Prof. Dr. David StadelmannUniversity of Bayreuth, GermanyWalter Eucken Institut, Germany

CREMA – Center for Research in Economics, Management and the Arts, Switzerland

How decentralization improves efficiency and protects future generations

True federalism works

• True federalism = decentralization and budgetary autonomy• True bottom-up procedure

• Better decisions through expenditure & revenue decentralization + local autonomy

• True federalism strengthens incentives for good politics

• Mechanisms• Exit & voice competition• Laboratory for ideas escape competition• Institutional congruence increase efficiency

Prof. Dr. David Stadelmann

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Institutional Congruence =

Fiscal Equivalence

Relevance of institutional congruence

Decision maker ≈ Contributor ≈

Beneficiary

Decision maker

ContributorBeneficiary

Institutional Incongruence Institutional Congruence

Relevance of institutional congruence

Decision maker ≈

ContributorBeneficiary

Too little public expenditure & neglect of needs

Decision maker ≈

Beneficiary Contributor

Too high expenditure & exaggeration of needs

Heterogeneity and comparisons

International success of Swiss system Sources: own calculations based on Economist Intelligence Unit, International Monetary Fund, World Economic Forum, OECD, World Value Survey

What makes Switzerland different?

Prof. Dr. David Stadelmann

Slide 8

• Competition induced through effective decentralization• Tax decentralization: ≈ 25% local jurisdictions, ≈ 40% cantons• Strict no-bailout rule, limited vertical and horizontal transfers• Constitutional setting according to Swiss Constitution

• Art. 3: „Les cantons sont souverains […] et exercent tous les droits qui ne sont pas délégués à la Confédération.”

• Principle of subsidiarity (Art. 5a)• Federalism = decentralization (irrelevance of terms “federalism” and “con-federalism”)

• Voice through direct citizen participation• E.g. fiscal referenda, debt brakes, etc.

Strong institutional congruence

Enormous heterogeneity inside Switzerland

• Enormous regional diversity in Switzerland regarding• Language• Religion• Topography • Etc.

Need for regional solutions Need for flexibility

Prof. Dr. David Stadelmann

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Heterogeneity regarding industrial structureSources: Swiss Federal Statistical Office

1st sector16651 employees2nd sector1 099 446 employees3rd sector3 778 411 employees

Banks are not everywhere & only banks are marginally relevant

Sources: Swiss Federal Statistical Office

Share & number of full time equivalent employees

Heterogeneity regarding policy preferences(Referendum for “Buying Defense Airplanes”)

Sources: Swiss Federal Statistical Office

Share of YES-votes

Heterogeneity regarding where foreigners live

Share of foreigners

Sources: Swiss Federal Statistical Office

Taxation and outcomes of Swiss cantons

True federalism works

• Large heterogeneity decentralization even more relevant• Decentralization theorem (Oates 1972, p. 32): “For a public good -

the consumption of which is defined over geographical subsets […] it will always be more efficient (or at least as efficient) for local governments to provide the Pareto-efficient levels of output […]”.

• BUT? Differences in outcomes?• Yes, of course!

• But: Relatively small outcome differences • But: Output generally better than in (large) centralized states

Prof. Dr. David Stadelmann

Slide 15

Heterogeneity induces differences in taxationSources: Swiss Federal Statistical Office

Taxation in % of single persons Gross income CHF 80’000, 2015

Taxation in % of married persons, 2 children Gross household income CHF 150’000, 2015

Business tax according to statues

Small differences in outcomes & impressive outcome levels

Unemployment rate 2015

Sources: Swiss Federal Statistical Office

Federalism generates interest in public finances

Sources: Neue Zürcher Zeitung (2014), Thalwil mit kleinerm Defizit, 01.04.14, Nr. 76, S. 18.

Limited fiscal equalization

National fiscal equalization in Switzerland

Prof. Dr. David Stadelmann

Slide 20

• Reform of fiscal equalization in 2004• Introduced through referendum• 64% yes votes

• Aim: Limited equalization of fiscal capabilities (≈ 5bn Swiss Francs) & extension of fiscal autonomy

• Mechanisms:• Resource based equalization• Burden based equalization• Hardship compensation (decreases 5% every year)

National fiscal equalization in SwitzerlandSources: Beobachter, Bürger & Verwaltung, https://www.beobachter.ch/burger-verwaltung/nationaler-finanzausgleich-ein-check-und-keine-fragen.

Orange: Contributing cantonsBlue: Receiving cantons

Federalism as a laboratory & protector of future generations

Interaction of federalism with cantonal self-imposed expenditure & revenue rules

Sources: Yerly, N. and Stadelmann, D. (2017), "Finanzautonomie und Fiskalregeln: Erfahrungen aus der Schweiz", Wirtschaftspolitische Blätter, forthcoming.

