د. اسراء المغازي - استاذ العلوم الإدارية المساعد

 

Tax  Decentralization 

and

Sustainable local development

 

January  2006

The  International Conference

Decentralization and Local Governance

Cairo 28-29 January 2006

 Introduction

There is convincing evidence, drawn from varied country contexts, that decentralization and local participation are effective mechanisms in achieving sustainable development  . There is also evidence that any decentralization process needs to be carefully designed, to ensure all regions of a country benefit equally. Often particular regions will have special development problems and straightforward decentralization policies will not deliver the anticipated benefits unless specific compensatory mechanisms are put in place.

Perhaps even more importantly, a process of decentralization promotes local good governance and facilitates implicit local “social contracts” between authorities and citizens, helping to deepen and spread a culture of democracy. The political debate in Egypt today has moved from the discussion on whether decentralization is a good thing, to what should be the nature of decentralization and how should it be done. Egyptians realize that excessive centralization is retarding national development and that the cost of not decentralizing is heavy. Decentralization promises to unleash fresh energies, capacities and contributions from the local level. By building the appropriate policy and institutional frameworks decentralization should inject dynamism into social and economic development and create, at the local level, a form of governance which will be able to better respond to the demands for more efficient and better quality services, while making decision-makers more accountable to the people.

This paper concludes Defining Decentralization, The types of decentralization,  Driving Forces of Decentralization, Problems while implementing decentralisation, benefits of  local sources of revenue , "which taxes” should be assigned centrally vs. locally.

 

Defining Decentralization

Decentralization is the transfer of authority and responsibility for public functions from a central government to local governments. Governments are typically heterogeneous and complex entities that may consist of central, provincial, and local layers. Centralization and decentralization are modes of governance—i.e. ways in which control is exercised and decision-making operates within the government. Decentralization involves devolution of different decision-making powers and responsibilities to sub-units of the

government.

 

The types of decentralization

·  political decentralization:  gives local citizens and their representatives more power in any type of decision making, including setting standards and legal frameworks.

 

·  Administrative decentralization re-distributes authority, responsibility and resources among different levels of government. Suitable capacities and institutional strength at all tiers are a precondition for the effectiveness of this.

 

·  fiscal decentralization: entails the definition of authority over raising revenues or access to transfers and making decisions on current and investment expenditures.

  

Driving Forces of Decentralization

There may be several rather than just one force including the following internal and external pressures and demands for decentralization:

   Regional political freedom, participation, and conflict resolution: Decentralization occurred as a political reaction to the failures of over-centralized political systems. This type of decentralization was at least in  the first place not driven by economic efficiency goals but by demand for regional independence and freedom from central government influence. Similarly, a large number of decentralization moves are driven by laten or open ethnic conflict, or its instrumentalization by local or central powers. Also, decentralization is seen as a way to reconnect central regimes to social groups from which they have become increasingly divorced.

         Pressure of global competition: Decentralization, curiously enough, is not just a parallel trend of globalization, but is very much driven by it. Increased competition between and within countries enforces efficient allocation of all resources, publicly and privately managed ones, at all levels including regional and local ones. This exogenous pressure is

             stimulating endogenous institutional and organizational change. Governments are forced to look at international policies when setting up their own policies. This holds true in trade, tax, stabilization, and even in social policies

.

Models of Fiscal Decentralization

 1- Decentralization is a broad term encompassing several arrangements of intergovernmental affairs. There are three basic variants:

-         Devolution is the most complete form: independently established subnational governments are given the responsibility for delivery of a set of public services along with the authority to impose fees an taxes to finance those services. Devolved governments have considerable flexibility to select the mix and level of services to provide to their citizens. Some financial support in the form of intergovernmental transfer may be provided by the center.

-         The essence of decentralization is that subnational (e.g., local) governments must be accountable to their citizens for the decision to spend the next additional pound (dinar, rial, sheqel, pound, etc.), and must be in a legal and financially viable position to make that decision.

-         A political corollary to full decentralization is that the tax and spending decision process be structured to represent the views of all citizens. This is why the concepts of democracy, fiscal decentralization, and public sector efficiency are closely related.

 

2-     Deconcentration refers to the decentralization of central government ministries. deconcentration with authority means that regional branches of central offices are created with some ability to make independent decisions. Deconcentration without authority occurs when regional offices are created with no independent capacity from the center. All deviations from normal practice must be approved by the center.

