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.
Monday, November 12, 2007
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
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
THE ELEMENTS OF FISCAL DECENTRALISATION
By Erny Murniasih
The shift from a centralised planning to a decentralised government system has been a widespread trend in many countries during the 1980s. There are many motives of why these countries have engaged in decentralisation: to stimulate economic growth, reduce urban-rural disparities, deepen democracy, and encourage civil society at the local level.
In principle, there are three varieties of decentralisation that can be distinguished corresponding to the degree of independent decision-making exercised at the local level: de-concentration, delegation, or devolution (Bird and Vaillancourt, 1999). To ensure that local governments have sufficient funding, the principle of ‘finance follows function’ should be in place. In such way, the set of functions are assigned to local governments with an adequately designated own source revenues and intergovernmental transfers.
In fiscal decentralisation program, there are key elements that should be applied according to public finance experts:
1. An appropriate set of functions for subnational governments. This element is supposed to address the question of ‘who does what?’ and ‘what are the functions and expenditure responsibilities of each level of government?’
2. An appropriate revenue-resource responsibilities. This element provides allowance for sub-national governments to levy taxes and charges.
3. A well-designed intergovernmental fiscal transfer system. Transfers are needed where vertical and horizontal imbalances persist and when there is problem of inter-jurisdiction spill over effect or externalities. Transfers can be formulated in some cases, depending on the purpose. They can be in the form of unconditional and/or conditional grants. The principle is that transfers should be sufficient to ensure that sub-national governments can afford to implement the decentralisation of functions.
4. An adequate access to develop capital. Access to development capital is vital to accelerate development, generating increased local revenues (Devas, 2006). This gives sub-national governments alternatives in financing their expenditures, particularly capital investment, in respect of functions assigned by central government. However, since borrowing could create problems for overall macroeconomic stability, experts in public finance advocate setting limits for local borrowing.
5. An adequate enabling environment for fiscal decentralisation. Substantial political is required to enable governments to establish constitutional and legal mandates for fiscal decentralisation and so to develop a strong foundation for fiscal decentralisation (Smoke, 2001). Even though such an internal driving-force does not guarantee successful fiscal decentralisation, there has to be substantial driving force to ensure a strong commitment to implementing the system.
The shift from a centralised planning to a decentralised government system has been a widespread trend in many countries during the 1980s. There are many motives of why these countries have engaged in decentralisation: to stimulate economic growth, reduce urban-rural disparities, deepen democracy, and encourage civil society at the local level.
In principle, there are three varieties of decentralisation that can be distinguished corresponding to the degree of independent decision-making exercised at the local level: de-concentration, delegation, or devolution (Bird and Vaillancourt, 1999). To ensure that local governments have sufficient funding, the principle of ‘finance follows function’ should be in place. In such way, the set of functions are assigned to local governments with an adequately designated own source revenues and intergovernmental transfers.
In fiscal decentralisation program, there are key elements that should be applied according to public finance experts:
1. An appropriate set of functions for subnational governments. This element is supposed to address the question of ‘who does what?’ and ‘what are the functions and expenditure responsibilities of each level of government?’
2. An appropriate revenue-resource responsibilities. This element provides allowance for sub-national governments to levy taxes and charges.
3. A well-designed intergovernmental fiscal transfer system. Transfers are needed where vertical and horizontal imbalances persist and when there is problem of inter-jurisdiction spill over effect or externalities. Transfers can be formulated in some cases, depending on the purpose. They can be in the form of unconditional and/or conditional grants. The principle is that transfers should be sufficient to ensure that sub-national governments can afford to implement the decentralisation of functions.
4. An adequate access to develop capital. Access to development capital is vital to accelerate development, generating increased local revenues (Devas, 2006). This gives sub-national governments alternatives in financing their expenditures, particularly capital investment, in respect of functions assigned by central government. However, since borrowing could create problems for overall macroeconomic stability, experts in public finance advocate setting limits for local borrowing.
5. An adequate enabling environment for fiscal decentralisation. Substantial political is required to enable governments to establish constitutional and legal mandates for fiscal decentralisation and so to develop a strong foundation for fiscal decentralisation (Smoke, 2001). Even though such an internal driving-force does not guarantee successful fiscal decentralisation, there has to be substantial driving force to ensure a strong commitment to implementing the system.
Is the Indonesian government still on the track facing decentralization program?
by Erny Murniasih
One might deem harshly that Indonesian economic is running with inadequate economic formula. Indonesian macro economy is tended to be vulnerable with external shocks, particularly with international influence. Such condition is dampened by the fact that the micro economy situation is not even better. At the time being, we are witnessing mismanagements in public finance, both at the national and the local governments’ level.
Taken into account, local economic development has only demonstrated a slow motion progress. The total GRDP of Provinces between 2005 and 2006 increased slowly at about 13 percent. The GRDP distribution concentrates in certain provinces. Province DKI Jakarta experienced the highest whilst Maluku Utara was the least. The gap between DKI Jakarta and Maluku Utara within these years is more than three times. Such condition reflects a strong inequality among regions.
Considering that local economic growth has persisted inequality, we should be aware that this condition would endanger the economic as a whole. The objective of decentralization program conducted in the early 2000s has been determined to increase welfare. With decentralization program, the amount of money transferred to local government, the so-called Intergovernmental Fiscal Transfers (IGFR), has a large extent of increase. The transfer is set forth to reduce imbalances between central and local government, and to increase fiscal capacity at the local level.
