Fiscal rules for sub-central governments –a Norwegian perspective

Rune J. SørensenNorwegian School of Management (BI), Oslo, NorwayE-mail: rune.sorensen@bi.no

For presentation at the second meeting of the network on fiscal relations across levels of government, OECD Headquarters, Paris 8-9 September 2005

Outline

1. Why regulate sub-central governments

2. The political ’strength’ of cental government

3. The Nordic system of local government

4. The Norwegian hospital sector5. The allocation costs of tax regulation

A need for central regulations?

1. Common pool problems:• due to vertical fiscal imbalances, and• ’weak’ central government.

2. Intertemporal imbalances:• due to local borrowing and residential

mobility, and• ’soft’ central budget constraints.

3. Imperfect voter controls

A need for central regulations cont.

Information problems may induce local politicians to vote for higher public spending levels :

1. Local government politicians offer voters a better service supply, while voters keep national politicians responsible for tax increases (or local deficits)

2. BUT: Central government sets minimum standards and entitlements, which must be met by local governments (”unfunded mandates”). Voters may keep local politicans responsible for tax increases

2. A ’strong’ central government?

Political structure of central government Election systems and party fragmmentation Types of parliamentary government

Selected empirical studies: Common pool: Inman & Fitts (1990); Borge

& Rattsø (2002) Intertemporal imbalance: Roubini & Sachs

(1989); Alesina & Perotti (1995); Inman (2003);

3. The nordic local government model

Fiscal federalism(the standard version) Local public goods Residential mobility,

including tax competition

Local discretion, including Local tax financing,

small central grants Discretion with respect

to tax rates

Administrative federalism

(Nordic model) Individual welfare

services Representative

democracy Extensive central

controls, including High share of

central grants Limited tax

discretion and other fiscal rules

-2

-1

0

1

2

3

4

5

1990 1993 1996 1999 2002 2005

%

-2

-1

0

1

2

3

4

5

Forecasts National Accounts

Norwegian local government consumptionForecasts in the National Budget and National Accounts1)

1990-2003 averages:Planned growth rate: 1,6 %Actual growth rate: 2,4 %

1)2002 is missing.

4. The Norwegian hospital sector In january 2002, Norway transferred the

responsibility for the hospitals from county governments to central government

Did transfer of responsibility from local to central government ”solve” problems of spending control?

Public health care spending i Norway 1997-2004

20000

22000

24000

26000

28000

30000

32000

1997 1998 1999 2000 2001 2002 2003 2004

NO

K p

er c

apit

a, 2

000

pri

ces

0

2

4

6

8

10

12

14

% G

DP

Production growth in the Norwegian hospital sector measured in DRG points. Source: Terje P. Hagen, University of Oslo 2005.

0

1

2

3

4

5

6

7

8

9

10

1999 2000 2001 2002 2003 2004 2005

An

nu

al g

row

th r

ates

(%

)

County responsibility Central government responsibility

Actual growth rate

Planned growth rate

5. The allocation cost of tax regulation

Rural municipalities: They receive large central grants, partly to

compensate diseconomies of scale and demographics, partly as part of regional policy.

The outcome is high levels of local public consumption, and very high levels of local public consumption relative to private revenues.

Urban municipalities: They receive small central grants. Local public consumption is very low relative to

private revenues. Does central rax regulation induce an allocation

loss?

Allocation loss due to Norwegian tax regulation (Sources: Statistics Norway 2003; Questionnaries to local politicians 1995,1999,2003, N=6247; Data from various population surveys 1993-2003, N=8594)

0

5

10

15

20

25

30

Less than 10.000 inhabitants More than 10.000 inhabitants

Lo

cal

pu

bli

c co

nsu

mp

tio

n *

100

/ p

riva

te i

nco

me

25

30

35

40

45

50

55

60

65

70

Tax

pre

fere

nce

s

Local public consumption aspercent of average private income

Voters: Percent willing to pay 1000NOK in increased taxes

Local council members: Averagedesired increase in local incometax rates *100

Estimates of allocation loss Assumptions:

Price elasticity: -0,4 Income elasticity: 0,6

Allocation loss (consumer surplus) based in 2003-data:1000 NOK per capita (municipal level) or about 3 percent of local government revenue

Source: Borge, L.-E. 2003. More tax autonomy for Norwegian local governments: possible implications for efficiency and service provision. Mimeo. Norwegian University of Science and Technology