Sub-Module 4: Institutional Design of Intergovernmental Fiscal Transfer

Transcription

1 Sub-Module 4: Institutional Design of Intergovernmental Fiscal Transfer Case Study 2: Fiscal Equalization in Asian Countries 1. Introduction a. Stability and flexibility of fiscal equalization systems In many countries, fiscal transfer from the central government makes up a large part of local government revenue. Consequently, the design of the fiscal transfer system has extreme importance in efforts by local governments to maintain a stable supply of services. In order for local governments to engage in stable fiscal management, it is important that the funds they will receive each year from the central government have high predictability in terms of amount. If there are large fluctuations in the transferred amount each fiscal year, it becomes extremely difficult to draft budgets amid strict fiscal constraints when the amount of money to be received cannot be predicted beforehand. However, if the national economy is considered, the amount to be transferred from the central government to local governments must have flexibility that is based on fiscal conditions and the economic climate in the central government. This is to ensure that the stability of the macro economy is not upset. One method thought to be a means of simultaneously achieving these two conflicting objectives to set the total level of transfers as a fixed proportion of total central government revenue, subject to renegotiation periodically (say, every three to five years) 1. As a stepping off point for discussion of stability and flexibility in fiscal equalization systems, this section will present the example of the Philippines, a country that sets the total amount of its fiscal equalization source at a fixed proportion of central government revenue. b. Design of the distribution formula of fiscal equalization systems 1 Litvack, Ahmad, Bird (1998) 1

2 Fiscal equalization systems should employ a distribution formula for fiscal transfer that is unambiguous, as simple as possible, and based on reliable data. Southeast Asia presents many examples of simple approaches that utilize population, area, type of local government, and other indices; however, this section will focus on the case of Indonesia, which is building a fiscal equalization system that includes mixed-base elements that consider both the fiscal demand and fiscal capacity of local governments. 2. Stability and flexibility in fiscal equalization systems: Considering the case of the Philippines The fiscal equalization system of the Philippines was established in In 1991, the Internal Revenue Allotment (IRA) was expanded through enactment of the Local Government Code of the Philippines under the Aquino government. The IRA is granted to local governments to the central government in order to balance local finances and to ensure systematic administrative management in local governments. The Local Government Code stipulates that 40% of internal revenue of the central government for the year three years previous shall be distributed to local governments as the IRA. The IRA is first distributed to each local government level as follows: To the provinces: 23%; to the cities: 23%; to municipalities: 34%; and to the barangays: 20%. Next, within each level, the IRA is distributed on the basis of population: 50%; land area: 25%; e equal sharing: 25%. Automatic determination of the total amount of fiscal transfer gives such transfer a high degree of predictability for local governments. It is therefore expected to lead to stable fiscal management. However, actual operation of the fiscal equalization system is unsteady, as the central government can reduce the amount of fiscal transfer when it faces fiscal difficulties. For example, in 1998, 5% of the IRA was not released to local governments due to fiscal austerity measures implemented by the Department of Budget and Management (DBM). This caused local governments to bring a lawsuit against the central government 2

3 contesting the legality of these measures; the suit was eventually taken to the Supreme Court 2. Although local governments ended up being declared the victors in the lawsuit, this did not necessarily mean that later IRA allotments from the central government to local governments would be conducted smoothly. In 2000, the Congress shaved off 10 billion pesos from IRA distribution and set it aside as unprogrammed funds ; in other words, funds to be distributed only if revenue exceeded a certain target. In the same year, the DBM asked local governments to submit Annual Investment Plans ahead of IRA delivery. This was a tactic designed to delay delivery in order to reduce the fiscal deficit of the central government. Furthermore, it was reported in 2001 that the central government took off 16 billion pesos from the amount it was required to deliver in order to pursue management based on a reconstituted budget. And in 2003 it was further reported that the central government shaved off 9 billion pesos off the amount it was obligated to deliver in an effort to reconstitute the budget Determining the distribution formula: Considering the case of Indonesia Since the collapse of the Suharto government in 1998, Indonesia has been pursuing rapid decentralization. In 1999, it formulated two laws toward this end: Law No. 22, which establishes a framework for local administration, and Law No. 25, which establishes a framework for fiscal balance between the central government and local governments. Law No. 25 provides for three fiscal transfer systems: revenue sharing, general allotments (Dana Alokasi Umum: DAU), and special allotments (Dana Alokasi Khusu: DAK). DAU are appropriated at a minimum rate of 25% of internal revenue. Ninety percent of DAU is allocated to the district/cities, while 10% is allocated to the provinces. It should be noted that the formula for determining distribution within each district/city or province is still being developed and improved through continuing trial and error. The formula presented here is the DAU calculation method of Rosario G. Manasan, Local Public Finance in the Philippines In Search of Autonomy with Accountability, Discussion Paper Series No Same as above 3

