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Abstract

The question of what makes fiscal decentralization work is faced by many policymakers around the world. This book draws on both the relevant literature and policy and technical advice provided by the IMF to a wide range of member countries, and discusses the key factors that help make decentralization sustainable, efficient, and equitable from a macroeconomic perspective. It focuses on institutional reforms (in the revenue and expenditure assignments to different levels of government, the design of intergovernmental transfers, and public financial management systems) that are suited to different countries circumstances, and their appropriate sequencing.

Title Page

OCCASIONAL PAPER 271

Making Fiscal Decentralization Work: Cross-Country Experiences

Annalisa Fedelino and Teresa Ter-Minassian

INTERNATIONAL MONETARY FUND

Copyright

© 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

  • Acknowledgments

  • Abbreviations

  • Introduction

  • Part I Lessons

  • 1 Fiscal Decentralization: Key Issues

    • A Brief Literature Review

    • Macrofiscal Implications of Decentralization

  • 2 The IMF’s Advice on Designing and Managing Fiscal Decentralization

    • Defining Spending Responsibilities

    • Ensuring Sound Public Financial Management

    • Designing Intergovernmental Revenue Arrangements

    • Identifying Mechanisms to Control Borrowing

  • 3 Lessons Learned and Challenges Ahead

  • Part II Background Studies

  • 4 Bolivia

    • The 1990s: Increasing Municipal Autonomy Leads to Fiscal Imbalances

    • The Early 2000s: Fiscal Unraveling

    • The Late 2000s: Stronger Prefecturas Demand Control of Hydrocarbon Resources

    • Conclusions

  • 5 China

    • The 1994 Fiscal Reform

    • Implications of the Current System

    • IMF Advice and Possible Reforms

  • 6 Colombia

    • The 1990s: First Round of Decentralization Reforms and IMF Advice

    • The Successful Transformation of Bogotá

    • IMF Advice in Recent Years and Remaining Challenges

  • 7 Democratic Republic of the Congo

    • Fiscal Arrangements Prior to Enactment of Decentralization Legislation

    • Deficiencies of the Constitutionally Mandated Fiscal Decentralization

    • The National Forum on Decentralization

    • The 2008 Decentralization Legislation

    • Current Transitional Arrangements

    • The Key Role of the New Organic Public Finance Law

  • 8 Indonesia

    • IMF Advice on Fiscal Decentralization

    • An Assessment of Recent Reforms and Remaining Challenges

  • 9 Kosovo

    • Overall Framework of the IMF’s Advice

    • Remaining Challenges

  • 10 Liberia

    • Administrative Rationalization

    • Strengthening Subnational Roles before Decentralization

    • Toward a Framework for Fiscal Decentralization

  • 11 The Former Yugoslav Republic of Macedonia

    • IMF Advice on Fiscal Decentralization

    • Current Intergovernmental Fiscal Arrangements

    • Remaining Challenges

  • 12 Mexico

    • The Subnational Debt Crises of the Mid-1990s

    • Current Intergovernmental Fiscal Arrangements

    • IMF Advice on Fiscal Decentralization

    • Recent Progress and Remaining Challenges

  • 13 Nigeria

    • IMF Advice on Fiscal Decentralization

    • Recent Progress

    • Remaining Challenges

  • References

    Tables

    • 1 Comparative Indicators for Case-Study Countries

    • 1.1 The Policy Rationale for Fiscal Decentralization

    • 2.1 Main Recommendations on Spending Assignments in Case-Study Countries

    • 2.2 Main Recommendations on Public Financial Management in Case-Study Countries

    • 2.3 A Taxonomy of Subnational Revenue Arrangements

    • 2.4 Assignment of Taxes to Subnational Governments

    • 2.5 Main Recommendations on Own-Revenue Assignments in Case-Study Countries

    • 2.6 Main Recommendations on Revenue-Sharing in Case-Study Countries

    • 2.7 Main Recommendations on Transfer Design in Case-Study Countries

    • 2.8 Approaches to Controlling Subnational Borrowing

    • 2.9 Main Recommendations on Subnational Borrowing Arrangements in Case-Study Countries

    • 4.1 Bolivia: Indicators of Fiscal Decentralization

    • 4.2 Bolivia: Summary of Subnational Governments’ Finances, 2005

    • 5.1 China: Indicators of Fiscal Decentralization

    • 5.2 China: Summary of Subnational Governments’ Finances, 2007

    • 5.3 China’s Transfers, 2007

    • 6.1 Colombia: Indicators of Fiscal Decentralization

    • 6.2 Colombia: Summary of Subnational Governments’ Finances, 2006

    • 7.1 Democratic Republic of the Congo: Indicators of Fiscal Decentralization

    • 8.1 Indonesia: Indicators of Fiscal Decentralization

    • 8.2 Indonesia: Summary of Subnational Governments’ Finances, 2006

    • 9.1 Kosovo: Indicators of Fiscal Decentralization

    • 9.2 Kosovo: Summary of Subnational Governments’ Finances, 2008

    • 10.1 Liberia: Indicators of Fiscal Decentralization

    • 11.1 FYR Macedonia: Indicators of Fiscal Decentralization

    • 11.2 FYR Macedonia: Summary of Subnational Governments’ Finances, 2008

    • 12.1 Mexico: Indicators of Fiscal Decentralization

    • 13.1 Nigeria: Indicators of Fiscal Decentralization

    • 13.2 Nigeria: Summary of Subnational Governments’ Finances, 2006

  • Figures

    • 1.1 Subnational Revenues and Expenditures as Shares of General Government, 2006

    • 1.2 Changes in Subnational Shares of Revenues and Expenditures, 2000–06

    • 2.1 Subnational Spending in Case-Study Countries

  • Boxes

    • 1.1 Measures of Fiscal Decentralization

    • 1.2 Fiscal Rules for Subnational Governments

    • 2.1 Sharing of Natural Resource Revenue

    • 6.1 Effective Decentralization in Bogotá

    • 9.1 The Comprehensive Settlement Proposal and Kosovo’s Legislation on Municipalities

    • 11.1 Phased Implementation of Fiscal Decentralization in FYR Macedonia

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.

1

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

article image
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 1–3) 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 4–13) 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.

1

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).

2

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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Cover Making Fiscal Decentralization Work
Making Fiscal Decentralization Work
Cross-Country Experiences
Author:
Ms. Annalisa Fedelino
ISBN:
9781589069855
ISSN:
0251-6365
Publication Date:
06 Oct 2010
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781589069855.084
Pages:
112

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