The the tax rates and, finally, (iv) which one

The second-generation theory has emerged towards the end of the last
decade of the twentieth century. The theory cover the concepts like political
economy approach, the economics of information, the principal-agent problem,
the theory of contract, and the theory of firm. The
second-generation theory argues the concept that the
public agents do not necessarily serve the public interest unlike to the concept of first-generation
theory of fiscal federalism. Similarly, they argue that asymmetric information exists between federal and
provincial governments unlike the availability of perfect information between federal
and provincial governments under the
first-generation theory (Sudhipongpracha, 2015).

           

There are
five main pillars of fiscal federalism. They are a) revenue assignments, b)
expenditure responsibilities, c) intergovernmental fiscal transfer, d) fiscal
institutions, and d) sub-national borrowing.

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2.2.1. Revenue Assignments

 

Theoretical
Review

 

The theory of tax assignment simply
deals with the following four issues (i) which level of government have to choose
the taxes to be imposed at any level, (ii) which level should define tax bases,
(iii) which one should determine the tax rates and, finally, (iv) which one
should enforce and administer the various tax tools. Many believe that the
sub-national governments should be empowered with the sufficient revenue
raising rights (Ambrosanio and Bordignon, 2006). Revenue-sharing arrangements
can be of two types: those in which multiple levels of government share the tax
base and those in which revenue is collected by one level but shared by
different levels (Rao, 1997). Federal countries have adopted both separated as
well as overlapped assigning tax powers among the levels of governments by
constitution. The taxes assigned to the central government are not assigned to
the states and vice versa (Boadway and Shah, 2009). However, there is no
globally accepted model to deal with these problems.

           

It is argued that taxes with a
nature of relatively immobile bases or assets and bases with evenly distributed
among jurisdictions should be levied by the local governments. It has many
merits including (i) prevents tax completion and revenue losses, (ii) prevents
the generation of horizontal fiscal imbalances, (iii) yield becomes stable in
real terms for expenditure planning. These arguments are put forward in
Musgrave’s traditional normative and Oates’s public choice approach. However,
these approaches have many drawbacks comprising (i) it is completely normative
approach, (ii) does not reflect the actual situation of the contemporary world,
and (iii) weak demarcation of the tax assignments between central and local
governments (Prasad, 2016). In this background, user charges, benefit taxes,
and taxes on relatively less mobile taxes could be the major sources of revenue
generation of the sub-national governments (Musgrave, 1985; Rao, 1997).

           

On the other, the nature of
taxes with broad and mobile tax bases need to be assigned to the central
government with two main purposes (i) economic stabilization, and (ii) redistribution
of income, wealth and resources. In this background, taxes on international
trade need to be exclusively levied by the central government.

           

The political economy approach
of tax assignment has been extensively extended in the contemporary world.
Therefore, the traditional theory is in shadow now. Under the political economy
approach, tax assignment and sharing at the various levels of governments is
determined by the negotiation among them. This approach is widely known as ‘A
Second-Generation Theory of Fiscal Federalism’ (Bardhan, 2006 and Oates, 2005).
In this juncture, universally accepted principle of tax assignment is not
available in the economic literature.   Summary
of international practice of allocation of taxing power among the various
levels of government is given in Table 3.3.

 

 

Table 3.3: Representative Assignments of Taxing Powers

 

Type of tax

Determination of
Base            
Rate

Collection and administration

Comments

Customs

 N                        N

N,
P

International trade taxes

Corporate income

N,U                N, U

N,
U

Mobile factor,
stabilization tool

Resource tax
Resource rent tax
(profits, income)

 
N                         N

 
N

 
Highly unequally
distributed tax bases

 Royalties, fees, charges, severance taxes;

S, L                 S, L

S,
L, P

Benefit
taxes/charges for state-local services

Conservation charges

S, L                 S, L

S,
L, P

To preserve local environment

Personal income

N N, S, L

N

Redistributive,
mobile factor; stabilization tool

Wealth taxes (taxes on
capital, wealth, wealth transfers, inheritances, and bequests)

N                    N,S

N

Redistributive

Payroll

N,S               N,S

N,
S

Benefit charge,
e.g., social security coverage

Multistage sales taxes
(value-aided tax VAT

N                    N,S

N,
S

Border tax adjustments
possible under federal assignment; potential stabilization tool

Single-stage sales taxes (manufacturer, wholesale,
retail)
   
Option A
   
Option B

 
 
 
S                       S,L
N                        S

 
 
 
S,L
N

 
 
