Local fiscal equalisation based on fiscal capacity: the case of Austria

This paper deals with local fiscal equalisation in Austria. The system of intergovernmental relations in Austria includes different regulations in order to equalise differences in the fiscal capacity of the municipalities. This leads to so-called 'compensation effects' because additional revenues from a local government's own tax are (at least partly) compensated by losses from equalisation grants. This paper carries out a detailed analysis of these compensation effects. It is shown that they create strong fiscal disincentives for the local governments: on average, 55 per cent of additional revenues from the communal tax (which is the most important of a local government's own taxes) are compensated by losses of equalisation grants. In extreme cases, local governments can lose up to 144 per cent of the additional tax yields collected. These local governments would be better off if they made no effort to increase their tax base.