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Thailand: Selected Issues

Author(s):
International Monetary Fund
Published Date:
September 2002
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V. Fiscal Decentralization in Thailand1

A. Introduction

1. Since the enactment of the 1997 Constitution, Thailand has embarked upon a decentralization process that is expected to be fully implemented by 2009/10. As discussed in the literature of fiscal federalism, if appropriately designed and implemented, decentralization can improve the quality and cost-effectiveness of public services.2 This paper takes stock of the ongoing decentralization process in Thailand, pointing out to some shortcomings, discusses future perspectives and provides some recommendations.

2. The main findings of this paper are:

  • The limited decentralization to date points to weaknesses in implementation. Devolution of revenues is preceding the devolution of functions. In addition, limited information on the decentralization process has been disseminated among the concerned agencies.

  • The efficiency gains from decentralization can be significantly reduced by institutional constraints. Four issues stand out. The lack of clarity in expenditure assignments could interrupt the delivery of essential services. Local governments do not have the administrative capacity to meet their responsibilities. Jurisdictions are not large enough to benefit from the economies of scale in the provision of some public services. Finally, there is only limited accountability for local governments.

  • Decentralization is likely to entail a bias in the budget towards higher deficit, jeopardizing national fiscal policy objectives. Decentralization makes budgeting a more fragmented process, so less fiscal discipline and accountability may be expected. Since a large share of local financing takes the form of transfers from the central government, local governments have incentives to overspend and to minimize local tax collection. An inadequate fiscal reporting system and the absence of a legal framework to promote responsible local borrowing could increase these risks.

3. This paper is organized as follows. Section B presents an overview of the institutional framework and reports on the recent decentralization experience. Section C describes local government financing (local taxes, revenue shares, grants, non-tax revenue and borrowing). Section D discusses the transfer of expenditure responsibilities. Section E discusses issues of local budgeting, accountability and fiscal reporting. The final section sums up and makes some recommendations.

B. Background3

4. From a fiscal standpoint, Thailand is a highly centralized country. Out of the consolidated government spending amounting to 19 percent of GDP in 2000/01, local governments spend only 14 percent, accounting for 2.8 percent of GDP (Table 1).4 In addition, local governments have very limited administrative and legal autonomy.

Table V.1.Thailand: Revenues and Expenditures by Levels of Govenrment(As a percentage of GDP)
Proj.Budget
1997/981998/991999/002000/012001/022002/03
Local Governments
Revenues2.02.12.12.93.23.4
Of which: Subsidies0.70.80.71.21.41.2
Expenditures2.12.21.82.82.93.3
Central Government
Revenues16.215.515.515.215.514.6
Expenditures18.719.018.418.119.517.7
Consolidated government 1/
Revenues17.616.816.916.917.416.8
Expenditures20.120.419.619.420.819.8
Sources: Thai authorities; and Fund staff estimates.

Refers to the consolidation between central and local governments. Social Security and extrabudgetry funds are not included.

Sources: Thai authorities; and Fund staff estimates.

Refers to the consolidation between central and local governments. Social Security and extrabudgetry funds are not included.

5. Most of the local government entities in Thailand are very small in term of financial resources, population served and area.5 Local governments exist in three forms: Tambon Administrative Organizations (TAOs) (6,745) or Sub-districts; Municipalities (1,129); and Provincial Administrative Organizations (PAOs) (75), which are divided into Districts (811). TAOs are usually based around small villages in rural areas in charge of basic public works (such as potable water supply, flood protection and rural roads), school milk and lunch provision, and community health awareness issues. As regards municipalities, many of the functions currently considered for transfer have been performed by the biggest municipalities for some time.6 These include the provision of primary health care and basic education, traffic management, urban planning, and building control. Decentralized functions currently handled by the small municipalities are similar to that of the TAOs, and are limited to basic municipal services. As deconcentrated bodies of the central government, PAOs are in charge of supervision over the provincial field units of central government departments (public health, education and public works), coordination among local governments, and the provision of major public works across boundaries of local entities within a province.7

6. The 1997 Constitution calls for decentralization of powers to local governments. Objectives envisioned in the 1997 Constitution include increasing the share of local government expenditures; assigning more revenue sources to local governments; revising the system of intergovernmental transfers to provide grants in a more transparent and predictable way; and promoting local accountability. The Constitution mandates the enactment of a decentralization act and a local personnel act, and the creation of a decentralization committee, among other legal reforms.