 
Higher compliance cost
Harmonized, lower compliance cost

“Sin” taxes
   Exercise on alcohol and    tobacco

 
N,S                 
N,S

 
N,S,P

 
Health care a shared responsibility

Betting, gambling

S,L                   S,L

S,L,P

State and local responsibility

Lotteries

S,L                  
S,L

S,L,P

State and local responsibility

Race tracks

S,L                   S,L

S,L,P

State and local responsibility

Taxation of “bads”
Carbon

 
N,U                
N,U

 
N,U

 
To combat global/national pollution

BTU taxes

N,S,L          
N,S,L

N,S,L,P

Pollution impact may be national, regional or
local

Motor fuels

N,S,L          
N,S,L

N,S,L,P

Tolls on federal/provincial/local roads
 

Effluent charges

N,S,L          
N,S,L

N,S,L,P

To deal with interstate, inter-municipal or
local taxes

Congestion tolls

N,S,L          
N,S,L

N,S,L,P

Tolls on federal/provincial/local roads

Parking fees

L                          L

L,P

To control local congestion

Motor vehicles
Registration, transfer taxes, and annual fees

 
S                          S

 
S

 
State responsibility

Driver’s kitchen and fees

S                          S

S

State responsibility

Business taxes

S                          S

S

Benefit taxes

Exercises

S,L                   S,L

S,L

Residence-based taxes

Property

S                          L

L

Completely immobile factor, benefit taxes

Land

S                          L

L

Completely immobile factor, benefit taxes

Frontage, betterment

S,L                      L

L

Cost recovery

Poll

N, S,L         
N,S,L

N,S,L

Payment for services

User Charges

N,S,L          
N,S,L

N,S,L,P

Payment for services received

 

Note: U
= supranational agency, N = national/federal, S = state or province, L =
municipal or local, and P = private 

Source: Shah, Anwar (ed.) The Practice of Fiscal Federalism: Comparative Perspectives, 2007

           

Almost in all federal
countries around the world, custom duties are levied at the central level. On
the other hand, taxes on the consumption of goods and services and main direct
taxes are levied concurrently on both the central and sub-national levels in most
of the federal countries. Switzerland has greater taxing powers with the
Cantons which generates around 80 per cent of the total tax revenue of the
country. In Canada, the federal government levies value added tax and provinces
levy retail sales taxes. Direct taxes are levied by both the federal as well as
provincial governments concurrently. In India, excise duties on manufactured
products and taxes on the sale and purchase of goods are levied by the central
and state governments respectively. VAT is levied by both the central and state
governments concurrently including manufacturing stage VAT by the central
government and destination-based VAT up to the retail stage by the states. The
central government levies non-agricultural income and wealth and the state
governments levy agricultural income and wealth (Schmidheiny, 2017). In Brazil,
VAT is levied at both the central and state levels. The sub-national
governments in Scandinavian countries and the United States are allowed to levy
personal income tax concurrently at both the central and sub-national levels (Boadway
and Shah, 2009).

 

 

 

 

Table 3.4: Share of Central and Sub-National
Taxes: Selected Countries and Years (Per Cent)

 

 
Country and year

Total tax revenues

Taxes on income

Taxes on property

Domestic taxes on goods and services

%Central

%State

%Local

% Central

%State

%Local

%Central

%State

%Local

%Central

%State

%Local

*Germany 1998

70.7

22.0

7.3

43.4

36.6

20.0

0.8

48.6

50.6

62.8

37.0

0.2

*Spain 1997

83.0

7.5

9.4

85.7

8.7

5.7

2.8

52.4

44.7

78.5

5.4

16.0

Ukraine 2001

74.3

0.0

25.7

35.6

0.0

64.4

0.0

0.0

0.0

80.5

0.0

19.5

*Canada 1999

52.5

38.5

9.0

63.5

36.5

0.0

0.0

21.1

78.9

41.0

59.0

0.1

*Russia 2001

69.7

0.0

30.3

27.6

0.0

72.4

5.2

0.0

94.8

82.7

0.0

17.3

*South Africa 1998

92.8

0.5

6.7

100.0

0.0

0.0

21.7

0.0

78.3

98.6

1.4

0.0

*Switzerland
2000

66.0

20.0

14.0

30.3

39.1

30.7

30.9

42.8

26.3

92.2

7.6

0.2

*Australia 1999

77.4

19.3

3.3

100.0

0.0

0.0

0.0

63.6

36.3

66.2

33.8

0.0

*United States
2001

69.3

19.1

11.6

83.0

15.5

1.5

10.0

8.0

82.0

15.7

67.6

16.8

*Argentina 2001

59.7

40.3

0.0

50.5

49.5

0.0

54.4

45.6

0.0

94.6

5.4

0.0

*India 1999

62.6

37.4

0.0

100.0

0.0

0.0

14.9

85.1

0.0

41.5

58.5

0.0

China 1999

45.0

55.0

0.0

24.4

75.6

0.0

0.0

100.0

0.0

55.7

44.3

0.0

Indonesia 1999

97.1

2.9

0.0

100.0

0.0

0.0

74.9

25.1

0.0

95.9

4.1

0.0

Note: *
indicates a federal country. Data for the emerging country group are shown in
italics

Source: The World Bank/Richard M. Bird, 2010

 

            In most developing and transitional economies, local
governments do not have significant tax collection powers. Richer and larger
countries are usually more decentralized in terms of revenue assignments (Table 3.4).

