.

Martin, J. (1991) Devolution and Decentralization in J. Boston et.al. Reshaping the State:

New Zealands Bureaucratic Revolution (OUP: Auckland)


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Mathews R. and B. Grewal (1997) The Public Sector in Jeopardy: Australian Fiscal

Federalism from Whitlam to Keating (Centre for Strategic Economic Studies: Victoria)

Musgrave, R.A. (1973) Public Finance in Theory and Practice (New York: McGraw Hill)

Netherlands Scientific Council for Government Policy (1990)Institutions and the City: the

Dutch Experience

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1965/1998 Special Feature

_______ (1997)Managing Across Levels of GovernmentPUMA

_______ (1983) Taxes on Immovable Property (Committee on Fiscal Affairs and the Ad Hoc

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OSullivan, A. et.al.(1995) Property Taxes and Tax Revolts: the legacy of Proposition 13

(Cambridge University Press)

Owens, J. and Norregaard, J. (1991) The Role of Lower Levels of Government: The

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Smith, S. (1996) European Integration and Local Government Finance in Pola op.cit.

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Travers, T. (1989) Community Charge and other Financial Changes in J. Stewart and G.

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Documents

Finance in OECD Countries IMPORTANT