7. The National Decentralization Act (NDA), which was approved in 1999, is the pivotal decentralization legislation to put the constitutional mandate into practice.8 The NDA establishes that: (1) local governments shall be entitled to at least 20 percent of the government’s total revenue in the year 2000/01, growing to at least 35 percent by 2005/06;9 (2) transfers of function to local governments will include infrastructure and planning, education, health and social welfare, social order, promotion of investment, commerce and tourism, environment, and local culture; and (3) transfers of functions to local governments must in principle be made within four years from the enactment of the NDA, with allowance for a transition period of six years, as a maximum, to enable local governments to improve their administrative capability. Another important law is the Local Personnel Administration Act (LPAA) establishing that transfers of central government’s staff to local governments: (1) will be flexible and should contain incentives for staff to be transferred; (2) will, in the first instance, be based on a voluntary mechanism; and (3) will not imply a worsening in labor conditions for any official.

8. The National Decentralization Committee (NDC) is in charge of the implementation and the monitoring of the decentralization process.10 The Committee operates through four Sub-Committees and nine Working Groups. As established in the NDA, the NDC produced the Master Plan11 to decentralize administrative powers to local governments, and prepared seven detailed operational action plans12 for the transfer of specific functions. These plans were completed in January 2001. However, the new government that took office following national elections revised the action plans, which were finally approved by parliament in February 2002.

9. In practice, decentralization to date has been limited. Some functions, such as public works and other delivery functions, have been decentralized through conditional grants. However, the disbursement rate of these has been very low, as local authorities have only limited discretion to make use of the funds. Also, although local governments’ share in the VAT and excise proceeds and grants from the central government were increased significantly in 2000/01 and 2001/02, as prescribed by the NDA, no additional devolution of mandated functions has taken place. Consequently, significant gaps between local revenue and expenditure occurred in 2000/01, and are expected for 2001/02, resulting in large local reserve funds. Finally, although about 2000 officials from the central governments were transferred in 2000/01 for a one-year period on a secondment basis, considerable disincentives should be removed there is still significant opposition from central government officials to being transferred.

C. Local Government Financing

Local Revenues

10. Local expenditure- and revenue-raising responsibilities of local governments present a considerable vertical imbalance (Table 2).13 The most important local taxes are the Building and Land Tax, the Land Development Tax and the Signboard Tax.14 This is consistent with the principle that lower-tier governments should be assigned taxes from relatively immobile tax bases. However, these local taxes in 2000/01 represented only 8 percent of total local revenues, amounting to 0.2 percent of GDP (Table 3). Since other local nontax revenues (such as license fees and fines) account for only 5 percent of total local revenues, this imbalance must be covered by revenue sharing arrangements15 or surcharges on national taxes, and by grants or subsidies from the central government. These two sources of revenues represented in 2000/01 47 percent and 41 percent respectively of total local revenues (Table 3).

Table V.2.Thailand: Vertical Imbalances(Ratio between own revenues and own expenditures, transfers excluded)
Prof.Budget
1997/981998/991999/002000/012001/022002/03
Local governments67.260.773.460.164.566.1
Central government98.995.9104.2105.8100.5100.8
Sources: Thai authorities; and Fund staff estimates.
Sources: Thai authorities; and Fund staff estimates.
Table V.3.Thailand: Structure of Local Revenues(percentages of total local revenues)
Proj.Budget
1997/981998/991999/002000/012001/022002/03
Own Local Revenues67.961.665.458.758.064.8
Locally collected16.917.920.012.212.311.8
Taxes 1/9.39.610.67.67.37.6
Nontax reveneus7.68.49.44.64.04.2
Collected by the central government 2/51.043.745.346.545.753.0
Subsidies/Grants32.138.434.641.342.035.2
Sources: Thai authorities; and Fund staff estimates.

Include the Building and Land Tax, the Land Development Tax, the Signboard Tax, the Slaugther Tax, Tobacco, Gasoline, and Hotel Taxes and the Swalow’s Nest Tax.

Shared taxes include the VAT, liquor, excise, gambling, and motor vehicle taxes.

Sources: Thai authorities; and Fund staff estimates.

Include the Building and Land Tax, the Land Development Tax, the Signboard Tax, the Slaugther Tax, Tobacco, Gasoline, and Hotel Taxes and the Swalow’s Nest Tax.

Shared taxes include the VAT, liquor, excise, gambling, and motor vehicle taxes.

