Recurrent resources

Objectives of financial transfers between government levels

There are many grounds for financial transfers between tiers of government and between local governments.

1)  Financial transfers for funding purposes serve to finance the responsibilities devolved upon the local authorities. They are aimed at indemnifying the local authority when it is obliged to fulfil a function on behalf of the higher level, such as providing a basic service across the entire territory in compliance with the demands of the central government. These transfers are also aimed at correcting vertical imbalances. This is particularly the case when the decentralised public authorities’ own resources are insufficient to enable them to finance the expenditure that falls to them.

2) Incentivising transfers are aimed at modifying the budgetary choices of the entities that benefit from them, to guide them towards the services desired by the level of government that is paying them. These transfers are generally linked to specific services, which the beneficiary should provide at the qualitative and quantitative levels established by the payer.

3) Transfers can have the objective of correcting and compensating for external effects (of a spillover effects type) relating to the decentralised provision of certain public services. This is particularly the case when the area in which the public services are being used or the recipient territory extends beyond the borders of the institutional space that is providing the service, or when non-resident economic agents can benefit from the services provided by a local authority without bearing the cost thereof. The education services provided and financed by a given region, for example, have positive external effects on other regions (particularly if individuals are mobile).

4) Financial transfers are also designed to correct horizontal imbalances between decentralised public authorities. Transfers then play a role to equalise resources – and also needs. They are generally aimed at “equalising” (bringing closer to the average) the means at the local governments’ disposal, so that these can offer public services of comparable quality (and within the same cost bracket) across a given territory. Supplementary resources are then transferred to the local authorities whose potential tax base is below the national average or whose “needs” are higher than the national average (for example communities in mountainous areas).

5)  The fifth type of financial transfers have a macro-economic dimension. It is not longer a question here of the general financing of decentralised budgets, nor of compensation, incentives or correction with a view to a better allocation of resources. In the first instance – at least in theory – the goal is to encourage a global demand that would be insufficient in the event of poor economic conditions. In the second instance, the objective is to steer regional development projects.

6) The sixth category concerns redistribution policies aimed at individuals.  These include, for example, individual welfare benefits, study grants and child allowance payments. They are not taken into account within the framework of this report as they are not aimed at local authorities in their capacity as such.

Intergovernmental transfers

Equalisation transfers

A well-structured transfer equalisation system is a crucial element of local funding, which notably enables combat against horizontal budgetary imbalances. The implementation of these mechanisms is necessary to mitigate various factors, such as poverty or population growth in certain municipalities. However, despite the increase in inequalities of revenue among local authorities around the world, few countries use effective equalisation grants to enable more egalitarian access to resources.

In Africa, only a couple of countries (Morocco and South Africa) have introduced these equalisation grants, while in the Middle East-Western Asia region they do not exist at all. The  situation is a little better in Latin America, where certain States (for example Brazil and Chile) use equalisation, but most have only retained a handful of elements, which they have incorporated into their revenue sharing programmes. Several Asian countries use equalisation transfers (Australia, Indonesia, Japan), while others ignore budgetary disparities (China, India, the Philippines, New Zealand). Equalisation subsidies are used in Eurasia, Europe and North America (but not at federal level in the United States), with varying degrees of success.

Conditional transfers

Conditional transfers granted by the State or intermediary authorities also make up part of local budgets. They serve to promote national standards and objectives for the provision of decentralised services such as, for example, certain aspects of education and health. They also help manage inter-administrative externalities regarding, for example, environmental or local investment issues.

Conditional transfers exist in many countries, particularly for infrastructure investments. Nevertheless, in certain regions such as Eurasia, conditional transfers are still at the embryonic stage. Other countries, like Egypt, Nigeria, Tanzania and Uganda rely almost exclusively on conditional transfers. This type of grant frequently entails several difficulties: their number and complexity, meaning high implementation costs for local authorities; their lack of transparency and stability, including timescales, and the risk of political manipulation. Furthermore, over-reliance on conditional transfers can mean hefty constraints on the autonomy of local authorities and drive them to neglect local priorities in favour of national priorities, thereby destroying everything that gives them their strength.

Grants based on performance and innovation

They are relative newcomers in the field of transfers. They have generally been introduced in certain African and Asian countries under the influence of international organisations. The local governments generally remain free to decide the best way to use the funds. This type of transfer brings together the flexibility of unconditional grants with an atypical form of conditionality. They can, however, end up favouring the municipalities with the greatest administrative prospects, and risk reproducing the defects of traditional aid programmes. To date, they have served above all to promote respect for financial and administrative management procedures, not to improve the provision of services. It is too early to pronounce definitive judgement on the effectiveness of this type of grant. 

Local taxes

User fees

The use of benefit taxes, which requires the beneficiaries of local public services to contribute, is not as widespread as those who promote them would wish, particularly in most decentralised developed countries. This lies on the grounds that the beneficiaries of local public services provided by local authorities (a necessary condition for the employment of benefit taxes) are increasingly difficult to identify, taking into account the nature of the services provided (education, health, social services, housing, employment, economic development, and so forth).

The local use of personal income tax 

Personal income taxes make sense in countries where the responsibilities exercised by the local authorities lead to individual consumption according to revenue. Such taxation can only be designed in the form of tax revenue sharing or, at a push, of shared/stacked taxes (surtax on personal income tax according to residence in countries of Northern Europe, Switzerland, in Eastern European transition countries). Yet, on the one hand, the stacking of income taxes has its negative effects: overtaxation (vertical fiscal externalities), relocations or optimisations. On the other hand, the spatial distribution of income tax bases is generally highly concentrated, which leads to very broad equalisation mechanisms (see below).

Local business taxes 

The use of local business taxes rests largely on taxes or charges based on the exercise and/or turnover of specific professions, rather like levies, which are very widespread in Africa, Asia and Latin America. Local retail sales taxes persist in the (rare) countries in which no VAT has been introduced at national level (United States) or coexist with federal VAT (Canada). In the latter case, national VAT revenue is often shared among the levels of government, with local authorities unable to adjust the rate at their level. 
Interesting proposals are currently emerging with a view to implementing “dual” VAT systems: one at national rate applicable to transactions between professionals, and the other opening up the possibility of local adjustments for sales to the general public. In the same vein, recent proposals re-examine the possibility of taxing added value at local level (therefore at differentiated rates) combining the taxation of employment revenues and that of capital revenues (added value then being taxed as the sum of employment and capital remunerations, just like the French professional tax phased out in 2010).