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Sharing of natural resource revenues Ehtisham Ahmad * * Based on work with Giorgio Brosio. The views in this presentation are personal and do not reflect those of the IMF, its management or Board of Directors. Issues Instruments choice: assignment of own-revenues from natural resources Efficiency considerations Accountability Macroeconomic issues What does experience show? Political economy considerations Transparency for good governance For discussion of Political Economy considerations see: Ehtisham Ahmad and Giorgio Brosio (eds), 2006, Handbook of Fiscal Federalism; and Ehtisham Ahmad and others: Emerging Issues in Fiscal Federalism (forthcoming) For transparency related issues: IMF, 2007, Guide on Resource Revenue Transparency Stylized facts Characteristics of natural resource exploitation: Huge geographic concentration of production; Sparsely populated regions may exercise small weight in national politics; Large disparities in per capita revenue of subnational units; “Boomtowns” phenomenon; Large, but unpredictable, fluctuations of price; Growing demands from producing area to retain a (large) share of oil rent create pressures, rivalries and strain on national unity. Instruments for sharing “economic rent” between levels of government Separation of taxes: for example, royalties to subnational governments and income tax to central government, or vice versa; Concurrence of taxes: each level of government levies taxes on oil rent (tax base sharing); Revenue sharing: revenue is collected by one (usually, the central) government only and shared to other levels; In kind sharing: contractors provide infrastructure to the producing areas; Intergovernmental transfers. Illustration of instruments for sharing rent Separation of taxes: Ri= tiBi, where collection (or revenue), Ri, is equal to locally determined share, ti, of the locally determined tax base, Bi., i is region/state Concurrence of taxes: Ri =(ti + li) Bi, where Ri are the total collections in jurisdiction i of the shared tax; li is the locally determined tax rate applied to the nationally determined tax base, Bi. Local revenue is ri = li Bi. Tax revenue sharing: the tax bases, the tax rates and the revenue shares are determined by the central government and the revenue is allocated according to the principle of origin: ri = α t Bi; or, ri = α Ri. Instruments for sharing rents from petroleum with subnational levels of government Method Own taxes Determination of Sub national the tax base Sharing of tax bases National Sharing of revenue National Sharing of Intergovernmental revenue in kind Transfers Mostly national National Mostly national Determination of Sub national the tax rates Sub national (within limits) Administration Mostly national National Sub national National National By the producing firm Origin Mostly national Origin Criterion for Origin determination of the beneficiary jurisdiction Origin Need, equity or other Choice of Sharing Instruments Arguments against subnational taxation of oil rent: Complexity of administration: collection by the most efficient means higher revenue; Delays in revenue accruing to the center Possible secessionist trends. Arguments in favor of subnational taxation of oil rent (the point of view of LGs): Benefits associated with taxing power; Direct control of revenue North American models—USA and Canada. Choice of Sharing Instruments Arguments against concurrent taxes Vertical tax competition can lead to greater overall tax burden; This applies especially to royalties. Complexity in coordination and administration Assignment of natural-resource revenue to subnational government Arguments against sub-national assignments (all natural resource revenues) Inefficiency in geographical allocation of factors of production Inefficient spending due to limited absorption capacity location of firms in oil producing areas with no comparative advantage; More resources than needed in Arauca (Colombia); Cajamarca (Peru) Possibilities of sub-national corruption; Volatility in prices: sub-national governments generally less able to absorb. Assignment of some revenue to subnational government Arguments for assignment (of some revenues, e.g., production excises) Localities should finance additional costs of investment in infrastructure. Peak load pricing: expansion of capacity paid by those who use it Compensation for environmental damage Examine adequate instruments for these purposes. Choice of sharing Instruments Revenue-sharing is most used : Political-economy rationale—automatic sharing in national resources But, difficult