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Decentralizing Revenue in Latin America: Why and How

Vicente Fretes Cibils and Teresa Ter-Minassian, Eds (2015)

Latin American countries have made great strides in increasing total revenue. The biggest challenge they face, however, is reforming tax institutions and rules. The importance of taxation as a development tool cannot be emphasized enough, since tax reform has significant implications for sustainable and inclusive growth in the region.

There are two reasons Latin America lags behind in its level of development in terms of taxation. First, most countries are still far from exhausting their revenue potential. Second, taxes are not yet designed to promote development. In particular, subnational governments in the region must generate more ownsource revenue because this will enhance budgetary resources for local development and increase the transparency of costs to provide local goods and services, thereby promoting efficiency. Furthermore, it will allow local authorities greater autonomy in choosing and implementing policies that are better tailored to the needs and preferences of the population demanding and receiving them.

The tax situation varies among countries, and the region suffers a clear imbalance in fiscal decentralization, with revenue substantially lagging behind spending. As a result, many subnational governments are highly dependent on transfers from central governments. In addition, this imbalance between own source revenue and transfers makes subnational government finances more vulnerable and less predictable, hindering the ability of local authorities to prepare more stable and realistic budgets.

Using case studies that span a range of countries of different sizes, levels of development, extent of decentralization, and systems of government, this book demonstrates that there are various factors holding back revenue decentralization in the region. Taking into account the likely economic, institutional, and political constraints on the reform process, the analyses show the following:

  • Revenue assignments at the subnational level need to be revisited to provide more meaningful ways to increase own-source revenue.
  • Reform efforts have to focus on strengthening capacities for subnational governments that already have appropriate revenue handles (property taxes).
  • Given the political cost to subnational governments of increasing the burden of taxation on their populations, incentives have to be created for them to better exploit their revenue potential.
  • Reforms to strengthen mobilization of subnational own-source revenue need to be accompanied by introducing or improving transfer systems aimed at equalizing, to the extent feasible, revenue capacities and spending needs.
  • Central governments need to support subnational governments in mobilizing own-source revenue through policy and administrative reforms.

Subnational revenue mobilization and reform in Latin America are essential, despite the obstacles for proceeding with revenue decentralization. There is no unique approach, and the path to reform will likely be context-specific and highly dependent on the balance struck between differing political and economic factors and interests. Should countries in the region take on this challenge, however, not only will revenue be generated in the future but the changes should contribute to sustained and inclusive growth.

Full text is available here.

Cibils, Vicente Fretes and Teresia Ter-Minassian, Eds., (2015). Decentralizing Revenue in Latin America: Why and How. Washington, DC: Inter-American Development Bank.

 

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