Page 1 of 9

Journal for Studies in Management and Planning

Available at

http://edupediapublications.org/journals/index.php/JSMaP/

ISSN: 2395-0463

Volume 03 Issue 10

September 2017

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 198

The Complexity of Raising Taxes by Subnational Government

and the effect for Public Goods Provision

Imuetinyan Press John Ugiagbe (Ph.D., Cert ED)

Department of Business Administration, College of Business and Management Studies,

Igbinedion University, Okada, Edo State, Nigeria.

Abstract:

The importance of taxation in any society should

never be underestimated because without the

payment of taxes by the jurisdictional citizenry there

will be virtually no provision of public goods and

services for the society to benefit from. Public goods

benefit everyone that lives in jurisdictional

community and it is the responsibility of every

government whether sub or central to ensure that

public goods and services are provided within the

preamble available resources. Therefore the

quantity or amount of public goods provision is a

function of budgetary phenomenon and not a fiscal

decision. This article posits taxation in its difficult

stead to raise, and also argues that if jurisdictional

governments are going to raise taxes, they must also

be accorded with expenditure responsibilities as the

two go together. The article also argues for the need

for equalisation either in form of grants or derivation

because of inequality of resources within a country.

The result of this is reduced tax bases with a

consequence of reduced public spending and taxes.

This article is qualitative research and uses

secondary sources of information to present its

argument. It argues that taxes is a function of the

jurisdictional populace and if judiciously applied can

derive the public goods and services that could

enhance the welfare of the people. The significance

of taxation and payment of taxes by the populace is

seen as crucial for the provision of public good,

therefore both the public and governments must play

their crucial role by adequate payment of taxes while

central government must ensure fiscal balance in

transfer both in vertical transfer and horizontal

transfer.

Keywords

Taxes, Sub-national Government, Public Goods

Provision, Taxation, jurisdictional populace,

jurisdictional Government

1. Introduction

In any transfer of funds from the central

government to subnational governments, it is

imperative that fiscal balance is achieved, that is, the

country must ensure that the revenues and

expenditure of each level of government are

approximately equal. Consequently no jurisdictional

governments will be left out in providing adequate

basic level of public goods and services for its

people; hence equity, fairness and equality in income

distribution would bring about alleviation in poverty.

Thus Petersen (2007) identifies four criteria of

transfer in a federal system: 1.The separate taxation

of the single jurisdiction, 2. Tax sharing, 3. Revenue

sharing, 4. Grant systems. Each of these has its

benefits and pitfalls, for example separate taxation is

where sub-national governments have legislative

revenue and administrative jurisdictional

sovereignties and as such provides sub-national

government most fiscal autonomy.

There are complexities, inequalities and economic

distribution problems attached to this method

because of the activities of the single jurisdiction.

But Tanzin (1996) enthuses that adopting a uniform–

grand rule or best, national charges that can provide

the most important autonomy to the jurisdiction

could surmount the problem arising from this

method. The tax sharing is the alternative method of

the revenue assignment. Under this approach

Petersen (2007) the sub-national governments get a

fraction of the national taxes originating within their

jurisdictions. This approach denies the local

jurisdiction fiscal autonomy over revenue. Whilst

they have autonomy on spending of the given

revenues, but they do not have power to control the

amount of revenues they received, for example

grants and some other transfers carry condition

clauses such as standard of performance and sort of

project to execute. Thus sub-national governments

cannot control the level of public spending. Any

expenditure responsibilities must also be matched

with power to raise revenue by allocating adequate

tax bases to jurisdictional governments.

Theory of Taxation

Fiscal federalism says Tiebout (1972) has the

benefit of allowing the people to influence the

decisions of government, which positively affect

their lives, but which, may have the same costs that

Page 2 of 9

Journal for Studies in Management and Planning

Available at

http://edupediapublications.org/journals/index.php/JSMaP/

ISSN: 2395-0463

Volume 03 Issue 10

September 2017

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 199

may negatively impact on the welfare of the people.

