Territorial Fiscal Self-Rule

  • Franz Xavier Barrios-SuvelzaEmail author
Living reference work entry
DOI: https://doi.org/10.1007/978-3-319-31816-5_3641-1
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Synonyms

Definition

As a topic of public finance, territorial fiscal self-rule addresses the most decisive territorial fiscal balance point, in which so-called internal own revenues – i.e., a narrow subset of own revenues – back the spending needs derived from assigned functional responsibilities upon which the substate unit has real policy decision-making.

Introduction

The concept of territorial fiscal self-rule (TFSR) differs from its closest cognates, such as fiscal federalism, fiscal decentralization, or financial autonomy. It is not burdened by the “federal bias” as the first concept is, nor distracted by the discussion whether “decentralization” encompasses deconcentration or other kinds of decentralization (political, administrative, and electoral) as in the second concept, nor is TFSR centered exclusively around the tax domain as in the third cognate concept. It is also not equal to the concept of “regional economic self-rule” (Sorens 2014), because TFSR’s concern with the functional side is not reduced to economic affairs and, as will be shown below, gives some specific transfers a decisive role in achieving territorial self-rule. In any case, TFSR is not interested in whether the territorial fiscal arrangement of a country leads it towards market economy (Weingast 2014), liberalism, or, for that matter, towards democracy (but see Breton 1993).

While TFSR is not about the major issue of the “vertical structure of power” (Breton 1993), TFSR absorbs, in a condensed way, decisions taken upon this structure of power. In other words, TFSR not only relates to pure financial issues but also to the material side implied in functional (Bird 2005) or sectorial responsibilities, thereby considering the territorial organization and structure of the state, and the alternative regimes that regulate the relationships between financial issues and the material side. These different regimes also encompass the possibilities of substate units to override mechanisms that may limit their revenue and spending power, acknowledging the fact that to have no limits at all does not seem plausible.

In line with many scholars, the TFSR approach endorses the critique of how pointless it is to merely count revenues or spending amounts in substate units’ hands relative to the total revenues or expenses of the whole public sector, without asking how much discretion these units really have upon their fiscal arrangement (Stegarescu 2005: 302; Hooghe et al. 2008: 127; Sorens 2014: 244; Gemmell et al. 2013: 1918). In contraposition to current approaches, however, TFSR first decouples fiscal self-rule from its anchoring mainly upon the tax capacity of territorial entities, and more specifically, upon own-source revenues. Second, the concept of TFSR is systematically linked to considering the domain of functions or “programatic autonomy” (Sorens 2014: 244) and asks, in a principled manner, how far is the authoritative reach of the territorial entities’ decision-making over these functions. Third, the dimension of functional responsibilities is understood as something underlying, but not collapsing with, the spending side, which in itself has to be integrated into the concept of TFSR along with the revenue side. Fourth, based on these premises, TFSR is broken down into different types, built in search of the setting in which some kinds of own revenues match the domain of functional and spending responsibilities upon which the territorial entity has real decision-making.

Decoupling TFSR from Tax Power and Own-Source Revenues

TFSR is based on the category of territorial own revenues, whereby taxes directly applied by the corresponding territorial entity – in spite of all the positive incentives that they may trigger in terms of allocative and productive efficiency (Slack 2017: 3) – are only part of a multitude of resources that also confer some degree of fiscal freedom to the territorial substate unit and that are not absolutely bereft of incentives in terms of allocative and productive efficiency. The backbone of territorial own revenues are unconditioned resources. These are those, whose sectorial destination is not predecided through a territorial authority other than the one exercising the corresponding spending power. Since the criteria of unconditionality builds upon the silence on the part of the granting territorial entity concerning the sectorial destination of territorially granted resources, the definition of unconditioned resources endorsed here is not based (but see Yilmaz et al. 2012) on the rule-driven quality of allocation of such resources, nor on the use of objective parameters that define the criteria for their territorial imputation. Moreover, unconditioned resources should not be confused with resources of a general purpose (but see Stegarescu 2005: 309). The “general purpose” relates to the roles that revenues may play (other roles being lowering disparities, capturing externalities, to name a few) in the whole system of revenue assignment, whereas “unconditioned” relates to the quality of resources. Therefore, unconditioned recourses may finance equalization systems, thus ruling out their role as a means for backing general purposes of the territorial entity. In the opposite case, namely, conditioned resources, the predetermination of the sectorial destiny on the side of the granting entity may be broad (i.e., so-called block grants) or narrow, and the fulfillment of this destination is expected to be verifiable by the entity granting the resources to the executing substate unit. Because here the definition of conditionality is mainly linked to the sectorial destination of territorial resources, it does not encompass – as is usually the case in mainstream literature – several exigencies that may accompany the transfer of resources such as matching grants, administrative skills on the side of the recipient, or the presence of some socioeconomic indicators that qualify a recipient for these transfers. To understand the complete idea of TFSR, it is also important to underscore that conditionality ends when beyond the assertion of a sectorial destiny for granted resources, the granting entity interferes in operational and concrete processes implied in the expenditure dynamic through commands directed towards the recipient entity. If this were the case, not conditioned, but the even more constraining category of territorial heteronomous resources emerges.

