Transfers and the Nature of the Mexican Federation

5 Decentral Mexico 5/26/00 8:49 AM Page 200 5 Transfers and the Nature of the Mexican Federation Thomas Courchene and Alberto Díaz-Cayeros This chapter analyzes the current practice of transfers in Mexican fiscal federalism and then considers alternative approaches to transfer design and implementation. The first section focuses on those principles that ought to inform the system of intergovernmental transfers in any federation, Mexico included. The second section examines the constitution and the programs of the Zedillo administration for evidence on the nature of the social contract underlying Mexican federalism. Then the analysis directs attention to the description, quantification, and assessment of the current set of intergovernmental transfers, including unconditional participaciones, the mostly conditional aportaciones, and the infrastructure transfers. For each of these categories and their components, per capita data are presented both in absolute value by state and in relation to the state’s ranking in terms of a poverty index. To these transfer data the following section adds data relat- ing to own-source revenues which, then, allows an assessment of the degree of vertical and horizontal imbalance in the Mexican federation. What emerges is a relatively high degree of horizontal balance, provided one excludes a few of the obvious outliers. The final section turns attention to some alternative scenarios for the evolution of Mexican fiscal federalism. Principles for Intergovernmental Transfers The analysis of Mexico’s theory and practice for fiscal federalism, described in the rest of the chapter, indicates that its system of intergovernmental transfers ought to satisfy eight principles. First, intergovernmental grants should complement the associated expenditure and tax allocations in ways that make the overall system res- onate well with the needs and underlying social values of the Mexican fed- 200 5 Decentral Mexico 5/26/00 8:49 AM Page 201 TRANSFERS AND THE NATURE OF THE MEXICAN FEDERATION 201 eration and society. For example, the importance of assuring relatively equal access to certain national public goods like education implies that the federation will have grants earmarked for those purposes. Second, intergovernmental grants should deliver the conception and degree of equity embedded in the Mexican “political contract.” This means that the equalizing or horizontal transfers to states should be tailored to deliver this degree of subnational equity. As an important aside, equity does not relate to the grants in isolation: it relates to the sum of the transfers and all other state revenues. That is, the states’ overall fiscal capacity should be brought up to the equity standard. Third, the transfer arrangements should be predictable over time. The set of transfers should be designed within a multiyear framework to allow the states a corresponding multiyear planning and budgeting horizon. Although absolute predictability cannot be guaranteed, a useful initial compromise might be a federal-state agreement over three or five years (preferably overlapping the presidential sexenio and the congressional three-year terms) with provisions requiring adequate notice for any changes. The fourth principle is a variant of the last: formulas should determine transfers as much as possible. This implies that the procedures of calcula- tion should be open and transparent, such that they can be reproduced by third parties. To facilitate this, Mexico could consider the establishment of a formal or informal agency representing both the federal government and the states. Australia’s Commonwealth Grants Commission is the pre- eminent exemplar of a formal, quasi-independent agency, while Canada’s technical working group of federal and provincial officials represents the informal variant. An important role for formula-based transfers is to de- politicize, at least to a degree, the overall transfer regime. These formulas will presumably be altered over time as conditions merit. But at any point in time the degree of objectivity and transparency of formula-based transfers tends to defuse what is, in effect, a zero-sum redistributional game. The fifth principle relates to the nature of the conditions that are attached to grants associated with expenditure areas. Consistent with meeting the expenditure goals, the conditions should respect state priorities. For example, different states may be able to satisfy these conditions in different ways—ways that relate to the social, cultural, and economic needs of their respective constituencies. This argues not for a one-size-fits-all approach to conditionality, but rather for conditionality defined in terms of “equivalencies.” In the fiscal federalism literature this has come to be associated with the term “competitive federalism” or “horizontal competition,” which means allowing states sufficient flexibility to design their own bundles of goods and services consistent with the agreed upon conditions or, preferably, equivalencies. This should tilt the federation in the direction of 5 Decentral Mexico 5/26/00 8:49 AM Page 202 202 FISCAL DECENTRALIZATION: LESSONS FROM MEXICO dynamic efficiency, since demonstrably superior approaches to policy design in some states will be copied by other states. The focus here is on conditional grants: we take it as axiomatic that unconditional grants will be spent in ways that reflect state priorities. The sixth principle relates to the objective of tax decentralization. Whatever the approach finally taken to equalization (or to the amelioration of horizontal imbalances), the incentives in this system should ensure that states that increase their tax effort or increase the effectiveness of their col- lection should be able to retain a meaningful share of the increased revenue. Even in developed federations one can still find equalization programs that embody 100 percent (that is, confiscatory) taxation with respect to subnational government revenue increases—transfers fall fully in line with revenue increases. The relevant formulas should prevent this and should retain some incentive for local tax effort. The seventh principle also anticipates greater tax decentralization. The overall grant system should be designed in a way that anticipates and accommodates the desire of states to enhance tax revenue. For example, an expansion of states’ access to tax revenues should automatically trigger the appropriate change in the flow of transfers; that is, the system should not have to be designed anew every time there is further tax decentralization. Any such institution of adjustment should respect principles three and six—assuring predictability and refraining from penalizing local tax effort. Finally, but hardly exhaustively, any new grant design should take the initial conditions into account. Part of the rationale in this chapter is that the current set of transfers presumably embodies the implicit social contract. This must inform the evolution of transfers. Furthermore, to be politically feasi- ble, any novel transfer arrangement must be accompanied by adequate and acceptable arrangements for transition from the old to the new system. Mexican Constitution and Fiscal Federalism The constitution is the framework document for all federations. Among other things, it specifies the division of powers among and between the various levels of government, including the assignment of responsibility for expenditure and taxation. In most federations, the constitution also speaks to the nature of the “federal social pact” and, therefore, provides some guidance on the nature and role of federal transfers. For example, in the Canadian federation, Section 36 addresses equality of opportunity for all citizens and also provides for equalization payments to provinces to “ensure that provincial governments have sufficient revenues to provide reasonable, comparable public goods at reasonably comparable tax rates.” As an important aside, in 1999 the federal government and the Canadian provinces signed a social pact (Framework Agreement on the Social Union) 5 Decentral Mexico 5/26/00 8:49 AM Page 203 TRANSFERS AND THE NATURE OF THE MEXICAN FEDERATION 203 designed to establish and promote the internal social and economic union. The German Basic Law embraces the concept of “uniformity of living conditions” for all Germans and actually enshrines the details of revenue sharing and the interländer revenue-sharing pool. Australia’s federal social pact is reflected in the guiding principle of the Commonwealth Grants Commission—“each state should be given the capacity to provide the average standard of state-type public services, assuming it does so at an average level of operational efficiency and makes an average effort to raise revenues from its own sources.” In other words, the constitution usually informs the design of intergovernmental transfers. The Mexican Constitution, however, provides little guidance on the appropriate role, operational principles, and design of intergovernmental transfers. The Mexican Constitution proclaims, in Article 40, that Mexico is a representative, democratic, federal republic, composed of free and sovereign states in regard to their internal regimes. Article 124 assigns to the states the residual authority or power over all areas not explicitly assigned to the federal government. However, most of the other provisions then proceed to limit the authority of the states. In fact, the Mexican Federal Pact, as expressed in various provisions of the

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