Integration, decentralization, taxation, and revenue sharing : Good governance, sustainable fiscal policy and poverty reduction as peace-keeping strategies

I. Introduction 
Economic integration is closely connected with the liberal ideas of free trade as well 
as mobility of people and capital. The formation of an extended economic area is of-
ten connected with decreasing per-capita cost of public goods and services (including 
a single currency) or increasing economies of scale. If citizen of such a region do 
face the advantages of economic cooperation, voluntary integration by democratic 
decisions seems to be a feasible option. But already in “pre-democratic” periods eco-
nomic integration took place, e.g. in the case of the numerous German states of the 
19
th
century, which in 1834 formed the German customs union (Deutscher Zollver-
ein), being the fore-runner of the 2
nd
German Empire formed in 1871. 
The process of European integration is another democratic example, started with the 
Treaty of Rome 1957 and the preliminary ending in 2007 with the Treaty of Lisbon. In 
spite of the fact that an European constitution has been refused by some member 
states the European Union (EU) has more or less got the character of a federal state, 
at least having an own budget and revenue from common customs as well as contri-
butions from the member states. Hence, former sovereignties of the European mem-
ber states have been transferred to the Brussels Commission or the European Par-
liament. With other words decentralized autonomies of the member states have been 
centralized on a new jurisdictional level. Therefore, integrative processes are usually 
accompanied by centralization, contrary to the fact that at least some of the members 
are organized as federal states in which decentralization plays in important role. 
Obviously integration and fiscal federalism are sometimes in conflict so that a careful 
analysis of both, integration and decentralization, is of utmost relevance evaluating 
the advantages and disadvantages of regional cooperation. A clear and conflict re-
ducing distribution of public tasks in between the jurisdictional levels is the major pre-
requisite for a rational and successful integration process, in spite of the fact that in 
the example of the EU the distribution of tasks in between the member states and 
Brussels was more the outcome of historical compromises than of rational planning. 
However, the following paper has the purpose to describe briefly the role of voluntary 
international integration and efficient national decentralization in an approach of a 
democratic constitutional setting in which human rights and individual self-
determination play a decisive role. Therefore in part II the basics of the economic 
theory of economic integration are summarized before in part III the main elements of 
fiscal federalism are discussed, while in part IV the urgency of a democratic setting 
connected with modern public choice arguments is described in more details. 
Efficient integration and decentralization then generate a distribution of public tasks 
over the different jurisdictional levels thus defining the different goods and services to 
be supplied on the supra-national, national, regional, and local sphere. The rules of 
good governance are then expressed within the institutional settings (institution build-
ing) as well as the efficient organization of the supply of public goods and services 
(yard-stick competition, benchmarking, and best practice analysis). The supply of 
public goods and services of the individual jurisdictional levels then creates the fiscal 
need of the jurisdictions under consideration. The public expenditures on the different 
levels have to be financed by the citizen, depending on the per-capita income within 
the single jurisdictions. Therefore, the jurisdictional levels have to be supplied with 
adequate taxes, contributions, and fees, which yield a properly revenue. The revenue 
potential of a jurisdictional level depends on the citizens’ per-capita income, which 

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determines its fiscal capacity. Because of a predominantly more or less unequal dis-
tribution of national, regional, and local per-capita income the fiscal (or revenue) ca-
pacities of the jurisdictional levels are heterogeneously distributed so that single ju-
risdictional levels have a fiscal capacity, which is more or less below their fiscal 
needs. Then problems of revenue sharing, intergovernmental grants (transfers) or 
fiscal equalization in vertical as well as horizontal direction arise, which will be dis-
cussed in part V. Part VI describes the consequences for tax reform processes and 
the tax administration while part VII briefly summarizes the results.