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Fiscal Federalism www.chilot.me Fiscal Federalism Teaching Material Prepared by: Endawke Tsegaw (LL.B &LL.M Candidate) Prepared under the Sponsorship of the Justice and Legal System Research Institute 2009 www.chilot.me Table of Contents Course Introduction ………………………………………………………………………….. 1 Course Objectives ……………………………………………………………………………. 2 Tools to the material …………………………………………………………………………. 3 Chapter One: Federalism and Fiscal Federalism in General ………………………………..... 5 Introduction …………………………………………………………………………….. 5 Chapter Objectives ……………………………………………………………………… 5 1.1. Federalism: General Overview …………………………………………………... 6 1.1.1 Forms of State Structure …………………………………………………..... 6 1.2.2. Conceptual Underpinnings of Federalism ……………………………….… 8 1.1.3. Rationales for Federalism ….......................................................................... 9 1.1.4. Constitutional Division of Power …………………………………….….. 11 1.2. Economic Policy and Commerce in Federation …………………………….….. 17 1.2.1. Foreign and Interstate Commerce in federation ……………….…………. 17 1.2.2. Economic policy and Federalism ……………………………….………... 18 1.3. Fiscal Federalism: Introductory Remarks …………………………….………... 21 1.3.1. Public Finance in Federalism ………………………………….…………. 22 1.3.2. Important Concepts of Fiscal Federalism …………………….…………...25 1.3.3. Fiscal Federalism: merit and demerit ……………………….……………. 26 1.3.4. Evolution and Development of fiscal federalism in Ethiopia …….……… 30 Additional reading on fiscal federalism ………………………………….…………… 33 Summary …………………………………………………………………….………... 39 Chapter Two: Allocation of Public Expenditure Responsibilities ……………….………... 41 Introduction ………………………………………………………….……………… 41 Chapter Objectives …………………………………………………….……………. 42 2.1. Meaning Public Expenditure ……………………………………….………….. 42 2.2. Objectives and Principles of Public Expenditure …………………….………… 44 2.3. Main Areas of Expenditure Responsibility: Capital and Recurrent ….………… 46 2.4. Roles of each Layer of Governments ………………………………….………. 47 2.4.1. Allocation of Expenditure Responsibilities ……………………….…….. 49 i www.chilot.me 2.5. Constitutional Method of Division of Expenditure Responsibility: the USA and Germany Experiences …………………………………………………….……. 51 2.5.1. USA Experience ……………………………………………………........ 51 2.5.2. Germany Experience …………………………………………………..... 55 2.6. Division of Expenditure Responsibility under FDRE Constitution …………..... 58 2.6.1. Allocation of Powers and Functions under FDRE Constitution ……….… 58 2.6.2. Budget Processing …………………………………………………….….. 66 Summary ………………………………………………………………………….….. 74 Chapter Three: Allocation of Public Revenue Sources ………………………………….… 76 Introduction ……………………………………………………………………….….. 76 Chapter Objectives ………………………………………………………………….... 76 3.1. Meaning of Public Revenue ……………………………………………….…….. 77 3.2. Revenue Sources of a Government: General ……………………………….…… 78 3.3. Purpose and Types of Taxes ……………………………………………….……. 82 3.3.1 Purposes of taxes …………………………………………………….…….. 82 3.3.2. Types of Taxes ……………………………………………………….…… 83 3.4. Methods of division of Revenue Sources between Federal, State and Local Governments ……………………………………………………………….…… 85 3.4.1. Constitutional Methods of Division of Revenue Powers in Federations .… 87 3.5. The Structure of Taxation Power in Ethiopia …………………………………... 90 3.5.1. Federal Power of Taxation ……………………………………………….. 92 3.5.2. State Power of Taxation …………………………………………….……. 94 3.5.3. Concurrent Power of Taxation ……………………………………….…... 96 3.5.4. Undesignated Power of Taxation …………………………………….…. 102 3.5.5. Local Taxation ……………………………………………………….…. 104 3.5.6. Limitations on Powers of Taxation ……………………………….…….. 106 Summary …………………………………………………………………….…....... 108 Meanings of Major Administrative Revenues ……………………………….……. 109 Chapter Four: Fiscal Imbalances & Intergovernmental Revenue Transfer ………….…... 112 Introduction …………………………………………………………………….….... 112 Chapter Objectives ……………………………………………………………….….. 113 ii www.chilot.me 4.1. Fiscal Imbalances in General: Meaning …………………………………….….. 113 4.1.1 Vertical Fiscal Imbalances …………………………………………….… 114 4.1.2. Horizontal Imbalance …………………………………………….……. 115 4.1.2.1. Intrastate Imbalance ……………………………….…...118 4.1.3. Causes and Implications of imbalances …………………………….…... 119 4.2. Inter-governmental Revenue Transfer: meaning …………………………….… 127 4.2.1. Objective of Transfer ………………………………………………….... 127 4.2.2. Types of Transfer ……………………………………………………...... 130 4.2.2.1. Revenue Sharing …………………………………………….... 131 4.2.2.2. Grants ……………………………………………………….… 138 4.2.3. Federal: States Transfer in Ethiopia ………………………………….…. 142 4.2.3.1. Intrastate Transfers …………………………………………..... 142 4.2.3.2. Regional Borrowings ………………………………………….. 144 Summary ………………………………………………………………………….… 151 Chapter Five: Institutional Arrangements and their Functions ……………………….