Sample Research Proposal on Intergovernmental Transfers

Governments in all countries where there is more than one level of government use intergovernmental fiscal transfers. These transfers of public money have attracted a great deal of attention from economists, particularly concerning justifications for them (Liew and Wang, 2004). According to Asher et al (2002), properly designed intergovernmental transfers can enhance competition for the supply of public goods, fiscal harmonization, sub-national government accountability, and regional equity (p.169). Intergovernmental transfers are the leading source of revenues for sub-national governments in most developing countries. Transfers take two broad forms. First, they may be used as an instrument for influencing programme design of sub-national governments. Broad conditions can be attached setting minimum standards that programmes in areas like health, education, and welfare must satisfy to be eligible for the transfers. Conditional transfers are directed at vertical equity objectives, such as ensuring that adequate levels of equality of opportunity and public services for the needy are being provided at the sub-national level. Transfers fulfill an equalization role. When the provision and partial financing of public services are decentralized to sub-national governments, different sub-nations will have different abilities to provide common levels of public services resulting in horizontal inequities. Intergovernmental transfers are the foundation of sub-national government financing in most developing and transition countries. Transfers are a compromise in that they permit the central government to be in command of the public financing system and offer a way to channel money into the budgets of provincial and local government at the same time (Atkinson, 2004). Prospects 1. Vertical Balance             An imbalance exists between the expenditure responsibilities of sub-national governments and their revenue raising powers. During the development's early stages, the main concern public sector responsibilities are infrastructure development and the provision of basic living necessities, and the protection of economic stability. This dictates fiscal centralization. But with economic advancement and urbanization, public expenditure needs shift more toward services provided by local governments such as local services, water supply and others. The outcome is an inability of local governments to provide adequate levels of public service. The gap must be filled in one of two ways: by giving local governments more revenue raising powers or by revenue transfers from the central government to the sub-national governments. 2. Equalization             Another reason for transfers is equalization. Most developing and transition nations are experiencing large regional fiscal disparities. Intergovernmental transfers aid in closing the gap between regions in terms of financial capacities. The prospective of equalize does not automatically mean that equalization will take place, nor does it mean that equalization is necessarily a good policy for a country. In order to asses equalization as a validation for intergovernmental transfers, we must consider three questions: How are intergovernmental transfers financed, what services do sub-national governments deliver, and what distribution formulae are used to allocate resources among the local governments? 3. Externalities             Another validation for exercising intergovernmental transfers is to equalize externalities. Local governments can have the power to under spend on services where there are considerable benefits. The design of an intergovernmental transfer system to address externalities raises two important issues that must be attended to by policy makers. The first is the size of the grant required. That is how much of a subsidy is required, and how much expenditure response will be required by the local government? Another issue is about three-level fiscal federalism. If the grant made to the provincial or state government, it may not reach the government that is responsible for the under spending. Related to this is the issue of how the intermediate level government will allocate its resources to the local level government. 4. Administrative Justifications             The last validation for employing intergovernmental transfers is that part of the public financing system is administrative. The argument goes that the central government has a capability to asses and collect taxes that is mush greater that that of sub-national governments. Therefore, it is less expensive for the central government to collect taxes and then to allocate the revenues to local government in the structure of transfers.           Challenges             Intergovernmental transfers can be challenging to design and implement. There are concerns that need to be considered and addressed effectively: 1. Even if national official recognize that stable, sources of revenue are necessary for sub-national governments to meet their increasing responsibilities, many worry about the macro-economic implications of institutionalizing major intergovernmental transfer programs.             Many countries are concerned that macroeconomic problems might arise if too large a percentage of central resources are guaranteed to sub-national governments every year. In some cases where the volume of resources being transferred to sub-national government is significant, these fears are justifiable. Fixed arrangements reduce central government control over the disposition of public resources, and a substantial proportion of sub-national governments in many developing countries have weak capacity and may not use resources well. 2. Intergovernmental transfers are often intended to meet a variety of difficult and sometimes conflicting objectives. Choices have to be made about priorities, and different types of programs are often required to meet different objectives.             