Spain

Abstract

This chapter reviews the main features of the Spanish model of fiscal federalism and its evolution over the last four decades. It begins by describing the allocation of expenditure responsibilities among the three levels of government in the country: central, regional and local. The allocation of taxes between levels of government is then presented, followed by a discussion of the role of intergovernmental transfers, with particular reference to equalization transfers. Next, we address the macroeconomic coordination and control of the subcentral deficit and indebtedness. The chapter concludes by setting out the challenges for fiscal federalism in Spain in the coming years.

1 Introductory Overview of the Country

The Kingdom of Spain, defined in the 1978 Constitution as a parliamentary monarchy, is an “Autonomic State” with essentially, de facto if not de jure, most of the features of a federation. The legal system is based on the Civil Law and the system of government is a stable full democracy.

Currently Spain has a population of 46,7 million, with a territory of 505,989 square kilometres, which incorporates the mainland in the Iberian Peninsula, plus the Balearic and Canary Islands and the North African city-enclaves of Ceuta and Melilla. The official language is Castilian (Spanish), which is co-official with Catalan, Euskera and Galician in the respective Communities where those other languages originate.¹

Historically, the country-state was the result of a process of unification of different kingdoms and territories, which culminated in the later part of the fifteenth century. These constituent units, often identified with significant geographical differences, had and continue to have in many cases strong cultural identities, including different languages. This historical legacy is critically important in understanding the strong demands for self-government and fiscal decentralization, which in the last quarter of the twentieth century have transformed Spain from one of the most centralized countries in the world at the time of General Francisco Franco’s death in 1975 into one of the most decentralized currently. The historical legacy is also fundamentally the reason for the adoption in the Spanish Constitution of an asymmetric system of intergovernmental finance where, as we will see below, two regions (the Basque Country and Navarre) operate with a fiscal framework completely different from that of the rest of the regions. The fast pace of reform and adaptation that Spain’s fiscal federalism continues to experience is influenced in many ways by these historical-political issues.

The current vertical organization of government includes, besides the central government, 17 Autonomous Communities (as the regional governments are called) and 2 Autonomous Cities at the intermediate level, and at the local level, 50 provinces and 8,131 municipalities.² The Constitution recognizes explicitly the existence and right to self-governance of local governments and the Autonomous Communities. Although the Autonomous Communities have some regulatory powers over the local governments, essentially the structure of government and the fiscal system are not hierarchical.³ Local governments have their own sources of revenues and receive transfers directly from the central government in what we can call a bifurcated system of finance, where the central government deals directly with the intermediate level and the local level governments and there are minimal fiscal relations between intermediate and local level governments.⁴

Overall, the very significant decentralization thrust of the past 40 years has benefited the intermediate level of government, the Autonomous Communities, that have gone from not existing to representing 32% of the consolidated public sector in 2016 (see Table 4). Over the last several decades the Autonomous Communities have emerged as the fastest growing level of government, with these expenditures mainly focused on health and the education, the two largest components of the total public expenditures after pensions.

Meanwhile, local government budgets represent 11% of total expenditures in 2016, very close to what they represented at the start of the decentralization process nearly forty years ago.⁵ The fact that the decentralization process has been dominated by the devolution of competences and revenues to the Autonomous Communities has led many observers and political forces in Spain to continue to talk about the need for a “second decentralization” focused on local governments.⁶

The level of political accountability is relatively high as all government representatives are democratically elected and responsible to their respective constituencies at the same time there is a significant presence of civil society⁷; however, there are no important elements of direct democracy.⁸ The Constitutional Court handles disputes between different levels of government. At the national level, the dominant role of the two political parties positioned at the centre-right and the centre-left has eroded, with the introduction of three other new national parties to the left and right as well as centre of the two traditional parties, prompting the need for parliamentary coalitions in order to govern; regional parties, especially in Catalonia and the Basque Country, continue to play key roles in their regions and as coalition members in the National Parliament.

Over the initial 30 years, when rapid decentralization took place, Spain enjoyed high rates of economic growth and prosperity, spotted with unusually high rates of unemployment associated with rigidities in labour market institutions. In 2008, GDP per capita was 24,275 euros. Over the same, Spain underwent a considerable increase in tax burden. In 1975 total tax revenues as a percent of GDP stood at less than 20%. By comparison, at that time, the average tax collection in the OECD was 31% of GDP. By 2002, Spain had converged to the OECD average with total tax revenues representing over 35% of GDP. The increases in real GDP and the considerably higher presence of the public service in the economy also allowed over that period a significant jump in the provision of public services at all levels of government. The Great Recession starting in 2008 hit the Spanish economy with significant virulence leading to significant increases in unemployment and the overall level of the national debt. Only in the most recent years has the level of economic activity recovered with rates of economic growth among the highest in OECD countries (in 2017, GDP per capita was 25,064 euros, above the level reached in 2008), but unemployment has only been reduced to about 14%. Most recently, the tax burden has risen to almost 40% of GDP, while the overall level of national debt stands at 95% of GDP.

2 The Allocation of Expenditure Responsibilities

The Constitution addresses the fundamental division of responsibilities across different levels of government. Table 1 shows the current assignment of responsibilities that, in general, follows conventional fiscal federalism principles, including subsidiarity. The responsibilities assigned to the central government concern stabilization and redistribution functions and the delivery of services with benefits extending to the entire national territory, such as international relations, defence, customs, financial system regulation, basic Social Security legislation and funding, national infrastructure and transport and so on. The central level is also responsible for ultimately guaranteeing the functioning of the internal common market, using its competence on the bases and coordination of the general planning of economic activity (Article 149.1.13 Constitution), as well as for guaranteeing the basic equality of all Spaniards in the exercise of rights and in the fulfilment of constitutional duties (Article 149.1.1).

Table 1 The assignment of responsibilities at different levels of government in Spain

With regard to the Autonomous Communities, the actual responsibilities assignment evolved over the years, ending with the Autonomous Communities taking on responsibility for the provision of a wide range of public services of a regional-local nature, such as health and education services, agriculture, industry, environment or regional infrastructures.

An interesting aspect of the devolution of responsibilities in Spain is that it has been asymmetrical. Originally, and mostly for historical-political reasons, only a small group of Autonomous Communities were devolved responsibilities in education and health matters. This led to a distinction between “high level Communities” (i.e. those with a high level of devolved responsibilities) and “low level Communities”. With time all Autonomous Communities came to have substantially the same responsibilities,⁹ although some minor asymmetries persist (e.g. only some Communities have powers for administration of the prison system and the police).