11. The central government exerts exerts considerable influence over how local government revenues are spent. About three-fourths of local grants16 in 2000/01 and 2001/02 were allocated for specific purposes, according to ad hoc criteria, without considering any equalization mechanism or any performance-based incentive (World Bank, 2000). This makes it very difficult to predict local revenues at the beginning of the fiscal year, undercuts incentives for responsible fiscal decision-making, and gives rise to a very low execution rate, since disbursements sometime depend on local government’s ex-post capacity to plan and procure investment projects.

Local borrowing

12. The NDA grants local governments, under certain conditions and with the permission from the Cabinet, the right to issue bonds and to borrow from the markets domestically or externally. However, local government borrowing is relatively unimportant in Thailand, since most local infrastructure projects are funded through transfers from the central government or through local government saving.17 Although they are allowed to do so, local governments rarely borrow from the markets due to their limited experience, and cumbersome approval processes. Nonetheless, as decentralization progresses and local governments assume more responsibilities, especially in infrastructure, local borrowing may become an increasingly important source of financing.

13. Legislation to promote a responsible borrowing framework is still being prepared. The forthcoming Public Debt Management Law (PDML) establishes that the ceiling for total annual external borrowing of the country includes local borrowing. In addition, the PDML states that the central government will not bail out local governments—e.g. the central government will let bankrupt local governments. However, further issues may need to be addressed, including aggregate limits on local indebtedness, local bankruptcy regulations, bank provisions for local debts, and other mechanisms for promoting responsible local borrowing.

D. Transfer of Expenditure Responsibilities

14. Decentralization of revenue has run ahead of the devolution of expenditure responsibilities. The current expectation is that the decentralization of functions will proceed in stages in tandem with the devolution of revenues. However, the need to modify legislation covering each expenditure function will probably delay the full implementation of the decentralization action plans. In addition, technical difficulties may arise in the transfer of some functions such as education or health, and the local delivery of public works, as well as in the transfer of staff. If by 2005/06 the central government has devolved to local governments a considerable amount of revenues (to meet the 35 percent level required by the NDA), but expenditure responsibilities are not devolved, the central government will face the risk of assuming the resulting deficit. On the assumption that the devolution of expenditure assignments to local governments does not occur in tandem with the devolution of revenues, the debt-to-GDP ratio would peak at over 67 percent of GDP in 2004/05 and would remain at that level for the rest of the projection period.

Thailand: Total Public Debt Projections

(In percent of GDP)

15. Given the impracticality of decentralizing health and education delivery to small jurisdictions, the authorities are applying a board model as an interim arrangement. The Ministries of Education and Public Health are testing decentralization service delivery models through special intermediary agencies at provincial and sub-provincial levels through Local Education Area Boards (LEABs) and the Area Health Boards (AHBs).18 Local governments will be represented on these, but they will not necessarily be coterminous with local government geographical boundaries or responsibilities.19 The purpose of this approach is to maintain the integrity of service delivery, as well as ensuring adequate conditions of employment for health care and basic education personnel. These boards will deliver health and basic education until local governments are ready to assume these responsibilities. As a pilot program, AHBs have been established in 17 provinces and the experiment may be expanded to the rest of the PAOs.

16. The transfer of central government staff along with functions has proved difficult.20 The NDC is preparing an action plan for transferring personnel from central to local governments to adjust the manpower balance between central and local administrations. Since conditions of service for central government staff are much more favorable than for local government staff, in terms of remuneration, allowances, career path opportunities and pension benefits, the transfer of central government staff on a voluntary basis will be difficult to achieve unless strong incentives are put in to place.

17. Transferring responsibility for delivery of public works to local governments may result in a forfeiting of the benefits that arise from economies of scale. It is highly unlikely that small local governments will be able to handle the technical delivery of public works in an efficient way. This could lead to a significant waste of resources. In this context, it is notable that the public works functions transferred de-facto in 2001/02 had a very low disbursement rate. Thus, there is a strong case to be made for implementing measures that stimulate the coordination of neighboring local governments.

E. Local Budgeting, Reporting, and Accountability

18. The current set of regulations governing local budgeting, procurement, governance, and reporting make it difficult for local governments to fulfill their responsibilities in a planned, pro-active and accountable manner. Since local governments are not given sufficient advance notice of future transfers and of functions to be devolved,21 they usually are reluctant to expand their budgets in anticipation of higher transfers, resulting in a buildup of unplanned reserve funds. These carry-over funds are subject to less scrutiny, transparency and accountability and are often used for one off projects, giving rise to a public works bias in local expenditure (Wegelin, 2002). In addition, current budgeting regulations for local governments impose a maximum of 40 percent of budgetary outlays for staff costs, which prevents the staff expansion needed to handle new functions and reinforces the public works bias.

