Front Matter

Front Matter

Author(s):
Annalisa Fedelino
Published Date:
October 2010
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    © 2010 International Monetary Fund

    Production: IMF Multimedia Services Division

    Figures: Tom Wood

    Typesetting: Michelle Martin

    Cataloging-in-Publication Data

    Fedelino, Annalisa

    • Making fiscal decentralization work: cross-country experiences / Annalisa Fedelino and Teresa Ter-Minassian—Washington, D.C.: International Monetary Fund, 2010.

      • p.; cm.

    • Includes bibliographical references.

    • ISBN: 9781589069855

    1. Intergovernmental fiscal relations. 2. Intergovernmental fiscal relations—Developing countries—Case studies. 3. Decentralization in government. 4. Decentralization in government—Developing countries—Case studies. 5. Fiscal Policy. 6. Fiscal Policy—Developing countries—Case studies. 7. Finance, Public—Management. 8. Finance, Public—Developing countries—Management—Case studies. I. Ter-Minassian, Teresa. II. International Monetary Fund. III. Title.

    HJ197.F43 2010

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    Contents

    Preface

    Fiscal decentralization and reforms of existing intergovernmental fiscal arrangements remain high on the policy agenda of many countries, both advanced and developing. Decentralization is often driven by political pressures, which tend to be especially acute in countries with some combination of multiple ethnicities and wide regional disparities in incomes or resource endowments. More generally, pressures for increased decentralization often reflect a desire for more participatory government and greater voice of local constituents in the allocation of budgetary resources.

    Regardless of its motivation, fiscal decentralization can have important macroeconomic implications. Depending on the design and implementation of critical intergovernmental fiscal arrangements, decentralization has the potential to hinder sound macroeconomic management and longer-term fiscal sustainability.

    Therefore, IMF advice to its member countries (whether in the context of surveillance, the design of IMF-supported programs, or technical assistance) has often focused on intergovernmental fiscal arrangements. This is one of the more complex areas of public finance, given that it spans a number of policy and institution-building issues; requires careful coordination and sequencing; and is strongly influenced by historical, political, and social, as well as economic, factors. Accordingly, the IMF has recognized that there is no single “right” model in this area, and has strived to tailor its advice to each country’s specific circumstances, taking into account macroeconomic constraints, the need to strike a balance between efficiency and distributional considerations, and the need to reflect relevant institutional factors.

    This occasional paper distills the main lessons from the IMF’s engagement with member countries on the issue of fiscal decentralization, in particular from the technical assistance provided by its staff to 10 countries: Bolivia, China, Colombia, the Democratic Republic of the Congo, Indonesia, Kosovo, Liberia, the former Yugoslav Republic of Macedonia (FYR Macedonia), Mexico, and Nigeria.

    The provision of IMF advice on fiscal decentralization has taken different forms, including dedicated staff missions, the fielding of short-or long-term resident experts, seminars and other training events, and the preparation of a substantial number of research books and papers.1 As evidenced by the case studies, the advice has spanned virtually all areas of intergovernmental fiscal relations. Regardless of the specific areas and forms of involvement, IMF advice has typically focused on the macrofiscal aspects of decentralization, with the primary goal of safeguarding macroeconomic stability and fiscal sustainability. This focus has reflected the core mandate of the institution and the comparative expertise of its staff. In the provision of its advice on fiscal decentralization, the IMF has frequently cooperated with other multilateral (notably the World Bank) and national institutions active in this area.

    Despite the differences in the form and coverage of IMF policy advice and the nature and circumstances of recipient countries, some general lessons can be drawn from the range of experience in this area. Based on some of these lessons, this occasional paper aims at making a contribution to sound and sustainable reforms in fiscal decentralization across the IMF membership.

    The main examples are the IMF volume on Fiscal Federalism in Theory and Practice (Ter-Minassian, 1997); the proceedings of a 2000 international conference on managing fiscal decentralization (Ahmad and Tanzi, 2002); and the Handbook of Fiscal Federalism (Ahmad and Brosio, 2006).

