An approach to metropolitan governance and finance

` International competition is increasingly between cities, not countries.''Bennett (1997)

Innovation is the key to prosperity, and most innovation occurs in large cities. Theconcentration of people and firms increases social and economic interaction andresults in greater exchange of ideas among people working in different fields in thesame location. Large metropolitan areas can achieve the critical mass required to attractand support high degrees of specialization in labour, knowledge, businesses, services,infrastructure, institutions, and media. To be globally competitive, cities need to providea wide range of services: transportation, water, sewers, garbage collection and disposal,police and fire protection, parks, recreation and culture, affordable housing, and socialassistance. Cities must also provide services to attract and retain highly trained humancapital. The `knowledge workers' who increasingly hold the key to economic successare attracted by such quality of life factors as diversity, tolerance, a lively arts scene,recreational opportunities, high-quality public schools, strong neighbourhoods, and safetyfrom crime (Florida, 2002).

Local governance and finance are critical in shaping the physical and socialcharacter of city-regions. The quality and nature of these institutions affect both thequantity and the quality of local public services and the efficiency with which they aredelivered (Slack et al, 2003). In this paper we review several `models' of governingstructure found in metropolitan areas around the world, from a fiscal perspective.The fiscal perspective is important. Money matters: who has it, where it comes from,and under what conditions it can be spent, and by whom. How public expenditures arefinanced is always a key issue in any city or metropolitan area strategy (World Bank,2002). In particular, experience demonstrates that the ability to self-financeöthat is, tobe free of the whims and wishes of othersöis a critical factor in determining whichmetropolitan institutions live and thrive and which fade away or die in bickeringbetween contending financial supporters.(1)

An approach to metropolitan governance and finance

Richard M Bird, Enid SlackInstitute on Municipal Finance and Governance, Munk Centre for International Studies,University of Toronto, 1 Devonshire Place, Toronto, ON M5S 3K7, Canada;e-mail: [email protected] 6 March 2006; in revised form 17 July 2006

Environment and Planning C: Government and Policy 2007, volume 25, pages 729 ^ 755

Abstract. In this paper we review several `models' of governing structure found in metropolitan areasaround the world from a fiscal perspective. We evaluate how different models achieve coordination ofservice delivery over the entire metropolitan area, the extent to which they allow for the equitablesharing of costs of services throughout the metropolitan area, and their ability to reduce negative orpositive spillovers of service delivery across local boundaries. We then consider the advantages anddisadvantages of different revenue-raising tools for metropolitan areas. We conclude by making a fewsuggestions with respect to metropolitan fiscal and governance developments in Latin America.

DOI:10.1068/c0623

(1) For example, as Davis and Raich (2003) show with respect to various attempts made over theyears to `institutionalize' some metropolitan structures in the Mexico City region, the only one thathad even limited success was the only one that gave the region any real control over its own finances.

An extraordinary variety of metropolitan governance institutions exist around theworld, reflecting both the complexity and the context specificity of the issues to beresolved (Divay and Wolfe, 2002). We focus here on four `models' of governmentstructure: one-tier, two-tier, voluntary cooperation, and special districts. Employingthe traditional binocular vision of economistsöfocusing on efficiency and equityöweevaluate how these different models achieve coordination of service delivery over theentire metropolitan area, the extent to which they allow for the equitable sharing ofcosts of services throughout the metropolitan area, and their ability to reduce spilloversof service delivery across local boundaries. Against this background, we then considerthe advantages and disadvantages of different revenue-raising tools for metropolitanareas. We conclude with a few preliminary remarks on the implications of our analysisfor metropolitan regions in Latin America.(2)

Four `models' of metropolitan governanceSome criteria that might be used to evaluate models of metropolitan governance from afiscal perspective suggest that a fragmented system of small government units may beappropriate. Others suggest that large, consolidated government units would work best.No `one size fits all' model emerges from this discussion. As is often the case withinstitutional design, while the questions to be dealt with seem universal, the answers areinvariably highly context specific and policy choices are seldom clear-cut (Stren andCameron, 2005).

The `subsidiarity principle', for example, suggests that the efficient provision ofservices requires decision making to be carried out by the level of government that isclosest to the individual citizen.(3) When this is done, it is argued, resources will beallocated with the greatest efficiency, accountability, and responsiveness.When there arelocal differences in tastes and costs, there are clear efficiency gains to be made bydelivering services in as decentralized a fashion as possible. Smaller, fragmentedgovernment units should also, in principle, stimulate competition between local juris-dictions which will induce them to offer the best possible mix of taxes and services(Klink, 2005).(4) Access and accountabilityöboth of which depend to a considerabledegree upon the extent to which citizens have access to local government through publicmeetings, hearings, elections, and direct contacts with officialsöare also likely easier toachieve when local government units are smaller and more fragmented (Faguet, 2004).(5)

(2) Our original motivation in considering this subject was as part of a broader study of fiscal andgovernance developments in Latin American metropolitan regions. Despite the obvious impor-tance of this subject, there has been no recent attempt to analyze urban finance in Latin Americasince the in-depth World Bank studies of the early 1970s (Bahl and Linn, 1992). The governmentalinstitutions whose taxing, spending, and borrowing are recorded in Latin America almost nevermap neatly into the economically relevant metropolitan area (Rodriguez-Acosta and Rosenbaum,2005). A few studies of metropolitan finances exist (Linder, 2004; Raich, 2006) but much morefieldwork has to be done before anyone can confidently prescribe what should be done in anyparticular country or how it might best be done. In this paper we therefore focus essentially onoutlining the issues that need to be examined in such studies rather than summarizing a body ofexisting work. While some interesting work has been done on fiscal decentralization in LatinAmerica (for example, Campbell, 2003; Faguet, 2004) only the few studies we cite in this paperdeal specifically with metropolitan area finance.(3) The subsidarity principle included in the Treaty of the European Union in 1992 in the context of thedivision of powers and responsibilities between European governmental bodies and their membercountries has been applied to the role and structure of government at all levels (Barnett, 1997).(4) Such competition is especially important with respect to the adaptability' that Bennett (1997)properly identifies as one of the most critical aspects of effective local governance in a global economy.(5) This point is obviously related to the issue of the `democratic deficit' raised (in the context ofinternational organizations) by Keohane and Nye (2001), for example.

730 R M Bird, E Slack

On the other hand, a larger consolidated government structure may be able to takeadvantage of economies of scale in service provision and thus reap lower per unit costsas the amount of the service they deliver increases.(6) The existence of externalities(interjurisdictional spillovers) also suggests that a larger government jurisdiction maybe needed to ensure that all benefits of a particular public service are enjoyed withinthe boundaries of that jurisdiction. A larger government jurisdiction may also help allcommunities with a small tax baseöwhether their needs are large or smallöprovidean adequate level of service. In economic (and fiscal) terms, the choice of an appro-priate governance structure for a metropolitan area depends upon how one weighsthese conflicting considerations.

One-tier modelUnder the one-tier model a single local government is responsible for providing thefull range of local services. The one-tier model can take two distinct forms: a seriesof small fragmented municipalities in a metropolitan area; or one large consolidatedmunicipality for the whole area.

Fragmented one-tier governments are common in the United States. Houston,Texas, for example, has been described as a model of ` fragmented single tiers'' (Savitchand Kantor, 2002, page 69). Houston is a city surrounded by 790 governments andspecial districts. These jurisdictions frequently overlap and compete for industry. Thestate of Texas permits cities to annex unincorporated areas, and Houston has over timetaken advantage of this legislation to blunt some of the competition. The city nowcovers over 600 square miles. Klink (2005) characterizes metropolitan institutions inthe US generally as spatially limited networks of general purpose government, specialpurpose bodies, and sectoral institutional structures.(7) Orfield (1997) similarly stressesthat US local governments are characterized by fragmentation, decentralization, andincome polarization.

Large, consolidated, single-tier governments have generally been formed either byamalgamation (the merger of two or more lower tier municipalities within an existingregion) or annexation (the appropriation of a portion of a municipality by an adjacentmunicipality). In 1998, the former two-tier structure in Toronto, Canada, was changedto a one-tier model by provincial legislation. In a one-tier structure, one political bodymakes metropolitan taxing and spending decisions. Services need not be provideduniformly throughout the metropolitan area. Particularly when a one-tier municipalityis created by amalgamating municipalities, differential services and service levels thatexisted in different parts of the city-region prior to the creation of the single tiersometimes persist under the unified government. For example, rural residents do notnecessarily receive all of the services available to urban residents. Of course, if onereason for amalgamation is to create a jurisdiction encompassing the entire city-region,presumably such differences in service delivery and tax rates should not be maintainedbeyond a short transition period.

