Cristian Sepulveda

The Consequences of Fiscal Decentralization on Poverty and Income Equality

Many countries around the world are currently pursuing policies for poverty reduction and the improvement of income distribution, and most of them are also implementing fiscal decentralization reforms. Although, separately, fiscal decentralization, poverty, and the distribution of income have been the subjects of extensive theoretical and empirical research, to date we have little understanding of what may be the impact of fiscal decentralization on poverty and inequality. We set out to shed some light on those relationships. We describe the possible channels through which fiscal decentralization might affect poverty and income inequalities and carry out an empirical analysis using panel data for a large number of countries. We find that fiscal decentralization may have significant effects on poverty and inequality. In particular, fiscal decentralization appears to lead to increases in the poverty measures we use, but it also appears to reduce income inequality if the general government represents a significant share of the economy (20% or more).

Explaining property tax collections in developing countries: the case of Latin America

This paper analyzes the problem of collecting property taxes in fiscally decentralized developing economies. The property tax is arguably the most important source of own revenues for local governments around the world, and economists generally agree that, although imperfect, the property tax is a good local tax. In practice, however, the property tax does not always become a productive revenue source and local governments do not gain the fiscal autonomy required to realize the benefits of fiscal decentralization. This problem is rather common among developing economies and particularly severe in Latin America. One of the main reasons for the poor tax performance of Latin American countries seems to be the lack of administrative capacity at the local level. This problem is notably aggravated, we argue, by a deficient design of the fiscal decentralization system. We also identify the main determinants of property tax performance in Latin American countries, and provide guidance for future reforms in the region.

Sub-National Revenue Mobilization in Peru

This paper analyzes the problem of sub-national revenue mobilization in Peru and proposes several policy reforms to improve collection performance while maintaining a sound revenue structure. In particular, the paper analyzes the current revenues of regional and municipal governments and identifies the main priorities for reform. Among the most important problems are the acute inequalities and inefficiencies associated with revenue sharing from extractive industries. These revenues represent a significant share of sub-national budgets and currently they are distributed without consideration of the relative expenditure needs or fiscal capacity of sub-national units. In order to address this problem, the paper proposes the incorporation of a measure of fiscal capacity into the formula of the FONCOMUN, the municipal equalization transfer program. Other reforms explored include the reassignment of revenue sources between municipal provincial and district governments and the assignment of new taxes to regional governments.

Toward a More General Theory of Revenue Assignments

Despite the extensive international experience with the assignments of revenue sources to different levels of government, the public finance literature still lacks a general theory of revenue assignments. Two sets of arguments have been separately developed in the literature to explain and guide the practice of revenue assignments. The first is based on Musgrave and Oates’ tradition, and emphasizes the benefit principle and other means for increasing accountability and efficiency in the allocation of public expenditures. The second is based on optimal taxation principles, which emphasizes the marginal cost of public funds and the correct mix of revenue instruments. The two approaches provide important insights to the problem, but they remain practically unconnected. This paper develops a theory of revenue assignments that integrates the two approaches. We discuss the validity and scope of currently applied revenue assignment rules, and provide practical recommendations to implement an optimal assignment of revenue sources.

Intergovernmental transfers: a policy reform perspective

Decentralisation and Reform in Latin America analyses the process of intergovernmental reform in Latin America in the last two decades and presents a number of emerging issues. These include the impacts of decentralization and the response of countries in the region to challenge such as social cohesion, interregional and interpersonal disparities, the assignment of social and infrastructure expenditure, macrofinancial shocks, fiscal rules and the sharing of natural resources revenue. The main aim of the book is to assess the effective working of decentralized arrangements and institutions, with a view of suggesting corrections and reforms where the system is not working according to expectations.

Substitution and Income Effects of Lump-Sum Income at the Aggregate Level: The Effective Budget Constraint of the Government and the Flypaper Effect

This paper analyzes the effect of a change in lump-sum (private) income on the tax and expenditure decisions of a government constrained by taxpayers’ behavioral responses to the tax policy. Changes in lump-sum income are generally characterized as pure income effects on taxpayers’ behavior, and considered by normative public finance theory as imposing no price effects on the economy. In this paper we show that pure income effects at the individual level can lead to three distinguishable effects at the aggregate level. The reason is that a change in lump-sum income affects taxpayers’ behavioral responses to taxation and the size of the tax bases, altering the marginal cost of tax collections. The optimal fiscal responses of a welfare maximizing government can be broken up into a “net substitution effect,” associated with a change in the marginal cost of public funds, a “private income effect,” associated with the increase in private consumption, and a “public income effect,” which is equivalent to the effect of intergovernmental transfers. As a consequence, the effects of lump-sum income and intergovernmental transfers on fiscal decisions are shown to be generally different, but consistent with empirical findings of the literature on the flypaper effect.

Public Goods, Labor Supply and the Source of Economic Distortions

According to the conventional public finance literature any tax instrument other than the lump-sum tax is inherently distortionary because it alters relative prices. This paper revisits the case of the labor income tax and shows that its supposedly distortionary effects are the result of a stringent assumption about labor supply behavior. The conventional time allocation model generally assumes that taxpayers disregard the marginal benefits of taxation, received in the form of additional public goods, in their labor supply responses to the labor income tax. In line with previous literature stressing the importance of government spending for labor supply behavior, this paper generalizes the traditional model by describing the behavior of taxpayers that consider both the marginal costs and the marginal benefits of the labor income tax. Under these less stringent assumptions the paper derives an efficient (undistorted) solution to the public goods problem, where taxpayers contribute to the public goods in accordance to their individual marginal benefits while the relative value of leisure remains equal to the pre-tax wage rate.

Reining in Provincial Fiscal ‘Owners’: Decentralization in Lao PDR

Lao People’s Democratic Republic is a small single-party State with an already long but erratic history of decentralization. Political drives towards decentralization and re-centralization have alternated for more than thirty years. Today, provincial governments enjoy a great deal of autonomy and collect around the sixty percent of all government revenues from a wide array of sources including the import tariff. Most central finance functions (tax administration, customs, and treasury) are de facto controlled by the provinces. In this paper we argue that the Lao PDR system of inter-governmental fiscal relations is not really decentralized, and can better be described as a sui-generis form of de-concentration. Although provincial governors are appointed at the central level, they have a high degree of fiscal autonomy. In addition, the provincial governors appoint the heads of district offices. The system is thus absent of proper accountability mechanisms between the citizenry and its political representatives. In addition, the excessive de facto power at the provincial level implies the sub-national authorities are not accountable either to the central government. Somewhat paradoxically, the major constraint towards fiscal decentralization in Lao PDR is the absence of a strong central government with the capacity to efficiently collect revenues and be able to control and monitor expenditures at the sub-national level. Significant re-centralization will need to take place before decentralization reform can go forward.