CHAPTER- II

Fiscal Federalism-Theory and Approaches

This chapter attempts to grapple with the concept of fiscal federalism. The chapter

examines the principles and the characteristics of fiscal federalism. It deals with the

rationale, need and objectives for transfer of resources. It also deals with closing the

fiscal gap, equalization and to correct spill over as rationale for transfer. The chapter

entails with vertical distribution of revenue competencies and expenditure

responsibilities between the federation and federating units, the causes of fiscal

imbalance in a federal set up and the need and approaches to fiscal transfers. Taxation

powers and expenditure responsibility has been discussed. What is the rationale for

decentralization? Centralization versus decentralization is the other points for

consideration. What are the practices around the world to tackle with the problems

and challenges before the fiscal federalism, it has been tested with the examples of

Australia, Nigeria, Germany, U.S.A., Brazil, Switzerland, Canada and India.

Centralisation marked the evolution of federalism in the last century in several

federations that were already well established like in USA, Canada and Australia.

Australian federation is also very much centralised. In Germany’s “co-operative

federalism” all decisions are co-ordinated through an extensive net of multi-level

committees. We can say that in the Brazilian system, there are no institutional

arrangements like the CGC of Australia or the FCs of India. The Nigerian model of

handling the task of resource transfers from the federal to the lower orders of

governments through the institution of Revenue Mobilisation, Allocation and Fiscal

Commission (RMAFC) in terms of Constitutional provisions makes it almost as

powerful as the Parliament, at least in fiscal matters.

The design of various aspects of inter-governmental fiscal relations includes

expenditure assignment, revenue assignment, inter-governmental transfers, tax

administration, budgeting and financial management in a multi-level government

setting, and the control of states government borrowing. There is broad consensus in

the literature that decentralisation of spending responsibilities can entail substantial

welfare gains. According to this view, efficiency in the allocation of resources is best

served by assigning responsibility for each type of public expenditure to the level of

61

government that most closely represents the beneficiaries of these outlays. A more

operational approach adopted by the European Union is the principle of subsidiary for

assigning responsibilities according to which taxing, spending and regulatory

functions should be exercised by lower levels of government unless a convincing case

can be made for assigning them to higher levels. It is generally recognised that both

distributional and, especially, macroeconomic management considerations argue

against arrangements that would assign all or most taxing powers to sub national

governments with upward revenue sharing. Such arrangements deprive the central

government of tax instruments for macroeconomic management. 1

Arrangements that assign all or most taxing powers to the central government are

undesirable as well. By separating spending authority from revenue-raising

responsibilities, these arrangements obscure the link between the benefits of public

expenditures and their price, namely, the taxes levied to finance them. Thus, they do

not promote fiscal responsibility in state politicians and their electorate2. Therefore,

the alternative favoured in the literature and most frequently observed in countries

around the world is one that provides for the assignment of own sources of revenue to

each level of government, in combination with various types of inter-governmental

transfers, to bridge any resulting gap between revenue and expenditure assignments.

There is, however, wide variation across the countries both in terms of revenue

assignments and inter-governmental transfers. Some countries espouse a principle of

complete separation of the tax bases for the different levels of government. Others

allow different levels to tap the same tax base. Examples of tax separation can be

found in, among others, India, Australia, and, for non-shared taxes, Germany.3 By

contrast, there is a considerable degree of tax overlapping in the United States and

Canada. Since most major taxes are typically assigned to the central government,

while substantial and growing expenditure responsibilities are devolved to regional

and local governments, sizable vertical imbalances frequently emerge at the sub

national government level4. Tax revenue sharing is the most important element of

inter-governmental fiscal relations. This issue has three major dimensions: tax

assignment between the federal and sub-national governments, vertical tax sharing

between the federal and sub-national governments, and horizontal redistribution of

shared tax revenue among the sub national governments.

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There are also horizontal imbalances, because the capacity to raise own revenues

differs across jurisdictions. These imbalances must be addressed through inter-

governmental transfers, or borrowing by deficit jurisdictions, or a combination of the

two. The design of an appropriate system of intergovernmental transfers is crucial to

promote desirable redistribution of resources among state jurisdictions.

Intergovernmental transfer mechanisms can be broadly grouped into two main

categories, revenue-sharing arrangements and grants, (general purpose grants and

specific purpose grants)5.

It may be noted that the ideas of fiscal federalism are relevant for all kinds of

government viz unitary, federal and co federal. The concept of fiscal federalism is not

to be associated with fiscal decentralization in officially declared federations only; it

is applicable even to non-federal states (having no formal federal constitutional

arrangement) in the sense that they encompass different levels of government which

have de facto decision making authority.6 This however does not mean that all forms

of governments are 'fiscally' federal; it only means that 'fiscal federalism' is a set of

principles that can be applied to all countries attempting 'fiscal decentralization'. In

fact, fiscal federalism is a general normative framework for assignment of functions

to the different levels of government and appropriate fiscal instruments for carrying

out these functions.7

Theories have approached the phenomenon of federalism broadly from three angles:

Institutional or neo institutional, Socio Cultural, and Economic. Fiscal federalism is

concerned with "understanding which functions and instruments are best centralized

and which are best placed in the sphere of decentralized levels of government”

(Wallace E. Oates, Journal of Economic Literature, 1999) while Fiscal

decentralisation involves transferring expenditure and revenue responsibilities from

the central government to sub national governments8.

Fiscal Federalism

The basic foundations for the initial theory of Fiscal Federalism were laid by Kenneth

Arrow, Richard Musgrave. Paul Sadweh Samuelson's two important papers (1954,

63

1955) on the theory of public goods, Arrow's discourse (1970) on the roles of the

public and private sectors and Musgrave's book (1959) on public finance provided the

framework for what became accepted as the proper role of the state in the economy.

As originally defined by Musgrave (1959) and Oats (l972), "fiscal federalism"

concerns the division of public sector functions and finances among different tiers of

government.  In undertaking this division, Economics emphasizes the need to focus

on the necessity for improving the performance of the public sector and the provision

of their services by ensuring a proper alignment of responsibilities and fiscal

instruments. While economic analysis, as encapsulated in the theory of fiscal

federalism, seeks to guide this division by focussing on efficiency and welfare

maximisation in determining optimal jurisdictional authority, it needs to be

recognised that the construction of optimal jurisdictional authority in practice goes

beyond purely economic considerations. Political considerations, as well as historical

events and exigencies, have in practice, played major roles in shaping the inter-

governmental fiscal relations in most federations.9 Within this framework, three roles

were identified for the government sector. These were the roles of government in

correcting for various forms of market failure, ensuring an equitable distribution of

income and seeking to maintain stability in the macro-economy at full employment

and stable prices.10

 The theoretical framework in question was basically a Keynesian one which

canvassed for an activist role of the state in economic affairs. Thus the government

was expected to step in where the market mechanism failed due to various types of

public goods characteristics. Economics teaches us that public goods will be under-

provided if left to private market mechanisms since the private provider would under

invest in their provision because the benefits accruable to her or him would be far

lower than the total benefit to society. Governments and their officials were seen as

the custodians of public interest who would seek to maximise social welfare based on

their benevolence or the need to ensure electoral success in democracies11.  Once we

allow for a multi-level government setting, this role of the state in maximising social

welfare then provides the basic ingredients for the theory of fiscal federalism. Each

tier of government is then seen as seeking to maximise the social welfare of the

citizens within its jurisdiction. This multi-layered quest becomes very important

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where public goods exist, the consumption of which is not national in character, but

localised. In such circumstances, local outputs targeted at local demands by respective

local jurisdictions clearly provide higher social welfare than central provision. This

principle, which Oats (1972) has formalised into the "Decentralisation Theorem"

constitutes the basic foundation for what may be referred to as the first generation

theory of fiscal decentralisation (Oats, 2004). The theory focussed on situations where

different levels of government provided efficient levels of outputs of public goods

"for those goods whose special patterns of benefits were encompassed by the

geographical scope of their jurisdictions"12. Such situation came to be known as

"perfect mapping" or "fiscal equivalence"13

 Nevertheless, it was also recognised that, given the multiplicity of local public goods

with varying geographical patterns of consumption, there was hardly any level of

government that could produce a perfect mapping for all public goods. Thus, it was

recognised that there would be local public goods with inter-jurisdictional spill-over.

For example, a road may confer public goods characteristics, the benefits of which are

enjoyed beyond the local jurisdiction. The local authority may then under-provide for

such a good. To avoid this, the theory then resorts to traditional subsidies, requiring

the central government to provide matching grants to the lower level government so

that it can internalise the full benefits14.

 Based on the following, the role of government in maximising social welfare through

public goods provision came to be assigned to the lower tiers of government. The

other two roles of income distribution and stabilisation were, however, regarded as

suitable for the central government. To understand the rationale for the assignment of

the redistribution function to the central government, we need to examine what the

implications of assigning this responsibility to the lower tier would imply. Given that

citizens are freely mobile across local or regional jurisdictions, a lower level

jurisdiction that embarks on a programme of redistribution from the rich to the poor

would be faced with the out-migration of the rich to non-redistributing jurisdictions

and in-migration of the poor from such jurisdictions to the redistributing one. If on the

other hand, the powers to redistribute were vested in the central government, a

redistribution policy would apply equally to citizens in all jurisdictions. There would

therefore be no induced migration15. The assignment of the stabilisation function also

65

follows from the chaos that would ensue if sub-central governments were assigned the

responsibility. Moreover, given the openness that characterises the relationship

between the regional governments, they are grossly constrained in carrying out

effective stabilisation policies. This is because these lower tiers of government have

very limited capacity to influence local employment levels and inflation.

 

From the foregoing, we can summarise the role assignment which flows from the

basic theory of fiscal federalism. The central government is expected to ensure

equitable distribution of income, maintain macroeconomic stability and provide

public goods that are national in character. Decentralised levels of government on the

other hand are expected to concentrate on the provision of local public goods with the

central government providing targeted grants in cases where there are jurisdictional

spill-over associated with local public goods.  Once the assignment of roles had been

carried out, the next step in the theoretical framework was to determine the

appropriate taxing framework. In addressing this tax assignment problem, attention

was paid to the need to avoid distortions resulting from decentralised taxation of

mobile tax bases. The extensive application of non-benefit taxes on mobile factors at

decentralised levels of government could result in distortions in the location of

economic activity.16 Following from the assignment of functions, taxes that matched

more effectively the assigned functions were also assigned to the relevant tier or level

of government. For example, progressive income tax is suited to the functions of

income redistribution and macro-economic stabilisation and is therefore assigned to

the central government. On the other hand, property taxes and user fees were deemed

more appropriate for the local governments. Benefit taxes are also prescribed for

decentralised governments based on the conclusion that such taxes promote economic

efficiency when dealing with mobile economic units, be they individuals or firms17.

 The final element of this basic theory is the need for fiscal equalisation. This is in the

form of lump sum transfers from the central government to decentralised

governments. The arguments for equalisation were mainly two. The first which is on

efficiency grounds saw equalisation as a way of correcting for distorted migration

patterns. The second is to provide assistance to poorer regions or jurisdictions.

Equalisation has been important in a number of federations.  For example, Canada has

an elaborate equalisation scheme built into her inter-governmental fiscal

66

arrangements.18 It should be pointed out however, that recent literature emphasises the

importance of reliance on own revenues for financing local budgets. A number of

authors (Weingast, 1995; McKinon, 1997) have drawn attention to the dangers of

decentralised levels of government relying too heavily on intergovernmental transfers

for financing their budgets.19 It was the theoretical framework of the neo-classical

economists that had justified the creation of multi-level governments in a country, on

the ground that such a system of government would provide optimum level of goods

and services at each territorial level, in accordance with the needs and aspirations of

the people. Fiscal federalism is a necessary adjunct of the concept of multi-level

government in a federal set-up. Since in a federation, there are several levels of

government functioning in their respective jurisdictions, there is the need for creating

such an optimum institutional arrangement which combines the advantages of

decentralisation as well as economies of scale, associated with centralised form of

government. Such an arrangement has to undergo revision from time to time,

depending upon the experience of running the federation, changing relationships

between different layers of government, reflecting changes in social, political and

economic conditions in the country.20

Fiscal federalism is concerned with "understanding which functions and instruments

are best centralized and which is best placed in the sphere of decentralized levels of

government".21 In other words, it is the study of how competencies (expenditure side)

and fiscal instruments (revenue side) are allocated across different (vertical) layers of

the administration. An important part of its subject matter is the system of "Transfer

payment" or grant money by which a central government shares its revenues with

lower levels of government. Federal governments use this power to enforce national

rules and standards. There are two primary types of transfers, conditional and

unconditional. A conditional transfer from a federal body to a province, or other

territory, involves a certain set of conditions. If the lower level of government is to

receive this type of transfer, it must agree to the spending instructions of the federal

government. An example of this would be the "Canada Health Transfer" in Canadian

system of fiscal federalism. The second type of grant, unconditional, is usually a cash

or tax point transfer, with no spending instructions. An example of this would be

Equalization payments or federal equalization transfer.

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Rationale for Transfer of Resources

Economic theory prescribes the following reasons for such a transfer:

(a) Promotion of efficient allocation of resources in public sector

(b) Inter-governmental fiscal equity and

(c) Federal taxation as a less distorting alternative to state taxation.

Transfers are needed also to neutralize spill over and the potential for inefficient

migration of labour and capital transfers, but all such transfers need to be carefully

designed to see that a right balance is struck between equity, efficiency and

autonomy. Transfers that are meant to correct spill over or externalities can result in

'backdoor centralisation' by shifting power over spending and public policy-making in

favour of the centre that may not have been warranted by the constitutional

arrangements. Hence there is a need for caution.22 Most of the public services such as

education, health and roads have spill-over or externalities and so the need for subsidy

to them. Public services provided by relatively wealthy states may be of better quality

compared to poorer ones. Therefore, the need for at least to maintain a minimum

standard of public services by states taking into account indices of need, tax effort and

fiscal capacity, transfer of resources is must23.

Distribution of functions and powers between the centre and the states under Indian

constitution is enough to show that the federal government in India is economically

more powerful. The constitution –makers have done it deliberately perhaps, to put the

Indian economy with speed on the road of economic development through planning

by the central government. However, in a developing country, the separation of

sources of revenue between the Union and the states may not be adequate and

sufficiently exclusive after sometime depending upon the charged needs and

circumstances. For all these difficulties a need arises for provision of further financial

adjustments. Therefore, Indian constitution has provided the machinery of the finance

commission to review the position at regular intervals and to recommend transfer of

resources from union to the states.

The Indian constitution provides that not merely the union shall levy taxes and share

the proceeds with the states but also that taxes shall be levied by the union for the

benefit of the states. It has been based on the principle that functions should rest

68

where they are better performed and taxes should be levied where they are better

administered and there is a regular method of transference revenues from one tier of

government to the other with a view to ensuring that a balance between functions and

finance is continuously attained without imparting the responsibilities of the either.

Fiscal analysts are unanimously of the view that the present levels of debt and deficits

of the government are unsustainable. Signs of the public sector breaking down are

already in evidence. To quote the Approach paper to the Tenth Plan (TPAP)24

'In many states we have

Engineers but no fund for construction or maintenance

Doctors, but no medicine

Teachers but no school buildings. (TPAP, p. 18)

This situation still exists, when 13th plan is going on. Intergovernmental fiscal

transfers are neither inherently good nor inherently bad. What matters are their effects

on such policy outcomes as allocated efficiency, distributional equity, and

macroeconomic stability? If, for example, the sole objective of fiscal decentralization

is the efficient delivery of public services, then what matters is how transfers affect

the effectiveness and efficiency of public sector operations. The most critical aspect

of intergovernmental transfers is thus not who gives them or who gets them but their

effects on policy objectives. These effects depend upon both the design of transfers

and the conditions in which they operate. Vertical imbalance refers to the difference

between expenditures and own-source revenues at different levels of government.

Horizontal imbalance refers to the differences between the resources available to

governments at the same level, that is, regional inequalities, which has to be

eliminated by transfer of resources. This is the rationale behind these transfers.

Transfer may be in the shape of grants or revenue raising powers or specific plan

contribution, or by transferring expenditure responsibilities or other local

arrangements.

