Harmonisation, Decentralisation and Local Governance.

Harmonisation, Decentralisation and Local Governance

DPWGs Country Specific Guiding Principles:Strengthening fiscal decentralisation and local authorities financing:

“Fiscal decentralisation is a key factor and driver for successful decentralisation.

Support to fiscal decentralisation should aim at strengthening the long-term

financial development and sustainability of local governments.”

Session overview

Understanding the context of fiscal decentralisation

Assigning expenditure responsibilitiesInstruments for financing local government

intergovernmental transfers local taxation and user fees investment capital

Budget implementationHarmonisation and alignment of support to

fiscal decentralisation

First and second generation fiscal federalismsCosts and benefits

Revisiting the wall of wonders

Decentralisation - Traditional definition

“Decentralisation is the transfer of authority and responsibility for public

functions from the central government to subordinate or quasi-independent

organisations or the private sector.”

(Litvack and Seddon 1999)

Observations about fiscal decentralisation around the worldIt is often history and politics -not economics-

that determines subnational government structure and drives fiscal decentralisation reforms

Many fiscal decentralisation reforms shifted the financial resources to the local government level, but failed to decentralise the discretion to manage these resources

New “consensus” on decentralisation

“(Fiscal) decentralisation is the empowerment of people by the (fiscal) empowerment of

their local governments.” (Roy Bahl, 2005)

Benefits associated with fiscal decentralisation?

More accountability on the part of government officials

More willingness on the part of the local population to pay for services

Promise of increased revenue mobilisationIncreases potential for innovation in

economic decision-making

Costs associated with fiscal decentralisationLess macroeconomic controlNational priorities for capital investment do

not conform to local government choicesLead to a lower rate of spending on

infrastructure, perhaps jeopardising national growth

Revenue centralisation gives a greater potential for equalisation

Linkages with administrative and political decentralisationThe system of intergovernmental fiscal

relations should be well-designed in its own right

The fiscal, political and administrative dimensions of decentralisation should be properly aligned

For every element of decentralisation (including fiscal decentralisation), there is a need to balance discretion with accountability

Linking fiscal decentralisation to domestic accountability

The provision of fiscal discretion to local governments - whether in the form of expenditure discretion or discretion over revenues - helps strengthening the downward accountability by: encouraging the citizens to participate in decision-

making processencourages them to monitor local government

financesmaking sure that local finances are actually used in

accordance with the priorities set forth in the budget

Intergovernmental finance: Four pillars

Musgrave’s economic roles of governmentFinance should follow function

Musgrave’s economic roles of governmentThe role of the public sector is to:Provide a stable economic environmentPromote a more equitable distribution of

income/resourcesAssure a more efficient allocation of resources

(when markets fail)

But, no-one says that these can all be done best by the central government!

Finance should follow functionOne cannot establish the required level of

subnational government revenues independent of an estimate of expenditure needs.

If finance does not follow function it becomes difficult to effectively impose a hard budget constraint at the subnational level if there is an insufficient revenue assignment.

The economically efficient assignment of revenues requires a prior knowledge of expenditure assignment.

Revenue assignmentIntergovernmental transfers

The revenue assignment question (second pillar)Which tax sources or non-tax revenue

sources (including fee revenues) will be made available to subnational governments in order to provide them with revenue sources?

Why have sub-national taxation?Sub-national governments are often more

accountable for controlling spending if they are also responsible for revenues

Reduces excessive demand by sub-national governments for transfers from the centre

Allows tax policy (tax levels and structure) to be tailored to the conditions and preferences of sub-national governments

Features of an ‘ideal’ local revenue sourceTaxes that achieve a ‘correspondence’ between the tax

and the benefits from local government services Relatively easy to administerShould not be easy to give ‘perverse incentives’ to

taxpayers Suitable local taxes are: Property taxes; Market fees and

other local user fees; A ‘piggy-back’ personal income tax; Motor vehicle taxes

Lessons learntLocal revenues should be an important part of a

well-functioning intergovernmental fiscal system, both for economic and accountability reasons

But, raising more local revenues is only efficient if the revenues are well-spent, and

Neither central politicians nor local politicians have a strong incentive to rely heavily on local government revenues

As a result, local revenues are often an under-emphasised part of fiscal decentralisation

ReasonsDesign

Intergovernmental fiscal transfers (the third pillar)

Own source revenues are (almost) never enough to cover local expenditure responsibilities

Central (or regional) governments may provide local governments with additional resources through a system of intergovernmental fiscal transfers

In most countries, transfers are (by far) the main funding source for local government, esp. for social sector services