According to all these premises, even transfers may count as part of own revenues of territorial entities if these transfers have the quality of unconditioned resources. It does not matter, in this context, whether transfers are classical ones (meaning already budgeted resources stemming from an upper territorial level), or transfers accruing to substate units following constitutional mandates that rule the apportionment of resources to the substate domain without intermediation of any previous politically bargained annual territorial current budgets.

Assuming the idea of own revenues based on unconditioned resources broadens the scope of the substate’s fiscal self-rule in comparison to the strong tradition of scholarship in fiscal federalism to focus on own-source tax revenues as the reference for virtuous territorial revenue (so Slack 2017: 12). Some authors concede that “general purpose grants” may be classified as “own or free revenues”, but are reluctant to base any kind of “financial autonomy” on them (Stegarescu 2005: 309). The view presented in this entry forces the observer to methodologically break down different components of territorial resources (own sources taxes being only one of them), to rescue unconditioned resources by contrasting them stronger against conditioned ones (Ladner et al. 2016: 327), and to scrutinize these unconditioned resources in order to determine the varying degrees of influence (Hunter 1977) recipient territorial entities may exert upon the revenue assignment process in the state. The fiscal space of substate units expands to the extent that this influence becomes more decisive. Under some circumstances, the influence may even affect the amount of resources allotted, as may be the case when territorial entities bargain tax sharing quotas (Stegarescu 2005: 308; Gemmell et al. 2013: 1920). In other words, the phenomena of unconditioned resources seems to imply more than simply a future non-constrained sectorial spending, namely something that may even reach the generation of resources.

It could be argued that relying on this understanding of own revenues, which includes tax sharing, overlooks that the national level may behave strategically, frequently bringing the whole system of territorial revenue assignment into instability. However, taking a look at the historical records of several federal countries that over decades have financed their respective equalizations systems through unconditioned resources (Bird 2005), it becomes clear that a central government committed to steady unconditioned transfers is possible. To be sure, this stability is more likely the more such agreements are constitutionally entrenched, and the more the corresponding society has a tradition of “legal culture”.

The Rationale of TFSR

Drawing on the idea of own revenues, as those whose backbone are unconditioned resources, redirects the attention to the pragmatical needs of territorial entities to cope with their responsibilities with varying degrees of freedom, away from lamenting over the difficulties to match spending responsibilities only or mainly to own-source revenues. Thus, the question now is how territorial own fiscal decision-making may be achieved to different degrees even under circumstances of weak own-source revenues, and how a package of functional responsibilities can be assumed, differentiating those, whose content is decided at the substate domain; from those whose content is decided in an upper territorial level but the executing substate unit is free to administer the operational details; and from those upon which the upper level has both policy and administrative command upon the responsibilities delegated to the substate unit.

