Sharing of Natural Resource Revenues/ Petroleum Revenue Decentralization International Experience and Iraq

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Sharing of Natural Resource Revenues/Petroleum
Revenue DecentralizationInternational Experience
and Iraq
Presented to Extractive Industries Legal and
Fiscal Regimes, Revenue Management, and Good
Governance May 16-17, 2007, I 2-220 Wednesday
230-315 pm
Presented by Monali Chowdhurie-Aziz, Senior
Public Sector Specialist, MNSED Kai Kaiser,
Senior Economist Public Sector Group
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Fiscal Decentralization and Natural Resources

• Prevailing Issues in Range of Countries
• Nigeria, Russia, Indonesia, Iraq, Bolivia, Sudan,
  DRC, Malaysia, PNG, etc.
• Challenges in applying developed country models
  for our clients
• Weak Institutions and poor governance contribute
  to resource curse at various levels of
  government
• Recent price increases and new discoveries in
  range of countries with pressures for
  decentralization
• Claims to oil revenues highly contested with
  diverse states

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Welcome to Southern Sudan
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Overview of Presentation

• Revenue Assignments in Decentralized/Inter-Governm
  ental Settings
• Political and Economic Arguments around
  Sub-National Natural Resource-Revenue Allocation
• Some International Experience
• How do we define Success?
• Illustrative Challenges from Iraq

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Natural Resource Revenues Must Be Seen Within the
Context of Good Intergovernmental Design

• Decentralization spans
• Political/Legal
• Including Constitutional Assignments (e.g., DRC
  2005)
• Fiscal
• Shaped by countrys economic/revenue structure
• Administrative
• Natural-resources can add to the complexity

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Five Fundamental Questions Facing Any
Decentralizing System

• Expenditure Assignments/Responsibilities
• Finance Follows Function Principle
• Revenues
• Own Source Revenues (autonomy of bases/rate
  setting)
• Role of Sub-Nationals in Negotiating
  Exploitation/Revenue Streams
• User Fees
• Intergovernmental transfers
• Derivation Based Revenue Sharing
• Transfers
• Fiscal Equalization
• Specific Purpose/Conditional Grants
• Subnational borrowing/debt
• Capacity Development Organizational,
  Institutional and Human

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Expenditure Assignment Considerations

• Macroeconomic stability
• Takes on special importance with natural resource
  revenue dependence
• Public Service Delivery
• Effectiveness/Efficiency
• Public Management Innovation
• Poverty Reduction
• Responsiveness
• Equalization
• Expenditure assignments often span multiple
  tiers of government

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Rationales for Intergovernmental Transfers

• Vertical imbalances
• Horizontal imbalances
• Inter-jurisdictional spillovers (externalities)
• Enhancing national objectives at the subnational
  level
• Paying for national programs implemented by
  subnational governments

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(Sub-National) Natural-resource revenue
assignments tend to make inter-regional
disparities prominent

• Assignment of Petro-Revenues to Sub-Nationals
• Shared versus Own Source (i.e., incorporates
  effort)
• How much is assigned to sub-nationals on
  derivation basis?
• Assignment of Other Revenues
• Property Tax?
• Income Tax? Other?
• Expenditure Needs
• Ideally funds follow function
• Transfer Design
• Vertical Shares/Pools?
• Horizontal Allocation Criteria

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Revenue Structures Vary Significantly
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Arguments Around Natural Revenues Sharing

• Arguments for Greater Degree of Centralization
• Stability Natural Revenues Subject to high
  Degree of Volatility
• Disparities Known and potential endowments
  highly unequal
• National Treasure Belongs to all the people!
• Local Capacity National governments better
  placed to manage
• Coherence in Natural-Resource Policy Avoid
  distortion across regions
• Revenue Transparency Easier if revenues accrue
  to one account
• Arguments for Decentralization/Derivation Based
• Cost-Reimbursement Including Environmental
  Costs
• Heritage Argument Non-renewable resource
• Political/Conflict Resolution Arguments
• Often very important where legitimacy between
  central and sub-national governments have been
  contested

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A Good Transfer System

• Transfers should be transparent and predictable
• Preference for formula-based
• Natural-resource revenue rich settings need to
  place special emphasis on transparency
• Equalization transfers should include
• A realistic measure of need
• Population, Area, Cost, Backwardness
• A realistic measure of fiscal capacity
• Adequate sub-national revenue autonomy
• Stable but flexible financing
• No Single Transfer May Meet All Objectives
• But, avoid proliferation of different grants

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Managing Transfers Across Levels

• Hierarchical Models
• 2nds tier has full autonomy over LG allocations
• Indonesian districts receive direct allocations
• Pakistan (with some modification)
• Nigeria transfer allocations earmarked to
  locals, but concerns about state interception
• National Models
• Direct allocations to second third tiers
• E.g., Indonesias provinces districts
• Guidelines for 3rd tier allocations
• Mixed/Asymmetric Models
• Special autonomy in Indonesia (Aceh/Papua)
• North/South Sudan
• Iraqs Regions/KRG

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Intergovernmental Revenue Management

• Addressing Petroleum Revenue Volatility
• Transfers Based on Realizations or Actuals
• Sub-National Revenue Predictability
• Ex Ante Rules
• Stabilization Accounts
• Addressing Petroleum Revenue Non-Renewability
• Heritage Funds
• Who benefits and when?
• Transfer Transparency
• Commissions for Dispute Clarification/Resolution
• Reporting to Higher Levels
• Revenue Transparency and Accountability

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The Challenge of Sub-National Accountability

• Natural-Resources Revenues May be Especially
  Prone to Weak Accountability
• Weak Bottom-Up Accountabilities
• No Representation Through Local Taxation
• Beneficiary Regions Subject to Windfalls
• Weak Top-Down Accountability
• Sub-National Allocation of Natural-Resources May
  Be Subject of Political Bargains
• Petroleum Revenues May Be Inherently
  Centralized
• Allocation to Sub-National Governments May (Also)
  Fail to Trickle Down
• Revenue-led Fiscal Decentralization Associated
  with Weak Accountability for Outcomes
• Explore Linkages to Sectoral/Frontline Outcomes?