Reasons for intergovernmental fiscal transfers

Providing incentives for efficient spending and utilisation of the municipal revenue base

Guaranteeing sufficient funds for managing local functions by mitigating vertical imbalances

Supporting regional equalisation of communities by mitigating horizontal imbalances

DesignDetermining the distributable pool:

1. as a fixed share of national government revenues; 2. as part of the annual budget decision; 3. as a proportion of approved specific local

expenditures to be reimbursed.Distribution of the pool among subnational

governments1. Gap-filling model2. Local government respects hard budget

constraint3. Fiscal capacity based methods

Design implicationsCentralised control and the uncertainty associated

with this:Can lead to poor budgeting practicesUndermines the accountability to citizensAffects the stability and predictability in local policy

makingMakes the system more prone to political pressures

DPWG-LGD underline the need for Development Partner (DP) dialogue, analytical work and technical assistance on this issue

Lessons learntThere is a need for:Close dialogue amongst all core stakeholders in

the design workProper buy-in to the introduction of the reforms

from core stakeholders, champions of the reform and clear institutional framework

Current follow-up and support to the administration of the transfer system (particularly regarding performance-based systems)

Transparency and accountability in all phases of the work on transfer systems

ImportanceRestrictions to subnational borrowing

Finally, the fourth pillar of subnational finance: deficits and debtIn many developed economies, local

borrowing is an appropriate way for local governments to fund capital infrastructure:

(i) it corrects the inter-temporal mismatch between costs and benefits (in terms of efficiency, equity, timing and practicality)

(ii) there are numerous mechanisms that can assure responsible borrowing

Restrictions on borrowingIn many LDCs, the absence of market-based mechanisms to enforce a ‘hard budget constraint’ requires restricting local borrowing:

Rules-based restrictions Permission required Local government bank / loan fund No borrowing allowed

Lessons learnt (1)Local government borrowing should be backed

by a robust and transparent legal framework and systems and procedures for where to borrow, for which purposes, and possible ceilings and monitoring and supervision frameworks

Central governments should maintain a hard line against subnational debt relief.

Intermediate borrowing institutions need to be carefully designed to avoid pitfalls

Lessons learnt (2)Debt thresholds may be established to ensure

that local governments borrowing is not getting out of hand.

Strong incentives for local governments to ensure creditworthiness should be supported

Local governments are not in a good position to function as borrowing institutions for others

In cases where there is no formal regime in place for local government borrowing, there are examples of severe informal borrowing.

PurposePerformance based grant systems

Purpose of local PFMAt their best, these mechanisms balance political

and economic risks, by: Providing a reliable account of money spent and received.Showing evidence that finance is being used responsibly

for the public good and in compliance with regulations.Demonstrating “value for money” and good governance

in terms of economy, efficiency, effectiveness and equity.Supporting good decision-making and assisting leaders

and managers to assess the financial consequences of policy choices.

Serving as a basis for planning for the future, maximising income sources and aligning these resources with service delivery objectives.

Performance based grant systemsShift from “traditional” ex ante control on

budgetary inputs to accountability ex post on the basis of results.

In a performance-based system, there is a need to monitor the quantity and quality of outputs, and to measure the result of delivering these outputs.

A key publication in this regard is UNCDFs 2010 publication on Performance Based grant systems.

Example of PFM in the education sector

Lessons learntPFM reforms should:Be part of the overall support to fiscal

decentralisation and other components of decentralisation in a mutually strengthening manner

Focus on incentives in addition to more traditional focus on technical improvements

Apply a step-wise approach where there is focus on the basic issues, while preparing for more advanced reforms

Support the intergovernmental fiscal transfer systemUse a learning-by-doing approach whenever

appropriate

Good practices in harmonisation and alignment of support

Small group discussion

Supporting the implementation of FD in partner countries

What is the policy objective of decentralisation in my country?

What is the current status of (fiscal) decentralisation in my country?

What reforms are government and donors already pursuing to enhance decentralised local governance?

What more can be done?

Challenges and opportunities for harmonisation & alignmentSupport to FD reforms has often been

fragmented, scattered and without and overall strategy and action plan

But there are several initiatives that show great potential to improved harmonisation and alignment:Performance Based Grant Systems Joint Financing AgreementsIntegrated fiscal decentralisation

Key lessons for development partners’ support for FD reformsIn small-groups, try to come up with a list of

around 10 key lessons on support to fiscal decentralisation reforms

What are – according to you - the most promising opportunities for harmonisation and alignment within the field of fiscal decentralisation reforms?(20 min)

Assign one group member to present your findings.