Fiscal Federalism 2022

Making Decentralisation Work

Report

20 December 2021

9. Intergovernmental fiscal relations and the COVID-19 crisis: Early lessons

Abstract

With all levels of government involved in handling the COVID-19 outbreak, intergovernmental relations have a crucial role to play in designing and implementing an effective response to the crisis. This chapter analyses the responses countries have taken through the channel of intergovernmental relations to tackle the pandemic at different stages of the crisis, highlighting lessons learnt. Not only have intergovernmental relations shaped the response to the crisis, but the crisis is shaping the future of intergovernmental relations. As the world economy and societies are going through radical changes due to the pandemic, fiscal federalism may have to adapt to the post-crisis period, when there are higher regional inequalities and greater interdependence between central and subnational policies.

Introduction

The COVID-19 pandemic is arguably one of the most disruptive events of the past century. The outbreak has affected daily life in unprecedented ways and might lead to permanent changes in our society. From our daily routines to economic policy, from public health to democracy, it is likely that the implications of the outbreak will be permanent and overarching.

When it comes to the implications of COVID-19 on policy making, one of the most widely discussed topics is fiscal federalism – that is, the division of governmental functions and financial relations across levels of government. The division of power across levels of governments is considered an efficient method for securing freedom in democracies (von Hayek, 1960[1]) and for maximising aggregate welfare, as each jurisdiction can choose its own public consumption bundle as opposed to when the same bundle is provided across all jurisdictions (Oates, 1972[2]).

In a crisis in which: a) containment measures have led to stringent restrictions to movement and freedom with substantial and asymmetric costs, b) the impact of policies and the regional severity of the crisis might affect neighbouring jurisdictions (i.e. via regional spill-over effects), c) tools to address the crisis are shared across levels of government, it is expected that there will be no unanimity with regard to the measures that should be taken and how these measures should be co‑ordinated, leading to tensions concerning the decision-making autonomy of different jurisdictions and levels of government.

It is important to note that this tension is inherent in the asymmetric preferences across regions and the importance of distribution of power for securing freedom in democracies and is, therefore, not created by fiscal federalism. Actually, fiscal federalism can be the institutional solution to these issues and, therefore, in the context of COVID-19, having a well-functioning fiscal federalism system and intergovernmental relations framework are key to address the challenges of an asymmetric and severe crisis.

The objective of this chapter is to analyse the measures employed by OECD member and partner countries through the channel of intergovernmental relations to tackle the COVID-19 outbreak throughout the different stages of the crisis and to discuss lessons learnt and the future outlook. Experiencing a crisis can give crucial lessons to improve our current systems and procedures. The COVID-19 crisis, although painful, should not be wasted and should be leveraged to improve fiscal federalism across countries in a permanent manner.

This chapter is organised as follows: the first section provides a framework to separate the COVID-19 crisis into three different stages and summarises the main challenges related to intergovernmental relation in the context of the current outbreak. The remaining sections focus on intergovernmental fiscal challenges and measures employed/suggested for tackling the crisis at its different stages. The second section covers the emergency phase, in which there was substantial uncertainty with regard to the impact of the outbreak and relative scarcity of medical equipment, leading to more extreme and centralised measures. The third section covers the resolution phase, characterised by the advent of vaccines that can pave the way to the end of the pandemic and by the enhanced understanding of the impact of containment measures and treatments. And the fourth section discusses how federalism can adapt to the disruptive changes that wil likely occur as a result of the outbreak and how intergovernmental policy levers can be adjusted to hasten the recovery of the economy.

Box 9.1. Summary of the main findings

Key findings of this chapter include:

The role of subnational governments and intergovernmental relations in tackling the crisis has varied substantially across countries depending on: 1) SNGs’ spending and revenue assignments; 2) SNGs’ discretion over tax policy; and 3) the intergovernmental grant systems and co‑ordination mechanisms in place.
State-of-emergency laws were used with great variety in OECD countries, with one group of countries effectively centralising decision-making power in the hands of the central government, while another group either did not declare a state-of-emergency or declared it but allowed SNGs to design and implement regionally targeted policies.
Some countries had problems with their state-of-emergency law and/or emergency framework. As they were not used often, the distribution of power across levels of government was, in some cases, unclear or suboptimal, leading to judicial disputes. Thus, it is now possible to fill the gaps of these laws, leading to a more predictable response in future crises.
While OECD countries have adopted centralised approaches twice as frequently to tackle the COVID-19 pandemic, both a centralised and a decentralised approach can be successful in containing the virus, as long as different levels of governments co‑ordinate themselves well.
Centralisation or decentralisation without effective intergovernmental co‑ordination has led the responses of some countries to be suboptimal. Regarding the former, costly measures were imposed throughout the whole country even if the outbreak was localised while in the latter case regional disparities in health capacity and lack of intergovernmental co‑ordination led to a suboptimal management of the resources.
Intergovernmental co‑ordination in the early stages of the crisis was particularly important for: 1) increasing the pool of resources available to tackle an asymmetric crisis within regions; 2) creating economies of scale in the procurement of equipment; 3) communicating consistently with the public; 4) promoting diffusion of effective policies and procedures; and 5) enhancing policy homogeneity in decentralised approaches.
Countries have been using a variety of institutions to co‑ordinate policy responses across levels of government and sectors. Some of these bodies were created with the purpose of handling emergencies while others re-oriented pre-existing bodies. Countries can keep these bodies after the crisis to enhance intergovernmental co‑operation lastingly.
Countries in which an emergency institutional framework already existed prior to the crisis called upon these to co‑ordinate a national response vertically (i.e. across levels of government) and/or horizontally (i.e. within the same level of government) in a more quick and predictable manner. Thus, having an intergovernmental co‑ordination mechanism in place prior to a crisis can be particularly helpful to enhance co‑operation when it is needed the most.
The role of different levels of government in vaccination programmes was kept mostly unaltered. In most cases, central governments were responsible for vaccine procurement, distribution, and, when necessary, financial support while SNGs for administering doses to local populations. This approach was largely successful in reducing regional disparities in vaccination access.
The fiscal impact of the crisis in its peak (fiscal year of 2020) was asymmetric across levels of government, with central governments having the largest increase in expenditures and decrease in revenues as compared to SNGs. This can be explained by the fact that central governments by and large: 1) rely more on buoyant taxes than SNGs; 2) are responsible for most social and business protection programmes; 3) provided more tax benefits and deferrals to tackle the crisis than SNGs; and 4) provided generous financial support to SNGs.
To support SNGs’ fiscal capacity to tackle the COVID-19 pandemic, central governments have stepped in, typically through additional grants, with no conditions attached, and through the lifting of fiscal rules. Loans and guarantees were used only by a minority of countries, all of which also provided support through grants. Hence, in most cases the support imposed substantial costs to central governments.
In the next years the fiscal burden of the crisis might shift from central governments to SNGs because: 1) in some countries grants' value are based on tax revenues from the previous year, affecting SNGs with a lag; and 2) central governments resorted substantially to deferrals, which leads to a postponement of tax revenue collection.
The COVID-19 crisis impacted sectors asymmetrically, as the necessary containment measures affected more heavily sectors related to tourism, food and accommodation. As economic activities vary across regions within countries, some jurisdictions were significantly more affected than others.
Regional asymmetries can be reduced not only with targeted fiscal support to SNGs but also with targeted income support to households. Income benefits to households can indirectly generate revenues for SNGs as these benefits are likely to be converted into household consumption and can be used to pay local taxes such as property taxation.
The COVID-19 crisis might generate structural changes to the economy, which can bring the necessity to reform intergovernmental fiscal relations.

The role of intergovernmental relations to tackle COVID-19

A framework consisting of three pillars synthetises good practices related to fiscal federalism: 1) fiscal capacity; 2) delineation of responsibilities across levels of government; and 3) intergovernmental co‑ordination. Figure 9.1, below, provides a quick summary of these challenges in the context of the COVID-19 pandemic (for more details on this framework see the first chapter).

Figure 9.1. Synthesising of challenges in intergovernmental relations to tackle COVID-19

Challenges related to intergovernmental relations varied across countries

Challenges related to intergovernmental relations and practices vary across countries depending on the degree of subnational autonomy, scope of SNGs’ responsibilities and characteristics of the existing intergovernmental relations framework, all of which are unique for each country. First, spending and revenue assignments vary widely across OECD countries (Forman, Dougherty and Blöchliger, 2020[3]), which drastically impact the roles of SNGs in tackling a pandemic. Second, the discretion that SNGs have on their tax policy differs by country (Dougherty, Harding and Reschovsky, 2019[4]), which leads to a varying degree of subnational dependency on central support. Third, each countries’ intergovernmental transfer framework1 has its own features, which greatly affects the funding and autonomy of SNGs. This is particularly relevant due to the fact that grants usually represent a substantial portion of SNGs revenues. Fourth, the intergovernmental co‑ordination mechanisms in place before the crisis and/or established to be used in case of emergencies can greatly affect the measures adopted and their effectiveness.

