Report No. 36516–MNA

Decentralization and Local Governance in MENA: A Survey of Policies, Institutions and Practices Public Disclosure Authorized A Review of Decentralization Experience in Eight Middle East & North Africa Countries

March 31, 2007

Sustainable Development Department Middle East and North Africa Region

Public Disclosure Authorized

Public Disclosure Authorized

Public Disclosure Authorized Middle East & North Africa Region World Bank

ABBREVIATIONS AND ACRONYMS

CVDB Cities and Villages Development Bank CEF Communal Equipment Fund CPSCL Fund for Loans and Support to Local Collectives EIJLMTWY Egypt, Iran, Jordan, Lebanon, Morocco, Tunisia, West Bank and Gaza and Yemen FAFO The Norwegian Social Science research Institute FCCL Local Government Common Fund GNI Gross National Investment IMF International Monetary Fund IPA Index of Public Accountability IQA Index of Quality Administration IGQ Index of Governance Quality LG Local Government LAT Local Allocation Tax LMIC Lower Middle Income Countries MNA Middle East and North Africa MNA-8 Egypt, Iran, Jordan, Lebanon, Morocco, Tunisia, West Bank and Gaza and Yemen MDG Millennium Development Goals OED Operations Evaluation Department PA Palestinian Authority PM Participations Municipals SED Social and Economic Development Group SF Studio Fiscal SDS Service Delivery Surveys SNC Sistema Nacional de Con financiación UMIC Upper Middle Income Countries WDR World Development Report

Vice President: Daniela Gressani Chief Economist: Mustapha Nabli Sector Director: Inger Andersen Sector Manager: Hedi Larbi Task Team Leader: Stephen Karam

ACKNOWLEDGMENTS

This document has benefited from the contributions of many different stakeholders, consultants and informed sources across the region and elsewhere. The Bank team was guided by Hedi Larbi, Sector Manager (MNSSD) and led by Stephen Karam (TTL). Significant contributions were made by a team comprised of Mihaly Kopanyi, Laura Vecvagare, Balakrishna Menon Parameswaran, Serdar Yilmaz, Caroline Bollini, Sameh Wahba, David Sewell, Rosanna Nitti, Francois Noisette, Nicolas Peltier, Ibrahim Dajani,and George Awwad. Peer reviewers Robert Ebel and Robert Beschel provided useful guidance to the team at various review stages. The assignment was implemented under the overall guidance of Hossein Razavi and Inger Andersen (Sector Director).

This paper draws heavily on the outputs of a number of field-based consultants who prepared country studies and/or led the service delivery survey (SDS) work in their respective country, including: Najib Maktari (Yemen), Fuad Malkawi (Jordan), Khaled Amin (Egypt), Kian Tajbaksh (Iran), Lina Abdallah (West Bank and Gaza), Mohammed Sbihi (Morocco), Ahmed Basti (Tunisia) and Mona Harb (Lebanon). The Norwegian Social Science Research Institute (FAFO), and particularly Jon Petersen and Mark Taylor, oversaw the training of SDA Country Teams, as well as implementation of the SDS in the five countries where it was carried out. FAFO analysis of the SDS data generated a rich set of findings and observations based on end-user and provider feedback, which were produced separately under a report entitled: Municipal Management & Local Governance: A Service Delivery Perspective – Giving Voice to End User Perspectives on Public Service Provision in the MNA Region.

Over the course of the two years of implementation, many government officials and government agency technical staff, too numerous to mention here, were consulted and provided valuable input and suggestions to the team in the eight countries surveyed, namely Egypt, Iran, Jordan, Lebanon, Morocco, Tunisia. West Bank & Gaza, and Yemen. Their participation in the first regional consultative workshop held in Amman in December 2004 and subsequently through bilateral communications provided important feedback and impetus to the team in focusing its second phase work geared mainly at listening to what end-users had to say about a variety of government services delivered at the local level. Throughout the assignment, Government officials at many levels supported the team by making available documentation for review and analysis, enabling field-based teams to interview and collect information from key ministry and agency staff, and provided their approval for the SDS to be implemented in five of the surveyed countries – Egypt, Iran, Morocco, West Bank & Gaza, and Yemen. In working with local city officials, mayors and technical staff, the SDS teams relied upon the support and facilitation of the city officials to complete the survey work. For this support and partnership, the team wishes to express its gratitude.