Consolidated one-tier governments were strongly favoured in the seminal study byBahl and Linn (1992) as providing better service coordination, clearer accountability,more streamlined decision making, and greater efficiency. The larger taxable capacityof a consolidated one-tier government increases its ability to borrow and to recovercapital and operating costs from user fees. Services may be funded more fairly because

(6) On the other hand, some evidence suggests that costs are higher for larger government unitsbecause of ``bureaucratic congestion'' (Boyne, 1992, page 336).(7) Portland, Oregon, is an exception. Portland's Metropolitan Service District, with a directlyelected council, is responsible for land use and transportation, solid waste disposal services, thezoo, and regional tourism (Klink, 2005).

An approach to metropolitan governance and finance 731

there is a wider tax base for sharing the costs of services which benefit taxpayers acrossthe region. Large one-tier governments can take advantage of economies of scale inservice provision. Municipal amalgamations internalize externalities: for example,rural residents outside of the original municipal boundary now have to pay for urbanservices that they use. However, redrawing boundaries is only a first step in linkingtaxes to service benefits by ensuring that the beneficiaries are located within thejurisdiction providing the services. The critical second step is to identify the benefitsreceived by residents and to tax them accordingly. For example, while it is fair tocharge rural residents for their use of urban services such as recreation facilities andlibraries, it is not fair to charge them for a garbage-collection service which they do notreceive (Vojnovic, 2000).

How successful consolidated one-tier governments have been in practice at achiev-ing accountability and efficiency (in terms of cost savings) is a matter of debate. Alarge-scale one-tier government may reduce access and accountability because thejurisdiction becomes too large and bureaucratic. To overcome this problem, in somecases community committees have been established to address local issues, or satelliteoffices have been set up across the municipality where people can pay tax bills, apply forbuilding permits, etc.(8) Such devices may increase accessibility (if not accountability),but they may also offset, to some extent, potential cost savings that might otherwiseresult from a larger government unit.

The empirical evidence on fragmented versus consolidated local governments in theUSA indicates that consolidated structures are associated with higher spending(Boyne, 1992). Evidence from municipal amalgamations in Canada also suggests thatcost savings have proved to be elusive (Sancton, 1996; Slack, 2000). When municipali-ties are amalgamated, some duplication is obviously eliminated. In particular, thenumber of politicians and bureaucrats is reduced. On the other hand, when municip-alities with different service levels and different wage scales merge, expenditures mayincrease. For example, when the fire departments of several municipalities are amalga-mated, it is possible to reduce costs by eliminating a number of fire chiefs. However,there are now thousands of fire fighters in the newly amalgamated municipality whoare doing the same job and working for the same employeröthe newly created city.Understandably, they will want to be paid comparable salaries and benefits, and nonewill be willing to take a pay cut. Salaries and benefits hence tend to equalize up to thehighest expenditure municipality. This upward harmonization of wages and salariesgenerally outweighs any cost savings.(9)

Amalgamations thus often increase costs by harmonizing service levels at thehighest service level enjoyed before the amalgamation. Amalgamations also reducecompetition between municipalities, weakening incentives to be concerned with effi-ciency, to be responsive to local needs, and to adapt to changing economic conditions.

(8) In 2002, for example, the provincial government merged the City of Montreal with a populationof 1 million and twenty-seven other municipalities on the island of Montreal (with a total pop-ulation of 800 000). The new city was divided into twenty-seven boroughs, each responsible for localservices such as garbage collection, swimming pools, snow clearing, and libraries. Nine of theboroughs were located in the central city where none had existed previously. Thus, althoughresidents of the ex-suburbs potentially lost control over some municipal services, residents of theformer City of Montreal potentially gained more autonomyöat least for a while. Subsequent`deamalgamations' have resulted in the City of Montreal now comprising only nineteen boroughs,with the city council having jurisdiction over all of the boroughs and an `agglomeration' councilhaving jurisdiction over the City of Montreal and fifteen reconstituted cities.(9) Of course, service-delivery costs could be reduced without changing government boundaries,for example, through such methods as the provision of services by one municipality to othermunicipalities, and the involvement of the private sector in service delivery.


The reduction in competition may reduce efficiency in the delivery of services andagain result in higher costs. On the other hand, if some localities could not previouslyafford to provide an adequate level of service because they did not have adequateresources, amalgamation may allow them to provide a level of service comparable tothat in richer localities in the region.

Two-tier modelThe two-tier model consists of an upper tier governing body (usually a region, district,or metropolitan area), encompassing a fairly large geographic area, and lower tier orarea municipalities (such as cities, towns, villages, townships). In principle, the uppertier should be responsible for services that provide region-wide benefits, generateexternalities, entail some redistribution, and display economies of scale. Services thatprovide local benefits should be the responsibility of the lower tier. Table 1 illustrateshow these criteria may be applied. An example of the adoption of a particular type oftwo-tier structure is the Greater London Authority Act of 1999.

Redistribution is achieved at the upper tier level through a combination of tax andspending policies. Taxes are generally levied at uniform rates across the region with thecontribution of each lower tier municipality to the upper tier municipality dependingupon the size of its tax base. The upper tier government makes expenditures onservices that benefit the entire city-region and are not necessarily distributed amongthe lower tier municipalities in the same way as revenues are collected. A uniform taxat the upper tier level combined with region-wide expenditures serves to redistribute

Table 1. Allocation of expenditure responsibilities in a two-tier model.

Function Upper Lower Justificationtier tier

Welfare assistant � income redistribution; externalitiesChild-care services � income redistribution; externalitiesSocial housing � income redistribution; economies of scale;

externalities

Public health � income redistribution; economies of scale;externalities

Ambulance � economies of scale; externalities

Roads and bridges � � local versus regional roadsPublic transit � externalities; economies of scaleStreet lighting � no externalitiesSidewalks � no externalities

Water system � economies of scaleSewer system � economies of scale

Garbage collection � economies of scale; externalitiesGarbage disposal � economies of scale; externalities

Police protection � externalities; economies of scaleFire suppression � local responsiveness; scale economies for

specialized servicesFire prevention/training � economies of scale

Local land-use planning � local access, responsivenessRegional land-use planning � externalitiesEconomic development � externalities

Parks and recreation � local responsivenessLibraries � local responsiveness


resources from municipalities with relatively large tax bases to those with relativelysmall tax bases. Of course, there may still be differentiation in service levels and taxrates with respect to services provided by lower tier municipalities.

Two-tier governance structures can permit any desired degree of redistribution.They have potentially important advantages over the one-tier model in terms ofaccountability, efficiency, and local responsiveness. Critics of the two-tier model arguethat costs will be higher because of waste and duplication in the provision of servicesby two levels of government, but there is little evidence to support this argument.However, two-tier structures are definitely less transparent and more confusing totaxpayers who can seldom determine precisely who is responsible for which services.Moreover, the existence of two levels of municipal council has been said to leadto considerable ` wrangling, inefficient decision-making, and delays in implementingpolicies'' (Kitchen, 2002, page 312).

Voluntary cooperationVoluntary cooperation has been described as `minimal' government restructuring inwhich there is an ` area-wide body based on voluntary cooperation between existingunits of local government in the agglomeration with no permanent, independentinstitutional status'' (Sharpe, 1995, page 12). Such structures are common in the USAand France. They are popular in part because they are politically easy to create and canbe disbanded equally easily. Although the voluntary model does not include an electedarea-wide government, it is an alternative method of recognizing the interrelationshipof localities within a region through some form of area-wide arrangement.

Cooperation takes different forms in different countries. Bologna, Italy, is anexample of an intermunicipal model of metropolitan governance on a voluntary basis(Klink, 2005). In 1994 forty-eight municipalities and the province of Bologna signedthe Accordo per la Citta© Metropolitana. The Metropolitan Conference is composed ofall the mayors and is presided over by the president of the province. Each municipalityis free to withdraw at any time and may participate as it chooses in some or all of theactivities of the Metropolitan Conference. In other countries voluntary cooperationmay take the form of consortia, communities of communes, urban communities (France),joint intermunicipal authorities (Spain and Belgium), public bodies, joint agencies, andcore cities (the Netherlands) (Hermann et al, 1999). The city-region of Vancouver is aNorth American example of a well-established voluntary cooperation structure. Suchstructures generally imply some degree of administrative integration as well as somepolitical linkage in that the member local governments have some form of representa-tion on the boards. Moreover, as a rule, these organizations can levy taxes or collectcontributions from the municipalities or can levy user fees to pay for services.

