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5 Fiscal Decentralization after Implementation of Local Government Autonomy in Indonesia Harryanto Nyoto* and Faudziah Hanim Fadzil** This research aims to explain the relationship between local fiscal capacities, intergovernmental transfers with the realization of the budget. Using the sample budget of 190 districts in Indonesia, three hypotheses have been tested. The results of this study indicate a high dependence of local governments, to grants from the national government. Although there are close links between local fiscal capacities with performance budgeting, intergovernmental transfers are not fully mediating the relationship. Keyword: Local own revenue, grants and transfer, local government budget Paper No. BR Introduction After application of local autonomy and fiscal decentralization, national governments seem unable to achieve its objectives. The government's efforts to improve the fiscal capacity of regions, which is done by allocating grants to local governments, seems to have not succeeded (Harryanto, 2009). Under the law, the allocation of grant has the objective, which includes to improve and to balance the fiscal capacity of regions. However, until 2009, unequal distribution of the local fiscal still exists. Revenue obtained from taxes and levies have not achieved an equal distribution, and even unable to finance the salary and wage expenses (Harryanto, 2009). The imbalance of fiscal capacity of the regions is determined by the difference in views between the national and regional governments. In the perspective of the national government, as has been mentioned in the statute, the allocation of subsidies and grants are used to enhance the ability of regions to finance the needed public services, and to organize and keep pace regional development. In terms of the local government view, before the implementation of regional autonomy, the central government has received such benefit from the exploiting local resources, so in this era of autonomy, the central government has to pay back what has been delayed. There are different ways of looking at the transfer, which creates a variety of local efforts that bring the results of development in the era of autonomy. Several studies (Pambudi, 2008; Firdausy, 2004) showed that local financial imbalances have forced local governments to encourage their income sources by developing new taxes and levies. By increasing the income sources in excess, causing the local economic development to be hampered. Fiscal Decentralization Page 5

6 2. Discussion and Concluding Remarks Empirical test results indicate that the local own revenue is positive and significantly influence the budget performance. These results are in accordance with the recommended and expected by the national regulation (Sidik & Kajatmiko, 2004), and the results of empirical studies by Lewis (2005). However, some researchers (Brojonegoro, 2004; Bayhaqi, 2004; Firdausy, 2004) argued that the local governments are still shrouded in various capacity constraints. Brodjonegoro and Mahi (2003) argued that local governments have no significant capacity. While Firdausy (2004) argued that fiscal decentralization, have implications for the emergence of local taxes that have proliferated, levy a burdensome and restrictions on business and trade. Similarly, Pambudi (2008) points out that fiscal decentralization brings about interference to the business, taxes and levies ignore the creation of a conducive of business climate. Meanwhile, the results of this study suggest that the local fiscal capacity, which is reflected from the local own revenues have not distributed evenly across the country. Inequality of the capacity was still pushing the local governments to impose tax efforts. These efforts are impeded the local economic growth. Local own revenue, and grants and transfer, each individually, have a significant effect on the budget performance. This finding is also supported by previous researches (Lewis, 2005; Sidik & Kajatmiko, 2004; Brodjonegoro, 2004). Local own revenue is a representation of the capacity of local financial resources. As a regional resource, this includes natural resources, human, and technology. The results of local resource management, whether for business purposes or for the purposes of infrastructure development, have an effect to the fiscal capacity for both locally, and nationally. Local fiscal resources are relatively more limited (Bayhaqi, 2004) and is very critical to developed, as it relates to economic activity (World Bank, 2007). The higher local taxes imposed on society, certainly can reduce the ability to expand their businesses (Pambudi, 2008). The greater resources held by national governments (Firdausy, 2004), as the result of oil and gas processing, forestry and plantations, the greater revenues are obtained. Nevertheless, this will create conflicts of interest because the exploitation of these natural resources will leave the cost to local communities, while the great benefits gained by the national government (Sidik & Kajatmiko, 2004). Differences of interest cannot be bridged by the grants and transfer (World Bank, 2007). There is always an obstacle in encouraging the creation of a balance between local fiscal capacities, as expected by law (Law No.32, 2005). Implications of fiscal resources held by the central government are the existence of a very high level of local dependence on the transfer (Lewis, 2005; Sidik & Kajatmiko, 2004). Although Lewis (2005) suggests that there is no empirical evidence that reliance on transfers cause local governments to develop new tax sources. However, the results Fiscal Decentralization Page 6

