## _wp1291

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### Definition and conceptual framework
- Vertical fiscal imbalances (VFIs) occur when spending decentralization outpaces revenue decentralization.
- VFIs lead sub-national governments to rely on central government transfers and borrowing to finance expenditures.
- VFIs break the link between sub-national service provision and its financial consequences for the electorate, undermining sub-national accountability and promoting soft budget constraints.
- The VFI used in this study (borrowed from Eyraud and Lusinyan, 2011) is defined as the share of sub-national own spending not financed through own revenues.
- Counterparts of VFI are sub-national borrowing and transfers received from other units of general government—both expressed as shares of sub-national own spending.
- Formal relationship (conceptual):
  - SNG spending = SNG own revenue + transfer received by SNG + SNG net borrowing
  - VFI = share of SNG own spending not financed through own revenues (conceptual formula as in source).

### Why VFIs matter, especially in crisis
- VFIs receive heightened scrutiny during difficult times, particularly when deficits become chronic and frequent bailouts are necessary.
- Sub-national bailouts can strain intergovernmental fiscal relations and may prompt re-centralization to eliminate the VFI.
- Changes in relative fiscal positions (e.g., central government revenues thriving while local revenues lag) bring VFIs into focus.
- The ongoing financial crisis has exacerbated fiscal pressures at all levels of government, increasing the relevance of VFIs for policy design.
- Recent econometric evidence (Eyraud and Lusinyan, 2011) confirms increases in VFIs are associated with a weakening of general government fiscal balances.

### Purpose, approach, and scope of the case studies
- Aim: identify periods of changes in intergovernmental relations that induced variations in the VFI and assess economic/environmental contributors to fiscal balances.
- Approach: complement cross-country econometric evidence with institutional case studies examining:
  - decentralization policies that brought about declining VFIs, and
  - the economic environment and external factors affecting fiscal balances.
- Countries selected (significant decline in VFI over past two decades):
  - Belgium
  - Italy
  - Norway
  - Spain
- Paper structure: defines VFI measure, then presents country case studies and analysis.

### II. The VFI: definition, measurement, drivers, and limitations
- No consensus exists in literature on VFI definition; common empirical indicators link VFI to transfer dependency.
- Drivers of VFI changes:
  - Direct decentralization decisions (devolving spending and/or revenue).
  - Changes in sub-national fiscal policy (weaker revenue effort or spending increases).
  - Changes in intergovernmental relations strengthening sub-national fiscal discipline (e.g., credible no-bailout policies induced by granting tax-setting powers).
- Limitations of the measure:
  - Does not accurately capture expenditure- and revenue-raising “powers” of sub-national governments.
  - Possible overstatement of sub-national “discretion” when tax sharing is recorded as own taxes or when discretion over tax rates and bases is limited.
  - Spending may be regulated or earmarked so sub-nationals de facto act as de-concentrated agents of the central government.
- Relation to general government fiscal performance:
  - Sub-national deficits are part of the general government balance; changes in VFI are partly attributable to sub-national deficit/surplus changes.
  - Fiscal balances at the general government level are correlated with VFI, with potential two-way causality.

### III. Case studies — major findings, episodes, and fiscal outcomes

A. Belgium
- Institutional structure:
  - Three levels of government: federal government; regions and communities; provinces and communes.
  - Three geographical regions: Flanders, Wallonia, Brussels-Capital; three language communities: Flemish, French, German.
- VFI magnitude and composition:
  - The large VFI in Belgium, between 60 and 70 percent over the last two decades, stems from strong revenue centralization at the federal level.
  - Communities have no own taxes; financed mainly through general-purpose grants.
  - Regions: nearly 80 percent of their funding consists of transfers, and only 20 percent from own taxes.
- Decentralization episodes:
  - 1980 Act of Regionalization: limited devolution of revenue-raising powers; lowest impact on sub-national own revenue shares among the three main acts.
  - 1988–89 large-scale expenditure decentralization: education to communities; regional development and investment to regions; tax-sharing system with “repartition keys”; own sub-national revenues rose but VFI increased as expenditure devolution outpaced revenue devolution.
  - 2001 Lambermont agreement / revenue devolution: new taxes transferred to regions; shared PIT margin increased; VAT transfers to communities increased; revenue-sharing mechanism revised to dampen transfer volatility; increased share of sub-national own taxes, reducing the VFI.
- Fiscal and macro outcomes:
  - Doubling of sub-national own expenditures in 1989 widened VFI by 15 percent; VFI narrowed slightly over next two decades.
  - After 2001 devolution, regional taxes increased by a couple of percentage points of GDP, lowering the VFI by a few percentage points.
  - By 2008, the VFI was still 59 percent.
  - Federal and sub-national fiscal positions improved in the 1990s and early 2000s, turning large deficits of the 1980s into a surplus in 2000.
  - Public debt declined from 130 percent of GDP in 1993 to 80 percent of GDP in 2007.
  - Consolidation mainly driven by federal across-the-board expenditure restraint; regional tax revenue growth was strong but federal primary surplus improvement was larger.