Voluntary cooperation is thus a way to provide services across a region withoutresorting to amalgamation. Municipalities retain their autonomy with respect toexpenditure and tax decisions but at the same time can achieve economies of scale inservice delivery and can address externalities associated with service provision (Sharpe,1995). Obviously, however, there may be problems of accountability when services areprovided by another jurisdiction. The voluntary model can work well when policymakers in the various local governments have the same objectives. It does not workso well, however, when different governments have divergent objectives. Some degree ofredistribution may or may not be accepted by the municipalities involved. Cooperationusually involves bargaining, and some municipalities in a region may not have much tobargain with. The problems faced by many metropolitan areas, particularly in developingcountriesöglobal competition, fiscal disparities, sprawlöare so great that any realsolution likely requires a governance structure that has a permanent institutional status.


An even less structured form of voluntary cooperation is through intermunicipalagreementsöformal or informal agreements between municipalities to provide specificservices, usually with no official area-wide body to oversee such arrangements.An example of such an intermunicipal agreement is the contract services plan inLos Angeles, under which Los Angeles County provides some services on behalfof municipalities in the Los Angeles metropolitan area on a contract basis. Similarcity ^ county links occur in other US jurisdictions as well (Sharpe, 1995).

Such agreements are generally entered into to reduce costs. They can work well forlocal services that can be contracted out or to share clearly identifiable costs. Suchagreements have proved effective for services such as fire fighting and emergencydispatch, maintenance of boundary roads, purchasing in bulk, and issuing debentures.This approach offers no solution, however, to the need for region-wide coordination.Furthermore, intermunicipal agreements generally provide no clear public accountabil-ity except through the contract or agreement. If something goes wrong, it is difficult forcitizens to know whether to complain to their local government or to the local govern-ment that has been contracted to provide the service. Experience suggests that inter-municipal agreements may increase the likelihood of intermunicipal litigation andconflicts (GTA Task Force, 1996). Such agreements may thus be successful in achievingcoordination and efficiencies for specific services, but they are not suitable for achiev-ing region-wide coordination. Indeed, they have been described as second-best solutionsto reorganization that can lead to ` an impenetrable jungle of ad hoc commissionsand complex arrangements that even the most conscientious municipal voter will neverunderstand'' (Sancton, 1993, pages 33 ^ 34).

Special-purpose districtsSpecial-purpose districts are sometimes used to deliver services that spill over municipalboundaries. Single-purpose special districts may provide similar municipal services forseveral municipalities or manage regional services with significant externalities. Thisform of cooperation among municipalities for region-wide services is used most widelyin countries in which there is a history of strong and autonomous local governments. Inthe USA, for example, one third of all local governments are special districts or schooldistricts. The boards of such special districts are usually indirectly controlled by theconstituent municipal councils and are responsible for the management of such servicesas transportation, water and waste management, and economic development, as well astaxing, price setting, and other policy making. However, school boards, responsible foreducation, are often directly elected.

One advantage of special-purpose districts is that each service spillover can beaddressed on an individual basis. Since it is unlikely that the spillover boundaries arethe same for each service, differently sized special districts could be establishedösuchas a region-wide transit district or a hospital district.(10) Other advantages may includethe delivery of services by professionals, with decision making somewhat removedfrom political influence; the provision of services in which more professional expertisethan may be available to the municipal government is used; and the use of dedicatedrevenues from user fees to finance capital expenditures (Bahl and Linn, 1992).

(10) Special districts to some extent illustrate the concept of functional, overlapping, competingjurisdictions (FOCJ), which envisages that ``welfare could be improved substantially by promotingcompetition between newly emerging jurisdictions that are organized along functions instead ofterritories'' (Frey and Eichenberger, 1996, page 315). In this approach, FOCJ are real governmentsin that they would have enforcement power and would be able to levy taxes; they would extendover areas defined by the functions they are responsible for; they would overlap geographically;and individuals and communities could choose which governmental unit they wanted to belong to.


But special-purpose bodies also create problems. First, since each body hasresponsibility for a single service it is not required to make tradeoffs between, forexample, expenditures on transit and expenditures on water and sewers. When thereare many independent special purpose bodies, it is difficult to coordinate interrelatedactivities.(11) Secondly, the proliferation of decision-making bodies has ` created adiffuseness of government organizations that is difficult for citizens to understand''(Kitchen, 1993, page 14). Such bodies weaken general-purpose local governmentsöboth through competition for resources and by reducing political accountability(Bird, 1995). Thirdly, there is no direct link between the expenditure decisions madeby the special purpose agencies and the local councils responsible for collectingproperty taxes to fund them. The absence of what Breton (1996) calls the `Wicksellianconnection' between expenditures and revenues reduces accountability.(12) Becauseaccountability is lacking, there is no incentive to be efficient: a higher level of tech-nical efficiency through more professional management is not the same thing aseconomic efficiency. Services may be better delivered but they are not necessarilydelivered to the right people in the right quantities and with the right qualities (Bird,1980).

The delivery of certain public functions by essentially nongovernmental organiza-tions has long been common in the UK, whether they are called quasi-autonomousnongovernment organizations (QUANGOs) or extragovernment organizations (EGOs).There are now over 4700 such organizations in the UK at the local level, whichreportedly manage nearly one third of all government expenditures (Amos, 1996). Thesebodies are generally run by appointees and are not subject to the same regime asgovernment agencies with respect to accountability, accessibility, and informationprovision. They may provide services efficiently, but they certainly do not do so in avery accountable fashion (Slack et al, 2003).

Conclusions on governance structureTo sum up, neither theory nor practice tells us clearly which model of governanceis best for large metropolitan areas.(13) Nonetheless, some conclusions do emergefrom this brief review. One is that a strong regional structure encompassing the entirecity-region is important. Metropolitan areas are characterized both by strong interde-pendencies (social, economic, environmental, and political ^ administrative) and byexternalities among local jurisdictions (Klink, 2005). Some form of regional structureis needed to address problems of a region-wide nature, such as fiscal disparities amongmunicipalities and externalities in service provision. A regional structure is also neededto resolve transportation and environmental coordination issues as well as to ensure

(11) Three ways have been suggested to address coordination problems (Bahl and Linn, 1992). Oneis to have overlapping membership so that some of the same people are on a number of districtboards. This may help coordination but does nothing about accountability. Another is to encouragedistricts with multiple functions instead of single-purpose districts: at the limit of course, this leadsback to general-purpose government. In addition, even if special districts remain separate authori-ties they may be made subject to political considerations in the decision-making process (as withelected US school boards).(12) As note by Locke and Tassonyi (1993), in Ontario, Canada, local municipalities, which areresponsible for collecting all property taxes, must take into account taxes levied by the upper tierand by school boards when they set their own levy, but they have no control over school-boardlevies and only limited influence on the upper tier.(13) Other reviewers of this issue have also concluded that no model fits all cases or stands outclearly above the rest (Divay and Wolfe, 2002; Klink, 2005; McMillan, 1997; Stren and Cameron,2005).


the economic competitiveness, social cohesion, and fiscal viability of city-regions in theglobal economic setting. Few problems and processes stop at municipal boundaries,and most feasible solutions require larger geographical units and access to a large poolof resources, both human and financial, than is likely to be at the disposal of smalllocal governments. Some form of regional structure seems necessary if cities are to takefull advantage of new and emerging opportunities for economic cooperation and forenhancing productivity and competitiveness in an increasingly knowledge-based econ-omy. They need a sound regional structure to enhance regionally based competitiveadvantages.

But what kind of regional structure? Different models have worked successfully, tovarying degrees, in different places. What is perhaps more important than the precisemodel of governance chosen for a city-region is simply that some form of effectivegovernance is in place. Voluntary intermunicipal agreements and special districts maybe effective for the provision of some services, but these approaches do not provide theneeded regional foundation for metropolitan areas which need to compete in the globaleconomy. In situations in which local autonomy is paramount and where objectivesare shared by policy makers in various local governments, voluntary cooperation canwork to some extent. It will not work well, however, when objectives differ among localgovernments, as of course they often do.(14)

The real choice thus usually comes down to one-tier versus two-tier structures.Because a one-tier structure is simpler to understand and more transparent thana two-tier structure it may enhance political and fiscal accountability. Two-tierstructures are inherently more complex and may result in undesirable duplication,overlap, and general confusion among citizens as to who is responsible for what andwho is paying for it. On the other hand, a two-tier structure may achieve greaterefficiency than is likely to be attained in a more centralized one-tier structure.Desirable economies of scale and scope can be realized at the upper tier level whileat the same time the continued existence and vitality of the lower tier permits moreresponsiveness to local variations in preferences and maintains the linkage betweenlocal financing and spending decisions. Any desired degree of regional redistributioncan be achieved within either a one-tier or a two-tier structure, although obviouslymost easilyöowing to the lower level of political transparencyöin a one-tierstructure with uniform tax rates across the city-region in which all taxes are madeavailable for redistribution. This seems to have been the principal reason for thechoice of the one-tier model in South Africa, for example (van Ryneveld and Parker,2002).