The System of TFSR

As has already been suggested in recent literature on fiscal federalism and fiscal decentralization, the concept of TFSR also insists in considering both sides – revenue and spending – for approaching this topic more systematically (Gemmell et al. 2013: 1922). If necessary, “autonomy to borrow” and “budget autonomy” could be ascribed respectively to revenue and spending sides of TFSR. For assessing the degree of TFSR an evaluation of the quantitative magnitude of the different kinds of revenues that underlie TFSR, relative to the whole aggregation of territorial revenue available, is advisable (Ladner et al. 2016: 327; Stegarescu 2005: 309). Having said that, distinguishing specific types of TFSR starts by marking out in which fields the respective territorial entity enjoys a real capacity of policy-making, or in other words, “policy scope” (Hooghe et al. 2008: 126). In general terms, this capacity is best approached by simply asking where can the entity legislate, whereby legislation is narrowly understood in the sense of “primary legislation” (Baldwin 2003). Alternative terms such as “authoritative decisions” (Hooghe et al. 2008: 126), or “independent … decision making” (Ladner et al. 2016: 332) are not clear enough for the purpose here. Both terms can be applied to situations in which substate units are free from administrative supervision from an upper level, but are still unable to make decisions on policy. Because legislative capacity, in the sense of primary legislation, is normal in composite states – such as federal ones – as here substate units of the intermediate level enjoy true legislative capacities, the idea of TFSR applied to simple states demands closer clarification. With regards to simple states – conventionally known as “unitary” ones – one can substitute the demanding parameter of primary legislation with rulemaking of a general scope, despite the fact that the latter are rules below the scale of primary legislation.

Following these premises, eight types of TFSR are presented here, four on the revenue and four on the expenditure side. On the expenditure side, the weakest alternative is named fiscal self-administration, in which those tasks are considered upon which the upper level decides the specific sectorial destination. Though weak, this scenario is considered as part of the whole system of TFSR because, as explained above, while the upper level determines the sectorial destination, it refrains from intruding upon the operational details of the spending process, leaving thus some decisional freedom for the executing territorial entity. The next scenario can be labeled fiscal self-decision, in which no specific sectorial exigency is expected from any upper level, granting the substate units much more fiscal freedom. A third scenario emerges if one looks at those functional responsibilities upon which a substate unit does have real influence on policy. In such a case, fiscal self-determination on the expenditure side arises. It is at this point where TFSR attains, as far as the spending side is considered, its most important expression. The last type is the extreme opposite to fiscal self-administration, namely, fiscal self-prioritization, meaning the spending on tasks of which can be assumed that consumers are explicitly willing to pay for their provision. For completing this system of types of TFSR on the expenditure side, it is now useful to see how the parameters on the revenue side dovetail to the just described parameters. The first parameter on the revenue side is called fiscal leeway on the revenue side, meaning some degree of fiscal maneuvering for the substate unit even if employing conditioned resources (Slack 2017: 4). The second is fiscal independence, meaning the possession of own revenues. This mirrors the situation described with fiscal self-decision on the spending side. It may be that some portions of own revenues have to be channeled towards areas of public policy upon which the respective substate unit has no policy-making decision, despite executing them without commands from the upper level. In fact, the mere existence of own revenues does not tell whether the territorial entity is financing mainly tasks upon which it has real decision-making. The third type emerges by subtracting those resources from the category of own revenues, which are absorbed for financing responsibilites over which the upper level has policy decision power. In such a case one reaches the category of internal own revenues, which underlie fiscal self-government. In this understanding of self-rule, one does not have to wait until the generation of own-source taxes is attained in order to speak of self-rule. True, this last category combines transfers, grants, and other revenues, which are both unconditional and not available for financing external policies. However, among these revenues are those upon which the territorial entity has the power to really decide – as in the case of own levied taxes – upon amount, the base, and/or the rate without depending on any upper level (Ladner et al. 2016: 335). The fourth scenario in which this is possible is called fiscal autonomy on the revenue side. As one can already see, as important as this last scenario might be for accomplishing many virtues concerning accountability, efficiency, and financial sustainability, seen from the perspective of the TFSR understood as a system, one has to consider many other different scenarios and combinations, whereby the ideal balance point is the one in which internal own revenues match those responsibilities upon which the territorial entity has real policy-making power. Before turning to this virtuous territorial fiscal balance point, the eight types of TFSR are presented in Fig. 1.
Fig. 1