In the context of the COVID-19 crisis, public services related to health, public order and safety, and social protection were especially2 pressed by the pandemic as containment measures, income support and treatment of the ill have prominently involved these government functions. As of 2019, SNGs are, on average, responsible for 34%, 23% and 18% of the general government’s expenditure on health, public order and safety and social protection, respectively (Figure 9.2).

In a survey of policy responses to the first wave of the pandemic, two challenges seemed to be more common in decentralised countries: overlapping activities between levels of government, and asymmetrical impacts or needs while financial compensation was more often reported as a challenge in centralised countries (OECD, 2020[5]). This suggests that countries face different challenges depending on the degree of (de)centralisation.

Figure 9.2. SNGs’ expenditure as a percentage of those of general government on selected government functions

Challenges also varied over time with the different phases of the pandemic

It is common to divide pandemics and epidemics into waves of infections, which occur partly due to changes in human behaviour, government responses and knowledge of the virus over the course of an outbreak, generating a different dynamic for each wave (Maragakis, 2020[6]). Figure 9.3 shows wave patterns for the COVID-19 pandemic in OECD and partner countries.

Figure 9.3. Number of COVID-19 related deaths per month in OECD and partner countries

In this chapter, we divided the virus outbreak into three phases: emergency, resolution and recovery phases. In short, the emergency phases coincide with the first wave of the pandemic, the resolution phase with the second wave and the recovery phase represents the phase in which countries must focus to recover from the social and economic effects of the pandemic.

Emergency phase

Context of the emergency phase

The COVID-19 pandemic caught authorities by surprise in the first trimester of 2020 and forced authorities to make important decisions and take action under deep uncertainty. In a matter of months after the first reported cases at the end of 2019, the COVID-19 virus had spread from China across the globe.

At this early stage of the outbreak, little was known about the actual mortality rate of the virus, nor about the effectiveness of treatments and containment measures. There was a shortage of medical equipment, personnel, and space to diagnose, test and treat the voluminous number of ill people.

It was under this great uncertainty and lack of preparedness for such a crisis that, in order to protect citizens, governments quickly designed and implemented responses to the first wave of the outbreak. On 21 February 2020, the day that Italy reported its first COVID-19 related death, the Italian central government announced that public spaces were closed in ten Italian towns in northern Italy (Kantis, Kiernan and Bardi, 2021[7]). Enforcement of severe lockdowns started to pop up everywhere around the globe, following Italian footsteps. Lack of capacity to diagnose, isolate and treat patients has led countries to employ measures to boost and optimise health system capacity by mobilising staff, medical supplies, and space through very creative means (OECD, 2020[8]).

Policies related to intergovernmental relations were designed and implemented under this same uncertainty and pressure.

Delineation of activities in the emergency phase

Responses’ degree of centralisation varies in terms of timing, substance and process

Centralised responses consist of central authorities proposing policies through executive orders, legislation or regulation in a manner that the same policy applies to the whole country. Decentralised responses are a result of a multitude of policies designed and implemented by every jurisdiction based on their responsibilities as assigned by primary law or the constitution. In practice, it was observed that even in centralised responses central governments have often provided some degree of autonomy to SNGs with regard to the substance, process and/or timing of the measures.

It is worth noting that substance and timing of policies are, to some extent, interdependent. In other words, depending on the state of the outbreak in a given locality (i.e. timing), different measures (i.e. substance) are recommended to maximise containment while minimising social-economic impacts. Precisely, when the daily infection rate is: a) high, containment policies that reduce mobility are more likely to control the virus; b) low, test-and-trace policies in combination with mandatory use of masks and restrictions of large events offer a better alternative (Égert et al., 2020[9]). In the case of lockdown enforcement, case studies3 of responses to the first wave showed that an adequate timing of lockdowns was essential to contain the virus, even more than the lockdown stringency (i.e. substance).

Both centralised and decentralised responses can be successful if levels of government co‑ordinate themselves

Although centralised responses were twice as frequent as decentralised ones in a survey of policy responses to the first wave of the pandemic,4 there are successful cases of both centralised and decentralised responses to the first wave of the crisis5 (see Box 9.2). The COVID-19 pandemic has some elements that favour a centralised response and others that favour a decentralised one and, as a result, it is not trivial to determine the optimal degree of centralisation/decentralisation to tackle the crisis. We argue that intergovernmental co‑ordination can make a centralised or decentralised responses successful.

On the one hand, centralised responses tend to generate more quick and homogenous responses, to generate economies of scope and scale, and to deal more effectively with regional spill-overs. Centralised responses also tend to facilitate accountability, since there is no room for levels of government to “pass the buck” to other levels. Furthermore, centralised responses can facilitate resource allocation since purchases of the necessary equipment (e.g. ventilators, personal protective equipment, tests, among others) are done on a larger scale and with centralised information, facilitating the transfers of these resources to the regions in need.

On the other hand, decentralised responses tend to deal more effectively with asymmetric impacts and preferences, and to create room for regional diffusion of innovative policies. This is especially relevant in a crisis in which containment policies have enormous costs that are asymmetrically distributed both across regions and socio-economic groups. For instance, regions whose economy depends on tourism were more vulnerable to lockdown enforcements; low-income households tend to suffer more economic and social costs related to, for instance, access to social protection and education. It is expected, therefore, that people’s preferences vary widely across regions within the same country, which is a compelling point for a decentralised approach.6

Box 9.2. Centralised and decentralised responses to the first wave of the pandemic

The United States offers an example of an almost fully decentralised approach to tackle the first wave of the COVID-19 outbreak, with the federal government mainly providing additional funds through the CARES Act, Medicaid programmes and the Federal Reserve Bank (FED). During the COVID-19 crisis, the degree of US fiscal decentralisation became even more pronounced. Lower levels of government in the United States have had autonomy to impose stricter policies than those imposed by upper levels (i.e. autonomy to change the substance of the policy), to select the appropriate timing for implementation and to operationalise policy implementation. As a result, SNGs have varied significantly with regards to the policies implemented in terms of substance, timing and process. For instance, while northeastern states imposed relatively strict lockdowns, states more reliant on tourism, such as Texas and Florida, were hesitant to enforce strict lockdowns affecting their jurisdictions; similarly, governors in small, rural states such as South Dakota and Nebraska tended to take very limited action. Governors in the northeastern states (e.g. New York, New Jersey, Connecticut and Pennsylvania) acted early and more aggressively in the implementation of comprehensive restrictions across the states.

In South Africa, the COVID-19 pandemic has led the central government to centralise responses to the first wave of the outbreak, but not fully, potentially due to limitations in its operationalisation. At the initial phase of the crisis the central government has declared a national state of disaster, issued regulations that SNGs had to implement and monitored their implementation through their Department of Cooperative Governance. In addition, a very strict national-wide lockdown was centrally imposed. Nevertheless, since in South Africa SNGs are responsible for the management of hospitals and public schools, measures were operationalised by SNGs with central government oversight. In addition, SNGs were, after five weeks of a strict lockdown, allowed to adjust their responses in case the prevalence of inceptions was low in a jurisdiction. As a result, at the initial phase, South Africa’s central government controlled the substance and timing of the responses. In a second phase, SNGs could vary the timing of their implementation. In both phases, the operationalisation of the responses was in the hands of SNGs.

In comparison to these other countries, France is a more centralised country. Healthcare expenditure is almost entirely centralised. It is not a surprise that the French response was, thus, very centralised (refer to Figure 9.2). From mid-March onwards, the central government announced and adopted a series of highly homogenous responses that entered into force throughout the entire country. Many of these measures were taken by overarching presidential Decrees. They involved lockdown enforcement, prohibition of gatherings and travel, eventually mandatory use of masks in public, among other measures. However, some local governments imposed more rigorous policies, such as Nice and Cannes, where wearing masks in public was mandated before the central government required it. France offers an example of a response to the first wave of the pandemic that was mostly centralised in terms of substance, process and timing.

Source: Cockerham and Crew (2020[10]) for the US case, Steytler (2020[11]) for the South African case and Buthe et al. (2020[12]) for the French case, as cited by de Biase and Dougherty (2021[13]).

State-of-emergency law were used, to a great extent, to centralise responsibilities

In virtually all countries, regardless of being federal or unitary, responsibilities and decision-making powers are distributed across levels of government by the constitution or by the primary law. The same constitution/law also commonly determines that, under extraordinary circumstances, some responsibilities might be centralised, with state-of-emergency laws or equivalent mechanisms. As a result, a centralised response can be the result of 1) a centralised assignment of responsibilities in ordinary times; or 2) a temporary assignment of powers to the central government as a result of an emergency mechanism that was triggered by an extraordinary event.

