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Impact of new legislation: Jakarta seminar on decentralization draws lessons from experiences of other countries

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 2000
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In mid-1999, Indonesia passed decentralization legislation that will fundamentally change the structure of the state, which, since the 1950s, has been highly centralized. While there are considerable pressures for decentralized governance in Indonesia, the transition will not be easy and needs to be carefully sequenced. A seminar titled “Indonesia: Decentralization Sequencing Agenda” was held in Jakarta, Indonesia, on March 20-21 to place Indonesia’s decentralization effort in the context of international experience. The seminar was sponsored by the IMF’s Fiscal Affairs Department, the Center for Social and Economic Research of the University of Indonesia, and the World Bank. Delivering the keynote speech, Bambang Subianto—a member of the president’s National Economic Advisory Council and former finance minister—said that the time for implementation was very short and that many provisions of the law would have to be implemented in the 2001 budget. Subianto looked to the seminar to provide a road map for the orderly implementation of the decentralization process.

Lessons from other countries

The seminar drew lessons for Indonesia from the experiences with decentralization of a number of countries, including Brazil, China, Colombia, India, and Italy. It featured presentations by external experts, as well as Indonesian academics and officials. The seminar focused on key issues for Indonesia, ranging from transfer of responsibility for making expenditure decisions and collecting revenues to management of the budget process and design of intergovernmental transfers, including untied general purpose transfers.

The IMF does not have a preconceived notion about the desired level of decentralization in its member countries, according to Ehtisham Ahmad, Advisor in the IMF’s Fiscal Affairs Department. Rather, individual countries must decide what is best for them, given their historical and political perspectives. However, he noted, the decentralization process needs to be carefully sequenced to avoid exacerbating macroeconomic imbalances, as illustrated by many countries that have already gone through this experience. A key lesson is that the decentralization of revenues and transfers should not precede the devolution of responsibilities. Moreover, to avoid a political backlash, it is imperative not to endanger the delivery of public services, such as basic health and education, during the transition to decentralization. Revenue and expenditure policies have to be designed carefully to create incentives for local governments to manage public finances effectively and to ensure that an inefficient centralized system is not replaced with an even more inefficient and corrupt local structure of governance.

Assigning functions, coordinating budgets

A variety of issues were raised at the seminar. First, participants stressed that, if decentralization in Indonesia is to be effective, it is important to assign different functions to the appropriate level of local government—provinces, districts, or associations of districts. The legislation requires that most expenditure functions be devolved in a “big bang” to districts during 2001. While participants felt that it would be relatively easy to assign the revenue shares and transfers to local government entities, they were uncertain as to whether the central and subnational governments could decide within the time available on the functions that would devolve to the districts in 2001 and whether the districts would be capable of assuming these functions. Nor was it clear whether districts should be responsible for such functions as teaching hospitals, the national transportation grid, or air traffic control.

Because the national budget cycle will shift to January from April beginning in 2001, only four months remain for decentralization proposals to be incorporated in the budget to be submitted to parliament. The participants also stressed that the success of the decentralization program will hinge on the establishment of systems to coordinate the management and reporting of the subnational budgets. The role of the ministry of finance in this area is crucial but requires further clarification.

Other key issues that Indonesia must address when it decentralizes its government, in the view of seminar participants, are how the existing central, or decon-centrated, staff will be allocated to local units; who will ensure that relevant assets, such as buildings and other infrastructure, are delivered; who will be responsible for regulation; and how policymaking will be coordinated across regions. It is also critical—and required by the legislation—that when responsibility for certain functions shifts to a different level of government, the necessary financing follow these functions. This will help prevent macroeconomic difficulties (such as increased general government deficits) as well as ensure that the salaries of former central employees—including teachers, doctors, and contrac-tors—for which local governments will assume responsibility are paid as of January 1, 2001.

Revenues and expenditures

A team representing the Center for Social and Economic Research of the University of Indonesia pointed out that existing revenue assignments need to be considered further. Currently, the team noted, local governments do not have control over tax rates and, hence, cannot raise more revenues to finance additional expenditures at the margin. Such control is critical for local accountability. Revenues from the land and property tax, for example, are shared, but the center determines the tax rate and the central tax administration collects the tax. It was agreed that the local units of government should be able to set the rates for this tax, even if the central tax administration remains responsible for land valuation, payments collection, and audits.

Participants felt that the regions should not be allowed unlimited borrowing possibilities, which could also lead to macroeconomic difficulties. Emil Salim, chairman of the president’s National Economic Advisory Council, suggested that Indonesia had much to learn from the experiences of Latin American countries with unconstrained local borrowing. A number of measures for managing expenditures were proposed, and participants noted that the IMF’s Fiscal Affairs Department is providing technical assistance in this area.

Seminar participants discussed other potential revenue sources that could be shared between the central tax administration and local and provincial levels of government. One possibility would be for the central government to allocate to the local governments a certain number of percentage points (known as “piggybacking”) from the personal income tax or, at the provincial level only, the corporate income tax. According to the participants, the proposals for sharing government revenues derived from the production of onshore oil and gas with the provinces and districts in which these resources originate were fraught with uncertainty. The complexity inherent in determining the revenue shares, given existing production-sharing arrangements, could lead to disputes as to the amounts to be shared. One proposed solution would be to assign a clearly defined royalty, levy excises on production to offset environmental damage, and implement the suggested piggy-backed income tax share. The revenue sharing would also exacerbate interregional disparities. In any case, the seminar participants noted, the issue of regional disparity must be addressed in the context of the general system for transfer among subnational governments.

Conclusion

Participants focused on more sequenced alternatives to the “big bang” approach to decentralization. Given the enormity of the task at hand, the Indonesian authorities could adopt two possible strategies. For 2001, they could decide to decentralize quickly to the provincial level in the first instance. Alternatively, the focus on districts could be maintained, but districts would assume responsibilities that they are capable of administering on a case-by-case basis. In both cases, the legislated principle that financing should follow function needs to be maintained so as not to endanger Indonesia’s economic stabilization.

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