Decentralization and Social Equity- I

Qiao, Martínez-Vázquez and Xuo (QMX) analyze the already classic discussion of the relationship between economic growth and social equity in their paper[1] through the perspective of decentralization. The writers argue that a certain level of fiscal decentralization leads to higher economic growth, but less social equity. They base their argument on studying the impact of decentralization on the geographical distribution of economic resources (as an element of equity), being its research’s cornerstone “the tradeoff between growth and equity in the context of China’s fiscal decentralization policy.” In this and a forthcoming post, I debate QMX’s argument by stating that fiscal decentralization is not necessarily a condition for social equity. I centered my analysis on the Mexican case, in general, and in Los Cabos, a municipality located in the southern State of Baja California Sur, in specific. As an example of a Sub-National Government, that has experienced a significant economic growth in the last ten years, but also increasing examples of social inequity[2] despite the traditionally centralized Mexican fiscal system.

As many developing countries around the world, Mexico is characterized by strong regional disparities. While the Federal District, the State of Mexico and the state of Nuevo Leon produce about 40 percent of total GDP (their average GDP per capita is around 10,000 USD a year), the most poor states: Chiapas, Guerrero, Hidalgo and Oaxaca account for only 7 percent of total GDP (with an average of 3,000 USD of GDP per capita) (INEGI, 2006; the World Bank, 2005). A system formally established based on three levels of government: federal, state, and municipal, the political and fiscal control have remained highly centralized.

Marina Los Cabos, Baja California Sur, Mexico

Marina Los Cabos, Baja California Sur, Mexico

Las Palmas, Los Cabos San Lucas, 10 kms from the resort area

Las Palmas, Los Cabos San Lucas, 10 kms from the resort area

The federal government has performed a central role in the modernization of the country, a fact that, for many years, pressured the balance of power between that administrative level and the Sub-National Governments (SNGs) in favor of the former. In addition to this, two elements increased the degree of centralization: a) The impact of diverse economic crisis that affected the ability of the local governments to fulfill the requirements in terms of social policy, and b) the import-substitution/industrialization strategy followed by Mexico for nearly forty years[3]. On the other hand, various fiscal agreements between the federal and the state governments gradually limited SNGs to only two main sources of tax revenue[4]: a turnover sales tax for states and a property tax for municipalities. Those sources of income have proved to be insufficient to cover for many of the necessary local public goods. In the case of some states, the situation has fostered an issue by which the central government ended up being rich while SNGs remained poor.

Regarding the resources allocation process, the method applied to transfer resources to the SNGs has been subjected to intense debate. Until the 80’s, federal government discretion largely determined the assignment of transfers. As a result, state governors and finance ministers spent an important part of their time lobbying the federal government in order to obtain resources. In 1980, after partially successful efforts of tax coordination, a revenue-sharing system, the National System of Fiscal Coordination (NSFC), was created. With the NSFC[5], states share the revenues coming from the federal government (main taxes). The system has undergone different changes[6], mostly in the percentage of state participation, but funds have always been distributed to the states and municipalities through a formula, which some analysts have defined as limited and biased[7].

The QMX Theory in the Mexican Case

Different from the Chinese case[8], Mexico has been ineffective to achieve a real fiscal decentralization. In 1995, the Mexican government implemented a partial decentralization process by which the number of shared responsibilities (financed by the federal government but provided by SNGs) has increased. This process started with shared responsibilities in education, and was extended to areas such as agriculture, health, security, and social development. As a result, in 1999, out of each peso of the federal government budget, nearly 31 cents were spent by the SNGs. However, they only had decision on how to spend on less than 50% of that amount. This situation, that remains nowadays, has imposed rigidity in SNGs finances as, on average, more than 55% of total revenues are devoted to current expenditures. For example, Los Cabos, one of the SNG with the highest contribution to the  Mexican national income, obtain only 12 cents from each Peso that the municipality provides to the federation.

[1] The Tradeoff between Growth and Equity in Decentralization Policy: China’s Experience (2006).

[2] I.E. unequal access to services and infrastructure, rising gap between high-end and lower income levels, and overall lack of an homogeneous access to opportunities of development)

[3] This strategy of development required huge amounts of public investment to support productive capacity.

[4] The federal government collects the main taxes: the value-added, corporate, and personal income taxes, which generate more than 70 percent of total tax revenue. The main direct sources of revenues of the lower levels of government are property taxes, payroll taxes and fees, and represent less than 4 percent of total tax revenues.

[5] The NFCS’ main goal is to harmonize the Mexican tax system and to avoid differences in levels of taxation, which could affect productive activities.

[6] Initially 18.7 percent of total tax income was redistributed among the states; this percentage was increased in 1995 to 20.5 percent because of the decentralization process initiated in Mexico that year.

[7] Arellano (1994) and Hernández (1999) point out the following: a) it supposes homogeneity in regions and thus homogeneity in the costs of public services; b) the part of the formula that rewards the positive changes in tax collection does not include all taxes and does not include potential total tax collection; this element favors rich states because they have a broader tax base; c) future collection is very sensitive to the base year; and d) there is asymmetric information in terms of the effort a state makes.

[8]“ The two rounds of reforms significantly changed China’s fiscal landscape including the relationship between central and local governments and the relationship between the public sector and non-public sector. The most salient features of this process of change include the following:

(i) A significant level of resources shifted from the government to non-government sectors during the reforms (see Figure 1). The overall budgetary revenue in GDP decreased from 22.9% in 1985 to 12.4% in 1998, and the overall budgetary expenditure in GDP decreased from 22.4% in 1985 to 13.6% in 1998. The impact of the TSS reform was more strongly felt after 1998; by 2002, the share of budgetary revenues had increased to 22% of GDP, with the central government taking some 60 percent of the revenues

(ii) More resources shifted from the central government to local governments (see Figure 1). The share of local government budgetary expenditure in total government budgetary expenditures increased from 60.3% in 1985 to 71.1% in 1998. Note that after 1996, the share of local government expenditures decreased over time but only slightly.

(iii) More resources at the subnational level shifted from the budget to extra-budgetary funds (see Figure 1). The ratio of extra-budgetary expenditure to budgetary expenditure of local governments kept increasing with only the exception of 1998.” (QMX, 2006)


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