What do metropolitan governments do?The traditional literature on fiscal federalism assumes that the major role of localgovernments is to provide goods and services within a particular geographic area toresidents who are willing to pay for them.(15) To the extent that the benefits and costs ofparticular services are confined to local jurisdictions, so that the actions of onemunicipality have no effect on other municipalities, efficiency is enhanced becausethe mix and level of services can vary according to local preferences. Moreover, local

(14) See Keohane and Nye (2001) for a discussion of similar issues in the context of internationalorganizations.(15) Local efforts to address income disparities will likely result in the movement of high-incomegroups to low-tax areas and low-income groups to high-tax areas. Nevertheless, local governmentsdo, in practice, invariably engage in some redistribution (Bird and Slack, 1993).


officials are often thought to be in a better position to respond to local tastes andpreferences than are central government officials.(16)

Cities spend on a variety of goods and services. Local government expenditures rangefrom those with private good characteristics to those with public good characteristics.The efficient provision of services requires local governments to charge for servicesthat have private good characteristics (for example, where it is possible to identifybeneficiaries and exclude those who do not pay, where there are no externalities, andwhere there are no undesirable redistributive consequences). User fees are appropriatefor services such as water, sewers, transit, and recreation.Where it is difficult or costlyto charge user fees, taxes and transfers are needed. Local governments are generallyassigned expenditure responsibilities for `hard' services such as roads and transit aswell as some `soft' services such as affordable housing and some social services.Property taxes may be appropriate to finance hard services which are property-related,complemented with borrowing to cover construction costs. The property tax is lessappropriate, however, to finance soft services. In Scandinavian countries in which socialservices are often a municipal function, for example, municipalities impose substantialincome taxes. To the extent that local governments deliver services which serve a widerregional or national purpose, some intergovernmental transfers may also be called for(Bird et al, 2003). Regional and local governments which deliver a wide range of servicesneed a mix of revenue sources that reflects the mix of services they provide.

Cities around the world provide similar services, but the distribution of expendituresamong these services differs across jurisdictions. A recent comparison of local finance inselected US and Canadian cities found important differences both in how services aredelivered and in how expenditures are reported (Slack, 2003). For example, public transit isrun as a utility in most cities; in others, however, transit revenues and expenditures areconsolidated with city revenues and expenditures (as in Toronto). In still other cities, onlythe subsidy from the city to the transit utility is included as a city expenditure (as in LosAngeles). Similarly, sometimes education expenditures are made by the municipal govern-ment (as in Boston and Detroit); in other cases, education is delivered by separate schoolauthorities, and these expenditures are not consolidated with municipal expenditures. Suchdifferences not only make it difficult to compare the distribution of expenditures amongfunctions but also to compare total expenditures across local governments.(17)

`A structure that fails to distinguish between major metropolitan areas and smallvillages makes it difficult to clearly define the functional responsibilities of local govern-ment'' (Burki et al, 1999, page 24). Yet the standard economic theory of local governmentsdoes not distinguish among large metropolitan areas, intermediate-sized cities, or townsand villages. If all local governments are assigned the same responsibilities, the assignment(16) Although the major role for cities is thus to provide services to residents, they do not have toproduce the goods and services themselves. Municipalities may, for example, contract out servicedelivery to another government or to the private sector. Indeed, as noted by Osborne and Gaebler(1992), experience suggests that most local governments need to concentrate more on `steering'(policy making) and less on `rowing' (service delivery) (see also Bennett, 1997). This importantdimension of metropolitan finance cannot be discussed further here, however.(17) Comparing the expenditures of fragmented cities in a metropolitan area with cities in which themunicipal government is coterminous with the metropolitan area is particularly tricky (Slack,2003). The City of Atlanta, for example, is located in Fulton County but the metropolitan area ofAtlanta stretches well beyond Fulton County. Similarly, the City of Toronto, although a one-tiermunicipality, does not cover the entire Toronto metropolitan area, which, at least by some defini-tions, comprises four other regional governments and twenty-five lower tier municipalities. Forsuch reasons, it is surprisingly difficult to compare revenues and expenditures in one metropolitanarea with another in the same country, let alone to make meaningful comparisons of municipalexpenditures across countries. Differences in `local' expenditures of central and state (provincial)governments further exacerbate the problems.


either reflects what the smallest municipalities can provide, or (more likely) thosemunicipalities will be unable to fulfil their assigned responsibilities. From any econo-mic perspective, it is clear that different types of municipalities should be distinguishedin terms of expenditure assignment. In Germany, for example, Berlin, Bremen, andHamburg have broader responsibilities than do other large municipalities althoughthese are also permitted to assume the responsibilities of counties (Burki et al, 1999).Many countries likewise make similar provisions for their national capital areas (Boydand Fauntroy, 2002).(18)

Expenditure levels and patterns in large metropolitan areas differ from those in smallercities, let alone rural areas, for reasons such as the sheer size of the population, its highdegree of spatial concentration, and its more heterogeneous nature. Big cities are generallyboth richer and provide a wider range of services than other local governments (Bird,1995). Local governments in large metropolitan areas are increasingly required to providea more sophisticated transportation and communications network as well as services thatimprove the quality of life (parks, recreational facilities, cultural institutions) to attractthose at the cutting edge of economic competitiveness. But large metropolitan areas alsoattract low-income individuals and households who seek employment opportunitiesand who take advantage of a wider range of more specialized social services than areusually available in smaller municipalities. The resulting high concentration of specialsocial needs within large metropolitan areas may also require higher expenditureson social services, social housing, and public health.

Large metropolitan areas thus tend to provide a wider range of services. Smaller citiesmay not have sufficient urban densities for a transit system to be economically viable.Cultural facilities (opera houses, art galleries) are less likely to be provided in smallerurban areas. In part because their own communities do not provide such services,people outside the metropolitan area often make use of metropolitan cultural facilitiesand other services. Indeed, one rationale for the creation of city-region governancestructures is to deal with such problems when the areas in which such users live arecontiguous with the metropolitan area. Metropolitan areas must also manage a morecomplex urban environment, structure land use to promote efficiency, and employ finan-cial tools in a way that promotes efficiency. All these tasks are generally considerablymore complex in metropolitan regions than for local governments in general.

Expenditures per household in large metropolitan areas are thus generally higherthan in other municipalities. Operating expenditures in London, for example, areabout 30% above the average for all local governments (ODPM, 2002). In particular,expenditures are higher on housing (two to three times higher in per capita termsthan in the rest of England) and on health (owing both to the higher costs ofoperating in London and to the high cost of the five medical schools in London)(ODPM, 2003). Other characteristics that differentiate London from other cities inEngland include its ethnic diversity (one in four Londoners is from an ethnic minority),income disparities (although London is a wealthy city, it has the second-highest unem-ployment rate among England's regions), and of course its role as a global city in terms offinance and business services.

To the extent that there are economies of scale in service provision, per capitaexpenditures for some services may be lower in big cities but the empirical evidenceon the existence of economies of scale is mixed. Hirsch (1959), for example, estimatedcost functions for police services, fire services, refuse collection, water, sewage, andeducation and found that expenditures per capita declined with the quantity provided(18) Interestingly, as Rodriguez-Acosta and Rosenbaum (2005) note, one unexpected side effect ofthe recent move toward increased decentralization in some Latin American countries has been todowngrade the importance of the `national capital' distinction.


for water and sewage but not for any of the other urban services. For some servicesexpenditures per capita actually rose as output expanded, indicating that there werediseconomies of scale. Other studies that have estimated cost functions have foundsome economies of scale for hard services such as water, sewers, and transportationbut generally not for such soft services as police, refuse collection, recreation, orplanning (Bird and Slack, 1993). Hard services are capital intensive, so large govern-ment units can more readily make the substantial capital investments needed to extendthe water-distribution system or build a least unit cost size sewage-treatment plant,for example (Bahl and Linn, 1992). Other services, such as policing, are highly labourintensive and hence unlikely to show significant economies of scale (Scicluna et al, 1982).

In a two-tier structure, the upper tier is generally responsible for services that areregion-wide in scale and scope. Table 1 illustrates what some might consider an `ideal'division of responsibilities. In reality, the division between upper tier and lower tier func-tions is very different in different cities. For instance, over half of the 2003/04 budgetof the Greater London Authority went on transportation, with policing being thesecond-largest item. The remainder of the authority's budget is divided between eco-nomic development, fire and emergency planning, and planning and other services. Thelower tiers (boroughs and the Corporation of London) are responsible for services suchas education, housing, social services, roads, local planning, and arts and leisureservices. Much of the finance for these services comes from central grants. In sharpcontrast, the budget of the Greater Vancouver Regional District (GVRD) is fairlysmall (Can$191 per capita in 2002 compared to Can$1135 per capita for the lowertier municipalities combined). Unlike in the London model, housing and social servicesare largely provincial responsibilities in the province of British Columbia. Whatremains at the local level is shared between the upper and lower tiers. For example,policing and fire protection are lower tier responsibilities in Vancouver (accounting for25.4% of lower tier expenditures) as are parks, recreation, and culture (15.1%). Lowertiers also make expenditures on water, sewers, transportation, development services,and waste management, and most GVRD expenditures are for water, sewers, and solidwaste management. A separate regional authority is responsible for transit.

