The second-generation theory has emerged towards the end of the lastdecade of the twentieth century. The theory cover the concepts like politicaleconomy approach, the economics of information, the principal-agent problem,the theory of contract, and the theory of firm. Thesecond-generation theory argues the concept that thepublic agents do not necessarily serve the public interest unlike to the concept of first-generationtheory of fiscal federalism.
Similarly, they argue that asymmetric information exists between federal andprovincial governments unlike the availability of perfect information between federaland provincial governments under thefirst-generation theory (Sudhipongpracha, 2015). There arefive main pillars of fiscal federalism. They are a) revenue assignments, b)expenditure responsibilities, c) intergovernmental fiscal transfer, d) fiscalinstitutions, and d) sub-national borrowing.
2.2.1. Revenue Assignments TheoreticalReview The theory of tax assignment simplydeals with the following four issues (i) which level of government have to choosethe taxes to be imposed at any level, (ii) which level should define tax bases,(iii) which one should determine the tax rates and, finally, (iv) which oneshould enforce and administer the various tax tools. Many believe that thesub-national governments should be empowered with the sufficient revenueraising rights (Ambrosanio and Bordignon, 2006).
Revenue-sharing arrangementscan be of two types: those in which multiple levels of government share the taxbase and those in which revenue is collected by one level but shared bydifferent levels (Rao, 1997). Federal countries have adopted both separated aswell as overlapped assigning tax powers among the levels of governments byconstitution. The taxes assigned to the central government are not assigned tothe states and vice versa (Boadway and Shah, 2009). However, there is noglobally accepted model to deal with these problems.
It is argued that taxes with anature of relatively immobile bases or assets and bases with evenly distributedamong jurisdictions should be levied by the local governments. It has manymerits including (i) prevents tax completion and revenue losses, (ii) preventsthe generation of horizontal fiscal imbalances, (iii) yield becomes stable inreal terms for expenditure planning. These arguments are put forward inMusgrave’s traditional normative and Oates’s public choice approach. However,these approaches have many drawbacks comprising (i) it is completely normativeapproach, (ii) does not reflect the actual situation of the contemporary world,and (iii) weak demarcation of the tax assignments between central and localgovernments (Prasad, 2016).
In this background, user charges, benefit taxes,and taxes on relatively less mobile taxes could be the major sources of revenuegeneration of the sub-national governments (Musgrave, 1985; Rao, 1997). On the other, the nature oftaxes with broad and mobile tax bases need to be assigned to the centralgovernment with two main purposes (i) economic stabilization, and (ii) redistributionof income, wealth and resources. In this background, taxes on internationaltrade need to be exclusively levied by the central government.
The political economy approachof tax assignment has been extensively extended in the contemporary world.Therefore, the traditional theory is in shadow now. Under the political economyapproach, tax assignment and sharing at the various levels of governments isdetermined by the negotiation among them. This approach is widely known as ‘ASecond-Generation Theory of Fiscal Federalism’ (Bardhan, 2006 and Oates, 2005).In this juncture, universally accepted principle of tax assignment is notavailable in the economic literature. Summaryof international practice of allocation of taxing power among the variouslevels of government is given in Table 3.
3. Table 3.3: Representative Assignments of Taxing Powers Type of tax Determination of Base Rate Collection and administration Comments Customs N N N, P International trade taxes Corporate income N,U N, U N, U Mobile factor, stabilization tool Resource tax Resource rent tax (profits, income) N N N Highly unequally distributed tax bases Royalties, fees, charges, severance taxes; S, L S, L S, L, P Benefit taxes/charges for state-local services Conservation charges S, L S, L S, L, P To preserve local environment Personal income N N, S, L N Redistributive, mobile factor; stabilization tool Wealth taxes (taxes on capital, wealth, wealth transfers, inheritances, and bequests) N N,S N Redistributive Payroll N,S N,S N, S Benefit charge, e.