This Policy Note and the consultative workshops and numerous other activities organized under this initiative would not have been possible without the generous financial support of the Norwegian Government through the World Bank-administered Norwegian Trust Fund for Private Sector and Infrastructure.

TABLE OF CONTENTS

PAGE NO. EXECUTIVE SUMMARY ...... i

INTRODUCTION ...... 1

Decentralization and Local Governance in MNA Countries ...... 1 Decentralization and Service Delivery MNA Countries ...... 3 Study Approach and Methodology ...... 4 POLICIES, INSTITUTIONS AND PRACTICE...... 6

A. The Structure of Sub-National Government in MNA-8 Countries ...... 6 B. Intergovernmental Systems ...... 10 Administrative Decision-Making ...... 10 Intergovernmental Fiscal Relations ...... 12 Expenditure Assignments and Local Government Expenditures ...... 14 Revenue Assignments and Local Government Revenues ...... 18 Own-source Revenues ...... 21 Intergovernmental Transfers ...... 23 Local Government Borrowing ...... 26 C. Governance and Accountability ...... 28 LOOKING FORWARD ...... 34

ANNEXES ...... 38

Annex 1 – Conceptual Framework ...... 38 Annex 2 – Average Annual Exchange Rates (local currency / US$) ...... 41 Annex 3 – Local Government Data in MNA-8 ...... 42 Annex 4 – Inter-governmental Relations in Countries around the World ...... 45 Annex 5 – Governance Indicators ...... 48 BIBLIOGRAPHY ...... 50

CHARTS Chart 1: MNA Local Government Expenditures ...... iii Chart 2: Municipal Revenues (US$ capita) ...... iii Chart 3: Municipal Investment Per Capita (US$) ...... iv

FIGURES: Figure 1: Sub-national Structure in MNA-8 Countries ...... 6 Figure 2: Population Served per Local Government Employee 2002 ...... 11 Figure 3: Share of Local Government Expenditures (% of total public expenditures) ...... 17 Figure 4: Composition of Local Government Expenditures...... 18 Figure 5: Local Government Revenue Composition ...... 21 Figure 6: Transfers and Local Government Expenditures (US$ per capita) ...... 23

TABLES: Table 1: Mean Number of Tiers of Government, Mid-1990s ...... 7 Table 2: Sub-national Governments in MNA-8 Countries ...... 8 Table 3: Selection of Local Government (LG) Officials ...... 9 Table 4: Decision-making Authority over LG Administrative Issues ...... 11 Table 5: Description of Select LG Training Program in Morocco ...... 12 Table 6: Central Control over Local Financial Decisions in MNA-8 Countries ...... 13 Table 7: Formal Assignment of Local Services in MNA-8 Countries ...... 15 Table 8: Actual Assignment of Local Services in MNA-8 Countries ...... 16 Table 9: Revenue Assignments in MNA-8 Countries ...... 20 Table 10: Intergovernmental Transfers in MNA-8 Countries ...... 24 Table 11: Governance Indicators (2002) ...... 29 Table 12: Kaufman Governance Indicators (2002) ...... 30 Table 13: Illustrations of Involvement of Civil Society in MNA-8 ...... 32

BOXES Box 1: Morocco New Impetus to Decentralization and Local Government Autonomy ...... 2 Box 2: Local Governments are doing Well in Hungary ...... 14 Box 3: Own-source Revenues in Iran: A Distorted Model of Self-sufficiency ...... 22 Box 4: Arguments for Sub-national Borrowing ...... 27 Box 5: The Main Principles of Good Governance ...... 29 Box 6: Reforming Incentive Structure in Columbia ...... 30 Box 7: Results of Municipal Reforms in Brazil and the Philippines ...... 31

