## _cr08189

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---

### I. Introduction — fiscal situation and consolidation need
- Austria has experienced persistent fiscal deficits even in years of strong growth; consolidation is needed to achieve the authorities’ objective—and commitment under the Stability and Growth Pact (SGP)—of reaching structural balance by 2010.
- Announced plans to implement major tax cuts in 2010 increase the need for substantial expenditure savings to make room for tax cuts and meet the structural balance objective by 2010.
- Aging pressures imply more savings likely needed over the medium and long term:
  - OECD (2007) projects public debt exceeding 100 percent of GDP by 2050 in the absence of offsetting measures.
  - A correction to subnational fiscal data in October 2007 worsened the 2006 general government deficit by 0.3 percentage points of GDP.

### II. Structure of Austrian fiscal federalism
- Institutional arrangement and scale:
  - Federal government and nine provinces (Länder).
  - Federal parliament: Bundesrat (representatives appointed by provincial parliaments) and Nationalrat (directly elected). Bundesrat can delay but not veto most Nationalrat-originating legislation; absolute veto on changes of Länder competences in the constitution.
  - Municipalities: 2,357 total.
    - Austria’s population is about 8 million.
    - Average municipality contains around 3,400 persons.
    - About 1,500 municipalities contain less than 2,000 persons.
    - There are 24 municipalities with more than 20,000 persons.
    - The smallest municipality contains around 60 persons.
  - Municipalities belong to voluntary associations—the Austrian Association of Municipalities and the Austrian Association of Cities and Towns—which represent municipalities in periodic intergovernmental revenue-sharing negotiations.
- Key legislation and processes:
  - Fiscal Constitutional Law and the “Finanzausgleich” or Fiscal Equalization Law (FEL) specify revenue allocation and transfers; FEL is normally negotiated every four years but can cover longer periods (2008–13 under the current agreement).
  - Internal Stability Pact (ISP) negotiates concurrently with FEL, sets multi-year general government fiscal balance target, and allocates this target between federal, provincial and municipality governments. ISP for 2005–08 targeted a balanced budget by 2008; under the new ISP for 2008–13 the target for achieving a balanced budget has been pushed back to 2010.
- Fiscal centralization and expenditure responsibilities:
  - Federal government (including social security funds) accounts for about 70 percent of general government spending, provinces 17 percent, municipalities 13 percent as of 2006.
  - Examples of constitutional assignments:
    - Federal government: higher education, vocational training, labor legislation, most public pensions, all health care excluding hospitals, framework legislation for hospitals, family support.
    - Länder: social welfare, primary education, hospitals, regional infrastructure, transportation, pensions for Länder civil servants.
    - Municipalities: local police, local infrastructure, social services.
  - In practice there are many joint responsibilities and overlaps—health care, education, social safety net—with opaque lines of responsibility and co-financing arrangements (e.g., municipalities required to contribute amounts ranging from 35 to 60 percent of their own taxes to provincial governments to help finance health care).
  - Delegation of tasks from higher to lower levels is substantial; with the exception of defense and taxation the bulk of federal administrative tasks are carried out by provincial officials.
  - Discretionary spending constitutes around 2 percent of municipal budgets.

### III. Revenue structure, tax autonomy, and fiscal outcomes
- Revenue sharing and joint taxes:
  - Up to 2004, different taxes were allocated by different allocation formulae; FEL for 2005–08 introduced a uniform allocation formula for most taxes (excluding Grunderwerbsteuer and Werbesteuer).
  - Under the current FEL most federal government transfers have been converted into fixed unconditional shares of the total revenue pool from joint taxes.
  - Currently, over 90 percent of all general government tax revenue is collected as joint taxes at the federal level.
  - Transfers of joint revenues: 73 percent to federal, 15 percent to provincial, and 12 percent to municipality governments.
- Subnational tax autonomy:
  - Own-taxes of the provinces (mostly Feuerschutzabgabe and Lustbarkeitsabgabe) constitute less than one percent of general government revenue.
  - Own-taxes of municipalities (mostly real estate and municipal payroll taxes) constitute about 5 percent of general government revenue.
  - Low tax autonomy at the subnational level has weakened spending efficiency and contributed to higher aggregate spending.
- Aggregate fiscal indicators:
  - General government expenditure in 2007 was 48 percent of GDP.
  - Tax revenue constituted 42 percent of GDP.
  - Persistent deficits have occurred despite a relatively high tax burden.
- Data, transparency and accounting issues:
  - Limited disclosure and insufficient application of accounting standards, particularly at lower levels of government.
  - ESA 95 accounting rules have been applied inconsistently, with varying on-budget treatment of health care spending across subnational governments and reports of some health care expenditures being booked as loans.
  - Difficulty obtaining comprehensive high-frequency fiscal data on individual provinces; the large number of municipalities complicates assessment at that level.