    Acknowledgments

    This occasional paper would not have been possible without the contributions of a number of current and former colleagues from the IMF Fiscal Affairs Department. In particular, we owe our thanks to the following authors and co-authors of the case studies: Alejandro Simone and Paulo Medas (Bolivia), Isabell Adenauer (Colombia), Andreas Westphal (Democratic Republic of the Congo, with input from Amine Mati and Oral Williams), Amine Mati and Eric Le Borgne (Indonesia), Pablo Lopez Murphy (former Yugoslav Republic of Macedonia), Mercedes Garcia-Escribano (Mexico), and Mauricio Villafuerte and Oral Williams (Nigeria).

    We would also like to express our appreciation to Ehtisham Ahmad, who gave us the initial inspiration for this occasional paper and provided invaluable contributions through discussions. Sarah Buss and Nezha Khaneboubi worked ably on the original manuscript. Special thanks also go to Sean Culhane and Joanne Blake of the External Relations Department for their advice and coordination of this publication.

    Abbreviations

    CDF

    County Development Fund (Liberia)

    CSP

    Comprehensive Settlement Proposal (Kosovo)

    DAU

    General Allocation Fund (Dana Alokasi Umum, Indonesia)

    DAK

    Special Allocation Grant (Indonesia)

    DBH

    Shared Revenue Fund (Indonesia)

    DGI

    Direction Générale des Impôts (Tax Collection Agency, Democratic Republic of the Congo)

    EAD

    Entités Administratives Décentralisées (Decentralized Administrative Entities, Democratic Republic of the Congo)

    ETD

    Entités Territoriales Décentralisées (Decentralized Divisional Entities, Democratic Republic of the Congo)

    FAD

    Fiscal Affairs Department

    FYR

    Former Yugoslav Republic (of Macedonia)

    GDP

    gross domestic product

    GFMIS

    Government Financial Management Information System

    GFS

    Government Finance Statistics

    IDH

    Direct Tax on Hydrocarbons (Bolivia)

    IMF

    International Monetary Fund

    HIPC

    Heavily Indebted Poor Countries

    LFLSG

    Law of Financing of Local Self Governments (FYR Macedonia)

    LLGF

    Law on Local Government Finance (Kosovo)

    LLSG

    Law of Local Self-Government (FYR Macedonia)

    MoF

    Ministry of Finance

    MoHA

    Ministry of Home Affairs (Indonesia)

    OECD

    Organization for Economic Cooperation and Development

    PFM

    public financial management

    PIT

    personal income tax

    PPP

    public-private partnership

    SLG

    state and local government

    TA

    technical assistance

    TSA

    treasury single account

    VAT

    value-added tax

    Introduction

    Pressures to decentralize—that is, transfer authority and responsibility for public functions from the central government to subnational entities—have become more evident over the years. Typically a political phenomenon, decentralization frequently takes on a fiscal dimension (hence the term “fiscal decentralization”) when changes in a country’s system of intergovernmental fiscal relations take place.1

    Changes in the assignment of spending responsibilities and their financing (through taxes, transfers, or borrowing) across government levels can have important macroeconomic implications. It is from this perspective—that fiscal decentralization can significantly affect macroeconomic management and, more specifically, governments’ budgetary balances and debt positions—that the IMF has provided policy advice to member countries undertaking reforms in this area.2

    This occasional paper presents an overview of advice provided by the IMF, in particular, its Fiscal Affairs Department (FAD), to member countries on intergovernmental fiscal relations. This advice, provided in the context of surveillance, use of IMF resources, or technical assistance, has spanned the gamut of issues involved in such relations (expenditure and revenue assignments, design of intergovernmental transfers, public financial management systems and revenue administration systems at the subnational level, subnational borrowing, and so on).