Types of fiscal self-rule on the revenue and expenditure side

Same Territorial Fiscal Balance with Counterintuitive Ratios of TFSR

The point at which internal own revenues match responsibilities upon which the entity has decision over policy-making (this point shall be named alpha balance point) represents the decisive balance point from the perspective of TFSR. But this is still only one territorial fiscal balance point among others, as, for example, one in which even delegated tasks from an upper territorial level are appropriately covered by reimbursement payments stemming from the delegating entity. The construction of TFSR as a system built by several revenue and spending types not only allows us to understand that TFSR is about degrees of financial freedom of the territorial substate unit but prepares us for the likelihood that the same balance point which is decisive for TFSR may be achieved by combining counterintuitive ratios of the different types of TFSR. In other words, it could be that a substate unit has weak “fiscal autonomy” – if under fiscal autonomy only own-source revenues are considered (Slack 2017: 4) – but at the same time exposes a remarkable TFSR. Thus, the alpha balance point may be achieved in time t+1 by decreasing the ratio of own-source revenues relative to total revenues compared to time point t. For illustrating this phenomenon, a highly stylized example is presented in Fig. 2. Assume that in period t a substate unit X exerts real policy-making power through own legislative power upon the field of education, but only executes (without any saying on policy matters) in the field of health. Assume further that for accomplishing these responsibilities in education and health unit X has received a massive amount of a portion of income tax collected by the national level in the form of unconditioned resources, which is constitutionally split between the national and the substate level which unit X is part of. Now assume that in period t+1, the constitution rules that in addition to education, the field of health also becomes a sector upon which unit X can legislate. Before this new arrangement is enforced, let us remember that both sectors were already financed by unit X with the only difference that in the education sector it had legislative power to regulate policies, whereas in the health sector it had not. Hence, because the new field represents costs that were already covered by unit X’s financial structure during period t, no significant change in the financial needs of unit X arise. For rounding up this example, assume finally that in period t+1 unit X is able to slightly increase its own-source tax revenues, which are being reinvested for delivering better services in both education and health. Now, if one compares unit X in period t to period t+1, the alpha balance point is achieved though under different ratios of TFSR. As can be seen in Fig. 2, while in period t+1 the degree of fiscal self-government has markedly increased, the degree of fiscal autonomy has barely done so. The ratio of own-source revenues relative to the package of responsibilities upon which unit X exerts policy influence has even decreased. In sum, the attainment of a broader TFSR has been achieved even by a rather modest or decreasing development of own-source revenues.
Fig. 2

Modeling the generation of a balance point of type “alpha”

The Vertical Dimension of TFSR

The approach entailed in the concept of TFSR includes taking the fact into account that fiscal self-rule at the scale of each territorial entity is one thing, and another thing is the manifestation of TFSR considering whole territorial levels (Bird 2005). What each single territorial substate unit may receive in the form of revenues is often mediated by huge processes of revenue distribution that previously occur among territorial state levels. The prospects of territorial fiscal self-rule of each single entity may be thus partially prefigured in the way large masses of tax revenues are apportioned among levels before each entity gets its specific lot. Likewise, responsibilities are actually often distributed in the constitution, whereby whole packages of sectors are assigned per level.

The Structural Dimension of TFSR

Depending on the territorial state form, territorial entities belonging to a respective territorial level possess diverging prospects of TFSR. In composite states, such as federal ones or so-called autonomic states like Spain or Italy, the predominant role of the intermediate level, under which the municipal level is made invisible, may trigger decisive constraints on the pattern of revenue assignment. Thus, the constitutional framework may not only influence TFSR because of being the mechanism through which responsibilities are assigned, or because in it lies one of the main sources for institutional predictability and constraint upon the national level to abide fiscal agreements, but because of the impact the state form itself exerts upon the revenue assignment system. The territorial state form influences, for instance, the status of major cities and their financial strength (Slack 2017: 4).

Conclusion

The concept of TFSR entails a systemic view of the different ways and patterns of substate units’ financial capacity for coping with their responsibilities, provided some degree of fiscal decisional freedom is detectable. It is distinguished from related concepts such as financial autonomy, fiscal federalism, and fiscal decentralization; because it is nonfederal-biased, it has a more realistic stance concerning own-source revenues, and it systematically considers regimes of state authority that link different components of revenues and spending to the distribution of functional and spending responsibilities. Future research may enhance this approach by increasing the supply of data covering details on the real decision-making power upon responsibilities (Stegarescu 2005: 326), and details concerning the costs implied in each functional responsibility.

Cross-References

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Authors and Affiliations

  1. 1.Faculty of Law, Social Sciences & EconomicsUniversity of ErfurtErfurtGermany