The Role and Objective of Transfers

Since circumstances and objectives differ from country to country, no simple, uniform

pattern of transfers is universally appropriate. Experience around the world reinforces

the common sense argument that for services to be efficiently provided, those

69

receiving transfers need a clear mandate, adequate resources, and sufficient flexibility

to make decisions. They must also of course be held accountable for results. To

satisfy these conditions, transfers must be properly designed. This need not have been

the case had the budget gaps of individual states been assessed on the basis of

objective norms independently of actual. Not that the Finance Commissions go

entirely by what the states project of their revenue and expenditure. Projections are

made by the FC, on the basis of growth rates or norms of their own. But the starting

point — the base year figures from which the projections start — still rely heavily on

history or past actual. The projections made by an FC are thus of no consequence to

its successor. They simply go into the 'dustbin of history'25 The design of

intergovernmental transfers depends upon the purpose for which transfers are given. It

is therefore, important to be clear about the objectives of various types of transfers to

evaluate their efficacy. By literary means federal transfers are recommended for:

Closing the fiscal gap, Equalization, Pullovers and some other merit good reasons.

Taxation should have an internal rationale and a connected set of reasoning with

respect to the particular country and in their historical contexts. Taxes involve

transfers of command over resources from the civilian sector to the government. Such

transferred resources are used by the government to serve public ends. But the laws

governing the transfers also have their rationale and have been evolved over a number

of years.

The adverse impact of a large fiscal deficit on the economy should not be

underestimated. Despite some initial beneficial effects of deficits, many studies have

highlighted the vicious cycle that is set in motion because of rising debt, rising

interest payments, fall in the growth rate of development expenditures and the

consequent impact on growth rate. It has serious balance of payments implications if

the government’s saving is not adequately matched by private saving to meet

investment. However, this is not an argument for balanced budget or fiscal balance at

zero deficits. The attempt should be to maintain the fiscal deficit at a level at which

the adverse impact on the system is minimal. The calculation of available resources

may face some additional difficulty in view of the impending changes in the

commodity taxation at state level, such as the introduction of VAT and other related

modifications. The considerations that should go in determining the distribution

among states have been examined in great length by the various finance commissions.

70

Equity issues have dominated such discussions as they should be. The effort has been

to identify variables which reflect the equity concerns. In designing a suitable scheme

of fiscal transfers, three considerations seem relevant:

(a) Need

(b) Cost disability

(c) Fiscal Efficiency

Need refer to expenditures required to be made but not met by own resources; cost

disabilities refer to such characteristics of a state that necessitate more than average

per capita cost in service provision due to factors that are largely beyond its control,

like large areas with low density of population, hilly terrains, poor infrastructure,

proneness to floods and droughts; and fiscal efficiency encompasses parameters like

maintaining revenue account balance, robust revenue effort, economies of expenditure

linked to efficient provision of services and the quality of governance26. Equity

considerations must, in effect, aim for ensuring the provision of selected services at

minimum acceptable standards across the country. It is seen that on average, the low-

income states spend only half of the average per person expenditure of high-income

states in social services. Such equalisation of services may demand some form of

conditional grants requiring monitoring of the use of funds to achieve the desired

objectives. At the same time, ‘efficiency’ in the use of resources should be ensured

and promoted. States that perform more efficiently in the delivery of services or raise

more revenues relative to their tax bases should not be penalised. The task of

formulating a sound transfer system has to establish a fine balance between equity and

efficiency, a system where fiscal disadvantage is taken care of but fiscal imprudence

is effectively discouraged. In such a system, states that are fiscally disadvantaged but

prudent stand to gain, and states that have the resources but do not use them well

stand to lose. Needless to say, fiscal responsibility must be shared by both the Centre

and the states. With the two channels of tax-devolution and grants, it should be

possible for the Finance Commission to achieve the goals of equity and efficiency

through a proper mix. A sound fiscal system is a necessary concomitant of sustained

growth with the equity. Resource transfers have to be an integral part of such a system

facilitating efficient use of resource, accelerated growth and balanced regional

development.

71

Closing the Fiscal Gap (Vertical Imbalance)

Filling the gap between projected expenditures and revenues after tax devolution with

grants, this is popularly known as the gap filling approach. An important reason for

giving transfers areas from the inadequacy in assigned revenues to satisfactorily

undertake functions of sub-central governments or what are the termed as vertical

fiscal imbalance.27 Even when assignments are done solely on economic

considerations, the imbalance does arise. Given the comparative advantage of the

central government in undertaking redistributive and stabilization functions, the more

productive tax and debt instructions get assigned to it. At the same time, sub central

Governments are better placed to provide public services corresponding to the

preferences of the people. Their role in the allocated function and therefore

expenditure is predominant. Consequently, revenue sources do not match expenditure

needs even in the richest unit of sub-central government28. In other words , while the

centre has the comparative advantage in raising revenues and ‘controlling free

riding’, the sub-central or state authorities are better placed to provide public

service efficiently corresponding to varying preferences.29This problem of vertical

fiscal imbalance would have to be resolved through intergovernmental transfers.

Transfers are how most countries achieve vertical fiscal balance, that is, ensure that

the revenues and expenditures of each level of government are approximately equal.

Such fiscal gaps may in principle be closed in other ways - by transferring revenue-

raising power to local governments, by transferring responsibility for expenditures to

the central government, or by reducing local expenditures or raising local revenues. In

most countries, however, sufficient mismatch in the revenues and expenditures

assigned to different levels of government remains for some balancing role to be

assigned to intergovernmental fiscal transfers30. No matter what its stated purpose

may be, any transfer from higher-level to lower-level governments will help close the

fiscal gap. This gap-filling role may be largely eliminated by better design of local

revenue systems.

For many purposes, however, it is useful to think of vertical fiscal balance as being

achieved when expenditures and revenues (including transfers) are balanced for the

richest local government, measured in terms of its capacity to raise resources on its

own31 Fiscal gaps will of course still remain for all poorer local governments, but

72

such gaps are better considered as part of the problem of achieving horizontal fiscal

balance within the local government sector rather than vertical balance between levels

of government.

Transfer of resources under devolution of taxes and duties, the successive Finance

Commission have been using the mechanism of grants- in-aid as prescribed under

article 275 of the constitution. For grants-in-aids the finance commission have been

taking the difference of gaps that remains after setting of the devolution amounts

against the projected deficits of the states. Any balance that remains is met by grant-

in-aid. This has been described as gap filling approach. The finance commission have

relied mainly on devolution of taxes and duties have been prompted by this

consideration. But in this process the advanced state receive much larger share.

Consequently, the inter–state disparity has widened rather than narrowed. While the

constitution provided for a fairly decentralised system of governance over a large area

which should have helped to secure accountability of governments, the gap between

providers of public services and their beneficiaries has widened as a result of the

centralisation that took place in the first three decades. Until now public service

delivery at local levels was effectively in the hands of governments above them.

Accountability has been weakened also by faults in the system of intergovernmental

transfers, to which critics have been drawing attention since long32

Equalization (Horizontal Equity)

The argument for equalization on horizontal equity ground was advanced by

Buchanan (1950) and later reformulated by Broadway and Flatters (1982). Taking

comprehensive income as the index of well-being, it is argued that the income tax

levied by the Central governments cannot ensure horizontal equity. The net fiscal

benefits (NFBs) will systematically vary, the residents in the resource rich (high

income) regions will have higher NFBs and their higher public consumption will not

be included in determining the tax base of the Central government.33

Broadway and Flatters define horizontal equity in two alternative ways, According to

the broad view; the fiscal system should be equitable nation-wide vis-à-vis the action

of all governments. Two persons equally well off before Central and state actions

must also be so afterwards. To conform to this concept of horizontal equity, it is

necessary to give transfers so that each province is enabled to provide the same level

73

of public services at a given tax rate (like in a unitary State) In contrast, the narrow

view of horizontal equity takes the level of real incomes attained by the individuals

after a State’s budgetary operation as the starting points and central fiscal action will

be directed to ensure horizontal equity after the state’s fiscal system has been

established. The central budget need not offset the inequalities introduced by the

operation of the State budgets, but take the income distribution effects of the state

fiscal operations34.

Ever since the era of planning and transfer of federal resources to the states, concern

has been expressed regarding equitable distribution of taxes, grants , awards and

loans in accordance with the needs and capacities of the states and the thrust of

development. In recent years, Centre- State financial relations have come under great

criticism. In India, thirteen finance commissions have attempted to reallocate the

resources between centre and the states. But the mechanism for mobilization,

allocation and transfer of resources has not been conductive to a progressive

reduction of disparities among the states . Although a majority of the development

activities lies with the states, their access to financial resources is very limited. The

fiscal imbalance referred to above varies from one state unit to another. Because of

their higher revenue capacity, the richer states can provide better standards of public

services than their poor counterparts. To offset these fiscal disadvantages, equalizing

transfers are called for.35

Horizontal fiscal balance, or equalization as it is usually called, is controversial both

because different countries have very different preferences in this respect36 and

because it is a concept with many different interpretations. For example, if horizontal

fiscal balance is interpreted in the same gap-filling sense as vertical fiscal balance,

what is implied is that sufficient transfers are needed to equalize revenues and the

actual expenditures of each local government. Such "fiscal dentistry,"37 makes no

sense. It also ignores local differences in needs, in costs, and in own revenue-raising

capacity. Equalizing actual outlays would discourage both local revenue-raising effort

and local expenditure restraint, since under this system those with the highest

expenditures and the lowest taxes get the largest transfers.

To Correct the Spill Over

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The rationale for specific purpose transfer is rooted in offsetting spill over. In the

absence of perfect measuring of the public services by sub-central governments, may

spill over the jurisdictions. To be cost-effective, specific purpose transfer made to the

States to ensure optimal provision of public service require matching contributions

from them, matching ratios should vary with the size of spill over. Subsidy is

required to ‘set the price right’. Often , the general-purpose transfers fail to achieve

full equalization, and in such cases the response to a uniform matching rate would

be non-uniform in rich and poor localities and this may require varying matches

rates among the sub-central units38 The rationale for transfers with the strongest basis

in the economic literature is that local services may spill over to other jurisdictions.

Although matching (or conditional) transfers make local governments more

susceptible to central influence and control, they also have the important political

advantage of introducing an element of local involvement, commitment,

accountability, and responsibility for the aided activities. Such grants may be

particularly important with respect to capital investment projects. If a central

government wishes to use its scarce budgetary resources to attain given standards of

expenditure on certain services provided by local governments, it should pay only as

much of the cost as is needed to induce each local government to provide that level of

service.

Another rationale for matching grants is to equalize differences in need or in

preferences. For example, the central government may wish to increase spending on

health. One way to do so is (as was done in Canada) to match local health care

expenditures, essentially on the grounds that those who choose to spend more on

health, are, by definition, more deserving of assistance. In principle, the correct

matching rate, or the proportion of the total cost paid by the central government,

should be determined by the size of the spill over (or, alternatively, the strength of the

preferences of the central government for the aided activity). The rationale is to

ensure that all local governments, regardless of their fiscal capacity, provide a similar

level of certain specified public services to their residents. The basic idea is simply to

set the price of the service to each local government in such a way as to neutralize

differences in capacity by varying the matching rate. Such equalization differs from

the general equalization argument discussed earlier in three ways. First, specific

services are designated -- either because they are thought to entail spill over or

75

because they are considered especially meritorious. Education and health have been

singled out in this way in a number of countries. Second, the specific level of service

to be provided is also established by the donor government. Third, the payment of the

grant is conditioned on that level of the specified services in fact being provided. With

respect to India, “The vast numbers of such schemes, their high administrative

overhead costs, and rigid eligibility criteria, have undermined effectiveness and

distorted state priorities.” (Of course, the aim of such transfers is precisely to “distort”

state priorities!)39

Grants are determined on the basis of projected gaps between non plan current

expenditures and post tax devolution revenues. Finance Commissions tried to fill the

gap. Some of the Commissions also attempted to enhance outlays on specified

services in the states by making closed-ended specific-purpose non matching grants.

A grant system can thus create poor incentives for local governments to raise their

own revenues. This effect is most obvious in a revenue-pooling system, such as that

used in Germany, Russia, and other countries, in which a given share of locally-

collected taxes is distributed among all local governments. In such a system, local

governments receive only a fraction of the revenue collected in their own

jurisdictions, with the rest distributed to other governments, usually through any

equalization formula sort of thing. Since the cost of local taxation is higher than the

benefit to the local treasury, the marginal cost of public funds appears artificially high

to the local government.

This disincentive effect is so clear that such revenue pooling arrangements seem never

to be used when local governments can influence the tax rate levied on shared bases.

But problems can arise even when tax rates are set by the central government if the

revenues are actually collected by local governments. For example, this incentive has

led to observably lower rates of tax collections by state governments in Germany40.

Similar problems led to the centralization of VAT collection in Mexico, where

originally the central VAT was supposed to be collected by the state governments.

And of course such disincentives have also been prominent in those transitional

countries (such as China before 1994 and Russia still) in which central revenues are

collected by tax administrations which are significantly influenced by local

governments.41 Under capacity equalization the aim is to provide each local

government with sufficient funds (own-source revenues plus transfers) to deliver a

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centrally-predetermined level of services. Transfers are based on a measure of each

jurisdiction’s potential revenue-raising capacity. Full equalization in the sense of

closing all gaps will be achieved only if the standard revenue-raising capacity which

the grant is intended to provide is set at the level of the richest local government. In

most countries, budgetary constraints lead to lower standards, such as the average

revenue-raising capacity of local governments. In such cases, localities with below-

average capacities obviously remain disadvantaged.

Principles of Fiscal Federalism

Economic interpretation of Federalism is addressed to explain the origins of

Federalism in terms of economic interests of the major classes and elites that

variously seek to promote their interests by the authorities of federal or regional

governments. The formation of the American federal union is attributed primarily to

the conflict and cooperation between merchant capitalists and farmers.42 Another

dimension of this approach is the burgeoning literature on fiscal federalism that refers

to the principles and patterns of revenue sharing between the federal and regional

government. From this perspective, federalism is not only a system of governance but

also an economic mechanism of equalization aimed at the reduction of economic

disparities as well as instituting social security for citizens, especially the poor, the old

and the children.43

Whatever the degree of devolution appropriate to the country, the legal framework

that governs the relationships between the central and local governments and the

arrangements for budgeting must be clear and efficient. It is, however, impossible to

provide for every situation. Conflict resolution mechanisms are ‘therefore’ important

to assure smooth inter-governmental fiscal relations. Such mechanisms can operate

through specialised bodies. In Australia, India, and Sri Lanka, for example, a Finance

Commission deals with financial relationships between the central government and

the other levels of the government.

The following principles are required for transparency and efficiency of national, and

sub national interaction.

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(a) Each level of government should have clearly assigned responsibilities,

regardless of what responsibilities are assigned to government as a whole.

(b) Overlaps should generally be avoided, and long concurrent lists of shared

responsibilities are particularly ambiguous.

(c) Fiscal and revenue-sharing arrangements between the central and local

governments should be stable.

(d) Sub national governments need to have a sound estimate of these resources

before preparing their budgets. Lack of predictability affects both efficiency

and fiscal control at the local level. Without an indication of the amount of

resources to be transferred to them, sub national governments cannot program

their expenditures.

(e) Incentives for increased efficiency are needed. However, the central

governments often reduce transfers to sub national governments when they

make economies in spending or improve their own tax collection.

The fiscal federalism literature provides some useful principles that could be invoked

when fleshing out alternative reform agendas and, in particular, the proposed

(re)assignment of functions (expenditure responsibilities and taxing powers) between

levels of government. These principles relate to: expenditure responsibilities; taxation

powers; and intergovernmental grants.

Expenditure Responsibilities

The first principle that deserves mention is that of subsidiary, which has been

interpreted in a federal system of government as implying that provision of goods and

services should be administered at the lowest level feasible within the national

interest44. The rationale appears to be that this permits such provision to most closely

match the preferences of the people.

The second principle to emerge is that of correspondence, which argues that where

consumption or use of a particular good or service is limited to the boundaries of a

particular jurisdiction, then its provision should be allocated to a sub-national

government whose boundaries are defined by the spatial benefit (or market area)

boundaries associated with this good or service45. The resulting allocation generates

economic efficiency since it allows for a matching of local demand and supply, with

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voters able to move between jurisdictions in search for an optimal mix of provision

and associated taxes and charges given their individual needs. An obvious difficulty

confronted when putting flesh around this principle is that, carried to the extreme,

each good or service provided by governments could conceivably have a different set

of spatial benefit (or market area) boundaries leading to a need for a multitude of

overlapping levels of government46. Clearly, common sense is needed when

interpreting this principle if only three levels of government are being considered.