B. Italy
- Institutional structure:
  - Three levels of sub-national government: regions, provinces, municipalities—no hierarchical links.
  - Decentralization asymmetric: “ordinary” and “special” statute regions; five special regions with extensive spending autonomy and central funding.
- VFI history and magnitudes:
  - Sub-national own revenues were only 2 percent of GDP in 1980; VFI reached 80 percent.
  - Revenue from taxes of sub-national governments increased from 3½ percent in 1990 to 8½ percent of GDP in 2000.
  - VFI shrank from 75 percent to 40 percent between the early 1990s and 2000.
- Major institutional episodes:
  - 1970s–1980s: health functions assigned to ordinary regions; massive tax reform centralized local taxing powers; forgone sub-national revenue replaced with earmarked transfers and tax sharing; sub-national spending exceeded own revenues and deficits were financed ex post by the central government.
  - 1990s reforms: further expenditure decentralization; new local taxes with some latitude in rate setting; increase in block grants and some regional sharing of central government taxes and own taxes; electoral reforms increased local accountability; municipal property tax in 1993; regional IRAP in 1998.
  - 2001 onward: constitutional changes toward greater decentralization and “asymmetric federalism”; executive powers transferred to municipalities and provinces with allowance for new taxes but central government transfers ruled out as ex post deficit financing; interregional redistribution fund introduced; sub-national borrowing allowed for investment; regions’ new tax legislative powers largely unrealized politically; VFI stabilized around 2000 level.
- Sectoral decentralization and fiscal outcomes:
  - Health and social sectors account for 80 percent of regional spending; health most decentralized via Local Health Authorities (LHAs).
  - General government primary balance swung into a surplus exceeding 4 percent of GDP between 1992 and 1995.
  - Consolidation driven by revenue measures (e.g., 1992 and 1997 tax measures) and expenditure containment (wage bill limits, pension reform, health cost containment).
  - Health spending declined from 6 ½ percent of GDP in 1991 to 5½ percent of GDP in 1999, aided by NHS salary controls, consolidation of LHAs, introduction of DRGs in 1994, and bed closures in 1996.

C. Norway
- Institutional structure and fiscal relations:
  - Four levels of government: central, regional, county, municipal.
  - Sub-national governments are under strict central control—administrative federalism; local and county governments are de facto central government agents.
  - Central government grants are a substantial part of sub-national revenue; local taxes highly regulated by center.
- Role of health sector:
  - Health sector accounted for almost 10 percent of GDP in 2009.
  - Before 2002, approximately 32 percent of sub-national spending was dedicated to health care.
  - Health spending broadly stable over 1990s at about 7 percent of GDP and increased by almost one percent of GDP in the 2000s.
- Evolution of decentralization and recentralization in health:
  - 1969: service delivery formally decentralized but tied to central planning and financing.
  - 1974: first wave of centralization with establishment of five geographical regions.
  - 1999: regional coordination of health plans made mandatory.
  - 2002: health services fully recentralized; central government took over public hospitals and specialist care; health regions became regional health enterprises (RHEs) purchasing care.
  - 2007: number of RHEs reduced from 5 to 4.
- Financing modalities and equalization:
  - Centralized financing used due to inadequate local tax bases; property taxes and user charges small shares of own expenditures.
  - 1980s: financed via central government retrospective reimbursements, later replaced with block grants.
  - 1997: activity-based financing introduced; block grant made proportional to number of hospital treatments.
  - Large equalization transfers address urban/rural income differences.
- VFI dynamics:
  - Increase in expenditure decentralization between 1996 and 1998 associated with decline in VFI due to sharp increase in share of sub-national revenues in total general government revenues (consequence of declining central government revenues in percent of GDP).
  - Re-centralization of health care in 2002 shrank VFI in following two years, but subsequent higher transfers and fiscal expansion resulted in VFI increasing thereafter.
  - Fiscal expansion during 2002–04 (accelerated use of oil resources, large public sector pay increases, increased hospital investments) coincided with recentralization and affected VFI.

