Funding Federalism: the Argentine Co-Participation System

At the end of last week, Buenos Aires provincial governor Daniel Scioli finalised the payment of the bi-annual aguinaldo bonuses with some help from the national government, seemingly bringing an end to a month-long crisis in the province.

As tensions cool to a simmer, however, news that Scioil has met with his counterparts in other provinces undergoing similar financial strain suggests that the financial challenges in Buenos Aires are far from solved, and that some of the concerns highlighted by last month’s crisis echo in provinces across the nation.

This recent conflict underscored a complex relationship between the provincial and national governments in Argentina, a theme that extends as a common thread throughout the country’s political history. The federal co-participation system represents one attempt to strike a balance between these two levels of government.

The federal co-participation regime is a tax sharing structure by which the federal government collects certain taxes, and then keeps a proportion of funds itself while distributing the remainder amongst the provinces. Understanding this co-participation scheme is a key to understanding the complex financial relationship between the provinces and the central government.

History and Structure of the Co-Participation Regime

The Argentine co-participation tax regime began in 1935, in the wake of the 1930s financial crisis. Today, the regime is enshrined in the Argentine constitution in Article 75.2.

At its core, the co-participation system is based on the principle of redistribution. Political scientist Matias Rohmer observes that in the constitution, the system is intended as “an equitable regime based on solidarity, that aims for the equitable development of all of the provinces.”

Under the co-participation system, there are two levels of redistribution: the primary distribution, or that between the federal and provincial governments, and the secondary distribution, or that among the provinces themselves.

Today’s co-participation system is still regulated by law 23.548 from 1988, the “Transitory Distribution Regime”. As its name implies, this law was intended as a temporary measure expected to hold only through 1989. Despite many attempts at reform and a call in the 1994 Constitution for a restructuring of the co-participation system in 1996, the process remains at a stalemate.

Because the law has never been officially reformed, the distribution is still informed by statistics from 1985 and 1987, which are now over 25-years old.

Today’s co-participation system is a labyrinth, incorporating a web of taxes, some of which fall exclusively under the regime – such as income taxes and the IVA (Value Added Tax) – while others are partially included – such as taxes on liquid fossil fuels and natural gas.

While the skeleton of the 1988 law has been maintained in the absence of a new law, a series of modifications have been passed that have rendered the regime extremely complex. Pablo Germán Ava, a sociology professor at the University of Buenos Aires (UBA) and congressional consultant, notes that this patchwork style of reform is not unique to the co-participation system, but it is rather characteristic of Argentina’s tax system on the whole, which has been constructed through “small reforms that were made in emergency situations.”

An Uneven Distribution

The current system generates certain inequalities in the distribution of funds which have been brought to the forefront by the dire financial situation some of the provinces are facing.

The Province of Buenos Aires and the City of Buenos Aires –integrated into the co-participation system in the 1994 constitution – have perhaps the greatest interest in altering the current regime. As these territories are among the wealthiest in the country, they contribute the most to the system, but receive some of the smallest shares of co-participation funds, in relative terms.

Given that the co-participation regime is redistributive, as Rohmer observes, “there is always going to be one province, or a group of provinces, that are richer and that contribute more than they receive.”

However, given that the Buenos Aires province alone contains nearly 40% of the country’s population, the echoes of its financial struggles – and its complaints about the co-participation system – carry a significant weight.  As Ava notes, “Buenos Aires’ weight is very important. You cannot let Buenos Aires fail.”

Under the 1988 law, the four provinces that contribute the most are supposed to be compensated additionally through a 2% recuperation fund written into the co-participation system. Throughout the 90s, the province of Buenos Aires was paid out of this fund, which has since been suspended.

Even though the fund has not been updated, the federal government does continue to spend a significant portion of its budget on infrastructure projects in the province. Ava says this suggests that the struggle is “not a problem of resources, it is a political problem of who spends where.”

While the province and the city of Buenos Aires have a stake in changing the system, many provinces do not necessarily want to see a change. Rohmer observes, “the immense majority [of provinces], receive more than they contribute.”

Rohmer argues that the problems are similar to those of disparity among regions faced by many federal systems. He further suggests, however, that “perhaps not all federal systems have the problems that Argentina has with regards to the profound disparities in development” between provinces and that “to understand the challenge [you must] situate it within the structural problem of inequalities in Argentina,” inequalities that “persist, and in some ways…have deepened” despite a distribution that historically favours poorer provinces.