From 2005 to 2007, the ratio of IGFR to total state budget has increased quite considerably. In 2005, the ratio was 27 percent, while it is 34 percent in 2007. A reference from the Government Financial Note mentioned that there is a positive correlation between the increase growth of IGFR and the increase of GRDP. The government claimed that IGFR has given substantial contribution to the enhancement of local economic development.
Nevertheless, does this mean that the government should be contented? From the above problem which shows that inequality and fiscal imbalances still persist, one might moderately incriminate that an increase of IGFR does not always answer the problem of enhancing local economic development. The next question that is worth to answer is how to make sure that the allocated-money spends on giving service to encourage economic development.
Have the local budgets so far been allocated to achieve this goal? If we have a look at the overall outlook of local budgets, we reveal that most of local budget is still accounted for local government officers’ salary. Between 2005 and 2006, local salary accounted for about 43 and 41 percent consecutively. Capital expenditure, which is supposedly allocated for public service provision, still accounted only around 20 to 25 percent.
On the other hand, we are currently stirred by the publication that some local governments put their idle money being parked in the banking sectors and the BI’s certificate (SBI). Up until March 2007, the total amount of local governments’ money being parked at the SBI has reached at about 62 trillion rupiah.
The contrast condition, which is involved the bureaucrats’ behavior in managing regional budget and finance, has given an evidence of lack of capacity both at the national and local levels. In national level, the government has not given clear and comprehensive guideline to facilitate decentralization program. While at the local level, the mindset of autonomy is defined as full discretion of managing local resources.
As a result, decentralization is running without a proper balance. On one side, the central government tends to increase the amount of IGFR for each year and give the money in term of block grant, rather than targeted grant. On the other side, local governments have full discretion on managing the money, including decision to put their idle money in banking sector for security reason.
With this background, it is worth noticing that firstly the central government should reconsider the mechanism of managing local budget and mediate capacity building to local governments, such as in procurement procedures. It is realized that the central government’s intervention on local budget is fairly undesirable. Many believe such experience would mean a down-graded of the process of implementing a fully decentralization program and would mean as ‘recentralization’.
However, guidelines from the central government in budget preparation are still necessary, even in any countries. This is not only necessary to ensure that local government will allocate their budget for public service delivery, but also to ensure that there are no delays on setting up the budget and will open the loop hole to put the public money in banking sector.
One might deem harshly that Indonesian economic is running with inadequate economic formula. Indonesian macro economy is tended to be vulnerable with external shocks, particularly with international influence. Such condition is dampened by the fact that the micro economy situation is not even better. At the time being, we are witnessing mismanagements in public finance, both at the national and the local governments’ level.
Taken into account, local economic development has only demonstrated a slow motion progress. The total GRDP of Provinces between 2005 and 2006 increased slowly at about 13 percent. The GRDP distribution concentrates in certain provinces. Province DKI Jakarta experienced the highest whilst Maluku Utara was the least. The gap between DKI Jakarta and Maluku Utara within these years is more than three times. Such condition reflects a strong inequality among regions.
Considering that local economic growth has persisted inequality, we should be aware that this condition would endanger the economic as a whole. The objective of decentralization program conducted in the early 2000s has been determined to increase welfare. With decentralization program, the amount of money transferred to local government, the so-called Intergovernmental Fiscal Transfers (IGFR), has a large extent of increase. The transfer is set forth to reduce imbalances between central and local government, and to increase fiscal capacity at the local level.
From 2005 to 2007, the ratio of IGFR to total state budget has increased quite considerably. In 2005, the ratio was 27 percent, while it is 34 percent in 2007. A reference from the Government Financial Note mentioned that there is a positive correlation between the increase growth of IGFR and the increase of GRDP. The government claimed that IGFR has given substantial contribution to the enhancement of local economic development.
Nevertheless, does this mean that the government should be contented? From the above problem which shows that inequality and fiscal imbalances still persist, one might moderately incriminate that an increase of IGFR does not always answer the problem of enhancing local economic development. The next question that is worth to answer is how to make sure that the allocated-money spends on giving service to encourage economic development.
Have the local budgets so far been allocated to achieve this goal? If we have a look at the overall outlook of local budgets, we reveal that most of local budget is still accounted for local government officers’ salary. Between 2005 and 2006, local salary accounted for about 43 and 41 percent consecutively. Capital expenditure, which is supposedly allocated for public service provision, still accounted only around 20 to 25 percent.
On the other hand, we are currently stirred by the publication that some local governments put their idle money being parked in the banking sectors and the BI’s certificate (SBI). Up until March 2007, the total amount of local governments’ money being parked at the SBI has reached at about 62 trillion rupiah.
The contrast condition, which is involved the bureaucrats’ behavior in managing regional budget and finance, has given an evidence of lack of capacity both at the national and local levels. In national level, the government has not given clear and comprehensive guideline to facilitate decentralization program. While at the local level, the mindset of autonomy is defined as full discretion of managing local resources.
As a result, decentralization is running without a proper balance. On one side, the central government tends to increase the amount of IGFR for each year and give the money in term of block grant, rather than targeted grant. On the other side, local governments have full discretion on managing the money, including decision to put their idle money in banking sector for security reason.
With this background, it is worth noticing that firstly the central government should reconsider the mechanism of managing local budget and mediate capacity building to local governments, such as in procurement procedures. It is realized that the central government’s intervention on local budget is fairly undesirable. Many believe such experience would mean a down-graded of the process of implementing a fully decentralization program and would mean as ‘recentralization’.
However, guidelines from the central government in budget preparation are still necessary, even in any countries. This is not only necessary to ensure that local government will allocate their budget for public service delivery, but also to ensure that there are no delays on setting up the budget and will open the loop hole to put the public money in banking sector.
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