D. Spain
- Institutional structure:
  - Four tiers of government: State, 17 Autonomous Communities (ACs), provinces, municipalities.
  - ACs established by the 1978 Constitution with asymmetry: foral regime for Basque Country and Navarre (large tax autonomy) and a “fast track”/“slow track” distinction for other regions.
  - Complete transfer of health and education services to “common” regime ACs achieved gradually by 2003.
- Decentralization and VFI evolution:
  - Decline in VFI achieved gradually via reforms in 1997 and 2002.
  - Spain experienced a large increase in own tax revenues as percent of total sub-national government revenues between 1995 and 2007.
  - Until 1996, ACs relied substantially on government grants or tax-sharing; own revenues accounted for up to 16 percent of general government receipts.
  - 1997 reforms: introduced tax “co-responsibility principle” allowing ACs to benefit from 30 percent of national income tax receipts and power to adjust tax rates and bases within limits; own revenue share in general government revenues increased to 19 percent; VFI shifted from 57 percent in 1996 to 49 percent in 1999.
  - 2002 reforms: broadened tax bases and regions’ discretionary power; ACs’ share of PIT increased to 33 percent; main consumption taxes included among shared taxes with margin to change rates; sub-national revenue shares rose to 13.2 percent of GDP in 2006; VFI declined to 30 percent of GDP.
  - End-2009: new financing system approved for common regime ACs transferred further resources and granted more discretionary powers on composition and volume of revenues.
- Transfer system adjustments:
  - Initially general-purpose grants; later modified to:
    - (i) a general grant (share of central government general revenues) for common services and education;
    - (ii) earmarked grants (e.g., for health and social services);
    - (iii) the Inter-Territorial Compensation Fund (ICF) for inter-regional differences and local capital expenditure.
  - 2002: regional health care financing consolidated within regional general revenue allocation system; earmarked grants replaced by a per capita equity targeting rule; transfer volume increased to match ACs’ actual spending.
- Fiscal outcomes and context:
  - Declining VFI coincided with improved fiscal performance between 1997 and 2007.
  - Improvements occurred against favorable economic backdrop: economic expansion beyond long-term potential, buoyant property-related revenues, and lower interest rates following EMU accession.
  - Transitory positive revenue surprises masked structural deficits.

### IV. Lessons from case studies — patterns, obstacles, and policy options
- General patterns:
  - Decentralization tends to be slow, incremental, and can experience setbacks.
  - Declining VFI is difficult because revenue devolution is sometimes resisted where spending responsibilities are decentralized.
- Obstacles to revenue devolution:
  - Loss of “cheap” resources: less populous and poorer local governments may resist revenue devolution fearing declines in equalization grants and higher disparities; some Spanish ACs initially opted out of financing agreements that altered revenue arrangements.
  - Inadequate tax base: broad-base taxes (PIT, CIT) may be less adequate for sub-national governments because of redistributive properties and mobility.
  - Weak administration: administrative capacity and data quality/accounting practices can impede greater revenue responsibilities (noted for Italy in the 1990s and beyond).
  - Tax competition: international trends toward lowering tax burdens and pressures to support economies during downturns, plus fiscal mobility, undermine incentives to raise sub-national taxes.
- Multispeed federalism as policy option:
  - Can address unequal regional preparedness for revenue devolution (developmental and administrative differences).
  - Examples:
    - Spain’s two decentralization “tracks” allowed faster expenditure autonomy for some regions; expenditure decentralization was matched by (incomplete) revenue devolution, widening the VFI.
    - Italy’s special statute regions experienced negative VFI early when revenue devolution exceeded expenditure responsibilities; Italy opened door to a two-speed revenue devolution process in 2001, not yet implemented.
  - Disadvantages: potential sacrifice of service uniformity, loss of reform momentum in lagging regions, increased complexity in transfer systems during transition.
- On eliminating VFI entirely:
  - Completely eliminating the VFI may not be possible or desirable because policymakers must balance sub-national accountability incentives against central government’s ability to insulate itself from bailout demands via controlled transfers.

### Measurement caveats and research directions
- The VFI here measures the actual mismatch between revenue and expenditure decentralization; cyclical developments and one-off events can drive wedges between actual and potential VFI.
- Future research could examine the impact of cyclical and one-off factors on historical VFI evolution during expansions and downturns.

*Source: IMF working paper chapter "1. Belgium: Decentralization, VFI, and Fiscal Balances, 1985–2009" and Sections II–IV from _wp1291 (provided PDF content).*

### 1. Belgium: Decentralization, VFI, and Fiscal Balances, 1985–2009 .......................................7

### 1. Belgium: Decentralization, VFI, and Fiscal Balances, 1985–2009

### Definition and conceptual framework
- Vertical fiscal imbalances (VFIs) occur when spending decentralization outpaces revenue decentralization.
- VFIs lead sub-national governments to rely on central government transfers and borrowing to finance expenditures.
- VFIs break the link between sub-national service provision and its financial consequences for the electorate, undermining sub-national accountability and promoting soft budget constraints.
- Recent econometric evidence (Eyraud and Lusinyan, 2011) confirms that increases in VFIs are associated with a weakening of general government fiscal balances.