4 3-1. Overview 4 The DAU allocation amount to be received by each local government is comprised of a lump sum amount (LSA), balancing factor amount (BFA), and formula amount (FA). DAU i = LSA i + BFA i + FA i = each local government a. LSA The LSA is distributed evenly to all local governments. It is determined by dividing 10% of the total DAU by the total number of local governments. LSA i = 0.1 DAU T Total number of local governments Methods that distribute funds uniformly without considering size of local government, expenditure needs, or fiscal capacity can be seen as providing allowances for the fixed expenses and indirect expenses of local governments. On the other hand, however, they are also seen as providing an incentive for local governments to break up into smaller units. b. BFA The BFA distributes 50% of the total DAU amount. It is distributed based on the share of all wages paid to civil servants in the relevant local government among total wages for civil servants in all local governments. It is established so that the amount of DAU allocation does not fall below the DAU allocation of the previous year. Wage i BFA i = 0.5 DAU T Wage i Wage: Estimated wage bill for Kabupaten/Kota civil servants for FY The following calculation method presentation is largely based on Bambang Brodjonegoro and Jorge Martinez-Vazquez (2002) and Blane D. Lewis (2002). 4

5 c. FA The FA distributes the amount obtained when the LSA total and BFA total are deducted from the DAU total. It is distributed based on the share of the annual expenditure gap of the relative local government among the annual expenditure gap of all local governments. FA i = (DAU T ΣLSA i ΣBFA i ) FG i FG i The annual expenditure gap is determined by deducting fiscal capacity from expenditure needs. It should be noted that cases in which fiscal capacity exceeds expenditure needs are considered to have a fiscal gap of zero. FG i = EN i FC i 3-2 Expenditure needs Expenditure needs are calculated from the total of annual local government expenditure and the expenditure needs index. Annual local government expenditure utilizes the real annual expenditure of local governments for the previous year (APBD). The expenditure needs index is a function of population, area, poverty, and cost; it uses the most recent annual data. EN i = APBDEXP T (0.4PI 0.1AI 0.1RPI 0.4CI) APBDEXP: Annual local government expenditure of the previous year PI: Population index AI: Area index RPI: Relative poverty index CI: Cost index The population index is obtained from the share of population in the relevant local government among the population of all local governments, and the area index is obtained from the share of area of the relevant local government among the area of all local governments. The relative poverty index indicates the level of poverty, rather than the number of impoverished people. And the cost index is an index showing differences 5

6 in construction costs among individual regions. 3-3 Fiscal Capacity Fiscal capacity is made up of potential local own-source revenue and shared taxes. FC i = OSR i SPT i SIT i 0.75SNR i OSR i: Potential local own-source tax and non-tax revenue SPT i: Shared Property Tax revenue SIT i : Shared Income Tax revenue SNR i : Shared Natural Resource revenue For OSR, potential revenue is used rather than actual revenue. As a result, if taxes that surpass the potential revenue amount are collected, the revenue of the local government increases by this surpassing amount. It can therefore be said to have a built-in incentive that urges local governments to make tax-collection efforts. Discussion Topics - What significance is there when, as in the case of the Philippines, the total amount of fiscal transfer is set as a certain percentage of national revenue? Moreover, what kinds of system should be set up to prevent interference in the macro-level stability of national finances by local government? - What kinds of indices should be used in your country when it designs distribution formulas for fiscal transfer? And, if data collection possibilities are considered, what indices are realistically adoptable? References Brodjonegoro, Bambang and Jorge Martinez-Vazquez (2002), An Analysis of Indonesia s Transfer System: Recent Performance and Future Prospects, International Studies Program Working Paper 02-13, Georgia State University Lewis, Blane D. (2002), 5. Indonesia appearing in Intergovernmental Fiscal Transfers in Asia: Current Practice and Challenges for the Future (ed. Yun-Hwan Kim and Paul Smoke), Asian Development Bank. JICA, Chiho Gyosei to Chiho Bunken: Hokokuso (2001) JICA, Gendai Indoneshia Chiho Bunken/Jichi no Kenkyu (2001) 6

7 Litvack, Jenne, Junaid Ahmad, and Richard Bird (1998), Rethinking Decentralization in Developing Countries, The World Bank. Mochida, Nobuki, Fiscal Decentralization and State-Local Finance: Fundamental Perspectives (2004) The World Bank (2003), Cities in Transition: Urban Sector Review In an Era of Decentralization in Indonesia 7