Colombia is a unitary country at a relatively advanced stage of decentralization. Colombia’s decentralization process began in the early 1980s and was reinforced by the 1991 constitution. In 2010, the country is a decentralized republic consisting of a central administration, 32 departments, 1,120 municipalities, and four special districts and indigenous territories that are politically independent. Subnational political and administrative institutions replicate the structure of the central administration, and governors, members of departmental assemblies, mayors, and members of municipal councils are elected directly.
Fiscal decentralization in Colombia has been driven by a belief that subnational governments are better positioned to deliver effective services, and therefore should receive commensurate resources. The constitution promulgated in 1991 stipulated large-scale revenue transfers from the center to subnational governments to finance their expenditures in social sectors. Transfers were intended to correct vertical imbalances and provide a stable income flow to subnational governments, as well as to address horizontal differences across subnationals.
However, increased revenue devolution was not matched by broader spending mandates, resulting in weakened fiscal discipline at the subnational level. The 1991 constitution established a revenue-sharing system, earmarked by sector; the base for calculating the transfers was extended to all current revenues (previously, only a share of selected tax revenues was transferred), and a gradual increase in the transferred percentages over time was targeted. Transfers increased dramatically, from 2.4 percent of GDP in 1990 to 6.2 percent of GDP in 2006 (Table 6.2). However, despite devolving more resources to subnational governments, the central government continued to carry out many of its original spending responsibilities, leading to overspending and inefficient service outcomes, including in the social sectors.
Colombia: Indicators of Fiscal Decentralization
Colombia: Indicators of Fiscal Decentralization
| Type of government | Unitary | |
| Population (million, 2007) | 46.0 | |
| Area (million km2) | 1.1 | |
| Levels of government | 3 | |
| States and provinces | 33 | |
| Municipalities | 1,120 | |
| Average municipality size (population) | 41,106 | |
| Minimum municipality size (population) | 242 | |
| IMF technical assistance missions on | 1995, 2005 | |
| fiscal decentralization | ||
Colombia: Indicators of Fiscal Decentralization
| Type of government | Unitary | |
| Population (million, 2007) | 46.0 | |
| Area (million km2) | 1.1 | |
| Levels of government | 3 | |
| States and provinces | 33 | |
| Municipalities | 1,120 | |
| Average municipality size (population) | 41,106 | |
| Minimum municipality size (population) | 242 | |
| IMF technical assistance missions on | 1995, 2005 | |
| fiscal decentralization | ||
Colombia: Summary of Subnational Governments’ Finances, 2006
Colombia: Summary of Subnational Governments’ Finances, 2006
| Percentage of general government |
Percentage of GDP |
||
|---|---|---|---|
| Total subnational revenue | 31.3 | 10.2 | |
| Own-source revenue | 12.4 | 4.1 | |
| Transfers from the center | 18.5 | 6.2 | |
| Total subnational expenditure | 32.7 | 10.7 | |
| Overall balance (before transfers) | n.a. | -6.6 | |
| Overall balance | n.a. | -0.5 | |
Colombia: Summary of Subnational Governments’ Finances, 2006
| Percentage of general government |
Percentage of GDP |
||
|---|---|---|---|
| Total subnational revenue | 31.3 | 10.2 | |
| Own-source revenue | 12.4 | 4.1 | |
| Transfers from the center | 18.5 | 6.2 | |
| Total subnational expenditure | 32.7 | 10.7 | |
| Overall balance (before transfers) | n.a. | -6.6 | |
| Overall balance | n.a. | -0.5 | |
Increased reliance on automatic transfers muted incentives for revenue collection and, ultimately, fiscal discipline.2 The rigid formula linking transfers to local governments to current revenue diminished the central government’s incentive to collect more revenue. Subnational governments came to rely on central transfers, rather than having to activate own-source revenue for additional spending, thus weakening accountability and fiscal discipline. Coupled with limited expenditure control, these circumstances led to a substantial increase in subnational debt levels (an increase of 40 percent in 1993, and an average of 23 percent each year between 1994 and 1999). In addition, bank lending to local governments rose substantially through the mid-1990s, with banks using the transfers from the central administration as collateral for their loans. Eventually, several departments collapsed financially, and had to be bailed out by the central administration.
