Fiscal Federalism

Background

Fiscal federalism refers to the financial relationship and distribution of fiscal functions among different levels of government, typically in a federal political system. This includes the division of authority over tax instruments and expenditure responsibilities between central (federal) and local governments.

Historical Context

Fiscal federalism has evolved as a mechanism to ensure efficient delivery of public services and equitable distribution of resources. It became particularly pertinent with the formation of federations such as the United States, Germany, and Canada. Historically, the balance of fiscal responsibility has been continuously redefined to address the changing needs and dynamics of societies and economies.

Definitions and Concepts

Central/Federal Government: Responsible for tasks that have national importance, such as defense, general welfare, creating framework economic policies, and major infrastructure projects.
Local Government: Focuses on localized public necessities like education, healthcare, and local infrastructure. They typically have limited taxing authority and depend heavily on intergovernmental transfers.

Major Analytical Frameworks

Classical Economics

Classical economists emphasized the minimum role of government but fiscal federalism wasn’t a primary concern in the era of classical economics.

Neoclassical Economics

Neoclassical economics looks at how local and federal authorities can efficiently allocate resources. The approach often highlights the importance of “subsidiarity” where decisions should be made at the most local level possible to enhance efficiency.

Keynesian Economics

From a Keynesian perspective, fiscal federalism involves adapting revenue and spending patterns to stabilize overall economic performance. Intergovernmental transfers are considered crucial for ensuring macroeconomic stability and tackling cyclical unemployment.

Marxian Economics

Marxian approach focuses on the perceived inequity within multilevel government financing structures. The critique often underscores how central financial decisions reinforce existing power structures and economic disparities.

Institutional Economics

Institutional economics looks at the rules, laws, and customs governing fiscal federalism. Policy frameworks and legislative patterns defining tax assignments and expenditure responsibilities are central to this analysis.

Behavioral Economics

Behavioral economists might study how the assignment of fiscal responsibilities influences the decision-making of local versus federal governments, accounting for human biases and incentivizing behaviors within institutions.

Post-Keynesian Economics

This perspective adds insights on how fiscal federalism can be structured to promote sustainable growth and distributional equity through comprehensive fiscal policies across multiple layers of government.

Austrian Economics

Austrian economists would critique fiscal federalism from the stance of government intervention inefficiency, insisting that local governments should have as much fiscal responsibility as possible to facilitate competition and consumer choice.

Development Economics

Fiscal federalism in development economics is analyzed for promoting local economic development by allowing government revenues to be used effectively for community-specific needs, while ensuring national economic coherence.

Monetarism

Monetarist perspectives emphasize controlling the supply of money as crucial. Intergovernmental fiscal transactions must be harmonized in the broader context of a national monetary policy to avoid inflation or deflation.

Comparative Analysis

Varying models of fiscal federalism are observed in different countries, shaped by their political, economic, and social contexts. The efficiency and effectiveness often depend on the clarity of revenue and expenditure assignments, as well as the robustness of intergovernmental transfer systems.

Case Studies

Canada: Known for its equalization payments ensuring comparable levels of service across provinces.
Germany: Features a system of cooperative federalism with extensive intergovernmental fiscal relations.
United States: Reflects a more distinct separation with significant variation and autonomy at the state and local government.

Suggested Books for Further Studies

“Federalism and Fiscal Transfers” by Robin Boadway and Anwar Shah
“Fiscal Federalism: Principles and Practices in the European Union” by Mark Baimbridge and Philip Whyman
“Handbook of Fiscal Federalism” edited by Ehtisham Ahmad and Giorgio Brosio

Intergovernmental Transfers: Financial allocations from a higher level of government to a lower one to help balance uneven resource distribution.
Subsidiarity Principle: A guiding principle stating that decisions and expenditures should be handled by the smallest, lowest, or least centralized competent authority.
Tax Assignment: The process of determining which level of government has the authority to controls certain taxes.
Devolution: The statutory granting of powers from the central government to government at subnational levels.