Box 9.3. Switzerland’s referendum and Sweden’s new state-of-emergency law

Switzerland’s referendum

Switzerland is a very decentralised country, with Cantons highly autonomous. Nevertheless, in order to tackle the COVID-19 pandemic, a state-of-emergency was enacted, and Cantons’ powers were centralised, which has led to a top-down and uniform implementation of containment measures across the country (Altherr, 2020[14]). Examples of nationwide measures taken by the Swiss government are restrictions of nonessential businesses, the closure of schools and quarantine measures. Gradual phase-out of these measures was also implemented with a high degree of uniformity across the country.

This approach did not please part of the population, which led a campaign over the prominent role of the central government in tackling the pandemic. This group argued that these measures can be applied without taking over a Canton’s power and this centralisation may set a precedent for undemocratic measures in the future.

The Swiss democratic system allows people to challenge parliamentary decisions if more than 50 000 signatures are collected within 100 days following the approval of a law. In September 2020, this group collected the necessary number of signatures and forced the matter to be voted on in a referendum, which was held in June 2021.

As a result, Switzerland was the first country that had, through direct democracy, granted to its citizens a say over the legal basis for tackling the outbreak. The attempt to veto the Swiss government’s anti-COVID policy nevertheless failed, with a majority of the public endorsing the policies implemented by the central government to tackle the pandemic.

Sweden’s new state-of-emergency law

At the beginning of the pandemic, Swedish policy makers were reluctant to support strong restrictions on personal freedom and, as a result, the government could not legally enforce lockdowns. While neighbouring countries were adopting strict lockdown measures, Sweden has avoided such measures and followed a voluntary approach to virus containment. Nevertheless, with the highest number of cumulative deaths related to COVID-19 in Scandinavia during the first phase and with regions reaching the maximum intensive care capacity (Edwards, 2021[15]), the Swedish Parliament, in January 2021, eventually approved a type of state-of-emergency law, which expired at the end of September 2021.

The Swedish law allowed the government to take extraordinary measures to tackle the pandemic, such as limiting the number of people in shops, business, public places, among others and fining wrong doers. However, restrictions on gathering in public spaces could not be of such magnitude as to prevent people from moving around the country. In addition, restrictive measures had to be brought before the parliament within seven days so that it could repeal the measures if it so desired.

Source: Geiser (2021[16]); Hofverberg (2021[17]).

In the first case, the central government is constitutionally/legally in charge of most of the responsibilities related to tackling a health crisis, such as healthcare, public health, social protection, and public order enforcement (e.g. Greece, Hungary, Iceland, Slovakia, Portugal, among other countries in which SNGs have a low expenditure share of general government – see Figure 9.2). In this case, although SNGs can have relevant roles in policy making and operationalisation of policies to tackle a crisis, most of the decisions are defined by central authorities, as it is in ordinary times.

In the second case, in times of crisis, the legal/constitutional assignment of responsibilities might be temporarily centralised by the force of state-of-emergency laws or equivalent mechanism. A wide range of countries already had such laws in place prior to the crisis (e.g. Canada, Germany, Italy, Mexico, South Africa, Spain, Switzerland, among others) or passed a state-of-emergency law during the COVID-19 pandemic (e.g. Sweden). Nevertheless, not all of these countries that had a state-of-emergency law actually declared a state-of-emergency (e.g. Canada)7 or have de facto centralised decision-making power after having declared such a state (e.g. Germany).8 In Switzerland, a group of citizens has even handed in signatures to force a vote on the powers from the state-of-emergency (see Box 9.3).

Although state-of-emergency laws are an interesting solution to rapidly delineate activities across levels of government in times of crisis, since states-of-emergency are not commonly proclaimed, it is, unfortunately, common to have unclear legal statutes (e.g. Switzerland).9 Another issue regards the fact that temporary centralisation can be challenging to pull off as management and governance procedures were designed considering the common division of responsibilities across levels of government.10

It is worth noting that, especially in times of crisis, there are some extraordinary powers/activities whose assignment was not clearly defined by the legislators (e.g. power to enforce lockdowns, to define what are essential services, among others) and, for these activities, the dividing line between the powers of each level of government allows for different interpretations and may lead to judicial disputes11 (Hegele and Schnabel, 2021[18]). It is also common for the primary law or constitution to give residual power to one level of government, meaning that all activities that are not clearly defined by the law/constitution are of the responsibility of a specific level of government.12

Intergovernmental co‑ordination in the emergency phase

Intergovernmental co‑ordination concerns the harmonisation of actions taken by different levels of government and/or jurisdictions through communication, exchange of information and negotiation.13 The opposite of co‑ordinated action is unilateral action, in which each level of government/jurisdiction determines and implements policies without informing/consulting other jurisdictions/levels of government. Given that: 1) many levels of government are involved in service delivery;14 2) there is substantial overlap in the assignment of activities across levels of government; and 3) COVID-19 have regional spill-overs, co‑ordination is crucial for each level of government and jurisdiction to focus on the activities that they are better prepared to do, reducing redundancy and improving consistency.

In the emergency phase of the crisis, the costs of un-coordinated action were enormous for multiple reasons. First, SNGs may engage in intergovernmental competition, leading to excessive purchases at high prices (OECD, 2020[19]). Second, lack of healthcare capacity was particularly prominent at the early stages of the crisis (OECD, 2020[20]), and, therefore, without intergovernmental co‑ordination, access to resources was limited to the resources available locally, while intergovernmental co‑ordination permits regions to access a greater pool of idle resources from other jurisdictions/regions.15 Third, inconsistent or fragmented regulatory regimes may hinder the quick adoption of new products and procedures discovered/designed elsewhere. Fourth, lack of monitoring the national situation and regional benchmarking may allow service standards to slip, particularly when data are absent or inaccessible, which is precisely the case for health care, in which data governance is lagging behind other sectors (OECD, 2020[20]). Fifth, at the early stages of the crisis, procedures and protocols were mostly inexistent and, thus, multiple levels of government were prone to giving conflicting information to the public and creating confusion and hindering policy accountability.

Therefore, intergovernmental co‑ordination in the emergency phase was particularly important for: 1) increasing the pool of resources available to tackle an asymmetrical crisis within regions; 2) create economies of scale in the procurement of equipment; 3) communicate consistently with the public; and 4) promote diffusion of effective policies and procedures. Moreover, with intergovernmental co‑ordination, decentralised responses can be made uniform when necessary16 and centralised responses can better adapt to local needs, leading to more heterogeneity (Hegele and Schnabel, 2021[18]).

Countries have either created or re-oriented institutions to improve co‑ordination

Countries have been using institutions to co‑ordinate policy responses across levels of government and to monitor the development of the crisis (OECD, 2020[21]). These bodies have been holding regular meetings with authorities from multiple levels of government and, often, scientists and experts from various sectors. Some of these bodies were created with the sole purpose of handling emergencies (e.g. Chile, France), while in other cases existing structures were adapted to tackle this specific crisis (e.g. Belgium, Italy, Poland).17 In addition to bringing SNGs into these bodies, some countries are also appointing co‑ordinators from outside the centre of government, such as public health officials (e.g. France, Ireland, United States) or officials with a background in economic and trade issues (e.g. Colombia), and some involve scientists in the decision-making process.18

Although the scope of action of these bodies has often been substantial, involving the monitoring of the crisis and the provision of direct support and advice to heads of government and ministers regarding multiple policy areas (e.g. health, transport, economy, among others), there also have been intergovernmental co‑ordination initiatives of more limited scope. Co‑ordination arrangements related to procurement19 and data sharing20 were frequently made during the emergency phase of the crisis.

When co‑ordination arrangements lead to a situation in which the executive branch of levels of government are involved in the implementation of a central programme, it can be said that the country is responding to the crisis using an executive federalism approach.21 In this situation, central authorities from the executive branch, such as from key ministries and the president/prime minister, act as national leaders, guiding discussions about the responses. It is worth highlighting that for such an arrangement to work, it is necessary for authorities of different levels of government to agree on the policies, as the responsibilities of SNGs are not centralised as they are with state-of-emergency laws.

Lastly and more notably in large countries that have approached the crisis with a decentralised response, horizontal co‑ordination arrangements were rapidly made between neighbouring jurisdictions to improve the consistency of the response and to deal with regional spill-overs. Factors that contributed to the rapid co‑operation were: 1) the existence of horizontal co‑operation arrangements prior to the crisis;22 2) geographical proximity; and 3) bipartisan co‑ordination.23

In summary

Despite the existence of various vertical and horizontal co‑ordination arrangements, an OECD survey on the impact of the COVID-19 crisis on regional and local governments found that co‑ordination mechanisms have produced mixed results in managing the COVID-19 crisis, in the view of local and state governments. More specifically, around 10%, 11% and 15% of the respondents found co‑ordination arrangements among: 1) the same level of government; 2) different levels of SNGs; and 3) between the central government and SNGs, respectively, to be ineffective or non-existent (OECD-CoR, 2020[22]). Therefore, despite the clear necessity and potential benefits of intergovernmental co‑ordination, it is not trivial to make neither vertical nor horizontal effective intergovernmental co‑ordination arrangements.