### Why VFIs matter, especially in crisis
- VFIs receive heightened scrutiny during difficult times, particularly when deficits become chronic and frequent bailouts are necessary.
- Sub-national bailouts can strain intergovernmental fiscal relations and may prompt re-centralization to eliminate the VFI.
- Changes in relative fiscal positions—such as when central government revenues thrive while local revenues lag—also bring VFIs into focus.
- The ongoing financial crisis has exacerbated fiscal pressures at all levels of government, increasing the relevance of VFIs for policy design.

### Purpose and approach of the case studies
- The case studies identify periods of changes in intergovernmental relations that induced variations in the VFI.
- The approach complements cross-country econometric evidence (Eyraud and Lusinyan, 2011).
- For each country studied, the analysis examines:
  - decentralization policies that brought about declining VFIs, and
  - the economic environment and external factors that may have contributed to changes in fiscal balances.

### Country selection and scope
- Countries selected because they experienced a significant decline in VFI over the past two decades:
  - Belgium
  - Italy
  - Norway
  - Spain
- The paper covers multiple country case studies with time spans indicated in the table of contents (e.g., Belgium: 1985–2009).

### Structure of the paper
- The remainder of the paper is organized to describe the measure of VFI and present the country case studies and analysis.

*Source: IMF working paper chapter titled "1. Belgium: Decentralization, VFI, and Fiscal Balances, 1985–2009" from the provided PDF content.*

### Section III presents four case studies on Belgium, Italy, Norway, and Spain; and Section IV

### _wp1291 - Section III presents four case studies on Belgium, Italy, Norway, and Spain; and Section IV

### II. THE VERTICAL FISCAL IMBALANCES
- Definition and measurement
  - No consensus exists in the theoretical and empirical literature on the definition of the VFI.
  - Common empirical indicators link VFI to transfer dependency; transfers are reported as shares of sub-national spending, sub-national total revenues, or central government revenues in various studies.
  - The VFI used in this study is an expansion of the most commonly used indicator and is borrowed from Eyraud and Lusinyan (2011): VFI is defined as the share of sub-national own spending not financed through own revenues.
  - By definition, counterparts of VFI are sub-national borrowing and transfers received from other units of general government—both expressed as shares of sub-national own spending.
  - The indicator measures the mismatch between spending and revenue decentralizations that widens when countries devolve more spending than revenue.
- Formal relationships (as presented)
  - SNG spending can be financed from either SNG own revenue, transfers received by the SNG, or borrowing:
    - SNG spending = SNG own revenue + transfer received by SNG + SNG net borrowing
  - VFI (following Eyraud and Lusinyan, 2011) expressed conceptually as the share of SNG own spending not financed through own revenues (formula notation provided in the source).
- Drivers of VFI changes
  - Direct decentralization decisions (devolving spending and/or revenue).
  - Changes in sub-national fiscal policy (e.g., revenue effort weakening or spending increases).
  - Changes in intergovernmental relations that strengthen sub-national fiscal discipline (e.g., credible no-bailout policies induced by granting tax-setting powers).
- Limitations of the measure
  - Does not accurately capture expenditure- and revenue-raising “powers” of sub-national governments.
  - Possible overstatement of sub-national “discretion” when tax sharing is recorded as own taxes or when discretion over tax rates and bases is limited.
  - Spending may be regulated or earmarked so sub-nationals de facto act as de-concentrated agents of the central government (frequently in health care).
- Relation to general government fiscal performance
  - Sub-national deficits are part of the general government balance; changes in VFI partly attributable to sub-national deficit/surplus changes.
  - Fiscal balances at the general government level are correlated with the VFI, with potential two-way causality.
  - Addressing these causal links requires econometric frameworks; this paper uses case studies for in-depth institutional and economic context.

### III. CASE STUDIES

H3: A. Belgium
- Institutional structure
  - Three levels of government: federal government, the regions and communities, and the provinces and communes.
  - Three geographical regions (Flanders, Wallonia, Brussels-Capital) and three language communities (Flemish, French, German).
  - Regions and communities have their own governments and are not subordinated to the federal government in expenditure policy; federal government handles judiciary, foreign policy, defense, and social security.
- VFI magnitude and composition
  - The large VFI in Belgium, between 60 and 70 percent over the last two decades, stems from strong revenue centralization at the federal level.
  - Transfers comprise a limited number of grants.
  - Communities have no own taxes; financed mainly through general-purpose grants.
  - Regions enjoy taxing power and receive federal grants; nearly 80 percent of their funding consists of transfers, and only 20 percent from own taxes.
- Decentralization episodes and effects on VFI
  - 1980 Act of Regionalization:
    - Introduced limited devolution of revenue-raising powers; lowest impact on sub-national own revenue shares among the three main acts.
  - 1988–89 large-scale expenditure decentralization:
    - Communities took charge of education; regions entrusted with regional development and investment spending.
    - Introduced a tax-sharing system with “repartition keys”; own sub-national revenues rose but VFI increased as expenditure devolution outpaced revenue devolution.
  - 2001 Lambermont agreement / revenue devolution:
    - New taxes transferred to regions; shared PIT margin increased; VAT transfers to communities increased; revenue-sharing mechanism revised to dampen transfer volatility.
    - Increased share of sub-national own taxes, reducing the VFI.
- Fiscal and macro outcomes
  - With doubling of sub-national own expenditures in 1989, VFI widened by 15 percent; narrowed slightly over the next two decades.
  - After 2001 devolution, regional taxes increased by a couple of percentage points of GDP, lowering the VFI by a few percentage points.
  - By 2008, the VFI was still 59 percent.
  - Revenue devolution associated with improvement in fiscal outcomes: federal and sub-national fiscal positions improved in the 1990s and early 2000s, turning large deficits of the 1980s into a surplus in 2000.
  - Public debt declined from 130 percent of GDP in 1993 to 80 percent of GDP in 2007.
  - Federal government contributed most to consolidation via across-the-board expenditure restraint; regional tax revenue growth was strong but federal primary surplus improvement was larger.

