INTERGOVERNMENTAL FISCAL TRANSFERS : THE INDONESIAN EXPERIENCE

By Erny Murniasih

In Indonesia, according to Law 33/2004 on Fiscal Balance between central and local government, intergovernmental fiscal transfers are aimed to reduce fiscal gap among tiers of government and between sub-national governments. The so-called ‘Balance Fund’ policy deploys in the form of: Revenue sharing, Specific Purpose Grant (DAK), and General Purpose Grant (DAU).

Revenue Sharing
Revenue sharing is allocated to sub-national governments in order to address the problems of imbalances between central and local governments. As in many countries, some major taxes remain at the central level, i.e. personal income tax, VAT, and property tax. Until recently property tax is still administered at the central level but almost all the money is allocated to local governments through revenue sharing.

The mechanism for revenue sharing derives from taxes and natural resources revenues based on derivation basis from the originating local governments. Revenue sharing from taxes comprises of sharing of revenue from property tax, property tax transfer fee, and PIT.
As for the shared revenue from natural resource, it consists of shared revenues from forestry, mining, fishery, oil, and gas. In addition, the new law on Central and Local Fiscal Balance stipulates additional shared revenue from geo-thermal energy and re-forestation fund. The latter is formed as an earmarked grant for rehabilitating forests in originating local government.

Pressures during the drafting of the new law on Central and Local Fiscal Balance, particularly from rich-natural sources regions, has resulted such changes. The law 33/2004 mandates additional revenue sharing mechanism from geothermal energy and re-forestation. The latter is an earmarked grant specifically for rehabilitating forests in originating regions.
Moreover, the new law also mandates additional percentage on the revenue sharing from oil and gas. According to this, sub-national governments will receive an additional 0.5 percent from oil and gas. Such additional amount is also earmarked for specific provision, that is, for education. Of the 0.5 percent, 0.1 percent goes for provinces, 0.2 percent belongs to originating local governments, and the rest 0.2 percent is divided equally to all local governments in the same province.

Other than these two main changes, the other mechanism on revenue sharing remains the same with the previous scheme in law 25/1999.


General Purpose Grant (Dana Alokasi Umum/DAU)
The DAU intends to address both problems of vertical and horizontal imbalance. Thus it is expected to equalise fiscal capacities across regions to finance public services.
Law 33/2004 sets forth the total amount for DAU allocation as at least 26 percent of net domestic revenues, and starting from 2007 the percentage becomes 26 percent. Previously the magnitude of DAU allocation is 25 percent. The portion for provinces and municipalities/districts is determined by the proportion of responsibilities assigned to each tiers of government (article 29).

In principle, the main content of amendment of DAU in the law 33/2004 concerns the formula for fiscal gap and the basic-amount allocation. The formula for fiscal gap is using the difference of expenditure needs and fiscal capacity. In the law 33/2004, expenditure needs are measured with using proxies of population, surface area, index of cost construction, the inverse of the Human Development Index (HDI) and the inverse of the Gross Regional Domestic Product (GRDP) per capita index.

From the fiscal capacity side, the calculation is based on own-source revenue (OSR) and revenue sharing. OSR is calculated based on the revenue raising capacity (potential revenues) while revenue sharing are shared revenues from tax and natural resources.

Moreover, a major breakthrough of DAU formula in the law 33/2004 is the elimination of hold-harmless provision in the beginning of year 2008. Historically, hold-harmless provision is to maintain all regions should receive DAU in current year at least equal with the amount of DAU received in the previous year. This has been part of the agreement between the Budget Committee in the parliament and the government in the DAU for 2002. The existence of hold-harmless policy in the DAU has certainly disrupted the performance of DAU to improve horizontal fiscal imbalance.


Specific Purpose Grant (DAK)
A conditional or earmarked transfer scheme, DAK, is allocated to specific regions and certain sectoral programs. DAK intends to ‘promote the attainment of minimum standards and compensate for benefit/cost spill-over related to priority capital investment’ (Sidik 2004,p.392). Hence, it is confined mainly to finance physical capital investment and limited-period financing of operational and maintenance needs.

The criteria for DAK are based on the general, special, and technical criteria. The general criteria should consider the financial capacity of the regions, while special criteria emphasise on the characteristic of the regions. Technical criteria are more specific and established by line ministries.

Conditional term attached in DAK lead to the limited scope of sub-national governments’ entitlement, particularly in the usage of funds. Central government gives direction for using DAK for designated sectors. In 2007, the designated sectors which received transfer from DAK comprise of: education, health, infrastructure, fishery, agriculture, local governments’ infrastructure, and environment.