A consequence of the lack of effective intergovernmental co‑ordination arrangements is the exacerbation of the flaws of a centralised or decentralised response. Centralisation without effective co‑ordination can lead to homogenous deployment of containment measures across regions, even when the outbreak is localised. This situation can lead to an unnecessary economic cost as some regions did not need stringent measures in the first place.24

On the other hand, decentralisation without effective co‑ordination can lead to a sub-optimal management of the resources, leaving the resources of some regions idle while other regions are having to deal with scarcity of beds, medical equipment, staff, among others. Responses that started un‑coordinated can be better co‑ordinated afterwards, leading to a successful response in a later stage of the crisis, as has happened to the United States that was severely hit by the first wave but introduced vaccines relatively fast in comparison to most other countries, despite its continental size.

Interestingly, pre-existing arrangements tended to lead to a quicker and more co‑ordinated action in comparison to arrangements that were organised afterwards. Australia is an example of a country that implemented intergovernmental co‑operation arrangements just before the COVID-19 crisis, in order to address the Australian bushfire season of 2020, leading to a better co‑ordination during the COVID-19 pandemic (Downey and Myers, 2020[23]). Korea is another example, explored in more detail in Box 9.4.

Box 9.4. Korea’s experience: learning from past mistakes

Korea was hit by multiple disasters throughout the last decades, such as the Middle East respiratory syndrome coronavirus (MERS-CoV) epidemic outbreak in 2015, the Sewol Ferry Disaster in 2014, the H1N1 pandemic influenza in 2009 and SARS in 2003. Notably, the Korean response to the MERS-CoV outbreak demonstrated significant shortcomings in its preparedness for public health emergencies. Korea was the most affected country in the world outside of the Middle East. The government and a number of medical institutions were criticised for, respectively, not disclosing relevant information to hospitals and citizens, and for discharging infected patients unaware of their situation.

Fortunately, most of these shortcomings were addressed throughout the last five years. Korea’s government: 1) established a dedicated Office of Communications and communication guidelines for officials; 2) invested in public health emergency process; 3) created the Ministry of the Interior and Safety to co‑ordinate and implement measures related to public safety, risk prevention and emergency preparedness, which are to some extent implemented at the local level while the central government controls most of the authority to determine and oversee the measures to be implemented.

As a result of these enhancements, Korea was able to flatten the contagion curve of the first wave without imposing strict lockdowns or substantially disrupting its economy. Korea was able to implement a test‑and‑trace strategy accompanied by the imposition of social distancing measures in the most heavily affected regions. Korea promptly 1) built screening centres; 2) developed a large-scale urban data gathering platform; 3) trained medical staff; and 4) engaged in holding official daily briefings as early as 30 January 2020. The rapid implementation of all these policies were likely possible because Korea had prepared its institutional structure and legislation prior to this crisis. Administrative barriers were, thus, diminished and debate regarding the policies to be taken were not as necessary as in other countries.

Source: OECD (2020[24]); de Biase and Dougherty (2021[13]).

Fiscal capacity in the emergency phase

At the beginning of the crisis, SNGs were expected to suffer a heavy shock

At the beginning of the COVID-19 outbreak, in a survey of policy responses to the first wave of the pandemic (OECD, 2020[5]), countries revealed that they were expecting that the crisis would affect subnational governments’ fiscal position significantly, with 17 out of 20 countries expecting SNGs’ debts and deficits to increase as a result of the crisis.25

On the expenditure side, countries expected that SNGs would suffer severe consequences from the initial phase of virus propagation that pushes up health, public order and social protection spending. Since these functions represent a significant share of SNGs budget (spending related to these government functions vary across countries from 3% to 81% and represent on average 34% of all SNGs budget – Figure 9.4), even marginal increases were expected to have a drastic impact on subnational budgets.

Figure 9.4. Share of health, public order and social protection expenditures for SNGs

On the revenue side, countries expected that SNGs would suffer a fall in revenues due to the weakening of economic activity and to tax policy changes. Regarding the former, expectations were dramatic, with preliminary indicators of the economic activity suggesting that the Global Financial Crisis was a relatively small crisis in comparison to the COVID-19 crisis (the drop in GDP in the first two quarters of 2020 was more acute than the drop in 2009 – see Figure 9.5). Regarding the latter, countries have given numerous tax benefits/cuts/deferrals to business and households in order to minimise liquidity and solvency problems.26

Figure 9.5. Quarterly GDP growth rate in OECD countries

SNGs have less room to manoeuvre and the shock could hinder their action

This “scissor effect” of increasing expenditures related to the pandemic and decreasing revenues as a result of a recession cannot be easily offset with either a reduction in expenditures related to other public services nor an increase in revenues as a result of a exogenous changes in tax policy because 1) a substantial portion of SNGs expenditures is either mandatory or regards essential services (e.g. education, health, public safety); and 2) SNGs depend on intergovernmental transfers and have limited autonomy to change tax policies (Dougherty, Harding and Reschovsky, 2019[4]). Therefore, fiscal balances were expected to deteriorate.

SNGs have less room to manoeuvre than central governments and, therefore, they usually react differently to shocks, usually in a more pro-cyclical manner, especially in the recovery phase of the crisis (Figure 9.6). First, SNGs cannot easily roll-up debt nor adjust their budgets to deal with acute shocks, which makes them more vulnerable to liquidity crises than central governments. More specifically, SNGs face borrowing limitations since subnational bond markets are usually less developed and illiquid than national bond markets, while there are borrowing rules that forbid subnational borrowing under some conditions.27 Second, SNGs fiscal policies are restricted by fiscal rules.28 Most OECD and partner countries impose budget balance rules (i.e. balanced budget, balanced current budget or a deficit target approaching zero) and/or expenditure limits to SNGs (Vammalle et al., 2020[25]). The restrictive nature of fiscal rules triggers concerns about pro-cyclicality and, particularly in the context of COVID-19, could limit the room for SNGs to carry out the necessary expenditure during the health crisis.

Figure 9.6. Pro-cyclical fiscal policy at subnational level: SNG investment usually fluctuate more than central governments in times of crisis

Central governments have stepped in so as to level SNGs’ fiscal capacity

Central governments and central banks stepped in to boost SNGs’ fiscal capacity so that they could spend on COVID-19 related programmes and avoid heavily pro-cyclical fiscal policy at the subnational level. Figure 9.7 shows that the most common response from central governments at the emergency phase was providing extraordinary grants, lifting fiscal rules,29 and providing additional loans and guarantees to SNGs (OECD, 2020[5]). These extra resources are provided by the central government mostly with no conditions attached30 but with additional accountability requirements.

The criteria to define the amount of funds transferred has varied across countries. In some countries central governments have been providing a fixed amount to SNGs, which was defined in advance based on an expectation of decrease in subnational revenues and increase in expenditures. In other cases, countries have been compensating revenue reductions caused by tax relief measures or by reductions in tax revenues due to the economic slowdown.

Figure 9.7. Measures employed by central governments to improve subnational fiscal capacity in the emergency phase

Central support is not risk-free and can lead to moral hazard if ill-designed

Although it is too soon to assess the impact of central support on SNGs policies and fiscal instances in the context of COVID-19, it is important to raise potential risks involving fiscal support to SNGs. In principle, effective fiscal support is based on a careful analysis of SNGs needs, designed in a manner that minimises moral hazard and considers SNGs’ autonomy and regional equity implications (OECD, 2020[5]).

First, depending on the rules under which the grants are provided, they may influence the policies implemented by SNGs.31 Second, if central governments frequently support SNGs in economic downturns through intergovernmental grants, SNGs might not have the incentive to maintain a resilient fiscal structure and may export the costs of policies to the central government. Third, depending on the rules under which grants are provided, they may generate undesired regional inequalities through the provision of more funds to some regions at the expense of others and since financial needs are not policy neutral (i.e. the financial needs of SNGs depend on their own past policy choices), these equity issues are very difficult to be addressed in a manner that satisfies all parties involved.

Resolution phase

Context of the resolution phase

One year after the start of the pandemic, uncertainty has been drastically reduced. On the economic side, indicators suggested a recovery quicker than expected. The recovery has formed a “square root shape” as envisioned by forecasters as early as April 2020 (Lehner, 2020[26]). This shape contrasts heavily with the “U shape” of previous crises for which the recovery was slower (see Figure 9.5, which depicts the shape of the COVID-19 and the Global Financial Crisis). There are at least two reasons that explain the relatively rapid recovery: 1) the underlying force of the recession is a health crisis, which contrasts to an investment bust or a financial crisis that comes with an overhang of excess investment to work off, which delays the onset of recovery; and 2) the rapid and decisive monetary and fiscal stimulus contained a possible contagion of household and firm bankruptcies that could have led to structural damage (Carlsson-Szlezak, Swartz and Reeves, 2020[27]).

