INTERGOVERNMENTAL FISCAL TRANSFERS : THE CONCEPT

By Erny Murniasih

The previous post has written about the key elements of fiscal decentralisation. One of the elements is intergovernmental fiscal transfers (IGFT). The IGFT has some objectives as follow:

a. To address vertical fiscal imbalances
Historically, the problem of vertical imbalances may always persist, since broad and substantial taxes remain at the central level. Indeed, sub-national governments are often left with low-yielding, unpopular taxes, mainly focused on production rather than wealth and income. This leads to difficulties in tax collection. Thus, intergovernmental transfers are needed to achieve vertical balance.

b. To address horizontal fiscal imbalances
In developing and transition countries, it is not unusual to have large disparities between the richest and the poorest regions. This may happen due to variations in the capacity of sub-national governments to generate own source revenues. Such variation depends on the performance of potential taxes which are derived from the nature of the local economic activities. The disparities will widen because the more urbanised local governments have the greatest taxable capacities. In addition, administrative capacities vary amongst sub-national governments. Hence, this will lead to horizontal imbalances. A system of equalisation grant might be justified to address such problems.

c. To address inter-jurisdictional spill-over effects (or externalities)
There are some public services that have spill-over effects (or externalities) on other jurisdictions. Higher education and pollution control are some examples. A local government may under-spend for these services without paying attention of the substantial public benefits. Therefore, central government should provide incentives or financial resources for local governments to address this particular problem.

There are types of intergovernmental transfer to address the various designated objectives.

a. Conditional transfers
In this scheme, the central government specify the purpose(s) for which the recipient government can use the funds. The types of transfers classified in this group:
(i). Matching open-ended grant, that is, the central government grant depends upon the local governments’ behaviour in spending.
(ii) Matching close-ended grants. This scheme employs a ceiling on the cost borne by central government due to budget constrains in central level.
(iii). Non-matching grants. In this scheme, central government offers fixed sum of money which is directed on a specified public good. Thus, local government does not have to match the contribution of central government.

b. Unconditional transfers
This type on transfers places no restriction of the use of the money. In theory, the scheme consists of revenue sharing arrangements and general purpose grants. The main justification for unconditional grants is that such grants can be used to equalise fiscal capacities of different local governments to ensure the provision of a minimum (or reasonable) level of public services (Ma, 1997). In Indonesia, IGFT (a.k.a in Indonesia “Kebijakan Dana Perimbangan”) consists of Revenue Sharing, General Purpose Grant, and Specific Purpose Grant.

... to be continued