Most countries have multiple objectives fir their sub-national governments, and this is often reflected in the variety of transfer programs. Unconditional grants, for example, are best for promoting autonomy and interjurisdictional resource redistribution, while conditional grants are a more efficient way of encouraging expenditures on particular types of target services. Sometimes the multiple transfer programs do not fit together well and get so complex that they create serious administrative problems. 3. Devising mechanisms for the allocation of intergovernmental transfers intended to meet particular objectives can be difficult. Deciding on the appropriate allocation standards can be complicated, and measuring them correctly can be even more problematic.             Proper definition of the allocation criteria for the available resources can be challenging. The challenges are connected to two fundamental issues identifying the main objective of a particular transfer program and defining how resources can best be allocated to meet that objective. 4. Transfers frequently suffer from political and institutional obstruction that encompasses their capacity to meet their planned objectives. 5. The general effect of intergovernmental transfers and other national policies connected to sub-national governments on broader development goals is difficult to establish. International Experience: Design of Transfers 1. Determining the Distributable Pool             Stability is a vital feature of a good intergovernmental grant system. Another is flexibility. There are three fundamental ways of determining the distributable pool: fixed proportion of central government revenues; ad hoc basis; formula driven basis.             In the Philippines, a large amount of funds transported to local governments come from a pre-determined share of national taxes – the Internal Revenue Allocation – and are allocated in accordance to population, area and equal share. These transfers are not generally conditional, with the exception of for the requirement that 20% should be used for development purposes. This condition does no seem burdensome in practice since local governments are using part of the 20% development fund for a range of medical, nutrition, social welfare, cultural, youth and sports expenditures. In Colombia 25% of national current revenues are being distributed to departmental governments in part in equal fractions and in part on the basis of population. The central government also distributes 30% of value0added tax revenues to municipal governments mostly on the basis of population. Several developed countries employ similar systems with respect to most major taxes. The local governments in Austria receive about 12% of income and value added taxes while in Japan, 32% of income and alcohol taxes goes to the local governments. Large federal countries like Brazil and Nigeria use such systems as well. Most transitional countries use "tax sharing" systems that allocate a fixed share of certain national taxes such as the income tax or the value added tax between local governments. Canada used an alternative system with respect to the largest federal transfer to the provinces. This transfer was originally set in per capita terms to be equal in amount to certain transfers it replaced, and was subsequently adjusted as a function of a three-year moving average of nominal GDP growth. Under mounting budgetary pressure, the federal government destabilized the link to GDP growth and for some year forced a "cap" on the absolute amount of transfers received by the most well off provinces. Such measures may alleviate federal finances, but they evidently vitiate to some degree the strength of revenue flow accumulating to the provinces. Germany, Denmark and to some level Chile employ "horizontal equalization" transfer where rich local governments directly transfer resources to poor localities without directly affecting central revenues. 2. The Distributive Formula             Any good transfer system should distribute funds on the basis of a formula. The necessary ingredients of most formulas for general transfer programs are needs, capacity and effort. Frequently, needs may be roughly but sufficiently substituted by some combination of population and the form or category of municipality. Relatively few developing countries include explicit capacity measures in their formulas. Nigeria includes a measure of tax effort in the basic distributional formula states, and Colombia has such an element in one of its transfer programs. Chile goes further and actually, "taxes" richer localities to some extent by reducing their transfers and raising those granted to poorer localities. Developed countries often include capacity measures in transfer formulas. In Spain, 25% of local transfers are distributed in compliance with local tax collections. Denmark and Sweden, as well as Canada and Australia, openly calculate local transfers on the assumption that the average "national" local tax rate is applied, thus creating an incentive to levy at least average taxes since those localities that levy above average local taxes are not penalized while those that levy below average taxes are not rewarded. Brazil allocates some transfers in accordance with per capita income levels in different states. Korea assumes that a standard tax rate is applied by cities and lowers the transfer if the actual rate is lower.