H3: B. Italy
- Institutional structure
  - Three levels of sub-national government: regions, provinces, municipalities—no hierarchical links.
  - Decentralization is asymmetric: regions divided into “ordinary” and “special” statute; five special regions with extensive spending autonomy and central funding.
- VFI history and magnitudes
  - Sub-national own revenues were only 2 percent of GDP in 1980; VFI reached 80 percent.
  - Revenue from taxes of sub-national governments increased from 3½ percent in 1990 to 8½ percent of GDP in 2000.
  - VFI shrank from 75 percent to 40 percent between the early 1990s and 2000.
- Major institutional episodes
  - 1970s and 1980s:
    - Most health functions assigned to ordinary regions; massive tax reform centralized local taxing powers.
    - Forgone sub-national revenue replaced with earmarked transfers and tax sharing; sub-national spending exceeded own revenues and deficits were financed ex post by the central government.
  - 1990s reforms:
    - Further expenditure decentralization; new local taxes assigned with some latitude in setting tax rates.
    - Increase in block grants and some regional sharing of central government taxes and own taxes.
    - Electoral reforms (1993 municipal; 1999 regional) increased local accountability.
    - Revenue improvements associated with institutional reforms (e.g., municipal property tax in 1993; regional IRAP in 1998).
  - 2001 onward:
    - Constitutional changes toward greater decentralization and “asymmetric federalism.”
    - Executive power transferred to municipalities and provinces, with allowance for new taxes but central government transfers ruled out as ex post deficit financing.
    - Interregional redistribution fund introduced; sub-national borrowing allowed for investment.
    - Regions’ new tax legislative powers largely unrealized due to political obstacles; VFI stabilized around 2000 level.
- Sectoral decentralization
  - Health sector achieved highest degree of decentralization; social and health sectors account for 80 percent of regional spending.
  - Health care managed at regional level through Local Health Authorities (LHAs) to guarantee essential levels of treatment determined centrally.
- Fiscal outcomes
  - Decentralization reforms of the 1990s associated with improved fiscal balance.
  - General government primary balance swung into a surplus exceeding 4 percent of GDP between 1992 and 1995.
  - Consolidation driven by revenue measures (e.g., 1992 and 1997 tax measures) and expenditure containment (wage bill limits, pension reform, health cost containment).
  - Health spending declined from 6 ½ percent of GDP in 1991 to 5½ percent of GDP in 1999, aided by measures including NHS salary controls, consolidation of LHAs, introduction of DRGs in 1994, and bed closures in 1996.

H3: C. Norway
- Institutional structure and fiscal relations
  - Four levels of government: central, regional, county, municipal.
  - Sub-national governments are under strict central control—described as administrative federalism; local and county governments are de facto central government agents.
  - Central government grants are a substantial part of sub-national revenue; local taxes are highly regulated by the center.
- Role of health sector in VFI
  - Health sector accounted for almost 10 percent of GDP in 2009.
  - Before 2002, approximately 32 percent of sub-national spending was dedicated to health care.
  - Norway’s health spending is among the highest in OECD per capita terms.
  - Public spending on health was broadly stable over the 1990s at about 7 percent of GDP and increased by almost one percent of GDP in the 2000s.
- Evolution of decentralization and recentralization in health
  - 1969: service delivery formally decentralized but tied to central planning and financing.
  - 1974: first wave of centralization with establishment of five geographical regions for economies of scale.
  - 1999: regional coordination of health plans made mandatory.
  - 2002: health services fully recentralized; central government took over responsibility of public hospitals and specialist care; health regions became regional health enterprises (RHEs) purchasing care.
  - 2007: number of RHEs reduced from 5 to 4.
- Financing modalities and equalization
  - Centralized financing used due to inadequate local tax bases; property taxes and user charges small shares of own expenditures.
  - 1980s: financed via central government retrospective reimbursements, later replaced with block grants.
  - 1997: activity-based financing introduced; block grant made proportional to number of hospital treatments.
  - Large equalization transfers provided to address urban/rural income differences.
- VFI dynamics
  - Increase in expenditure decentralization between 1996 and 1998 associated with decline in VFI due to sharp increase in share of sub-national revenues in total general government revenues, consequence of declining central government revenues in percent of GDP.
  - Re-centralization of health care in 2002 shrank VFI in the following two years, but subsequent higher transfers and fiscal expansion resulted in VFI increasing thereafter.
  - Fiscal expansion during 2002–04 (accelerated use of oil resources, large public sector pay increases, increased hospital investments) coincided with recentralization and affected VFI.