Financing large metropolitan areasAs with expenditures, revenue needs and patterns tend to be different in large metro-politan regionsöreflecting both the different nature and level of services they provideand their greater ability to levy taxes. Such areas often haveöand should haveögreater fiscal autonomy than other urban or rural areas in the sense both of greaterresponsibility for local services and of greater ability (and responsibility) to levy theirown taxes and collect their own revenues. How should big cities be financed?

User chargesA first important observationöthough widely ignored in practiceöis that local govern-ments of all sizes should, wherever possible, charge directly for services (Bird, 2001a).Appropriately designed user fees (prices) allow residents and businesses to know howmuch they are paying for the services they receive from local governments. Whenproper prices are charged, governments can make more efficient decisions about howmuch to produce and citizens can make more efficient decisions about how much toconsume.(19) User charges are especially appropriate for services such as water andpublic transit, where benefits are confined largely to individual consumers.

(19) In a recent rigorous empirical study, for example, Borge and Rattso (2003) show that user-charge financing of sewer service by Norwegian local governments has significantly reduced thecost of such service.


Charges are especially important in large metropolitan areas because they not onlyresult in more efficient use of services but also encourage more efficient land use. Ifmarginal cost pricing is used, higher fees are charged to consumers who are far awayfrom existing services and hence costly to serve, and lower fees are charged to con-sumers who are closer. If consumers are charged the average cost, however, those inoutlying areas (where costs are relatively higher) pay less than the marginal cost of theservice: that is, they are subsidized. Uniform pricing of urban services, while politicallyappealing, is inherently economically inefficient. Urban sprawl is encouraged as peoplein the central, high-density area often pay more than the marginal cost of the service, ineffect subsidizing the use of services by those further out (Slack, 2002). Studies in Chile,for instance, show that underpricing and distortions in water and sewer pricing haveresulted in severe locational distortions (Daniere and Gomez-Iban¬ ez, 2002). An addi-tional important benefit of more appropriate pricing of urban services is to reducepressure on urban finances indirectly by reducing the apparent need for more invest-ment in underpriced infrastructure. If something costs users nothing they will generallywant more of it, but this does not mean that cities should give it to them.

A common reaction to suggestions to increase reliance on user-charge financing isthat the results are simply too regressive to contemplate. In reality, almost the oppositeis true in large urban areas: those who benefit most from the underpricing of servicesare those who make the most use of them, and (especially in developing countries) thepoor are not well represented in this group (Bird and Miller, 1989; Lampietti et al,2001). Relatively simple pricing systems, such as low initial `life-line' charges for thefirst block of service use, can often deal adequately with any remaining perceivedinequity resulting from introducing more adequate pricing systems.(20)

TaxesWhere user charges cannot be employed because the benefits of a particular service arenot confined to individual consumers, taxes that are borne by local residents are anappropriate means of finance when the benefit area of the service is largely cotermi-nous with the municipal boundary. A truly local tax might be defined as one that isassessed by local governments, at rates decided by local governments, and collected bylocal governments (Bird, 2006). In the real world, however, many taxes possess onlyone or two of these characteristics, and the `ownership' of the levy may be unclear.In some countries, a tax may be called a `local tax' and part or all of its proceedsmay accrue to a city, but the rate and base of the tax are determined by a central orprovincial/state government. Such taxes are best thought of as central or provincial/state government taxes that are allocated to cities through a form of transfer. Thisinterpretation is particularly plausible when there is little connection between theamount transferred and the amount collected locally. In appraising local taxes, namesand appearances can be deceiving.(21)

The traditional theory of fiscal federalism prescribes a very limited tax basefor local governments. The only good taxes are said to be those that are easy toadminister locally, that are imposed solely (or mainly) on local residents, and that donot raise problems of harmonization or competition either horizontally (between localgovernments) or vertically (between local and central governments). One of us (Bird,2006) has argued that a good local tax has the following characteristics:

(20) For extensive discussions of local user charges, see, for example, Bailey (1988), Bird andTsiopoulos (1997), and Downing (1977).(21) For a useful attempt to disentangle some of these issues, see OECD (1999).


Table 2. Evaluation of possible metropolitan government revenues.

Criterion User charges Property tax Excises Personal income Payroll tax Sales Business taxes(R )a (L )b (R ) tax (R ) (R ) tax (R ) (L, R )

Revenue adequacy adequate for someactivities; not ingeneral

adequate forgeneral localgovernment

unlikely to suffice unlikely yes, ifindustrial area

yes not likely

Revenue buoyancy no not much varies yes yes yes probably

Correspondence ofpayers andbeneficiaries

excellent ifdesigned well

fair if properlydone

not high not high depends onemploymentpattern

depends onmobility

depends ondesign

Local accountability excellent low not good unlessrate set regionally

low unless have ratediscretion

yes if have ratediscretion

yes if canset rates

usually low

Administrative cost sometimes high fairly high low very high unlessimposed as regionalsurcharge

not high moderate sometimeshigh

Compliance costs irrelevant inprinciple

vary, but nothigh

low as a rule medium not high moderate often high

Latitude forcorruption

low moderate low probably high inmost countries

low moderate high

Political acceptability not high in mostcountries

moderate high in someinstances

low high perhaps high

Distortionary impact none moderate can be low moderate not too high may be low Usually high

Progressivity not relevant inprinciple (thoughmay be in politicalterms)

possibly regressive ingeneral, exceptfuel

largely unknown not very no usuallyunknown

Reduces regionaldisparities

may do so to someextent

no no no no no no

a RÐregional (upper tier).b LÐlocal (lower tier).

742R

MBird,

ESlack

N:/psfiles/epc2505w

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(1) The tax base should be relatively immobile, to allow local authorities some leeway tovary rates without losing most of their tax base.(2) The tax yield should be adequate to meet local needs and sufficiently buoyant overtime (that is, it should expand at least as fast as expenditures).(3) The tax yield should be relatively stable and predictable over time.(4) It should not be possible to export much, if any, of the tax burden to nonresidents.(5) The tax base should be visible to ensure accountability.(6) Taxpayers should perceive the tax to be reasonably fair.(7) The tax should be relatively easy to administer efficiently and effectively.Local governments need a significant degree of freedom to alter the level and composi-tion of their revenues, if local autonomy and local accountability are to be meaningfulconcepts. A good local tax is one where local governments set the rates but the tax basedoes not foster tax exporting. Rate flexibility is essential if a tax is to be adequatelyresponsive to local needs and decisions, while remaining politically accountable. Restric-tions on local ability to shift taxes to nonresidents are critical to ensure that localbudgetary decisions are both efficient and accountable.

Table 2 illustrates possible metropolitan taxes against these criteria. The only majorrevenue source that passes most of these tests is the residential property tax.While lessimportant, to some extent taxes on vehicles and user fees may also qualify.

The table distinguishes between taxes which are potentially suitable for local (lowertier) governments in a metropolitan region and those potentially suitable for a region-widegovernment. The potential revenue sources for city-region metropolitan governmentsare much wideröcloser to those of states or provinces than those of traditional localgovernments.

Property taxesThe property tax is especially appropriate for financing local services for at least tworeasons. First, real property is immovable: it cannot move away when it is taxed.Second, there is a connection between the types of services funded at the local leveland the benefit to property values. To the extent that it approximates the benefitsreceived from local services, the property tax is like a benefit tax. But not all taxeson property are equally good. Residential property taxes are particularly appropriate tofund local governments because they are borne by local residents.(22) Those who enjoythe benefits of local services are required to pay for them.

On the other hand, the nonresidential portion of the property taxögenerally the mostimportant part of the tax in developing countriesöis inherently less appropriate forfinancing local government expenditures. Taxes on business may be partially exportedto residents of other jurisdictions who are consumers of the products or services producedin those properties or who own the business. Tax exporting reduces accountability becausethose bearing the burden of the tax are not the same people as those enjoying the benefits.Local residents may demand greater expenditures than they otherwise would because theyknow that much of the cost will be paid out of other people's money'. Some restrictionon the use of nonresidential property taxes through such measures as a maximum rate,or at least requiring a uniform rate on residential and nonresidential property, may thusbe desirable. Large metropolitan areas have relatively more commercial and industrialproperty than do smaller urban areas. A larger commercial/ industrial tax base permitslocal governments to make greater expenditures. To the extent that such taxes exceedthe benefits received by business from local government activities and are exported,restrictions may be needed especially in metropolitan areas.