A more permanent manifestation of asymmetrical assignments is at the local level, where the minimum services to be provided by municipalities depend on their size (see Table 1). Local governments are assigned services with typically local benefit areas, such as water and sewerage, parks, street lighting and so on. It is notable that none of the education services (e.g., basic education) or health services (e.g., primary health) are assigned at the local level. Although there has been and continues to be considerable discussion about the devolution of more expenditure responsibilities from the intermediate to the local level of government, and most in particular basic education, in the context of the “second decentralization”, the assignment of responsibilities has remained stable for many years now. At the local level, a cooperative approach among local governments with insufficient scale for the provision of a variety of services is well developed. The cooperative arrangements are known as mancomunidades, or associations of local governments, and they operate as special districts across several local governments in the provision of water services, garbage collection, tourism and social services.

The responsibility assignments in Table 1 need to be qualified further. While the Autonomous Communities exercise their powers within a framework of complete freedom in the case of some functions (such as regional public works, infrastructure and transport), in some other cases their autonomy is restricted with differing intensity by upper-level governments. The most significant limitations are present in the area of social services for healthcare and education. These are truly co-shared responsibilities (competencias concurrentes). Although the Autonomous Communities have responsibility for delivery and implementation of those services, the central government has significant regulatory powers for several service dimensions, such as establishing the basic conditions for the provision of the service or the rules governing access by users, among others. These rules typically provide minimum standards nationwide and cannot be altered by the regional governments. However, the Autonomous Communities have the power to enact specific regional laws applicable within their territory with the purpose of improving service provision and so on.

Table 2 presents the most recent available data (2016) on the functional distribution of expenditures at different government levels. As can be seen, the central level is specialized in defence, social protection, general public services and public order and security; the Autonomous Communities, in education and health services¹⁰; and local governments, in environmental protection, housing and communal services, and recreation, culture and religion.

Table 2 Non-financial expenditures by function and level of government in 2016 (Percent)

3 Taxation Responsibilities

The system of revenue assignments—taxes and grants—in Spain is rather complex by international standards. This complexity arises from two sources. First, there are significant differences in the bifurcated revenue assignments at the intermediate and local levels of government and those two systems need to be discussed separately. Second, the system of revenue assignments at the intermediate level of government is complicated by a very marked asymmetry between two groups of Autonomous Communities. Thus, it is useful to separate in the discussion the financing of regional governments and their two types, and the financing of local governments.

3.1 Revenue Assignments of the Autonomous Communities: The Common Regime

The Spanish Constitution establishes two basic different systems for financing the regional governments. The “common” regime applies to all Autonomous Communities with the exception of two: The Basque Country and Navarre. These two Autonomous Communities operate under the “special” or “charter” (in Spanish foral) regime.¹¹ The two systems introduce a fundamental asymmetry in the financing of regional governments that fundamentally benefits the two Autonomous Communities under the special regime.

The revenue assignment in the common regime was originally established by the “Autonomous Communities Financing Act” of 1980 (Ley Orgánica de Financiación de las Comunidades Autónomas—LOFCA); this law was comprehensively refurbished in 2001 and 2009. For this reason, the revenue assignments in the common regime are typically known as the “LOFCA system”. While LOFCA establishes the basic principles of the system, specific implementation issues as well as disputes are settled within the “Fiscal and Financial Policy Council” (Consejo de Política Fiscal y Financiera -CPFF), a consultative intergovernmental body, composed of the ministers of finance and public administrations of the central government and the finance ministers of the Autonomous Communities. The representatives of the central government have the same weight as the sum of the autonomic representatives. One of the most important responsibilities of the CPFF has been to assess the evolution of the regional finance system on a regular basis and to recommend any necessary changes. The recommendations made by the CPFF are embodied in a Financial Act passed by the National Parliament. Significant reviews of the LOFCA system took place in 1986, 1992, 1996, 2001 and 2009.

Initially (end of the 1970s and early 1980s), the financing system of the regions in the common regime was based on lump-sum general grants. These grants were calculated to cover the expenditure needs arising from the devolved expenditure responsibilities using the “net effective cost” method. In essence, this method attempts to establish the monetary value (cost) of each devolved competence in each Autonomous Community, identifying all costs (direct, indirect, new and replacement investment) incurred by the central level to provide that competence in each region in the year prior to its devolution, and subtracting, where appropriate, the fees charged to users of the service, since those fees are also transferred to the Autonomous Community.¹² Although this methodology suffers from some well-known problems, it must also be recognized that the effective cost method did provide an effective bridge in the process of devolution and avoided excessive budgetary tensions. The problem lies in the fact that, as explained below, this methodology is to certain extent still in use for the computation of equalization grants.

This approach had two very clear weaknesses. First, it tended to perpetuate whatever differences existed across regions under the centralized provision of services before their devolution to the regional governments. Thus, the approach did not guarantee an equal provision of public services. Second, the complete reliance on grants, as opposed to own taxes, meant that regional governments had practically no revenue autonomy. This blunted the greater efficiency and accountability benefits typically associated with fiscal decentralization.

Both central and regional government authorities commonly agreed to these flaws. The subsequent evolution of revenue assignments to regional governments can be seen as a continued process of gradual corrections to these problems, starting with the tools offered by the LOFCA’s initial version in 1980.

On the one hand, the method for calculating expenditure needs was modified. In 1986, there was an agreement to replace the net effective cost method with a quantification of regional spending needs based on indicators that would more accurately reflect the expenditure needs of each Autonomous Community. The concept of expenditure needs was identified as the costs each regional government would need to incur in order to provide the same level of public goods and services as other regional governments. In the following section we will explain in more detail how regional expenditure needs are currently calculated.

On the other hand, the revenue assignment to the Autonomous Communities was also reformed. Funding of regional governments exclusively on the basis of general purpose grants was abandoned after an initial period and replaced from 1982 to 1984 with a system consisting of a set of devolved or “ceded taxes” (tributos cedidos) and the following general equalization transfers: until 2001, the “Sharing in Central Government Revenues” (Participación en Ingresos del Estado); between 2002 and 2008, the “Sufficiency Fund” (Fondo de Suficiencia); and since 2009, the “Transfer from the Guarantee Fund for Fundamental Public Services” (Transferencia del Fondo de Garantía de Servicios Públicos Fundamentales) and the “Global Sufficiency Fund” (Fondo de Suficiencia Global). These tools provided regional governments with revenue sources much in line with standard practices in other decentralized countries. Next, we will describe the taxes ceded. Equalization transfers will be dealt with in the next section.