The third principle involves giving due recognition to economies of scale in the

provision of goods and services, with a case generated for movement of provision to a

higher level where it costs less if produced or provided by single jurisdiction rather

than separate smaller ones.47 It has been argued more recently that possibilities for

separation of production from provision should be exploited where feasible, since this

may permit provision to be retained with smaller units, while at the same time

allowing them to take advantage of mutually agreed co-operative production

arrangements at a scale sufficiently large to generate maximum cost savings48

The fourth principle recognises the constraints imposed by existing jurisdictional

boundaries and argues for the need for a mechanism to resolve inter-jurisdiction spill-

over or spill-ins of benefits (and/or costs) of a particular good or service. In the

absence of such mechanisms, economic inefficiency in the form of under- (or over-)

provision of such goods or services would result. The case is thereby created for

responsibility for these goods or services to be either transferred to a higher level of

government, or for it to remain at the lower level but for intervention by a higher level

through system of tied grants aimed at providing ‘compensation’ to those lower level

jurisdictions disadvantaged by the nature of the observed spill-over (or spill-ins). The

tied grant solution is preferred where location-specific or individual-specific cost

differences occur between jurisdictions and/or where economies of scale are

exhausted at comparatively low population levels and/or geographic spreads49

The fifth principle recognises that inter-jurisdictional differences in the nature, cost

and/or level of provision of particular goods or services could generate negative

impacts on the mobility of factors of production, resulting in economically inefficient

location choices. The next principle suggests that accountability is strengthened if

responsibility for a particular function is tier-specific50 For many important functions

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this is not a realistic option, with most analysts acknowledging that assignment of

responsibilities will most often resemble a marbled not a tiered cake51 What is

necessary, then, is to ensure that the nature of this marbling is not randomly generated

but rather emerges from a process of careful deliberation (and is the subject of

periodic renegotiation as economies of scale and other characteristics of production or

provision change over time). If expenditure responsibility in a broad area (e.g.

education or health) is necessarily shared, then respective roles in segments of this

area need to be agreed and mutually understood, with cooperative arrangements put in

place to ensure appropriate on-going coordination between these segments to ensure

they mesh well together at key transition points52

Taxation Powers

The principle of fiscal equivalence implies that each level of government should

finance its assigned functions with funds it raises itself. However carried to extreme

this would lead to significant inefficiencies in tax collection from many revenue

sources and distortions to location choices of individuals and firms. The latter concern

has also led to arguments suggesting that taxes on highly mobile tax bases should be

allocated to higher levels of government, as should taxes on tax bases that are uneven

across jurisdictions53

The resulting lack of alignment of expenditure responsibilities and tax assignments

leads to a situation of vertical fiscal imbalance where revenue raising capacity of at

least one level of government exceeds its expenditure needs whilst the reverse is the

case for the other levels. In general there is support for tax sharing rather than

reassignment of tax bases and rate schedules in this situation, implying the need for a

system of intergovernmental transfers or grants. Such a system needs to be managed

carefully; in particular, a high level of autonomy over expenditure priorities and

service management is required by the recipients in order to ensure that the efficiency

benefits of competitive federalism are not constrained 54

Intergovernmental Grants

Clearly there is a need to evaluate the implications of various change options for the

magnitude and nature of both vertical and horizontal equalisation payments with a

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recognition that the order of magnitude of such payments may need to involve both a

one-off compensation for past inadequate service provision in some newly emerging

jurisdictions, and a steady state set of payment schedules for such jurisdictions in the

future.

Centralised Vs. Decentralised Administration

Even in non-federal states, there has been a growing movement towards greater fiscal

decentralisation in recent years. Some analysts have attributed this to globalisation

and deepening democratisation the world over on the one hand and increasing

incomes on the other55. Other specific reasons for increasing demand for

decentralisation are:

 

(a) Central governments increasingly are finding that it is impossible for them to

meet all of the competing needs of their various constituencies, and are

attempting to build local capacity by delegating responsibilities downward to

their regional governments.

(b) Central governments are looking to local and regional governments to assist

them on national economic development strategies.

(c) Regional and local political leaders are demanding more autonomy and want

the taxation powers that go along with their expenditure responsibility56 

Moreover, in recent years, decentralisation has become a feature of reform agenda

promoted and supported by the World Bank and other multilateral institutions. The

rationale for this has been in part that decentralisation promotes accountability. It is

not therefore surprising that by 1997, 62 of 75 developing nations had embarked on

one form of decentralisation or another.

Fiscal decentralisation involves transferring expenditure and revenue responsibilities

from the central government to sub national governments. The degree of

decentralisation can be measured by the extent of autonomy of the sub national

entities from the central government. The degree of devolution, assignment of

expenditures, and revenue arrangements should be tailored to the country context and

depend on a host of factors including socio, economic and political. Ultimately,

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however, each country needs a system tailored to its specific requirements. Over the

past few decades a clear trend has emerged worldwide towards the devolution of

spending and, to a lesser extent, revenue raising responsibilities to state levels of

government. The view that decentralisation of spending responsibilities can entail

substantial gains in terms of efficiency and welfare has long been held in the

economic literature, Tie bout (1961), Musgrave (1969), and Oates (1972) are of this

opinion57.

The questions arise:

(a) How federal and non-federal countries are different with respect to 'fiscal

federalism' or 'fiscal decentralization' and

(b) How fiscal federalism and fiscal decentralization are related (similar or different)?

A centralised administration would have certain advantages, notably a uniformity of

procedures, which would promote consistency of treatment of taxpayers across the

country and reduce compliance costs and permit economies of scale. A decentralised

administration, on the other hand, would entail greater responsibility and

accountability of the state authorities for the performance of taxes assigned to them,

as well as greater flexibility in adapting systems and procedures to local needs and

conditions. Decentralised administration is more likely to be effective for local taxes,

such as property taxes, business licence fees, user fees, and other minor levies.

Decentralised administration of state level taxes, such as personal or company income

taxes, or even a general sales tax, to be carried out effectively, may require a

systematic exchange of relevant information among state administrations. Substantial

decentralisation of expenditure responsibilities also poses new challenges for public

expenditure management by the various levels of government. These challenges relate

to:

(a) Need to coordinate the budgetary policies of the central and state governments to

ensure their consistency with national macroeconomic objectives;

(b) Need to promote responsiveness of all levels of government to the preferences of

their constituents in both the allocation of budgetary resources and the delivery of

goods and services;

(c) And need to ensure sound financial management.

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The design of inter-governmental fiscal relations is importantly influenced by non-

economic (political, social, and cultural) factors, as well as by economic

considerations. Within the narrow economic context, the design of these arrangements

reflects a balance among different (and not always easily reconcilable) objectives,

namely allocated efficiency, income redistribution, and macroeconomic management.

It could be desirable to agree on multi-year contracts between the central government

and local governments covering both expenditure assignments and revenue

arrangements (tax sharing, grants, etc.). These contracts could, if appropriate, include

performance criteria; minimum standards for services rendered by local government,

etc. They would define relationships in a transparent manner and would ensure

predictability. As with any other contract, of course, the utility of this arrangement

would depend largely on how well it is monitored and respected. National law should

provide standard accounting and budgeting rules for state governments.

Rationale for Decentralization

Much of the decentralization which has taken place in the past decade has been

motivated by political concerns. For example, in Latin America, decentralization has

been an essential part of the democratization process as discredited autocratic central

regimes are replaced by elected governments operating under new constitutions. In

Africa, the spread of multi-party political systems is creating demand for more local

voice in decision making. In some countries, such as Ethiopia, decentralization has

been a response to pressures from regional or ethnic groups for more control or

participation in the political process. In the extreme, decentralization represents a

desperate attempt to keep the country together in the face of these pressures by

granting more autonomy to all localities or by forging "asymmetrical federations." 58A

variation on this theme has been decentralization as an outcome of long civil wars,

such as in Mozambique and Uganda, where opening political opportunities at the

local levels has allowed for greater participation by all former warring factions in the

governance of the country. The transition economies of the former socialist states

have also massively decentralized as the old central apparatus crumbled. In many

countries, decentralization simply has been happened in the absence of any

meaningful alternative governance structure to provide local government services. In

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some cases (particularly in East Asia) decentralization appears to be motivated by the

need to improve service delivery to large populations and the recognition of the

limitations of central administration.59

Although the main reason for decentralization around the world is that it is simply

happening, there are a multitude of design issues that affect the impact of different

types of decentralization on efficiency, equity and macro stability. Economists justify

decentralization on the grounds of allocated efficiency. The rationale is that decisions

about public expenditure that are taken by a level of government closer, and more

responsive, to a local constituency are more likely to reflect the demand for local

services than similar decisions taken by a remote central government. The secondary,

also important benefit in that people are more willing to pay for services which they

find to be responsive to their priorities, especially if they have been involved in the

decision making process with regard to delivering the services. One argument asserts

that a primary economic rationale for decentralization is to improve the

"competitiveness" of governments and enhance innovation -- hence the likelihood that

they will act to satisfy the wishes of citizens.

A number of issues, both theoretical and practical, complicate the view of whether

decentralization is a good or unfortunate economic strategy. At the macro level, an

important concern has been that decentralization may make stabilization policies more

difficult to implement, and indeed, may itself lead to destabilizing levels and

composition of overall public expenditures and public debt. Another perspective on

this, however, is that decentralized systems can be designed to avoid destabilizing

effects and ensure correct incentives. Some of the "decentralization" in the 1980s, for

example, was actually an offloading of fiscal imbalances by central governments to

provincial governments. Under these circumstances, it is not surprising to see a strong

association between decentralization and fiscal imbalances at lower levels. Another

macro level controversy for which evidence is inconclusive is whether

decentralization retards economic growth.

Concerns about equity, inter jurisdictional and interpersonal, have been central to the

discussion of decentralization. Some jurisdictions are better endowed with resources

than others, perhaps because of size or location. In addition, historical circumstances

(e.g., apartheid) may have created local. Thus, an intergovernmental fiscal program

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may be designed to shift resources to disadvantaged areas to ensure that all citizens

enjoy a minimum level of service, regardless of location, or receive enhanced

assistance to accelerate amelioration of deficits, because of location. The allocation of

poverty program grants to sub national levels should be analysed within a particular

country context since lack of transparency, or inadequate specificity in transfer

design, sometimes results in wealthier areas receiving more resources than poorer

areas.

It is usually argued that ultimately central governments are responsible for ensuring

interpersonal equity, but local governments also play very important roles in

implementing central distributional programs and in determining a host of tax,

expenditure and intra-locality transfer schemes. Where local economies are

intrinsically open and many resources, especially key human resources, are mobile,

only limited success should be expected from jurisdictionally focused distributional

programs. The specific services to be decentralized and the type of decentralization

will depend on economies of scale affecting technical efficiency and the degree of

spill over effects beyond jurisdictional boundaries. These are issues that need to be

taken into account in the design of a decentralized system. In practice, all services do

not need to be decentralized in the same way or to the same degree. In an important

economic sense, the market is the ultimate form of decentralization in that the

consumer can acquire a tailored product from a choice of suppliers. The nature of

most local public services limits this option and establishes a government role in

ensuring the provision of these services, but it does not automatically require the

public sector be responsible for the delivery of all services. Where it is possible to

structure competition either in the delivery of a service, or for the right to deliver the

service, the evidence indicates that the service will be delivered more efficiently.60

Although politics are the driving force behind decentralization in most countries,

fortunately, decentralization may be one of those instances where good politics and

good economics may serve the same end. The political objectives to increase political

responsiveness and participation at the local level can coincide with the economic

objectives of better decisions about the use of public resources and increased

willingness to pay for local services. At least five conditions are important for

successful decentralization:

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(a) The decentralization framework must link, at the margin, local financing and

fiscal authority to the service provision responsibilities and functions of the local

government - so that local politicians can bear the costs of their decisions and

deliver on their promises;

(b) The local community must be informed about the costs of services and service

delivery options involved and the resource envelope and its sources - so that the

decisions they make are meaningful. Participatory budgeting, such as in Brazil, is

one way to create this condition.

(c) There must be a mechanism by which the community can express its preferences

in a way that is binding on the politicians --so that there is a credible incentive for

people to participate;

(d) There must be a system of accountability that relies on public and transparent

information which enables the community to effectively monitor the performance

of the local government and react appropriately to that performance- so that

politicians and local officials have an incentive to be responsive; and,

(e) The instruments of decentralization --the legal and institutional framework, the

structure of service delivery responsibilities and the intergovernmental fiscal

system-- are designed to support the political objectives.

Fulfilling these goals is a tall order, but achievable. Successful decentralization is

closely related to observing the design principles of: finance following [clear

assignment of] functions; informed decision making; adherence to local priorities; and

accountability. However, applying these principles in practice has not proven to be

simple. Country circumstances differ, often in subtle and complex ways; consequently

the policy and institutional instruments that establish decentralization have to be

shaped to the specific conditions of individual countries.

In most other respects, the Drafting Committee favoured and accepted the

recommendations of the Expert Committee, with some modifications in some cases.

Among the most significant provisions so accepted was the one relating to the

Finance Commission61. The Expert Committee had recommended the aforesaid

principles for devolution etc. only for a limited period. For the long term, it had

recommended setting up of an expert body, Finance Commission, to make periodic

recommendations on three broad issues namely:

86

(a) Allocation between provinces of the centrally administered taxes assigned to

them,

(b) Considering applications for grants-in-aid for provinces and recommending

thereon, and

(c) Considering and reporting on other matters referred to it by the President.

The basis for allocation of revenues between the provinces was to be reviewed by the

Finance Commission every five years, or, in special circumstances, earlier. In this

respect, the Drafting Committee concurred with the recommendations of the Expert

Committee and the provisions relating to constitution and functions of the Finance

Commission were, with some drafting changes, incorporated in the Constitution.

The Constituent Assembly had adopted the Constitution of India on the 26th

November, 1949. A few of articles, namely, articles 5 to 9, 60, 324, 366,367,379, 380,

388,391 to 393, were brought into force on that day itself, whereas the majority of the

provisions, including those relating to the financial matters, were brought into effect

from 26th January, 1950. The Constitution of India, as it was adopted by the

Constituent Assembly on the 26th November 1949, had recognised the necessity and

the significance of specifying the powers and functions of the Union and the States

and their mutual relationship at the interface. The main features of the federal

structure envisaged in the Constitution are as follows:

(a) The distribution of functional domain, which includes the powers to make laws,

between the Union and the States by virtue of the lists contained in the Seventh

Schedule. List I contains the list of functions in the exclusive domain of the

Union, List II, of the States and List III, concurrent

(b) The executive power given to the Union to give directions to the States in the

normal circumstances (article 257) and during the operation of a proclamation of

emergency (article 353)

(c) Superiority of Union laws over State laws in cases of overlap or conflict (article

254).

(d) Residuary powers of legislation vest with the Centre (article 248).

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(e) The power given to the Parliament to legislate on exclusively State subjects in the

following situations:

(i) With respect to the matters in the State list in national interest, but for a

limited period (article 249)

(ii) In respect of any matter in the State list if the proclamation of emergency

is in operation (articles 250 and 353)

(iii) For two or more States by consent of those States (article 252).

While the Constitution has indicated the broad framework for the terms of reference

of the Finance Commission, it allows the Finance Commission to determine its own

principles for making recommendations in relation to the tasks assigned to it. The

Constitution also permits the Finance Commission to follow its own procedure in the

matter. In addition to the Constitutional provisions, Parliament has enacted the

Finance Commission (Miscellaneous Provisions) Act, 1951, which prescribes the

qualifications for the chairman and members of the Finance Commission and also the

procedure that the Finance Commission should follow to perform its duties. The

ensuing paragraphs review the principles adopted by the Finance Commissions for

assessment of the finances of the Centre and the States and for the tax devolution,

grants-in-aid and other items of the Transfer of Resources.

In many federations most major taxes are collected centrally but the revenue is shared

between the national and sub-national levels of government. The sub-national levels

of government are then left to balance their budgets by imposing their own taxes to

supplement their fixed share of national tax. Mathews (1986, p.54), who did take

fiscal federalism seriously, noted that “ in a modern federation, the revenue powers

and expenditure responsibilities of the different levels of government are so

interdependent that it is no longer possible for governments to make effective taxing

and spending decisions without regard to the effects of those decisions on other

governments”.62 In a federation, the ideal situation is for each level of government to

raise the taxes necessary to fulfil its expenditure responsibilities. This ensures that

each government is accountable and cannot shift blame to another government for

high taxes or inadequate expenditure. It also forces governments to make the hard

choices involved in balancing the burden of tax against the need for services.