3-    Delegation is intermediate between devolution and deconcentration. Subnational governments (not branches of government) are given responsibility for delivering certain services, but are subject to some supervision by the central government (which may provide some form of finance for the service).

In practice, all governmental systems are likely to have some elements of devolution, deconcentration and delegation. Centralization-- decentralization is a continuum rather than a dichotomy .

 

Federalism is a special case: a system of government in which public sector decisions can be taken at various levels of government--a compromise between a unitary state and complete decentralization.

§  Under a unitary system subnational units function largely as an administrative unit of the center. One government dominates the fiscal decisions, which may include granting some devolution or deconcentration with authority. Thus, a certain degree of local autonomy can emerge even in unitary states. The set of unitary systems includes Mexico, Japan, Korea, and each of the initial six FDI countries (Czech Republic, Estonia, Hungary, Latvia, Lithuania, Slovenia).

With federalism public sector decisions are made by different governments that are independent of one another. Examples of such federations include Germany, Belgium, Germany, Australia, Canada, India, and Brazil. A working federalism (there are numerous variants) can be thought of as a compact or covenant among governments and between the governments and their citizens.

Some federal countries are highly centralized (Malaysia), while some unitary countries have a high degree of decentralization (China, Russia). As a nation, the United States is a decentralized federation. However, each of the 50 U.S. states operates under its own set of unitary (but also often highly decentralized) arrangements.

  

The Traditional Framework of Multi-Level Finance

:

The traditional analysis of public finance examines the fiscal functions of subnational and central governments in terms of their respective (and largely separate) roles and responsibilities for allocation, stabilization, and income distribution. The general conclusion is that, for the efficiency reasons, the allocation function is largely a subnational responsibility. The traditional approach then goes to assign the stabilization and distribution roles to the center. To summarize, the traditional model emphasizes:

§  . The privatization issue in the broader context of the appropriate dividing line between public vs. private sector activity.

 

§  Stabilization as a central rather than subnational responsibility. Because of the general economic openness of subnational governments, subnational units will be ineffective in dealing with unemployment or inflation because markets are so interrelated that leakages will result. One institutional result of this economic reality is that the basic tool of stabilization--control over the money supply through a monetary authority--rests with a Central Bank.

 

§  Securing equity in the overall distribution of income as a largely central responsibility. As with the stabilization argument, this argument derives from the spatial realties of national vs. subnational jurisdictions. The open nature of the subnational economy--people and business firms are free to move from one locality to another--will frustrate any single subnational jurisdiction’s attempt to significantly change the income profile of its residents through fiscal policies.

 

 

As noted, this leaves the efficiency argument--i.e., allocation policy--as the traditional raison d’être for the subnational role. This is not to say that an efficient provision of public goods requires only subnational activity. Indeed, that is not the case. Some social goods are such that the incidence of their benefits is nationwide (national defense, certain aspects of public health, some court systems), while others are geographically limited (street lighting, water distribution, public safety, fire protection).

 

Problems while implementing decentralisation:

§  Often only limited power is transferred to the lower levels

 

§  Financial autonomy at these levels is often restricted, as they are not given access to credit or the permission to levy taxes. The limited amount of funds transferred to lower levels hamper rthe implementation of projects.

 

§  With respect to these financial aspects of decentralisation mentions that the implementation of decentralisation projects will often lead to an increase of total government spending, causing system failure as only limited funds are available.

 

§  The limited transfer  of  functions and funds often can be traced back to the lack of political will at the central level to really delegate power to the regional and local level. The central level remains strongly involved in the politics at these levels, often replacing elected bodies by a representative of the central government.

 

§  The lack of capacity at the local level with respect to human resources and infrastructure constitutes another factor hampering the implementation of decentralisation projects. Often, employees at the local level are not capable of performing the functions that are being transferred, simply because they have not received the appropriate training. A lack of infrastructural capacity hampers particularly.