EXECUTIVE SUMMARY

The following provides a brief overview of the findings from a two year partnership initiative between the World Bank and eight selected Middle East and North African (MNA) countries who have jointly engaged in a review of municipal management and decentralization experience and practice in the region1. i. A Different Pattern of Decentralization. In the context of increasing global decentralization, the surveyed MNA countries demonstrated overall that they are aware of and in some respects responsive to this global trend. They have expressed this orientation through public policy pronouncements and through various state-led initiatives. In terms of concrete actions, political/electoral measures have been the most significant steps taken to date. All of the surveyed countries have carried out local elections at least once in the last several years. Yemen passed a sweeping decentralization law in early 2000, launching local council elections for the first time and devolving significant powers to local authorities; Lebanon reinitiated local elections in 1998 after a 20 year hiatus during the civil war; and local council elections were reinitiated in West Bank & Gaza in December 2004 for the first time in nearly 30 years; in Egypt, considerable authorities have been devolved to Governorates in recent years with plans for further expansion based on successful implementation. Most recently, Jordan has begun revising its Law on Municipalities in preparation for new local elections and includes within it a provision for women‘s representation on local councils. Morocco has further decentralized by devolving more responsibilities to local elected municipal councils in the context of the newly revised municipal law (charter 2002). However, the pace and underlying principles of decentralization in MNA are in some respects quite different and not always entirely clear. With few exceptions, MNA countries still feature remnants of their inherited colonial past where the sharing of power between the central and local levels of government is still heavily skewed toward the former. Indeed, power sharing in MNA for the moment may be best characterized by deconcentration of central authorities than outright delegation or devolution of powers.

Political & Administrative Issues ii. Outdated legal and regulatory frameworks. With the notable exception of Morocco a recurring pattern observed in all surveyed countries in the region is the complex and cumbersome legal and regulatory framework governing sub-national or local government sector. To give just one example, Jordan has some 43 different laws and regulatory ordinances concerning municipalities. Many of these laws contradict one another, overlap, or otherwise contribute to a confusing set of signals to principal actors at the local level with regard to organizational mandates and associated linkages between investment planning, financing, and budgeting for operations and maintenance, among other areas. Realignment of the formal and informal ―rules of the game‖ should therefore be a top priority in most of the countries reviewed. In particular, outdated laws should be revised to reflect appropriate practices and more effective enforcement put in place to bring practices in line with sound legal and regulatory provisions. This is clearly a medium term objective that would require a broad consultative process to ensure long-standing effect.

11 In this report, the countries will henceforth be referred to by the first letter of the country (E=Egypt, I=Iran, J, L, M, T, W, Y, etc.) to facilitate comparisons without needless repetition of the country names. Taken together, the sampled countries are referred to as MNA-8.

i iii. Central/local power sharing through hybrid electoral/administrative structures. Although elected local governments have been introduced at the lowest municipal or village level in all MNA-8, they take on very different forms at each level. For instance, some consist of an elected council and elected executive body (I, L, M, T), while others have an elected council and appointed executive body (E, J, Y), and in yet other countries (I, L) there are elected councils that include representatives of the central or upper government who continue to wield significant powers. An exception is WBG where both the council and the executive power were appointed by the central government (at least prior to the December 2004 elections). The central governments can also suspend and even dissolve local governments as is the case in Iran and Jordan. iv. Intermediate tier of government. In many MNA countries, the two upper tiers of sub- national governments – Governorates, Provinces, Prefectures – are de facto deconcentrated units of the central governments (except in WBG) that are led by appointed governors and either have only an appointed executive council (E, I, J) or include also an elected council, which only has a consultative function (L, M, T, Y, W). This governance structure is supplemented by a cluster of deconcentrated functional or service units at the local/regional level (agents of the line ministries or state-owned service enterprises) that constitute the backbone of the public service systems in most MNA-8 countries (E, I, J, Y). In the best cases, such agencies bring important scale efficiency gains, but as largely technocratic and centrally-directed service providers, they can also undermine the ability of local governments to respond to the needs of their constituencies in ensuring local services are provided. In addition, under these arrangements, it is hard to predict and difficult to track down where and how decisions are effectively made. Answers to such complex institutional issues cannot be adequately addressed for each country in a regional review given the broad range of different circumstances in each country, and thus it should be underscored that there is no blueprint for such reforms. It may be imprudent, for instance, to directly assign these functions to local governments, certainly in the near term. Rather, it might be more appropriate to establish a principal-agent relationship in which such entities are contracted by local governments for work within their jurisdiction and held accountable to them on a performance basis. v. Devolution of expenditure and revenue authorities must keep pace with increased political representation. As voice and political representation is increasingly granted at the local level, government policy makers will need to ensure that administrative and fiscal systems keep pace and realign accordingly, lest these initiatives fall flat due to neglect or raise expectations that cannot be met through the existing functional and administrative assignments that still significantly curtail local authorities or administrations. vi. Structural/functional versus behavioral/incentive-based responses to calls for change. Country studies revealed that sub-national reform programs in MNA-8 countries have mainly focused on organizational changes (restructuring, training, updating job descriptions), while still retaining extensive control by the central government (internal accountability). The current control mechanism and the decision making structure have resulted in a situation where the actual responsibility for the local service delivery in most cases still remains with the central government. Thus, many of the reforms so far have ignored or not taken full advantage of incentive structures or instruments (i.e. ―various rewards and penalties confronting the individuals involved in the delivery of urban services‖; Dillinger, 1994). In some cases, it could even be argued that perverse incentives have been created inadvertently.