On the public health side, there was a significant decrease in case fatality rates in comparison to the peak of the first wave of the crisis.32 As a result of an unprecedented action of the private sector and governments, multiple effective vaccines have been developed and administered across countries, with the first mass vaccination programme starting in early December 2020 (WHO, 2021[28]). Although vaccination started at a slow pace in some OECD and partner countries, in less than a year and a half from the start of the pandemic, multiple countries were able to fully vaccinate the majority of their populations, an unprecedented achievement (Figure 9.8). This is crucial, as vaccination is regarded as the sole secure path to herd immunity, which can be achieved when a substantial portion of the population is vaccinated33 (WHO, 2020[29]).

Figure 9.8. Share of population fully vaccinated against COVID-19 in OECD and partner countries

Vaccination programmes

OECD countries have had a historic success with the introduction of vaccines in less than one year from the start of the outbreak. As supply was limited when vaccines were introduced, OECD countries focused on prioritising 1) vulnerable populations for vaccination, such as elderly, people with pre-existing conditions and those more exposed to the virus, such as health care workers; or 2) the use of vaccines to reduce transmission of the virus in a way to contain its spread and the emergence of new strains (OECD, 2021[30]).The administration of vaccines involves multiple tasks whose responsibility is assigned to different levels of government such as funding its development and production (in some cases), procurement, distribution and application. In ordinary times, the central government is often the level of government responsible for vaccine procurement, with SNGs having a crucial role in the administration of immunisation programmes (Figure 9.9).

It is worth noting that expenditure on public health services, which includes immunisation programmes, tends to be more decentralised than healthcare in OECD countries (de Biase and Dougherty, 2021[13]) and, therefore, the operationalisation of vaccination programmes has involved SNGs more than other health programmes aimed at tackling COVID-19.

Figure 9.9. SNGs’ expenditure as a percentage of general government’s on government functions related to vaccination

In the context of COVID-19, the delineation of activity across levels of government related to vaccination has been kept roughly the same, with a tendency for more centralisation, notably regarding procurement in the European Union.34 Therefore, in most cases central or supra-national governments are responsible for the procurement while SNGs are engaged in administering the doses to the local population,35 with, in some cases, financial support from the central government to compensate the costs arising from the vaccination campaign, staff and equipment. In some countries, SNGs can establish their own vaccination programme, while in others they must follow central guidelines related to the prioritisation of specific groups.36 Despite this central role of SNGs, regional disparities in accessing COVID-19 vaccines have mostly been modest, and primarily a result of the asymmetric distribution of vulnerable populations (OECD, 2021[31]).

Democracy and COVID-19

One key benefit of federalism is the distribution of political power across different actors, which allows for decentralised decision making that can more easily take into account local preferences. Both outcomes contribute to the enhancement of democracy, freedom of citizens (von Hayek, 1960[1]) and to maximise aggregate welfare (Oates, 1972[2]). Naturally, this benefit can only be fully reaped when elections are being held in all levels of government in a legitimate manner.

The COVID-19 pandemic has not only been a threat to the well-being of citizens but also to the democratic health of elections. Political campaigns and elections involve large gatherings of people and could potentially aggravate the dissemination of the disease. Higher health-risk voters, like the elderly, may decide to abstain from voting to avoid running the risk of being infected. This could result in selective participation which may decrease the legitimacy of people elected and could even question the democratic system. Therefore, ideally, the measures implemented to prevent the spread of the virus should not hinder the democratic process, whether by limiting electoral campaigns or by imposing measures for the elections (Council of Europe, 2020[32]).

Measures were taken to contain the virus while having elections

During the first wave of the COVID-19 pandemic, about one-third of OECD countries decided to postpone local elections for public health reasons. However, most governments authorised elections again with a delay, taking place either a few weeks late, as in Canada or as much as a year late as in Australia or the United Kingdom. One of the main concerns for authorities was to make sure that the voter turnover did not decrease because of fear of contracting the virus at polling stations or due to a confusion as to where and how to vote. In 2020, elections in some countries had lower turnouts compared to the previous election years, with the largest drop of 15%, while others recorded higher turnouts than before (Maizland, 2020[33]).

To prevent contamination and provide safe in-person voting, most countries enforced sanitary measures, notably masks and social distancing (Asplund et al., 2021[34]). Staggering voting hours reduced the number of people who could vote at one time. Moreover, to reduce crowding on election days, some countries increased the number or the size of polling stations, extended their working hours or extended the election day over several days. Early voting allowed citizens to vote before the election day. Depending on the country, the period for early voting can be available for all voters or only for specific categories. Eventually, some countries even allowed voters in quarantine or who had tested positive for COVID-19 to cast their vote during designated times on election day.

Many jurisdictions decided to switch to special voting arrangements (SVA), allowing higher risk groups to vote without having to be present at the polling stations. Certain jurisdictions encouraged voters to vote by mail whereby the ballot is delivered to the voter, who then returns it completed, before a deadline. Another SVA was to expand proxy voting, which is a SVA where a voter authorises another person to cast their vote for them. For some, proxy representatives were allowed to vote on the behalf of coronavirus patients and those in isolation. Finally, home-based, and institutional-based voting arrangements, which are SVA where a voter can cast the ballot from its current place of residence, were widely used in several countries.

One option, which was not widely used during the pandemic, is electronic voting (e-voting), which is voting that uses digital means to either aid or take care of casting votes, can be relevant in case of outbreaks such as the COVID-19 crisis. Many countries are moving to allow parliaments and subnational councils to debate and vote online (de Mello and Ter-Minassian, 2020[35]). However, e-voting raises a host of technical challenges, first, if a large part of the population does not have access to the Internet, or does not know how to use electronic devices, then governments have to ensure data protection, transparency and cyber-security. In the end, trust is essential for introducing digital solutions in elections. That is why the use of technology needs to be accompanied by national or supranational guidelines regarding the use of technical solutions and procedures, which ideally should cover proxy votes, testing, auditing and public access (Council of Europe, 2020[32])

Limitations imposed on political campaigns

Local electoral campaigns are the key components of the democratic process. However, campaigns often involve large gatherings, raising the risks of COVID-19 transmission. There have been ongoing debates as to whether electoral campaigns should be restricted to protect public health. Countries implemented measures from limiting the participants attending public gatherings to bans on in-person political events. Door-to-door campaigns were often still allowed with restrictions on the number of people per group, the obligation to wear masks and recommendations on the duration of the events. Measures such as temperature checks, sanitation of indoor venues, a limited time duration during gatherings and sanitisation of microphones were also implemented.

However, the most effective way of reducing the spread of virus was campaigning through online platforms, social media or non-digital mechanisms. Online remote campaigns allowed candidates and political parties to communicate virtually their ideas and their programme of reforms. For example, in the United States, both parties used social media and held party conventions online (Sullivan, 2020[36]). Non-digital mechanisms, such as short message service, telemarketing, postal mailing, TV, newspaper and radio talks were also largely used, especially in countries where part of the population did not have access to the Internet. Nonetheless, restrictions were not always closely monitored – face masks were not always used, and large-scale in-person rallies had sometimes gone ahead despite government restrictions in several countries (OSCE, 2020[37]).

Fortunately, even during the COVID-19 pandemic, virtually all OECD countries were able to hold central, state and local elections. In order to minimise election-related contaminations, countries put in place different measures, concerning electoral campaigns and the elections itself to avoid the spread of COVID‑19 among the population and to reassure the population.

Fiscal capacity in the resolution phase: asymmetries across levels of government and regions

Figure 9.10, below, illustrates the fiscal situation of different levels of government, suggesting that central governments’ finances suffered more than those of SNGs in 2020 in most OECD countries.37 In this group of countries, the median decrease for SNGs’ tax revenues was 0.6% while central governments’ tax revenues suffered a median decrease of 2.8% (Panel A). On the expenditure side, SNGs’ and central governments’ median consolidated expenditure growth was of 4.1% and 15.0%, respectively (Panel B). Finally, Panel C shows the substantial increase in intergovernmental grants in 2020 – which the average and median value are around 14% and represent, on average, 47% of their total revenues (see circles in Figure 9.12, Panel B), more than offsetting reductions in revenues and increases in expenditures for some OECD countries.