19. There are serious information problems that weaken local accountability. It has been reported that local officials are not fully aware of their responsibilities and functions. In addition, the central government is unable to assess the progress of fiscal decentralization. Fiscal data from local authorities are reported 18 months after the end of the fiscal year. Comprehensive local data are not collected centrally and must be pieced together from various agencies. In part as a result from the great diversity and large number of local governments, there is a great disparity in terms of the quality of data submitted from one local authority to another.

F. Conclusions and Recommendations

20. Overall, the decentralization plans in Thailand are ambitious, but are quite rigid in terms of timing, and risk being undermined by flawed implementation. Several institutional reforms are needed to ensure that Thailand will benefit from the efficiency gains from decentralization. In addition, reform of the fiscal relations between the central and the local governments is needed urgently to reduce the vertical imbalance and to assure the fiscal neutrality of the decentralization process.

21. The recommendations on the institutional front are as follows:

  • The discretion of local government to tailor the provision of public services to the needs of local populations should be strengthened. A capacity-building program should be implemented to improve local governments’ ability to deliver social services and to break the public works bias, A system of incentives should be put in place to encourage the transfer of skilled central government officials to local governments. The budgeting and accounting guidelines need to be simplified and the specific-project grants should be replaced by general-purpose grants so that local governments have more control over their own spending.22 Subsidies should be allocated according to a transparent and predictable formula to facilitate local government budgeting.

  • The potential for smaller local governments to consolidate to benefit from economies of scale in the joint delivery of public services should be explored. Many analysts have pointed out that decentralization is not feasible in Thailand unless the building block is larger, at least at the size of current Districts or preferable PAOs.23 Comparative international experience also seems to suggest that most countries in which decentralization is implemented focus on a much more manageable number of larger units.24 Consolidation could be achieved through voluntary cooperation that leads to the formation of associations of neighboring local governments.25 The government could institute an incentive grant for associations of local governments serving a certain amount of population. Another way of encouraging the cooperation would be through a gradual and asymmetric assignment of fiscal responsibilities among local governments, devolving responsibilities only to associations of local governments that fulfill a minimum set of requirements (economic size, population, land) and shifting them to the superior level of government otherwise.26

  • Local accountability should be enhanced. Local governments should be better informed about their responsibilities. Fiscal reporting by local governments should be improved.

22. As regards intergovernmental fiscal relations, actions along the following lines would be useful:

  • Devolution of revenues to local governments should be linked more closely with devolution of expenditure functions. Given the technical difficulties in the devolution of some expenditures, an escape clause in the time set for the devolution of revenues could be introduced in order to ensure that financing is not preceding the devolution of functions.

  • Local revenue mobilization should be increased either through improved administration of existing revenue sources, restructuring existing taxes,27 or developing new sources of revenues, since many local authorities have room to increase local tax efforts.28 As an incentive, the allocation of grants could include a matching element related to the generation of local revenues.

  • Debt ceilings and bankruptcy procedures for local governments should be introduced, a no-bail-out policy should be strictly observed. In terms of borrowing policy, there are problems with both the current administrative controls on local borrowing, which reduce the scope of local governments to exercise discretion, and the approach of relying on financial markets to impose the necessary discipline over local borrowing.29 An alternative approach, used by many countries, is to put in place rules that “mimic” market discipline (Ter-Miniassian, 1997), by linking limits on the indebtedness of local governments to their debt service capacity, and by rules that limit local borrowing to investment (golden rules), or that establish that short-term borrowing for liquidity purposes has to be repaid by the end of each fiscal year. To be effective, a rules-based approach would need to be supported by clear and uniform accounting standards and fiscal reporting. It is also recommended that current constraints on local governments should remain in place at least until 2006, i.e., at least during the first phase of the decentralization process.

Bibliography

    AhmadE.HofmanB.MaJ.RyeD.SearleB. and StevesonJ.(1999)Indonesia: Decentralization—Managing the Risks,Fiscal Affairs Department, International Monetary FundWashington, D.C.

    BirdR. M.(1999)Rethinking Subnational Taxes: A New Look at Tax Assignment,International Monetary Fund WP/99/165Washington, D.C.

    DrummondP. and MansoorA.(2002)Macroeconomic Management and the Devolution of Fiscal Powers,International Monetary Fund WP/02/76Washington, D.C.