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However, it is neither efficient nor practical for many types of taxes to be imposed

and administered by numerous different governments across the one country.63

Current Practices Around the World

To analyse the fiscal federalism in India and Canada, it is must to go through the

current practices going on in some other federations. After all, fiscal relations are not

originated inside the country or some specific region, but it develops because of so

many factors and pressures from the outside. Australia, Germany, Nigeria, Brazil,

U.S.A, is the countries having some of the similarities with India and Canada.

Australia

Australian fiscal federalism is clearly defined by two distinguishing features: (1) the

extent of vertical fiscal imbalance within the federation, and (2) a detailed and

comprehensive approach to horizontal fiscal equalization, which guides the

distribution of funding transfers between the federal, or Commonwealth, government

and the states and territories..64 Currently, the Commonwealth government raises

about 80 percent of all government revenue, but requires only 61 percent of the pie to

meet its own expenditure needs, while state and territory governments raise just 17

per cent of all revenue, but require 33 per cent-twice that amount - to meet their

expenditure responsibilities.65 In some areas, the roles and responsibilities of different

spheres of government have become blurred, giving rise to duplication, overlapping,

and cost-shifting. Many think that the vertical fiscal imbalance in Australia is too

large and has unwelcome implications for accountability, and weakens the motivation

for fiscal reform.

While vertical fiscal imbalance in Australia might be considered undesirably large,

some degree of centralization of tax powers provides a national fiscal capacity to

undertake national objectives and priorities. The objective of the second feature is, to

equalize the fiscal capacities of the state and territory governments, and the current

approach is based on a comprehensive assessment of their relative revenue capacities

and expenditure needs. These transfers are considerable, totalling about $58 billion

Australian dollars per year, and comprise, on average, over 50 per cent of total state

revenue. They are critical to state budgets.66

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A significant proportion of the transfers from the Commonwealth government to the

states and territories, currently of the order of 40 per cent of total transfers, take the

form of Specific Purpose Payments (SPPs). These are tied grants for designated

purposes, essentially to support specific national priorities in areas such as health and

education, and typically come with strings attached. Some observers see this as

undermining genuine subsidiary, competitive federalism, and the development by the

states of more efficient ways of funding and delivering services, and hence effectively

undermining the benefits of federalism. While horizontal fiscal equalization is

generally accepted as the guiding principle for the distribution of untied grants to the

states and territories, its implementation continues to be sensitive and contentious.

Some states argue that the process has become too complex and detailed, and that

many of the differential assessments of state revenue capacities and expenditure needs

do not reflect real, material differences in state circumstances. The role of equalisation

payments in public finance is summarized by Boadway (2004, p.1):

“Equalization should facilitate the decentralization of fiscal responsibilities to

provincial and local governments, which is a defining characteristic of federations. It

should do so in a way that does not compromise the discretion of these orders of

government to pursue their objectives in the way they see most fit. Equalization also

complements the complex system of interpersonal redistribution at both the federal

and provincial levels of government. While the latter is concerned largely with

equalizing access to private goods and services among households with different

incomes and wealth, equalization is concerned with equalizing access to public

services among households of a given type in different provinces”.67

The Australian approach to fiscal equalization indicates that Australians do not want

the type and extent of regional disparities that exist in some other federations. This

approach allows the various jurisdictions to determine their own local choices and

preferences. It is a particular concept of equity that can perhaps best be described as

aiming to deliver fairness rather than equality. And it is generally agreed that a fiscal

federal system set in stone would not necessarily remain appropriate in another time.

In Australia, there are currently 6 States and 2 territories and approximately 774 local

governments. The monopoly of the national government in tax administration is one

of the distinguishing attributes of the Australian fiscal system. Under the present

90

system income taxes on individuals and businesses, sales tax, excise taxes, and taxes

on international trade are Commonwealth taxes. The States’ most important taxes are

on payrolls, financial and capital transactions, gambling, insurance, and motor

vehicles. Local governments tax immovable property.

In Australia, the Commonwealth Grants Commission (CGC), is not a Constitutional

institution and has come about by way of a federal legislation and it has played a

pioneering role in equalisation arrangements. The Australian inter-governmental

fiscal transfers system deal with vertical fiscal imbalance and horizontal fiscal

imbalance between the States through specific grants, specific purpose payments and

block grants (general revenue grants) from the federal government to the States and

local governments. The approach adopted in Australia of determining the TOR68 for

the CGC69 in formal consultation among the Commonwealth and the States is

extremely interesting and gives some thoughts for consideration in the Indian context

too.VAT is a major source of revenue in many countries, including Australia, India

and Canada. It is considered to be an efficient and buoyant source of revenue when

properly designed and administered. In Australia, there is a federal VAT levied

throughout the country, which is distributed to the States through an equalisation

grant. Another impressive feature of TOR for the CGC is that it assigned the task of

not only preparing the index of relative share of each State, but also the annual update

of the relativities. This second part of the TOR for CGC is very appropriate and useful

even for India, as the system in vogue so far freezes the status of the States for five

years. For instance, In India, the levels of revenue receipts and expenditure are

determined by the Finance Commission for the entire award period based on historical

data leading to determination of the base year figures and then projecting an assumed

annual growth rate for the five-year period. The changes in the economic environment

that occur during the five years of the award period have weight for the end of that

period to get reflected in the scheme of fiscal transfers. The tax devolution being in

terms of ratios is liable for fluctuation, whereas the revenue deficit grants are fixed in

numbers. As a result, if the tax receipts of the Union turn out to be less than the FC’s

projection for a particular year, States get proportionately less tax share, leading to

widening of the revenue deficit. However, the grants-in-aid are not adjusted to take

care of such situation. Thus, the dynamism in the arrangements for fiscal transfers,

91

available in Australia through the annual review of relativities by the CGC, is a model

that could be adopted in India too.70

In Australia, the federal government has retained the exclusive power to tax income.

This arrangement has ensured that the tax system has a high degree of uniformity in

tax rates and tax bases. Australia has chosen to use equalisation grants to close

vertical imbalances and reduce horizontal fiscal disparities among sub-national

governments. Australia also achieve a considerable degree of uniformity in sub-

national service levels and show that transfer dependency and equalisation need not

give rise to fiscal profligacy but it is a well designed transfer system. The most

difficult and most necessary area to reform is Commonwealth-State financial

relations. There are two big problems here. The first is that the Commonwealth

collects 82% of all taxes in Australia, but that most expenditure for service provision

(such as hospitals, schools, police and public transport) is the responsibility of the

States. This means that the States are dependent upon grants from the Commonwealth

in order to perform their constitutional functions. It should also be noted that overall,

the Commonwealth’s funding of the States, as a proportion of GDP, is at a thirty-year

low, starving the States of the funds that they need to ensure long-term infrastructure

to provide services.71

Australia, New Zealand and U.K combine legally mandated transparency with rules

and objectives for deficits and debt levels. In addition, transparency improved as a

result of new reporting requirements. In Australia, the States do not have any rule that

prohibit them from running deficits. There is, however, a broad consensus that States

should maintain fiscal balance. Such arrangement provides the necessary flexibility

for the States to run deficits during hard times. During the 1980s, Australia prohibited

sub-national Governments from accessing capital markets and centralised all loans

through the Australian Commonwealth’s Loan Council. The Loan Council was

reconstituted in 1993, and States now operate with more flexibility. As a part of

reforms the States are also required to improve the frequency and openness of their

financial reporting not only to permit monitoring of their financial activities but also

to provide more reliable information to the financial markets. Many States have

greatly reduced their levels of general government net debt over the past decade. For

analysis see Chart 1

92

S.P.P. (Specific Purpose Payments)

In Australia, the Commonwealth provides the following types of payments to the

States. See Chart 2 for details.

(a) Three types of National Partnership payments — project payments, facilitation

payments and reward payments; and

(b) General revenue assistance, consisting of GST payments and other general

revenue assistance.

The Intergovernmental Agreement provides that all payments for National SPPs and

National Partnership Agreements will be paid by the Commonwealth Treasury to each

state treasury on the 7th day of each month. The Commonwealth provides payments

to the States for specific purposes to enable important national policy objectives in

areas that may be administered by the States to be pursued. These payments cover

most functional areas of state and local government activity including health,

education, skills and workforce development, community services, housing,

Indigenous reform, infrastructure and environment.

In 2010-11, the Commonwealth has made payments for five National SPPs: National

Healthcare SPP; National Schools SPP; National Skills and Workforce Development

SPP; National Disability Services SPP; and National Affordable Housing SPP. An

equal per capita distribution of National SPPs ensures that all Australians, regardless

of the jurisdiction they live in, are provided with the same share of Commonwealth

funding support for state service delivery. In the case of the government schools

component of the National Schools SPP, the relevant population is each State's share

of full-time equivalent student enrolments in government schools. The States are

required to spend each National SPP in the relevant sector. For example, the States are

required to spend the National Affordable Housing SPP in the housing sector, but they

have budget flexibility to allocate funds within that sector in a way that ensures that

they achieve the mutually agreed objectives for that sector outlined in National

Agreements.72 The Commonwealth provides National Partnership payments to the

States to support the delivery of specified projects, facilitate reforms, or reward those

jurisdictions that deliver on nationally significant reforms. Some payments for

93

specific purposes under the previous federal financial arrangements have become

National Partnership project payments in Australia.

The Commonwealth recognises the need to support the States to undertake priority

national reforms. Consequently, when an area emerges as a national priority, National

Partnership facilitation payments may be paid in advance of the States implementing

reforms. This recognises the administrative and other costs associated with

undertaking the reforms. National Partnership reward payments can be used to reward

those States that deliver reform progress or continuous improvement in service

delivery. National Partnership agreements set out clear, mutually agreed and

ambitious performance benchmarks that encourage the achievement of reforms and

continuous improvement in service delivery.

Total Payments for Specific Purposes

Total payments to the States for specific purposes constitute a significant proportion

of Commonwealth expenditure. In 2010-11, they are estimated to total $45.5 billion,

down from $53.3 billion in 2009-10 (a decrease of 14.7 per cent), and represent 12.8

per cent of total Commonwealth expenditure. From 2011-12, an agreed portion of

GST is dedicated to health and hospital services.73

To sum up, the financial arrangements between the centre and the states in Australia

are governed by Constitutional provisions only to a limited extent, mainly in relation

to sharing to expenditure responsibilities and revenue authority. While the

Constitution assigned customs and excise to the domain of the Centre, in course of

time the Centre expropriated even income tax and corporation taxes even though this

was done without any Constitutional requirement. The expenditure responsibilities of

the states continue to remain expensive, leading inevitably to the requirement of fiscal

transfers. The arrangements for fiscal transfers are controlled largely in terms of

intergovernmental agreements rather than any Constitutional schemes. Fiscal transfers

are no more in terms of tax devolution but are by way of grants which are generally

accompanied with certain conditionality’s. The Commonwealth Grants Commission

determines the relative shares of the States. However, the net result of the existing

arrangements for fiscal resource sharing and transfers is preponderance of the Centre

over the provinces74.

94

Nigeria

The first phase of the development of fiscal federalism in Nigeria occurred during the

1948-1952 period. This phase was marked by a centralised financial arrangement in

which the excess in the budget of the central government was allocated to regional

governments on the principle of derivation. The expenditure needs of the central

government thus took precedence. In the second phase (1952-54) autonomous

revenue and tax jurisdiction for the regional governments was introduced in addition

to the operation of the principle of derivation for the sharing of federally collected

revenue. The basic elements of the second phase were carried over to the third phase

(1954-59). A major distinguishing factor of this phase was the emphasis on the

derivation principle in the sharing of federally collected revenue. 75

 Debates on Nigeria's fiscal federalism preceded the gradual evolution of Nigeria into

a colonial federal state in 1954 throughout its history; it has been evident that

Nigerians have always been sensitive to the fiscal dimensions of its federation.

Nigeria's media have been awash with the debate over the nature of resource

generation, distribution, and challenges of equalization in the federation. At the

National Political Reform Conference in 2005, delegates from some states of the

federation staged a walk-out because of the nature of resource distribution.76 The

Nigerian Constitutions from 1960 to 1999 recognized the citizenship of the every

Nigerian. All Nigerians supposedly have the right to settle down anywhere in the

country to pursue their legitimate businesses and are expected to have equal rights

everywhere in practice. But this is not true. In reality there is a contradiction. The

ethnic consciousness, indigenous ship-citizenship rights are not still well-defined and

accepted. Many states and communities recognize their indigenes and can easily

isolate settlers, and treat them so, no matter how long they have lived in the area. In

the political process this has become very controversial and has generated many

violent crises. In some cases the spill-over or hang-over of these issues have led to

electoral violence, because it becomes important who is elected– indigene or settler.

The Jos North violence, the Wase case, the Tiv–Jukun and similar cases77 of violence

illustrate the explosive nature of this issue in the polity and in the electoral process.

State governments may want to enact laws stating the residency requirements for

95

those who have lived for a long time in a local area. It may even enact law for a

twenty–five-year residency requirement for citizenship.78

As often described, the Nigerian federation between October 1, 1960 and January 15,

1966 witnessed a situation in which regional tails wagged the federal dog.79 Nigeria

returned to democratic rule on May 29, 1999, after about three decades of military

rule. In addition, the military rulers were succeeded by a former military Head of

State, General Olusegun Obasanjo. Intergovernmental cooperation could not take

place under Obasanjo, because he personalized his quarrels with former Governor

Tinubu of Lagos. While the federal government has respected the autonomy of states,

it has also appealed to state governments to respect the constitutionally guaranteed

autonomy of local government councils. Generally, not only has there been a sigh of

relief over Yar’Adua’s style of administration and his adherence to the principles of

the rule of law, the misuse of security agencies to prosecute political opponents seems

to have receded to the background. Federal–state relations seem more cordial, and the

prospects of intergovernmental relations seem higher. Many Nigerians are impressed

by what difference can be made by leadership and leadership styles in a federal and

democratic setting. Perhaps, the picture of the real Yar’Adua as a leader will become

clearer after the courts rule on challenges to his election. For now, however, Nigeria

seems to be on the threshold of a new democratic and federal polity.80 Like in all

politics, the human dimension is important in effecting adjustments in a federation.

The quality of leadership is important in the nature of these adjustments. After all, no

matter what laws and structures are established, the system has to be operated by

human beings. The values of accommodation or tolerance, fairness, justice, and equity

are human values which only human beings can actualize.81

Nigeria needs to diversify her mono cultural economy. Her deregulation and

privatization policies must be pursued with all sense of patriotism and sincerity,

transparency and accountability. One must not forget that democratic culture and

stability cannot thrive in a society where there is abject poverty. The federal

government’s poverty eradication programmes have so far failed to tackle the

problem. Nigeria needs to work seriously on the economy to save her democracy. 82

96

Brazil

Brazil is a country which is accounted for undeniable achievements, holding

tremendous potential and facing complexes challenges. Its more than US$ 500 billion

of Gross Domestic Product allow it to be ranked among the ten biggest economies of

the world. With a population near 170 million of people, it is also the fifth most

populated country of the world and its area of more than 8.5 millions square

kilometres rank it as the fifth biggest country of the world.

The Brazilian Federation was created along with the Republic back in 1889. The Tax

System adopted by the newly created Federal Republic was inherited from the

Imperial Regime. Naturally, the main changes introduced were to ensure that the

States would have some financial autonomy. So, it was adopted the regime of

separation of tax revenues for the different levels of government. The tax on imports

was kept as exclusively source of revenue for the Central Government and the States

were entitled to tax the proceedings of exports, plus taxes on rural and urban estates

and tax on industries and professions (a primitive form of tax on goods and services).

As for the Municipalities (Local Governments), the Republican Constitution provided

that the States would be in charge of establishing specific taxes, so that to ensure their

financial autonomy. At the beginning of the Federation, therefore, the Local

Government was the weak link of the chain depending heavily on the State

Governments.83

It is worth to mention that all along the initial period of the Brazilian Federation, the

functions and responsibilities of the different levels of government remained basically

unaltered. It can be partially explained by the fact that until the fifties Brazil was

mainly a rural country, with a low percentage of the population living in urban areas.