Figure 9.10. Growth of revenues and expenditures of different levels of government (2019 to 2020)

These asymmetries across levels of government and regions can be explained by the differences in tax mixes and expenditure assignments

Crises commonly hit levels of government asymmetrically, with the fiscal stance of central governments being more heavily affected than SNGs (Figure 9.11). That was precisely what happened in 2020 – on average, central governments experienced a fiscal deficit of 20% of their revenues while at the subnational level the average fiscal deficit was of 2.5% of SNGs’ revenues. This asymmetry can be attributed to structural and non-structural disparities.

Figure 9.11. Central governments’ fiscal balances fluctuate more and are more affected by crises than SNGs’

First, in times of crisis, it is common for central governments to adopt a more expansionary fiscal policy, as they have more access to financial markets and are not restricted to borrowing constraints nor fiscal rules as SNGs are. In addition, central governments often support SNGs in these periods in order to minimise a counter-cyclical policy from the latter (refer to Figure 9.6, which shows the tendency of SNGs to reduce investments in times of crisis, leading to a pro-cyclical policy at the subnational level).

Second, structurally, each level of government has a different composition of revenues and expenditures, with crises affecting sectors, tax bases and types of expenditures unevenly. Notably, central governments are typically in charge of the majority of the social protection programmes (refer to Figure 9.2), which have strong anti-cyclical behaviour.

With regard to revenues, not only does a substantial portion of SNGs’ revenues comes from upper levels of government (refer to diamonds in Figure 9.12, panel B) but also the tax mixes of SNGs’ own revenues differ significantly from those of the central government. There are constraints on the types of taxes that are collected at the subnational level and, as a result, SNGs’ tax mix tends to be less diversified than those of the central government. In a very simplified manner, taxes levied on mobile tax bases, such as liquid assets or some taxes on business, can be avoided by moving assets or the business to jurisdictions with a lower tax rate and/or more tax benefits, which could also create a race to the bottom effect.

SNGs tend to rely on property taxes (on average 40% of their tax revenues), income taxes (34%), and good and service taxes (19%) in contrast to central governments, which rely more on good and service taxes (35%), income taxes (32%) and social security contributions (29%), who rarely make use of property taxes (2%). In terms of property taxes, SNGs tend to rely on recurrent taxes on immovable property (on average 82% of their property tax revenues) while central governments’ property tax revenues are constituted of the taxation of financial and capital transactions (on average 53% of their property tax revenues), estate, inheritance and gifts (17%), and net wealth (11%). Regarding income taxes, SNGs tend to rely more on personal income taxes (on average 81% of their income tax revenues) while central governments have a more balanced reliance between personal (67%) and corporate income tax (33%). Figure 9.12 summarises this information.

Figure 9.12. Revenue composition of different levels of government

This clear difference between SNGs’ and central governments’ tax mixes affects their vulnerability to shocks on two fronts. First, the sensitivity of tax revenues to downswings differs, with some taxes being more heavily affected than others. Second, in order to tackle the COVID-19 crisis, at least in a first moment, tax packages aimed at supporting households and businesses affected more central governments’ tax revenues, damaging central governments the most. It is worth noting, though, that in the next years this situation might shift as 1) in some countries grants’ value are based on tax revenues from the previous year, affecting SNGs with a lag; and 2) central governments that resorted to deferrals will receive these taxes with a lag.

SNGs’ tax mixes tend to be less elastic to downswings than those of the central government in the short-term

The sensitivity of tax revenues to changes in economic activity is commonly captured by forecasters through the use of short-term38 tax elasticity and/or tax buoyancy. The former controls for discretionary tax changes, whereas the latter does not.39

Interesting conclusions with regard to the short-term responses of tax revenues can be drawn based on Figure 9.12 (above) and Figure 9.13 (below): 1) property taxes tend to be significantly less buoyant at the subnational level, probably because SNGs rely more on recurrent taxes on immovable property which has more stable tax base in comparison to other property taxes; 2) SNGs’ income tax revenues tend to be less buoyant than central governments; 3) although SNGs’ payroll tax revenues are slightly more buoyant than central governments’ revenues with the same tax, SNGs rarely rely substantially on this type of tax; 4) goods and services taxes are the only type of tax that substantially affect SNGs finances and that are more buoyant in the short-run at the subnational level; and 5) the short-run buoyancy for total tax revenues is, in most cases, higher for central governments in comparison to subnational governments. As a result, SNGs’ tax revenues are likely to be less affected by downswings than central governments’ tax revenues.40

Figure 9.13. Comparison of central government and SNGs short-term tax buoyancies in times of crisis

Tax measures to support business and households tend to affect central government more than SNGs

Not only SNGs’ tax mixes are less sensitive to downswings but also in economic crises the central government tends to provide more support through the tax system. To tackle the COVID-19 crisis, the most common tax measures employed by OECD countries were: value added tax (VAT) payment deferrals (81%), corporate income tax deferrals (73%), tax incentives for investment (e.g. through accelerated depreciation of investments, enhanced deduction, tax credit, among others) (65%), enhanced personal income tax allowances and credits (59%), enhanced loss carry-back provisions (41%), VAT accelerated refunds (41%) and VAT reductions (35%) (OECD, 2021[39]). In contrast, relatively few governments introduced changes to property taxes over the last year, which is the most important source of tax revenues for SNGs, and those that did often targeted at severely affected businesses, such as businesses that registered a significant fall in revenuesor that that suffered the most significant restrictions on activity.41

As a result of the fact that: 1) SNGs have received financial support from the central government at the emergency phase (refer to Figure 9.7 and Figure 9.10 Panel C); 2) SNGs’ tax mix is less sensitive to economic downswings; 3) most tax measures aimed at providing liquidity to business and households are managed at the central level; and 4) central governments tend to be in charge of the majority of the social protection spending (refer to Figure 9.2), the central government has absorbed most of the fiscal shock of 2020.

Revenues and expenditure growth varied widely and in an uncorrelated manner across regions, creating completely different situations within countries

This analysis of the aggregate data by level of government masks the fact that jurisdictions have suffered disparate impacts from the crisis and, therefore, although on an aggregate level SNGs seem to have been hit less by the crisis, individual jurisdictions might have suffered substantially. In other words, the burden of the crisis in terms of decrease of revenues and increase in expenditure is not symmetrically distributed across regions and jurisdictions within countries.

Preliminary data of the financial situation of states in four countries shows a substantial asymmetry within countries both in terms of revenues and expenditures (Figure 9.14). For instance, the range of revenue growth was, roughly, 2% to 24%, -8% to 15%, 0 to 14% and -15% to 10% while the range of expenditure growth was -13% to 18%, 0% to 20%, -1% to 14% and -2% to 18% in Brazil, Germany, Spain and the contiguous United States,42 respectively. It is worth noting that the correlation between the growth in expenditure and revenues was significant in Germany (0.77) and Spain (0.73), while it was insignificant in Brazil (0.22) and the contiguous United States (-0.16).

Figure 9.14. Disparities in growth of revenues and expenditures within countries

This pattern of substantial asymmetries in revenues and expenditure growth and lack of correlation between them can lead to enormous disparities in the fiscal situation of individual jurisdictions, creating solvency and/or liquidity risks for some while leaving others undamaged or even in a better fiscal situation after the crisis. It is worth highlighting that an extraordinary asymmetry of such dimension will very likely not be offset by fiscal equalisation transfers, which aim at reducing structural disparities across regions (OECD, 2020[5]).43

Disparities across regions are caused by the asymmetric nature of the COVID-19 crisis, which is hitting regions and sectors with a wide variation

These substantial disparities across regions cannot be explained solely by the differences in the composition of revenues and expenditures across jurisdictions, which tend to be smaller across regions than across levels of government, even in countries in which SNGs have substantial autonomy.44 It is likely, therefore, that, these disparities were caused by asymmetric nature of the COVID-19, which has hit regions (OECD, 2021[31]) and sectors in different orders of magnitude. Especially regarding the latter, there tends to be substantial differences in the sector-dependency of each region,45 especially considering that in a globalised world local development tends to benefit from having specialised clusters.

Recovery and post-pandemic phase

Similar to other crises, the COVID-19 crisis might generate structural changes to the economy, which bring about the need for policy makers to implement reforms to intergovernmental fiscal arrangements. More notably, the COVID-19 caused an acceleration of the digitalisation of the economy and had asymmetric impacts across sectors, which might: 1) change the distribution of income across and within levels of government as economic sectors are unevenly distributed across regions; 2) lead to income concentration as the drop in employment has been sharper for low-skilled jobs and lower paid workers are less likely to be able to work from home (OECD, 2020[40]); and 3) aggravate structural inequalities regarding access to education (OECD, 2020[41]), healthcare and social protection, potentially increasing spending needs. Intergovernmental relations arrangements might require reforms so that they can deal with these new challenges.

