OECD Fiscal Federalism 2022 – Making Decentralization Work

Fiscal federalism refers to the distribution of taxation and spending powers across levels of government, and is the focus of the OECD’s Network on Fiscal Relations across Levels of Government. Through decentralization, governments can bring public services closer to households and firms, allowing for better addressing local preferences. However, unless properly designed, decentralization can also make intergovernmental fiscal frameworks more complex and risk reinforcing interregional inequalities.

The latest OECD publication on the topic synthesizes the work of the Network over the past decade and a half, on how to balance the policy trade-offs inherent in intergovernmental fiscal relations, making use of its novel analytical results.

The Coronavirus crisis has put unprecedented fiscal pressure on all levels of government. States and localities are key players in the design and implementation of many policies, and they played a crucial role in tackling the crisis, notably in the health, public order and social care areas. Subnational governments are responsible for more than half of all public investment, almost a third of public expenditure and they raise about one-fifth of revenue. How they manage these fiscal resources along with other levels of government helps to determine whether recovery from a downturn is swift or drawn out.

This volume of Fiscal Federalism surveys recent trends and policies in intergovernmental fiscal relations and subnational government, as countries emerge from the Coronavirus crisis. The chapters draw insights into good practices in fiscal federalism and how to resolve policymaking trade-offs, while delving into more detailed examinations of:

  • the design of fiscal equalization systems;
  • subnational tax and spending autonomy;
  • public sector performance across levels of government;
  • digitalization challenges and opportunities;
  • subnational accounting and insolvency frameworks;
  • funding and financing of local government public investment;
  • early lessons from the COVID-19 crisis for intergovernmental fiscal relations.

Chapter overview: Key findings and recommendations

Chapter 1: Examines the design of intergovernmental fiscal relations, including how tax and spending powers are assigned to promote sustainable and inclusive economic growth. This synthesis chapter consolidates much of the OECD’s work on fiscal federalism over the past 15 years, and identifies a range of good practices in the design of country policies and institutions related to strengthening fiscal capacity, delineating responsibilities across levels of government and improving intergovernmental co-ordination.

Chapter 2: Examines the transfer of financial resources to and between subnational governments with the aim of mitigating regional differences in fiscal capacity and expenditure needs. This chapter compares national approaches, covering the three modes of fiscal equalization: pure revenue equalization, revenue/cost equalization and gap-filling equalization, describing the distinct impacts of each approach on subnational revenue disparities.

Chapter 3: Overviews the Fiscal Network’s assessment of sub-central government tax autonomy in OECD countries. This chapter provides an overview of the methodology used to characterize tax autonomy, and utilizes it to assess local government tax autonomy in the 50 US states. The analysis reveals that US local governments have somewhat more tax autonomy than local governments in the average OECD country.

Chapter 4: Presents new measures of subnational spending autonomy across key sectors of local government service delivery, which allows the analysis of alternative arrangements on outcomes. The chapter examines how the performance of the public sector can be strengthened through the assignment of responsibilities at the most effective level of government for their delivery, focusing on health care. Performance monitoring and evaluation systems are also illustrated that can enable the benchmarking of public services to promote learning about good policy practices.

Chapter 5: Looks at these issues in the areas of tax and expenditure policy, service delivery and fiscal-financial management, as well as regulatory practices and policies. The digital transformation calls for co-operation among the different layers of administration in support of effective and efficient digitalization of subnational governments. This chapter reviews and discusses these opportunities and challenges.

Chapter 6: Reviews the early detection of state and local fiscal problems in order to resolve them quickly before they turn into crises. A survey was undertaken to investigate the quality of subnational accounting, as well as the use of subnational accounts by national governments that monitor subnational finances. The results show that in many countries subnational accounting has characteristics that should help in the early detection of fiscal problems, including the use of accrual accounts.

Chapter 7: Stipulates rules and procedures to resolve debt in a prompt and orderly way. This chapter identifies the benefits of setting up an insolvency framework for subnational governments, complementing existing budget rules and procedures. It analyses different design options of subnational insolvency frameworks by drawing on existing regimes for municipalities in Colombia, Hungary, South Africa, Switzerland and the United States as well as proposals for sovereign bankruptcy procedures in the literature.

Chapter 8: Offers a framework to analyze the key factors which affect the capacity of local governments to fund and finance public investment. Most studies on subnational government debt focus on the regional or state level, and very few studies analyze public investment specifically by local governments. This chapter aims at filling this gap, presenting a framework to analyze the key factors that matter, and illustrates the framework with five country examples: Denmark, Finland, Ireland, Netherlands and New Zealand.

Chapter 9: Analyzes the responses countries have taken through the channel of intergovernmental relations to tackle the pandemic at different stages of the crisis, highlighting lessons learnt. With all levels of government involved in handling the COVID-19 outbreak, intergovernmental relations have had a crucial role to play in designing and implementing an effective response to the crisis. As the world economy and societies are going through radical changes due to the pandemic, fiscal federalism may have to adapt to the post-crisis period.

Read the full document on the OECD website (open access):

OECD (2021), Fiscal Federalism 2022: Making Decentralization Work, OECD Publishing, Paris, https://doi.org/10.1787/201c75b6-en.