FIGHTING POVERTY THROUGH FISCAL DECENTRALIZATION

5.1 IMPLICATIONS FOR POLICY REFORM
International donors can play in important role in strengthening local revenue-raising powers
particularly in the framework of technical assistance to the host country in reforming its tax system.
The experience with tax reforms in countries ranging from Russia to Tanzania reveals that central
governments tend to underestimate the importance of subnational governments’ revenue autonomy
for instilling good governance at the local level, which in turn has a direct impact on poverty
reduction. Besides misleading assessments of local tax progressivity made out of the context of the
whole tax system and benefit incidence, local taxes are commonly eliminated in the name of
simplified tax structure, uniform environment for economic activities and uniform treatment of
taxpayers. While these goals appear valid they are not necessary incompatible with larger revenue
autonomy of local governments. A closed list approach to revenue assignment can achieve many
benefits of local revenue autonomy while minimizing losses to economic efficiency and equity. In
particular the authorized list could exclude the most distortionary taxes thus removing obstacle for
internal commerce and economic growth.
International donors can provide national governments technical assistance in developing a list of
authorized local taxes with desirable characteristics, possibly including their positive effects on
poverty reduction. These characteristics would follow logically from the goal of decentralization and
the role that local governments are expected to play in poverty reduction. To the extent that economic
rationale for decentralization is to improve efficiency of government services, the benefit principle is
pursued to link the costs of public services to the benefits delivered to local residents. Similarly,
horizontal or political accountability of subnational officials requires the ability of subnational
governments to affect at the margin the level of their revenues by choosing tax rates for some of the
most important taxes assigned to them. 19 Inadequate revenue autonomy generally weakens local
taxpayer awareness of taxes and interest on the quality and level of local services delivered. Finally,
local revenue instruments should generate a stable revenue yield to ensure the continuity of provision
of basic public services and safety nets for the poor.
Although local taxation is not an appropriate instrument for income redistribution, it can include
provision of relief of hardship and other measures to protect those with the lowest incomes.
International donors can be instrumental in providing technical advice on how to design such tax
relief provisions in an efficient manner.
19 Other forms of local tax autonomy, including the ability to change tax bases or the ability to introduce or eliminate some
taxes, are generally less desirable since they can easily lead to increases in compliance and administration costs.
22 FIGHTING POVERTY THROUGH FISCAL DECENTRALIZATION