Ceded taxes are taxes established and regulated by the central level, whose revenues are totally or partially assigned to the Autonomous Communities. Until 1997, regional governments were granted no discretion vis-à-vis the structure of the ceded taxes, although in some cases they were put in charge of their administration and collection. Thus, in the initial period through 1997, ceded taxes should be considered an extension of the tax sharing system instead of own taxes providing regional governments with meaningful tax autonomy. Starting in 1997, several degrees of discretion were granted to the regional governments vis-à-vis some of the ceded taxes, allowing the Autonomous Communities to set the tax rate and establish tax credits and allowances. Thus, progressively, some ceded taxes became own taxes for the regional governments.¹³

Table 3 provides the current status of the ceded taxes regarding the arrangements for the distribution of revenue collections, the level of government in charge of administration and collection and the discretionary powers granted to the regional governments over that particular tax. Table 3 shows that, at present, almost all direct taxes over which the Spanish government has full regulatory capacity (as these taxes are not affected by the harmonizing rules of the European Union (EU)) have been ceded (in different shares) to the Autonomous Communities accompanied by autonomous regulatory powers. The only significant direct taxes that have not been ceded to the Autonomous Communities are the Corporate Income Tax and Social Security Contributions; the central government retains exclusive authority over the collection, administration and regulation of these taxes. However, the restrictions imposed by the harmonization of indirect taxes (VAT and excises) in the EU means that with respect to these taxes the formula of tax sharing is maintained, and therefore the Autonomous Communities share in their revenues but have no regulatory powers over their structure.

Table 3 Taxes assigned to Autonomous Communities

The arrangements for the personal income tax deserve special mention because they are not those found in a typical piggyback scheme in other decentralized countries. The law divides the tax schedule for the personal income tax into a central government schedule and a regional government schedule. The revenues from the central government schedule, which is equal to 50% of the total tax, are allocated at the central level, while those from the regional schedule, equal to also 50%, are allocated to each Autonomous Community. Central and regional governments may maintain this tax schedule, in which case they will receive 50% of the total tax take, or they may increase or reduce the rates and, in that case, the impact on tax revenues will be separately confined to the government that has undertaken that measure. Regional governments share 50% of general tax credits and may also establish their own tax credits, which would only affect regional tax liabilities.

Overall, regional autonomy in the personal income tax is exercised in a coordinated and harmonized fashion with the central government in order to minimize taxpayer compliance costs. The definition of taxable income is common for both central and regional taxes. Taxpayers need to fill out only one tax return that incorporates the central and regional income taxes. In the case of the regions under the common regime, the State Tax Administration Agency (Agencia Estatal de Administración Tributaria—AEAT) collects and distributes the revenues between the central and the regional governments.

The Autonomous Communities have made use of their regulatory powers on ceded taxes, albeit in different ways according to different regions and tax instruments. In general, the Autonomous Communities have reduced their fiscal effort for direct taxes (in particular, wealth tax and inheritance and gift tax) and have increased it for indirect taxes (capital transfer tax, stamp duties). With regard to the personal income tax, the Autonomous Communities have habitually established their own tax credits, but until 2007, no Community had modified the regional tax rates. During the Great Recession, all the Autonomous Communities have legislated changes on their tax schedules, in general, to increase the tax burden of their residents.

There is some evidence that taxpayers have reacted to differences in taxation between Autonomous Communities by moving to another region to purchase some goods (such as fuel: see Leal et al. 2009) or to change their residence, in response to regional differences in direct tax burdens (Agrawal and Foremny, 2019; López-Laborda and Rodrigo, 2022). For years there has been a genuine race to the bottom in the case of the inheritance and gift tax, which could ultimately lead to its disappearance, as has already happened in other federal countries.

Besides the ceded taxes, regional governments may introduce their own regional taxes and surtaxes, as well as fees, charges and public prices. For these taxes, the Autonomous Communities have full powers of collection, administration and regulation. However, the LOFCA imposes strict bounds on the type of taxes regional governments can introduce on their own. Most importantly, this law prohibits regional governments from levying taxes on taxable activities that are already subject to levies by the central level or by municipalities. However, the central level can levy taxes on taxable activities already taxed by the Autonomous Communities. If this results in a decrease in the revenues of the Autonomous Communities, the central level must implement the appropriate compensation or coordination measures in favour of the regions.

The above limitations have led the Autonomous Communities to specialize, above all, in environmental taxes. Although there are currently more than seventy “genuine” autonomic taxes, their collection is very limited. Politicians and business people are often concerned about how the proliferation of regional taxes may affect the internal market and the overall economic union of the country.

3.2 Revenue Assignments of the Autonomous Communities. The Charter System

The charter (foral) system applies to two Autonomous Communities: Navarre and the Basque Country. The financing arrangements for these two regions are called the Convenio in Navarre and the Concierto in the Basque Country, with both terms referring to the asymmetric conditions incorporated into the two special laws for the two regions: the “Economic Agreement between the State and Foral Community of Navarre Act”, (Ley del Convenio Económico entre el Estado y la Comunidad Foral de Navarra) and the “Economic Agreement with the Autonomous Community of the Basque Country Act”, (Ley del Concierto Económico con la Comunidad Autónoma del País Vasco).

In contrast to the financing system for the Autonomous Communities under the common regime, the charter system is not based on the assignment of specific revenues to fund a given level of spending. The chief feature of the charter system is that it provides the two regions concerned with a very high level of fiscal autonomy. Both the Convenio and the Concierto basically recognize the capacity of the charter regions to establish and regulate their own tax systems,¹⁴ provided that the solidarity principle and a common economic space is guaranteed together with all other Autonomous Communities in the country¹⁵; this means that the freedom of movement and residence of people and the freedom of movement of goods, services, and capital are all ensured.

In essence, the charter regions are financed exclusively through tax revenues called “agreed taxes” (tributos convenidos in Navarre and tributos concertados in the Basque Country). The two charter regions have wide powers over these taxes, which are, in general, considerably greater than the powers that have been granted to the Autonomous Regions under the common regime in the case of the ceded taxes.¹⁶

Table 3 lists the “agreed taxes” and the powers granted to the charter regional governments over them, which in most cases are full powers. Social Security Contributions are the only relevant tax that is currently outside the charter regime list of agreed taxes.

In contrast to the tax assignments for regional governments under the common regime, the charter regions have full powers over personal and corporate income taxes. The finance departments of the charter regions also have control over the administration of the main indirect taxes, the VAT and excise duties.¹⁷ However, for the indirect taxes the charter regions have no regulatory powers, for the reasons explained above.

The Autonomous Communities under the charter regime have lower effective tax rates than the rest of the country but, given that they have higher relative income per capita, the tax burden is similar and the tax collection per capita is clearly higher than for the average of Autonomous Communities under the common regime (Zubiri, 2015).

