Maintaining taxes at the centre despite decentralization: interactions with national reforms

Although fiscal (de)centralization literature explains easily the centralization of taxes on the basis of a superior tax administration capacity, it finds more difficult to argue why in federal and decentralized systems subnational governments are ready to accept the demise of their taxing powers. This paper aims to contribute to the debate by analyzing the conditions under in which sub-national governments are willing to cede their taxing power to a central authority. A simple bargaining model is used to illustrate the choices available to both the central (federal) government and the sub-national governments (regions), where the main contribution lies in the introduction of the expenditure side of the budget and of its relevance for solving the commitment issue. We conclude that tax centralization will take place – transfers will prevail over sub-national taxes – if substantial efficiency gains from the centralized administration of taxes are expected. To support this conclusion, the paper presents evidence from decentralization processes in Argentina, Canada and Italy.