It might be helpful, as we take up the pesky issue of the wherewithal of federalizing, to find out how others have divided the pie and allocated resources between the central government and the sub-national entities.
Khairil Azmin Mokhtar did an interesting study that he titled “Federalism in Malaysia: A Constitutional Study of the Federal Institutions Established by the Federal Constitution of Malaysia and their Relationships with the Traditional Institutions in the Constitution.” For a federal state to exist both in law and in fact, Mokhtar argues, both the federation and the sub-national governments should be guaranteed financial independence, to enable each level of government to perform its constitutionally ordained functions. By this premise, it will not be correct to ask how the central government will finance the regions. The very question suggests that one is still confined to the unitary paradigm of a central government allocating funds to local governments. Rather sub-national units should have revenue generating power to a degree markedly greater than that conceded either by constitutional provision or by statute (largely the latter) to local government units. States or regions constituting the federation should not await the goodwill or the benevolence of the grantor. Says Mokhtar: “The grant is a constitutional right of the receiving government, and the right is essential to maintaining its sovereignty and independence as an equal partner in the federation.”
But Mokhtar admits that in Malaysia, that fiscal and monetary policy are federal concerns entrenches the strength and the centralized position of the federal government, and although the states of Malaysia are given the means by which to raise their own revenues, they are still chiefly dependent on the federal government. And so he laments that prosperity and woe on the state (sub-national) level depend on alliances and allegiances. “Good and cordial relations exist between federation and state if they are of the same party, however the relationship between federation and states governed by the opposition party is to the contrary.” One experience is instructive. There was nothing in the Malaysian Constitution that stood in the way of states entering into financial arrangements with a company. And when one state demanded advance payment of royalties, this certainly afforded the contracting state some relief. But the question was soon raised as an issue of law whether advance payment of royalties constituted a “loan” that states were forbidden from contracting. While the Federal Court held that such payments did not bear the character of loans, Parliament was unhappy about the derogation of its fiscal supremacy and the diminution of its control—and it amended the law in such wise as to make such payments subject to the approval of the federal government.
For German federalism, an elementary principle is “fiscal equalization” which includes both vertical equalization—equalization between different levels—and horizontal fiscal equalization— which refers to transfers within the same level. Arthur Gunlinks study entitled “The Länder and German Federalism” in the Issues in German Politics series, identifies five stages of fiscal equalization. There is first the vertical distribution of separate and joint tax ventures. The Federation and the Lander have an equal claim to current revenue to cover costs of government on their levels, endeavoring, as far as practicable, at a fair balance, avoiding an overburdening of taxpayers and providing uniformity of living conditions in the territory of the federation. The general rule is that one source of funds can be taxed on only one level. But it is also clear that German federalism eschews the principle that the federation has the principal right to income generation only with the attendant obligation to share the Länder. The second stage of the equalization scheme is “horizontal distribution of joint tax revenues”. The Länder derive their income principally from personal income tax and corporate tax—with corporations taxed at the place where the production facilities are to be found, rather than at the location of the head office. Under this stage, the “local yield principle” also obtains: the Länder keep what they yield. Obviously, this means that the rich sub-national entities remain rich, while the poor continue to chafe in their misery, although the poorer Länder have consistently argued that the funds should be distributed on the basis of need or population. The third stage, “horizontal distribution based on tax capacity” where the needs of the Länder that have revenue below the per capita average receive supplementary funds from what is left of the VAT, after 75 percent has been distributed to the different Länder. In other words, 75 percent of VAT is distributed to the Länder on the basis of population—and when the revenue of the unit still remains lower than the per capita average, from the remaining 25 percent of the VAT is taken what is needed to approximate equalization of Länder share. Horizontal fiscal equalization refers to same-level transfers from richer units to poorer units, allowing for differentiated assistance. This allows the Länder to provide as far as possible the same services to all Germans. Finally there are federal supplementary grants—transfers from the federal government designed to diminish disparity between the sub-national units.
Under the Constitution of India, there are two gigantic consolidated funds: “the Consolidated Fund of India”— consisting of all revenues received by India and loans raised through the issuance of treasury bills and all moneys received by the national government. By contrast “the Consolidated Fund of the State” consists of revenues received by the Government of a State as well as loans it raises by the issuance of similar bills. Instructively for us, Shukla (updated by Pal Singh), writing on the constitutional law of India wryly comments: “In any Federation, the problem of allocation of resources is necessarily difficult, since two different authorities (the national and the regional governments each with independent powers) are raising money from the same body of taxpayers. The constitutional problem is simplified if it is possible to allocate separate fields of taxation to two authorities. But the revenues derived from such a division, even where it is practicable, may not fit the economic and financial requirements of each authority.” Thus it is that the Constitution of India attempts a solution to the problem by itemizing what revenues from which sources the federation may raise and which, in respect to the States.
What is clear however is the necessity of some central coordinating body that constantly calibrates the delicate balance between the needs of the federation as such and the regions or the states. Equally important is the role of the Supreme Court of the Constitutional Court (in the case of the ConCom Draft, the Supreme Court) that will rule with definitiveness on which revenues are properly federal, which are regional. Ratnapala and Crowe, commenting on the Australian Constitution, teach, like the Germans, that the balancing act must involve “vertical fiscal balance” which occurs when regional units have flexible sources of revenue that allow them to deliver the services they are obligated to render, and horizontal fiscal balance which is disturbed when there is gross disparity between the incomes and the revenue of sub-national entities. They propose four conditions for the economic viability of a federation: the free movement of goods and services, capital and people across borders; the grant of power to the central government to legislate with respect to interstate and overseas trade and commerce compatible nonetheless with the autonomy of the regions; the grant of power to state governments to legislate with respect to trade within the state; finally, the grant of fiscal power to the central and state governments in proportion to their need to carry out their administrative operations and provide essential public goods within their levels.
Two things are clear: It is not reasonable to expect a hard and fixed formula for the minutiae of allocation at the very outset, although general parameters and margins must be set. Also, the allocation of resources, the sharing of revenue and the distribution of fiscal powers will be as analogous as the very concept of federalism—since, I have always maintained, that while there are some elements that mark a federation in contrast to a unitary state, federalism takes many forms and admits of different permutations.
We cannot be spared these shadows that presage the dawning of a different day.