IN order to make a federal system of administration meaningful and effective, the smaller states that would be created will require reliable sources of sufficient revenue to carry out the myriad of government functions they will be inheriting from the central government.
Of the many things that could dampen the new-found enthusiasm for creating a federation, the realities of paying for it are probably the worst, and will likely be the reason for the initiative’s failure. That is not an inevitable outcome, but a highly probable one that depends on how much financial power the central government is willing to sacrifice.
In general terms, the sources of revenue for the government are income taxes levied on individuals and businesses, which also include things like capital gains and estate taxes; loans in the form of proceeds from the sale of debt instruments such as government bonds; property taxes; the value-added tax (VAT); customs duties, or taxes on imports; excise taxes on certain goods such as fuel, luxury goods, and tobacco and alcohol; income from government investments; revenue from the operations of government-owned and -controlled corporations; royalties from mining and petroleum operations; loans and grants from foreign governments and institutions; fees and costs levied for government services; and miscellaneous collections, such as fines and penalties.
Under the current system, the bulk of those revenues are collected by the national government, with the one significant exception being property taxes. Even these, however, are constrained by national-level law, being uniformly set at two percent of the assessed value of real property in the NCR and one percent elsewhere. Apart from property taxes, other sources of revenue at the local government level are miscellaneous fees and levies, which only serve to defray a small part of the cost of government functions, and allotments from the national government, primarily the internal revenue allotment—the biggest source of funding for LGUs—and a share of royalties from mining and petroleum operations.
There are two ways to look at the devolution of government revenue. In a legitimate federal system, the individual states have their own sources of revenue, and the federal system develops its own sources independently, which might include certain levies against the states—essentially a form of annual dues for membership in the federal union. A simple example that has gained recent attention is the proportional contribution paid by the individual member countries of the European Union; the potential loss of Great Britain’s annual payment of about 8.5 billion has caused a great deal of consternation in Brussels.
In the US system, since that is the one local advocates of federalism are aping, whether they like to admit it or not, the federal government’s main sources of revenue are income taxes (including mineral royalties), excise taxes, customs duties, and proceeds from debt instruments. The states, on the other hand, have a somewhat broader set of options; of those sources of federal-level revenue, the only ones the states cannot also tap are customs duties and to a large extent excise taxes (although there are some the states can impose), since those are trade-related. Sales taxes—what we call VAT here—are collected at the state and even sometimes the county or municipal level, and states can impose their own income taxes, mineral royalties, and issue their own debt instruments; property taxes, as a rule, are collected at the local level, but the organization of those is left to the individual states, and not dictated by a national law.
If the intention, therefore, is to create a true federal system here, in the context of revenue collection the national government could legitimately lay claim to customs duties and some excise taxes, where those are generated as a result of interstate or international trade; it could continue to collect income taxes with the rationale that individuals and businesses are citizens of the nation, but would have to sharply reduce those to allow the states fiscal room to impose their own. The national government would have to give up the VAT, and abolish the law setting the rates of property taxes, because those are tantamount to restraint of intrastate trade in their current form. It could continue to collect revenue through other currently used means, but would in most cases have to make downward adjustments in order to allow the states space to manage their own finances.
If instead the intention is to simply reduce national-level revenue collection by an amount deemed necessary to fund the powers devolved to the states—which seems to be the general concept under consideration—then what is being created is not a true federal system in which central government authority is derived from the consensus of the states, but rather a still-unitary system with a somewhat more equitable balance of authority between the national and local levels.
That could still work to bring the better political and economic management proponents of federalism are seeking, but carries with it a much bigger risk of creating inequities or perpetrating existing ones among the various regions of the country, simply because of the increased complexity in the design of the government model.
Again, the current troubles of the EU provide a simple example; the one-size-fits-all approach is clearly not working to sustain what the EU’s creators envisioned, with a majority of people in one country wishing to drop out of the club, and several others (notably Greece and Italy) being put in bad financial straits by their particular inabilities to align their economic management with a model that in any other context wouldn’t match their specific circumstances.
Clearly, a great deal more study and national soul-searching is needed before the country embarks on a change of this magnitude, but that requires time and a level of objectivity that the current political system may not allow.