g., social security coverage Multistage sales taxes (value-aided tax VAT N N,S N, S Border tax adjustments possible under federal assignment; potential stabilization tool Single-stage sales taxes (manufacturer, wholesale, retail) Option A Option B S S,L N S S,L N Higher compliance cost Harmonized, lower compliance cost “Sin” taxes Exercise on alcohol and tobacco N,S N,S N,S,P Health care a shared responsibility Betting, gambling S,L S,L S,L,P State and local responsibility Lotteries S,L S,L S,L,P State and local responsibility Race tracks S,L S,L S,L,P State and local responsibility Taxation of “bads” Carbon N,U N,U N,U To combat global/national pollution BTU taxes N,S,L N,S,L N,S,L,P Pollution impact may be national, regional or local Motor fuels N,S,L N,S,L N,S,L,P Tolls on federal/provincial/local roads Effluent charges N,S,L N,S,L N,S,L,P To deal with interstate, inter-municipal or local taxes Congestion tolls N,S,L N,S,L N,S,L,P Tolls on federal/provincial/local roads Parking fees L L L,P To control local congestion Motor vehicles Registration, transfer taxes, and annual fees S S S State responsibility Driver’s kitchen and fees S S S State responsibility Business taxes S S S Benefit taxes Exercises S,L S,L S,L Residence-based taxes Property S L L Completely immobile factor, benefit taxes Land S L L Completely immobile factor, benefit taxes Frontage, betterment S,L L L Cost recovery Poll N, S,L N,S,L N,S,L Payment for services User Charges N,S,L N,S,L N,S,L,P Payment for services received Note: U= supranational agency, N = national/federal, S = state or province, L =municipal or local, and P = private Source: Shah, Anwar (ed.) The Practice of Fiscal Federalism: Comparative Perspectives, 2007 Almost in all federalcountries around the world, custom duties are levied at the central level.
Onthe other hand, taxes on the consumption of goods and services and main directtaxes are levied concurrently on both the central and sub-national levels in mostof the federal countries. Switzerland has greater taxing powers with theCantons which generates around 80 per cent of the total tax revenue of thecountry. In Canada, the federal government levies value added tax and provinceslevy retail sales taxes. Direct taxes are levied by both the federal as well asprovincial governments concurrently.
In India, excise duties on manufacturedproducts and taxes on the sale and purchase of goods are levied by the centraland state governments respectively. VAT is levied by both the central and stategovernments concurrently including manufacturing stage VAT by the centralgovernment and destination-based VAT up to the retail stage by the states. Thecentral government levies non-agricultural income and wealth and the stategovernments levy agricultural income and wealth (Schmidheiny, 2017). In Brazil,VAT is levied at both the central and state levels. The sub-nationalgovernments in Scandinavian countries and the United States are allowed to levypersonal income tax concurrently at both the central and sub-national levels (Boadwayand Shah, 2009). Table 3.
4: Share of Central and Sub-NationalTaxes: Selected Countries and Years (Per Cent) Country and year Total tax revenues Taxes on income Taxes on property Domestic taxes on goods and services %Central %State %Local % Central %State %Local %Central %State %Local %Central %State %Local *Germany 1998 70.7 22.0 7.3 43.4 36.
6 20.0 0.8 48.6 50.6 62.
8 37.0 0.2 *Spain 1997 83.0 7.
5 9.4 85.7 8.7 5.7 2.
8 52.4 44.7 78.5 5.4 16.
0 Ukraine 2001 74.3 0.0 25.7 35.
6 0.0 64.4 0.
0 0.0 0.0 80.5 0.
0 19.5 *Canada 1999 52.5 38.5 9.0 63.
5 36.5 0.0 0.0 21.1 78.
9 41.0 59.0 0.
1 *Russia 2001 69.7 0.0 30.
3 27.6 0.0 72.
4 5.2 0.0 94.8 82.7 0.0 17.
3 *South Africa 1998 92.8 0.5 6.7 100.
0 0.0 0.0 21.7 0.0 78.
3 98.6 1.4 0.
0 *Switzerland 2000 66.0 20.0 14.0 30.
3 39.1 30.7 30.9 42.8 26.
3 92.2 7.6 0.2 *Australia 1999 77.4 19.3 3.
3 100.0 0.0 0.
0 0.0 63.6 36.3 66.2 33.
8 0.0 *United States 2001 69.3 19.1 11.
6 83.0 15.5 1.5 10.
0 8.0 82.0 15.7 67.
6 16.8 *Argentina 2001 59.7 40.3 0.0 50.5 49.
5 0.0 54.4 45.
6 0.0 94.6 5.
4 0.0 *India 1999 62.6 37.
4 0.0 100.0 0.0 0.0 14.
9 85.1 0.0 41.5 58.5 0.
0 China 1999 45.0 55.0 0.0 24.4 75.6 0.
0 0.0 100.0 0.
0 55.7 44.3 0.0 Indonesia 1999 97.1 2.9 0.
0 100.0 0.0 0.
0 74.9 25.1 0.0 95.
