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Unformatted text preview: rojects, such as infrastructure and education, are
spread over time, which means that not only present residents of a locality, but also future residents will consume
the services provided by the projects. Therefore, the benefit principle of taxation suggests that future residents
should also contribute the cost of investment. For this purpose borrowing is an appropriate tool that offers a means
through which payments for capital projects can be spread over the life of the project so as to coincide more closely
with the stream of future benefits (Oates, 1972). 2. Economic Development: Delaying infrastructure investments might have a negative impact on subnational
economic performance. Such a negative impact will have a direct effect on residents’ life in terms of less
employment opportunities and decline of earning levels. Therefore, borrowing is an appropriate tool for subnational
governments in investing on infrastructure projects to stimulate regional economy. 3. Synchronization of Expenditure and Revenue Flows: Access to financial tools offers an opportunity to subnational
governments to synchronize expenditures incurred and revenue collection. For a variety of reasons expenditure
incurred and tax intake may not be fully synchronized for a particular year. In such a situation, borrowing provides
subnational governments to smooth out the mismatch and provide services without disruption. There are at least two different channels through which subnational governments can borrow: through a public
intermediary such as infrastructure bank or direct borrowing from private capital markets. The international experience
suggests that lending through a public entity, either central government lending or public financial intermediary, suffers
from political favoritism (World Bank, 1990). Direct access to private markets entails development of market-based
169 Commission on Fiscal Imbalance relationship between lenders and subnational governments, which requires the use of private credit rating and bond
insurance agencies to monitor subnational borrowing. Establishing these institutions offers a potential for improving
transparency and political accountability in local government management. As capital markets emerge, residents of local
governments would learn more about the financial health of their governments.
Subnational borrowing is an important component of the devolution of fiscal powers to local authorities. However, a welldesigned regulatory framework for subnational borrowing is necessary to ensure that subnational borrowing does not
provide perverse incentives to lending institutions and subnational governments for excessive lending and borrowing.
Such a framework includes standardized accounting procedures for subnational governments, disclosure of subnational
governments’ liabilities and repayment capacity (see Figure 16). However, these measures by themselves will not be
sufficient to curb moral hazard problem. The macro concern of moral hazard occurs when subnational governments are
backed by the central government by...
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