### IV. Identified reform priorities and political challenges
- Five commonly cited reform areas:
  - (i) Disclosure and accounting standards and benchmarking of expenditure norms, particularly at provincial and municipality levels.
  - (ii) Overlapping and unclear expenditure responsibilities across different levels of government, which blur accountability.
  - (iii) The complex system of revenue sharing and intergovernmental transfers, which creates incentive problems.
  - (iv) Weak subnational tax autonomy.
  - (v) The multitude of small municipalities.
- Political and constitutional reform prospects:
  - Major constitutional reform effort (Konvent) unsuccessful in 2005 due to lack of required parliamentary supermajority. Working groups continue to make proposals.
  - Current grand coalition government has required votes to make constitutional changes, but lack of broad political support—including at the subnational level—has so far prevented agreement on fundamental changes.

### V. Principles for efficient fiscal federalism — implications for Austria
- Core advantages of federal systems:
  - Accommodate local preferences and enable beneficial yardstick competition.
  - Local governments better discern resident preferences, aware of local conditions, and more accountable—improving allocative efficiency and welfare.
  - Allow experimentation across localities and protection of property rights and minority interests.
- Core disadvantages and coordination needs:
  - Decentralization creates coordination problems (macroeconomic stabilization, tax and wage competition, spillovers/externalities, free-rider problems).
  - Imbalances between expenditure responsibilities and taxation powers necessitate intergovernmental revenue sharing and grants.
- Design considerations and subsidiarity:
  - Subsidiarity principle: entrust responsibilities to the lowest level of government capable of carrying them out without producing substantial externalities and spillovers.
  - Tasks with national scope (defense, foreign affairs, pensions, competition policy, labor market policy) should generally be central government responsibilities.
  - Even where primary responsibility is subnational, the central government often retains a coordinating role (e.g., core curricula, minimum standards of care, limiting damaging tax and wage competition).
  - Expenditure assignments should have clear lines of demarcation, transparent reporting, and, where possible, closely related activities assigned to a single level of government or governed by simple and transparent interactions when multiple levels are involved.

### VI. Expenditure assignment evidence (selected results)
- Selected sector allocation percentages (Central / Subnational / Joint):
  - Defense: 95.2 / 0.0 / 4.8
  - Foreign affairs: 85.4 / 0.0 / 14.6
  - Old age and disability pensions: 82.5 / 0.0 / 17.5
  - Competition: 80.0 / 5.0 / 15.0
  - Justice: 80.0 / 0.0 / 20.0
  - Labor market: 76.2 / 2.4 / 21.4
  - Higher education: 59.5 / 21.4 / 19.0
  - Local police: 36.8 / 52.6 / 10.5
  - Health: 30.0 / 7.5 / 62.5
  - Social assistance: 29.3 / 22.0 / 48.8
  - Transport infrastructure: 27.9 / 14.0 / 58.1
  - Primary & secondary education: 21.4 / 47.6 / 31.0
  - Sanitation: 12.2 / 63.4 / 24.4
  - Water: 9.8 / 56.1 / 34.1
  - Local transport: 7.1 / 66.7 / 26.2
  - Garbage collection: 7.3 / 82.9 / 9.8

### Assignment of expenditure tasks and subsidiarity (Austria-specific findings and recommendation)
- Current practice reduces subnational expenditure discretion despite constitutional assignments not being inconsistent with subsidiarity:
  - Assigning closely related tasks to different government levels, earmarking of transfers, delegation of tasks from higher levels, and complex co-financing arrangements have reduced discretion.
  - These arrangements have rendered the system opaque, and limited accountability, efficiency, and yardstick competition.
  - Result: subnational expenditure inefficiencies and reluctance by the Länder to contemplate fundamental reforms.
- Recommendation:
  - Simplification and rationalization of assignment of expenditure tasks to substantially increase subnational discretion and accountability.
  - Clear demarcation of expenditure tasks, greater transparency, benchmarking of standards for public service provision to stimulate yardstick competition.
  - Reconsider delegation of tasks to lower government levels and pervasive earmarking.
  - To entrench subnational discretion, a higher level of tax autonomy would be warranted.