Therefore, the demand for public services was incipient. Thus, in addition to the

traditional government functions of defence, justice and public administration, the

only important public service provided by government at that time was Education,

that was a responsibility shared by the Federal Government (College Education),

States (Secondary Education) and Municipalities (Primary Education).84

The year of 1946 represent the beginning of a new stage in the Brazilian Federation

evolution as well to its Tax System. In the year before the Vargas Dictatorship had

ended, a new congress was elected to vote a democratic constitution and a president

97

was democratically elected again after 15 years. Although the new constitution did

not introduce radical changes on the Tax System, it promoted significant efforts of

decentralization, giving to the State Governments and mainly to the Local

Governments more autonomy as well as sources of revenue. It also institutionalized a

mechanism of tax revenue sharing among the different levels of government.85 To

summarize that long historical road of the Fiscal Federalism in Brazil is sufficient to

underline three aspects:

(a) The gradual shift from a system based on Taxes dependent of Foreign Trade to one

entirely dependent on domestic transactions

(b) The gradual introduction and improvement of a System of Financial Transfers

between the different levels of government

(c) Cyclical movements of centralization and decentralization referred to the amount

of financial resources shared by each level of government as well as the autonomy

of each level to define their own taxes; these cycles can be summarized as follows:

post 1891: first Republican Constitution = decentralization

post 1936: Vargas dictatorship = centralization

post 1946: Democratic Constitution = decentralization

post 1964: Military regime = centralization

post 1988 : Back to democracy = decentralization

Constitutional Provisions

Unlike other federal constitutions, which typically define municipal governments as

creatures of their respective states, the 1988 Constitution establishes municipal

government as a third tier of government with a Constitutional status equal to the

States. States therefore cannot compel or prohibit actions taken by the municipalities

within their jurisdictions.86 The 1988 Constitution deepened the process of

decentralisation in Brazil and granted greater autonomy to States and municipalities in

debt and expenditure management and control. In 1989 less than half of all

government spending was controlled by the federal government. Brazil's new

constitution gave autonomous broad powers to states and municipalities on certain tax

and spending functions, with independent municipalities.

Presently, a Republic with 3 levels of government (the Central, Federal Government,

the intermediary) Brazil is a highly decentralised, three-tiered federation with 27

98

States (24 states, two federal territories, a federal district) and 5,559 municipalities.

Differently from other known republican experiences, the Brazilian Federation was

not a result of conviction of the people in general, but rather decided at the highest

levels of authority to divide the unitary State that prevailed during the Imperial

Regime. The Constitution enumerates certain concurrent powers and functions for the

Union, the states, the Federal District and the municipalities. These include, among

others, protection of public property and assets of historical, artistic and cultural

value, environment, forests, promotion of agriculture, dairying, and housing, poverty

alleviation measures etc. (article 23). The residuary powers of legislation are vested in

the States. However, in case of a conflict between a federal law and a State law, the

former would prevail87, just like India.

The decentralization was considered as a natural reaction to the twenty years of

authoritarian regime and to the centralization of powers and financial resources at the

federal level, which it supported. 88 The Brazilian Constitution has given equal regard

to the States and Municipalities as well as the Union, in respect of tax sharing. The

Constitution defines a system of "unconditional" transfers between the Union, the

States and the Municipalities, which can be either direct or through creation of special

funds (indirect). Regardless of their type, transfers always occur from higher to lower

levels of government; that is, from the Union to the States and from the Union to the

Municipalities or from States to their respective Municipalities89.

Reforms in the Tax System

Some authors90 argued that changes in the Tax System introduced by the Federal

Government to restore its financial balance jeopardized by the 1988 Constitution and

to ensure macroeconomics stability brought mostly negative consequences to the

Federate equilibrium, either by concentrating revenue at the Federal Government, or

by imposing political and administrative constraints over the sub national

governments.91 The indisputable priority assigned to the fiscal balance, established by

the agreement with the International Monetary Fund, forced the Federal Government

to raise taxes and create new ones but it is increasing the tax burden and deteriorating

the quality of the tax system.

99

Brazilian Development Model, meaning that the private sector should replace the

financially weakened public sector as responsible for the investments in the

productive sectors and infrastructure. This would allow the country resume its growth

trend. In its new “model” the public sector should be in charge only for the

investments in the social sectors. Reforms in the recent past have focused on

strengthening vertical inter-governmental fiscal relations. The Fiscal Responsibility

Law and complementary legislations contain the key incentives for fiscal probity at all

levels of government. Federal transfers to sub-national governments account for

approximately one-fifth of federal revenues and for 30 per cent and 70 per cent of

total State and municipal expenditure, respectively.

There is also a sweeping function assigned for the Union, namely, “to prepare and

carry out national and regional plans for the ordaining of the territory and for

economic and social development”92. For the States, the Constitution provides for

only one clause of exclusive powers and functions, which is, the power to operate,

directly or by means of concession, the local services of piped gas, as provided for by

law, it being forbidden to issue any provisional measure for its regulation93

In case of Brazil the main objectives of tax reform is to reduce tax evasion and to

strengthen local revenue mobilisation particularly at the municipal level. Greater

emphasis on local revenue mobilisation reflects the efforts to reduce dependency of

lower levels of government on grants and transfers from higher levels of government.

The major revenue reforms relate to introduction of VAT and own-source tax revenue

of the States. In Brazil, federal VAT applies to industrial goods, while the State VAT

taxes the circulation of goods in general and some services and municipalities levy

charges on a specified list of services. It is noteworthy that the federal VAT is fully

creditable against the State VAT. Although the Brazilian States obtain nearly 85 per

cent of their own source revenue from the State VAT there are a number of complex

technical and administrative problems concerning the application of different VATs in

different States. In addition, the tax bases to these three taxes overlap leading to

confusion and inefficiency.94

100

Fiscal Responsibility Legislation (F.R.L.)

If the Financial Restructuring Program was “inspired” on IMF practices, the FRL on

the other hand, was explicitly suggested by the IMF on the agreement signed between

the Fund and the Brazilian Government in 1999, in the crisis that preceded and

followed the devaluation of the Real (the Brazilian currency). The Law was voted and

enacted, a little more than one year after the signing of the Agreement. The Law is

very broad and complex, encompassing many public finance aspects. Brazil enacted

the FRL95 (2000) after a history of repeated fiscal crises and a long history of the

federal government bailing out sub-national governments. Brazil has combined deficit

and debt rules, expenditure rules and transparency into its fiscal responsibility

legislation. Brazilian States suffer from inflexible budgets because committed

expenditure on pension, interest and wages represent most of their current expenditure

Brazil’s FRL also require multi-year budgets with three year targets for revenues,

expenditure, and indebtedness. A Law that had the concern with equilibrium and

equality in the Federal System should have looked to differentiate among different

states and municipalities, as long as the core philosophy, namely, responsible fiscal

and financial management is accomplished. Being a Law inspired entirely by an

economic view of the administrative process (fiscal responsibility, balanced budget

and so on), it lacks a concern with the quality of the administration and services

rendered to the public. Finally, the FRL imposes further reduction in the degree of

fiscal autonomy of sub national governments.

In Brazil, increased revenue autonomy and decreased transfer dependency is seen as

an important mean of fostering greater fiscal discipline among sub-national

governments. Tax autonomy, however, is not sufficient condition for reducing the

vertical gap as sub-national governments operate under a hard budget constraint. In

Brazil, the equalisation transfer represents a very large allocation of resources. These

include the State and Municipalities Participation.

A crucial challenge for Brazil to come is, therefore, to balance the public sector

finance in order to cope with these social demands. Being a federation, an equally

important challenge is to assign to which different level of government their

responsibilities in that task and the corresponding financial resources to cope with it.

101

That is not an easy challenge, since the struggle between the federal and the states and

local governments to increase its share of the public sector revenues seems to be an

endless one. In fact, that struggle has been deepened in the recent past, following the

1988Constitution that implemented a strong decentralization of tax revenues.

Moreover, the Federal Government that normally would resist to giving-up revenues

as a natural political instinct recently had added to its line of reasoning the necessity

to maintain a strict control on the financial flows in order to ensure balanced finance

for the public sector and the economic stability. To justify that sort of reasoning it is

alleged that the federating unit (states and local) levels of government are known to be

less committed to fiscal discipline.96 This “bad reputation” of sub national

governments with respect to fiscal discipline can be explained by mixed reasons:

(a) The populism and clienteles that characterizes politics in Brazil and that is

more generalized at the sub national levels

(b) The heavily reliance on transferred revenues at the sub national levels that

encourage governments to increase spending with no corresponding increasing

in taxing on local taxpayers, among others

As mentioned before, the drive for centralization and control over the sub national

governments are usually justified on the ground of the bad reputation of these levels

of governments as managers. According to these lines of reasoning the sub national

governments, due to a tradition of clientelistic politics and lack of a commitment to

national goals, such as economic stability, tend to waste the public money and not to

show commitment with fiscal discipline. 97

Switzerland

Its highly fragmented structure of local governments and serious horizontal fiscal

imbalances make Switzerland a surprisingly powerful model for Eastern European

countries that are currently facing the challenge of fiscal decentralization. In spite of

the substantial differences in the tradition and current practice of intergovernmental

fiscal relations, transition economies may learn valuable lessons from the Swiss case

in the fields of direct democracy, horizontal cooperation, expenditure and revenue

assignment, and fiscal discipline. Switzerland is one of the most non-centralized

102

countries in the world. Despite the relative success of Swiss federalism, most federal

countries follow the principles of coordinated rather than competitive federalism.

Switzerland’s existence as a modern federal state dates back to 1848. The government

is made up of seven members, elected by the Federal Assembly. The government

members take it in turns to act as president. The Swiss people can influence political

affairs through the highly developed system of direct democracy. Switzerland’s

position as a neutral state allows it to play an important humanitarian role in world

affairs and to act as a mediator between conflicting parties. Switzerland in its modern

form came into being in184898. Until that time, Switzerland was not a real state, but a

loose alliance of autonomous cantons whose degree of cooperation with each other

varied from one period to another. Before 1848 the cantons were free to secede from

the confederation if they wanted to. Switzerland's 1848 constitution made it into a

federal state, giving it a central authority that counterbalanced and limited the power

of the individual cantons. Since the Constitution of 12th September 1848,

Switzerland has been, in institutional terms, a relatively complex system of three

layers of government: (1) the communes, at the local level, (2) the Cantons, at the

intermediate level and the Confederation, at the national level - which are

interconnected by many vertical and horizontal relationships. At the end of this

decade, there were 26 Cantons and 2903 communes.

Fiscal federalism in Switzerland can be characterised in terms of overall fiscal

restraint and minimising the centralisation of fiscal power. It is bottom-up

“federalism. Constitutional arrangements, both at the federal and the cantonal levels,

certainly explain this performance. The subsidiary principle - which recommends that

competencies in the provision of public services should be vested to the lowest

possible level in the fiscal hierarchy - has been probably more scrupulously respected

in this country than in many other federations because of both constitutional

guarantees and a traditional mistrust of global nation-wide policies99. Four

institutional characteristics are essential in the working of Swiss federalism: (1) the

vertical division of power in the Constitutions, (2) direct democracy, (3) initiatives

and referenda and (4) horizontal co-operation between governments at the cantonal

and communal levels.

103

Some areas, such as foreign policy, are now solely in the hands of the central

government. The cantons no longer have the right to secede. The constitution was

designed to balance as fairly as possible the interests of the state as a whole with the

interests of the individual cantons. For historical reasons, Switzerland's official name

is still the "Swiss Confederation". In Latin this is Confoederatio Helvetica, from

which the country's international abbreviation, CH, is derived. However, this is in fact

a misnomer: a confederation is an alliance of autonomous entities. Since 1848

Switzerland has been a federation: a grouping of entities with a central authority. The

word Helvetica refers to the Helvetians100, one of the many Celtic tribes living in what

is now Switzerland at the time of the Roman conquest."Switzerland is not like any

other state, whether in regard to the events that have occurred there in the past several

centuries, or in regard to its geographical situation, or in regard to the great

differences between the customs of its various parts. Nature has made your state a

federal one, and no wise man would want to flout her."101

Legislative Branch: Parliament

The Federal Assembly is made up of two chambers, the National Council representing

the people, and the Council of States, representing the cantons. The make-up of the

Assembly reflects the desire to balance the interests of the cantons, to ensure that

smaller ones are not dominated by larger ones. The 200 seats in the National Council

are distributed between the cantons in proportion to the size of their population, while

the Council of States has two members for each canton, and one for each half canton,

making a total of 46. However, the two chambers are of equal weight.102

Executive Branch: the Federal Council

The Federal Council, Switzerland's government, has seven members. Each year, a

different member becomes Federal President. The post confers no special powers or

privileges, and the president continues to administer his or her own department. The

four strongest parties are represented in the council.

Fiscal Democracy

In fiscal federalism, institutions play an important role in shaping the relations

between the layers of government. It is therefore of interest to shed some light on the

104

working of the institutions in Switzerland, particularly on the rules and principles,

which govern the assignment of functions and revenue sources to decentralised

jurisdictions.

The federal principle was threatened in Switzerland during the two world wars and

the great Depression. The federal government initiated an income tax at the start of

the First World War, when customs duties dropped dramatically. The federal

government also imposed a number of emergency taxes to meet the exigencies of the

war, many of which continued for a number of years after the war. New provisions

were introduced in the 1930’s to cope with the depression and subsequently the

Second World War. A similar process surrounded the development of welfare policies

in the 1930’s and 1940’s. While there was a need for the federal government to

introduce social legislation during the depression ,much of the action taken was the

un constitutional , or at least extra constitutional, relying upon broad emergency or

the power to make urgent arrest. However most of this new legislation was

approved in a major constitutional amendments on July 6, 1947 . these policies

were enshrined in article 31, now often referred to as the “ economic article”. The

social policy initiative of the federal government were thus legitimated by the

people.103

By 1984 the federal government received roughly 60 percent of its revenue from

sources to which it was not entitled under the constitution . The federal constitution

resorted to “urgency arrest” to claim these special taxes. The federal government was

thus at the point of overwhelming the cantons, but the people rejected a constitutional

amendment enshrining these new federal taxes in 1950. In 1958 the people approved a

constitutional amendment that continued some of these taxes but only as

“temporary” measures.104 In short , the highly federal process of fiscal change

ensured the support of the people and guaranteed cantonal sovereignty in the field of

direct taxation.

The principals of fiscal federalism are supposed to follow the general proposition of

article 3 of the constitution. The federal government as which its jurisdictional

powers, is entitled only to revenue sources expressly delegated to it. The constitution

of 1848 provided the federal government recourse to custom duties , post office

revenues , stamp duties , alcohol and tobacco taxes and some other minor taxes .

105

All other taxes are a cantonal prerogative. Article 3, coupled with the constitutional

amendments process, has prevented the federal government from invading cantonal

areas o taxation . Although the cantons are partially dependent upon federal

transfer , the three order of government divide the revenue pool almost equally . the

federal , cantonal and local share of revenue was 35 per cent , 34 percent and 31

percent while the proportional share of spending was 31 per cent , 39 percent and

30 percent respectively105 .

The most notable feature of fiscal federalism in Switzerland is the near complete

separation of revenue sources between the federal and cantonal governments. The

federal government relies almost wholly on indirect taxes, while the cantonal

governments rely almost exclusively on direct taxes. Income tax is the only notable

area of overlap between the federal government and the cantons, but this is relatively

minor. Moreover all income tax is collected by the cantons, which subsequently

transfer the federal share to the central government. The federal constitution gives

significant powers both to Switzerland’s 26 regional cantons and to the individual

towns and villages in them. A handful of cantons have used ultra-low taxation to

attract wealthy individuals to stimulate economic growth. Among the best known are

Zug and Schwyz, both not far from Zurich. Most recently, Obwalden, a small,

mountainous canton near Lucerne, slashed tax rates to match its low-tax rivals.

Federal transfers to the cantons are of three sorts: tax sharing, conditional grants and

reimbursement. Conditional grants constitute just under the half of these transfers ,

but in total these transfers account for only 20.6 percent of cantonal revenue in

1980’s. Conditional grants thus form only about 9 percent of cantonal revenue. In the

sum, the system of cantonal fiscal sovereignty has worked well. While the federal

principal has been threatened in times of crisis, the highly federal constitution has

allowed the cantons and the people to constrain the quasi-federal government. In

Canada, the provinces were unable to constrain the federal government in the post-

war reconstruction phase.106

The Swiss federal system emphasises the sovereignty of sub central jurisdictions, i.e.

the Cantons and the local communities. This sovereignty is derived from the federal

and cantonal constitutions, which list not only the tasks of each government level, but

also fix their right to levy some sorts of taxes. Thus, the assignment of competencies

106

and revenue sources is guaranteed at each level of government. The vertical division

of power, intended to prevent stable majorities from being able to exploit minorities,

is strongly safeguarded in the Constitution107 Article 3 of the new Federal Constitution

of April 18th, 1999 guarantees the Cantons' sovereignty in all the spheres in which the

Constitution does not explicitly provide for the federal government's competence.

