A convergence fund must replace federal coparticipation

The problem with coronavirus is concentrated in the Buenos Aires Metropolitan Area (AMBA). This explains the decision of the federal and the City’s and the Province of Buenos Aires’ governments to maintain the lockdown in the metropolitan area. Google’s mobility indicator shows that while in the interior of the country, the reduction in mobility to workplaces is 23%, on average, in the AMBA, it is reduced by 45%.

Freedom in the interior of the country will not produce a faster economic recovery in those places. One reason is the concentration of logistical power in AMBA, which comes from the colonial periods. Another is how taxes are collected and distributed. On average, the provincial states are financed 72% by the federal coparticipation of national taxes and only 28% by provincial taxes. In some provinces, the dependency on federal taxes reaches 90%. With AMBA semi-paralyzed for the lockdown, the funds coming from coparticipation to the provinces are stagnant. With inflation at 45% yearly, a stagnating coparticipation is generating severe fiscal troubles in the provinces.

Is there a need for such a level of dependence of the provinces on the federal funds? Analyzing some data provided by the Ministry of Economy could help to shed light on the answer. According to this source, it can be seen that:

• The provinces in the central region of the country generate 78% of the GDP and hold 71% of the population.
• The Southern provinces produce 9% of the GDP and hold 6% of the population.
• The Northern provinces produce 13% of the GDP with 23% of the population.

These data show that underdevelopment is concentrated in the North of the country. Therefore, it is clear that some resources need to be transferred from the most productive regions to the North to help correct development asymmetries. For the rest of the country, with more than three-quarters of the population, there is enough economic potential to prosper without coparticipation and develop autonomously. In other words, there is no need for a mega-mechanism of transfer of resources, such as the federal coparticipation, to reduce regional development gaps. A smaller mechanism focused on the North should be sufficient.

Federal tax coparticipation, as designed in Argentina, generates perverse incentives associated with provinces dependence on the federal State. The total tax burden in Argentina is 28% of GDP, of which the federal State collects 23 points, thus only 5 points are collected by the provinces directly. Of the 23 points, only 8 points return to the provinces via coparticipation. This imbalance generates two significant distortions. On one side, a disproportionate share grabbed by the federal level. On the other hand, the heavy dependence of all provinces, not just the underdeveloped ones, on federal transfers.

Coparticipation failed from different points of view. One is that it proved not to be a useful tool for correcting regional asymmetries. On the contrary, it deepened them to the point that Buenos Aires City shows quality of life similar to developed countries while the North is assimilated to the most backward ones. More negative still is that the concentration of resources and decision-making power at the federal level fed provincial dependence and a perverse incentive structure. Provinces are incentivized to woo the federal authorities instead of building local development capacities.

Updating the coparticipation is pointless. Firstly, no province will ever give up a share of its participation. Secondly, its incentives are inherently perverse. More conducive would be to dismantle the entire coparticipation scheme and let each province to finance itself with its own revenues. For regional asymmetries, the wealthier districts (mainly Buenos Aires City) should finance a Convergence Fund to promote development in the more backward regions of the North. This Fund would be a lot smaller than an overwhelming coparticipation scheme.