### Subnational taxation powers — findings and policy options
- Conceptual findings:
  - Significant tax autonomy is generally warranted for a proper and efficient federal system.
  - At the margin an increase in subnational expenditure should require a commensurate increase in revenue from local taxes under subnational control.
  - Subnational governments should have significant policy discretion over at least a share of their total revenues.
- Austria-specific findings:
  - Subnational tax autonomy in Austria is not strong enough:
    - Low share of own-taxes at the subnational level.
    - International comparisons (Blochliger, 2006) indicate limited discretion over rates and base of tax revenue.
    - Since 2002, the share of joint taxes in general government tax revenue has increased further (Schratzenstaller, 2008).
- Policy options and guidance:
  - Strengthen subnational tax autonomy in a revenue neutral fashion.
  - Apply subsidiarity in tax assignment: assign taxes to the lowest government level capable of efficient implementation without significant spillovers/externalities.
  - Ideal local tax: levied on a relatively immobile and well demarcated local tax base (property taxes commonly assigned to local governments).
  - Specific instruments:
    - Real estate tax:
      - OECD notes the real estate tax in Austria has potential to generate substantially higher revenues.
      - Increasing real estate tax revenue would require upgrading market-value assessments (current valuations are considerably below actual market values).
      - Municipalities should be given considerable discretion over this tax; changes should be implemented carefully to avoid disturbing market conditions.
      - To ensure revenue neutrality, central government tax yield would need to be reduced in commensurate fashion.
    - Profit taxes:
      - Generally not appropriate as subnational taxes due to strong cyclical component and allocation difficulties across jurisdictions.
    - VAT:
      - Discretion over VAT rates and base typically left to central government; local autonomy over VAT generally increases complexity and inefficiency.
    - Personal income tax:
      - Usually levied by central government, but provinces can levy income taxes in some countries via discretion over tax rates on the central base.
      - Possible Austrian arrangement: allow provinces to set a rate on the portion of the federal income tax base arising from their residents; federal administration collects all PIT revenue and passes provincial shares; provincial rate variation could be limited to a band to limit tax competition.
- Operational principle:
  - To avoid administrative complexity and fragmentation of the tax base, many shared taxes should retain a common base with limited local rate variation.

### Revenue equalization — issues and recommendations
- Purpose and practice:
  - Revenue equalization formulas seek to partly or fully offset differences in fiscal capacity and fiscal costs across subnational governments.
  - Austria’s objective: ensure roughly similar living standards across the country; formulas have included both fiscal capacity and fiscal cost criteria.
  - Outcome: objective largely met in Austria, with a low gini coefficient of fiscal capacity between subnational governments after equalization.
- Efficiency trade-offs:
  - Question whether country-wide similarity of results is compatible with an efficient fiscal federal system that allows local choice and yardstick competition.
  - More efficient focus: equalize capacity rather than outcomes to preserve subnational adaptation and competition.
- Adverse incentives and design recommendations:
  - Minimize disincentives to subnational tax effort:
    - Increased subnational revenues from higher tax efforts should not be offset by reductions in transfer inflows.
    - In Austria, offsets are large, and even more than 100 percent in some poorer areas, significantly reducing subnational discretion.
    - Recommendation: base assessments of revenue-raising capacity on well defined and comprehensive norms for tax base and tax rate, not on actual revenues collected by the recipient.
  - Minimize rent-seeking in cost equalization:
    - Use well defined, non-adjustable norms for cost assessments.
    - Minimize equalization of cost differences arising from economies of scale to preserve incentives for efficient mergers or cooperation.
    - Reconsider use of municipality size as a factor in revenue shares.
  - Avoid adverse incentives from common-pool revenue sharing:
    - Pervasive earmarking and conditionality can create incentives for subnational governments to increase expenditure knowing burdens are spread across the country.
    - Argues for simple and transparent rules for determining transfers and revenue sharing.
- Recent reform and remaining issues:
  - Recent simplification in the current FEL is a positive first step: fixed unconditional revenue shares reduce rent-seeking and increase subnational autonomy via reduced earmarking.
  - Problem: fixed unconditional shares of joint taxes encourage procyclical fiscal policy at subnational levels:
    - Booming revenues automatically increase subnational revenues and tempt spending increases; depressed revenues force painful cuts.
    - Mitigation options: multi-year frameworks with explicit targets or ceilings on the size of the pool of revenues to be distributed.