Article 42, defines in a restrictive manner the assignment of functions to the

Confederation: "it shall accomplish the tasks which are attributed to it by the

Constitution."

Tax Administration

In principle, each level of government and each government within a same level may

have its own tax administration. Thus the Cantons have a legal obligation to collect

the (FDT)108 on individual income, corporate profits and capital and on capital gains.

They also participate in managing the federal withholding tax and stamps duties. In

addition, because the powers of the State tax administrations are limited to the

territorial area of the State to which they belong, whereas economic activities may

spill over cantonal limits, a decentralised tax administration creates problems and

conflicts.

Equalization

The differences in the Cantons in terms of size, geography, population and economic

potential are so great that, without equalisation measures, fiscal federalism would

perform under regional disparities which would be intolerable. Therefore, the federal

government intervenes to correct the primary distribution of resources between the

Cantons with three main policy measures: fiscal equalisation, agricultural aid policy

and assistance to mountain areas, with the purpose of strengthening structurally weak

regions.109

It is necessary to stress the fact that, in Switzerland, there are no constitutional

provisions and no claims from the cantonal governments that equalisation measures

should compensate entirely for the differences between the Cantons in order to obtain

identical economic or fiscal conditions. The pragmatic objective is to render regional

disparities politically acceptable so that remaining differences do not end anger the

cohesion of the Confederation. According to the 1959 federal law on equalisation, the

107

original objective was to enable the Cantons to provide minimum acceptable levels of

certain public services without much heavier tax burdens in some cantons than in

others. Equalisation related to policies aimed at correcting fiscal imbalance, whether it

resulted from differences in the revenue-raising capacities of the Cantons or because,

in some jurisdictions, the relative unit cost of providing some defined levels of

services was above the national average.

From the very beginning, equalisation has excluded differences in cantonal outlays for

services other than or above minimum standards and differences in the

progressiveness of the tax rate schedules that reflect the concept of income

redistribution or the mix between benefit tax and ability-to-pay tax at cantonal level.

At the local level, many cantons have introduced inter-communal equalisation, with

similar ends and means. The most direct means for reducing cantonal disparities is

through fiscal equalisation measures,110i.e. payments from the federal government to

the Cantons with the purpose of reducing differences in fiscal capacity.

The main characteristics of the fiscal-financial system are the following:

(a) Each level of government and each government within the same level has

direct access to many, but at least two major revenue sources: at the federal

level, direct taxation and VAT; the cantonal level, direct taxation and grants

plus revenue sharing.

(b) Based on VAT with an actual normal rate of 7.5 %, the main consumption and

expenditure taxes are exclusive and belong to the federal level. Taxation on

motor vehicle is cantonal; the communes can levy minor taxes on dogs,

entertainment and games.

(c) Direct taxation is a joint taxation of the Confederation (individual income plus

corporate profit), the Cantons and the communes (individual income and

wealth plus corporate profit and capital). For the Cantons and the communes,

taxation of individual income and wealth and of corporate business profits and

capital ("direct taxation") is the major source of revenue (43 and 47 per cent).

(d) For the communes, revenues from public property (7 %), user charges from

local public services (mainly: water, sewage and purification plants, garbage

collection) and indemnities (in total 28 %), are in sum the second most

important revenue sources. However, these sources are limited. Revenues

108

from immovable properties, whether public or private, are subject to the

federal legislation on rent control.

(e) The Cantons and the communes have a rather low dependence on transfer

payments: the Cantons receive 17 % of total revenues in the form of specific

grants from the Confederation, and the communes 13 % from the Cantons.

Although three levels of taxation might sound expensive, personal taxes in

Switzerland are relatively modest compared with much of Europe. Even “average”

cantons tend to charge less than elsewhere in Europe, the Swiss say encourages

cantons and local administrations to maximise efficiency.111

United States

USA had a fairly decentralised federal system for the first one hundred and fifty

years. The United States federal system is highly decentralised, and generally

regarded as an example of a well-managed federal fiscal system. Currently, the US is

composed of 50 States, 1 federal district and 87,525 local governments. The

Constitution of the United States allows the States to perform all functions that are not

expressly reserved for the federal government and do not violate the Constitution.

Both the federal and State tiers of government levy a tax on personal income,

although the federal income tax leaves only limited room for the States. Most States

rely on the use of personal income tax and general sales taxes, which produce more

than two-thirds of their tax revenue.

Before the Great Depression, of the total public expenditure (forming 10% of GNP)

only 30-35 percent was accounted for by the federal government; the share of the

states' and local governments taken together formed 65 percent (states 15 percent). In

the course of the next thirty years or so, the expenditure-GNP ratio rose to over 30

percent with the share of the federal, states and local governments forming 70, 20 and

10 percent of the total respectively.112 United States has experienced a change in the

mix of revenues and spending at each level of government towards greater

decentralisation. In 2002, States derived nearly 66 per cent of total revenues from own

sources while local government raised 55 per cent of total revenues from own sources.

Federal government expenditure accounted for 50 per cent of total expenditure in

109

2002, while the remaining half of total expenditure was accounted for by the State and

local governments.

Although the US is characterised by very low fiscal imbalance, State and local

governments are heavily dependent on transfers from the federal government to meet

their financial needs with the transfers from the federal government accounting for

about 30 per cent of State’s total revenues. Similarly local Governments depend on

inter-governmental transfers for nearly 37 per cent of their total revenues (33 per cent

from State and 4 per cent from federal level). While there is no system in place to

equalise fiscal capacity across States, horizontal fiscal equalisation occurs only

indirectly via grant-in-aid programmes113. Sub-national governments in the United

States are, in principle, free to borrow without federal involvement. But in reality, the

federal government subsidises sub-national borrowings by exempting the interest on

State and local bonds from federal income taxation. The national and federal elements

were intelligently combined in the American constitution on the basis of which the

Americans were able to overcome the crisis of confidence and national unity. The

Americans have been able to adjust according to the needs of time largely in terms of

the federal spirit of the constitution.114 There have been pressures and tension in the

American political system on account of racial discrimination, excessive use of the

powers executive, and on the mode of decentralisation of power. But by virtue of the

practical wisdom the Americans could work with the same constitution by making

adjustments in the National and federal elements. Except the minor adjustments

there have not been drastic changes in the constitution on the power and position of

the congress , the president and the judiciary .115 The federal framework provides

maple scope for a vast country like the united states to make progress while

guaranteeing the fundamentals rights of the people and their participation in the

state management .

Germany

The modern German federation was established only after World War II. The present

state of German federalism can only be understood against its historical background.

During most the 19th century, Germany consisted of a patchwork of mini-states

subject to hegemonies, and interests of both German-speaking superpowers (such as

110

Prussia and Austria) and centrally controlled European nation states (such as France,

Russia, and the United Kingdom).

Some key elements are given below, of the German national character and

institutions:

(a) The desire to regroup the nation in line with language and cultural heritage116;

(b) The readiness to share the fruits of national economic development and growth on

an even footing (interpersonal, sectored and regional solidarity);

(c) The joint representation of state governments in the second chamber of the federal

parliament (the Bundesrat);

(d) The acceptance of uniform standards and harmonized taxes throughout the nation

including homogeneity of policies at lower tiers of government117.

Therefore, in an ultimate sense, the philosophy of the German brand of federalism is

highly symmetrical as to potential outcomes. It may, however, imply vast

asymmetries in the functioning of institutions and the workings of political and

bureaucratic procedures. In order to achieve the uniformity of living conditions and

homogeneity of policies, for instance, there must be uniform, typically

centralized,118guiding principles for the whole nation. This by itself introduces a new

type of asymmetry at the vertical level. While other federations such as the United

States or Canada accept concurring sovereignties at various levels, with full taxing

and expenditure powers for each tier, the German model of federalism can be

characterized as asymmetrical power sharing. In this different paradigm, the

federation (apart from its exclusive competencies such as foreign affairs and defence)

sets out a general framework for policy making for all level(and eventually

municipalities),119 implement and administer such policies within these general

setting. The historic roots of this form of power sharing can also be found in the

German Reich where the states (and municipalities) had already had a long tradition

of administration that the centre could build upon, while the Reich itself had no

comparable infrastructure on its own (except for its exclusive responsibilities such as

defence).

In particular, the tax law is identical, even for state and municipal taxes and the states

are denied any form of own taxation. Tax revenue is typically shared and apportioned

among layers of government according to the constitution (income taxes) or law

111

(VAT), and disbursed horizontally among regional entities according to formulae with

strong equalization components. Homogeneity of policies is also fostered at the

national level through the voting mechanism for the national parliament (Bundestag),

which follows the model of proportional representation while excluding all parties

that fall below 5 percent of the vote. 120

The lack of policy discretion at lower tiers of government, and the .emptiness of the

agenda of state parliaments combined with the inability of states to use own tax

instruments is exacerbated by a host of intergovernmental transfers that are all

destined to foster national homogeneity and uniformity of living conditions. It begins

with the formula apportionment of the jointly appropriated VAT onto regions (mainly

population based and highly equalizing); it proceeds through the horizontal

redistribution of resources among states according to the Equalization Law

(Finanzausgleich); and is completed through a number of asymmetrical vertical grants

by the federal government in favour of .states in need.121. The German fiscal

federalism is of corporatist nature. Taxes are uniform throughout the nation and their

proceeds are jointly appropriated. Revenue from exclusive state taxes is only percent

of the total. This leads not only to a jumble of political responsibilities; it also tapers

financial autonomy through the packaging of tax policy and a mix-up of joint

financing schemes.122 The costs of solidarity are yearly transfers of resources from

West to East the volume of which is enormous: it corresponds to more than twice the

official development aid of all industrialized countries to all developing countries in

the world.123

At a second level, there is the Finanzausgleich scheme, a redistribution of resources

among the states. Such a scheme is logical for a situation where there are no vertical

fiscal imbalances. If such imbalances did exist as in Australia in favour of the

Commonwealth, or in the EU in favour of the member states, regional equalization

schemes would typically be implemented in the form of vertically asymmetrical per

capita grants (downwards in Australia, upwards in the EU). In the absence of such

vertical imbalance, however, regional equalization must be arranged horizontally

among the participating states (see figure2 for detailed analysis.). Germany is unique

in having created such a system, which is, of course, based on a federal law reigning

the mechanics of the scheme with uniform rules.124

112

In Germany (like in Canada) the focus of equalization is on taxable capacity only,

with little or no concern for specific burdens. As the tax law is uniform throughout

Germany (except for some limited discretion of municipalities to vary their tax rates),

there is no need to standardize taxable capacity among regions (as in Canada),

because effective tax collections can be considered to reflect the regional variations of

tax potentials.125 Economists and public finance experts have increasingly taken the

view that the corporatist German approach to federalism is outdated and constitutes

even a risk in the age of globalization. According to this view, modern government is

expected to meet the challenge of markets in the same way as the private sector, and it

should agree to competition among public entities and institutions.126 It is obvious that

German federalism must also be contemplated in the context of European integration.

It is true that the European Union (EU), in her quest for intergovernmental decision-

making machinery among sovereign national states, has greatly benefited from

German experience with its cooperative approach.127

But the German model has one important constituent that is solidarity. This limits its

usefulness for integration where interregional cohesion is much weaker indeed. A

corporatist Model of federalism is therefore not acceptable for Europe, neither now,

nor in the foreseeable future. How could this affect German federalism? It is

interesting to note that European integration has already induced the strengthening of

regions both economically and politically; that it has fostered a process of

decentralization even in unitary states; and that elements of competitive federalism

are now increasingly being discussed throughout Europe and in Germany in

particular, not only by economist academics, but also by politicians and lawyers. In

this vein of competitive federalism the governments of some states, notably Bavaria,

have begun to question the existing financial constitution asking for less

intergovernmental solidarity in exchange for greater autonomy at the state level and

requesting, in particular, the right to levy some own taxes. The recent ruling of the

Constitutional Court on the Finanzausgleich128 has to be understood before this

background.

The conflict on equalization, and hence the degree of interregional solidarity, as

opposed to greater freedom to act of lower tiers of government, and hence subsidiary,

113

is illustrative for the fundamental issues. If ever the German federation and its public

sector is to become more lively, more active and entrepreneurial, more creative and

inventive at lower tiers of government, it is time to redesign not only equalization in

the light of the Court’s ruling, but also to tackle more fundamental issues that go

beyond the constitution, and bring stronger competitive elements to bear in the

German Federation.

Canada

The Canadian federation, born in 1867, now consists of ten provinces and three

territories129, corresponding to the States and the Union territories of India,

respectively, in addition to nearly 5,600 municipalities which derive their basic

powers and responsibilities from the Constitution of 1867. The Constitution of

Canada has specified the exclusive legislative powers for the federation and the

provinces, except for only four concurrent powers, namely, exporting non-renewable

natural resources, forestry resources, and electrical energy, old age pensions and

benefits, agriculture and immigration.130The more significant expenditure

responsibilities assigned to the federal government include national defence, building

of railways, roads, canals, harbours and bridges to link the provinces with each other

and with the rest of the world, unemployment insurance, postal service, currency &

coinage, census etc. The expenditure responsibilities assigned to the provinces include

the administration of justice, local institutions, health, hospitals, education, welfare,

prisons and other matters of a “local nature”.131The provinces’ authority extends to all

taxes with the exception of customs duties and excises, over which the federal

government has exclusive authority. In practice, this means that both levels rely on

many of the same types of taxes, most importantly personal and corporate income

taxes and consumption taxes. Natural resources are owned formally by the provinces,

only provincial and local governments tax property and gambling revenues, and rely

on a large variety of user fees and charges. Though the provinces have virtually

complete freedom to define their own tax bases and rates, in practice, most provincial

income taxes are collected by the federal government on the condition that the

provincial base is identical to the federal base. In Canada tax collection agreement

between the federal and provincial governments provide for joint use of the same

income tax base. The provinces with the exception of Quebec and Ontario set their

114

own personal and corporate income tax rates as a proportion of the rate charged by the

Centre. The taxes are collected by the federal government and then remitted directly

to the provinces.

In Canada, there is a federal VAT that is imposed throughout the country. In contrast

to Brazil, the provinces of Canada levy a variety of consumption taxes. Since 1997,

three provinces have consolidated their sales taxes with the federal value-added tax

(referred to in Canada as the Goods and Services Tax, or GST) as a Harmonized Sales

Tax, which is also collected by the federal government. Provinces are free to borrow

with no review or control by the federal government. Quebec levies a VAT which is

levied at a uniform rate. Alberta does not have a broad based consumption tax and the

remaining five provinces apply some form of retail sales tax (RST). As in Brazil,

Canada’s VAT is fully creditable.132 The fact that the devolution of expenditure

functions often involves several levels of government, there is a need for inter-

governmental co-operation in order to ensure the successful implementation of

decentralisation reforms. In Canada, the Fiscal Spending Control Act of 1992

established a nominal expenditure limit and the main objective was to control public

expenditure growth, reduce fiscal imbalances and stop the increase in public debt. The

deficit of 5 per cent of GDP in 1995 became a surplus of more than 1 per cent of GDP

by 1999, and the ratio of net public debt to GDP was reduced from around 70 per cent

in 1995 to 52 per cent in 2000.133 The size of a country’s vertical imbalance is largely

a function of expenditure and revenue assignments. The smaller vertical gap in

Canada can be attributed to the fact that the provinces of Canada have access to all the

major broad- based taxes and there are no constitutional rules on exclusive use of

certain bases by different levels of government. The provinces are also able to set

their own rates. Currently provinces raise most of their revenues from own-sources

and overall federal transfers account for only about 13 per cent of total revenues of

the provinces. Transfer dependency, however, varies greatly among the provinces

from 10-12 per cent in the high income provinces to nearly 40 per cent in the low

income provinces.