The high degree of tax decentralization in the charter Autonomous Communities and the relatively high income levels of these two regions guarantee full financing of their expenditure needs without any transfers from the central government. In fact, the regimes for the Basque Country and Navarre call for negative transfers to be remitted from those two regional governments to the central government. These negative transfers are called the “quota” (cupo) in the case of the Basque Country and the “contribution” (aportación) in the case of Navarre. The rationale for these negative transfers is for the two regions to contribute to the financing of the cost of public goods and services provided by the central government in the entirety of the national territory. In contrast to this single payment, or quota for short, by the charter regions, all other regions under the common regime can be seen as “contributing” to the financing of central government services in several ways. The most important of these are the non-ceded taxes collected in their territories (50% in the personal income tax, 100% in the corporate income tax, 50% in the VAT, 42% in excises and so on).

The amount of the negative transfer or quota for the charter regions is based on a fairly complex formula. In short, the share in the cost of central government goods and services (the so-called “non-assumed expenditures”, cargas no asumidas) attributable to each charter region is based on an “imputation index”, which is basically a relative income function (vis-à-vis the entire national economy). The imputation index is 1.6% for Navarre and 6.24% for the Basque Country.¹⁸

The quota is calculated for a base year, and the calculation methodology should be reviewed every five years. For any year after the base year, the quota is calculated by applying to its value in the base year the rate of growth of central government taxes equivalent to the foral “agreed taxes”.

The discussion above provides a description of the “basic financing model” for the charter regions. But as in the case of the common regime regions, the Basque Country and Navarre may establish their own taxes and surtaxes, fees, charges and public prices.

In 2016, own taxes amounted to 4.1% of non-financial revenues for Navarra, and 3.4% for the Basque Country; agreed taxes represented 93.9% of non-financial revenues for Navarra, and 94.3% for the Basque Country; and grants represented 2.0% for Navarra and 2.3 for the Basque Country. It should be borne in mind that, in the Basque Country, agreed taxes are provincial in nature and no autonomic (see note 16).

An evaluation of the charter system produces a mixed scorecard. This system scores high from the standpoint of financial autonomy and accountability of sub-national governments. In contrast to the common regime regions, the charter regions finance all their expenditure out of their own revenues. But, there is more. In fact, the degree of fiscal autonomy provided by the charter system to the regional government is quite unique in the international experience. A similarity can be found in the “single channel” scheme that some Russian regions practiced in the early 1990s against the wishes of the federal government in Moscow, whereby the regions collected on their own all taxes, including those that were supposed to be federal taxes and negotiated with Moscow a single payment or remittance (Wallich, 1994).

It would be misleading to confuse the degree of autonomy granted to the charter regions in Spain with that existing in the world’s most fiscally decentralized countries, such as the United States, Switzerland or Canada. In those countries, some of the federal taxes may be administered by the sub-national governments and then remitted, as in the case of Canada and Switzerland, and sub-national governments have their distinct separate taxes, as in the United States and Canada, but in none of those countries are sub-national governments assigned most or all the taxes and then agree with the centre on a single payment transfer as a contribution to the cost of providing federal services.

The important drawbacks of the charter system emanate from the asymmetric nature of the arrangement vis-à-vis the common regime applied in the rest of the Spanish regions. In the first place, the greater financial autonomy provided by the charter regime provides the means and incentives for asymmetric tax competition between these regions and the regions under the common regime. For example, if a charter region decides to implement tax measures to attract firms from other regions, for the most part the regions under the common regime are unable to react, because, for example, they do not have regulatory powers over corporate income tax. Although there is much concern about this issue, especially among regions neighbouring the foral ones, evidence of the existence of tax competition is only anecdotal to date. Moreover, it is also true that this asymmetry has been reduced as the common regime Autonomous Communities have been expanding their regulatory powers on the ceded taxes.

Secondly, the charter regime may be seen as unfair to the rest of the regions under the common regime. A comparison of the structure of the common and charter financing systems shows that an equal level of tax effort will provide the charter regime regions with higher revenues while both types of regions have the same expenditure obligations: depending on the estimates, between a minimum of 30% more per capita revenues, and a maximum of more than 100% (Zubiri, 2015; Zabalza and López-Laborda, 2017). In other words, the regions under the common regime would need to levy higher tax rates on their constituents to provide the same standard of regional public services. An explanation for this difference is that the charter system is so designed that citizens residing in the charter regions finance out of their taxes the cost of regional public goods and -with the quota remittance- the respective share of national public goods and services, but do not contribute to financing interregional equalization transfers. However, the citizens of the regions of common regime finance with their taxes the respective regional public goods and services and their part in the national public goods and services, but they also finance transfers to allow equalization among Autonomous Communities under this regime. The literature also points to other deficiencies in the application of the charter regime such as the calculation of the non-assumed expenditures¹⁹ or the adjustment for VAT and excise duties (explained in note 17).

3.3 Revenue Assignments of Local Governments

Municipal governments have their own revenue assignments separately from those of the regional governments. Local revenues are regulated by the “Law on Local Finance” (Ley Reguladora de las Haciendas Locales) of 1988, updated in 2004 and frequently amended since then.²⁰ As in the case of the charter regions, and in contrast to what is practiced vis-à-vis the common regime regions, the financing system of local governments is not based on the computation of expenditure needs that then have to be financed with a particular set of revenues.

Five taxes are currently assigned to municipal governments. Three are mandatory in all the municipalities: the property tax (Impuesto sobre Bienes Inmuebles—IBI: the most important in terms of revenue), the local business tax and the vehicles tax. The other two taxes, a tax on land value increases and a tax on constructions, facilities and infrastructure, are optional taxes; it is up to the municipal council whether these two taxes are to be introduced or not.²¹ In practice, most municipalities have decided to apply these two optional taxes. In general, municipal governments enjoy a high level of autonomy in setting tax rates, allowances and tax credits for local taxes within the framework of the (centrally issued) law, and make wide use of these powers. Therefore, it is fair to say that local taxes are truly own municipal taxes.

In the case of the property tax, the Ministry of Finance, through the Office of the Cadastre (Dirección General del Catastro), centrally manages the most significant aspect of this municipal tax, the assessment of property values. This is an unsatisfactory situation for many municipalities, especially in the case of large cities, which feel they would be better able to manage the assessment of property values within their borders. Large local governments have at different times requested from the central government the ability to do their own property assessments. In periods of fast increases in property values, as was the case between 2000 and 2007 throughout Spain, the delay in assessed values catching up with real market values made this problem more acute. This situation has led to expensive emergency revisions of cadastral values in order to increase revenue collections from the property tax. Nevertheless, the typical municipality had proceeded to lower the property tax rates after a revised increase in cadastral values. Property tax burdens have become a particularly sensitive issue and the overall equity of the tax has been increasingly questioned, especially in the light of the fact that housings expenditures are proportionally higher for the lower income population and the lack of circuit-breakers for pensioners whose property values have increased quite considerably but their incomes have not.

With some exceptions (such as property assessments or the census of economic activities), local taxes are administered by the municipal governments themselves. However, in the case of small municipalities lacking administrative capacity and skilled personnel, it is often the case that tax administration is delegated upward to the tax agency of the province or the regional government.