9 4.1 0.0 Note: *indicates a federal country. Data for the emerging country group are shown initalicsSource: The World Bank/Richard M. Bird, 2010 In most developing and transitional economies, localgovernments do not have significant tax collection powers. Richer and largercountries are usually more decentralized in terms of revenue assignments (Table 3.4). EmpiricalReview International Agegnehuand Behaylu (2015) examines that Australia has a highly centralized tax system.There is very little sharing of tax bases across the tiers of government. Morethan 82 percent of national revenue is collected by the centre throughcontrolling major revenue bases such as income tax on individuals andcompanies, excise duties and levies, and taxes on international trade and VAT.The remaining 18 percent is collected by the state and the local governments.The states raise their revenue from the tax bases such as pay roll tax andstamp duties, land use and natural resource tax, motor vehicle tax, gamblingtax, and royalty from resource extraction. The local governments collect fromthe tax bases such as property tax, and parking fees and charges. The state governments are free to impose taxrates on all tax bases that are not reserved to other tiers of government bythe Constitution or by subsequent legislative or judicial decisions. Australianfederation is characterized by a high level of vertical fiscal imbalancebetween the federal and sub-national governments. Sub-national governments arehighly dependent on federal transfers. State and local governments require some40 percent of total public sector expenditure to meet their obligations butraise only about 18 percent of total public sector revenue. A number ofstakeholders are questioning this model and making criticism (Agegnehu andBehaylu, 2015). Fernando(2007) has analyzed the Brazilian taxation system based on the 1988Constitution. States and municipalities have independent taxing powers inBrazil. The federal government is solelyresponsible for imposing taxes on both individual and corporate income taxes,foreign trade, and rural property and payroll. The federal government has also theresidual powers to intervene in the economic sphere and any other potential taxsource not clearly assigned to the state or local governments by theconstitution. Goods andservice taxes are concurrently levied by the federal and state governments inBrazil. The federal government is authorised to tax on manufacturing goods andthe social contributions. VAT, property tax and motor vehicle tax are levied bythe state governments. The local governments collect sales tax of urbanproperty and user charges. In this perspective, Brazil is characterized by ahigh degree of revenue decentralization at the state level in comparison tomany federal countries around the world (Fernando, 2007). Accordingto Boadway and Shah (2009), the federal government in Canada has theconstitutional right to raise tax revenue by any mode of taxation. However,both levels of government enjoy a very broad based and shared taxesjurisdiction. The federal government raises major share of its revenue fromthree broad-based tax sources-personal income taxation, sales taxation, andpayroll taxation. The Canadian provinces have full discretionary powerregarding the choice of their tax systems. They enjoy an independentlegislation and administration of taxes within their jurisdiction. Provincescan levy VAT, both personal and corporate income taxes, excise taxes, resourcestax within their jurisdictions. Property tax is the main source of the localgovernments. Unlike Australia and Germany, the Canadian tax system is moredecentralized. The provinces are provided adequate autonomy both in terms ofdetermining tax bases, rates and generate own revenue. Feld andHagen (2007 states that the central government in Germany has an exclusiveauthority over the major taxes including customs duties, both personal andcorporate income taxes, turn over tax, insurance tax and VAT. Taxes aregenerally collected by the federal government and then shared to the states andthe local governments on approved percentages based on the constitutional provisions.Unlike Canada, the German tax system is more centralized. The states and localgovernments lack discretionary power over determining tax bases and rateswithin their jurisdiction. The taxes exclusively assigned to the states andlocal governments are: property tax, motor vehicle tax, inheritance tax,lottery tax, tax on beer and tax on local business, fishery and hunting tax,and entertainment tax. The states and local government tax base isinsignificant to finance their expenditure needs. CBEC (2017)shows that the central government has the power to levy the major broad-basedand mobile tax bases including taxes on non-agricultural incomes and wealth,corporate income taxes, customs duties, and excise duties on manufacturedproducts for reasons of stabilization and redistribution in India. The centralhas also been assigned all residual powers which imply that the taxes notmentioned in any of the lists automatically fall into its domain. The major taxpowers assigned to the states include taxes on agricultural income and wealth,taxes on the transfer of property (stamp duties and registration fees), taxeson motor vehicles, taxes on the transportation of goods and passengers, salestax on goods, excises on alcoholic beverages, entertainment tax, taxes onprofessions, trades, callings and employment, property tax and taxes on theentry of goods into a local area for consumption, use or sale (octroi).However, from the viewpoint of revenue productivity, only the tax on the saleand purchase of goods is important.