…. 154 Introduction ………………………………………………………………….….. 154 Chapter Objectives ………………………………………………………….…. 154 5.1. Fiscal Institutions in general …………………………………………….... 155 5.1.1. The Structure and Role of Institutions …………………………….... 155 5.2. Federal Fiscal Institutions ……………………………………………….... 156 5.3. States Fiscal Institutions ……………………………………………….…. 159 5.4. Institution Responsible for Revenue Transfer ………………………….… 164 5.4.1. International Experience ………………………………………….... 164 5.4.2. Ethiopian Approach ………………………………………………... 166 Summary ……………………………………………………………………………….... 172 Course Summary and Conclusion ……………………………………………………….. 174 1. Course Summary and Conclusion ……………………………………………...174 2. Selected Issues of Fiscal Federalism and Future Concerns …………………..181 Interstate Competition ………………………………………………………….... 181 iii www.chilot.me Migration and mobility …………………………………………………….……. 182 Spillover effect …………………………………………………………….…….. 182 Double Taxation ………………………………………………………….……… 183 Reference Material………………………………………………………………………….184 iv www.chilot.me Course Introduction The concept of federalism, though USA origin, has got a great acclamation by many states contemporarily due to its manifold purposes: conflict resolution, convenience of administration and local empowerment as well as political, economical and social benefits. Ethiopia through the 1995 FDRE Constitution, joined the world states of federation. However, it is not immune from potential dangers of fragmentation and conflicts which may weigh less or otherwise than the benefits from one state to other. Fiscal federalism constitutes the core and difficult area of federalism which measures the degree of division of powers among the constituent units of federations for the financial power is an engine of every activity. It is tough area for natural resources are limited and endowed unevenly from place to palace and constitutional redistribution is not fairly accepted by all concerned. In a geographical area of more than one level of government, allocation of revenue sources and expenditure responsibilities are elementary subject matters of fiscal federalism. Invariably, in all federations the allocation revenue sources follows the allocation of expenditure responsibilities which in turn signifies the division of powers and functions. The federations‟ system of divisions of powers and functions easily reflects in fiscal federalism. Other elements of fiscal federalism are the extensions of the two main subjects that as unavoidable problems and their solution. These are fiscal imbalances which are caused by the gap between allocation of expenditure and allocation of revenue sources both vertically between the states and the center and horizontally among the states. These problems quest constitutional methods of solution. Some of the schemes involve fiscal transfer from one level of government to the other, mostly from the center to the states. In addition, the whole machinery of fiscal federalism is geared by some specific institutions which arethis effect. This course material discusses fiscal federalism mainly Ethiopian Constitution‟s fiscal arrangement by exploring each subject matter under separate chapter. Accordingly, it has five chapters and course summary and conclusion with future concerns of fiscal federalism. To this end, chapter one provides conceptual underpinnings of federalism in general and fiscal federalism in particular and other related issues. While chapter two and chapter three deal with allocation of expenditure responsibilities and revenue sources respectively, chapter four is 1 www.chilot.me devoted for the discussion of intergovernmental fiscal imbalances and fiscal transfer. Lastly, chapter five explains institutional frameworks and it is followed by summary and conclusion of the course. Course Objectives General objectives Generally, upon the completion of this course, students are expected: to acquire the basic knowledge of the conceptual underpinnings and institutions of fiscal federalism; to acquaint themselves with problem solving skills in fiscal federalism; and to enhance their personal competence to engage in different fiscal institutions of the country in their future career. Specifically, students will be able to: understand the method and objectives of dividing power between the levels of governments in general and under the Ethiopian constitution in particular; identify the issues of public finance and federalism enshrined in FDRE Constitution, explain the principles of sharing of revenues and expenditures among the States and Federal governments, appreciate the base, assessment type and methods of implementations of sources and spending the finances of both Federal and State Governments, and solve theoretical and pragmatic problems
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