(22) Like most short statements about tax incidence, the text statement is too simple to be fullyaccurate: for a more detailed discussion, see Bird and Slack (1993).


Despite their many virtues as a source of local revenues, property taxes are relativelycostly and difficult to administer properly, and these problems are exacerbated as thesize of the tax burden increases. Moreover, in most countries even a well-administeredlocal property tax cannot finance major social expenditures (education, health, socialassistance). Local governments financed primarily by property taxes must either con-fine their activities essentially to providing such local services as street cleaning andrefuse removal or remain heavily dependent on transfers from senior levels of govern-ment. Indeed, this is the pattern even in most developed countries. Matters are generallyworse in developing countries, which seldom allow local governments any rate flexi-bility, although there is, as always, great variation from country to country (Bird andSlack, 2004).

Income taxesIncome taxes represent the most important source of local tax revenues in thirteenOECD countries such as Sweden, Norway, the Czech Republic, Switzerland, andBelgium (OECD, 2000). A strong case can be made for a local income tax to supple-ment property taxes for large metropolitan areas. Even within the largest metropolitanareas, however, it is probably desirable to `piggyback' onto higher level income taxes(that is, to levy the tax as a supplement to a central or provincial income tax) ratherthan to impose independent local taxes. Of course, such a supplemental local incometax only makes sense if there is an effective and well-functioning central income taxin place, which is unfortunately seldom true in developing countries such as those inLatin America.(23)

A metropolitan income tax can be justified on the grounds that governments inlarge metropolitan areas are increasingly being called upon to address issues ofpoverty, crime, land-use planning, regional transportation, and other region-wide needs(Nowlan, 1994). To the extent that large metropolitan areas are required to providesocial services, an income tax would appear to be a more appropriate revenue sourcethan a property tax because it is more closely related to ability to pay. Furthermore,since mobility across jurisdictions in response to tax differentials is less the larger thegeographic area, large metropolitan areas are more able than other local governmentsto take advantage of income taxes. A quite different justification for income taxes forlarge metropolitan areas might be on benefit grounds. Since the residential propertytax is tied to the consumption of housing rather than the consumption of public goods,even this portion of the property tax is a benefit tax only to the extent that housingconsumption and local goods consumption are highly correlated across differenthouseholds (Thirsk, 1982). In large metropolitan areas with a heterogeneous popula-tion, however, income is in all likelihood more highly correlated with consumption ofpublic services than it is with property value. In this sense, a local income tax mayactually be a better benefit tax than a property tax in large metropolitan areas (Nowlan,1994). Of course, this argument would not apply when there is a strong relationshipbetween income and property values, which may be true in large cities in manydeveloping countries.

Because income taxes increase or decrease in response to changes in wages andsalaries, revenues respond immediately to changes in the economy. The fact thatincome taxes are responsive to changes in the local economy provides an advantagefor cities that levy income taxes in an economic boom, but it may become a prob-lem in an economic downturn. In US cities, for example, recession has resulted inslower than expected growth in revenues from income, sales, and tourist-related taxes

(23) Shome (1999), for example, depicts the weak, and weakening, state of personal income taxes ina number of Latin America countries.


(Pagano, 2002).(24) Property-tax revenues, on the other hand, respond less quickly tochanges in the economy because economic growth is not capitalized fully into realestate investment and landownership. Moreover, in many countries, even if propertyvalues do increase, assessed values are not updated on a regular basis (Bird and Slack,2004).

In view of the possible merits of income taxes as a source of metropolitan finance,countries concerned with establishing sustainable metropolitan governments shouldexplore further the possibility of imposing regional surcharges on personal incometaxes. However, no quick fix for metropolitan revenues in most developing countriesis available from this quarter given the combination of weak personal income taxes atthe central level and the obvious reluctance of central governments to share productivetax bases with local governments.

Payroll taxesPayroll taxes have been important sources of regional government finance in Australiaand, to a lesser degree, in a few other countries such as Mexico and South Africa. Suchtaxes have several advantages and at least two disadvantages. Their advantages are thatthey are easily administrable, at least when imposed on large enterprises, and relativelyproductive at relatively low rates. Their disadvantages are, first, that they act as a taxbarrier to employment in the modern sector and introduce distortions into the choiceof production techniques, and second, that in most countries the payroll-tax basis isalready heavily exploited to finance the central government's social security systems. Ofcourse, if payroll taxes can work on a regional basis, so can flat-rate earned-incometaxes, which in practice are likely to be levied on much the same base. An advantage ofincome taxes in a local context is that they can more easily be levied on a destination(resident) basis than can origin-based payroll taxes (Bird and Wallich, 1992). A sur-charge on a nationally uniform personal income tax base would be a more appropriateway for local governments to tax wages in most developing and transition countriesthan through payroll taxes levied on employers. However, a payroll tax, levied as a finaltax on payrolls at the enterprise level, is undoubtedly simpleröalways an importantconsideration when tax administration is weak.

Vehicle and fuel taxesThe strongest economic and administrative case for regional excises is with respect tovehicle-related taxes (Bahl and Linn, 1992). The most important tax on automobilesfrom a revenue perspective is the fuel tax, which is also the simplest and cheapest formof automotive taxation from an administrative perspective. Fuel taxes can generally belevied at the regional level. Moreover, different regions could impose taxes at differentrates if they chose to do so since they would probably not be able to differ much fromthe rates imposed by their neighbours, given the mobility of the tax base. Differentialregional fuel taxes could be imposed at the refinery or wholesale level, with the refineror wholesaler acting as the collection agent for the regional governments and remittingtaxes in accordance with fuel shipments. Such municipal fuel taxes are levied in manyUS jurisdictions and in a few larger Canadian municipalities. In the Canadian case,however, the provincial government sets the tax rate, collects the revenues, and remitsit to the municipalities. Those cities that do levy a fuel tax generally piggyback ontostate/provincial fuel taxes, principally because the administrative costs of levying their

(24) Fifteen US states allow municipalities to levy income taxes. The method for setting local taxrates varies across states. For example, the authority to set tax rates is sometimes constrained bythe state or by voter approval. Some cities levy local income taxes on earnings; some levy onearnings and business net profits. Some cities apply taxes to nonresidents as well as to residents(Von Ins, 2001).


own taxes would be prohibitive. The revenues generated from these taxes are oftenearmarked for local roads and transit services.

A local fuel tax is not the same as a direct user charge in the sense that it does notreflect the marginal social cost of vehicle use, but it may still be considered broadly tobe a benefits-based tax (Slack, 2002). Such a tax would likely be most appropriate forlarge metropolitan areas that have transit systems which would benefit from a dedi-cated source of revenue. So long as roads are underpriced, there is a strong case tosubsidize urban transit, and a well-designed `road tax' can usefully deal with both sidesof this problem at once. However, if automotive taxation is intended to price either theuse of publicly provided services or externalities, fuel taxes are at best a crude instru-ment. Toll roads and an appropriate set of annual automobile and driver license feesare preferable. For example, vehicle fees might be based on such features as age andengine size (older and larger cars generally contribute more to pollution), location ofthe vehicle (cars in cities add more to pollution and to congestion), and axle weight(heavier vehicles do exponentially more damage to roads and require roads that aremore costly to build).

Sales taxesIn many countries the search for a regional revenue source that is economicallysensible, administratively viable, and reasonably elastic comes down to a general salestax. Given the obstacles to income taxes in most developing countries in Latin Americaand elsewhere, the only big tax that remains as a possible source of metropolitanregional revenue is probably some form of general sales tax. The general sales taxnow found in most countries is, of course, a value-added tax (VAT). The future ofthe retail sales tax, once favoured as a regional tax (Musgrave, 1983), and still in placein most US states and a few Canadian provinces, seems dim. The dominance of theVAT poses a serious problem for the finance of regional (including metropolitan)governments, however, since most tax analysts consider independent subnationalVATs either infeasible or undesirable for a number of reasons. Some emphasize highadministrative and compliance costs. Others stress the possible loss of macroeconomiccontrol and central governments' general reluctance to share the VAT base. Still othersemphasize the problems arising from cross-border (interstate) trade, arguing that, iflevied on an origin basis, subnational VATs are distortionary, and if levied on adestination basis, they are unworkableöat least in the circumstances of developingcountries.(25) While there has been much discussion in the literature about the possi-bility of implementing a VAT at the regional level in countries such as Argentina andBrazil, the reality is that as yet no one has managed to do so (Bird and Gendron, 2001).The prospect of metropolitan area governments in Latin America or other developingregions being able to introduce such taxes seems remote.