Equalisation systems can be fine-tuned to the post-crisis reality in a manner that disparities in revenue capacity and expenditure costs are re-calibrated, so as to minimise regional asymmetries and increase the pace of regional convergence. It is worth noting that regional inequalities can also be minimised with policies that are unrelated to fiscal relations, such as with cash transfer programmes, which were widely employed during the COVID-19 era and might become more relevant, as they are the most effective tool to deal with income inequality (Joumard, Pisu and Bloch, 2012[42]). As these programmes are targeted at vulnerable groups, since the distribution of these groups is uneven across regions, it is likely that the poorest regions will benefit more from them, which would not only impact regional convergence but also equalise SNGs revenues indirectly.46 Effective regional development policies can have similar effects.

Regarding increasing spending needs, countries have a window of opportunity to implement reforms to deliver inclusive, resilient and sustainable economic growth after the pandemic. Fiscal frameworks can be made more sustainable through reviews of public spending to ensure priorities match citizens’ ambitions and needs, and through reassessments of taxation to ensure a fair, efficient and progressive tax system (OECD, 2021[43]). These reforms affect the distribution of income across levels of government and, therefore, it is crucial for central governments to co‑ordinate with SNGs in a manner that the revenues are distributed across levels of government according to their expenditure mandates.

Similar to what happened after the Global Financial Crisis, the COVID-19 crisis may intensify the need for some countries to change their fiscal rules. More specifically, the rules may become mis-calibrated due to the post-crisis fiscal stance of SNGs, and/or they may become ineffective to deal with an abrupt increase in regional inequality. In light of the latter, there have been debates about the replacement of standardised rules with fiscal standards. More specifically, fiscal standards leave room for judgement together with a process to decide whether the standards are met, which requires a larger surveillance role for independent fiscal councils as well as a judicial body for adjudication over disputes (Blanchard, Leandro and Zettelmeyer, 2021[44]). Consequently, these councils can lead to a more flexible application of fiscal rules by considering in its assessment: 1) specific characteristics of each jurisdiction; and 2) the situation of the economy in order to avoid counter-cyclical policies. Nevertheless, it is worth noting that this structural change is not without risks: 1) accommodative independent fiscal councils can make fiscal rules inoperative; and 2) frequent changes in the fiscal rule framework might signal an accommodative stance to the market, reducing its positive impact on the credibility of the fiscal policy. As a result, such changes need to be well-designed and well-communicated.

To conclude, such a crisis creates a window of opportunity to implement reforms that had been already envisioned. There might be opportunities to improve the framework used to handle public health crises and to improve intergovernmental co‑ordination permanently as a result of the lessons learnt during the crisis. With regard to the former, some countries had problems with their state-of-emergency laws and/or emergency frameworks, as they were not used often, the distribution of power across levels of government was, in some cases, unclear or suboptimal. Amendments can, hence, be used to improve these pieces of legislation and protocols made to improve (de)centralisation of activities. In addition, co‑ordination arrangements were widely employed across OECD countries with great success. These arrangements can be kept and extended to achieve other policy goals. Countries should seize the opportunity and use the COVID-19 crisis to make structural changes to improve policy delivery. A crisis should never be wasted.

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[1] von Hayek, F. (1960), The Constitution of Liberty, The University of Chicago Press.

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[29] WHO (2020), Coronavirus disease (COVID-19): Herd immunity, lockdowns and COVID-19, https://www.who.int/news-room/q-a-detail/herd-immunity-lockdowns-and-covid-19 (accessed on 2021 May 25).

Notes

← 1. The intergovernmental transfer system involves statutory rules related to tax sharing (i.e. endowment to SNGs of a portion of revenues collected at an upper level of government), equalisation transfers (i.e. transfer of financial resources to and between SNGs with the aim of mitigating regional differences in fiscal capacity and expenditure needs) and a multitude of other types of grants (e.g. earmarked/non-earmarked, compulsory/discretionary, matching/non-matching, etc.), all of which having specific dynamics that greatly affect the order of magnitude of the funds transferred to SNGs and how they are distributed across jurisdictions.

← 2. Other government functions were also affected, such as education, transport and economic affairs.

← 3. For instance, in Germany and Switzerland (Huber and Langen, 2020[45]) and in some American states, such as Texas, in which counties that had enforced lockdowns before having a state-wide lockdown enforcement order experienced less cases (Dave et al., 2020[57]).

← 4. The OECD’s Network on Fiscal Relations held a survey to member countries concerning the main challenges and measures deployed to tackle the COVID-19 outbreak through the channel of intergovernmental relations. Twenty tree OECD and partner countries answered the questionnaire.

← 5. For instance, despite Germany having approached the first wave of the pandemic in a rather decentralised manner while Switzerland and Austria have implemented centralised responses, all three countries were largely successful in contain the virus within their borders during the emergency phase of the crisis (Desson et al., 2020[49]).

← 6. In the context of the COVID-19 pandemic, containment measures go far beyond the usual scope of healthcare. Lockdown enforcement, closure of schools, prohibition of large gatherings, closure of regional and international borders are just some examples of measures that are not directly related to healthcare but have been employed to slow the spread and prevent health systems becoming over-burdened. Many of these policies have a substantial impact on regional economies and they can have an enormous cost. Therefore, it is expected that dwellers’ preferences will vary across regions with regard to the stringency of these policies.

← 7. Due to historical and political factors the Canadian “national emergency” state is considered a central intrusion into provincial jurisdictions and, therefore, the parliament decided not to declare an emergency state (Lecours et al., 2020[62]).

← 8. In Germany, at the start of the COVID-19 pandemic, the parliament declared a nationwide epidemic emergency, allowing the Federal Health Ministry to regulate by legislative decree a wide range of issues (Milbradt, 2020[48]). Nevertheless, despite the centralisation of powers, the federal government allowed states to vary substantially with regards to the substance and timing of the measures.

← 9. Switzerland in mid-March, 2020, proclaimed that the country was in an “extraordinary situation” which has raised some questions that were not clearly defined by the law such as the extent to which federal decrees apply equally to all cantons and the further measures that cantons were entitled to take in an independent manner (Altherr, 2020[14]). Despite this lack of clarity, the Swiss federal government consulted cantons prior to taking measures, which minimised political problems. In the end measures were applied uniformly across the whole country, which has led to a mostly consistent response from a highly decentralised country.

← 10. More specifically, a state-of-emergency that centralises decision making is more likely to be effective in case the information necessary for making decisions is also centralised. Therefore, in case a country operates in a highly decentralised manner, it can be difficult to achieve this centralisation of information in the short-term, hindering its effectiveness. In addition, a drastic change in the way in which organisations work can be tough to implement at the rapid pace that is necessary to tackle an emergency.

← 11. An example of a country in which COVID-19 related responsibilities were, to some extent, defined as a result of judicial disputes between levels of government is Brazil (Falcão and Vivas, 2020[52]).

← 12. India’s constitution gave the central government residual power over activities whose assignment was not clearly defined. As a consequence of these assignments, despite having substantial asymmetry in healthcare capacity and in the impact of the outbreak in the country, India tackled the first wave of the crisis with a centralised approach in which lockdowns were enforced throughout the country, following central orders (Choutagunta, Manish and Rajagopalan, 2021[51]).

← 13. Among other dimensions, intergovernmental co‑ordination can be distinguished between vertical (i.e. between different levels of government) and horizontal (i.e. within the same level of government); formal (i.e. legally or through a joint declaration) or informal; and binding and non-binding (Hegele and Schnabel, 2021[18]).

← 14. For instance, a study from the OECD Network on Fiscal Relations has found that healthcare is often managed by multiple levels of government, with substantial overlap, with policy design and output monitoring largely in the hands of the central government while budget and input autonomy are managed at the subnational level (Dougherty and Phillips, 2019[58]).

← 15. In a survey of policy responses to the first wave of the pandemic, countries reported to have either allocated health inputs and patients across jurisdictions according to demonstrated need or hospital beds (e.g. Austria, Australia, Belgium, Colombia, Estonia, Finland, Italy, Japan, Korea, Luxembourg, Mexico, Poland, Slovakia, Spain, South Africa, Switzerland, and the United States). In more than 80% of cases, these reallocations of resources were made in a co‑ordinated manner involving the central government and SNGs.

← 16. For instance, despite the relative absence of central mandates, German states employed rather similar policies, varying mostly the timing of the implementation (Desson et al., 2020[49]). Australia was another relatively decentralised country that was able to deliver a very efficient and relatively homogenous policy response to the crisis (Rozell and Wilcox, 2020[47]; Downey and Myers, 2020[23]).

← 17. Poland established the “COVID-19 Counteraction Fund” that, although is not a mechanism of multi-level governance, has facilitated co‑ordination across levels of government.

← 18. For instance, Italy created a scientific-technical committee that has a supporting role in monitoring the state of the epidemic and providing guidelines on lockdowns and travel restrictions decisions (OECD, 2020[5]).