 

 

§  rural, often small municipalities, as they cannot meet the technical requirements

 

FUNCTIONS OF LOCAL GOVERNMENT

The scope of services allocated to local governments has been gradually widening. While countries have developed their own mix of the share of responsibilities between the various levels of government, typical responsibilities of local government are shown as follow:

§  local development

§  land use planning

§  protection of the natural and built environment

§  housing

§  water supply

§  sewage

§  drainage of rainwater

§  public cemeteries

§  local public roads and public areas

§  local public transport

§  fire protection

§  local public security

§  primary education including kindergarten

§  health care

§  social services

§  cultural and sport activities

§  libraries and cultural centres

 To ensure that the new responsibilities of local government are adequately financed , decentralization of powers must be accompanied by sufficient revenue. Decisions are required as to which revenue sources should be available for the exclusive use of local governments and which should be subject to inter-governmental sharing. Revenues through grants and other inter-governmental transfers play a large role in the finances of local governments in most countries. However, to ensure that fiscal autonomy of a local government is real, it is essential that a significant percentage of the total revenue of the local government is regarded as its ‘own revenue’, i.e. under its control. Local taxes are an important source of locally-derived revenues.

 

Financing  local Governments:

The current system inherited from the era of central planning is characterized by:

 

(i) sub national government dependence on transfers and shared taxes from the central government, and

 (ii) an almost complete lack of robust (e.g., broad based, buoyant) own-revenue sources. As long as this situation prevails, it will not be possible for local governments to contribute to their nation's fiscal health by increasing their own tax effort.

 

Possible revene sources for local governments:

The composition of revenues varies greatly from one country to another but the main types of local government revenues are typically the following:

§  Revenue from the sale of services (non-tax revenues and user charges/fees).

§  Borrowing, e.g. for investment expenditure.

§  Different types of grants (e.g. general and specific) made available to local governments from the central government

§  Tax revenues: local taxes (e.g. property tax) or shared national taxes.

fees are an important source of revenue, especially if local governments are viewed primarily as service providers. In part, this view is in agreement with the concept of decentralizing certain responsibilities to the local level by using efficiency criteria for the allocation of resources. Such services could therefore be financed through a charging system. - User charges and fees. A general rule in public finance is to charge for services whenever direct beneficiaries can be identified. User charges and fees have a particularly appropriate role in infrastructure financing--new construction as well as upgrading and maintenance

 

Borrowing is usually a minor source of finance for local governments in most developing market economies. This reflects the generally conservative position of most local governments and limited sources of finance. In principle, there is no reason that local governments should not borrow, but their access to credit should be constrained in some way to prevent them from overgrowing or when macroeconomic circumstances require stringency. Many countries permit only borrowing which is limited to agreed and defined purposes and amounts. The amount of debt any city may incur must be related to its payment potential. Repayment may be based on revenues from the investment itself (for example if user charges are imposed on a market) or from general taxes.

Sources of borrowing include:

(i)    bond finance (once local fiscal integrity is established and capital markets develop),

(ii) the commercial banking system;

(iii)                       a central government loan fund operating out of ministries of local government, and

(iv)     a municipal development bank, usually capitalized by the center. Which of these options is appropriate for a given country depends on many factors.

 

In most countries where capital markets are not well developed, whatever the option chosen, the central government or its agency establishes a limit on the total amount of credit available to local governments, sets the terms of the loans, defines the acceptable uses of debt finance and controls the flow of loan funds. One reason for imposing such discipline is that public sector borrowing may crow out private sector credit demands. From a macro-economic point of view, it is generally desirable to constrain overall public sector borrowing

 

Grants from the central government are a key factor. While grants are declining they still remain a significant revenue source for local government. In a number of countries, 50 percent or more of a local budget is represented by transfers from the centre. Grants will remain important given the breadth of new local government responsibilities and the generally inadequate level of local revenue sources. Grants should normally provide only part of local revenue because local governments are usually more accountable for revenues that they raise directly, and because tax-payers are better able to link the receipt of public services and the payment of the taxes if both are housed within a single government.

Tax sharing between the central and subnational governments:

Tax revenues can also be shared between the central and subnational governments. Under -these arrangements the center collects taxes and then agrees to share some percentage with subnational jurisdictions. The system has the advantage of administrative simplicity and feasibility, an important consideration in most transition countries in which localities are yet to develop their own administrative capabilities. The disadvantages of system :

(v)                         It maintains the old regime’s system of local fiscal dependence and, thus, the undermines central as well as local fiscal accountability;

(vi)                      It is incompatible with the efficient provision of local public services, which requires a system of intergovernmental transfers that is firm enough to serve as a basis for budget certainty and flexible enough to be compatible with structural reform: and, to the extent sharing is on a “origin” or “derivation” based, as it almost always is,

(vii)                    It is may exacerbate local fiscal disparities (undercuts the equalization attributes of formula based transfers).