### Size of local jurisdictions — evidence and policy implications
- Efficiency considerations:
  - Austria’s municipalities are well below average size compared with a selection of countries.
  - Large number of small municipalities limits economies of scale and increases logistical effort to monitor fiscal outturn.
  - OECD (2007) calculations point to decreasing average costs as municipality size increases towards 5,000 residents.
  - Scope for further efficiency gains via mergers, cooperation, and adoption of information technology.
- Current policy and incentives:
  - New FEL provides modest financial incentives for voluntary mergers or cooperation across municipalities and across Länder borders.
  - Financial incentives are temporary and small—around 80,000 euros in the first year and declining thereafter—and have generated limited response.
- Human capital and managerial capacity:
  - Small municipalities reportedly have difficulties attracting managerial talent; mergers could alleviate this problem.
- International precedents:
  - Denmark: number of municipalities decreased from 1,390 to 275 in 1970, and decreased further in 2007 to 98, with the target that municipalities should contain at least 10,000 persons.
  - Sweden: number of municipalities and cities reduced from 2,414 to 949 in 1952; currently the number of municipalities stands at 290.
  - Finland: debating reduction in number of municipalities (416 in 2007).
  - Netherlands: number of municipalities reduced from over 1,200 to 489 in 2003, and further reduced to 458 by 2006.
- Implementation note:
  - Substantial public debate and preparation are required for municipal restructuring.
  - Success odds could improve with a comprehensive study quantifying costs of the status quo and defining broad parameters for an efficient municipality size in Austria.

### Transparency, disclosure, and fiscal framework improvements
- Disclosure and transparency:
  - Current disclosure and transparency standards do not permit the Austrian public to make informed comparisons about the efficiency of spending and the quality of outcomes in various subnational jurisdictions.
  - Overhauling disclosure and transparency standards would stimulate public debate and be a necessary first step to build a public consensus for deep reforms.
  - Practices that reduce public visibility of fiscal transactions should be reconsidered, including the extensive use of extra budgetary units at all levels of government.
  - Move towards the full use of ESA 95 accounting standards in recent years is welcome.
- Fiscal framework improvements and timelines:
  - Vigorous implementation of commitments under the ISP to implement medium term expenditure frameworks at all levels of government.
  - Plans to implement medium term expenditure frameworks at the federal level in 2009.
  - Move to output-based budgeting to be implemented in 2013 by the federal government.
  - These measures are complementary and supportive of improved accountability and predictability.

### Concluding assessment and policy urgency
- Structural characterization:
  - Austria’s political system is clearly federal, but its fiscal arrangements more closely resemble a unitary fiscal structure, given the limited discretion at subnational levels.
  - Potential benefits of federalism have generally not been realized; subnational governments have limited scope or incentive to tailor provision of public services according to local preferences or engage in yardstick competition under current arrangements.
- Fiscal sustainability imperatives:
  - Drivers for reform include significant tax cuts envisaged for 2010 and the buildup of aging pressures over the medium and long term.
  - The fiscal position needs to be put on a firmer footing in view of these stresses.
  - Achieving fiscal sustainability requires substantial expenditure savings, which plausibly can be done only by overhauling the fiscal federal system to strengthen accountability, transparency and incentives at the subnational level.
  - Given the timing for tax cuts, efforts to reform the fiscal federal system need to be intensified.
- Scope of reform and constitutional obstacles:
  - There is scope for significant reforms even under the current framework.
  - Rationalization of expenditure responsibilities across governmental levels, needed for a more fundamental streamlining of the system, would require constitutional change.
  - Recommendation: efforts to achieve the necessary consensus for constitutional reform in this area should be intensified.

*Source: IMF staff report content from the provided PDF chapter.*

### Bibliography ...........................................................................................................

### _cr08189 - Bibliography ...........................................................................................................

### I. Introduction — fiscal situation and consolidation need
- Austria has experienced persistent fiscal deficits even in years of strong growth; consolidation is needed to achieve the authorities’ objective—and commitment under the Stability and Growth Pact (SGP)—of reaching structural balance by 2010.
- Announced plans to implement major tax cuts in 2010 increase the need for substantial expenditure savings to make room for tax cuts and meet the structural balance objective by 2010.
- Aging pressures imply more savings likely needed over the medium and long term:
  - OECD (2007) projects public debt exceeding 100 percent of GDP by 2050 in the absence of offsetting measures.
  - A correction to subnational fiscal data in October 2007 worsened the 2006 general government deficit by 0.3 percentage points of GDP.

