Reflections on Emerging Roles of Intergovernmental Fiscal Transfers: From Financing to Accountability in Decentralized Subnational Governance, Preserving the Environment and Responding to Fiscal Shocks

We review the types of federal-state transfers used in federations in OECD and developing economies and outline their purposes. We discuss economic principles and better practices in the design of transfers, and we summarize the ways in which actual transfers deviate from better practices. We offer some examples of innovative, yet simple and pragmatic, ways of designing equalizing transfers. Traditionally, federal transfers have been used to facilitate decentralized governance by financing decentralized expenditures and dealing with regional fiscal disparities. While the traditional focus remains pre-eminent, emerging newer roles for these transfers include citizen-based accountability for results, protecting the environment, preserving biodiversity, promoting nature conservation, coping with climate change, natural disasters and calamities, and responding to fiscal shocks. We reflect upon relevant economic principles and design considerations for fiscal transfers to support these roles. We emphasize political decision-making as an important constraint on transfer design and highlight how design and practice can be compromised by political considerations. Finally, we identify future challenges likely to face the design of federal-state transfers. We emphasize that federations are very diverse in their level of development, their heterogeneity, their degree of decentralization and their social and political norms. No one transfer design fits all. Nonetheless, the basic function of federal-state transfers as instruments for creating incentive structures that facilitate efficient and equitable decentralized provision of public services, strengthen government accountability, preserve and protect the environment and overcome the adverse impact of fiscal shocks, apply universally and informs the effective design of transfers.