    NorregaardJ.(1997)Tax Assignment” in TeresaTer-Minassian(ed.)Fiscal Federalism in Theory and PracticeInternational Monetary FundWashington, D.C.

    OatesW. E.(1999)An Essay on Fiscal Federalism,Journal of Economic Literature Vol. 37 (September) pp. 11201149.

    PisauroG.(2001)Intergovernmental Relations and Fiscal Discipline: Between Commons and Soft Budget Constraints,Working Paper 65International Monetary FundWashington, D.C.

    SuwanmalaC.(2002)Fiscal Decentralization in Thailand,” in Bali Intergovernmental Reform Workshop, 2002Bali.

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    Ter-MinassianTeresa (ed.1997) Fiscal Federalism in Theory and Practice (Washington, D.C.International Monetary Fund).

    WebsterD.(2002)Implementing Decentralization in Thailand: the Road Forward”,Capacity Building Projects Office of the Decentralization to Local Organizations Committee and World Bankdraft memo.

    WegelinE. A.(2002)Thailand: Decentralization Capacity Assessment. Finding and Recommendations,Capacity Building Projects Office of the Decentralization to Local Organizations Committee and World Bankdraft memo.

    WeistD.(2001)Thailand’s decentralization: Progress and Prospects,draft memo.

    World Bank(2000)Thailand Public Finance in TransitionSeptemberWashington, D.C.

Prepared by Teresa Dabán.

Drummond and Mansoor (2002), Oates (1999), Fomasari, Webb and Heng-fu Zou (2000) Pisauro (2001), Tanzi (1995) and Ter-Minassian (1997) present excellent surveys on the advantages and drawbacks of fiscal decentralization.

For the institutional background and legal framework, this paper draws on Weist (2002), Wegelin (2002), and World Bank (2000).

The consolidation examined here refers only to central and local governments. Social security and extrabudgetary funds are not included. In Indonesia and the Philippines, which also implemented a decentralization process during the 1990s, local governments spend about 17–18 percent of the general government expenditure, representing 3.9 percent of GDP in Indonesia and 3.4 percent of GDP in Philippines. See Ahmad and others (1999) for Indonesia.

A more detailed description of the structure of governance in Thailand can be found in Suwanmala (2002).

Municipalities in Thailand are of four types: the Bangkok Metropolitan Administration and Pattaya city, that have special status; the 20 Tesaban Nakorn, which have population of over 50,000 and have metropolitan status; the 86 Tesaban Muang, which have population of over 10,000, and generally are provincial capitals; and the Tesaban Tambons, which are small towns or peri-urban areas on the periphery of larger municipalities.

Deconcentration refers to the delegation of central government responsibilities to its own branch offices located in provinces or districts, with the functions remaining the responsibility of the central government. Decentralization refers to the transfer of a significant degree of administrative and legal autonomy for public expenditure and revenue from the center to lower levels of government.

Act Determining Planning and Staging of Decentralization B.E. 2542 (1999).

This ratio was 14 percent in 1999/00.

The NDC, chaired by the Deputy Prime Minister, is composed of officials from the local and central governments. The Office of the National Decentralization Committee (ONDC) serves as the Secretariat of the NDC. The ONDC currently is understaffed (it has 35 professionals), given the magnitude of the task assigned to the NDC. In addition, the staff skills and experience levels are not fully consonant with the responsibilities of the office. In particular, the ONDC is ill equipped to disseminate and explain the decentralization action plans to the almost 8,000 local governments (and the central government line departments). See Wegelin (2002).

Plan to Decentralize Administrative Power of Local Administrative Organizations (1999).

Operations Plan Staging of Decentralization to Local Government Organization, (2002).

Revenue and expenditure assignment among different levels of government give rise to vertical imbalances (that is pre-transfer fiscal balances) when the own revenues and expenditures of various levels of government are unequal.

The Building and Land Tax and the Land Development Tax accounts for half of locally collected revenues. The central government determines the rate and base of these local taxes.

Shared taxes included the VAT, liquor, excise, gambling, mineral and petroleum, motor vehicle and specific business taxes. Their structure is determined and revenues are collected centrally.

Currently three types of subsidies are used: (1) general-purpose subsidies, which are distributed according to local expenditures needs and revenue capacity (30 percent of total subsidies); (2) specific project subsidies (40 percent of total), and (3) subsidies with transfers of responsibility, allocated only to TAOs, and used as a transitional tool to meet the 20 percent target for local revenues as prescribed by the NDA (30 percent of total).