← 19. Some examples of institutional arrangements employed to better co‑ordinate procurement activities are: 1) a temporary centralisation of the purchases; 2) joint procurement arrangements involving jurisdictions at the same level of government; and 3) sharing information about prices and suppliers (OECD, 2020[19]). Increased centralisation of purchasing medical and health products has been adopted in Canada, Colombia, Latvia, Germany, Korea, Estonia, Italy, Lithuania, Poland, Spain, Switzerland and Slovakia, among others; decentralised but co‑ordinated procurement systems was successfully employed in Italy to tackle the first wave of the crisis (OECD, 2020[19]).

← 20. Data has been used to improve the effectiveness of test-and-trace policies, which has been considered among the most effectives strategies to reduce contagion while minimising restrictive measures that have significant economic costs (Égert et al., 2020[9]). Countries with standardised national electronic health records that produce high quality data can more easily extract value from their data in times of crisis (e.g. Canada, Denmark, Estonia, Finland, Israel, Singapore, Slovakia and the United Kingdom) (OECD, 2020[20]). Some countries with decentralised data management have successfully consolidated a national database in a matter of months by defining standards that SNGs must follow in collecting and sharing the data with the central authority (e.g. Austria, Germany and Switzerland) (Desson et al., 2020[49]).

← 21. An example of a country that successfully responded to the first wave of the crisis using this approach was Australia (de Biase and Dougherty, 2021[13]).

← 22. Co‑operation across municipalities was observed in Chile, Denmark, France, Israel, Latvia and Sweden while across regions in Belgium, Switzerland and the United States (OECD-CoR, 2020[22]). Notably in the United States, a myriad of inter-state co‑operative arrangements was made to tackle the first wave of the crisis by co‑ordinating action related to the closure of schools, nonessential business, parks, among others. There are examples from the northeastern states (i.e. New York, New Jersey, Connecticut, Pennsylvania, Rhode Island, Delaware, and Massachusetts), West Coast (i.e. California, Colorado, Nevada, Oregon, and Washington) and Midwestern (i.e. Illinois, Indiana, Kentucky, Michigan, Minnesota, Ohio, and Wisconsin) (Benton, 2020[50]).

← 23. There has been evidence of diffusion of COVID-19 responses to neighbouring jurisdictions in Brazil, Mexico and the United States and to jurisdictions governed by aligned political parties in Mexico and the United States (Bennouna et al., 2020[46]). In some cases, the political party was a better predictor of the policies implemented than the local severity of the outbreak (Kettl, 2020[59]).

← 24. For instance, this probably has happened in India (Choutagunta, Manish and Rajagopalan, 2021[51]).

← 25. Results from a survey held by the OECD Network on Fiscal Relations in June 2020.

← 26. This topic is covered in more detail in another section. Here it is worth noting that not all deferral of taxes that are shared with SNGs are going to impact SNGs finances. For instance, in case the deferred tax is transferred to SNGs only after the deferral end date, SNGs might not face any reduction in revenue. In addition, governments that have extended temporarily unemployment schemes to a wide group of workers might have supported the consumption of these workers, so SNGs that depend more on value added taxes might have been protected somewhat by the action of the central government.

← 27. A survey held by the OECD Network on Fiscal Relations found that restrictions on SNG borrowing are very frequent and vary significantly across countries (Vammalle et al., 2020[25]). Restrictions may apply only to borrowing for current expenditure, capital expenditure or both and to borrowing to specific purposes. About two-thirds of surveyed countries have some type of restriction on the level or growth rate of debt or debt service. In some countries subnational borrowing requires an approval from the central government or from other SNGs. Borrowing abroad or in foreign currency is frequently forbidden for SNGs.

← 28. Institutional arrangements whose purpose is to mitigate subnational fiscal risks through the imposition of constraints on fiscal policy, usually operationalised by limits on certain aggregates.

← 29. In particular in the EU countries, this was allowed by the “general escape clause” by the European Commission. At the European level, the European Commission proposed on 27 March 2020 to activate the general escape clause of the Stability and Growth Pact as part of its strategy to respond quickly, forcefully and in a co‑ordinated manner to the COVID-19 pandemic.

← 30. One example of an exception is Brazil, in which SNGs benefiting from central government exceptional transfers suffer limitations to increase personnel spending until the end of 2021.

← 31. For instance, in principle in cases in which SNGs are in charge of enforcing lockdowns, they might choose the level of enforcement to maximise their own benefits. Heavily enforced lockdowns might damage the local economy more but might reduce the health costs and, thus, could be ideal for SNGs that are fully financially compensated by the central government and that bear health costs. The opposite is also true: SNGs that do not bear health costs and that are not compensated by central governments could simply enforce weak lockdowns in a manner to transfer the health costs to the central government.

← 32. Studies have suggested that this can be explained by numerous reasons: 1) availability of care homes and hospital beds which enables patients to be treated even at early stages of the virus; 2) improved infection control in hospitals, which tends to affect more vulnerable patients; 3) clinicians have become more skilled and adept at treating patients with COVID‑19; and 4) a younger age-profile of patients (Mahon, Oke and Heneghan, 2020[53]).

← 33. This proportion varies by diseases (e.g. 95% for measles, 80% for polio) and it is not known this proportion for COVID-19, and it will likely vary according to the community, the vaccine, the populations prioritised for vaccination, and other factors (WHO, 2020[29]).

← 34. In the European Union there was a tendency for member states to take a centralised EU approach to securing supplies and providing support for the development of vaccines under the EU vaccines strategy.

← 35. In Australia, Chile, Germany, Finland, Japan, Korea, Mexico, Spain and Sweden, the central government is generally responsible for vaccine procurement while SNGs have a substantial role in administration the vaccines, which usually includes preparing the sites, organising the staff, storage/logistics of the equipment and rolling-out vaccines. One interesting exception is Italy, in which there also are state governments negotiating directly with suppliers of vaccines (Reuters, 2021[54]).

← 36. For instance, in Canada, Finland, the United States and the United Kingdom, states/devolved nations have some autonomy to decide how they allocate doses across populations.

← 37. The OECD Fiscal Decentralisation database is available at http://oe.cd/FDdb.

← 38. Forecasters consider that the response of tax revenues to economic activity is dynamic and can be better captured with Error Correction Models that estimate short-run, long-run and speed of adjustment (from short-run elasticities/buoyancies towards long-run ones) coefficients (Enders, 2018[55]). In the context of short and abrupt crises, short-run relationships tend to be more meaningful than long-run ones.

← 39. Since tax elasticity captures the effect of the cycle controlling for exogenous tax policies, it is considered a better indicator to measure the reaction of tax revenue to changes in the macroeconomic conditions (Jenkins, Kuo and Gangadhar, 2000[61]). There are also compelling arguments in favour of using tax buoyancy, being the most prominent ones the fact that discretionary tax changes are part of fiscal policy and, thus, should be captured by the coefficient, and that it is practically impossible to isolate tax revenues from changes in the tax framework, which hinders the estimation of “pure” tax elasticities (Lagravinese, Liberati and Sacchi, 2020[60]).

← 40. Although it is soon to properly assess the impact of this crisis on tax bases, it can be the case that in this crisis the sensitivity of tax revenues shifted as a result of the huge asymmetric impacts on different sectors of the economy.

← 41. Examples of countries that 1) deferred or waived the payment of business property taxes are Bulgaria, Chile, Israel, Italy, Japan, Peru, Singapore and the United Kingdom; 2) benefited residential property owners are Chile, Greece and Macau; and 3) Reduced property transaction taxes are Czech Republic, Israel, Korea, the Netherlands and the United Kingdom (OECD, 2021[39]).

← 42. For the United States the growth rate refers to the last three trimesters of 2020 in comparison to the same period in 2019 while for other countries it refers to the full year of 2020 in comparison to 2019.

← 43. In some cases, asymmetries introduced by the pandemic will not be reflected by equalisation payments for several years due to the use of lagged variables in the underlying formulae. Moreover, funds for equalising transfers are often tied to dedicated revenues streams or capped at a certain growth rate, potentially below the growth rate observed in certain jurisdictions, which may cause equalisation funds to shrink as a result of the pandemic.

← 44. The more autonomous SNGs are, the larger these differences tend to be. This results from differences in tax limitations. For instance, in the United States, states can vary substantially their income taxes rates, with some states having no income taxes while others relying substantially on this type of tax. In countries in which SNGs cannot vary their tax policy significantly, it is expected that SNGs tax mix will also be more similar. The same holds true for expenditure assignments, in which SNGs might face limitations on their autonomy as a result of earmarked transfers and/or mandated expenditure floors.

← 45. Regions most dependent on tourism and trade suffered more from the economic slowdown as a result of the pandemic (OECD, 2021[31]).

← 46. For instance, in Brazil, the income distribution programme “Bolsa Familia” has contributed to the decline of regional inequality in the country (Góes, Karpowicz and Cuevas, 2017[56]).

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