H3: D. Spain
- Institutional structure
  - Four tiers of government: State, 17 Autonomous Communities (ACs), provinces, municipalities.
  - ACs established by the 1978 Constitution with two asymmetry tracks: the foral regime for Basque Country and Navarre (large tax autonomy) and a “fast track”/“slow track” distinction for other regions.
  - Complete transfer of health and education services to “common” regime ACs was achieved gradually by 2003.
- Decentralization and VFI evolution
  - Decline in VFI achieved gradually via reforms in 1997 and 2002.
  - Spain experienced a large increase in own tax revenues as percent of total sub-national government revenues between 1995 and 2007.
  - Until 1996, ACs relied substantially on government grants or tax-sharing; own revenues accounted for up to 16 percent of general government receipts.
  - 1997 reforms:
    - Introduced tax “co-responsibility principle” allowing ACs to benefit from 30 percent of national income tax receipts and power to adjust tax rates and tax bases within defined limits.
    - Own revenue share in general government revenues increased to 19 percent.
    - VFI shifted from 57 percent in 1996 to 49 percent in 1999, in line with increased devolution and declining sub-national deficits.
  - 2002 reforms:
    - Broadened tax bases and regions’ discretionary power to set rates; ACs’ share of PIT increased to 33 percent; main consumption taxes included among shared taxes with margin to change rates.
    - Sub-national revenue shares rose to 13.2 percent of GDP in 2006; VFI declined to 30 percent of GDP.
  - End-2009: new financing system approved for common regime ACs transferred further resources and granted more discretionary powers on composition and volume of revenues.
- Transfer system adjustments
  - Initially financed through general-purpose grants; later modified to:
    - (i) a general grant (share of central government general revenues) for common services and education;
    - (ii) earmarked grants (e.g., for health and social services); and
    - (iii) the Inter-Territorial Compensation Fund (ICF) for inter-regional differences and local capital expenditure.
  - 2002: regional health care financing consolidated within regional general revenue allocation system; earmarked grants replaced by a per capita equity targeting rule; transfer volume increased to match ACs’ actual spending.
- Fiscal outcomes and context
  - Declining VFI coincided with improved fiscal performance between 1997 and 2007.
  - Improvements occurred against favorable economic backdrop: economic expansion beyond long-term potential, buoyant property-related revenues, and lower interest rates following EMU accession.
  - Transitory positive revenue surprises masked structural deficits.

### IV. LESSONS FROM CASE STUDIES
- General patterns
  - Decentralization tends to be slow, incremental, and can experience setbacks.
  - Declining VFI is difficult because revenue devolution is sometimes resisted where spending responsibilities are decentralized.
- Obstacles to revenue devolution
  - Loss of “cheap” resources:
    - Less populous and poorer local governments may resist revenue devolution fearing declines in equalization grants and higher disparities; some Spanish ACs initially opted out of financing agreements that altered revenue arrangements.
  - Inadequate tax base:
    - Taxes with broad bases (PIT, CIT) may be less adequate for sub-national governments because of redistributive properties and mobility, limiting tax autonomy.
  - Weak administration:
    - Administrative capacity and data quality/accounting practices can impede greater revenue responsibilities (noted as an obstacle in Italy during the 1990s and beyond).
  - Tax competition:
    - International trends toward lowering tax burdens and pressures to support economies during downturns, plus fiscal mobility, undermine incentives to raise sub-national taxes.
- Multispeed federalism as a policy option
  - Can address unequal regional preparedness for revenue devolution (developmental and administrative differences).
  - Examples:
    - Spain’s 1978 Constitution introduced two decentralization “tracks,” allowing some regions faster expenditure autonomy; expenditure decentralization was matched by (incomplete) revenue devolution, widening the VFI.
    - Italy’s special statute regions experienced negative VFI early on when revenue devolution exceeded expenditure responsibilities; Italy opened the door to a two-speed revenue devolution process in 2001, not yet implemented.
  - Disadvantages of multispeed federalism:
    - Potential sacrifice of service uniformity.
    - Possible loss of reform momentum in lagging regions.
    - Increased complexity in transfer systems during transition.
- On eliminating VFI entirely
  - Completely eliminating the VFI may not be possible or desirable due to the need to balance autonomy that creates incentives for financial control and accountability against central government’s ability to insulate itself from bailout demands via controlled transfers.
- Measurement caveats and research directions
  - The VFI in this study measures actual mismatch between revenue and expenditure decentralization; cyclical developments and one-off events can drive wedges between actual and potential VFI.
  - Future research could examine the impact of cyclical and one-off factors on historical VFI evolution during expansions and downturns.

