Practice Advice on Public Financial Management
Intergovernmental Grants (OECD)
Summary Advice: The author of this OECD paper advises that countries have developed several approaches to contain the negative side effects of their intergovernmental transfer system (Bergvall et al., 2006; Blöchliger and Charbit, 2008). Their various approaches can be divided into: 1) measures on the tax revenue side, 2) measures on the grant side, and 3) institutional measures, with the three groups sometimes overlapping.
Main Points: The approaches can be summarized as follows:
- Tax effort can be increased if the potential tax base instead of actual tax revenue is used to assess SCG tax capacity. Many countries use a representative tax system (RTS), where potential revenue from each sub-central tax is determined by multiplying a standard tax base with a standard tax rate, or they use the revenues from a central government tax to assess sub-central tax capacity. A RTS should cover all major sub-central taxes and their bases. Alternative indicators for assessing potential tax capacity include sub-central GDP or household income (macroeconomic approach). RTS can help reduce strategic behavior and prevent SCGs from manipulating tax capacity indicators in order to obtain more grants.
- Spending pressure can be reduced if grant allocation is based on a few broad-based geographic, demographic or socio-economic need indicators. Having few indicators covering principal sub-central needs tends to be more transparent and produces less statistical headaches in the allocation of entitlements. Indicators should be outside subcentral control to ensure that SCGs cannot manipulate them. Most countries today use standard or norm cost approaches whereby grant allocation is independent of actual expenditure incurred by SCGs. Also, spending performance can be increased if grants serving several purposes – e.g. simultaneously to subsidize SCG services and to equalize SCG disparities – are disentangled and separate grant systems developed.
- Finally, institutional reforms can help contain grant-related budget drift. Some countries set transfer caps irrespective of sub-central financial needs. Establishing agencies and other arms’ length independent bodies responsible for grant distribution can help channel transfer increases and reduce the pressure from special interest. Also, an adequate set of budget management rules can improve fiscal discipline. In several countries intergovernmental grants are shown as a single and separate budget item, thereby increasing transparency. A twostage budget procedure, whereby the overall grant budget is negotiated separately from the distribution formula, can also contain pressure from special interest.
Source: OECD (2009). Hansjörg Blöchliger and Oliver Petzold, “Taxes or Grants: What Revenue Source for Sub-Central Governments?” OECD Economics Department Working Papers, No. 706 at http://search.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=ECO/WKP(2009)47&docLanguage=En (accessed 13 November 2012).
Page Created By: Matthew Seddon on 13 November 2012. Updated by Ian Clark on 2 January 2013. The content presented on this page is drawn directly from the source(s) cited above, and consists of direct quotations or close paraphrases. This material does not necessarily reflect the official view of the publishing organization.