Despite the significant degree of local tax autonomy, there has not been any considerable degree of tax competition, perhaps with the exception of the anecdotal case of the vehicle tax, where some small municipalities have bet on the minimum tax rates allowed in order to attract the rental vehicles market.²²

Large cities (those with a population larger than 75,000 inhabitants, and also the capital cities of all provinces and of the Autonomous Communities, regardless of their population size) also have a share on three central government taxes: the personal income tax (with a sharing rate of 2.1336%), the VAT (with a sharing rate of 2.3266%) and excise taxes (with a sharing rate of 2.9220%). The municipalities have no powers over the regulation or administration of these tax shares.

Another important financing source for municipalities are charges based on the straight application of the benefit principle, such as user fees for local services for water, access to municipal sports facilities and local transport.

The only tax assigned to the provincial governments is a surtax on the local business tax raised by the municipalities in the provincial territory. Metropolitan areas can establish a surtax on the taxable base of the property tax of properties located in their territory. No other local entity may levy taxes or surtaxes. Like large cities, provinces have a share on the personal income tax (at a rate of 1.2561%), VAT (with a sharing rate of 1.3699%) and excise taxes (with a sharing rate of 1.7206%).

To conclude this section, Table 4 shows the changes in non-financial expenditures and revenues by level of government since 1995. We can see that, while the share of the local level in general revenues and expenditures has hardly changed throughout the period being considered, the share of the autonomic level has increased quite significantly. Table 4 also shows that the recent economic crisis slowed down the process of decentralization of expenditures, especially to the Autonomous Communities. In 2016, the Autonomous Communities accounted for almost one-third of the country’s non-financial expenditure and one-sixth of non-financial revenues.

Table 4 Composition of non-financial public expenditures and revenues by level of government, 1995–2016 (Percent)^a

4 Intergovernmental Fiscal Transfers and Revenue-Sharing

Because Spain’s decentralization system works in a bifurcated fashion without any significant hierarchical relationship between regional and local governments, it is necessary to discuss the system of central transfers to the regions and that to local governments separately.

4.1 Transfers to Regional Governments

Autonomous Communities under the common regime receive unconditional equalization grants and also conditional grants.²³ The following paragraphs describe the most salient features of the methodology used to determine the equalization transfers under the regional financing model applied since 2009. According to the Spanish Constitution, the degree of equalization must be established between two limits, neither of which must be exceeded. The upper limit is that of full equalization. The lower limit corresponds to the equalization of fundamental public services (the exact services to be identified by the central government), and which in any case must be satisfied in order to comply with the principle of equality of all Spaniards.

The first stage consists of calculating the expenditure needs of each Autonomous Community. To this end, regional services are divided into two categories: “fundamental public services”, made up of education, health and essential social services, which represent around 70% of all regional expenditure, and the remaining autonomic services, which we will identify as “non-fundamental public services”.

For fundamental public services, the expenditure needs of each Autonomous Community are calculated year by year through the use of a set of agreed indicators that reflect the demand and cost factors related to the provision of these services. The indicators used are: population (with a weighting of 30%), population protected by the public health system according to age groups (38%), population over 65 (8.5%), population between 0 and 16 (20.5%), surface area (1.8%), population dispersion (0.6%) and insularity (0.6%). The population of an Autonomous Community corrected by these indicators is called the “adjusted population”.

For non-fundamental public services, a less precise procedure is applied, which does not quantify expenditure needs by means of indicators. The financing needs for non-fundamental services are calculated for each region simply as the difference between the total expenditure guaranteed to that Community by the previous financing model in the base year established by the intergovernmental body CPFF (with some corrections due to the contribution of additional revenues by the central government) and its expenditure needs for fundamental public services. In short, the model restricts itself to ensuring that no Autonomous Community receives less revenue to finance its services than it has historically received, which constitutes the much-discussed “hold harmless” or “status quo clause” which, to a certain extent, continues to link regional revenues to the effective cost calculated decades ago.

The second stage consists of calculating the fiscal capacity of each Autonomous Community, which is the potential revenue collections that it could obtain from its ceded taxes if it required its citizens to make the same level of fiscal effort as the other Communities.

Finally, the third stage consists of calculating the transfers, which constitute the closing element of the financing model. For fundamental public services, a transfer is applied which is called the “Transfer from the Guarantee Fund for Fundamental Public Services”. It is calculated each year as the difference between the expenditure needs of each Community in these services, quantified as explained above, and 75% of the fiscal capacity derived from the ceded taxes plus some fees and charges. This transfer, which may be positive or negative, is therefore a genuine equalization grant, which guarantees, year after year, that if an Autonomous Community requires its citizens to make the same tax effort on its ceded taxes as the other Communities, it will also be able to provide, if it so wishes, the same level of educational, health and social services.

As for non-fundamental public services, there is also a transfer, known as the “Global Sufficiency Fund”, which is calculated as the difference between the financial needs of each Community, quantified as described above, and 25% of the fiscal capacity derived from the ceded taxes plus some fees and charges. This transfer can also be positive or negative and its objective is not equalization but sufficiency, for two reasons. On the one hand, as has been pointed out above, the system does not accurately calculate the Autonomous Communities’ expenditure needs on these services. On the other hand, the transfer of the Global Sufficiency Fund is not recalculated every year, as is the case for the transfer of the Guarantee Fund: the value of the Global Sufficiency Fund in the base year evolves for all the Autonomous Communities at the same rate as the taxes at the central level (the so-called National Tax Revenues, Ingresos Tributarios del Estado—ITE). Both the Transfer from the Guarantee Fund for Fundamental Public Services and the Global Sufficiency Fund are negative for Madrid and the Balearic Islands, the two regions with the greatest tax capacity.

There are still two other transfers, quantitatively less important than the previous ones, which are known as “Convergence Funds” (Fondos de Convergencia). The “Competitiveness Fund” (Fondo de Competitividad) seeks to avoid, first, that the revenues that the model provides to the richest Autonomous Communities are excessively less than what they could obtain if their revenues depended solely on their fiscal capacity, and second, that there are large differences in the total “per adjusted inhabitant” financing between Autonomous Communities. The “Cooperation Fund” (Fondo de Cooperación) aims to stimulate regional convergence. It is therefore more of a regional development instrument than an autonomic financing instrument in the strict sense.

All these transfers are unconditional, so the Autonomous Communities can freely decide how to use these revenues.

