Fiscal Decentralization

Drs. Achmad Lutfi, M. Si.

Depth of Decentralization

 Deconcentration.
 Responsibilities are moved downstream.

 Delegation.

 Local government are agent of central government.

 Devolution.

 Power to decide is moved downstream.

 Proponent argue for devolution.

Up- or Down- stream ?

 Bottom up approach.
 Emphasizes participation and efficiency.
 Top down approach.
 Shift problem (deficit) from central government.
 Decentralization.
 Bottom up requires genuine democracy.
Potential Problem

 Decentralization may cause an unstable macro economy

(Argentina, Brazil, China).
 This occurs when revenue and expenditure decentralized are
unbalance.
 But : south Africa and Columbia managed these problem.
Definitions

Fiscal Decentralization refers to an

intergovernmental system where the balance of power
moves toward the sub national government sector.

Intergovernmental Fiscal Relations refers generally

to division of fiscal powers and responsibilities among
levels of government.
Advantages of Fiscal Decentralization

 Move Government closer to the people.

 Broaden the Tax Base.
 Allow for alternative service delivery in social services.
Components of System of Fiscal
Decentralization
 Necessary Conditions.
 Elected Local Council.

 Locally Appointed Chief Officers.

 Significant Local Government Revenue Capacity.

 Significant Local Government Expenditure Responsibility.

 Budget Autonomy.

 Hard Budget Constraint.

 Transparency.
Components of System of Fiscal
Decentralization
 Desirable Conditions.
 Freedom from Excessive Central Expenditure Mandates.
 Unconditional Transfers from Higher Level Governments.
 Borrowing Powers.
Obstacles to Fiscal Decentralization

 Increase in Number of Local Units of Government.

 Unfunded Mandates.
 Failure to Devise Expenditure Assignment.
 Too Few Tax Sources for Local Units.
 Failure to Develop Credit and Borrowing System.
 Financial Controls Retained by Central Level.
 Lack of Intergovernmental Fiscal System based on Transparency
Rather than Negotiation and Political Influence.
Local Borrowing

 Advantage: Capital investments.

 Problems:

 moral hazard.
 expectations of bailing out.

 can increase instability (expenditures far exceed tax revenue).

Solutions

 Increased tax powers to LG (many rich countries).

 Allow LGs to bankrupt (Morocco).

 Use fungible transfers as collateral (Tunisia, South

Africa, Argentina)…
 …but this requires high predictability of transfers (through

law or the constitution).

Local Taxing Powers

 Local capacity.
 Upstream accountability (Uganda).

 Downstream accountability (information to

voters and tax payers).

 High autonomy can work (Colombia,

Pakistan).
Problem with Local Taxes

 Vertical imbalance:
 CG collects taxes more efficiently.

 Solution: residents pay for what they get - and no more (no tax

exporting).
 Horizontal imbalance:

 Some regions are richer than others.

 Solution: transfers (Nordic countries).

Transfers

 Targeted transfers are often used for infra

structure (Morocco, Tunisia).
 Fungible transfers may also work

(Colombia, rich countries)…

 …but require high local capacity.

 Alternative may be Social Investment Funds

(SIFs).
Requirements of a SIF

 Latin American experience suggests the following:

 Cost-sharing by all involved.

 Demand-driven project identification.

 Transparency and accountability.

 Autonomy from red tape.

 Can increase cost-efficiency.

Conditions for Success

 Local decision process is democratic.

 (so Argentina has been more successful than China).
 Costs must be borne by decision-makers...
 …so LG need to control rates (and bases) of at least some

taxes.
 This is a reason why countries fail.