Most of the subnational financial problems were tackled by a series of reforms in the second half of the 2000s. Fiscal rules were established that brought down local debt and put local public finances on a sustainable footing. A reform of the transfer system moderated the growth in intergovernmental transfers, and mechanisms were set up to improve macroeconomic coordination among layers of government. At the same time, political decentralization—which, among other things, allowed for local election of mayors—contributed to the success of fiscal decentralization, especially in those local governments where reformist politicians skillfully took advantage of various reforms to improve fiscal outcomes. Bogotá’s remarkable performance (discussed in more detail later in this chapter) provides an example of this de facto asymmetric decentralization.3
The 1990s: First Round of Decentralization Reforms and IMF Advice
By the mid-1990s, a number of shortcomings in the decentralization framework were evident. The decentralization process was hampered by the lack of adequate own-resource instruments at the subnational level, particularly in the smaller municipalities and departments; expenditure responsibilities were ill-defined across layers of government; and taxes and transfers were not linked to expenditure needs and were excessively earmarked, based on purely sectoral considerations. Therefore, subnational governments were struggling to cover the portion of their operating expenses not funded by transfers, while having little incentive to manage other expenditures effectively. IMF technical assistance was requested by the authorities in mid-1995 to address some of these issues.4
A rebalancing of intergovernmental fiscal relations was necessary. Staff advice focused on establishing a nondistorting transfer system that would take into account both own-revenue capacities of subnational governments and their expenditure needs. Spending responsibilities were to be clarified, while more operational flexibility was to be provided through general-purpose transfers. Several tax measures were also proposed to increase the revenue-raising capacity of subnational governments, along with some options for improving local tax administration.
The macroeconomic risks posed by high subnational indebtedness also needed attention. Debt levels had rapidly increased in the early 1990s, and could come to jeopardize the country’s macroeconomic stability. Moreover, limited and incomplete information on subnational debt levels hampered the monitoring and accountability of local fiscal operations. Accordingly, the second technical assistance mission recommended a number of measures to address the growing indebtedness of the subnational governments: reducing the maximum amount of revenue that territorial governments could use as collateral for contracting commercial debt, including transfers from the central government; limiting borrowing to finance investment projects (this is the so-called golden rule, mandating that current spending be covered by revenue); and close monitoring by the central Ministry of Finance of territorial debt levels, including through collaboration with local public accounting offices.
Partly building on these recommendations, Colombia implemented several crucial reforms that improved the overall fiscal decentralization framework on a sustained basis. A number of important legislative initiatives helped rein in debt levels and establish fiscal discipline:
Starting in 1997, Colombia enacted a series of laws that critically contributed to sound fiscal and macroeconomic management at all levels of government. Law 358 was designed to curb excessive debt levels of subnational governments by linking their ability to contract debt to liquidity and solvency indicators. A local entity not adhering to these indicators would have to establish a fiscal adjustment plan, to be monitored by the central Ministry of Finance. However, subnational debt still grew by 15 percent a year on average during 1998–2000, and the performance plans did not always bring about stronger fiscal discipline at the local level because transfers continued to grow and there was no enforced ceiling on expenditure.
In 2000, in response to the above-described developments another law was passed, which established a set of fiscal rules for subnational governments. It classified departments into five categories, and municipalities into six, based on several indicators related to population and fiscal performance. The law limited the operating expenses of subnational entities to a certain percentage of their freely disposable revenue, that is, revenue excluding earmarked transfers. Subnational governments that did not comply with these ceilings had to establish corrective adjustment programs, to be monitored by the Ministry of Finance.
In 2003, Law 819 improved fiscal coordination among different levels of government, requiring both the central administration and local governments to present each year a consistent 10-year macroeconomic framework. Although the liquidity and solvency indicators of Law 358 remained binding, Law 819 established an additional rule, that budgets would need to be balanced over a 10-year period. It further stipulated that fiscal policy design and management had to be consistent across government levels: both the central and decentralized budgets had to fully comply with the medium-term frameworks, as well as expenditure authorizations and revenue collection at all levels of government. Law 819 also introduced a market-based mechanism for controlling subnational debt—the obligation for each department and municipality with a population greater than 100,000 inhabitants to obtain a credit risk rating from a rating agency.
As a consequence of these initiatives, the fiscal discipline of subnational entities improved between 2000 and 2006. Spending grew less rapidly than during 1997–99, subnational deficits decreased, and the stock of territorial debt grew by only 5 percent on average over the period. Many fiscally distressed subnational governments benefited from undertaking macroeconomic adjustment programs in collaboration with the Ministry of Finance. As a result, subnational debt declined from 9.6 percent of GDP in 1999 to 5.3 percent in June 2006; and the subnational fiscal balance changed from a deficit position during 1997–2001 to a surplus between 2002 and 2005 (0.3 percent of GDP per year, on average).
