Challenges of Budget Management in Decentralization Budget Management and Financial Accountability Course Dana Weist Lead Public Sector Specialist, PRMPS [e-mail] 2 March 2004

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Challenges of Budget Management in
Decentralization Budget Management and
Financial Accountability Course Dana WeistLead
Public Sector Specialist, PRMPSdweist_at_worldbank.o
rg2 March 2004
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Decentralization A World-Wide Phenomenon

• Underway in over 85 countries
• Political and economic rationales
• Varieties
• Deconcentration
• Delegation
• Devolution

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Decentralization Trends
Source International Monetary Fund. Government
Finance Statistics Year Book , various years,
Country Tables
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Differences Across Regions
Subnational Share of Expenditures
Subnational Share of Revenues
Note Simple average of most recent observations
in available countries. Numbers in parenthesis
indicate number of countries represented.
Source International Monetary Fund. Government
Finance Statistics Year Book 1998, Country Tables.
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Positive or Negative Outcomes?

• If designed well, decentralization can
• Move decision making closer to people
  (subsidiarity principle)
• Enhance efficiency and responsiveness of service
  delivery
• Improve economic growth
• Potentially alleviate poverty
• But, design is complicated, since it spans
  political, fiscal, and administrative policies
  and institutions

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Key PE Questions

• Who is doing what?
• How is it being financed?

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Macroeconomic Stability

• Key factor is hard budget constraint
• Creates incentives for subnational fiscal
  discipline
• Limits risk of central government
• Can be softened through several channels
  (intergovernmental fiscal system, financial
  system, SOEs, borrowing, etc.)

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Equity

• Extent of fiscal equalization
• Ways and means for targeting poor places and poor
  people

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Four Pillars of Intergovernmental Fiscal System

• Expenditures
• Revenues
• Intergovernmental transfers
• Subnational borrowing/debt

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Expenditure Issues

• Objective significant and clear expenditure
  responsibility and autonomy
• Subsidiarity principle provide services at
  lowest level of government compatible with
  "benefit area" associated with those services
• Distinction between production and provision
• Do local services respond to local needs?
• Do citizens have meaningful opportunities for
  voice?
• Do officials face incentives to respond?
• Assign expenditures first, then assign revenues
  that match expenditure needs

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Local Revenue Issues

• Own resources typically inadequate to carry out
  assigned functions
• Revenues not adequately responsive to changing
  needs
• Striking variations in size and capacity one
  size doesnt fit all
• Local revenue mobilization strengthens
  accountability -- link taxes with benefits
  derived from local government services
• Simplest and most effective form of tax autonomy
  discretion to set tax rates

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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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A Good Transfer System

• Transfers should be transparent and predictable
  (formula-based)
• Equalization transfers should include
• A measure of need
• A measure of capacity
• Adequate sub-national revenue autonomy
• Stable but flexible financing
• Avoid a proliferation of conditional grants

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Local Borrowing

• Benefits
• Finance long-lived assets efficiently and
  equitably
• Overcome liquidity problems of lumpy investments
• Pay-as-you-use financing
• Improve selection of investments
• Risks
• Soft budget constraint
• Macro-instability

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Borrowing Risks Can Be Managed

• Strengthen intergovernmental fiscal system
• Apply administrative controls
• Implement rule-based framework
• Establish market-based system
• Impose other controls

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Decentralization Challenges

• Balance responsibilities with resources,
  capacity and accountability
• Subsidiarity
• Finance follows function
• Responsibility with capacity (learn by doing)
• Accountability through political channels, own
  source revenues, participation and transparency
• Create incentives for implementation to match
  formal arrangements

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Operational Implications of Decentralization

• Many more potential clients
• Weaker client capacity
• Limited knowledge of Bank processes and
  requirements
• Weak capacity in project preparation and
  procurement
• Local accountability may be weak and potential
  for local corruption may be high
• Shorter time frame for local officials
• Need for
• Improved data
• Streamlined Bank processes?
• Experimentation and new solutions?

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Public Expenditure Management Lens

• Clarity in expenditure assignment?
• Adequacy of resources?
• Formula-based transfer system?
• Hard budget constraint?
• Budgeting and reporting systems
• Uniformity vs. flexibility
• Carrots vs. sticks