### II. Structure of Austrian fiscal federalism
- Institutional arrangement and scale:
  - Federal government and nine provinces (Länder).
  - Federal parliament: Bundesrat (representatives appointed by provincial parliaments) and Nationalrat (directly elected). Bundesrat can delay but not veto most Nationalrat-originating legislation; absolute veto on changes of Länder competences in the constitution.
  - Municipalities: 2,357 total.
    - Austria’s population is about 8 million.
    - Average municipality contains around 3,400 persons.
    - About 1,500 municipalities contain less than 2,000 persons.
    - There are 24 municipalities with more than 20,000 persons.
    - The smallest municipality contains around 60 persons.
  - Municipalities belong to voluntary associations—the Austrian Association of Municipalities and the Austrian Association of Cities and Towns—which represent municipalities in periodic intergovernmental revenue-sharing negotiations.
- Key legislation and processes:
  - Fiscal Constitutional Law and the “Finanzausgleich” or Fiscal Equalization Law (FEL) specify revenue allocation and transfers; FEL is normally negotiated every four years but can cover longer periods (2008–13 under the current agreement).
  - Internal Stability Pact (ISP) negotiates concurrently with FEL, sets multi-year general government fiscal balance target, and allocates this target between federal, provincial and municipality governments. ISP for 2005–08 targeted a balanced budget by 2008; under the new ISP for 2008–13 the target for achieving a balanced budget has been pushed back to 2010.
- Fiscal centralization and expenditure responsibilities:
  - By international standards the federal system is rather centralized: federal government (including social security funds) accounts for about 70 percent of general government spending, provinces 17 percent, municipalities 13 percent as of 2006.
  - Constitutional assignments: anything not listed for the federal government is generally handled by Länder and municipalities. Examples:
    - Federal government: higher education, vocational training, labor legislation, most public pensions, all health care excluding hospitals, framework legislation for hospitals, family support.
    - Länder: social welfare, primary education, hospitals, regional infrastructure, transportation, pensions for Länder civil servants.
    - Municipalities: local police, local infrastructure, social services.
  - In practice there are many joint responsibilities and overlaps—health care, education, social safety net—with opaque lines of responsibility and co-financing arrangements (e.g., municipalities required to contribute amounts ranging from 35 to 60 percent of their own taxes to provincial governments to help finance health care).
  - Delegation of tasks from higher to lower levels is substantial; with the exception of defense and taxation the bulk of federal administrative tasks are carried out by provincial officials. Discretionary spending constitutes around 2 percent of municipal budgets.

### III. Revenue structure, tax autonomy, and fiscal outcomes
- Revenue sharing and joint taxes:
  - Up to 2004, different taxes were allocated by different allocation formulae; FEL for 2005–08 introduced a uniform allocation formula for most taxes (excluding Grunderwerbsteuer and Werbesteuer).
  - Under the current FEL most federal government transfers have been converted into fixed unconditional shares of the total revenue pool from joint taxes.
  - Currently, over 90 percent of all general government tax revenue is collected as joint taxes at the federal level.
  - Transfers of joint revenues: 73 percent to federal, 15 percent to provincial, and 12 percent to municipality governments.
- Subnational tax autonomy:
  - Own-taxes of the provinces (mostly Feuerschutzabgabe and Lustbarkeitsabgabe) constitute less than one percent of general government revenue.
  - Own-taxes of municipalities (mostly real estate and municipal payroll taxes) constitute about 5 percent of general government revenue.
  - Low tax autonomy at the subnational level has weakened spending efficiency and contributed to higher aggregate spending.
- Aggregate fiscal indicators:
  - General government expenditure in 2007 was 48 percent of GDP.
  - Tax revenue constituted 42 percent of GDP.
  - Persistent deficits have occurred despite a relatively high tax burden.
- Data, transparency and accounting issues:
  - Limited disclosure and insufficient application of accounting standards, particularly at lower levels of government.
  - ESA 95 accounting rules have been applied inconsistently, with varying on-budget treatment of health care spending across subnational governments and reports of some health care expenditures being booked as loans.
  - Difficulty obtaining comprehensive high-frequency fiscal data on individual provinces; the large number of municipalities complicates assessment at that level.