*Source: _wp1291 - Section III presents four case studies on Belgium, Italy, Norway, and Spain; and Section IV*

### References

### _wp1291 - References

### Fiscal decentralization, intergovernmental transfers, and fiscal federalism
- Ambrosanio, F., M. Bordignon, and F. Cerniglia, 2008, “Constitutional Reforms, Fiscal Decentralization and Regional Fiscal Flows in Italy,” Working Paper IEF0084 Università Cattolica del Sacro Cuore.
- Bahl, R., and S. Wallace, 2007, “Intergovernmental Transfers: The Vertical Sharing Dimension,” in Fiscal Equalization: Challenges in the Design of Intergovernmental Transfers, ed. by J. Martinez-Vazquez and B. Searle (New York: Springer).
- Bird, R., and A. Tarasov, 2004, “Closing the Gap: Fiscal Imbalances and Intergovernmental Transfers in Developed Federations,” Environment and Planning C: Government and Policy, 2004, Vol. 22, pp. 77–102.
- Blöchliger, H., and D. King, 2006, “Fiscal Autonomy of Sub-Central Governments,” OECD Working Paper No. 2. (Paris: Organization for Economic Co-operation and Development).
- Blöchliger, H. and O. Petzold, 2009, "Taxes or Grants: What Revenue Source for Sub-Central Governments?" OECD Economics Department Working Papers 706 (Paris: Organization for Economic Cooperation and Development).
- Bordignon, M., 2000, “Problems of Soft Budget Constraints in Intergovernmental Relationships: The Case of Italy,” IADB Research Network Working Paper #R-398.
- Eyraud, L., and L. Lusinyan, 2011, “Decentralizing Spending More than Revenue: Does It Hurt Fiscal Performance?” IMF Working Paper 11/226 (Washington: International Monetary Fund).
- Jin, J., and H.-F. Zou, 2001, “How Does Fiscal Decentralization Affect Aggregate, National, and Subnational Government Size?” Journal of Urban Economics, Vol. 52, pp. 270–93.
- Rodden, J., 2002, “The Dilemma of Fiscal Federalism: Grants and Fiscal Performance around the World,” American Journal of Political Science, Vol. 46, No. 3, pp. 670–87.
- Rattsø, J., 2003, “Vertical Fiscal Imbalance and Fiscal Behavior in a Welfare State: Norway” in Fiscal Decentralization and the Challenge of Soft Budget Constraint edited by J.A. Rodden, G.S. Eskeland, and J. Litvack, The MIT press.

### OECD and working-paper analyses of sub-central government finance
- Bach S.H.B., and D. Wallau, 2009, “The Spending Power of Sub-Central Governments: A Pilot Study,” OECD Economics Department Working Paper No. 705, ECO/WKP (2009) 46 (Paris: Organization for Economic Cooperation and Development).
- Blöchliger, H., and D. King, 2006, “Fiscal Autonomy of Sub-Central Governments,” OECD Working Paper No. 2. (Paris: Organization for Economic Co-operation and Development).
- Blöchliger, H. and O. Petzold, 2009, "Taxes or Grants: What Revenue Source for Sub-Central Governments?" OECD Economics Department Working Papers 706 (Paris: Organization for Economic Cooperation and Development).
- Charbit, C., “Explaining the Sub-national Tax-Grant Balance in OECD Countries,” WP (2009) 11, OECD, Paris, 2009.
- Leibfritz, W., 2009, “Fiscal Federalism in Belgium: Main Challenges and Considerations for Reform,” Economics Department Working Paper No. 473, OECD.
- Joumard, I., and C. Giorno, 2005, “Getting the Most Out of Public Sector Decentralization in Spain,” OECD, Economics Department Working Paper No. 436.

