How Developed Countries Approach Fiscal Decentralisation: Key Models and Lessons

When we talk about making local governments more effective, one crucial conversation centers on how they fund their activities. Around the world, developed countries have experimented with different approaches to fiscal decentralization-the process of transferring financial powers and responsibilities from central to local governments. From the flexible federalism of the United States to the property-based systems in Canada and the UK, and even Hungary’s innovative budgeting reforms, these models offer valuable insights into building responsive, accountable local governance systems.

The United States: A flexible approach to fiscal federalism 🔗

The American system represents one of the most flexible models of fiscal decentralization globally. At its core, fiscal federalism in the United States operates on the principle that different levels of government should have independent taxing powers suited to their responsibilities.

What makes the U.S. model distinctive is its diversity of revenue sources at the local level. Property taxes have historically provided almost all local tax revenue, giving municipalities a stable funding base. However, local governments don’t stop there. Many American cities and counties supplement property taxes with local income taxes, sales taxes, and user fees for specific services like water, sewage, and parking.

Consider a typical American city like Columbus, Ohio. Residents pay property taxes to fund schools and local infrastructure, a municipal income tax that supports city services, and various user fees when they visit public pools or parking facilities. This multi-layered approach gives local governments flexibility to respond to community needs without constantly seeking approval from state or federal authorities.

How the system balances flexibility with support 🔗

The American model isn’t purely decentralized. The federal government plays a crucial role through grants and transfers, especially during economic crises. During the COVID-19 pandemic, the federal government provided approximately 900 billion dollars in additional grants to state and local governments, demonstrating how fiscal federalism can provide both autonomy and a safety net.

This flexibility comes with trade-offs. While local governments can tailor their tax structures to community preferences, this can create significant disparities. Wealthier communities with strong property tax bases can fund excellent schools and services, while less affluent areas may struggle even with higher tax rates. This has sparked ongoing debates about equity and the appropriate balance between local control and national standards.

Canada and the United Kingdom: Property taxes as the cornerstone 🔗

Both Canada and the United Kingdom have built their local government finance systems primarily around property taxation, though with notably different structures and challenges.

Canada’s municipal property tax system 🔗

In Canada, property taxes serve as the principal source of revenue for municipalities, accounting for about ten percent of total taxation in the country. The system works through an annual assessment process where municipalities determine the value of properties within their boundaries and apply a tax rate to generate required revenues.

What’s interesting about the Canadian approach is its relative simplicity combined with significant provincial variations. A homeowner in Vancouver might pay a much lower tax rate than someone in Charlottetown, Prince Edward Island, reflecting different local needs, property values, and fiscal capacities. The property tax typically includes both a municipal portion and an education component, ensuring that schools receive stable funding alongside other local services.

However, Canada faces challenges with this model. Canadian municipalities have some of the highest property tax rates in the world compared to OECD countries, partly because they have limited access to other revenue sources like income or sales taxes. This heavy reliance on property taxes can burden middle and lower-income households disproportionately, as they pay a larger share of their income in property taxes compared to wealthier residents.

The United Kingdom’s council tax system 🔗

The UK takes a different approach with its council tax, introduced in 1993 as a tax on domestic property that replaced the controversial poll tax. Properties are assigned to bands based on their value, with eight bands in England and Scotland (A through H) and nine in Wales (A through I).

The council tax system includes an interesting hybrid element-it’s partly a property tax and partly a personal tax. A household with two or more adults pays the full amount, while single-person households receive a discount. This recognizes that service costs don’t scale perfectly with property values but also considers occupancy.

The system has proven remarkably efficient, with collection rates around ninety-seven percent. However, it faces criticism for being regressive at higher property values. Because there’s no upper limit for the highest band, someone living in a multimillion-pound mansion might pay only three times what someone in a modest flat pays, despite the enormous difference in property values.

Hungary’s programme budgeting: Modernizing municipal finance 🔗

While the United States, Canada, and UK represent established democratic systems with mature fiscal frameworks, Hungary offers an example of how countries in transition can modernize their approach to municipal finance through programme budgeting and enhanced transparency.

Shifting toward accountability and citizen participation 🔗

Hungary has undertaken significant reforms in its municipal finance system over the past two decades. The country modernized its budget process first as part of pre-accession preparations for joining the European Union and then continued reforms post-accession to improve fiscal consolidation and transparency.

One innovative approach has been the introduction of programme budgeting, which shifts focus from simply tracking inputs and expenses to measuring outcomes and performance. Rather than just reporting how much was spent on various line items, programme budgeting requires municipalities to articulate what they aim to achieve and how resources contribute to those goals.

Consider a practical example: Instead of merely budgeting for “social services,” a Hungarian municipality using programme budgeting would break this down into specific programmes-elderly care, youth support, disability services-with clear objectives, performance metrics, and citizen engagement mechanisms. Budapest’s District XIV (Zugló) pioneered an interactive municipal budget website that presents budget information in accessible formats, allowing citizens to understand where their money goes and participate in budget decisions.

Participatory budgeting in practice 🔗

Hungary’s reforms have increasingly incorporated participatory elements. Through participatory budgeting initiatives, residents don’t just receive information about budgets-they actively shape spending priorities. In one Budapest district, citizens co-developed eight projects with municipal experts, then voted to allocate sixty-five thousand euros among them, with the top projects receiving funding.

This approach serves multiple purposes. It increases transparency and accountability, as politicians must explain budget choices in terms citizens understand. It builds trust between residents and local government. And it channels local knowledge into decision-making, potentially leading to more effective use of limited resources.

Lessons from different approaches 🔗

Each of these models offers distinct advantages. The United States demonstrates how revenue diversity can provide fiscal flexibility and responsiveness to local preferences. Canada and the UK show that property-based systems can deliver administrative simplicity and high collection rates, though they must address equity concerns. Hungary illustrates how newer democracies can modernize municipal finance through programme budgeting and meaningful citizen participation.

The common thread across successful fiscal decentralization models is balance-between local autonomy and central support, between diverse revenue sources and administrative simplicity, between flexibility and equity. No single model fits all contexts, but understanding these different approaches helps policymakers design systems suited to their own circumstances while learning from others’ experiences.

What do you think? How would you balance the need for local autonomy in fiscal decisions with ensuring that all communities, regardless of their wealth, can provide adequate services to residents? What revenue sources make the most sense for local governments in your context?

References

1. https://federalism.org/encyclopedia/no-topic/fiscal-federalism/
2. https://www.gao.gov/products/117388
3. https://pmc.ncbi.nlm.nih.gov/articles/PMC8344450/
4. https://www.nerdwallet.com/ca/p/article/mortgages/what-is-property-tax
5. https://cupe.ca/fair-taxes-and-municipal-revenues
6. https://en.wikipedia.org/wiki/Council_Tax
7. https://www.researchgate.net/publication/227461772_Budgeting_in_Hungary
8. https://www.interregeurope.eu/good-practices/interactive-municipal-budget