Financing local governments: Determinants and effects of taxes and grants

Taxes and grants are the most important sources of financing for local governments all over the world. The purpose of the project is to investigate economic and political implications of taxes and grants using Norwegian data. The project has focused on property tax, vertical fiscal imbalances, central government reforms and the wage level for Chief Municipal Officers (CMOs). The purpose has been to identify causal effects using different econometric methods. In Norway, the property tax is controversial and unpopular. A main reason for this is that the property tax is regressive, which means that payment of property tax as share of household income is decreasing in income. This is confirmed by one of the papers in the project. Even if the property tax makes up a higher share of income in low-income households, high-income households have more valuable residences and must pay a higher amount. In a related paper we investigate whether the level of property tax is affected by income inequality or housing wealth inequality. The main result is that the property tax is unaffected by income inequality. On the other hand, we find that housing wealth inequality increases the property tax. Our interpretation of this finding is that the property tax to some extent is redistributive. Norwegian municipalities can have a basic deduction in the property tax. This feature makes the property tax more redistributive. The project has investigated how the party composition in the municipal council affects the basic deduction and the level of the property tax. The results support the hypothesis that the most left-wing parties prefer a high property tax, but somewhat surprisingly we do not find that the same parties use the basic deduction as a mean equalize income among households. A revenue composition where central government grants make up a large share of total revenues is labeled as vertical fiscal imbalance (VFI). In the international literature there is a concern that VFI leads to deficits and low efficiency. One of the articles utilizes a natural experiment where the aggregate tax share (inversely related to VFI) first was increased and then reduced. We find that a higher tax share contributes to increased efficiency, but we are unable to detect the underlying mechanisms. A series of papers in the project study how the municipalities respond to central government grants and reforms. Grants and reforms are motivated by a desire to transfers resources to particular areas of the country or to promote services that are highly valued by the central government. One of the papers analyzes the implications for employment in the public and private sector of increased central government grants. A key finding in the paper is that more grants from the central government work to increase public sector at the expense of private sector employment, a kind of “local Dutch disease”. The project also compares the equalization systems in the Nordic countries. The Action Plan for the Elderly (APE) provided matching grants to nursing homes and specially adapted dwellings. The project studies how APE affected the budget deficit and services for the young (childcare and education). We find that increased utilization of APE increases the budget deficit and leads to lower priority of services for the young. The childcare reform was associated with central government transfers to achieve full coverage. We find that increased childcare coverage increases property values, an example of capitalization of services into housing values. The project also has studied how expectations of future municipal mergers have affected the municipalities’ dispositions prior to the merger. We find that if local policy makers think that a future merger is more likely, they respond by running down funds and increasing investments. Two articles analyze labor market outcomes for CMOs and politicians' attitude to school reform. The first paper analyzes the impact of operating surplus and respectively wages and turnover among Norwegian CMOs. The results show that CMOs earn higher wages and experience lower turnover when the net operating surplus increases. However, the impact on the wage is quite low, consistent with the hypothesis that public sector incentives should be low powered. The other article studies a policy experiment where council members receive different information about student performance. The main finding is that school performance has strong effect on governance-related reforms, but only weak effects on resource-related reforms.

Prosjektet har og kan ha virkninger og effekter for forskningsfeltet og for beslutningstakere. For forskningsfeltet: - Ny innsikt gjennom å utføre empiriske analyser på norske data - Kan på sikt bidra til mer internasjonalt samarbeid For beslutningstakere: - Ny kunnskap om eiendomsskattens fordelingsegenskaper - Fordelingen av boligformue, men ikke inntektsfordelingen, har betydning for nivået på eiendomsskatten - Ny innsikt om betydningen av skattefinansiering for effektivitet - Statlige overføringer og reformer kan ha utilsiktede effekter - Moderate effekter av økt netto driftsresultat på lønn til kommunedirektører - Informasjon om elevprestasjoner påvirker lokalpolitikernes syn på skolereformer

The research project addresses key elements of the Norwegian system of financing that are of great importance for performance, resource use, and the workings of local democracy. These are (i) vertical fiscal imbalance (tax financing), (ii) property tax and capitalization of taxes and services, (iii) grant financing, and (iv) political effects of the system of financing. Fiscal decentralization is typically asymmetric, with stronger decentralization of spending responsibilities than financing. There is a concern that vertical fiscal imbalance reduces local accountability and creates a soft budget constraint problem. In part 1 of the project we utilize variation in the degree of tax financing (vertical fiscal balance) across Norwegian local governments and over time in order to investigate the empirical relevance of these concerns. In Norway local tax discretion is in practice limited to the municipal property tax. The property tax is controversial and receives much attention in the local political debate. In part 2 of the project we will investigate economic and political determinants of property tax, and also analyze to what extent property tax and services are capitalized into housing values. Grant financing is in place to promote fiscal equalization and to stimulate the supply of particular services. In part 3 of the project we will evaluate whether reforms in the fiscal equalization scheme since 1986 have contributed to increased or reduced variation in the provision of welfare services. In addition we will investigate unintended consequences of earmarked grants related to the plan of action for the elderly and the child care reform. The system of financing has implications for fiscal autonomy, accountability, and the working of local democracy. These links addressed in part 4 where we investigate whether voter participation and recruitment of political candidates are affected by vertical fiscal imbalance and the use of the property tax.