    IMF advice has been tailored to countries’ specific circumstances. Recognizing the largely political nature of a country’s decentralization agenda, staff have not taken a position in favor of or against it, and have focused advice on the appropriate sequencing and design of decentralization, with a view to minimizing risks to macroeconomic stability and debt sustainability while safeguarding the provision of public services. This paper seeks to distill key lessons from advice on various aspects of intergovernmental fiscal relations, based primarily on staff engagement on this topic with 10 countries: Bolivia, China, Colombia, the Democratic Republic of the Congo, Indonesia, Kosovo, Liberia, FYR Macedonia, Mexico, and Nigeria. These countries were selected because of the significance of the IMF’s engagement with them on intergovernmental issues, but especially because they differ markedly in economic, institutional, and sociopolitical characteristics, thereby providing a representative sample of the range of countries receiving IMF advice on fiscal decentralization in recent years. Specifically, as shown in Table 1, the case-study countries vary significantly along a number of dimensions. Two countries have federal government structures (Nigeria and Mexico) while the others are unitary countries; some have limited area and population (Liberia, Kosovo, and FYR Macedonia), while others are much bigger or more populated (China, the Democratic Republic of the Congo, and Nigeria). They also differ in the number of levels of government: most have three, but the smaller ones (Kosovo and FYR Macedonia) have only two, and China has five.

    Table 1.Comparative Indicators for Case-Study Countries
    BoliviaChinaColombiaCongo, Dem. Rep. ofIndonesiaKosovoLiberiaMexicoFYR

    Macedonia
    Nigeria
    Population (million, 2007)9.41,307.646.057.5231.62.23.5103.12.0136.3
    Area (in km2 million)1.19.31.12.31.910.91.01.925.40.9
    Type of governmentunitaryunitaryunitaryunitaryunitaryunitaryunitaryfederalunitaryfederal
    Levels of government3533323323
    Number of states or provinces1931331133n.a.1532n.a.37
    Number of lowest subnational
    government211244,0161,1201,005510361262,45484774
    of which: minimum size
    (inhabitants)1,28724214,0655,0001021,33119,710
    Average size of
    municipality (inhabitants)84,17229,70641,10657,262498,15362,11142,00924,245176,037
    GDP per capita (US dollars, 2008)23568462,303149081,2761267,4842,350474
    Sources: World Bank World Development Indicators; IMF World Economic Outlook; and administrative divisions of countries.Note: … = data not available; n.a. = not applicable.

    Bolivia: Departmental prefectures. China: 22 provinces, 5 autonomous regions, and 4 municipalities. Colombia: 32 departments and 1 capital district. Congo, Dem. Rep. of: Regions (10 provinces and 1 capital city), expected to be expanded into 27 new provinces by 2009.

    Indonesia: Provinces (30 provinces, the capital, and 2 special districts). Liberia: 15 counties. Mexico: 31 states and 1 federal district. Nigeria: 36 states and a federal territory.

    Nominal GDP per capita for Kosovo. Real GDP per capita for all other countries.

    The paper is structured as follow: Part I (Chapters 13) distills the lessons learned from the last two decades of IMF engagement on fiscal decentralization. Chapter 1 reviews key issues in intergovernmental fiscal relations, based on a brief review of the relevant literature. Chapter 2 focuses on the main building blocks of such relations: (1) defining spending assignments and strengthening their management and (2) designing financing mechanisms, consisting of revenue assignments, transfers, and borrowing arrangements. These building blocks need to be coherently structured and managed so that subnational governments face credible “hard budget constraints” and respond to incentives to behave fiscally responsibly. The main lessons and future challenges for the IMF’s role in the fiscal decentralization policy debate are outlined in Chapter 3. Part II (Chapters 413) provides more depth to the fiscal decentralization experience in each of the case-study countries, casting the IMF staff advice against a brief historical, institutional, and political context in each country as of the end of the first decade of the 2000s.

    This paper does not make a distinction between different forms of government (unitary versus federal), and uses the term “subnational governments” for the levels of government below the central or federal government (states in a federation and other jurisdictions in unitary or federal countries).

    This publication looks at “downward” decentralization, that is, the arrangements between a sovereign or national state and its lower levels of governments. Because political and economic processes and activities are becoming global and require global action (Tanzi, 2008; Bordignon, 2006), examples of upward devolution of powers are increasing, raising issues of coordination, monitoring, and control of behavior of countries that are members of economic unions. The European Union, in its enlargement and the establishment of a monetary union, is one such example.

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