### IV. Identified reform priorities and political challenges
- Five commonly cited reform areas:
  - (i) Disclosure and accounting standards and benchmarking of expenditure norms, particularly at provincial and municipality levels.
  - (ii) Overlapping and unclear expenditure responsibilities across different levels of government, which blur accountability.
  - (iii) The complex system of revenue sharing and intergovernmental transfers, which creates incentive problems.
  - (iv) Weak subnational tax autonomy.
  - (v) The multitude of small municipalities.
- Political and constitutional reform prospects:
  - Major constitutional reform effort (Konvent) unsuccessful in 2005 due to lack of required parliamentary supermajority. Working groups continue to make proposals.
  - Current grand coalition government has required votes to make constitutional changes, but lack of broad political support—including at the subnational level—has so far prevented agreement on fundamental changes.

### V. Principles for efficient fiscal federalism — implications for Austria
- Core advantages of federal systems:
  - Accommodate local preferences and enable beneficial yardstick competition.
  - Local governments better discern resident preferences, aware of local conditions, and more accountable—improving allocative efficiency and welfare.
  - Allow experimentation across localities and protection of property rights and minority interests.
- Core disadvantages and coordination needs:
  - Decentralization creates coordination problems (macroeconomic stabilization, tax and wage competition, spillovers/externalities, free-rider problems).
  - Imbalances between expenditure responsibilities and taxation powers necessitate intergovernmental revenue sharing and grants.
- Design considerations and subsidiarity:
  - Subsidiarity principle: entrust responsibilities to the lowest level of government capable of carrying them out without producing substantial externalities and spillovers.
  - Tasks with national scope (defense, foreign affairs, pensions, competition policy, labor market policy) should generally be central government responsibilities.
  - Even where primary responsibility is subnational, the central government often retains a coordinating role (e.g., core curricula, minimum standards of care, limiting damaging tax and wage competition).
  - Expenditure assignments should have clear lines of demarcation, transparent reporting, and, where possible, closely related activities assigned to a single level of government or governed by simple and transparent interactions when multiple levels are involved.

### VI. Expenditure assignment evidence (selected results from cross-country survey)
- Selected sector allocation percentages (percentage of countries reporting Central / Subnational / Joint responsibility):
  - Defense: 95.2 / 0.0 / 4.8
  - Foreign affairs: 85.4 / 0.0 / 14.6
  - Old age and disability pensions: 82.5 / 0.0 / 17.5
  - Competition: 80.0 / 5.0 / 15.0
  - Justice: 80.0 / 0.0 / 20.0
  - Labor market: 76.2 / 2.4 / 21.4
  - Higher education: 59.5 / 21.4 / 19.0
  - Local police: 36.8 / 52.6 / 10.5
  - Health: 30.0 / 7.5 / 62.5
  - Social assistance: 29.3 / 22.0 / 48.8
  - Transport infrastructure: 27.9 / 14.0 / 58.1
  - Primary & secondary education: 21.4 / 47.6 / 31.0
  - Sanitation: 12.2 / 63.4 / 24.4
  - Water: 9.8 / 56.1 / 34.1
  - Local transport: 7.1 / 66.7 / 26.2
  - Garbage collection: 7.3 / 82.9 / 9.8

*Source: IMF staff report content from the provided PDF chapter.*

### 21.      For Austria, although the broad assignments of expenditure tasks under the

### _cr08189 - 21. For Austria, although the broad assignments of expenditure tasks under the

### Assignment of expenditure tasks and subsidiarity
- Current practice reduces subnational expenditure discretion despite constitutional assignments not being inconsistent with subsidiarity:
  - Assigning closely related tasks to different government levels, earmarking of transfers, delegation of tasks from higher levels, and complex co-financing arrangements have reduced discretion.
  - These arrangements have rendered the system opaque, and limited accountability, efficiency, and yardstick competition.
  - Result: subnational expenditure inefficiencies and reluctance by the Länder to contemplate fundamental reforms.
- Recommendation:
  - Simplification and rationalization of assignment of expenditure tasks to substantially increase subnational discretion and accountability.
  - Clear demarcation of expenditure tasks, greater transparency, benchmarking of standards for public service provision to stimulate yardstick competition.
  - Reconsider delegation of tasks to lower government levels and pervasive earmarking.
  - To entrench subnational discretion, a higher level of tax autonomy would be warranted.

