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![Page 1: Principles for Designing Transfers Jorge Martinez-Vazquez Georgia State University The Challenge of Designing Intergovernmental Fiscal Transfers in Bolivia.](https://reader036.fdocuments.net/reader036/viewer/2022062314/56649ee85503460f94bfa000/html5/thumbnails/1.jpg)
Principles for Designing Transfers
Jorge Martinez-VazquezGeorgia State University
The Challenge of Designing Intergovernmental Fiscal Transfers in Bolivia
The World Bank Institute
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Rationales for Intergovernmental Transfers
Vertical imbalances Horizontal imbalances Externalities (inter-jurisdictional spillovers) Enhancing national objectives at the
subnational level Paying for national programs implemented by
subnational governments
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Features of a Good Transfer System
Promote budget autonomy at the subnational level – Lump-sum versus conditional transfers
Provide adequate revenue to subnational governments– Transfers are not a substitute for revenue
assignments– The role of revenue sharing
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Features of a Good Transfer System (cont.)
Provide positive incentives– Encourage tax effort and revenue
mobilization – Promote expenditure efficiency– Discourage fiscal deficits or a “soft budget
constraint”
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Features of a Good Transfer System (cont.)
Enhance equity and fairness – Overall, transfers increase with fiscal
(expenditure) needs and decrease with fiscal (revenue) capacity
Stability Transparency Simplicity
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Types of Intergovernmental Grants Unconditional or lump-sum Categorical or conditional (for capital
and/or recurrent expenditures) – Non-matching– Matching
• Open-ended• Close-ended
Direct cost reimbursement
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Designing Transfer Systems: Determining Pool of Funds
Ad hoc at budget time Using rules
– Percent of central government total revenues
– Percent of some types of central revenues Direct reimbursement
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Funding Approaches
Vertical funding: the center provides the funds)
Horizontal (“Robin Hood”) funding:
subnational governments provide some funds
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Design of a Transfer System: Distribution of Funds
Ad hoc Formula Cost reimbursement Competition Derivation basis
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Design of a Transfer System: Institutional Requirements
Data requirements Institutional responsibility for design and
monitoring – Central government agencies (micromanagement) – An independent “Grants Commission”
Developing subnational capacity Phasing-in to hold (partially) harmless Periodic evaluation
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Economic Impact of Grants Potentially substantial impact on level and
composition of subnational spending Lump-sum grants tend to increase spending more
than an equal increase in aggregate local income (“flypaper effect”)
Unconditional grants have an income effect Conditional grants have a restricted income or
“voucher” effect Matching, conditional grants tend to be most
stimulative because of an added price effect (matching rates can be made to vary across jurisdictions by fiscal capacity, etc)
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Types of Conditional Grants Recurrent versus capital expenditures Transitional or special purpose versus
permanent needs Block grants versus restricted grants Spend the funds any way you want to as long as
they are spent on a particular type of good Impose service standards, minimum expenditure
requirements, access levels and other restrictions on the use of funds
Conditional grant programs often spell out in great detail how funds must be spent
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Issues in the Design of Conditional Grants Pursuing too many conflicting objectives:
explicitly address priorities or use different grants Local spending is most responsive to matching
arrangements and minimum expenditure mandates: which to use?
Without matching arrangements, minimum expenditure mandates may be needed to prevent retrenchment in expenditure effort
Use of fiscal capacity in the formulas helps leverage central government resources
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What are Equalization Grants?
Unconditional, general purpose transfers
Total amount of fund typically determined by a funding rule
Total amount or divisible pool of funds distributed among regional and local governments based on a formula that considers expenditure needs and/or local revenue-raising ability (fiscal capacity)
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Purposes of Equalization Grants
Restore horizontal balance by equalizing fiscal conditions among subnational governments
Contribute to closing vertical imbalances (the differences in expenditure needs and revenue availability for the central and subnational governments)
Contribute to “nation building”
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How Simple: Why Not Give Local
Governments “What They Need”?
Can’t we just do the following?
Transfer regioni =
Actual expenditures regioni – Actual
revenues region i
Center may not have funds to fill entire gap
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How Simple: Why Not Give Local
Governments “What They Need”? (cont.)
Actual expenditures generally do not equal needs
Actual revenues generally do not reflect ability to collect revenues (fiscal capacity)
Negative incentives will be provided: local governments will collect lower revenues on their own and will not use prudence in establishing expenditures.
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Components of an Equalization Mechanism Determine exact objective(s) of equalization:
what should be equalized and by how much
Determine sources (central government revenues versus fraternal [“Robin Hood”] contributions)
Determine size of equalization fund (vertical allocation of resources): stable rule versus ad hoc determination
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Components of an Equalization Mechanism (cont.)
Determine the equalization mechanism (formula)
Determine the variables or allocation factors that will be used (i.e., measures of fiscal capacity, fiscal need, fiscal effort)
Adjustment of actual payments for other transfers?
Simulation, implementation, and evaluation
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Universal Principles for Equalization Grants Fund should provide adequate
resources; balance national priorities and local autonomy
Fund should be distributed in equalizing manner
Allocation should be predictable over time
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Universal Principles for Equalization Grants (cont.)
Mechanism should be simple and transparent
Mechanism should use reliable and generally accepted data
Approach should avoid negative incentives
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Universal Principles for Equalization Grants (cont.)
Grants should be unconditional
Reform should avoid sudden large changes (or use a “hold harmless” or a phase-in approach)
Use separate funds for regional and local governments
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Desirable Characteristics for Allocation Factors
Accurately reflect specific characteristics (i.e, statistically sound)
Regularly updated in the future (every 1-2 years)
Come from an independent source respected by all stakeholders
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Desirable Characteristics for Allocation Factors (cont.)
Be drawn from a source that cannot be manipulated by the central government or one or more local governments
Reflect needs or demands for public goods (e.g., number of clients) rather than outputs such as infrastructure
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Goals for Capital Transfer
Address externalities across local governments
Assist in financing “lumpy” capital investments
Offset significantly different infrastructure endowments (when these are not the result of voluntary decisions)
Pursue sectoral objectives
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Capital Transfers: Issues and Constraints
Is there a bias? Do central authorities believe capital expenditures are always more efficient than recurrent expenditures?
How to achieve “additionality” or “maintenance of effort”? (Earmarking and the fungibility of funds)
Will local governments take ownership and maintain the infrastructure? (The use of matching arrangements).
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Flexibility in Use of Capital Grants
Project-based grants: closely administered and monitored by line ministries
Use of categorical or block grants
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Allocation of Capital Grants
Ad hoc decisions and negotiation (e.g., Italy until recently, many countries in transition)
Use of a pre-established formula (e.g., Australia funds schools building by no. of students and price/cost factors) (not always feasible)
Use of a competition process with defined application procedures (possibly subject to manipulation)
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Design of Capital Transfers: Summary
No single best approach to design capital transfers.
However, non-transparent, highly detailed and discretionary procedures should be avoided.
Matching requirements carry many benefits.