Fiscal Federalism: Aims, Instruments and Outcomes

Abstract

Federations are created and maintained for both economic and political reasons. An essential component of fiscal federalism is the existence of two or more tiers of government (national, state or provincial, local), each of which raises at least part of its revenue from within its own jurisdiction. Frequently, as for Australia and the United States, the tiered system of government arises from the federation of colonies or separate sovereign states: this has been termed ‘coming-together federalism’. The expression ‘holding-together federalism’ has been used to describe countries like Belgium, Spain and Canada where an important aim of fiscal decentralisation is to satisfy important political and cultural differences across regions. A federal system necessarily involves decentralisation of decision making. Decentralisation can also be carried out by national governments through regional offices. In the past two decades much attention has been paid by the World Bank and others to the wider issues of decentralisation in developing countries. Britain provides an example of a move to decentralisation in a developed country. 1 In this article, however, I will confine the discussion to government economic activity in a federalist system. Much of the discussion will be related back to Australia where I will assume as given the broad structure of three tiers of government. Some comparisons with Canada will also be made. A tiered system of government requires decisions to be made about what functions of government are best performed at each level, how government activity is to be financed, and the way different levels of government relate to one another through instruments such as intergovernmental grants. Within Australia substantial regional differences exist in income levels, cost of housing, climate, topography, population density, and demographic and ethnic composition. If these differences are to be recognised adequately then some decentralisation of decision making is required. The main thrust of the article is to emphasise that while fiscal relations between tiers of government are multifaceted and complex, they need to be evaluated as a whole. It is the total architecture of fiscal federalism that matters. In order to conduct an overall evaluation of a complex structure it is first necessary to set out the broad aims of governments (national, state and local) considered collectively. In the first part of the article I therefore look at the guiding principles by which to evaluate fiscal federalist structures in general and the Australian model in particular. I then move on to apply these criteria to Australian practice. The economic outcomes of fiscal federalism must necessarily be evaluated against a set of aims, some of which conflict. Section 2 of the Fiscal Federalism: Aims, Instruments and Outcomes