to agree on sharing percentage Acheh discussion Could enhance regional inequalities Usually considered as part of a “package” Revenue sharing: Alleviate or exacerbate political conflict? Sharing the “pie” stokes conflict (Nigeria) Symmetric and contract federalism: Sharing of revenues with all levels of governments (not only states/regions) Districts/Municipalities may have different political objectives (Indonesia); Central government could use intersecting policy instruments, construction of national infrastructure by resource-rich jurisdictions; such as “trade and commerce” clause to build unity Concurrent use of instruments, including redistributive transfers Ensures that all regions and governments have stake in the union— with federal management of natural resources What is the experience? Issues What is the practice of sharing of oil-revenue rents in multi-level countries? What do the numbers tell us? How to ensure transparency and equitable distribution? Political economy and maintenance of national unity Instruments to collect natural resource economic rents Instruments (as explained in the previous lecture) Auctioning of exploration and exploitation rights Government equity in projects Production sharing Taxes/royalties The best strategy for the government depends on its degree of risk aversion. Political economy constraints are important; and A combination of instruments may be needed. Tax instruments Fixed fees Specific (or, ad valorem) royalties non-neutral but largely used Income tax with-higher-than normal tax rate Progressive income tax Resource rent tax almost neutral allows extraction of total rent Instruments for sharing rents Separation of (own) taxes Concurrence of taxes (tax base sharing) Revenue sharing Intergovernmental transfers Table 1. Classification of Oil Revenue Assignments in Unitary and Federal Countries Full decentralizat ion Shared revenue bases Algeria Azerbaijan Bahrain Indonesia (until 2000) Iran Iraq (under discussion) Kuwait Libya Norway Oman Qatar Saudi Arabia United Kingdom Yemen Unitary countries Federal countries Full centralization United Arab Emirates 1/ 1/ Upward revenue-sharing arrangement. C: Rather centralizing arrangement. D: Rather decentralizing arrangement. Revenue sharing Colombia (D) Ecuador (C) Indonesia (since 2001) (C) Kazakhstan Canada United States Mexico (C) Nigeria (D) Russia (D) Venezuela (D) Sharing of oil revenues Considered, or adopted in many parts of the world (Nigeria, Indonesia, Sudan) • Political economy arguments widely used Finance basic expenditures “persuade” oil producing regions to stay in the federation—political economy Could finance infrastructure in other regions: national cohesion Revenue-sharing mechanisms Oil revenue is collected centrally and redistributed according to a formula Convenient way to transfer fiscal resources to subnational governments Can be supplemented by transfers to address equalization concerns or special regional needs But: drawbacks for macroeconomic management, including volatility; and May exacerbate tensions and conflict. Difficulties with oil-revenue sharing •Volatility with respect to price (and production) changes • Difficulty in establishing a percentage •Indonesia and Nigeria • May generate unsustainable spending in upturns • Inadequate revenues for basic spending in downturns • Inefficiency in geographical allocation of factors of production • Location of firms with no comparative advantage Table 2: Oil Revenue Volatility in Selected Countries, 1997-2000 Oil revenue Volatility (in percent of GDP) (in percent) 1/ 2/ Total revenue Volatility and grants (in percent) (in percent of GDP) 2/ 1/ Oil revenue (in percent of total revenue) 1/ Unitary countries 3/ Azerbaijan Algeria Bahrain Colombia Ecuador Indonesia Iran Kuwait Libya Norway Oman Qatar Saudi Arabia Yemen 16.6 5.7 21.4 13.0 2.6 7.4 5.6 13.3 38.6 23.0 8.9 30.2 16.7 24.6 21.6 27.6 29.1 25.9 26.3 38.3 32.1 32.7 42.0 19.2 8.0 30.8 15.6 27.4 27.4 31.9 32.8 19.6 32.7 24.6 27.7 25.1 17.5 25.5 60.7 39.0 52.3 39.5 28.6 33.6 33.1 12.6 5.1 13.3 15.1 2.8 15.9 11.5 18.2 13.3 14.7 4.0 6.9 19.9 15.5 20.4 48.2 28.6 64.4 51.9 9.4 31.3 31.1 49.8 63.0 59.9 16.9 76.0 57.3 72.0 63.8 Federal countries 3/ Canada Mexico Nigeria Russia United Arab Emirates United States Venezuela 12.7 7/ 5.3 23.8 3.8 18.2 8/ 12.2 28.2 25.9 17.7 39.3 26.4 22.4 31.1 34.6 29.0 46.2 21.5 31.8 13.1 34.6 29.9 25.9 9.9 0.5 4.4 28.6 14.2 6.3 1.6 13.8 44.7 … 24.7 72.4 28.8 52.0 … 45.7 Source: Ahmad and Mottu , in Davis, Ossowski and Fedelino (eds.) 2003. 1/ Average during 1997-2000. 2/ Defined as the standard deviation in percent of the mean over the period 1997-2000. 