Why theory and practice are different: The gap between principles and reality in subnational revenue systems

Ensuring adequate subnational revenue is a core concern of fiscal decentralization. Public finance principles for selecting and designing subnational revenue sources have been widely used during the prominent wave of decentralization efforts in developing countries over the past three decades. Available empirical literature, however, suggests that subnational revenue generation often fails to meet needs and expectations, even where normative advice has been or seems to have been followed. Are the principles inappropriate, or are they just poorly applied? This chapter argues that both factors are often at play. Basic principles are valuable, but they can be challenging to use and do not cover certain critical factors. Even if the principles are relevant and well applied, implementation commonly faces powerful constraints. Yet despite unsatisfying performance, revenue system design remains substantially based on a conceptually narrow normative framework that lacks a sense of pragmatic strategy and is often overwhelmed in practice by contextual factors it fails to or only weakly considers. The necessity for “context specific” fiscal decentralization reforms is by now well accepted. Bahl and Bird (2008) recently underscored the need for adopting an inductive approach that helps to determine what works rather than a deductive one that makes theoretical statements about what should work. Less explicitly recognized is that the breadth and diversity of relevant contextual factors extends well beyond the realm of those typically considered, such as political will, level of development, federal versus unitary system, public sector capacity, etc.