Fiscal federalism and Fiscal Autonomy: Lessons for the UK from other Industrialised Countries

et al., 1981), a phenomenon which has become known as the ‘flypaper effect’ (ie grant
money sticks where it hits). The usual economic explanation for this observation is that local
politicians will not be compelled to cut taxes in response to increases in grant, but will
behave differently when local income increases and raises taxation yields. Although evidence
on the ‘flypaper effect’ tends to be limited to federal countries where there is substantial
fiscal autonomy, and therefore greater scope to test the hypothesis, it seems likely that local
politicians tend to be more accountable with respect to local taxation decisions than centrally
determined grant allocations. Unfortunately, beyond this indirect evidence, there is little
comparative empirical evidence across OECD countries on whether there is over- or under-
provision of public services, and on whether there are significant differences in willingness to
pay taxes to fund public services between sub-central governments in the UK and in other
comparable countries.

However, the literature on fiscal federalism also provides clear guidance on the limits that
should be imposed on fiscal autonomy. Four arguments can be highlighted here. First, the
usual argument against complete fiscal autonomy is one of equity⁹: jurisdictions with
different levels of income and wealth will have very different tax resources at their disposal,
and the need to ensure that citizens have access to a roughly equal level of public services
will imply some degree of redistribution between sub-central governments. For this reason no
industrialised countries, not even federal states, have opted for complete fiscal autonomy.
Redistribution can be achieved either through the use of transfers funded from general
taxation, or through some kind of ‘pooling’ arrangement between the sub-central
governments, or by implementing tax-sharing arrangements designed to benefit poorer
because they pre-date the post-1996 reforms.

⁹ We should distinguish the equity argument from that of insurance over the business cycle. Maintaining a
centralised system of welfare benefits will allow a system of insurance to be maintained even in the presence of
substantial fiscal autonomy.

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