In Canada, the primary goal of inter-governmental fiscal transfer is to maintain

minimum national standards in provincial-local public services, thus compensating for

vertical and horizontal imbalances between the provinces. Accordingly, unconditional

115

block transfers are made to low-income provinces to provide a minimum national

standard of public services. The major two are the Canada Health and Social Transfer

(CHST) and Equalisation Transfer. While the latter focuses on horizontal imbalances,

the CHST is the primary means for closing the vertical fiscal gap.134 The Canadian

Constitution Act 1982 is much more explicit about the role of governments and takes

a whole-of-governments approach. Section 36 is reproduced below:

Without altering the legislative authority of Parliament or of the provincial

legislatures, or the rights of any of them with respect to the exercise of their

legislative authority, Parliament and the legislatures, together with the government of

Canada and the provincial governments are committed to promoting equal

opportunities for the well-being of Canadians; furthering economic development to

reduce disparities in opportunities; and providing essential public services of

reasonably quality to all Canadians.135

Parliament and the government of Canada are committed to the principle of making

equalisation payments to ensure that the provincial governments have sufficient

revenues to provide reasonably comparable levels of public services at reasonably

comparable levels of taxation. The Canadian constitution explicitly recognises that it

is the collective effort of all levels of government in a nation that matters. It also

explicitly recognises the need for intergovernmental transfers to meet objectives.

Intergovernmental transfers, which include but are wider than equalisation transfers,

break the nexus between own-source revenue and expenditure for each tier of

government.

To sum up, in Canada, the fiscal transfers to the provinces are in the nature of grants

rather than any tax sharing or devolution. These grants are broadly of two types. One

is the Equalisation payments that have a Constitutional basis, whereas the other, the

Canada Health and Social Transfers, emanates purely from inter-governmental

agreements. Even in respect of the Equalisation payments, the Constitutional

prescription gives only a broad hint and the exact details have been left to be worked

out by the executive. For implementation of both these schemes, again, there is no

Constitutional or legislative arrangements and the details are worked out at the level

of executives of the governments concerned. Fiscal transfers in Canada move by the

executive federalism.

116

India

In India, both the Union and the State have been provided with independent sources

of revenue by the constitution. The Parliament can levy taxes on the subjects included

in the Union List. The State can levy taxes on the subject in the State List. By and

large taxes that have an inter-state base are levied by the Centre and those with a local

base by the State. Transfer of resources can be materialised by three channels-

Finance Commission, Planning Commission and ministerial grants136.

The structure of centre –state fiscal relations in India is such that the states have

insufficient resources to meet their constitutional responsibilities , even though more

and more taxes have been devolved to the states . In fact as the sates have been

forced to borrow from the centre to meet their revenue – expenditure gap, they

have become considerably indebted to the centre . India‘s fiscal relations, as which

its legislative relations, thus violate the federal principle. The constitutional and

fiscal subordination of the states to the centre has been the source of considerable

strain in India. The details of India’s fiscal relations are enumerated in articles268

through 293 of the constitution. Revenue sources emanate from the division of

powers categorized in list 1(Union powers) and list II (state powers ) of the seventh

schedule . Customs and excise duties are the central government’s main sources

of revenue (almost 80 percent of its total), while the states rely primarily on sales

taxes (almost 60 percent of their total), but also land revenues and duties on

alcohol , vehicles, and entertainment . Many of the state taxes are collected by the

union government and later distributed to the states. Income tax is the major shared

revenue source. The union government is also obligated by the terms of article 275

to provide grants – in-aid to the states in need of assistance as determined by

parliament . The distribution of revenues, and grants – in-aid between the centre and

the states are determined by a finance commission appointed by the president under

the terms of article 280 of the constitution.

The finance Commission is a constitutional body set up every five years in

accordance to Article 280 of the Constitution, to make recommendations relating to

the distribution of the net proceeds of taxes between the Union and the States, the

principles which should govern the grants-in-aid of the revenues of the States out of

117

the Consolidated Fund of India and the measures needed to augment the Consolidated

Fund of a State to supplement the resources of the Panchayats and the Municipalities.

In addition, any other matter may be referred to the Commission by the President in

the interests of sound finance. In other words we can say that the prime responsibility

of the Finance Commission is to balance the net revenue account of the Centre and

the States and to reduce the interstate fiscal imbalance. The two other dimensions are-

First one is, to make recommendations in respect of the local bodies, the Panchayats

and the Municipalities. The other is to perform a residuary role of making

recommendations on any matter in the interest of sound finance. We have so far had

twelve Finance Commissions. The reports of the Finance Commission make a strong

foundation for the implementation of fiscal federalism in the country. The

recommendations of the thirteenth Finance Commission will cover the period of five

years from 1st April, 2010 to 31st March 2015. The Commission has submitted its

report in February 2010. It is clear that in the financial sphere too the centre is better

equipped. The centre can exercise control over the state finances and grants in aid

both in general and special to meet the expenditure on development schemes. During

financial emergency, the president has the power to suspend the provisions regarding

division of taxes between the Centre and the State. The President can also impose

other restrictions on the expenses of the state.

State plans are framed within the priorities of the central plan and they are executed

with the approval of the Planning Commission. Further the States have to carry out

the centre sponsored schemes for which the Centre gives grants and the conditions

under which these are to be made. The Planning Commission has created an over-

centralized planning system. It can be said to some extent, that no initiative is left to

the States and the centrally formulated schemes have been inappropriately and

unimaginatively imposed upon them. Centre-state fiscal relations in India have been

further strained by economic planning. The planning commission was formed in 1950

by executive order; it does not have constitutional authority, like the finance

commission , it does not have statutory standing as it was not established in law by

parliament . Now however the planning commission is responsible for a larger

transfer of resources from the centre to the states than the finance commission. This is

accomplished by article 282, the first “miscellaneous” financial provision in the

constitution.

118

State autonomy has been infringed by the planning commission in a number of ways.

first as the seventh finance commission noted, ”The centrally , sponsored plan

schemes are generally in the fields of responsibilities assigned to the states or in

the concurrent list. The federal government has appropriated a number of state

responsibilities through its “declaratory power.”Second the states have to receive

central government approval for almost every facet of the planning process , from

revenue and expenditure budgets , establishment and location of industries and

related development programs. Third federal government bureaucrats have assumed

a significant role in the administration of the planning process137.

India’s quasi-federal legislative relations were duplicated in the constitution’s fiscal

provisions. The state received insufficient resources to meet their constitutional

obligations. Since independence the state fiscal dependence on the centre has

increased. The planning process has also served to erode the jurisdictional powers of

the states and seriously disrupt state legislative priorities. The Sarkaria commission

on centre-state relations steadfastly supported the status quo in all areas of India’s

federal system. The commission refused to entertain even moderate proposals to

reform the planning process , and it rejected all state proposal to transfer some

union revenue sources to the states. Much of the strain in centre-state relations,

however, emanates from the quasi-federal legislative and fiscal relations

To sum up

Centralisation marked the evolution of federalism in the last century in several

federations that were already well established like in USA, Canada and Australia.

Australian federation is also very much centralised with the states collecting barely 30

percent of total government revenues, but accounting for about 47 percent of the total

expenditure, signifying a large vertical fiscal imbalance138,However, disenchantment

set in all the three countries in question with what was perceived as excessive

expansion of the public sector and centralisation. Large governments came to be

associated with inefficiency while centralisation was seen as a factor inhibiting the

initiative of governments at the lower levels and thus the realisation of the fruits of

multilevel governance. The closing two decades of the last century saw substantial

offloading of responsibilities by national governments to those below both in USA

and Canada while a strong body of opinion has emerged in Australia as well asking

119

for decentralisation (Collins, 1993). The moves to reform the system of

intergovernmental relations towards decentralisation across countries have, however,

not gone in one direction alone. The results are mixed.

In Germany’s “co-operative federalism” all decisions are co-ordinated through an

extensive net of multi-level committees while Australia, Canada (off the lines New

Zealand also) use periodic formal meetings of elected officials and bureaucrats to

discuss mutually important fiscal issues. In India too, the signals are mixed. The

campaign for decentralisation while securing the recognition of local governments139

A federal system can be evaluated from an economic perspective on the two criteria

of equity and efficiency140. Federations are created and maintained for both

economic and political reasons but in most countries, whether federalist or not,

government consists of two or more tiers: national, provincial or state, local or

regional. In some cases, such as Australia and the United States, the tiered system of

government has arisen from the federation of colonies or separate sovereign states:

this has been termed “coming-together federalism”. The expression “holding-together

federalism” has been used to describe countries like Belgium, Spain, and Canada

where an important aim of fiscal decentralisation is to satisfy important political and

cultural differences across regions. In other instances, such as modern Britain and a

number of developing countries, the national government has decentralised some

decision making141.

We can say that in the Brazilian system, there are no institutional arrangements like

the CGC of Australia or the FCs of India, and major fiscal transfers take place under

detailed guidelines provided in the Constitution itself and some other transfers being

made at the level of the executive authorities with legislative support. However,

fixation of the detailed guidelines and principles for resource transfers by

constitutional provisions makes it a very rigid arrangement. The legislative part of

resource transfers would be susceptible to political wrangling, as the Brazilian system

is reputed to be. The Brazilian arrangements do not, therefore, appear to be suitable

for India. For somewhat similar reasons as were noted in respect of the Brazilian

model, the Canadian model of executive federalism for fiscal transfers also does not

appear suitable for India. It may be recalled that in Canada, there is no institutional

arrangement of the type of Finance Commission and the federal parliament itself lays

120

down the guidelines for such transfers, every five years. For the complex and diverse

socio-economic conditions obtaining among the States in India, the Canadian model

does not appear appropriate. It is also seen that in India the difference between

revenue and expenditure concentration was the highest, implying that while the

states are used mainly as spending agencies , much of the revenue collections was

undertaken by the centre.

In all other federations, state could finance more than two-third of their expenditure

from own sources and in the United States the extent of state dependence on federal

transfers was the lowest. It is also seen that the differences between the states share of

revenue and expenditure was the highest in India. Canada and India were the two

countries where the share of states expenditure in total was more than one-half. But

whereas in Canada the provinces could finance more than 75 percent of their

expenditure from own revenue sources , share of states own revenue in India was

just 43 percent.

The Nigerian model of handling the task of resource transfers from the federal to the

lower orders of governments through the institution of Revenue Mobilisation,

Allocation and Fiscal Commission (RMAFC) in terms of Constitutional provisions

makes it almost as powerful as the Parliament, at least in fiscal matters. Certain other

significant features of this arrangement (such as the permanency of the RMAFC), the

fact that it has the powers to monitor the accruals to and disbursement of revenue

from the Federation Account and, consequently, to review the functioning of all

revenue collection agencies and institutions makes it a highly powerful institution. All

of the countries studied in this context, the strongest TOR for the body equivalent to

the Indian Finance Commission appears to be in the case of the Nigerian RMAFC, not

only in its contents but also in terms of constitutional backing. However, it is difficult

to visualise the relevance of such an arrangement in a democratic set up such as India.

In India, the Constitutional institution for audit of government accounts, namely, the

Comptroller &Auditor General of India, itself works within the limits of

Parliamentary supremacy.142

121

NOTES

122

1 Bagchi, Amresh, Fifty Years of Fiscal Federalism in India: An Appraisal. New Delhi: National Institute of Public Finance and Policy, 2003

2 Bagchi, Amresh, On the Need to Strengthen the Equalising Role of Fiscal Transfers, Report of the Eleventh Finance Commission, Government of India, 2000

3 Teresa Ter Minassian, Intergovernmental Fiscal Relations in a Macroeconomic Perspective: An Overview, available on www. Flipcart.com

4 Adarkar B.P., Indian Fiscal Policy, Allahabad: Kitabistan, 1941,ASIN: B0007J9RWG, available atwww. books. Google. co.in

5 Arora, Guljit K.,Globalisation, Federalism and Decentralisation- Implications for India, New Delhi: Bookwell,2002, ISBN: 81-85040-54-0

6http://wikipedia.org

7http://wikipedia.org

8 Bhattacharya, B.B, Public Expenditure, Inflation and Growth- A Macro econometric Analysis for India. Institute of Economic Growth, Delhi : published by Oxford University Press, 1985

9Peter Ozo-Eson, Fiscal Federalism: Theory, Issues And Perspectives, DAILY INDEPENDENT News Paper, August 29, 2005 10 Musgrave, Richard A, Fiscal and Monetary Problems in a High-Level Defense Economy: A Study in Taxable Capacity, Washington D.C. American Economic Review, 1985, v40(2), 209-221.

11 McLure, Charles E, Fiscal Federalism and the Taxation of Natural Resources. Toronto: Lexington Books, 1983

12Wallace Oats, Taxation and Fiscal Federalism: Essays in “Developments in Environmental Economics” Aldershot, U.K.: Edward Elgar,2004, pp. 12

13Olson Mancur c., The Principle of Fiscal Equivalence: The Division of Responsibilities among Different Levels of Government, available at http://www.getcited.org/pub/100001997

14 Bird, R. M., & Rodriguez, E, Decentralization and Poverty Alleviation. Public Administration and Development,1995 p., 199–219, available at Bird, R. M., & Rodriguez, E, Decentralization and Poverty Alleviation. Public Administration and Development,1995 p., 199–219

15 Arora, Guljit K, Globalisation, Federalism and Decentralisation Implications for India. New Delhi: Bookwell, 2002, ISBN: 81-85040-54-0

16Gordon  David B., 1983, Rules, discretion and reputation in a model of monetary policy, Journal of Monetary Economics, Elsevier, vol. 12(1) 

17 Musgrave, Richard A, Fiscal and Monetary Problems in a High-Level Defense Economy: A Study in Taxable Capacity, American Economic Review, 1950, v40(2), 209-221.

18In Canada, equalization payment is an unconditional payment of grants to only those provinces with below average taxable capacity (Krelove, Stotsky and Vehoren: 1997).

19

20 Huther, Jeff and Shah, Anwar, A Simple Measure of Good Governance and Its Application to the Debate on the Appropriate Level of Fiscal Decentralization. Washington D.C.: World Bank, 1996

21 Wallace E. Oates, "An Essay on Fiscal Federalism," Journal of Economic Literature, 1999

22 Jeffery Petchey, Fiscal Capacity Equalisation and Economic Efficiency,1997

23 Feldstein, M. J.,Wealth Neutrality and Local Choice in Public Education. New York: American Economic Review, 1975,p. 65, 75–89.

24 Tenth Plan Approach, Planning Commission, Government of India, Paper,p. 18

25 M. Govinda Rao, Raja J Chellaiah, Fiscal Federalism In India, Indian Council of Social Science Reserarch, 2000

26 Bhattacharya, B.B, Public Expenditure, Inflation and Growth- A Macro econometric Analysis for India. Institute of Economic Growth, Delhi, published by Oxford University Press, 1985

27 Hunter, Federalism and Fiscal Balance, Australian National University Press, 1977, pg 226, www.hetsa.org.au

28 Richard M. Bird, Threading the Fiscal Labyrinth: Some Issues in Fiscal Decentralization, National Tax Journal, 1993

29 Albert Breton, ‘Towards an economic theory of competitive federalism', European Journal of Political Economy, 3(1–2), 263–329. TPC Tax Topics |  Fiscal Federalism

30 Robin Broadway and Paul Hobson, Equalisation :Its contribution to Canada’s Economic and Fiscal Progress, 1993

31 Richard M. Bird, Threading the Fiscal Labyrinth: Some Issues in Fiscal Decentralization , National Tax Journal, 1993

32 Rao and Chelliah, Fiscal Federalism in India, New Delhi, : Indian Council of Social Science Research, 1996 ; http://www.getcited.org/pub/100210268, G. Thimmaiah, A Critique of Financial Commission, Allahabad : A.H. Wheeler & Company, 1981

33 Buchanan, J. M. and C. J. Goetz , Efficiency Limits of Fiscal Mobility: An Assessment of the Tiebout Model, Journal of Public Economics, 1972, Vol 1, p. 25-43.available at books.google.co.in

34 Boadway, Robin and Frank Flatters, Equalization in a federal State: An Economic Analysis, Economic Council of Canada, Ottawa: Canadian Government Publishing House, 1982

35Richard M. Bird and Michael Smart, Intergovernmental Fiscal Transfers: Some Lessons from International Experience Torontr: International Tax Program Rotman School of Management University of Toronto January 2001; revised March 2001

36 Richrd M. Bird, , Intergovernmental Perspective is published four times a year by the U.S. Advisory Commission on Intergovernmental Relations, Washington, D.C. 20575: Jackson Place,1986

37 Rao and Chelliah, Survey on research on Fiscal Federalism in India, New Delhi: National Institute of Public Finance and Policy, 1991

38 Martin Feldstein, Lecture Slides NBER Reporter, 1975; Rao and Das-Gupta, Tax Reforms in India, 1993, available at books.google.co.in/books?isbn=8131718441

39 Dr. Mathew McCartne on Economic Blogger

40 Baretti, Huber, and Lichtblau , Is There a Connection Between Tax Administration & Political Power, working Paper, Barcelona: University of Barcelona, 2000

41 Bird, Ebel, and Wallich, Decentralisation of the Socialist State: Intergovernmental Finance, Washington D.C: The World Bank, 1995

42Charles Beard, An Economic Interpretation of the Constitution of the United State, New York: McMillan, U.S.A., 1921

43 Ibid

44 Robert D. Brown, Approaches to a Fiscal Theory of Political Federalism,  2002; Access Economics 2004; Twomey and Withers, Minding the Gap: Appraising the Promise and Performance of Regulatory Reform in Australia, Canberra: ANUE Press, Australian National University, 2007

45Oates 1972, 2005; Warren 2005; Williams , 'Fiscal federalism: aims, instruments and outcomes', Canberra: The Australian Economic Review, Vol. 38, No. 4, 2005, p. 352.