The non-bailout of bankrupt LeukerbadSources: http://www.geo.de/reisen/community/bild/152742/Leukerbad-Schweiz-Blick-vom-Gremmipass-auf-Leukerbad

The riddle of low Swiss municipal debts

• Common wisdom: Debts = burden for future generations• Ricardian equivalence: Debts = no burden for future

generation if ...

• Common belief: Ricardian conditions not met in reality• Particularly not at local/regional level

• Common wisdom: Debts = burden for future generations

Prof. Dr. David Stadelmann

Slide 25

(cont’d…) The riddle of low Swiss municipal debts

• Moralist view: Debts = bad

• Homo oeconomicus: Debts = cool• Politicians: Debts = coolest thing in world

• (Just pretend that debts are a bad)

• The riddle: Why do most Swiss local jurisdictions and Cantons have comparatively low public debts?

• Solution: “We owe it to ourselves” • … due to debt capitalization

Prof. Dr. David Stadelmann

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Solution to the riddle

Prof. Dr. David Stadelmann

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Local jurisdictionLeuk

Local jurisdictionLeukerbad

Lower public net debts

Higher public net debts

Debt capitalization: Property prices in Leuk higher than in Leukerbad

Local public debts affect property pricesSources: David Stadelmann & Reiner Eichenberger, 2014. "Public debts capitalize into property prices: empirical evidence for a new perspective on debt incidence," International Tax and Public Finance, Springer, vol.

21(3), pages 498-529.

600 800 1000 1200

Property prices in comm

Property Prices

600 800 1000 1200

Communities with low public net debtsCommunities with high public net debts

Local public debts affect property pricesSources: David Stadelmann & Reiner Eichenberger, 2014. "Public debts capitalize into property prices: empirical evidence for a new perspective on debt incidence," International Tax and Public Finance, Springer, vol.

21(3), pages 498-529.

• Capitalization of net debts• 60-100% debt capitalization

• Public debts no struggle between generations • Public debts struggle between today’s property owners and tenants

• Federalism with real autonomy of local jurisdictions protects future generations from public debts

Prof. Dr. David Stadelmann

Slide 30

Local public debts affect property prices

Insights generalize

Insights from Switzerland generalize(e.g. in Denmark)

Sources: Nielsen (2015), Fraud and Capitalization of Municipal Debt, mimeo, Copenhagen Business School, Denmark.

Insights from Switzerland generalize(e.g. in Scandinavia in general)

Insights from Switzerland generalize(e.g. in Ancient Greece)

Sources: Eichenberger & Stadelmann, "Athen als Modell", Frankfurter Allgemeine Sonntagszeitung, Nr. 45, 13. November 2011.

Conclusions

Prof. Dr. David Stadelmann

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Conclusions

• Federalism with true regional and local autonomy works• Fosters institutional congruence• Leads to competition• Induces comparisons

• In federalist systems jurisdictions generate new ideas• Innovation and flexibility central in globalizing world

• Federalism = protector for future generations

• Insights generalize

Thank you!

Prof. Dr. David Stadelmann

Slide 37

Find my research papers on: • http://bit.ly/StadelM

• … or search on Google: “David Stadelmann” Bayreuth

@davidstadelmann

Appendix

Innovation, decentralization & grantsSources: Eidgenössische Finanzenverwaltung (EFV) (2016), Finanzstatistik der Schweiz 2014, Jahresbericht, Bundesamt für Statistik, Neuchâtel.

Commuting in Switzerland as a form of exitSources: Eidgenössische Finanzenverwaltung (EFV) (2016), Finanzstatistik der Schweiz 2014, Jahresbericht, Bundesamt für Statistik, Neuchâtel.

Net commuting balance

Finances of cantons and local jurisdictionsSources: Eidgenössische Finanzenverwaltung (EFV) (2016), Finanzstatistik der Schweiz 2014, Jahresbericht, Bundesamt für Statistik, Neuchâtel.

Consequences of debt capitalizationSources: Stadelmann, D. & Eichenberger, R. (2012), 'Consequences of Debt Capitalization: Property Ownership and Debt versus Tax Choice.', Southern Economic Journal 78(3), 976-998.

• Increase of efficiency through „Voting by Feet“ (Tiebout 1965, Banzhaf & Walsh 2008)

• Higher quality of education with financial autonomy of jurisdictions (Barankay & Lockwood 2007, Adam et al. 2014)

• Decentralization protects from exploitation by leviathan (Brülhart & Jametti 2007, Eichenberger & Schelker 2007)

• Smaller shadow economy and higher tax morale in decentral systems (Buehn et al. 2013, Torgler et al. 2010)

• More stable public finances (Baskaran 2010)• Higher life satisfaction (Frey & Stutzer 2000)

Prof. Dr. David Stadelmann

Slide 43

Further strengths of federalism