BENEFITS OF LOCAL SOURCES OF REVENUE:

Reasons why the revenues of local governments should come from local sources:

§  Local taxes are necessary to enable a local government to vary the quantity and quality of its services in respect of local preferences.

§  If a local government relies on grants there is a danger that local politicians can spend the money inefficiently.

§  There tends to be greater accountability for money raised locally than with fiscal transfers from the centre.

§  Grants from the central government often come with pre-conditions attached and constrain the way the grant is spent.

 

"which taxes” should be assigned centrally vs. locally:

 

Because subnational government must remain dependent on sharing of central tax revenues, national tax policy will significantly affect the subnational revenue base. National tax policy becomes subnational tax policy. A sorting out process is, however, beginning in several countries. The key point of discussion focuses on "which taxes"

should be assigned centrally vs. locally:

 

-  Broad based business levies. Business taxes are less well suited to subnational government. In order to minimize potential distortions in the flow of factors and goods within a nation, high degree of national uniformity is desirable for levies such as the corporate income tax and the value added tax (VAT). Furthermore the VAT carries with it certain institutional characteristics that make it an inappropriate local tax source (border adjustments).

 

-  Personal income taxes (PIT). Often a national tax, the PIT can be also be effectively utilized locally, even for small units of government. The tax can be most effectively and quickly developed by allowing for some form of "piggybacking" of the tax on the centrally defined and administered PIT. Under these arrangements the local government accepts the center's definition of the tax base, but then takes on the responsibility for setting the local tax rate.

 

- Real property tax. The role of the property tax is a major unanswered question in many transition economies. they are ideally suited as benefits levies. In some countries progress is being made to take the first and necessary steps of setting up the required institutional mechanisms (e.g., cadastre, tax billing and collection systems).

 

- Sales taxes. Excise and single stage retail taxes should be prime candidates for local use, especially if an taxing region is large enough to avoid revenue loses of customers crossing border into lower tax regions. As with user charges, certain excise taxes serve a regulatory as well as revenue generating function (e.g., automotive taxes).

 

Conditions for a good local tax:

 

    The revenue of a good local tax should increase over time in order to match the natural growth in costs and to fulfil the growing need for local public services.

    Local taxes should not be too sensitive to cyclical fluctuations.

    A good local tax should be distributed relatively equally among local governments. Equalization of the revenue between local governments may be required to balance differences in access to tax bases.

    The size of the potential revenue is important. If the local governments are allowed only relatively small yielding taxes, vertical imbalances will result (i.e. the assignment of more responsibilities to local governments than they can finance from their local revenue sources).

    There should be a close relationship between the citizens who pay and the citizens who benefit.

 

The situation in Egypt:

 

For many years, Egypt has been governed under a highly centralized system.  Various experiments with decentralization and devolution of authorities have occurred in more recent history, but basically Egypt has and continues to be governed as a unitary system, where all local government units operate as fiscal and administrative extensions of the central government.  Although the legal framework provides vague openings for local fiscal and administrative autonomy, in fact, power flows downward, with each successive unit left a portion of what descends from the governmental level above. 

       At each level of government (governorate, district, and village), there is an executive council, chaired by the chief executive, and made up of representatives from various central ministries.  While on paper, these councils seem to have all the authorities required to be responsive to community needs, they have little control over local resources.  Funds provided by the central government are tied to specific activities before arriving at the local level.  Similarly, the elected local popular councils would seem to have broad powers to oversee and review local government budgets and management performance, but in practice they have turned into advice-giving rather than decision-making bodies.  The result is that local government in Egypt has neither the financial resources nor the political mandate necessary to involve citizens in meaningful economic and political decision-making.

 

The need for decentralization in Egypt:

 

    Policy in Egypt has been planned and implemented with no adequate participation from non-governmental institutions, or bodies representing civil society from the private sector (e.g. chambers of commerce, investors’ associations) or labour unions and consumer associations, or indeed, from local public units. However, experience from other countries has shown that stakeholders’ involvement in executive decision making at all levels promotes good governance, reduces the scope for arbitrary central government decisions, improves bureaucratic performance and predictability, and reduces uncertainty and the cost of doing business.

    There is a growing demand for increased autonomy at the regional level, driven by an awareness of the wide gap in access to and quality of services across and within regions, and the growing competition among local leadership to emerge as success stories in development.