Business taxesFinally, many countries have regional and local business taxes in such forms ascorporate income taxes, capital taxes, nonresidential property taxes, transit taxes(octroi), license fees (patente), and various forms of industry and commerce taxes(Bird 2003). Most of these taxes would not score highly on most reasonable criteria.Few are equitable. Almost none are neutral. Most accentuate rather than reducedisparities between localities, giving most to those that have mostöthough this may,of course, make them especially attractive to metropolitan areas. Most also lendthemselves to tax exporting, thereby violating the correspondence principle whereby(25) A number of Indian states recently introduced VATs (Bagchi, 2005), but it probably remainsfair to say that the only well-functioning destination-based, subnational VAT now in existence isthat in the province of Quebec in Canada (Bird and Gendron, 1998).


those who pay should be those who benefit. All too many are costly to administer,especially taking into account the cost of compliance and the facility with which suchtaxes tend to become essentially discretionary in operation and, hence, the basis forcorrupt transactions.

Nonetheless, the political realities of governing in a democratic society are suchthat local governments generally impose taxes on local business. Such taxes are pop-ular with officials and citizens alike for several reasons. They often produce substantialrevenue and are more responsive to economic expansion than are property taxes.Moreover, in many countries, local governments have more discretion over the rate,base, and application of such taxes than of any other form of taxation. Since no one isquite sure of the incidence of such taxes, it is easy to claim that they are paid bysomeone other than local residents, which makes them politically palatable. In addi-tion, there is a good economic case for local business taxation as a form of generalizedbenefit tax. Specific public services benefiting specific business enterprises should, ofcourse, be paid for by appropriate user charges, but where recouping the marginalcost of cost-reducing public sector outlays through user charges is not feasible, someform of broadly based general levy on business activity may be warranted. This line ofreasoning suggests that a broadly based levy neutral to factor mix, such as a tax onvalue added, is likely the best form of local business tax (Bird, 2003). Such a tax existsin Italy (Bordignon et al, 2001), was adopted in 2004 in Japan, and was recentlyproposed both in South Africa and in France. It deserves consideration elsewhere.

Intergovernmental transfersTransfers from senior levels of government provide another important source of rev-enue for local governments in most countries, in part because ` few countries permitlocal governments to levy taxes capable of yielding sufficient revenue to meet expand-ing local needs'' (Bird, 2001b, page 114). Such fiscal imbalance can be addressed byincreasing the sources of revenue at the local level or by reducing expenditure respon-sibilities.(26) For example, large metropolitan areas could be given access to morerevenue sources, leaving unconditional grants essentially for smaller urban and ruralareas.

Grants are appropriate where services spill over municipal boundaries (for example,regional highways) so that there may be underallocation of resources to a servicebecause local decision makers do not take into account benefits that accrue to non-residents. One way to provide an incentive to allocate more resources to servicesgenerating such interjurisdictional externalities is through a transfer from a senior levelof government, particularly a conditional, matching grant (Bird and Slack, 1993). Such agrant should be conditional because it has to be spent on the service that generatesthe externality. It should also be matchingöthat is, with some local government con-tributionöto reflect the extent of the externality. In large metropolitan areas someexternalities can be internalized within the jurisdiction if boundaries are extended toinclude all of the users of the service. Nonetheless, for services that generate externali-ties beyond the borders of the metropolitan area and, for example, clearly contribute tointernational competitiveness, some transfers may still be appropriate.

Unconditional equalization grants may also be appropriate if some municipalities aresimply unable to provide an adequate level of service at reasonable tax rates, perhapsbecause the costs of services may be higher in such communities, or the need for servicesmay be higher, or the tax base may be smaller. An appropriate formula for such agrant takes into account both differential needs and capacities (Bird and Smart, 2002).

(26) Fiscal `balance' is a tricky concept (for discussion, see Bird and Tarasov, 2004,Vaillancourt andBird, 2005).


In most countries, however, it seems unlikely that large metropolitan areas shouldreceive equalization grants except perhaps in the form of capitation payments forsuch nationally important but locally provided services as education and health (Birdand Fiszbein, 1998). Large metropolitan areas generally have much larger (per capita)tax bases than smaller urban or rural areas. Economic activity and higher densities ofresidential, commercial, and industrial development contribute to a larger tax base.The higher costs of services and the greater need for services than in other urban areasseems unlikely to outweigh the much greater potential tax base in the context of LatinAmerica, for example.(27) An alternative approach to achieve equity may be to designthe governing structure to cover the entire metropolitan area. By combining richcommunities and poor communities, equalization can take place at least within themetropolitan area. Such equity concerns were, for example, the main reason that the one-tier governance model was adopted in 2000 in Cape Town, South Africa (van Ryneveldand Parker, 2002).

On the whole, both in principle and in practice, transfers are less important forlarge metropolitan areas than they are for other local governments. Indeed, in coun-tries with wide regional economic disparities there seems to be no reason why thewealthiest regions (including large metropolitan areas) should not be able to raiseand spend most of their budgets themselvesöalthough even they seem likely to remainto some extent transfer-dependent when it comes to financing education and health.To achieve this goal, however, and to reduce their present dependence on intergovern-mental transfers, not only do large metropolitan areas need an appropriate governingstructure, but they also, as a rule, need more and different revenue sources than otherlocal governmentsöas it were, a portfolio of revenues including both a property tax(for stability) and some form of income or sales tax (for elasticity).

Financing infrastructureLarge metropolitan capital works are financed mainly from central funds in manycountries. As Kain and Liu (2002) demonstrate in a study of the effect of centralgovernment financing of the metro in Santiago, Chile, however, this practice may resultboth in increased regional inequality and in distorted metropolitan growth. Metropolitaninfrastructure should generally be financed locally, and often by borrowing.

BorrowingLocal governments in most countries are not permitted to borrow to meet operatingexpenditure requirements. They are, however, often permitted to borrow to makecapital expenditures. Where the benefits of a capital investment (for example, theconstruction of a water-treatment plant) are enjoyed over a long period of time, saytwenty-five years, it is both fair and efficient to pay for the project at least in part byborrowing so that the stream of benefits matches the stream of costs through thepayment of debt charges. Nonetheless, local access to capital markets is often heavilyrestricted in developing countries (Rodden et al, 2003). Even in countries with well-developed capital markets, smaller municipalities may only be able to borrow througha financing authority or state/provincial bodyöin part to reduce borrowing costs bypooling the borrowing requirements of different municipalities. In countries in whichlocal governments can borrow directly, a municipality's bond rating largely dictatesthe rate of interest (and other features) necessary to make its bonds marketable.These ratings involve detailed assessments of municipal capacity to bear debt and toraise revenue even in depressed economic circumstances. On the whole, the size of a(27) Moreover, the costs of services in remote areas tend to be even higher than in large metropol-itan areas, owing to higher transportation costs (greater distances), higher heating costs (climaticconditions), etc (Kitchen and Slack, 2006).


municipality is negatively correlated with the interest rate attached to the debt instrument,so that smaller local governments generally pay higher servicing costs than do larger ones.Large metropolitan areas tend to have more access to bond markets than do smallermunicipalities.

Provided there is no central subsidization of such borrowing (for example, throughguarantees, explicit or implicit), financing capital investment in this way is a good ideain principle. In practice, however, some countriesönot least in Latin Americaöhaverun into substantial difficulties as a result of imprudent local and regional borrowingand have imposed tight restrictions on it.While in the long run, as Rodden et al (2003)show, such restrictions should be loosened, in the immediate future it is unlikely thatmost developing countries in Latin America or elsewhere will give even their largestcities much leeway in this respect. For this and other reasons, cities are turningincreasingly to `private' infrastructure finance.

Development chargesOne approach widely used to pay for infrastructure in the USA and Canada is throughdevelopment charges, sometimes called `lot levies' or `exactions' (Snyder and Stegman1986). A development charge is a one-time levy imposed on developers to financegrowth-related capital costs associated with new development (or, in some cases,redevelopment). These charges are levied for works constructed by the municipality,and the funds collected are used to pay for the infrastructure made necessary by thedevelopment. The rationale for charging developers for such costs is that `growthshould pay for itself ' and not be a burden on existing taxpayers.(28)

Who ultimately pays development chargesöthe new buyer, developers, or prede-velopment landownersödepends largely upon the demand and supply conditions inthe market for new housing (Slack and Bird, 1991). Over the long term, however, itseems likely that most charges imposed for new housing developments will be borne bybuyers. If properly implemented, such development charges can act, in effect, as a formof marginal cost pricing and hence induce more efficient development patterns anddiscourage urban sprawl (Slack, 2002). To succeed in this, charges have to be differ-entiated by location to reflect the different infrastructure costs. Unfortunately, fewinstances of such appropriately differentiated charges can be found in practice.