Gordon (1982) explains that decentralization

decision can produce externalities in a way that a

unit of government can create costs for non-residents

through both its public goods supply and decision on

taxation. Therefore if decentralization is to be

effective, sub-national governments must have

adequate revenues that are enough to finance the

expenditure that are assigned. Brueckner (2004)

exclaims that sub-national governments are reluctant

to set high taxes because of fear of competition

which high taxes may create, which may put a sub- national in disadvantage relative to other

jurisdictions and will lead to under-provision of

public goods – under-estimation of public goods and

services delivery cost may also arise due to the tax

exporting to non-residents in each jurisdiction in a

decentralized system. Consequently, the notion

competition and tax exporting will now be explored.

Assignment of Expenditure Responsibility

So far, literature on decentralization shows that

efficiency in the provision of public services can best

be achieved by decentralization: because

jurisdictionnal communities have different variations

in tastes and preferences. Following this logical

phenomena, national public goods should be

delivered at national level and local public goods

provided at the local level of governments and local

agents should be accountable for their actions to their

citizens, hence they should decide the service types,

quantity, quality and local taxes should be levied to

pay for these services (Oates, 1972). Accountability

makes decentralization works smoothly, without

which there would be controversy and instability in

the decentralized system. This entails that

expenditure and functional obligation must be clear

at different levels of government: for example,

according to Martinez-Vazguez (1998) decentraliza- tion had failed in Latin America because revenues

were assigned before decision to transfer expenditure

from central government to local governments. It

follow therefore that expenditure should be the

fundamental step for decentralization, hence

efficiency in the provision of the public goods can be

achieved. The principle of subsidiary that has already

been spoken about demands that efficient

expenditure assignments should be undertaken to

shift each function to the lower level of government,

which is able to fulfil the task in the best manner.

Rodden (2003) posits that local governments

could be too small in some cases to efficiently carry

out the responsibility. In this circumstance, central

government in assigning the expenditure

responsibilities should decide which levels of

government should be responsible for which

functions and activities. Rodden (2003) went on to

say that there is bound to be duplication of functions,

which would hurt efficiency and accountability. An

example where this is prevalent is in the area of

education and health provisions. The central

government is involved in providing and setting

policies and standards, where as local governments

providing schools and kindergarten services directly

to the local residents. In the case of transitional

countries, expenditure according to Shah (2004) was

mandated to the local governments, without the

central providing the necessary revenue sources. The

result was a poor service delivery and increase in

budget deficits at sub-national governmental levels

and so shifting the budget downward by the process

of decentralization.

There are no general guidelines for an optimal

expenditure assignment but assignment should be the

first fundamental step for the design of

decentralization system of intergovernmental

finance. Therefore without a clear expenditure

assignment responsibility the adequacy assessment

of tax and revenue assignment as well as financial

transfers to different levels of local governments will

be impossible. According to Martinez- Vazquez

(1999) there are four main criteria for effective

expenditure assignment; efficiency, redistribution

and stabilization objectives, no single best

assignment and the importance of clear and stable

assignment.

Revenue Assignment

Tanzi (1996) asserts that in order that sub-national

governments are able to function properly and are

able to provide the public goods and services that its

local jurisdictions required of them, they must have

sufficient and adequate revenues, own revenue

sources to perform and carry out the tasks expected

of them. This raises the issue of ‘tax assignment

problem’. The question then is which and what

revenue sources to be assigned to local governments

and in what proportion and how can these

assignments be achieved! Musgrave (1959) and the

public finance theory tells us that government has

three fundamental functions: macroeconomic

stability, income distribution, and allocation of

resources.

The macroeconomic stability says Musgrave

(1959) came to be assigned to the central government

and its function is to ensure high employment and

stable prices. It is assumed that sub-national

governments cannot be assigned with this because

they are detached from national policies and have

limited capacity to borrow; hence corporation taxes

with stabilization effects, and progressive income tax

should be assigned to the central government and

taxes they are more insensitive to the

macroeconomic conditions such as consumption

Page 3 of 9

Journal for Studies in Management and Planning

Available at

http://edupediapublications.org/journals/index.php/JSMaP/

ISSN: 2395-0463

Volume 03 Issue 10

September 2017

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 200

taxes, general sales taxes and excise and property

taxes can be assigned to the local governments. The

redistribution function is to ensure the equitable

income distribution, helps to alleviate poverty and

came to be assigned to the central government due

disparities in local geography and unsuccessful

attempt of the subnational government in the

redistribution policies.