    A more important factor for change is the ongoing and expected further decline in central budget revenues (a major part of which were rents from petroleum and the Suez Canal). These have shrunk from an average of 40 percent of GDP throughout the interval from the mid-1970s to the early 1990s, to less than 25 percent of GDP in recent years. The state can no longer justify its centralized political and administrative control because it can no longer afford to deliver subsidized goods and services or new jobs in the civil administration at the same scale as in the past.

    From an urban planning perspective, the longstanding debate on governorate jurisdiction has recently been revived as the process of informal urbanization in both urban and rural areas has been rising at a staggering pace, eating up a full million feddans (one sixth of Egypt’s fertile valley) in the last two decades. The experience of establishing new cities that combine industrial and residential zones has been positive but it begs the question of where the national master plan is for deploying existing and future additions to the population, and why urban planning at the local level has not kept pace with the need to designate waste and desert lands where local communities can formally and lawfully migrate to with the least social and economic cost. Egypt’s population has grown from 36.5 million in 1974 to 70.5 in 2004, an increase of 34 million. In the meantime, the combined current capacity of the new residential and industrial cities does not exceed 15 million (about half a million each for the first generation of cities).

    The  growing public awareness of increasing bureaucratic transaction costs in doing business, and little monitoring or accountability of civil service agencies and officials, and the major problem that results in significant waste of resources is also the lack of coordination among line ministries, departments and semi-autonomous agencies.

All these factors are providing a strong case for decentralization as a mechanism for reform.

 

The most problems face Empowering local  government:

 

Many of the issues are still plaguing Egypt today.

    Lack of Local Government Fiscal Autonomy:

§  Local government fiscal autonomy is a key factor in promoting citizen participation in local government decision-making and increasing government responsiveness to citizens.  To promote this, meaningful resource decisions must be made at the local level, i.e., which taxes and fees to impose and at what levels.  With more than 80 percent of their budget coming from the central government, local government units in Egypt have little impact on the determination of developmental priorities in their communities.

§  Tax system consists of three major taxes ( income tax- sales tax- international trade tax which  the central authority determines the extent of the tax base and in setting the tax rates.

§  All tax revenue collected by the central government

§  All revenues go into Ministry of Finance accounts, and then are returned to the local governments.

§  Local governments are assigned property taxes on agricultural land and urban buildings, motor vehicles and drivers licenses taxes, and entertainment taxes. They receive shares of taxes on imports and exports, mobile capital, commercial and industrial profits, and  Suez Canal Authority profits. One half of the taxes on imports and exports, mobile capital, and commercial and industrial profits is distributed to the place of collection and one half is provided to the General Secretariat for Local Administration to distribute to local governments in the form of grants.

 

 

    Lack of Management Capacity at the Local Level:

In the current configuration, administrative officials working at the local level are line-ministry employees attached to their respective ministries.  There is no clear mechanism to oblige them to follow the directives or coordinate with the governors or local popular councils.  Unless this line of authority is changed to make local bureaucrats answerable to locally elected officials, decentralization and local accountability to citizens cannot become a reality. 

Recently, the Government of Egypt has expressed interest in addressing these issues through pursuing some form of decentralization.  Moreover, President Mubarak frequently mentioned decentralization as a priority during his 2005 campaign.  While such declarations in the past have not resulted in sustained efforts at policy reform, the strength and breadth of recent public statements is strong evidence that the GOE is much more committed to decentralization. In addition, the Egyptian Parliament has been discussing a new law for local administration that will, among other things, strengthen the role and authorities of the elected local popular councils. According to GOE, this new law will be presented to the new Parliament early 2006. Most Egyptians convinced that the moment is right to engage the GOE in a dialogue and to pilot some reform initiatives.  

 


Recommendations:

 

To ensure that the new responsibilities of local government are adequately financed to achieve sustainable development    decentralization of powers must be accompanied by sufficient revenue this could be by:

 

      Devoting all revenue of  a property tax  & fees to the local government.

 as a good local revenue stream that is relatively predictable, stable and non-distortionary with regard to its impact on economic decisions.

 

      To insure sustainable balanced development to every governorate , the devoted share of revenue to local government   must be determined by some dimensions such  :

 

§  Population Number

§  General  essential services needed.

§  Individual income average in the region.

§  Development planning . 

      Reviewing the dimensions between the central  and local authorities concerning :

 

§  Legal authority to imposing tax . ( who can impose the tax ?– The Parliament / The Governorate Peoples' Councils) .

§  collection and  regulation tax, authority .

§  Distribution  revenue rates  between central and local government .

 

 

         
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