Toward a More General Theory of Revenue Assignments

Abstract

Despite the extensive international experience with the assignments of revenue sources to different levels of government, the public finance literature still lacks a general theory of revenue assignments. Two sets of arguments have been separately developed in the literature to explain and guide the practice of revenue assignments. The first is based on Musgrave and Oates’ tradition, and emphasizes the benefit principle and other means for increasing accountability and efficiency in the allocation of public expenditures. The second is based on optimal taxation principles, which emphasizes the marginal cost of public funds and the correct mix of revenue instruments. The two approaches provide important insights to the problem, but they remain practically unconnected. This paper develops a theory of revenue assignments that integrates the two approaches. We discuss the validity and scope of currently applied revenue assignment rules, and provide practical recommendations to implement an optimal assignment of revenue sources.

Keywords: revenue assignments, fiscal federalism, optimal taxation, marginal costs of funds, public expenditures

JEL Classification: H21, H40, H71