Federal Fiscal Transfers to Regions and Fiscal Behaviour of Regional Governments

Publication date
Saturday, 20.04.2002

Authors
S. Sinelnikov, P. Kadotchnikov, I. Trunin

Series
CEPRA

Annotation
This paper shows that under certain conditions, not only the grant type but also the specific allocation mechanism can introduce negative fiscal incentives for subnational authorities. In other words, under certain financial assistance allocation methods, the transfer size can lead not to the expansion of public goods provision on the subnational level (which is often the aim), but to a drop in the grant recipient's tax revenue. This work investigates the hypothesis that the state of certain "fiscal" incentives depends on whether the equalizing transfer allocation technique is based on actual amounts of regional tax revenues and spending or on some estimates for subnational fiscal capacity and spending needs.

The decentralization process for expenditure and taxing powers that presently , occurs in many countries, provides benefits, other than those for firms and individuals directly, that improve efficiency as well as equity in the federation. In such conditions, interbudgetary transfers represent a key budgetary tool. Economic research of effective interbudgetary transfers has focused only on various ways in which different grant types influence decision-making by regional recipients of assistance. Such an analysis abstracts from the particular influence of national policy in the area of interbudgetary equalization, and partially, the influence of the allocation mechanism of equalizing transfers on subnational tax and budgetary policy.

This paper shows that under certain conditions, not only the grant type but also the specific allocation mechanism can introduce negative fiscal incentives for subnational authorities. In other words, under certain financial assistance allocation methods, the transfer size can lead not to the expansion of public goods provision on the subnational level (which is often the aim), but to a drop in the grant recipient's tax revenue. This work investigates the hypothesis that the state of certain "fiscal" incentives depends on whether the equalizing transfer allocation technique is based on actual amounts of regional tax revenues and spending or on some estimates for subnational fiscal capacity and spending needs.

In order to study the mechanism generating the regional authorities' fiscal incentives with respect to equalizing transfers, this paper utilizes a simple subnational behavior model in which the federal government sets its financial assistance policy in order to reach interbudgetary equalization. The empirical part of this work is based on a series of econometric estimations for assistance allocation model parameters. In the empirical part of the paper, the model of assistance allocation was estimated based on panel data. We then tested the degree to which the principle of allocation of financial assistance in the Russian Federation from 1994 to 2000 created incentives for regional authorities to change the amount of public and private goods produced in their territory. The work concludes that a change in the assistance allocation principle, as well as its dependence on the type of aid and region, alters the effects the assistance has on subnational authorities' decision-making in regards to tax revenue and budgetary spending.

 

Contents

Introducton 5
1. The Economic Theory of Fiscal Federalism and the Impact of Interbudgetary transfers on the Decision-Making of Subnational Authorities 8
1.1. Models explaining the effect of interbudgetary grants on the fiscal and spending behavior of subnational authorities 12
1.2. Models for the allocation of interbudgetary equalizing transfers 20
2. Modeling regional fiscal behavior 28
2.1. The allocation of financial assistan equation including the amount of financial aid as an explanatory variables
2.2. Models of regional fiscal behavior 34
  2.2.1. The analysis of the optimal values of regional budget revenues and expenditure for the logarithmic utility function 38
  2.2.2. Conclusions from the theoretical analysis of thdget revenues and expenditure for the logarithmic utility function 38
  2.2.3. Conclusions from the theoretical analysis of the regional fiscal incentives model and economic policy proposals 45
2.3 Estimation of the financial aid allocation models from the federal center to the Russian regions 47
 2.3.1. Estimation of the linear federal grant allocation model 48
 2.3.2. Tests of hypotheses of regional fiscal behavior 59
  2.3.3. Conclusions from the empirical analysis and economic policy proposals
Appendices 72
Appendix 1. Technical aspects of different models for interbudgetary equalizing transfers allocation 72
Appendix 2. The interdependence between the regional deficit calculated using fiscal capacity and expenditure needs and the gross regional product 77
Appendix 3. Lists of groups of poor and northern regions of the Russian Federation 80
Appendix 4. Estimation results of the financial aid allocation for the poor regions 81
Appendix 5. Estimation results of the financial aid allo
Appendix 6. Estimation results of the models of the tax revenues
Appendix 7. Estimation results for the models of tax revenues including the amount of financial aid as an explanatory variable per tax types
Appendix 8. Estimation results of the expenditure
Appendix 9. Estimation of the dependence of expenditures on the amount of the financial aid for different expenditure items 97
References 99

Notes

Federal Fiscal Transfers to Regions and Fiscal Behaviour of Regional Governments
Moscow 2002
Authors: S. Sinelnikov, P. Kadotchnikov, I. Trunin
Editor: N. Glavatskaya
Page setting: V. Yudichev

ISBN 5-93255-073-2

The research and the publication were undertaken in the framework of CEPRA (Consortium for Economic Policy, Research and Advice) project funded by the Canadian Agency for International Development (CIDA).

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