The poorest provinces are the most dependent on the central government and co-participation funds. Although all of the provinces have a right to collect their own taxes, there is great variation as to what proportion of provincial budgets is composed of co-participation funding.

In the provinces of Jujuy, La Rioja, and Santiago de Estero – some of the poorest in the country – federal funding accounts for over 90% of the public budget; in essence, observes Rohmer, these provinces “practically do not collect any of their own taxes.”

Even beyond these extreme cases, the vast majority of provinces are over 50% dependent on federal funds (which includes co-participation and other transfers from the national government). Even the budget of the province of Buenos Aires, for example, is composed of approximately 50% federal funding and 50% local taxes.

Only other four territories are ‘self-financing’, which is to say that their budgets are made up by more than 50% local funding; the capital city of Buenos Aires, where federal funds make up only 12% of the total public budget, and the resource-rich provinces of Chubut, Neuquén, and Santa Cruz, which obtain much of their funding from royalties.

Rohmer suggests there could be a political motive behind the low local taxes collected in some provinces, as the co-participation system allows for local governments to “not assume the cost of charging their citizens another tax” and can instead depend on “support from the taxes that the nation collects.”

Many of the provinces’ financial situations are further complicated because of structural debt, a topic of concern for decades as government services have been slowly transferred to the provinces without necessarily being accompanied by a parallel raise in funding.

This process came to a head in the 90s, when the country operated under the neoliberal model and, as Ava comments, “a way to finance budget was by debt. It was an idea from the Washington Consensus that …when a province was not very good at handling their budget, the market would punish them with high rates so that the province would go down with their expenditures. But it didn’t work that way. The provinces were expanding their budget, expanding their deficit, and the market was still financing them.”

At this time, the Menem government also arranged the so-called federal pact, by which the federal government shifted the responsibility for some services – such as education and health – to the provinces, while taking on the pension system, which it in turn privatised.

Challenges to Altering the System

Despite the difficulties the current system of co-participation presents for some provinces, major challenges exist to altering it. Perhaps the most significant challenge is the constitutional requirement that any change be approved not only with an absolute majority in the federal congress, but also by every provincial congress.

Given that the change would probably require some provinces to receive less income from co-participation, the possibility of each provincial congress approving a new distribution seems unlikely. As Ava observes, “It’s difficult to have a winning situation for everybody. Nobody wants to give up anything of their resources… it’s a big cake, but everyone has a part already. So nobody wants to give up anything.” 

Ultimately, any change to the co-participation system may be dependent on the federal government’s willingness to shrink its own 42% share of co-participation taxes. As the federal government is also in great need of financing, however, this possibility seems unlikely.

For now, the federal government has aimed to increase assistance to the provinces in other ways – such as executing infrastructure projects and helping local governments to refinance their debt – without altering the co-participation law.

The federal government has raised some co-participated taxes – such as income tax and IVA– in a move that ultimately sends more money to the provinces. As Rohmer observes, “the provinces are benefiting every year and every month from the effort that the nation makes in taking on the cost to raise co-participated taxes”.

An Unlikely Reform

Is, then, a reform possible in the near future? Ava suggests otherwise; “I don’t think that there is a solution—an easy solution, and political opposition will veto any kind of attempt.”

He further points out that in the 80s, when the law was negotiated and eventually passed, “it was a very particular situation, because [former president Raúl] Alfonsín was leading the federal government, and the Buenos Aires province was … [ruled] by the same party.” The Buenos Aires province therefore gave up some of its own resources in order to help the federal government in negotiations with other local governments ruled by the opposition.

Ava suggests that “considering the current political situation, it would be very difficult to have that situation again.”

Rohmer also emphasises that in Argentina, the co-participation debate appears as one part of a larger debate about the tax system in the country. He suggests, “Argentina continues to have a very unjust tax system, very regressive”, in which  IVA continues to eclipse the progressive income tax in importance.

He suggests, however, that this tax system would be hard to change; “obviously, changing the tax system generates a conflict in any country in the world. The government needs to have the willingness and the desire to change the tax system.”

What’s more, Rohmer suggests, the government needs to communicate any proposed changes and their significance to the people. He observes, “even if there was a government that was willing, that had the political force, the parliamentary support, the support of the governors… if it is a government that doesn’t know how to communicate well with the population and win them over in terms of what the reform is going to mean for the majority of them in general, they will have problems.”

What do Argentines think about the co-participation system? Click here to find out.