### Subnational taxation powers
- Conceptual findings:
  - Significant tax autonomy is generally warranted for a proper and efficient federal system (reasons include local adaptation to preferences, strengthened accountability, hardening of subnational budget constraints, and mitigation of central government bailout time inconsistency problems).
  - Ideally, at the margin an increase in subnational expenditure should require a commensurate increase in revenue from local taxes under subnational control.
  - Subnational governments should have significant policy discretion over at least a share of their total revenues.
- Austria-specific findings:
  - Subnational tax autonomy in Austria is not strong enough:
    - Low share of own-taxes at the subnational level.
    - International comparisons (Blochliger, 2006) indicate limited discretion over rates and base of tax revenue.
    - Since 2002, the share of joint taxes in general government tax revenue has increased further (Schratzenstaller, 2008), suggesting no improvement in subnational tax autonomy.
- Policy options and guidance:
  - Strengthen subnational tax autonomy in a revenue neutral fashion.
  - Apply subsidiarity in tax assignment: assign taxes to the lowest government level capable of efficient implementation without significant spillovers/externalities.
  - Ideal local tax: levied on a relatively immobile and well demarcated local tax base (property taxes commonly assigned to local governments).
  - Specific instruments:
    - Real estate tax:
      - OECD notes the real estate tax in Austria has potential to generate substantially higher revenues.
      - Increasing real estate tax revenue would require upgrading market-value assessments (current valuations are considerably below actual market values).
      - Municipalities should be given considerable discretion over this tax; changes should be implemented carefully to avoid disturbing market conditions.
      - To ensure revenue neutrality, central government tax yield would need to be reduced in commensurate fashion.
    - Profit taxes:
      - Generally not appropriate as subnational taxes due to strong cyclical component and allocation difficulties across jurisdictions.
    - VAT:
      - Discretion over VAT rates and base typically left to central government; local autonomy over VAT generally increases complexity and inefficiency.
    - Personal income tax:
      - Usually levied by central government, but provinces can levy income taxes in some countries via discretion over tax rates on the central base.
      - Possible Austrian arrangement: allow provinces to set a rate on the portion of the federal income tax base arising from their residents; federal administration collects all PIT revenue and passes provincial shares; provincial rate variation could be limited to a band to limit tax competition.
- Operational principle:
  - To avoid administrative complexity and fragmentation of the tax base, many shared taxes should retain a common base with limited local rate variation.

### Revenue equalization
- Purpose and practice:
  - Revenue equalization formulas seek to partly or fully offset differences in fiscal capacity and fiscal costs across subnational governments.
  - Austria’s objective: ensure roughly similar living standards across the country; formulas have included both fiscal capacity and fiscal cost criteria.
  - Outcome: objective largely met in Austria, with a low gini coefficient of fiscal capacity between subnational governments after equalization.
- Efficiency trade-offs:
  - Question whether country-wide similarity of results is compatible with an efficient fiscal federal system that allows local choice and yardstick competition.
  - More efficient focus: equalize capacity rather than outcomes to preserve subnational adaptation and competition.
- Adverse incentives and design recommendations:
  - Minimize disincentives to subnational tax effort:
    - Increased subnational revenues from higher tax efforts should not be offset by reductions in transfer inflows.
    - In Austria, offsets are large, and even more than 100 percent in some poorer areas, significantly reducing subnational discretion.
    - Recommendation: base assessments of revenue-raising capacity on well defined and comprehensive norms for tax base and tax rate, not on actual revenues collected by the recipient.
  - Minimize rent-seeking in cost equalization:
    - Use well defined, non-adjustable norms for cost assessments.
    - Minimize equalization of cost differences arising from economies of scale to preserve incentives for efficient mergers or cooperation.
    - Reconsider use of municipality size as a factor in revenue shares (see Pitlik, 2008).
  - Avoid adverse incentives from common-pool revenue sharing:
    - Pervasive earmarking and conditionality can create incentives for subnational governments to increase expenditure knowing burdens are spread across the country.
    - Argues for simple and transparent rules for determining transfers and revenue sharing.
- Recent reform and remaining issues:
  - Recent simplification in the current FEL is a positive first step: fixed unconditional revenue shares reduce rent-seeking and increase subnational autonomy via reduced earmarking.
  - Problem: fixed unconditional shares of joint taxes encourage procyclical fiscal policy at subnational levels:
    - Booming revenues automatically increase subnational revenues and tempt spending increases; depressed revenues force painful cuts.
    - Mitigation options: multi-year frameworks with explicit targets or ceilings on the size of the pool of revenues to be distributed.