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Gauging Performance of Natural Resource Revenue
Sharing in an Intergovernmental Context

• Glue or Solvent for National Cohesion?
• Revenue Flows Translate Into Development Outcomes
• Finance Follows Function
• Accountabilities Promote Service Delivery
• Revenue Assignments/Collection Consistent with
  Coherent Revenue Policy
• Effective in attracting investment to best placed
  locations
• Consistent with Good PFM at all Levels
• E.g., as benchmarked by PEFA
• Intergovernmental Arrangements Consistent with
  Fiscal/Macro-Economic Stability
• Overgrazing undermines stabilization/heritage
  arrangements
• Natural-Resource Rents Dont Subvert Countrys
  Institutional Development/Integrity
• Corruption Further Corrodes Representative/Legitim
  ate Institutions

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Fiscal Decentralization in Iraq

• Legacy of centralization
• With some history asymmetric arrangements,
  notably Kurdistan
• High Dependence on Petroleum Revenues
• gt95 percent of domestic revenues in 2006/2007
• Oil concentrated mainly in south
• Debates around old and new oil
• 2005 Constitution with Federal Vision
• Distinction between provinces and regions
• Tendency to overlap regions with ethnic identify

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Prevailing Asymmetric Arrangements in Iraq
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Petroleum is Concentrated in the South
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(Illustrative) Fiscal Gaps in Iraq?
Sources PC Oil Revenues are drawn from April
workshop Module 3, Estimates for Baghdad Own
Source and Shared Revenues are proxied by
Jakarta, Indonesia
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Political Economy of Management, Regulation and
Development of Hydro-Carbon Revenues

• In a Low Trust Environment
• Kurds view the development of their oil fields as
  having been historically under-resourced.
• Historically Denied their share of revenues from
  the center
• Currently revenues are not transparent and are
  poorly managed at the centre
• Suggested solutions
• Distinction between old Fields and new field
  in the Constitution
• Contracting for new field in Kurdistan by KRG
• Allocate share of actual revenues to region
  based on population
• Variant of this has already been in place by
  allocating 17 of national budget, minus a series
  of sovereign expenditures

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Political Economy of Management, Regulation and
Development of Hydro-Carbon Revenues

• Problems with Suggested Solutions
• Contradictory rules for oil exploration
• Optimal resource development requires policies
  for that development of old and current are
  coordinated (and distinction itself may be
  difficult in practice)
• Coordination is important if stabilization is
  left to the subnational
• Incentive for the one with the smaller budget to
  run a pro-cyclical fiscal policy while the one
  with the larger budget absorbs the costs of the
  counter-cyclical policy

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Petroleum Revenues and The Future of Iraq

• On-Going Constitutional and Legal Debates
• Revisions to 2005 Constitution
• Parallel to debates on Hydrocarbon Law, Revenue
  Sharing Law, Law on Local Governments, and
  Revenues Sharing Law
• Concerns about lack of transparency
• Future of Development Fund for Iraq (DFI)
• Significant Pressures to Increase Revenue Flows
  to Provinces/Regions
• Allure of concentrated oil wealth may increase
  incentives to create regions around ethnic lines
  (Shiastan, Sunnistan)
• But also uncertainty about location of actual oil
  reserves behind veil of ignorance and various
  myths of manna
• Need to come to some arrangements that
  accommodate all main actors

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Areas of On-Going Engagement in IraqAround
Natural-Resource Sharing

• Clarify options of intergovernmental sharing and
  transfers to executive and legislative
  counterparts
• Emphasize that revenues should need to follow
  functions, not vice versa, as well as principles
  of (rule-based) equalization
• Identify options for revenue management and
  revenue assignment, as well as institutional
  arrangements to mediate these in practice across
  interests of various regions
• Promote sub-national PFM capacity
• in advance of new roles, responsibilities, and
  financing
• Promote bottom-up and top-down accountabilities
• Promote Revenues Arriving at Frontline Service
  Delivery
• Schools, Clinics, Communities around outcomes
• Limited Incentives for Revenue Diversification

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New institutional arrangements will have to
mediate respective concernsgiven prevailing
realities

• Prospective but underappreciated institutions
• Public Commissions for Revenue Management
• 2005 Constitution Art. 106), including audit
  functions, to be regulated by Law (pending)
• Public commission for interest of regions
• (Art. 105) (pending)
• Asymmetric arrangements may be the most practical
  solution
• Overcentralization may itself be recipe for
  secession, less transparency
• Question is whether decentralization dynamics
  work for or against resource curse?
• E.g., contestation for revenue transparency, or
  overgrazing to maximize own returns

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QA
Selected References ESMAP (2005). Comparative
Study on the Distribution of Oil Rents in
Bolivia, Colombia, Ecuador, and Peru. Washington,
DC, ESMAP (Joint UNDP/World Bank Energy Sector
Management Assistance Programme 142. ODI, 2006.
Sub-National Implementation of the Extractive
Industries Transparency Initiative (EITI).
London, Prepared for the EITI Secretariat and
DfID, London, Issues Paper, April. Fiscal
Decentralization and Sub-National Public
Financial Management in Iraq, Washington, DC
MNSED (mimeo)
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Annex Alternatives Forms of Structuring
Intergovernmental Grant Programs
Vertical Shares Method of determining the total
divisible pool
Source Adapted from Roy Bahl (2006)