Figure 1 summarizes the operation of the financing system in 2016 by comparing, for each Autonomous Community, its “per adjusted inhabitant fiscal capacity” with its “per adjusted inhabitant total financing”, i.e. once all the transfers explained above have been applied. This Figure reflects at least two results that may attract attention. The first is that, after operating the various transfers, there is still certain dispersion in the per adjusted inhabitant financing of the Autonomous Communities. The second is that these differences are not related to the tax capacity of the Autonomous Communities. It is observed that the ranking of the Communities according to their tax capacity is reversed after the transfers, so that, for example, the three richest Communities end up having fewer revenues per adjusted inhabitant than almost all the others; in other words, the so-called “principle of ordinality” is not respected in the current system of transfers. This is true, and it has caused the complaints of some Autonomous Communities, like Catalonia, which has introduced into its Autonomy Statute the guarantee of the fulfilment of this principle (with some qualifications). But it should not be ignored that, as has been explained, the objective of the current financing system is not to make possible equality in the levels of provision of all autonomic services, for the same fiscal effort, but only for public services that have been classified as fundamental. In addition, although Fig. 1 provides a representation of the autonomic financing that is usually carried out, it must be interpreted with caution, because it is evaluating the revenues available to the Autonomous Communities to finance all their services with an indicator—the adjusted population—that the autonomic financing model only uses to quantify the expenditure needs of the fundamental services, as also explained above.

Fig. 1

(Source Authors’ elaboration, based on De la Fuente [2018])

Fiscal capacity and total financing of the Autonomous Communities per adjusted inhabitant, 2016 (Average = 100)

In addition to the transfers described so far, the regions receive conditional transfers from the central government to finance certain regional policies, for example, in the area of unemployment or dependency (known as “Managed Grants”, Subvenciones Gestionadas), or to finance collaborative projects between the central government and the Autonomous Communities, for example, in the area of scientific and technical research (known as “Agreements and Contracts-Programme”, Convenios y Contratos-Programa). Some regions also receive conditional grants intended to foster regional development, under the overall objective of reducing regional disparities in income and wealth. Examples of this type of grant are the “Inter-Territorial Compensation Funds” (Fondos de Compensación Interterritorial—FCI) and several grants from the European Union budget, such as the “European Regional Development Fund”.

In 2016, own taxes amounted to 6.2% of non-financial revenues for all the Autonomous Communities under the common regime, and ceded taxes, 74.8%. On the other hand, equalization grants represented 12.9%, and other grants, 6.1%, respectively, of non-financial revenues.

4.2 Transfers to Local Governments

The current transfer system for local governments was last updated in 2004.²⁴ It provides municipalities primarily with unconditional grants directly from the central government. Although the system of unconditional grants is ultimately enacted in a law from the National Parliament, the substance of the law is elaborated in a process of negotiation between the Ministry of Finance at the central level and the Spanish Federation of Municipalities and Provinces (Federación Española de Municipios y Provincias—FEMP), representing all local governments.

The funds are distributed according to different formulas that differentiate between large cities and medium and small municipalities.²⁵ Large cities receive the “Complementary Fund” (Fondo Complementario), which is calculated for the base year as the difference between the transfers received by each municipality with the financing model prior to 2004,²⁶ and the tax sharing calculated as explained in the previous section. For any year after the base year, the Supplementary Fund is calculated by applying to its value in the base year a growth rate equal to the increase in central government taxes, ITE.

For all other municipalities, medium and small, the amount of a transfer fund, called “Sharing in Central Government Revenues” (Participación en Ingresos del Estado), is distributed among them every year according to an index formula with three variables: population, with an assigned weight of 75%, the inverse of the tax capacity, with a weight of 12.5% and fiscal effort, with also a weight of 12.5%.²⁷ The pool of funds is adjusted every year by the rate of growth in central government taxes, ITE.²⁸

The system of local transfers has been criticized from several angles.²⁹ For example, the distinction between the large and the rest of the municipalities lacks a clear rationale and transparency. In addition, the formula lacks flexibility vis-à-vis the new problems faced by the country, such as the massive increase in the number of immigrants in certain parts of the national territory which has resulted in considerable increases in municipal (and regional) expenditures for social protection.³⁰ Several equity issues have also arisen because of the out migration from rural and mountain areas and the maintained support to facilities and services in those areas vis-à-vis urban areas with much higher population densities. In addition, it is only very indirect that the transfers to the local governments pursue an equalization objective.

Provincial governments also benefit from the “Complementary Fund”, which is calculated and evolves as explained above for large cities.

In addition to transfers from the central level, local governments also receive transfers from the Autonomous Communities and provinces, although of lesser importance.

In 2016, own and shared taxes represented 64.5% of non-financial revenues for all municipalities, and transfers, the remaining 35.5%. This means that there is a significant level of autonomy and accountability at the municipal level, although there are significant variations in tax effort (and expenditure levels) across municipalities.

5 Macroeconomic Management

Macroeconomic coordination and control of the subcentral deficit and indebtedness has gone through several phases in Spain. In a first stage, from the Constitution of 1978 until the end of the eighties of the last century, it was based on compliance with classic rules: for instance, regional debt burdens could not exceed 25% of current public revenues, the debt with a term longer than one year could only be issued to finance investments and central government authorization was required to issue Public Debt titles or to borrow in foreign currency (Article 14 LOFCA).

Subsequently, the process of Economic and Monetary Union in the framework of the EU and the integration into the Euro area since 2002 meant a far-reaching change, given the European restrictions to the deficit (which must be less than 3% of GDP, except in exceptional cases), to the debt (with a reference limit of 60% of GDP) and, especially, by the commitment to subject national macroeconomic policy to EU scrutiny, through the Stability Programmes, which contain the national budgetary policy in the medium term (the current year and the three following years).

Given that the central government is responsible to the EU for complying with those limits, and given the degree of fiscal decentralization reached in Spain, this made it necessary to strengthen internal budgetary coordination mechanisms within the European framework. The tool used has been the successive Budgetary Stability Laws, initially formulated in 2002 and with a 2012 version currently in force, the “Budgetary Stability and Financial Sustainability Law” (Ley Orgánica 2/2012, de 27 de abril, de Estabilidad Presupuestaria y Sostenibilidad Financiera—LOEPSF). This latest version of the budgetary stability law is motivated by the reform of article 135 of the Spanish Constitution, carried out in September 2011 to formulate at the constitutional level the obligation of all public administrations to maintain structural budget balances, except in the exceptional cases provided for in the LOEPSF itself.³¹ These cases allow separation from the budgetary balance only in situations of serious economic recession or emergency situations, due to natural disasters or any other cause beyond the control of the public administrations. Apart from the obligation to respect budgetary stability, understood as structural budget balances or budgets close to balance, and control of the Public Debt/GDP ratio, the LOEPSF establishes a spending rule, in the sense that the growth of expenditure in all public administrations must not exceed the medium-term GDP growth rate. As we will see later, this rule has been important, especially for local governments.