Public ^ private partnerships.The private sector can be more directly involved in the provision and financing ofpublic sector services through explicit public ^ private partnerships. Public ^ privatepartnerships involve the direct participation of one sector in a venture controlledby the other sector. Both partners contribute funds or services in exchange for theenjoyment of certain rights or future income. Partnerships may involve private partici-pation in public works or public participation in private venturesöpublic equity inprivate undertakings is common in transitional countries, for example. Under such anarrangement, a local government becomes a partner in a private profit-making projectin return for its assistance in establishing the project. For example, the government

(28) Many other levies are sometimes imposed on developers: land dedications that require thedeveloper to set aside land for roadways, other public works, school sites, or for environmentalreasons; parkland dedications that require a portion of the land used for development to be setaside for parkland, or that a cash payment in lieu of parkland be made; density bonusing, underwhich developers are granted higher densities than otherwise permitted in return for meetingconditions such as providing day care, preserving an historic building, etc; connection fees to permitdevelopers to buy into existing capacity of water and sewer facilities; and oversizing provisions(sometimes called front-end financing) that require developers to provide more infrastructure than isstrictly required for their development.


might provide property (usually land) or services in return for a share of the revenues.The private sector clearly gains from such an arrangement because its repayment to thepublic sector depends on the profitability of the venture: that is, the government sharesthe risk. On the other hand, the resulting uncertainty of the revenue stream to the localgovernment is an argument against such ventures.

Perhaps the most common form of involvement of the private sector in the provi-sion of public services is one in which a private firm contributes part of the initialcapital cost of a facility and operates it under the city's guidance for some years,ultimately transferring the facility to the municipality. Under this arrangement, thedeveloper finances the facility and then recovers its investment through operatingrevenues. The government avoids the initial capital costs and gives up any profitsassociated with the operation but gets the facility in the end. Another commonarrangement is that of contracting out for services such as water and sewers, wastemanagement, recreational facilities, and transportation. Empirical studies on contract-ing out suggest that services are usually provided at a lower per unit cost (Kitchen,2002). The efficiency gains realized by contracting out are due more to increasedcompetition than to the fact that the service is provided by the private sector.Competitive tendering promotes an environment in which contractors are forced tobe efficient. Opponents of contracting out have argued that in some instances privatesector delivery is of lower quality and requires significant monitoring by the localgovernment. Nonetheless, on the whole most evidence suggests that contracting outöup to and perhaps including the extreme of privatizationöis economically efficient.Of course, simply replacing a public monopoly with a private monopoly is unlikely tomake things better and may make them worse.

A principal advantage of public ^ private partnerships is that by relieving munici-palities of the financial responsibility for up-front capital costs they enable neededinfrastructure to be builtöeven at times when government funding is constrained(Tassonyi, 1997). Partnerships can build facilities without incurring municipal debt.The operation of facilities and programs by private or not-for-profit operators reducesmunicipal operating expenditures and may perhaps enable additional revenue to becollected. Moreover, such operations permit the public sector to draw on private sectorexpertise. Offsetting these potential gains, however, several potential risks are associ-ated with public ^ private partnerships. For the private sector, for instance, there arerisks that the regulatory framework could change and cause delays in the project. Forthe public sector, there is the risk that the public services provided may not be what thepublic wants or that the private sector may not be able to carry out its expected role.There is also a nonnegligible risk in many cases that the long-run cost of private sectorfinancing may turn out to be greater than the cost of public sector financing wouldhave been (Slack and Bird, 1991). The details of how such arrangements are structuredand how the risks are shared will determine whether or not they will be successful froma public policy perspective.

Based on experience in developed countries, metropolitan governments in develop-ing countries must, if they enter into such arrangements, be especially careful not toend up assuming the downside risk of projects while allowing their private partnersto reap any upside gains. We still have much to learn about how best to let the marketinto the business of delivering urban public services in a relevant and useful way.

Some implications for metropolitan areas in Latin AmericaOne way to sum up this very broad survey of the relationship between metropolitanarea governance and finance is to see what it implies with respect to financing metro-politan areas in Latin America. The crucial question is less how much government


activity has to be financed than what kind of government activity has to be financedand who should and can finance it. At the present time, for example, there areexamples in Latin America of most of the forms of governance discussed earlier,such as the (more or less) one-tier metro models in Quito, Bogota, and Caracas, thekind of two-tier model found in Santiago; and the limited voluntary cooperation foundin Sa¬ o Paulo; and examples of special-purpose bodies in, for example, Buenos Aires(Klink, 2005). Some metropolitan regions may be considered to be too centralizedöwhether as a result of the dominance of the central city (this has been said of Bogota attimes) or, more commonly, the dominance of the central government (as has been saidof Chile).(29) More commonly, many metropolitan regions seem too fragmented foreffective and equitable service financing and provision. Indeed, it is perhaps not toomuch of an exaggeration to say that no one who has looked in any detail at anyparticular urban region in this (or any?) part of the world seems happy with the par-ticular structure (or nonstructure) of governance that exists or with the accompanyingfinancing arrangements.

While no one answer fits all circumstances, the evidence does seem to suggest thatmost countries would be well advised to move towards developing some more effectivesystems of governance for the whole metropolitan region than now exist. In LatinAmerica, for example, no country seems to have a government structure that encom-passes the economically relevant metropolitan region.(30) The precise nature of the`best' system for any particular region is highly context dependent and the politicaldifficulties of moving very far, or very quickly, in the indicated direction are often sogreat that not much is likely to happen soon. Any change in the present structurerequires changing the allocation both of power and of money and is not going to beeasy.(31)

No quick or easy solution to metropolitan governance problems is likely in LatinAmerica. Constitutional amendments to permit metropolitan regions to have provin-cial status, for example, might be desirable in some countries but are unlikely to be putinto place either easily or quickly. Fortunately, perhaps, outcomes may be moresusceptible to change by altering financial than by altering governance arrangements.In this connection, it is especially important that metropolitan regions should beessentially self-financing. The present situation is far removed from this ideal sincemost big cities in Latin America remain highly dependent on central financial support.In the long run, however, viable solutions to the problems of metropolitan areascan be attained only when those who live there have to make the critical decisions,pay for them, and live with the consequences. Only thusöand not by some magic,central planning, wave of the wandöare the `right' decisions, albeit probably slowlyand painfully, likely to be made.

In metropolitan areas, as elsewhere, good government along these lines requirespublicly elected and responsible mayors and councils with a substantial degree oforganizational independence and full responsibility, in as open and transparent away as possible, for their own financial management. Over the last few decades many(29) As Ades and Glaeser (1995) show, most major metropolitan capitals in Latin America arealmost certainly too large as a result of the extreme overcentralization of policy and regulation thatlong characterized most countries of the region.(30) In addition to Klink (2005) and Lefe© vre (2005), see Glaeser and Meyer (2002) on Santiago,Davis and Raich (2003) and Raich (2006) on Mexico City, World Bank (2002) on Cali, Linder(2004) on Lima, and Acosta et al (1999) and Zapata et al (2002) on Bogota.(31) Davis and Raich (2003), for example, suggest that to move forward in the Mexico City region anumber of alternative (and perhaps complementary) paths need to be pursued: amendingthe constitution to permit metropolitan region governments; building on voluntary cooperation;perhaps establishing special districts; and so on. None, they say, is likely to prove easy or simple.


countries in Latin America have made considerable strides in increasing the democraticaccountability of local governments (Campbell, 2003). Almost nowhere, however, hasthis advance been matched by the improvements in financial arrangements needed toensure that this new freedom is exercised wisely. As Meyer and Glaeser (2002, page 10)correctly say:

` proper public policies will not persist (or will not be implemented adequately)unless the political institutions are designed to provide politicians with the rightincentives to implement those policies.''

In the metropolitan regions of Latin America, what is needed to begin to movetowards this ideal is, first, some form of effective metropolitan governance and,second, an appropriate fiscal structureöboth between the region and the rest of thecountry and within the region. As we have discussed, a variety of solutions may bepossible to the governance question. To improve metropolitan governance in mostcountries in Latin America, however, what seems most needed is more comprehensiveappraisal and understanding of some of the critical fiscal aspects of metropolitan areasalong the lines set out in this paper.

Acknowledgements. We are grateful to Uri Raich, two anonymous reviewers, and participants in aworkshop organized by the Inter-American Development Bank (IDB) for comments on earlier versionsof this paper. An earlier but much more detailed version in Spanish is available as Àspectos fiscales dela gobernabilidad metropolitana'', in 2005 Gobernar las metropolis Eds E Rojas, J R Cuadrado-Roura,J M Fernandez Gu« ell (Banco Interamericano de Desarrollo,Washington, DC) pp 263 ^ 347.

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An approach to metropolitan governance and finance

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