Local authorities typically spend money they receive as natural resource revenues or as transfers from national or supranational institutions. But a new study of two mountainous regions in Switzerland that receive substantial hydropower royalties finds that the municipalities forward most of the income to their citizens by lowering taxes. The research by Patrick Leisibach, Simon Luechinger, Jonas Roellin and Christoph Schaltegger estimates that the tax take of a municipality declines by 1.3 Swiss francs for every 1 franc increase in natural resource revenues.

What explains the results? One reason might be that while external financial resources can affect the financial conduct of local authorities, financial conduct could also influence how much external resources they receive – and previous studies may have failed to take that into account. But it also may be an outcome of the Swiss context: an institutional setting that fosters the respect of voter preferences with fiscal autonomy, direct democracy and stable external resource flows.

Local authorities typically receive external financial resources that top up whatever they raise from taxing their own citizens and firms. Examples include widely used intergovernmental transfers in federal countries, natural resource revenues (for example, provincial oil and gas royalties in Canada), and European Union structural funds to strengthen regional cohesion. How do local authorities use these external resources?

The new study addresses this question for Swiss municipalities from two mountainous regions, which receive substantial hydropower royalties. According to the researchers’ estimates, municipalities forward a good deal of the natural resource revenues to their citizens by lowering taxes. This contrasts with most earlier findings, which indicate that local authorities mainly spend external revenues.

In this case, the division of the external resources between the private and public spheres closely resembles the division for municipalities’ own resources such as household incomes and profits. This outcome might be due to an institutional setting that fosters the respect of voter preferences with fiscal autonomy, direct democracy and stable external resource flows.

Although external financial resources can affect the financial conduct of local authorities, it can also be the other way round – that is, their financial conduct influences how much external resources they receive. For example, in this context, local authorities may encourage hydropower production to bankroll their spending spree. This is an important challenge in estimating the effect of external resources.

To get around this, the researchers focus on changes in natural resource revenues that are unrelated to local politics. In particular, they leverage the facts that the federal level sets the rate at which hydropower production is taxed and that a given rate increase has larger revenue effects in municipalities with sites better suited for hydropower plants.

Focusing only on these changes, which are unrelated to local politics, the study establishes that local authorities use the natural resource revenues to lower tax rates. The tax take of a municipality declines by 1.3 Swiss francs for every 1 franc increase in natural resource revenues. The estimated effects on spending, investment and debt are imprecise and, therefore, the researchers cannot reject the possibility that natural resource revenues have no effect on these fiscal measures.

According to most of the older work on this topic, lower-level authorities spend nearly all of their external financial resources. More recent evidence is more balanced, but findings of big effects on spending still predominate.

Why do the new results differ? One explanation is that early contributions often failed to address adequately the challenge that the relationship between external financial resources and financial conduct runs both ways.

Further, the Swiss context makes it more likely that citizens get their way. For a comparable institutional environment in the United States, Lutz (2010) also finds that external financial revenues mostly finance tax reductions. Thus, a favourable institutional environment seems to align fiscal policy with citizens’ interests.

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‘The effects of natural resource revenues on municipal finance’

Authors:

Patrick Leisibach (University of Lucerne)

Simon Luechinger (University of Lucerne and ETH Zurich)

Jonas Roellin (University of Lucerne)

Christoph Schaltegger (University of Lucerne and University of St Gallen)

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Reference:

Lutz, Byron (2010) ‘Taxation with representation: Intergovernmental grants in a plebiscite democracy’, Review of Economics and Statistics 92(2): 316-32.