7 of several studies (Firdausy, 2004; Pambudi, 2008) show different things. Recent observations (Pambudi, 2008) still shows there are still many regions levies in the form of user charges that are not clear designation. Simultaneously both the independent variable local own revenue, and grants and transfer has a positive and significant impact on budget performance. This finding is supported by previous researches (Lewis, 2005; World Bank, 2007; Asian Development Bank, 2004). Under the law, that local own revenue is used to finance the needs for public services, while grants and transfer is used to help the fiscal capacity of improving public services and regional development (Sidik & Kajatmiko, 2004). However, in fact, the regions relies heavily on financial transfers (Lewis, 2005), and significant sources of income in the hands of central government (Firdausy, 2004; Bayhaqi; 2004). Therefore, it is unavoidable to make the transfer of local government as the main financial sources. This means that the effort of the national government to encourage the local own revenues have not been achieved. Finally, it can be concluded that the experience of regional autonomy with fiscal decentralization policy has encouraged local governments to increase regions fiscal capacity. However, the unavoidable dependence of local governments to transfer from national government is still very high. The situation is still carrying the potential conflict of interest between the two levels of government, particularly in setting priorities for programs into the budget. The local own revenue is a potential source that is effective in promoting the performance of the budget. The mediator's role of grants and transfer, in fact, weaken the significant of local own revenue to the budget performance. This is because regions fiscal capacity is concentrated merely on the grants and subsidy, but effective financial management is on the local own revenue.. Fiscal Decentralization Page 7

8 BIBLIOGRAPHY Asian Development Bank 2006, Fostering Public Participation in Budget Makings: Case Studies from Indonesia, the Marshal Islands, and Pakistan, Asian Development Bank, the Asia Foundation, pp Bahl, Roy, Martinez-Vazquez, Jorge & Sjoquist, David L 1992, Central City-Suburban Fiscal Disparities, Public Finance Quarterly, Vol. 20. No.4, pp Bayhaqi, Akhmad 2004, Decentralization in Indonesia: the Possible Impact on Education (Schooling) and Human Resource Development for Local Regions, Paper presented at The 2nd International Conference on Indonesia: Decentralization and Structural Reformation, Faculty of Social and Political Sciences, Diponegoro University, Semarang, July 7-8th,2004. Brodjonegoro, Bambang 2004, Three Years of Fiscal Decentralizations in Indonesia: its Impact on Regional Economic Development and Fiscal Sustainability, Department of Economics, University of Indonesia, Jakarta. Fernandez, Joe 2007, Indonesian Participatory Budgeting Effort, Institute for Policy and Community Development Studies/Indonesia Forum for Budget Transparency (IPCOS/FITRA), Jakarta. Firdausy, Carunia Mulya 2004, Indonesia, Center for Economic Research Indonesian Institute of Science, Jakarta. Harryanto 2008, Budget Performance and Process of Local Government of Indonesia, Unpublished PhD Desertation, Universiti Utara Malaysia. Ji-Wen, Lin & Shu Szu-Chien 2000, An Agency Theory of State-Society Relation in Mainland China and Taiwan, Paper prepare for Annual Meeting of the American Political Science Association. Lewis, Blane D 2001, The New Indonesian Equalization Transfer, Bulletin of Indonesian Economic Studies, Vol. 37, No. 3, p , Jakarta. Lewis, Blane D 2003, 'Indonesia', Chapter 5 in Intergovernmental Fiscal Transfers in Asia: Current Practice and Challenges for the Future, edited by Paul Smoke & Yun-Hwai Kim, Asian Development Bank. Fiscal Decentralization Page 8