The process of setting budgetary policy begins with the Stability Programme presented by Spain to the EU, which contains the maximum projected deficit for the Spanish Public Sector as a whole, disaggregated by levels of government. The medium-term budgetary policy proposal is presented to National Parliament by the central government, which must previously request the report from the CPFF (which proposes the deficit and debt path of the Autonomous Communities) and from the “National Commission of Local Administration” (Comisión Nacional de Administración Local—CNAL), which proposes the path corresponding to local governments. In all cases, the recommendations and opinions of the supervisory bodies of the EU must also be taken into account. It is the National Parliament that finally approves the medium-term budgetary path for the Spanish Public Sector as a whole.

The central government formulates a proposal for the distribution of the regional deficit objectives among the different Autonomous Communities and the CPFF must give its opinion on this proposal. Although the CPFF must obligatorily issue its report on it, it is the central government that finally sets the debt and deficit objectives for each Autonomous Community. In practice, except for one year, the objective set for the Autonomous Communities as a whole has been the one established for each of them.

Any public administration that fails to meet its deficit or debt objectives or the spending rule must formulate an “Economic and Financial Plan” (Plan Económico-Financiero—PEF), explaining the reasons for non-compliance, specifying the measures to be applied to return to the path of stability and the timetable for its implementation. If the central government is the noncompliant one, its PEF will be presented to the National Parliament for its approval. If the noncompliant is an Autonomous Community, its PEF will be submitted to the CPFF for approval and subsequent follow-up. Non-compliance by a local government means submitting a PEF of the same characteristics indicated above to its Autonomous Community, if this latter has assumed the powers of local financial supervision in its Autonomy Statute, or to the Ministry of Finance, in the other case. In either case, the CNAL is informed. Sanctions are contemplated in the event that any public administration fails to comply with its obligations to submit a PEF or fails to comply with the provisions thereof, which may amount to a fine of 0.2% of its GDP.

As can be seen in Table 5, for the period 2007–2017, except for the surplus of 2.2% of GDP recorded in 2007, there has been a deficit in the remaining years due to the effects of the 2008 crisis, to which we will refer later.

Table 5 Deficit as a percent of GDP, 2007–2017

In the most recent period, starting in 2012, with the entry into force of the current version of the LOEPSF, the most striking fact is the change of sign of the budgetary policy of local governments, which since 2012 have been in surplus, with an average annual value of 0.5% of GDP. Three factors contribute to explain this result. First, the fact that local governments largely base their revenues on a property tax (IBI) levied on cadastral values, which have maintained their value in the period. Second, and to a large extent, the application of the spending rule to these governments. And third, the fact that, as we have explained above, there are no exceptional circumstances that allow local governments to evade the obligation of budgetary equilibrium.

The deficit of the Autonomous Communities has been gradually reduced, greatly influenced by the behaviour of some Autonomous Communities of great economic and demographic weight, which have registered deficits (Catalonia and Valencian Community, in particular). Also since 2014, the central government deficit has been significantly reduced, due to the combined effect of the LOEPSF rules and the effects of the economic recovery.

When analyzing the constitutional reform of September 2011, enshrining budgetary stability, it must be realized that it began to be applied in a context of significant economic difficulties. The crisis starting in 2008 had deep effects on the subcentral deficit and debt in Spain. The fall in revenues associated with the crisis caused significant delays in payments to suppliers, deteriorating the situation of the private sector. At the same time, the locking of the financial markets made it practically impossible to finance the deficit through debt issues or bank loans. The lesson of that period was that market discipline does not act gradually, making the credit of the most indebted Autonomous Communities more expensive, but rather abruptly cuts off credit flows to all subcentral governments, without discriminating as to their level of indebtedness.

In order to reconcile the new stability framework with the financial problems of that moment, two extraordinary financing mechanisms were issued by the central government in 2012, with the purpose of allowing a gradual adjustment of the subcentral indebtedness. The first of them provided credit to meet payments to suppliers of the autonomic and local governments pending before 2012. The second mechanism, the “Autonomic Liquidity Fund” (Fondo de Liquidez Autonómico—FLA), was aimed at financing the autonomic deficit, in view of the locking of the financial markets.

However, these instruments, initially conceived as extraordinary mechanisms, which made sense as a practical solution for gradually approaching budgetary stability, were modified in 2014, creating the so-called “Fund for Financing Autonomous Communities” (Fondo de Financiación a Comunidades Autónomas—FFCCAA) mainly to set up the FLA as a permanent financing instrument, intended both to finance the current deficit, and deviations from the deficit of previous years. Bearing in mind, moreover, that in several years the interest rate on these loans has been set at 0% and the repayment term has been extended, the result is that a “soft budget constraint” has been created with this mechanism. A “Local Entities Financing Fund” was also created in the same reform.³²

A recent report by the Spanish Court of Auditors (Tribunal de Cuentas) shows that 37% of the total resources of the FFCCAA were used in 2015 to finance deficit deviations from previous years and that in 2016 this percentage was 19.3% (Court of Auditors, 2019: 27). Although the regions that obtain funding from the FFCCAA are subject to conditionality requirements and must present a PEF, describing the adjustment measures to be adopted and the deadline for returning to the situation of budgetary equilibrium, experience shows that the PEFs of the noncompliant Autonomous Communities are repeatedly altered and new PEFs are formulated, which place the goal of budgetary equilibrium on a longer time horizon.

From a critical perspective, it is somewhat paradoxical that the setting of the objective of budgetary sustainability at the constitutional level in 2011, when accompanied by financial facility instruments, initially designed to operate temporarily—so that the most indebted Autonomous Communities would gradually re-establish their budgetary situation—has resulted in the creation of incentives for a, seemingly permanent, soft budget constraint.

As the most noncompliant Autonomous Communities have absorbed the majority of the FFCCAA (out of a total of 148,597 million € provided to the fifteen Autonomous Communities under the common regime between 2012 and 2016, the two most indebted represent more than 50% of the total: Catalonia, with 50,037 million € and Valencian Community, with 34,225 million €) and have replaced loans from financial institutions with loans from the FLA, market discipline has ceased to function at the regional level. There is also the anomalous situation that the central government is the main and almost the only lender of the most indebted autonomous governments, with the added problem of making intergovernmental political relations more intricate.

In 2018, Spain exited the EU’s Excessive Deficit Procedure (EDP), as its deficit was below the European reference value of 3% of GDP. However, several regional governments are still excessively dependent on the FLA and should reduce their high level of indebtedness, due to the high interest rate risk they will face when the ECB proceeds to normalize interest rates, with the consequent effect on the cost of debt.

Finally, it should be noted that investments by subcentral governments have been the main budgetary adjustment tool following the economic crisis of 2008. Subsequently, when the effects of the economic recovery have been felt, from 2013 onwards, the spending rule has meant that the growth in current expenditure (salaries and supplies) has left no room for investment by local treasuries, despite the fact that, as seen above, these have been in a continuous surplus position since 2012.

