THE WORLD BANK INSTITUTE SOUTH ASIA URBAN AND CITY MANAGEMENT COURSE January 921, 2000

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THE WORLD BANK INSTITUTESOUTH ASIA URBAN AND
CITY MANAGEMENT COURSEJanuary 9-21, 2000

• DECENTRALIZATION AND FISCAL DECISION-MAKING
• Outline of the Presentation to be made on January
  11, 2000
• Om Prakash Mathur
• HDFC Chair in Housing and Urban Economics
• National Institute of Public Finance and Policy,
  New Delhi

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DECENTRALIZATION AND FISCAL DECISION-MAKINGScope

• Decentralization has become common throughout the
  developing world. Of the 75 developing and
  transitional economies with a population of over
  5 million, all but 12 claim to have initiated
  measures to transfer some political,
  administrative, and fiscal powers to
  local/municipal governments.
• In this session, I propose to discuss the
  following issue in what different ways is the
  process of decentralization, involving transfer
  of spending responsibilities to local
  governments, being financed? What kinds of
  fiscal responses have emerged in the developing
  countries, to finance decentralization?

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Contd..

• I argue in the session that if the potential
  gains of decentralization are to be realized, it
  will be necessary for the developing countries to
  develop and design appropriate fiscal packages
  for financing new spending responsibilities that
  local/city governments have come to acquire in
  the decentralization context. So far, the
  progress in developing appropriate fiscal
  initiatives has been tardy.

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Organisation

• 1 The session would begin with a brief
  introduction of the concept of decentralization,
  the rationale used in the developing countries
  for promoting decentralization, and the nature of
  issues that it has given rise to.
• 2 It will be followed by an exposition of the
  decentralization theorm, and of the principles
  that govern the allocation of functions and
  fiscal powers between the different tiers of
  government and between the government and the
  private and the voluntary sectors. It will point
  out the reasons why, on efficiency
  considerations, certain taxes can not be devolved
  on local/city governments, why there is a cap on
  local government borrowing, and why there is
  limited autonomy with local/city governments.

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Contd..

• 3 Current fiscal initiatives to decentralization
  comprising revenue-raising powers,
  revenue-sharing arrangements, and grants-in-aid
  will be discussed at some length. Adequacy of
  these responses and the main concern represented
  by a lack of synchronization between
  decentralization of spending responsibilities and
  decentralization of revenue resources/revenue-shar
  ing authority will be examined.
• 4 Noting that the stakes in decentralization
  among developing countries are high, the need to
  better align fiscal responses with spending
  responsibilities will be emphasized. The
  proposition that the potential gains of
  decentralization will depend on how developing
  countries design and implement fiscal packages
  will be advanced.

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1Decentralization trends are slowly but
decisively spreading out to the developing world
..

• A common feature throughout the developing world
• Of the 75 developing and transitional economies
  with a population of over 5 million, all but 12
  countries have initiated steps to decentralize
  political, administrative, and fiscal powers to
  local governments
• It has meant dispersion and reallocation of
  powers, on the one hand, between different tiers
  of government, and on the other hand, between the
  government and the private sector.
• Decentralization is on attempt an the part of
  the government to become more responsive to
  citizens needs and preferences. For this to take
  place, new sets of rules defining the
  relationship between the central and local
  governments are being established.

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Decentralization is occurring in different
forms..

• Deconcentration Dispersion of responsibilities
  from the central to lower units of government.
  It does not involve transfer of authority lower
  units of government are used to improve the
  efficiency and effectiveness of service delivery.
• Delegation Refers to a situation where the
  central government delegates responsibility for
  administration of public functions to local
  governments, who remain accountable to the
  central government.
• Devolution Transfer of some authority for
  decision-making, finance and management to local
  government units.

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Potential Gains of Decentralization are large and
varied..

• Enhances the efficiency and responsiveness of
  governments.
• Enhances welfare by tailoring the mix and level
  of public goods to collective preference schedule
  of local jurisdiction.
• Improves the overall economic performance of
  public agencies by involving the tax payer more
  closely in spending decisions.

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Contd..

• Introduces competitiveness among local
  governments in order to better satisfy the
  priorities of citizens.
• Results in efficiency gains from greater voice
  from local constituents
• But the realization of potential gains is
  contingent upon, among others, the application
  of the new set of rules defining central-local
  relations combined with fiscally responsible
  behaviour of local governments. So far, there is
  not enough experience and evidence to evaluate
  its outcome.

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Decentralization has given rise to a number of
issues and questions are being asked about its
impact on ..

• Quality of governance
• Size of government
• Macroeconomic stability
• Accountability and transparency
• Corruption
• Synchronization between decentralization of
  spending responsibilities and decentralization of
  revenue-raising authority

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2The Decentralization theorm suggests..

• Macroeconomic stabilization and income
  distribution should be assigned to central
  government, and resource allocation to
  local/municipal governments (Musgraves classical
  formulation).
• Functions that have spillovers are better handled
  by higher levels of government, and conversely,
  functions that are discrete, are better served by
  local/municipal governments.
• Musgraves formulation has come to be
  supplemented by the principle of subsidarity A
  function is assigned to a higher level of
  government only when it is in a better position
  to carry it out compared to a lower level of
  government. As a result, local governments in
  many countries are experincing important changes
  in the division of authority vis-à-vis the higher
  levels of government.

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Contd..