46Access Economics 2004, available at www.adfvc.unsw.edu.au

47Access Economics 2004; Williams, Fiscal federalism: aims, instruments and outcomes, The Australian Economic Review, Vol. 38, No. 4, 2005, p. 352.

48Dollery 2005, available on books.google.co.in/books ?isbn=0868407518

49Oates 1972, 2005, available on books.google.co.in/books? isbn=1107008131

50Brogden 2006; Selway 2001, available on books.google.co.in/books? isbn=1921313420

51Wiltshire, Tax Aspects of Fiscal Federalism - A Comparative Analysis book, University of Queensland, Australia, 2007 52Warren, Benchmarking Australia's Intergovernmental Financial Relations. Interim Report, Accessible at www.dlgrd.wa.gov.au/lggc/  Wilkins, R.B. , 'Federalism: Distance and Devolution.' Australian Journal,2004

53Access Economics 2004; Dahlby 2001, available at www.adfvc.unsw.edu.au

54Allen Consulting Group 2006; Grewel and Sheehan 2003; Hancock and Smith 2001; Saunders 2002; Warren 2006

55Vito Tanzi, On fiscal federalism: Issues to worry about, 2000, available at https://www.imf.org

56James Edwin Kee, Fiscal decentralization: Theory as reform, Washington D.C: Publication of Deptt. Public Policy and Public Administration, The George Washington University57 Oates, W. E. , Fiscal Federalism. New York: Harcourt Brace Jovanovich. 1996, ISBN: 0-15-527452-X

58 Rainer baubok, Asymmetry in multinational Federation, Working Paper Series, Austrian Academy of Social Sciences, available at http://www.eif.oeaw.ac.at

59 Reid, Bradford G, Fiscal Management and Stabilisation Policy in Federal Systems, in Fiscal Relations in Federal Countries: Four Essays, Paul Boothe (Ed.), Forum of Federations, 2003, ISBN: 0-9730767-3-9

60 Rao, M. G. and Sen T.K, Fiscal Federalism in India: Theory and Practice, Delhi: Macmillan, , 2003

61For details see The Framing of India’s Constitution, a study commissioned by the Indian Institute of Public Administration, New Delhi, with B. Shiva Rao as chairman (1968). Seeb also, Report of the First Finance Commission, Government of India, 1952, Chapter II.

62 R.L.Mathews, R.C. Jay., Federal finance: Australian fiscal federalism from Federation to McMahon , Melbourne : Centre for Strategic Economic Studies Victoria University, 1997.

63OECD, ‘Fiscal Relations across Government Levels’, Economic Studies No 36, (2003), pp 161-2.

64Alan Morris - Equity, Imbalance and Egalitarianism, Mc gill- Queen’s Press, Dialogues on the Practice of Fiscal Federalism: Comparative Perspectives By Raoul Blindenbacher, Abigail Ostien Karos

65Alan Morris - Equity, Imbalance and Egalitarianism, Mc gill- Queen’s Press

66 Alan Morris - Equity, Imbalance and Egalitarianism, Mc gill- Queen’s Press

67 Boadway, R. W. and Paul A.R., (Ed.) , Equalization: Its Contribution to Canada's Economic and Fiscal Progress. Ontario: Queen's University, 2004 Policy Forum Series 36. ISBN: 0-88911-780-2

68Terms Of Reference

69Commonwealth Grants Commission

70 Future Arrangements for Loan council Monitoring and Reporting, Canberra: Australian Loan Council,1993

71R Robertson, Budget/Federalism Watch, Research Note, Macquarie Bank, 15 May 2007

72 http//:www.gov.au/budget2010

73 Dollery, Brian, A Century of Vertical Fiscal Imbalance in Australian Federalism. Working Paper No. 2002-06, University of New England: Department of Economics, 2002, ISSN: 1442 2980

74 Garnaut, R., Equity and Australian Development: Lessons from the First Century, Australian Economic Review, University of New England, Department of Economics, 2002, ISSN: 1442 2980

75 Egwaikhide, F.O. and V. A. Isumonah , Nigeria Paralysed: Socio-Economic Life under General Sani Abacha, 2001, Africa Development, vol. xxvi, nos. 3 & 4, pp. 219-241

76 K. C. Wheare, Federal Government, London: Oxford University Press, 1964

77J. IsawaElaigwu, Nigeria: Yesterday and Today for Tomorrow Essays in Governance and Society Jos: AHA Publishing House, 2005, pp. 139-153 for the list of 100 selected cases of communal violence as at December 2004.

78Federal Government of Nigeria, The Constitutional Conference Containing Resolutions and Recommendations Lagos; Government Printer, 1995, Vol. II, p. 61.

79R.L. Watts The Contemporary Relevance of The Federal Idea, in African Journal of Federal Studies 1(1) 2000, pp. 10-11.

80 Ashwe, Chiichii, Fiscal Federalism in Nigeria, Canberra: Australian National University, 1986, Vol. II

81 Elaigwu, J. Isawa and Erim E.O. ,Foundation of Nigerian Federalism, Jos, Plateau State, Nigeria, Institute of Governance and Social Research, 3 Volumes,2001

82T.Y. Danjuma, Revenue Sharing in Nigerian Federalism in J. Isawa Elaigwu, P.C. Logams and H.S. Galadima (eds.) Federalism and Nation-Building in Nigeria: The Challenges of the 21 st Century, Abuja: National Council on Intergovernmental Relations, 1999, pp. 87-115.83Serra, José e Afonso, José Roberto R, O Federalismo Fiscal à Brasileira: algumasreflexões, mimeo, Mont-Tremblant, Canadá, Outubro paper presented at the International Conference on Federalism, held by the Forum of Federations, 1999. pp. 3-6,

84 Afonso, José R.R. and de Mello, Luiz , Brazil: An Evolving Federation, Mimeo: Paper presented at the Conference on Fiscal Decentralization, IMF Headquarters, Washington D.C., November 2000.

85Most of this section is based on Varsano, Ricardo, A Evolu;ção do SistemaTributárioBrasileiroao Longo do Século:anotações e reflexòesparafuturasreformas, mimeo, Working Paper n. 405, IPEA (Institute of Applied Economics of the Planning and Budget Ministry), Rio de Janeiro, 1996, pp. 2-12.

86Rezende, Fernando and Afonso, José Roberto R., Fiscal Federalism: The Brazilian Case, paper presented to the Federalis Workshop, mimeo: Stanford University, April,2001

87D.D.Basu, Constitution of India, Article 24, Paragraphs 3 and 4, ibid

88World Bank Report, Brazil – Issues in Fiscal Federalism, mimeo, Document of the World Bank, Washington, May2002.89http://www.receita.fazenda.gov.br/principal/Ingles/SistemaTributarioBR/BrazilianTaxSystem/ transfers.htm

90José Cezar Castanhar,Afonso, José Roberto R and Mello, Luiz de“Brazil: Na Evolving Federation”, mimeo, paper presented at the IMF/FAD Seminar on decentralization, held in Washington, DC, on November-2000.

91VIII Congreso International del clad sobre la Reforma del Estado y de la Administración Pública, Panamá, 28-31 Oct. 2003, available at http//www.clad .org

92Articles 21 and 22 of the Constitution of Brazil, www.servat.unibe.ch/icl/br00000_.html

93Basu, N.1.,Article 25, paragraph 2

94 Afonso, José R.R. and de Mello, Luiz, Brazil: An Evolving Federation, Mimeo: Paper presented at the Conference on Fiscal Decentralization, IMF Headquarters, Washington D.C., November 2000.

95 Fiscal Responsibility Legislation, available on www.v-brazil.com/government/laws/LRF.html

96Serra, José e Afonso, José Roberto R, “O Federalismo Fiscal à Brasileira: algumasreflexões”, p. 3, mimeo, paper presented at the International Conference on Federalism, held by the Forum of Federations, Mont-Tremblant, Canadá, Outubro 1999.97Mônica Mora& Ricardo Varsano, Fiscal Decentralization and Sub national Fiscal Autonomy in Brazil: some facts of the nineties, Rio de Janeiro: IPEA, mimeo December, 2001, pp. 23

98 Available at http//:www.swissworld.org/en/history

99 Adamovich, I.B., Fiscal Federalism for Emerging Economies: Lessons from Switzerland. Montevideo: Latin American and Caribbean Economic Association, 2001

100Pre Roman inhabitants of Switzerland

101Napoleon I (1769-1821) Letter to the delegates of the Swiss cantons, 1802, available at www.swissworld.org/en/politics/general.../ch_confoederatio_helvetic..

102 Adamovich, I.B, Fiscal Federalism for Emerging Economies: Lessons from Switzerland. Montevideo: Latin American and Caribbean Economic Association, 2001

103 Feld, Lars P., Tax Competition and Income Redistribution: An Empirical Analysis for Switzerland, in: Public Choice, 2000, (105), 125-164

104Basta L. R. and Fleiner T. (ed.), Federalism and Multiethnic States: the Case of Switzerland, Institut du Fédéralisme, Université de Fribourg, Études et colloques no 16, 1996

105Bohn, H. and R. Inman. 1996. Balanced Budget Rules and Public Deficits: Evidence from the U.S. States., NBER Working Papers , No. 5533. Dafflon, B., 2000.

106 Frey, Bruno S. and Bohnet, Iris, Democracy by Competition - Referenda and Federalism in Switzerland, Publius: The Journal of Federalism, 1993, p.71-81.

107 Knapp, Zimmermann, Federalism in Switzerland: A Survey, 1986

108Federal Direct Tax (FDT), www.comparis.ch/taxcalculator

109However, Blöchliger and Frey note that there is no overall co-ordination of regional equalisation measures, and there are also a number of measures with indirect redistributive effects which exacerbate regional disparities. (1993, p. 231)

110Other regional measures, mostly in the form of conditional grants

111Daniel J. Mitchell, A Swiss Response to American Fiscal Imperialism, This article appeared in Real ClearMarkets.com on February 13, 2012.

112James Buchanan and R.A. Musgrave, 1999,available on web.mit.edu/jrodden/www/materials/Leviathan.pdf

113 Feldstein, M. J., Wealth Neutrality and Local Choice in Public Education, Washington D.C.: American Economic Review,1975, p. 65, p. 75–89

114 For details see Carl j. Fried rich , Trends of federal ism in theory ad practises, New York 1968 ,p 12 ;see also Arthur E. Sutherland, Constitutionalism in America –Origin and development of its Fundamental ideas ,1965 ch. 13.115 Morton Grodzins , The American system 1967 , ch 3,5.116Legally, a German citizen is not defined by language, however. The criterion is still blood relationship, a rather doubtful remnant of Nazi ideology. This criterion proved to be highly controversial (and expensive) in recent years because it encompasses the descendants of German emigrants, even from the time of czarina Katharine, who are now alienated from German culture, while it excludes the children of foreigners, born and residing in Germany

117 Baretti, C., Huber, B., & Lichtblau, K., A Tax on Tax Revenue. The Incentive Effects of Equalizing Transfers: Evidence from Germany, Munich: Working Paper CESifo, University of Munich, 2000

118Indeed, centralizing such principles is the rule, but uniform principles can also be established through horizontal coordination among states. This is affected in conferences of state ministries and conforming treaties among governments. One prominent example is the cooperation in education and culture through the Kultus minister konferenz.

119Municipalities are, however, accorded some discretion to set tax rates within predetermined level.

120This provision has worked mainly in favour of the PDS, successor party of the former communists, and hence in favour of East German citizens.

121Despite these constitutional provisions, there have been some (successful) incidents of .pork-barrelling between the federal government and some states with decisive votes, most recently in the context of securing support for the tax reform of the year 2000.

122Paul Bernd Shahn,pspahn@wiwi.uni-frankfurt.deAugust, 2001

123It is difficult to establish an exact amount for the transfer because of regional asymmetries in the expenditures and revenues of the federal government. Official figures concentrate on direct intergovernmental transfers, which total between 140 and 150 billion DM or one third of West Germany’s GDP. This figure is, however, understated because federal outlays and tax expenditures are unevenly distributed among regions and highly biased in favour of the East. Also the participation of Eastern states in the proceeds from VAT on a per capita basis is a concealed equalization method because it allows them to tap the (higher) tax potentials of the West indirectly.

124 Baretti, C., Huber, B., & Lichtblau, K., A Tax on Tax Revenue. The Incentive Effects of Equalizing Transfers: Evidence from Germany. Working Paper CESifo, University of Munich, 2000

125Paul Bernd Spahn, pspahn@wiwi.uni-frankfurt.de August, 2001

126Kronberger Kreis, Fiscal Fragmentation in Decentralized Countries: Subsidiary, Solidarity and asymmetry , IBRD, The World Bank, 2000

127 Fossati A. and Panella G. (Ed.), Fiscal Federalism in the European Union. Routledge Studies in the European Economy. London: Routledge, 1999, ISBN: 0-415- 20262-0

128BVERFG, 2 BVF 2/98 of November 11, 1999, Nos. 1. 347;http://www.bverfg.de/

129Canada’s three territories remain under the constitutional authority of the federal government and their legal structures are specified in several federal statutes. These statutes have delegated extensive powers to the territorial legislatures that roughly correspond to the list of provincial powers

130The federal government has the jurisdiction to legislate in the area of criminal law, while the provinces are responsible for the administration of the same.

131 Kitchen, H, Municipal Revenue and Expenditure Issues in Canada , Canadian Tax Paper no. 107, Canadian Tax Foundation, Toronto, 2002

132 Kitchen, H, Local Taxation in Selected Countries: A Comparative Examination, Institute of Intergovernmental Relations, Working Paper 2004(5), Queen’s University.

133 Kushner, J. and D. Siegel, Effect of Municipal Amalgamations on Political Representation and Accessibility, Canadian Journal of Political Science, 2003, 1035-1051.

134 Boadway, Robin W., and Paul A. R. Hobson, Intergovernmental Fiscal Relations in Canada, Toronto : Canadian Tax Foundation, , 1993.

135The Canadian Constitution Act 1982, Section 36, books.google.co.in/books?isbn=0458959502

136 Pratibha Agarwal, Fiscal Federalism in India: Impact of Union Transfers on State Finances, New Delhi: New Century Publications, ISBN: 9788177082937

137 Bagchi, Amresh, Fifty Years of Fiscal Federalism in India: An Appraisal. New Delhi: National Institute of Public Finance and Policy, 2003

138Collins, Vertical Fiscal Imbalance, Proceedings from a workshop, Canberra: ANU Press, 1993

139Charlie Jeffrey, Recasting German Federalism: The Legacies of Unification, Continuum International Publishing Group, available at books.Google.co.in  140 Brennan and Pincus, argue that the trade-off between equity and efficiency should be embodied in institutional design and that a suitable way to consider the trade-off is through the use of a social welfare function. books.google.co.in/books?id=48frAAAAMAAJ

141McLean, discusses the relevance of Australian practice to Britain, Comparative work on Canada and Australia, 2004.142 Elaigwu, J. Isawa and Erim E.O, Foundation of Nigerian Federalism, 3 Volumes. Institute of Governance and Social Research, Jos, Plateau State, Nigeria, 2004