Mclure (1999) posits that the corporate income

taxes and progressive income taxes are the most

common instruments of the income redistribution

and thus should be assigned to the central

government. Many countries, for example such as

India, Russia, Brazil, contends Tanzi (1996) have

assigned major tax bases to subnational governments

for their exclusive use. In Brazil, writes Bahl (1994)

the general Value Added Tax (VAT) Is assigned to

the state. In Nigeria According to Alm and Boex

(2002) taxes and VAT are collected by each state in

the federation, pooled in the federation Account and

jointly shared on a principle of derivation between

the central government and state governments, the

VAT thus pooled is shared on the basis of 50% to

central government and 50% to states government.

In India according to Bahl (1994) the sales tax is

assigned to the states. In Russia tax and excise duty

is assigned to the subnational governments. In India

the central governments are left mainly with the

income tax and at the same time the central

government of India is left with servicing public debt

burden.

The central government spending tended to grow

as its share of total tax has been fallen (Bahl, 1994).

Tax assignment can also be a constitutional problem

in many countries, for example, reports Tanzi (1996)

in Brazil, total revenues received by the central

government fell from 22.2% in 1980 to 57.5% in

1990, while state rose from 22.25% to 27.9% during

the same period and that of municipals rose from

6.6% to 14.6%. The Brazilian constitution helps to

compound the decline in centrally retained tax

revenue, contributing to larger fiscal deficits and

macroeconomic problems. Tanzi (1996) says that

macroeconomic problems are often inevitable in a

situation where sub-national governments are

assigned bases that are large and dynamic and also if

the spending responsibilities of the central

government (debt servicing, pensions, and national

public goods) cannot easily be comprehend. This

problem according to Tanzi (1996) was also

experienced in India. Therefore if macroeconomic

adjustment requires central government to increase

its tax base the central government will find it

difficult if important tax bases are not available to it,

example Brazil and India. If this happens the central

government will have to rely on less efficient or less

productive tax bases, hence Tanzi (1996) posits:

“Either the level of taxation would have to be lower

than desired or the structure of taxation of taxation

will be less efficient than it could be”. (p.307)

In some federal countries of the world, such as

Nigeria, some tax bases are assigned to the exclusive

use of particular level of government; other tax bases

may be shared. The sharing may be of two kinds,

such as different level of government may tax the

same the same base, or one level may collect the tax

from a given base and share the revenues with other

levels. For example, Alm and Boex (2002) in Nigeria

tax raised from one level is returned to the central

government to be shared amongst the states and

central government. Another example is the USA;

the regional government and most states tax personal

income tax. Counties and Municipalities piggyback

on states income taxes. In Argentina sales are taxed

with a Value Added Tax (VAT) at national level, but

at provisional level at a cascading turnover tax. The

example of this says Tanzi (1996) is common, and

they prevail in Columbia, Brazil, Pakistan, Russia

and other countries.

In 2003, the Argentina the federal government

revenue before sharing and transfer was 54%. The

Argentine’s position shows that when faced with the

need to correct macroeconomic imbalance, they ran

into problems. Argentina introduced major tax

reforms and made highly successful administrative

reforms. These policies sharply raised the share of

taxes in gross domestic product (GDP) but the

potential impact of the effort of reducing the public

sector’s fiscal deficit was dissipated by the revenue

sharing agreement, which required that 57% of any

individual tax-revenue coming from the central

government’s effort be shared with the provincial

government. “Thus provincial government viewed

economic stability as a national public goods and

thus as the responsibility of national government”

(Tanzi, 1996. p.308). Argentina authority tried to

reduce its spending through privatization,

employment reduction, and other ways, partly as a

result of additional revenues received by the central

government from the process of this policy, the sub- national governments simply thwart the central

government efforts by increasing the spending and

the level of their employment. Thus the benefits lost

by the central government as a result of reducing

central government employment probably exceeded

benefits gained by increasing provincial –level

employment. It also raises more problems. The

federal government that finds itself great need of

raising revenue but also has to share some tax

revenue with subnational governments will have a

strong incentives to raise revenue from the taxes that

are not shared or from the taxes that will go mainly

to the central government. As a result, the structure

of the taxes will be distorted, and unshared taxes will