### Country case studies and national experiences (Italy, Spain, Belgium, Norway, Belgium)
- Balassone, F., and others, 2008, “Fiscal Consolidation in an Evolving Institutional Framework: the Italian Experience,” Servizio Studi, Ministero dell’Economia e delle Finanze.
- Bibbee, A., 2007, “Making Federalism Work in Italy,” OECD Economics Department Working Paper No. 590 (Paris: Organization for Economic Cooperation and Development).
- Bibbee, A., and F. Padrini, 2006, “Balancing Health Care Quality and Cost Containment: the Case of Norway,” Economics Department Working Paper No. 481(Paris: Organization for Economic Cooperation and Development).
- Bordignon, M., 2000, “Problems of Soft Budget Constraints in Intergovernmental Relationships: The Case of Italy,” IADB Research Network Working Paper #R-398.
- Buglione, E. and M. Maré, 2008, “The Taxing Powers of Sub-National Governments and the Role of Own Taxes in Italy: Issues and Perspective,” Presented at the OECD Conference on Financing Sub-Central Governments: Explaining the Balance Between Taxes and Grants.
- ———, 2010 “Tax Competition and Fiscal Federalism in Italy,” 2010, Presented at the OECD Conference on Tax Competition between Sub-Central Governments.
- Garcia-Mila, T., and T. McGuire, 2002, “Fiscal decentralization in Spain: An asymmetric transition to democracy,” Economics Working Paper 866, Department of Economics and Business, Universitat Pompeu Fabra, Barcelona.
- López, G., J. Costa-i-Font, and I. Planas, 2004, “Diversity and Regional Inequalities: Assessing the Outcomes of the Spanish System of Health Care Services,” Working Papers 745, Department of Economics and Business, Universitat Pompeu Fabra, Barcelona.
- Molero J.-C., 2001, “Analysis of the Decentralization of Public Spending in Spain,” Public Finance and Management, 1 (4), 500–56.
- Mora, T., 2009, “Spanish Regional Public Budget Reactions to Revenue Gains: the Dependence on the Transfer System,” Urban Public Economics Review, Núm. 10, 2009, pp. 73–91 Universidad de Santiago de Compostela España.
- Miaja, M., 2005, “Fiscal Discipline in a Decentralised Administration: The Spanish Experience,” OECD Journal on Budgeting, Vol. 5, No. 2.
- Piperno, S., 2000, “Fiscal Decentralization in Italy: Some Lessons”, draft presentation at IMF Conference on Fiscal Decentralization.
- Vinuela, J., 2001, “Fiscal Decentralization in Spain,” draft presentation at IMF Conference on Fiscal Decentralization.
- Verdonck, M., P., Cattoir, and K., Algoed, 2009, “Assessment of the Belgian Fiscal Equalization Mechanism and Proposals for Reform,” Actes du Congrès des économistes belges de langue française, CIFoP, Charleroi.
- International Monetary Fund, 2003, Belgium: Selected Issues Paper, IMF Country Report No. 03/50 (Washington).

### Health care decentralization, cost containment, and policy reform
- Bibbee, A., and F. Padrini, 2006, “Balancing Health Care Quality and Cost Containment: the Case of Norway,” Economics Department Working Paper No. 481(Paris: Organization for Economic Cooperation and Development).
- Fattore, G., 1999, “Cost Containment and Reforms in the Italian National Health Service,” in Health Care and Cost Containment in the European Union, ed. by E. Mossialos and J. Le Grand, pp. 733–81.
- Magnussen, J. T., P. Hagen, and O. Kaarboe, 2007, “Centralized or Decentralized: A Case Study of Norwegian Hospital Reform,” Social Science and Medicine, 2129–37.
- Minas, R., 2010, “(Re)centralizing Tendencies Within Health Care Services,” Institute for Futures Studies 2-10:9, Stockholm.
- Saltman, R., 2008, “Decentralization, Re-centralization and Future European Health Policy,” European Journal of Public Health, Vol. 18, No. 2, 104–6.
- International Monetary Fund, 2010b, “Macro-fiscal Implications of Health Care Reform in Advanced and Emerging Economies,” Available at: http://www.imf.org/external/np/pp/eng/2010/122810.pdf.

### Governance, political economy, and institutional perspectives
- Fiorino, N., and R. Ricciuti, 2007, “Legislature Size and Government Spending in Italian Regions: Forecasting the Effects of a Reform,” Public Choice, Vol.131, pp 117–25.
- Borge, L.-E., 2006, “Centralized or Decentralized Financing of Local Governments? Consequences for Efficiency and Inequality of Service Provision,” Working Paper No. 14/2006, Department of Economics, Norwegian University of Science and Technology.
- Garcia-Mila, T., and T. McGuire, 2002, “Fiscal decentralization in Spain: An asymmetric transition to democracy,” Economics Working Paper 866, Department of Economics and Business, Universitat Pompeu Fabra, Barcelona.
- Mora, T., 2009, “Spanish Regional Public Budget Reactions to Revenue Gains: the Dependence on the Transfer System,” Urban Public Economics Review, Núm. 10, 2009, pp. 73–91 Universidad de Santiago de Compostela España.

*Source: _wp1291 - References (PDF).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2012/_wp1291.pdf_