For the last few weeks, the issue of inter-jurisdictional fiscal disharmony with reference to the imposition of several taxes was widely circulated in the media. The federal government has been at loggerheads with several provincial and local units over the issue of new taxes. Provincial and local governments recently introduced new taxes, fees and charges under a number of headings considering it to be their domain while the federal government has opposed the move arguing that it was unconstitutional as it violates Article 236 of the constitution.

Article 236 states that there shall be unhindered movement of goods and services across provincial or local boundaries. The dispute arose after Karnali and Provinces 1 and 3 imposed what they called district export tax on forest, agriculture and mineral products.

Fiscal disharmony

In addition to the provincial governments, local units have also imposed taxes on a number of items. Birgunj Metropolis recently imposed an entry fee on vehicles passing through. The metro council has even introduced taxes on parking, rickshaws, pull carts. The federal government has opposed all these new taxes. This has resulted in an incidence of vertical fiscal disharmony due to a conflict between federal, provincial and local units, and horizontal fiscal disharmony among sub-units within a sub-central unit as some ward committees and business communities have opposed them. The vertical and horizontal anomalies require an assessment of the issue and its causes and consequences with reference to the theory and practice of federal finance.

The tax dispute is a case of fiscal disharmony which emanates from overlaps due to concurrency in the functioning of different levels of government. In theory, a certain degree of disharmony and conflict is unavoidable with regard to federal finance. The problem that has arisen in federal Nepal is thus not at all unique or abnormal. To some extent, the source of this conflict lies in the very constitutional arrangement of federal Nepal. Schedules 7 and 9 of the constitution demonstrates concurrency of federal, provincial and local units in their jurisdiction in a number of subjects comprising both tax and non-tax revenues.

Similarly, the Intergovernmental Fiscal Arrangement Act 2017 contains many provisions for having interdependence (complementarities and substitutability) in fiscal activities among all three levels of government. Because of this concurrency and interdependence, overlapping can occur among different jurisdictions between different levels (vertical), or among different units within a sub-central unit (horizontal). However, because of this spill-over effect, governmental units in a federation enjoy a competitive relationship. Nonetheless, no governmental unit should be able to exploit others, and if does so, there should be an effective mechanism to counter it.

It is also important to ensure that no jurisdiction is able to get a ‘free ride’ on others by passing the burden of financing public services of its residents to non-residents. Indeed, the essence of fiscal federalism is to coordinate the policies of different levels of government to foster welfare-oriented competition and avoid incidences of inter-jurisdictional tax competition.

In a representative democracy like Nepal, there exist chances of sub-central governmental units indulging in tax competition to attract trade and industry into their localities and thus exportation of tax to non-residents. This, however, can bring various types of barriers—fiscal and physical—to the free movement of factors and products, and thus distort the pattern of resource allocation and bring inequity.

This, in turn, can give rise to the exploitation of weak governmental units by stronger ones. The issues discussed above requires the creation of a mechanism to ensure an optimal degree of tax harmonisation—keeping in view the fiscal autonomy of governmental units and welfare loss due to resource distortion and inequity arising from inter-jurisdictional tax competition and tax exportation.

Low taxes, broad base

On the basis of the experience of tax reform in several countries, federal Nepal should focus on broadening the tax base, levying lower level and less differentiated tax rates, simplifying the tax system, making it transparent and thereby avoiding cascading effects. A broader tax base obviates the need to have high tax rates, reduces incentive effects and also imparts neutrality. Additionally, this reduces tax avoidance and evasion.

At the same time, sub-central units should have the autonomy to determine the standard of public services and the fiscal policy to finance them. Besides, it becomes necessary to ensure that the tax system is not used by any governmental unit to gain at the expense of others. In other words, sub-central units should be given residence-based tax assignments. So far as source-based taxes are concerned, attempts should be made to transform them into residence-based taxes through wider inter-governmental consultations, negotiations and detailed discussions.

The role of the central government (through its various agencies) in monitoring the working of inter-governmental relationships is equally vital.

Mishra is a lecturer at National College