Decentralization and Public Expenditure Analysis and Management Dana Weist Senior Public Sector Specialist, PRMPS dweist@worldbank.org 23 May 2002 Page 1
Decentralization: A World-Wide Phenomenon Underway in over 85 countries Political and economic rationales Varieties Deconcentration Delegation Devolution Page 2
What Kinds of Countries Choose Decentralization? Large More developed More heterogeneous Internal discord and natural resources Page 3
Decentralization Trends Developing Countries 1970s 1980s 1990s Transition Countries 1990s OECD Countries 1970s 1980s 1990s Subnational Expenditure Shares 13.0% (48) 13.2% (43) 13.8% (54) 26.1% (23) 33.8% (22) 32.3% (23) 32.4% (23) Subnational Tax Shares 10.4% (43) 7.7% (35) 9.3% (28) 16.6% (14) 18.7% (22) 18.7% (22) 19.1% (23) Source: International Monetary Fund. Government Finance Statistics Year Book, various years, Country Tables Page 4
Differences Across Regions 60% Subnational Share of Expenditures 35% Subnational Share of Revenues 50% 30% 40% 25% 30% 20% 10% 20% 15% 10% 5% 0% Sub-Saharan Africa (4) East Asia and the Pacific (4) Latin America and the Caribbean (9) Europe and Central Asia (13) High Income, OECD (18) South Asia (1) 0% Sub-Saharan Africa (5) East Asia and the Pacific (7) Latin America and the Caribbean (13) Europe and Central Asia (15) High Income, OECD (21) South Asia (1) Middle East and Northern Africa (1) Note: Simple average of most recent observations in available countries. Numbers in parenthesis indicate number of countries represented. Source: International Monetary Fund. Government Finance Statistics Year Book 1998, Country Tables. Page 5
Positive or Negative Outcomes? If designed well, decentralization can: Move decision making closer to people Enhance efficiency and responsiveness of service delivery Improve economic growth Potential tool to alleviate poverty But, design is complicated, since it spans fiscal, political, and administrative policies and institutions Page 6
Key PE Questions Who is doing what? How is it being financed? Page 7
Four Pillars of Intergovernmental Fiscal System Expenditures Revenues Intergovernmental transfers Subnational borrowing/debt Page 8
Expenditure Issues Objective: significant and clear expenditure responsibility and autonomy Subsidiarity principle: provide services at lowest level of government compatible with "benefit area" associated with those services Distinction between production and provision Assign expenditures first, then assign revenues that match expenditure needs Page 9
Local Revenue Generalizations Resources often inadequate to carry out assigned functions Simplest and most effective form of tax autonomy: discretion to set tax rates Striking variations in size and capacity one size doesn t fit all Mix of local revenues needed Local revenue mobilization strengthens accountability Page 10
Criteria for Local Taxes Accountability and Transparency Benefit/Tax-Price Link Neutrality (Non-distortion) Taxpayer Equity/Fairness Regional (Place) Equity Reliability, Stability, Buoyancy/Elasticity Administration and Compliance Page 11
Rationales for Intergovernmental Transfers Vertical imbalances Horizontal imbalances (equalization) Externalities (inter-jurisdictional spillovers) Enhancing national objectives at the subnational level Paying for national programs implemented by subnational governments Page 12
Equalization Transfers A measure of need A measure of capacity Adequate sub-national revenue autonomy Stable but flexible financing Page 13
Local Borrowing Benefits Finance long-lived assets efficiently and equitably Overcome liquidity problems of lumpy investments Pay-as-you-use financing Improve selection of investments Risks Soft budget constraint Macro-instability Page 14
Borrowing Risks Can Be Managed Strengthen intergovernmental fiscal system Apply administrative controls Implement rule-based framework Establish market-based system Impose other controls Page 15
Decentralization Challenges Balance responsibilities with resources, capacity and accountability Finance follows function Responsibility with capacity (learn by doing) Accountability through political channels, own source revenues, participation and transparency Create incentives for implementation to match formal arrangements Monitor and be prepared for change Page 16
China s Provincial Public Expenditure Review Successor to 1999 PER Reviewed central government s public expenditure system, budgetary institutions, and practices Noted need for assessment of subnational finances Significant tax reform in 1994 strengthened central revenues Budget reforms underway (budget classification and preparation, procurement, expenditure management and auditing, extra-budgetary funds) China s lending is substantially subnational Page 17
China s Five Levels of Finance 1. Central government - 1.3 billion population 2. Provincial governments (31) 45.3 million pop. 3. Prefectural governments (331) 3.7 million pop. 4. County level (2109) -- 580,000 pop 5. Townships (44,741) -- 27,000 pop. Page 18
Highly Decentralized Spending Central expenditure share only 30% Remainder distributed among other four tiers Cities account for 100% of expenditures for Social security Unemployment insurance Social welfare such as minimal living stipend Counties and townships together account for 70% of education 55-60% of health Post transition, local governments responsible for financing and providing services Page 19
Findings Improper assignment of functions: local governments carrying out national functions Insufficient local revenues No effective system of transfers Local responsibility for infrastructure, yet borrowing legally prohibited Local governments highly dependent on extrabudgetary finance Growing regional disparities Inefficient subnational expenditures Page 20
Recommendations Strategy for intergovernmental fiscal reform Clear and explicit assignment of expenditure and revenue functions Explicit equalization mechanisms Sectoral strategies to guide local expenditures Incentives for local budget management Local borrowing framework Subnational government financial management system Page 21
For More Information www.worldbank.org/public sector/decentralization www.decentralization.org Page 22