Transfer arrangements were also modified in 2001. A constitutional reform was passed, changing the automatic tax-sharing system for a transition period (2002–08). Transfers were to grow in real terms by 2 percentage points over 2002–05 and by 2.5 percentage points over 2006–08.5
This reform, coupled with the fiscal responsibility legislation described above, was instrumental in promoting greater fiscal discipline across the different levels of government. Moving from an automatic revenue-sharing system to one in which real transfers grew at a defined rate helped to address some of the incentive problems at the local level. Moreover, the system ensured a more stable and predictable flow of resources for local administrations. This relatively steady growth in the level of transfers led to lower spending at the local level because windfall gains were less likely. For the central administration, the reform helped to control the growth in mandated transfers.
The Successful Transformation of Bogotá
Through an improved decentralization framework, the capital city Bogotá was able to tackle its severe public finance problems and position itself as one of the best-performing subnational entities in Colombia. In the late 1980s, Bogotá was plagued by low tax revenues, limited investment spending, and a high debt burden, which translated into financial strain and low coverage and poor quality of basic services. The city was, however, able to use asymmetric decentralization options to its advantage. In particular, Bogotá received special status as Capital District in the 1991 constitution, and was granted an organic statute through a law in 1993; these measures allowed the city more political, fiscal, and administrative autonomy than other municipalities enjoyed. Moreover, the constitutional reform of the intergovernmental transfer system in 2001 granted Bogotá additional resources for specific social programs while reducing earmarking of the overall transfers from the central government.
Bogotá skillfully used these specific advantages under the decentralization process. Its organic statute and resulting tax autonomy allowed the capital city to increase several tax rates and to expand tax bases (Box 6.1).6 It also significantly improved its tax administration, including through an anti-evasion program, and created important institutional structures, such as a fiscal policy council, which were instrumental in upgrading its budgetary management. Moreover, Bogotá introduced performance budgeting, adopted a medium-term fiscal framework, and significantly enhanced fiscal transparency by disseminating its fiscal data regularly and on a timely basis through the Internet. Its bonds were rated by several internationally recognized credit agencies. Revenue collection increased significantly, and through the enhanced control of current outlays, resources could be shifted toward public investment. Debt levels fell, and both the provision and quality of services improved dramatically. Primary education coverage, for example, reached 90 percent in 2003, and drinking water coverage is almost universal today.
IMF Advice in Recent Years and Remaining Challenges
Although the reforms described above led to better management of subnational spending and borrowing, the central administration continued to run a def cit. An IMF technical assistance mission in 2004 helped take stock and identify areas that needed further reform.
Limited progress in the assignment of expenditure responsibilities across the different layers of government was the main reason for the center’s fiscal difficulties. The opposition by strong unions to the decentralization of certain services hindered a clear specification of responsibilities among government levels for certain sectoral expenditures, particularly in education and health. Against this background, the 2004 mission recommended the following approaches to the main pending issues:
Institutions and macroeconomic coordination. Coordination mechanisms between different levels of government needed to be strengthened further. An institution to assume leadership of all aspects of fiscal decentralization was desirable, so that budgets and fiscal targets could be coordinated more systematically, as stipulated by the 2003 responsibility law.
Expenditure responsibilities. After a sound diagnosis of remaining overlaps in expenditure responsibilities, the same institution should clarify the roles and service responsibilities of the different layers of government, especially in the health and education sectors.
Transfers. The transfer system should remain permanently decoupled from the central administration’s revenues, and possibly linked to the rate of inflation, which would curb pressures on the central administration’s deficit. The distribution side of intergovernmental transfers should be simplified, with a view to reducing earmarking to provide more room for local expenditure discretion. Moreover, the distribution should be based on local own-revenue capacity and expenditure needs.
Local revenue. Further tax and tax-administration measures should be identified to increase local own-revenues. Possible measures include streamlining or strengthening the local property tax assessment and a simplification of local tax instruments such as the consumer tax.7 Differences in revenue bases across Colombian municipalities are significant, and would need to be reflected in an appropriately defined equalization transfer system.