6 Challenges to Fiscal Federalism

Spain has undergone a fast and deep process of decentralization since the late 1970s. Over this period, what was a rigidly centralized country has emerged as one of the most decentralized in the world, in which sub-national governments play a fundamental role in the provision of the public goods and services that are closest to the lives of citizens and are most likely to affect their welfare. A growing body of evidence confirms that decentralization is contributing to improve the provision of goods and services such as education, health or infrastructure (Solé-Ollé, 2009), although its effects on inequality are less clear.

The Great Recession has had a harsh impact on the intergovernmental relations in Spain, calling into question the assignment of responsibilities and revenues between levels of government. For some observers, central government intervention in many areas of responsibility of Autonomous Communities remains too high and has increased during the recent economic crisis, effectively reducing sub-national autonomy (Viver and Martín, 2012). Consequently, there have been demands for the further clarification of the division of responsibilities between levels of government and increased recognition and respect for subcentral competences.

On the revenue side, there are widespread demands for a new revision of the revenue assignments at the regional and local levels. In 2017, two commissions of experts were appointed—one for regional financing and the other for local financing—which produced reports that same year offering a diagnostic of the main problems and offering reform proposals (Ministerio de Hacienda, 2018). Although no progress has been made since then, it is very likely that a new reform of regional and local financing will be tackled in the short-medium term. This reform will have to address the problems that have been on the table for a long time, some of which are briefly discussed below. For reasons of space, we will limit ourselves to those at the regional level.

As we have seen in the previous sections, although the decentralization of tax sources has lagged behind expenditure responsibilities, progress in this area has been very significant. However, there are still some avenues open for deepening tax decentralization. In the first place, it is possible to further increase the allocated share in some ceded taxes (e.g., excises). Secondly, since European Union regulations prevent the existence of regional differentiated VAT rates, the Autonomous Communities can be allocated the power to collectively decide the common regional VAT rate as is done, with different qualifications, in countries such as Australia or Canada. In this way, the Autonomous Communities could face symmetrical economic shocks, enacting policy changes in both direct and indirect taxes.

The third way forward is more ambitious. As we have seen, ceded taxes are characterized by having a common regulation imposed by the central level, although in some cases the Autonomous Communities have the power to establish the tax rate and tax credits and allowances. This formula does not differ substantially from that followed in other federal countries, in which, although regional governments have more powers over their taxes, in practice they seek to harmonize their basic elements. The fundamental difference is that in these countries tax harmonization is voluntary, while in the case of ceded taxes it is imposed by the central level. Within this framework, a possible reform would consist of extending the powers of the Autonomous Communities in the ceded taxes, favouring harmonization between regions, but not imposing it.

Finally, there is also a broad consensus on the need to ensure greater participation of the Autonomous Communities under the common regime in tax administration, participation which is currently very limited, as shown in Table 3.

The above measures may contribute to further reducing the dependence of the Autonomous Communities under the common regime on central transfers, to make possible the existence of greater asymmetries between regions in tax regulations and management (as some Communities claim) and to reduce the enormous differences that still exist between the common regime and foral regime Communities.

Vertical fiscal imbalances remain an issue of debate. Regional (and local) governments have continued to complain about the lack of sufficient funding and have demanded (and frequently have received) additional funding from the central government, being less important whether these funds came as transfers or as an increase in tax decentralization. Beyond the issues of whether regional governments have been assigned adequate autonomous tax sources and how much they have been predisposed to use these sources, we note two things here that are clearly quite decisive in resolving any issue of vertical imbalances. First, that all regional expenditure responsibilities have been devolved by mutual agreement between the regional and central governments, after using the “effective cost method” as a way to derive expenditure needs. Second, it remains a disputed issue and in no case has it been conclusively demonstrated that the evolution of central and regional revenues has resulted in any vertical fiscal imbalance to the detriment of the Autonomous Communities.

The incentives and behaviour of the regional and central governments further contribute to muddle the issue of vertical imbalances. Regional governments in Spain have been operating under a soft budget constraint. Concerning expenditure responsibilities, citizens see the central government as ultimately responsible for the delivery of certain regional services, such as health and education. As far as revenue is concerned, as we discussed in the previous section, the extraordinary funding mechanisms introduced from 2012 onwards, and especially the Fund for Financing Autonomous Communities, have also contributed to the softening of the Autonomous Communities budget constraint. On the other hand, the central government sometimes has taken decisions de facto involving unfunded expenditure mandates for the Autonomous Communities in certain expenditure programmes. In other occasions, the central government has undertaken tax reforms which have had a significant impact on the revenues of regional governments, for example reducing the yield of various (ceded) regional taxes, without compensation or counterbalancing measures.

With regard to the correction of horizontal fiscal imbalances, the current system of intergovernmental financing provides a strong level of equalization between regions under the common system, but only for the so-called fundamental public services. It would be desirable to extend the equalization system to the other services of the Autonomous Communities, and to reduce the numerous transfers that now exist to a single one, in order to gain in simplicity and transparency.

Determining the degree of regional equalization is the issue of greatest conflict between Autonomous Communities. This is ultimately a political decision with positions naturally taken according to who benefits and who pays. Beneficiary regions support full equalization on the grounds of solidarity, while those regions with the highest fiscal capacity point to the disincentive and efficiency effects of high levels of equalization and support, at most, a partial level of equalization that guarantees, in any case, the fulfilment of the “principle of ordinality”.

The asymmetric treatment of common regime and charter regions continues to be a thorny issue. The Spanish Constitution permits the existence of two financing systems with very different structures. However, the Constitution does not allow the results of the two systems to differ; that is, for Autonomous Communities with the same expenditure responsibilities to provide different levels of public services depending on whether they receive funding under the common or charter regime. As we have already explained, the literature has clearly identified the shortcomings of the charter system and how to resolve them. An obvious measure, among others, would be to involve the charter regions, probably gradually, in the system of equalization with the rest of the Autonomous Communities.

From the point of view of macroeconomic management, the Fund for Financing Autonomous Communities should be reformed so as to stop financing deficit deviations. It would also be necessary to call for greater compliance with the Economic and Financial Plans, in order to prevent its repeated modification (and prolongation). To reinforce this last aspect, it could be interesting to study the possible application of bankruptcy mechanisms to subcentral governments, in exceptional cases, as they currently exist in some other countries (Harold, 2018).

Finally, and from an institutional point of view, a reform of the Fiscal and Financial Policy Council (CPFF), whose recommendations always depend on the agreement of the central government, also seems necessary. The position of the Autonomous Communities should be strengthened in those issues that are of their preferential or exclusive interest, such as the distribution of the overall deficit objective of the Autonomous Communities among the different regions.