3/ Unweighted average. Coverage General government Central government Oil and gas Nonfinancial public sector Nonfinancial public sector Oil and gas. General government. 4/ Oil and gas. Central government. 5/ Oil and gas. 6/ Consolidated government General government 4/ Central government Central government General government. 4/ Public sector. Excludes excises on gasoline General government Oil and gas. Federal government General government General government. 9/ Public sector (excl. nonrecurrent operations) Chart 1: Volatiliy of Total Revenue in Selected Oil-Producing Countries, 1997-2000 Standard deviation of total revenue (in percent of average) 30 25 20 15 10 5 0 0 10 20 30 40 50 Oil revenue as a share of total revenue 60 70 80 Assigning Revenue Bases Assignment of specific oil revenue bases to subnational governments Tax bases may be overlapping Subnational governments are accountable National equalization system may take oil revenue into account by not providing or limiting equalization transfers to oil-rich regions Examples: Canada, United States Assigning revenue bases (II) Cover additional costs of investment in infrastructure: expansion of capacity paid by beneficiaries Compensation for environmental damage environmental excise directly linked to production An oil fund/ “Alaskan dividends” Providing dividends to citizens directly Idea of “dividends” appears politically appealing, especially if Assets managed externally BUT “Alaskan fund/ dividends” With significant deficits, diversion of oil revenues would exacerbate catastrophic fall of spending (e.g., proposals for Iraq) especially with limitations on Borrowing Non-oil revenue sources May lead to a reduction in needed investment or other priority public expenditures Amounts to be distributed as dividends would be small (especially if there are considerable external debts) “Alaskan fund/ dividends” (contd.) May be difficult to target, Political economy of by passing weak administration may not be effective— Still need to be administered Possibly weaker oversight of fund May generate a parallel budget, with poor transparency and oversight Would take years for the dividend to grow into any significant payments Ensuring transparency All revenues through central account of Treasury (TSA) If stipulated; Regional shares to regional TSAs from Central TSA Transfer mechanisms clearly defined (discussed by Boadway) If Stabilization Fund, all resources through budget, and no spending without appropriations “Norwegian” model Accountability and transparency Financial management system design: Transparency code Penalties for misreporting and misuse Probability of detection and oversight Independent audit (EITI) Information flows Centrally determined formats for Budget classification (GFS2001 and UN COFOG); Tracking and reporting expenditures Managing cash Importance of Treasury Single Accounts Setting up separate funds could weaken transparency # Not inconsistent with decentralized operations Consistent reporting and transparency Principles common to all level of governments and agencies Need for timely and complete information on the finances of subnational governments, as well as of the center: Including information on oil revenues Assurance through improvement in reporting and audit mechanisms Require work on the budget classification, common reporting formats Macroeconomic considerations Focus on non-oil revenues Resources as wealth: consume revenues consistent with permanent income expectations Ossowski and Barnett (2003) in Davis et al Better position on the macroeconomic stance, risks and long-run sustainability Evaluation of fiscal risks and contingent liabilities; including from sub-national operations PPPs: evaluate full costs and benefits Do resource related Funds help? Kuwait future generations; Iran Preconditions important: Clear operational rules and responsibilities Presentation of fund operations to Legislature together with regular budget No direct spending from the Fund (everything to be appropriated in the budget) Activities reported to Parliament Neither Kuwait not Iran meet these conditions “Norwegian style” stabilization fund Clear oversight of investments Subject to strict reporting and audit Prevents parallel budget arrangements Transparent mechanisms, but difficult to replicate with weaker political systems Conclusions Various instruments available for “maximizing” the government’s take Institutional arrangements vary— political economy driving factor Efficiency, revenue and macroeconomic considerations important Ensure transparency and good governance