Reporting and monitoring of subnational governments. To promote transparency and accountability of local governments, a comprehensive set of fiscal data should be regularly released at the local level and consolidated into an overall position of the total public sector. Less-demanding reporting requirements, however, should be set for smaller municipalities that lack the capacity to draw up medium-term comprehensive macroeconomic frameworks and provide monthly data. In the interim, the central government should continue to rely on below-the-line data to monitor subnational operations.
Effective Decentralization in Bogotá
The city of Bogotá provides a good example of the way in which a major transformation in fiscal management and service provision at the local level can take place when effective decentralization is implemented. Since the mid-1990s the city managed to increase its resources dramatically and use them to improve its service delivery—not an easy task in a city with a population of more than 7 million. From a city facing a severe financial and urban crisis in the late 1980s, with public utilities, education, health, urban transport, and sanitation services in disrepair, the city turned around to become a beacon of modern management and change, as a result of three main factors:
The sequencing of the decentralization process in Colombia, starting from the popular election of mayors and ending with the granting of greater administrative autonomy, led to a major shift in the balance of intergovernmental powers in favor of subnational governments. Popular elections opened the door to the selection of mayors with great leadership skills, who are largely credited with the turnaround in the city’s predicaments.
Asymmetries in the decentralization process (enshrined in a 1993 organic statute, among other provisions, giving the city greater fiscal, political, and administrative autonomy) paved the way for tax and spending reforms. On the revenue side, a new gasoline tax was introduced, rates were increased (mainly for the industry and commerce tax), and tax bases were expanded (for property and vehicle taxes); these actions resulted in a significant increase in the city’s revenue. On the spending side, the city improved the management of public utilities and social services. Entities that were no longer needed or that were extremely inefficient were eliminated, others were merged, excessively large staffs were reduced, and wages were kept under control; for example, hospitals were merged or shut down, hospital staff was reduced, and results-oriented management and competition with private hospitals were introduced. In addition, the city significantly expanded opportunities for private participation in service provision through the adoption of concessions.
Bogotá has also placed emphasis on the market as a fiscal disciplinary factor, welcoming private participation to improve the management and reduce the cost of services, and implementing fiscal transparency measures to ensure that the market and the political and social control mechanisms function efficiently.
An important constitutional amendment in mid-2007 introduced a reform to the intergovernmental transfer system. Transfers to local governments are mandated to grow in real terms by 4 percent over 2008–09; 3.5 percent in 2010; and 3 percent over the period 2011–16. From 2016 onward, local governments are to receive a fixed share of central government revenues. The reform was originally expected to reduce central government transfers as a share of GDP, although this may be difficult to achieve in the projected lower-growth environment.
Although this is a welcome step, further reforms to the intergovernmental transfer system are needed. IMF staff have encouraged such reforms to ensure that intergovernmental transfers do not undermine the ability of fiscal policy to adjust and sustain the required fiscal surplus over the medium term. Proposals by the Expenditure Commission to broaden the local tax base, remove central government guarantees on local borrowing, and increase local cofunding of transport projects could, over time, alleviate pressure on transfers and increase incentives for fiscal discipline.
Formal mechanisms to improve macroeconomic coordination among different government levels in the definition of fiscal targets are also warranted. Information flows and consultation still need improvement.
This case study is based on Ahmad, Ruiz, and Garrido (1995); Ahmad, Vehorn, and others (1995); Adenauer (2005); Seade, Adenauer, and others (2005); and Lozano, Ramos, and Rincon (2007).
Between 1996 and 2006, transfers to subnational governments increased by more than 460 percent.
De jure asymmetric arrangements are based on legal provisions that allow for a more rapid take-up of responsibilities, typically in the main urban centers and advanced regions, relative to other subnational governments. In Bogotá, the city government managed to take advantage of the opportunities afforded by the legislation to all subnational governments, effectively resulting in asymmetric decentralization.
A first mission in early 1995 focused on reforming subnational taxation and transfers, shortly followed by a second mission in late 1995 to examine subnational debt and macroeconomic management.
Beyond 2008, the rate of transfer growth was to be linked again to the central government’s revenue. This clause was not implemented because of a constitutional amendment in late 2007 that permanently changed the transfer system.
Municipalities already had some flexibility to increase rates for most taxes before the organic statute was approved. Bogotá exploited this opportunity.
“Property assessments” are prepared relatively infrequently by the national cadastre office. A few municipalities (Bogotá, Medellin) have their own cadastre offices; this has allowed Bogotá to increase its property tax base substantially.