### Size of local jurisdictions
- Efficiency considerations:
  - Size of local jurisdictions affects economies of scale, spillovers/externalities, and ability to attract managerial expertise.
  - Austria’s municipalities are well below average size compared with a selection of countries.
  - Large number of small municipalities limits economies of scale and increases logistical effort to monitor fiscal outturn.
  - OECD (2007) calculations point to decreasing average costs as municipality size increases towards 5,000 residents.
  - Scope for further efficiency gains via mergers, cooperation, and adoption of information technology.
- Current policy and incentives:
  - New FEL provides modest financial incentives for voluntary mergers or cooperation across municipalities and across Länder borders.
  - Financial incentives are temporary and small—around 80,000 euros in the first year and declining thereafter—and have generated limited response.
- Human capital and managerial capacity:
  - Small municipalities reportedly have difficulties attracting managerial talent; mergers could alleviate this problem.
- International precedents and statistics:
  - Denmark: number of municipalities decreased from 1,390 to 275 in 1970, and decreased further in 2007 to 98, with the target that municipalities should contain at least 10,000 persons.
  - Sweden: number of municipalities and cities reduced from 2,414 to 949 in 1952; currently the number of municipalities stands at 290.
  - Finland: debating reduction in number of municipalities (416 in 2007).
  - Netherlands: number of municipalities reduced from over 1,200 to 489 in 2003, and further reduced to 458 by 2006.
- Implementation note:
  - Substantial public debate and preparation are required for municipal restructuring.
  - Success odds could improve with a comprehensive study quantifying costs of the status quo and defining broad parameters for an efficient municipality size in Austria.

### Transparency and disclosure
- Principle:
  - Transparent, accurate, and standardized fiscal information is key to efficient fiscal federalism.
- Benefits:
  - Promotes public accountability and enhances yardstick competition.
  - Helps increase efficiency of tax administration and capital market discipline on fiscal units.

*Source: _cr08189 - 21.*

### 45.      One reason for the current inertia over reform is that disclosure and transparency

### _cr08189 - 45.      One reason for the current inertia over reform is that disclosure and transparency

### Disclosure, transparency, and public accountability
- Current disclosure and transparency standards do not permit the Austrian public to make informed comparisons about the efficiency of spending and the quality of outcomes in various subnational jurisdictions.
- Overhauling disclosure and transparency standards would:
  - Stimulate public debate over public spending choices.
  - Be a necessary first step to build a public consensus for deep reforms.
- Practices that reduce public visibility of fiscal transactions should be reconsidered, including:
  - The extensive use of extra budgetary units at all levels of government.
- Positive recent development:
  - Move towards the full use of ESA 95 accounting standards in recent years is welcome.

### Fiscal framework improvements and timelines
- Recommendations to render the fiscal framework more transparent and predictable:
  - Vigorous implementation of commitments under the ISP to implement medium term expenditure frameworks at all levels of government.
  - Plans to implement medium term expenditure frameworks at the federal level in 2009.
  - Move to output-based budgeting to be implemented in 2013 by the federal government.
- These measures are presented as complementary and supportive of improved accountability and predictability.

### Concluding assessment of fiscal federal relations
- Structural characterization:
  - Austria’s political system is clearly federal, but its fiscal arrangements more closely resemble a unitary fiscal structure, given the limited discretion at subnational levels.
- Consequences:
  - Potential benefits of federalism have generally not been realized.
  - Subnational governments have limited scope or incentive to:
    - Tailor provision of public services according to local preferences.
    - Engage in yardstick competition under current arrangements.

### Fiscal sustainability imperatives and reform urgency
- Drivers for reform:
  - Economic realities, including:
    - Significant tax cuts envisaged for 2010.
    - The buildup of aging pressures over the medium and long term.
- Policy implication:
  - The fiscal position needs to be put on a firmer footing in view of these stresses.
  - Achieving fiscal sustainability requires substantial expenditure savings, which plausibly can be done only by overhauling the fiscal federal system to strengthen accountability, transparency and incentives at the subnational level.
- Timing:
  - Given the timing for tax cuts, efforts to reform the fiscal federal system need to be intensified.

### Scope of reform and constitutional obstacles
- Potential within current framework:
  - There is scope for significant reforms even under the current framework.
- Limits to administrative fixes:
  - Rationalization of expenditure responsibilities across governmental levels, needed for a more fundamental streamlining of the system, would require constitutional change.
- Recommendation:
  - Given the important role of overhauling fiscal federal relations in ensuring fiscal sustainability, efforts to achieve the necessary consensus for constitutional reform in this area should be intensified.

*Source: IMF staff report excerpt.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr08189.pdf_