9 Lewis, Blane D 2003, Local Government Borrowing and Repayment in Indonesia: Does Fiscal Capacity Matter?, World Development, Vol. 31, No. 6, pp Lewis, Blane D 2005, Indonesia Local Government Spending, Taxing and Saving: An Explanation Pre and Post-Decentralization Fiscal Outcomes, Asian Economic Journal, Vol. 19, No.3, pp Lupia, Arthur & Mathew McCubbins 1994, Who controls? Information and the structure of legislative decision making, Legislative Studies Quarterly, vol. 19, No.3, pp Lupia, Arthur & Mathew McCubbins 2000, Representation or abdication? How citizens use institutions to help delegation succeed, European Journal of Political Research, vol. 37, pp Lupia, Arthur, 2001, Delegation of Power: Agency Theory, Published in Neil J. Smelser and Paul B. Baltes (ed.) International Encyclopedia of the Social and Behavioral Sciences 5, pp , Oxford, UK: Elsevier Science Limited. Mack, Janet & Christine Ryan 2006, Reflection on the Theoretical Underpinnings of the General Purpose Financial Reports of Australian Government Departments, Accounting, Auditing, and Accountability Journal, vol.19, No.4, pp Mahi, Raksaka, & Bambang Brodjonegoro 2003, The Indonesian Political Economy of Decentralization, presented at the International Symposium on Indonesia s Decentralization Policy: Problems and Policy Directions, Hitotsubashi University, Tokyo. Mulgan, Richard 1997, Contracting out and Accountability, Australian Journal of Public Administration, vol. 56, No. 4, pp Mulgan, R 2000, Comparing accountability in the public and private sectors, Australian Journal of Public Administration, vol. 59, No.1, pp Pambudi, Agung 2007, Local Economic Governance of Indonesia in Indonesia: a Survey of Businesses in 243 Regencies/Cities in Indonesia, 2007, Komite Pemantauan Pelaksaan Otonomi Daerah (KPPOD), Asian Foundation, and United States Agency for International Development (USAID). Fiscal Decentralization Page 9

10 Preacher, Krisptopher J, & Leonardelli, Geoffrey, J 2010, Calculation for the Sobel test: An interactive calculation tool for mediation tests, viewed 12 December 2010, < Sanusi, Anwar 2008, Government Reorganization to Improve Public Services: a Lesson from Some Local Government in Indonesia, Center for Institutional Studies, National Institute of Public Administration, Republic of Indonesia. Shi, Min and Jacob Svensson 2002, Political Budget Cycles in Developed and Developing Countries, Mimeo, IIES, Stockholm University. Sidik, Machfud and Kajatmiko 2004, Indonesia Fiscal Decentralization: Combining Expenditures Assignment and Revenue Assignment, Ministry of Finance Department, Republic of Indonesia, Jakarta. World Bank 2007, Spending for Development: Making the Most Indonesia s New Opportunities, Indonesia Public Expenditure Review 2007, the World Bank, Jakarta. World Bank 2007, Spending for Reconstruction and Poverty Reduction, Public Expenditure Analysis, the World Bank, Jakarta. World Bank 2008, Making Decentralization Work for Development: Methodology of the Local Government Performance Measurement (LGPM) Framework, the World Bank, Jakarta. Fiscal Decentralization Page 10

11 Exhibit 1 Validity and Reliability Test for the Data. No Variables Cronbach s Alpha KMO Variance Explained (%) 1 Local Own Revenues 2 Grants and Transfers 3 Budget Performance Exhibit 2 Coefficients(a) Unstandardized Coefficients Standardized Coefficients t Sig. Collinearity Statistics Model B Std. Error Beta Tolerance VIF , 1 (Constant) **) Local Own Revenue **) a Dependent Variable: Budget Performance (Constant) **) Grant and Transfer **) a Dependent Variable: Local Own Revenue (Constant) **) Grants and Transfers **) a Dependent Variable: Budget Performance 1 (Constant) **) Local Own Revenues **) (Constant) **) Local Own Revenues *) Grants and Transfers **) a Dependent Variable: Budget Performance **) significant at α = 0.001, *) significant at α = Fiscal Decentralization Page 11

12 Exhibit 3 ANOVA(b) Model Sum of Squares df Mean Square F Sig. 1 Regression **) Residual Total a Predictors: (Constant), Local Own Revenue b Dependent Variable: Budget Performance 1 Regression **) Residual Total a Predictors: (Constant), Local Own Revenue b Dependent Variable: Grant and Transfer 1 Regression Residual Total a Predictors: (Constant), Grants and Transfers b Dependent Variable: Budget Performance 1 Regression Residual Total **) 0.00 **) 0.00 **) 2 Regression Residual Total a Predictors: (Constant), Local Own Revenues b Predictors: (Constant), Local Own Revenues, Grants and Transfers c Dependent Variable: Budget Performance **) significant at α = 0.001, *) significant at α = 0.05 Fiscal Decentralization Page 12

13 Exhibit 4: Test for mediator effect used Sobel Test: Sobel = a*( ( a s b b 2 2 b s a ) ) a = Sa = b = Sb = Sobel = , p = 0.00 Where: a = regression coefficient of Local Revenue Sa = standard error of regression coefficient of Local Revenue b = regression coefficient of Grant and Transfer Sb = standard error of regression coefficient of Grant and Transfer Fiscal Decentralization Page 13