Would fiscal devolution work? Lessons from Spain

Caroline Gray outlines some of the key lessons that can be drawn from Spain’s experience of fiscal devolution between regions.

Prime Minister Andy Burnham wants to give mayors in England the power to retain a share of locally raised income tax and business rates. This is a landmark proposal for such a fiscally centralised country and the theory behind it seems sound: devolving financial powers should increase accountability, making regional leaders more clearly responsible for the consequences of their spending decisions. It should also improve efficiency by putting decisions into the hands of those closest to local realities and best able to assess needs. And it is not hard to argue that this would be preferable to the current deals-based approach to regional and local funding in England, where strategic authorities are too often left competing against one another to make their case for investment to Westminster.

Yet theory does not always translate into practice. Poorly designed fiscal devolution may create more problems than it solves. Considering the experience of other countries is a useful way to learn valuable lessons, and Spain offers an interesting example.

Spain is divided into seventeen regions, fifteen of which operate under a regional financing system that combines centrally-raised taxes, shared taxes and regional taxes (the remaining two regions have greater fiscal autonomy). Regional governments retain 50% of income tax receipts and have the power to vary rates on their share within certain parameters. Meanwhile, business rates – the other tax Burnham has proposed devolving – are set and collected by local authorities (an administrative level below the regions, equivalent to English councils), which retain the proceeds as a primary source of funding for local services.

While fiscal devolution has brought benefits to Spain, its experience also reveals lessons about what can go wrong. Spain’s regions have greater fiscal and spending powers, but their experience shows that transferring powers alone is not enough to guarantee accountability and efficiency.

Firstly, the Spanish case highlights the importance of a credible no-bailout commitment by central government, while also demonstrating how difficult such a commitment can be to enforce in practice. During the construction-fuelled boom years before the 2008 financial crisis, Spain’s regional financing system seemed to work well. Through a combination of central government transfers, regionally-raised revenues and relatively unrestricted borrowing, regional governments had ample fiscal space to pursue their priorities. Yet the model unravelled in the wake of the financial crash, when several regions found themselves on the verge of bankruptcy. Story after story about over-spending on vanity projects – including unnecessary airports – and corruption scandals surfaced.

Central government had arguably been too willing to turn a blind eye to regional spending and borrowing decisions, but once crisis hit, it could not credibly commit to a no-bailout principle either. Madrid became the lender of last resort, providing emergency support to cash-strapped regions via new mechanisms such as a Regional Liquidity Fund. Originally conceived of as a temporary measure, that Fund is still in place today.

Spain’s experience shows how difficult it would be to enforce a no-bailout principle in practice. Regardless of whether some regional governments had spent irresponsibly, could a government realistically refuse to intervene, given the implications for citizens’ access to essential services? And could it really allow regional defaults when those failures would inevitably have had a knock-on effect on perceptions of its own creditworthiness? The challenge for England if fiscal devolution is to work will be striking the right balance: enough central oversight to prevent strategic authorities reaching crisis point, but not so much control that it undermines the autonomy devolution is intended to provide.

A second lesson concerns the importance of transparency. Fiscal devolution can only increase accountability if it is clear which level of government is responsible for raising which revenues, how any redistribution mechanisms work to share revenues among regions, and ultimately where exactly responsibility for spending decisions lies.

In the Spanish case, there was never a consensus as to who exactly was responsible for the dire predicament in which many regions found themselves after the financial crisis. The regional financing system is complex, combining central, shared (‘partially ceded’) and regional (‘ceded’) revenues, alongside redistribution mechanisms that adjust for factors such as regional GDP per capita, population and geographical characteristics. These mechanisms are widely seen as treating some regions more generously than others. Did regions such as Valencia become heavily indebted because of poor spending decisions, or because they were treated unfavourably by the financing system itself? Did Catalonia’s fiscal problems stem from over-spending and corruption, or from the extent to which its wealth was redistributed to other regions? Did the Basque Country fare better because it managed its finances well, or because its fiscal autonomy model allowed it to retain a greater share of its revenues? The answer to each question is of course complex, but the lack of transparency made it possible for different political actors to promote different narratives.

The interviews I conducted with regional finance ministers in Spain for my latest research suggest that these questions remain unresolved. Explanations for regional funding challenges range from claims that the central government does not contribute sufficient resources to the system, through to arguments that a regional ‘race to the bottom’ over certain devolved taxes has contributed to fiscal pressures. Views also differ over the fairness of the technical criteria used to allocate funding. These problems are compounded by the lack of effective forums for negotiation between central and regional governments, with many regional governments feeling that those with greater political influence benefit from bilateral deals and trade-offs that are not available to others – a dynamic that could easily be replicated in England, where regional disparities in political influence already exist. England should take heed of these lessons if fiscal devolution is to succeed.

By Caroline Gray, Senior Lecturer in Politics and International Relations, Aston University.