Transcript The Tiebout Model

Regional Economy: The Case
of Decentralization
Arti Adji
Experience of the NIE (1)
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Level of public spending in NIE (18% of
GDP) < in industrialized countries (40%
of GDP).
Industrialized countries: Keynesianism
and creating welfare state. NIE: small
government and rely on market and
economic incentives.
Experience of the NIE (2)
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Korea: most interventionist but keep public spending
under tight control.
Hongkong: non-interventionist, provide public
services and economic infrastructure.
Singapore: good governance: rule of law, property
right, fair commercial practices.
Emphasis in NIE: human capital formation with govt
take role in providing education and health for the
poor.
Composition: 1/3 consumption, 1/3 subsidies and
transfers, 1/3 interest payments and govt
investment.
Experience of the NIE (3)
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NIE experience impressive growth rate due to
high rate of gross fixed capital formation
(30% of GDP).
Public investment: 3% of GDP (10% of total
investment).
High savings rates (Korea: 35% of GDP).
Private investment has been driving economic
growth.
Seldom experience budget deficits.
Indonesia (1)
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Over the past 10 years, there has been a remarkable
transformation in the way public resources are
managed and allocated.
1997-8. The economic crisis. The economy
contracted, public spending fell. Debt and subsidies
increased while development spending declined.
2001. Big bang decentralization. 1/3 of central govt
expenditure was transferred to the regions.
2006. An extra US$15 billion to spend. The reduction
in fuel subsidies opened up space for additional
spending, debt levels dropped below 40% of GDP,
aggregate expenditure increased by 20 percent and
transfers to sub-national governments grew by 28%.
Indonesia (2)
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Provinces and local govt manage 40% of total public
expenditures and carry out > 50% of public
investment.
Total govt debt fell < 40% of GDP by the end of
2006.
Spending on subsidies and administration: 1/3 of
total expenditures. Subsidies: 15% of budget.
Public infrastructure = 3.4% GDP (never recovered
from post-crisis low level.
Public investment has recovered and returned to the
pre-crisis level of 7%; sub-national governments now
manage half of Indonesia’s public investment.
Four Pillars of Decentralization
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Tax Assignment
Expenditure Assignment
Intergovernmental Transfers
Regional Borrowings
Tax Assignment
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Definition: allocation of tax responsibilities among multiple tiers
of government.
Principles:
progressive redistributive tax should be centralised;
taxes suitable for economic stabilisation should be centralised;
unequal tax bases between jurisdictions should be centralised;
taxes on mobile factors of production should be centralised;
residence-based taxes, such as excise, should be levied by
states;
taxes on completely immobile factors should be levied by
regional authorities;
benefit taxes and user charges can be levied appropriately by
all levels
US Tax Assignment
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United States has a decentralised tax
administration with each federal, state, and
regional government having its own tax
administration to collect the taxes it imposes.
There is piggyback system: the federal
government collects income tax and then
gives a fixed 10 per cent of that yield to
regional government.
Japan Tax Assignment
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Taxes are the greatest source of regional revenue in Japan:
about 35 per cent, which is about three times the proportion of
regional taxes in the case of Indonesian regionals.
Regional governments do have some flexibility with certain
taxes, provided that these are approved either formally or
informally by the central Japanese government.
What Indonesia can learn from this is how to structure the tax
system in a manner that gives regional governments the
capacity to raise a greater proportion of total revenue from
regional taxes. And as the Japanese case shows, this can be
done in a way that is flexible and involves the central
government as a monitor and ultimate authority.
Australia Tax Assignment
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The Commonwealth Government controls the major highyielding taxes: personal income tax, customs and excise duties,
company income tax, and sales tax. It left only low-yielding
smaller revenue sources for state and municipal governments.
Australia espouses the principal of complete separation of the
tax base for different levels of government. In Indonesia, by
contrast, the central government has dominated the tax system
by monopolising all the high-yielding tax sources.
There are annual meetings of the state Premiers with the Prime
Minister to discuss the fiscal formula used to allocate centrallycollected taxes back to the state governments. This provides the
state governments with the chance to plead their case for
altering the formula on a regular basis.
Argentina Tax Assignment
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The federal government collects the main
taxes such as income tax, value added tax,
excise taxes, foreign trade taxes, liquid fuel
and energy taxes, gross assets tax, social
security taxes, and a number of minor levies.
Provincial and municipal governments collect
real estate tax, automobile tax, road taxes
and the provincial turnover tax.
Provincial tax collection represents about 45
per cent of total provincial government
revenue.
Expenditure Assignment
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Definition: allocation of responsibilities
for expenditure between multiple tiers
of governments.
The effectiveness of expenditure
assignments can be judged by the
following criteria: economic efficiency,
fiscal equity, political accountability and
administrative effectiveness.
US Expenditure Assignment
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The federal government is responsible for national
defence and public welfare spending.
State governments are responsible for transportation,
public works, public welfare and higher education.
Regional governments provide basic goods and
services, primary and secondary education, and
police and fire services.
The distribution of function in the United States is
very clear-cut. There is no overlap. In the
Indonesian case, bureaucratic confusion has become
exacerbated after the reforms owing to the lack of
functional clarity and the many overlapping areas of
responsibility.
Australia Tax Assignment
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The federal government is in charge of social security
and welfare and some health spending.
State governments finance non-tertiary education,
other health services, housing and community
amenities, law and order, and public safety, transport
and communications, and social services.
Municipal government is responsible for the provision
of transport services, recreational and cultural
facilities, and some housing and community services.
These are financed by fines, including traffic and
parking fines.
Tiebout Model
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Market generally fails to provide public
goods efficiently since market does not
force individuals to reveal their true
preferences for public goods; everyone
has an incentive to free-ride; therefore
government intervention is required.
Tiebout suggests that the ability of
individuals to move among jurisdictions
produces a market-like solution to the
Tiebout Model Cont’d
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Assumptions:
Government activities generate no externalities.
Individuals are completely mobile.
People have perfect information with respect to each
community’s public services and taxes.
There are enough different communities so that each
individual can find one with public services meeting
her demands.
The cost per unit of public services is constant, so
that if the quantity of public services doubles, the
total cost also doubles.
Public services are financed by a proportional
property tax.
Communities can enact exclusionary zoning laws—
Optimal Federalism
Disadvantages of Decentralized System:
 Efficiency Issues:
 Externalities
 Scale economies in provision of public
goods.
 Inefficient tax systems.
 Scale economies in tax collection.
Optimal Federalism Cont’d
Equity Issue: Due to “vote with your
feet”, redistributive program can be
abandoned.
Advantages of Decentralized System:
 Tailoring Outputs to Local Tastes.
 Fostering Intergovernment Competition.
 Experimentation and Innovation in
Locally Provided Goods and Services.
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