Given that local governments have under spent significantly in the last few years, they have built up large reserve funds. Local governments must submit 10 percent of their funds to the Local Development Fund at the Ministry of Interior.

Transfer of education will comprise primary and secondary education. Transfers of health care services will comprise promotional/preventive and curative health care provided through three layers of support: primary health care centers (at the Tambon level), secondary health care center (at district hospitals), and tertiary health care centers (at provincial hospitals).

This follows practice on other countries. For example, the United States and Canada have formed boards to deliver services ranging from education to fire fighting and wastewater management.

The NDC is preparing an action plan for transferring personnel from central to local governments to adjust the manpower balance between central and local administrations.

Webster (2002) points out to some deeper norms, such as the passive culture of local governance in Thailand. That is the opposite of other East Asian countries, such as the Philippines, in which local governments are very aggressive in taking on new functions under conditions of decentralization.

In 2002/03 and beyond direct and unconditional grants for local authorities will replace most of the indirect specific grants, granting local governments more autonomy than previously. However, it is envisaged that local governments will only be able to receive their grants directly from the central government from 2005 onwards as this requires a change in the Budget Act, which at present does not recognize local governments as being eligible to be budgeting heads.

See Webster (2002) and Wegelin (2002). The current building blocks of Thailand’s decentralization effort are TAOs. Webster points out that the problems with basing decentralization on so many small and rural units of government are: (1) TAOs are too small to be efficient, viable as autonomous cost-effective local government units in their own right (for instance, TAOs can afford to pay only lower-level, less experienced, and more junior staff, ensuring that the most needy rural groups are governed by the least experienced people); (2) TAOs are too fragmented as to be accountable units of local government in terms of meeting their responsibilities; (3) municipalities are not taking advantage of the decentralization process although urban areas are expected to grow considerably in the near term.

In Indonesia, for instance, with a population of more than 200 million, decentralization focuses on the Kabupaten (District), in the Philippines the Municipal level is the key building block, and in Japan the Prefecture level.

Consolidation could also be achieved through formal mergers into larger local government units, although it may be politically difficult. This has been done in other countries such as Japan, China and Canada. The Tambon Act states that TAOs that share the same boundary within the District can be merged into one TAO with the consent of the citizens. The Ministry of Interior also has a right to merge small TAOs with population of less than 2,000 into one bigger TAO. However, mergers have to be based on the consent of the residents in the local governments concerned.

However, in spite of the attractiveness of this idea, some risks exist. The existence of local government units with very different fiscal power can make the decentralization process very complex. In addition, the asymmetric approach can introduce notorious differences in the political influence of the local governments in national policy. In any case, the public services affected by this asymmetric process of decentralization should be valued in order to guarantee that the quality of the public services does not depend on the level of government in charge of the provision.

For instance, the planned Property Tax that will replace the Land and Building Tax is welcome, but there is typically more potential for such tax in urban than in rural areas. The characteristics of the new Property Tax are as follows: (1) the base will be defined as the capital value and not as the rental value, as it is now. That will increase tax collection since rental values reflects mainly the current use of the property, while capital value, generally based upon market values, is said to reflect the value of the property in the best alternative use and, (2) some exemptions will be phased out, such the exemption of residential property.

It is generally acknowledged in the literature that the most obvious candidates as “good” local taxes are land or property taxes and, to some extent personal income taxes. Unless the local jurisdictions are large such as in Canada, Brazil, United States, or India, consumption taxes, as well taxes on capital income, in particular corporate income taxes, are generally considered less appropriate at the local level because of the mobility of the corresponding bases. See Norregaard (1997) and Bird (1999) for a discussion.

The preconditions for purely financial market discipline to work are very demanding (Ter-Minassian, 1997). First, adequate information on the local government’s outstanding debt and repayment capacity should be available to potential lenders. Second, bank provisions for local debts should not treat governments as privileged borrowers and bankruptcy procedures should be clearly established. Finally, and perhaps the most important, there should be no perceived chance of a bailout. On this last point, it should be noted that in the recent international history of intergovernmental fiscal relations, there are no examples of local governments allowed to go bankrupt (which would involve default on their debt) in the more advanced federal states. On the contrary, there have been many cases, both in developed and developing countries, where local government financial crises have been resolved through the intervention of the central government. Examples are the bailout of New York City in 1975, and of the bailout of Bremen and Saarland in Germany in 1992. See Pisauro (2001).

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