Historical Path-Dependence in Intergovernmental Tax Arrangements

• In Event: Labor, Taxes, and Fiscal Federalism: American and Cross-national Studies

Abstract

Economic theories suggest that fiscal federalism and decentralisation are shaped by heterogeneous demands embedded in regional, cultural and ethnic diversity. Notwithstanding, institutions persist, and recent evidence indicates that they may carry precolonial and pre-modern features.
This paper investigates the role of deep historical elements in shaping intergovernmental tax arrangements. Unlike other features of decentralisation (expenditure or fiscal transfers), tax arrangements across government layers have received far less empirical considerations. Existing research has predominantly discussed the gap between expenditure and fiscal decentralisation. The discussion on the appropriate level of tax-related decision-making at the sub-central level appears to have stagnated over the years. There remain limited or no existing attempts to explain cross-country variations, not just across but also within nominally federal and unitary states.

First, the paper echoes the differences between tax revenue decentralisation (and its operationalization in existing research) and the discretionary and decision-making power over tax instruments, legally assigned to each government tiers through existing legal frameworks.

Second, and to the best of our knowledge, this paper is the first to provide empirical estimates on explanatory factors of cross-country variations in inter-governmental tax arrangements. While the conventional approach to tax assignment is such that tax bases suitable for economic redistribution or stabilization are assigned to federal or central governments while those with low-inter-jurisdictional mobility are assigned to lower-tier authorities, recent evidence suggest that countries vary quite significantly on the level of tax-related decision-making assigned to lower-tier government units and may not all comply with the aforementioned principles. The cross-country variation also goes beyond the conventional classification of countries into nominally federal or unitary. For instance, Malaysia, a federal country, is by far more tax-centralised than the Philippines, Thailand or Indonesia which themselves are classified as unitary. Well-established federations, such as the United States, Switzerland, and Canada, also appear to have departed from the top-down approach on tax assignment. As these countries were formed out of independent colonies, the governance of the fiscal space began from the perspective of the subnational governments which agreed to transfer legitimacy and power to upper-layer governments, thereby adding to the relevance of countries historical trajectories in the analysis of institutions.

Third, while we rely on the existing literature on the determinants of decentralisation, the paper goes beyond the economic arguments to consider the historical trajectories of countries which, as established by recent empirical research, have contributed to shaping political and fiscal institutions more broadly.

Finally, the paper draws from a unique dataset on tax and revenue assignment in a wide range of countries to proxy the multi-layer tax arrangements. The dataset was completed through desk research involving an in-depth review of the country's tax codes, laws and decrees, policy documents, as well as grey literature in the areas of public finance and local taxation. The decision-making power of all government tiers, in terms of setting the tax instruments, deciding over the tax rate and tax base and collecting the tax revenues, has been coded for each major tax instruments. Several indicators are derived to proxy the degree to which tax-relevant decisions are taken by each government tier.

The empirical results indicate the existence of a historical path-dependence in intergovernmental tax arrangements. We evidenced a statistically significant correlation between the precolonial state centralisation, colonial legacy, and modern-day sub-national control over the tax system in 72 countries. Lower-tier governments in countries with a higher degree of pre-colonial state centralisation, for instance, tend to have a greater discretionary power over tax matters in modern-time, whereas countries that have experienced a violent independence tend to have a more centralized tax structure. The results are robust to extensive controls and instrumental variable estimations for precolonial centralisation using the Neolithic transition timing, the ecological diversity and Tsetse suitability index suggested in previous research.

Authors

• Rose Camille Vincent, Maastricht University; Université Clermont-Auverne(CERDI-CNRS)

• Kaj Thomsson, Maastricht University