Empirical
Review

 

International

 

Agegnehu
and Behaylu (2015) examines that Australia has a highly centralized tax system.
There is very little sharing of tax bases across the tiers of government. More
than 82 percent of national revenue is collected by the centre through
controlling major revenue bases such as income tax on individuals and
companies, excise duties and levies, and taxes on international trade and VAT.
The remaining 18 percent is collected by the state and the local governments.
The states raise their revenue from the tax bases such as pay roll tax and
stamp duties, land use and natural resource tax, motor vehicle tax, gambling
tax, and royalty from resource extraction. The local governments collect from
the tax bases such as property tax, and parking fees and charges.  The state governments are free to impose tax
rates on all tax bases that are not reserved to other tiers of government by
the Constitution or by subsequent legislative or judicial decisions.

           

Australian
federation is characterized by a high level of vertical fiscal imbalance
between the federal and sub-national governments. Sub-national governments are
highly dependent on federal transfers. State and local governments require some
40 percent of total public sector expenditure to meet their obligations but
raise only about 18 percent of total public sector revenue. A number of
stakeholders are questioning this model and making criticism (Agegnehu and
Behaylu, 2015). 

 

Fernando
(2007) has analyzed the Brazilian taxation system based on the 1988
Constitution. States and municipalities have independent taxing powers in
Brazil.  The federal government is solely
responsible for imposing taxes on both individual and corporate income taxes,
foreign trade, and rural property and payroll. The federal government has also the
residual powers to intervene in the economic sphere and any other potential tax
source not clearly assigned to the state or local governments by the
constitution. 

           

Goods and
service taxes are concurrently levied by the federal and state governments in
Brazil. The federal government is authorised to tax on manufacturing goods and
the social contributions. VAT, property tax and motor vehicle tax are levied by
the state governments. The local governments collect sales tax of urban
property and user charges. In this perspective, Brazil is characterized by a
high degree of revenue decentralization at the state level in comparison to
many federal countries around the world (Fernando, 2007).

 

According
to Boadway and Shah (2009), the federal government in Canada has the
constitutional right to raise tax revenue by any mode of taxation. However,
both levels of government enjoy a very broad based and shared taxes
jurisdiction. The federal government raises major share of its revenue from
three broad-based tax sources-personal income taxation, sales taxation, and
payroll taxation. The Canadian provinces have full discretionary power
regarding the choice of their tax systems. They enjoy an independent
legislation and administration of taxes within their jurisdiction. Provinces
can levy VAT, both personal and corporate income taxes, excise taxes, resources
tax within their jurisdictions. Property tax is the main source of the local
governments. Unlike Australia and Germany, the Canadian tax system is more
decentralized. The provinces are provided adequate autonomy both in terms of
determining tax bases, rates and generate own revenue.

 

Feld and
Hagen (2007 states that the central government in Germany has an exclusive
authority over the major taxes including customs duties, both personal and
corporate income taxes, turn over tax, insurance tax and VAT. Taxes are
generally collected by the federal government and then shared to the states and
the local governments on approved percentages based on the constitutional provisions.
Unlike Canada, the German tax system is more centralized. The states and local
governments lack discretionary power over determining tax bases and rates
within their jurisdiction. The taxes exclusively assigned to the states and
local governments are: property tax, motor vehicle tax, inheritance tax,
lottery tax, tax on beer and tax on local business, fishery and hunting tax,
and entertainment tax. The states and local government tax base is
insignificant to finance their expenditure needs.

 

CBEC (2017)
shows that the central government has the power to levy the major broad-based
and mobile tax bases including taxes on non-agricultural incomes and wealth,
corporate income taxes, customs duties, and excise duties on manufactured
products for reasons of stabilization and redistribution in India. The central
has also been assigned all residual powers which imply that the taxes not
mentioned in any of the lists automatically fall into its domain. The major tax
powers assigned to the states include taxes on agricultural income and wealth,
taxes on the transfer of property (stamp duties and registration fees), taxes
on motor vehicles, taxes on the transportation of goods and passengers, sales
tax on goods, excises on alcoholic beverages, entertainment tax, taxes on
professions, trades, callings and employment, property tax and taxes on the
entry of goods into a local area for consumption, use or sale (octroi).
However, from the viewpoint of revenue productivity, only the tax on the sale
and purchase of goods is important.

            

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