• Fiscal resources should be proportional to the
  share of each tier of government in public sector
  burden.
• An appropriate structure of local finance, i.e.,
  the use of taxes, user charges and transfers
  depends on their spending responsibilities. This
  is explained by the fact that different sources
  of revenue have different patterns of incidence.
  User charges impose costs directly on individual
  consumers therefore, there is an argument for
  assignment of user charges for financing those
  services whose benefits are confined to
  individual consumers. Where benefits can not be
  confined, taxation is a better proposition.

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Contd..

• The comparative advantage of one tier in the
  provision of a class of public sector goods, may
  not be matched with a similar advantage in
  revenue collection. This fact provides
  legitimacy to transfers as an important
  instrument for financing local goods and
  services.
• Transfers are justified on account of the lack of
  synchronization between spending responsibilities
  and revenue resources.
• Transfers permit central government to use local
  bodies for advancing such objectives as income
  distribution

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Contd..

• Often local governments provide goods which not
  only benefit their own citizens, but produce
  benefits for other localities as well. Transfers
  are justified for externality-producing
  expenditures.
• Efficiency in tax administration for certain
  revenues requiring centralization is one of the
  reasons why certain taxes can not be devolved on
  local governments.
• That local fiscal policy should not unduly impact
  macroeconomic stability or pose macroeconomic
  risks is the principal reason for central
  regulation on local government borrowings.
• Benefits of street lighting are unambiguously
  local but benefits of education and health may
  extend beyond the local jurisdictions.

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3Fiscal initiatives to meet the complex demand
of decentralization are expanding..

• Assignment of revenue base to local governments
• Application of user charge principle
• Intergovernmental transfers, i.e., creating a
  pool of tax and/or non-tax revenues for sharing
  between different tiers of government.

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Other responses to decentralization ..

• Autonomy to local/municipal governments,
  including autonomy in matters of borrowings
• Privatization and public-private partnership in
  the provision of municipal level services
• Fiscal initiatives constitute an integral part
  of intergovernmental relations.

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But the developing countries are finding it
difficult to make much impact on account of the
..

• Nature of local taxes which are far less buoyant
  than those that are leviable by higher levels of
  government
• Poor and ineffective local tax regime
• Lack of autonomy with local governments in
  matters of determing tax exemption policies, tax
  rates, rebates, and in matters of using other
  financing resources/mechanisms
• Inability on the part of local governments to
  strike a cost-price balance for better
  application of user charge principle, often due
  to regulations.

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Contd..

• Ad-hoc and unpredictable nature of transfers.
• Limits imposed on local/municipal governments in
  matters of staff appointments, salary structures
  and other monetary perquisites, constraining
  their ability to adjust expenditures to revenues.
• Weak legal, regulatory and institutional
  frameworks for local government borrowing.
• Absence of accountability, transparency and
  information disclosure in local government
  functioning.

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4The benefits of decentralization so far are
limited.. The gains of decentralization in
terms of tailoring of outputs to local
circumstances or local accountability, or
improved synchronization between spending
responsibilities and revenue resources have been
slow to show up. Although worldwide experience
is insufficient to evaluate the outcome of
decentralization, serious problems persist in
thedeveloping countries __

• Reluctance on the part of countries to clearly
  define the spending responsibilities of local
  governments. Conceptually too, matching
  functions to the different tiers of government on
  the basis of benefit-jurisdiction model has
  proved to be far more difficult.

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Contd..

• Fiscal affairs of higher and lower tiers of
  government continue to be dealt with independent
  of each other.
• Lack of clarity about the degree of autonomy that
  may be given to local governments in matters
  relating to tax bases, tax rates, exemptions and
  their access to capital markets, as also about
  the conditions under which the central government
  may intervene.

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A broader consensus, however, exists on ..

• Change in the fiscal relationship between the
  central and local government is indispensable for
  improving the performance of public services.
• Reduction in uncertainty associated with
  transfers, with transfers to be determined on the
  basis of a set of rules rather than negotiations

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Two concluding statements ..

• There is no road map to decentralization. The
  world now consists of more than 200 ongoing
  experiments. Of the countries that have embarked
  on decentralization, none yet has the length of
  history that would permit an ex-post evaluation
  (Dillinger. 1994)
• Decentralization frontier is unexplored. There
  are infinite possibilities even with the same
  service. A service can be partitioned. Policies
  can be decided at one level operational
  authority can be exercised at another level.

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Readings

• Bird, Richard. 1994. A Comparative Perspective
  on Federal Finance, in Keith G. Banting (et.al).
  The Future of Fiscal Federalism. School of
  Public Policy, Queens University Kingston.
• Bird, Richard and Francois Vailloncourt (Eds).
  1998. Fiscal Decentralization in Developing
  Countries. Cambridge University Press
  Cambridge.
• Burki, Shahid Javed (et.al). 1999. Beyond the
  Center Decentralizing the State. The World
  Bank Washington D.C.

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Contd..

• Dillinger, William, 1994. Decentralization and
  Its Implications for Urban Service Delivery,
  Urban Management Programme Discussion Paper No.
  16. The World Bank Washington D.C.
• Estache, Antonio (Ed). 1995. Decentralizing
  Infrastructure Advantages and Limitations.
  World Bank Discussion Paper No. 290. The World
  Bank Washington D.C.
• Litvack, Jennie (et.al). 1998. Rethinking
  Decentralization at the World Bank. A Discussions
  Paper. The World Bank Washington D.C.
• Mathur, Om Prakash. 1999. Decentralization in
  India A Report Card. National Institute of
  Public Finance and Policy, New Delhi.