ii Intergovernmental Fiscal Relations vii. Fiscal Decentralization Chart 1: MNA Local Government Expenditures The preceding observations are based on a review of the legal and regulatory frame-works of Chart: MNA Local Government Expenditures eight surveyed MNA countries, as well as an analysis of the Wordwide (federal) structures and assignment of EU countries Worldwide (unitary) responsibilities within the EU accession countries intergovernmental system. Eg y p t Mo r o c c o

Further evidence of the cautious WBG pace of decentralization may be Ir a n Le b a n on found in the patterns of Tu n isia intergovernmental fiscal rela- J o r d a n tions. The small share of local 0% 10 % 20% 30% 40% government expenditure in total % o f t o t a l p ub lic e xp e nd it ure s public expenditures indicates a very high level of fiscal centralization. Sub-national governments in most MNA-8 countries (except E,M,W) share less than 5 percent of total public expenditures, which is similar to the poorest Central American countries and is far below the world average of the federal countries (38 percent) or the unitary countries (22 percent). viii. Limited Local Government Expenditure Authority. One fundamental cause of the low levels of local government expenditures is the limited number of responsibilities and lack of clarity in expenditure assignment between local, intermediate and central authorities. This lack of clarity has often resulted in a significant gap between legally assigned and effectively provided local services (J,L,M,T,Y) and suggests that neither the key technical and institutional instruments nor basic incentives are in place for cost-cautious service delivery in those MNA countries surveyed. In addition, some central governments (M,L) continue to retain strong ex ante expenditure authority (in some cases for expenditure items of less than US$ 3,500). ix. Low Investment Expenditures at the Local Level. Sub-national investment expenditures in MNA surveyed countries also exhibit Chart 2: Municipal Investment Per Capita (US$) a very low share of total public investment expenditures, ranging from a 90 meager US$6 per capita in Jordan to a 80 high of approximately US$12 per capita 70 in Egypt. These investment expenditure 60 50 levels are dwarfed by those in Turkey 40 (about US$55 per capita), Hungary (just 30 under US$80 per capita) and Brazil 20 (about US$30 per capita). This reflects 10 how narrowly defined the field of - responsibilities assigned to Local Egypt Jordan Morocco Tunisia Yemen Turkey Hungary Brazil Governments in MNA-8 is today.

iii x. Revenue Assignment and Collection Low in MNA. Despite having a surprisingly long list of taxes and fees assigned to them in most MNA countries, LGs have few independent own source revenues. The rates and bases for these revenues (property tax, local fees and charges) are in most cases defined and administered by central governments. As such, over Chart 3: Municipal Revenues (US$ capita) time, many of these potentially useful fiscal Municipal revenues (US$ per capita) instruments at the local level translate into what may be 500 termed ―nuisance taxes.‖ 450 400 Lack of autonomy over 350 revenues sources provides no 300 250 incentives to local 200 governments to exploit their 150 100 revenue bases and de-links 50 taxation and spending. - Egypt Jordan Lebanon Morocco Tunisia Turkey Hungary Moreover, actual collection of the main taxes such as property tax revenue in several cases is handled by Ministries of Finance, often assessing a 10% collection fee while lacking appropriate incentives to ensure collection efficiency. xi. Weak Local Government Budgeting Capacities In a well functioning fiscal system, budgets reflect local priorities, based on forecasting and mid-term plans, and are vital tools in developing and implementing local strategies. In MNA-8 countries budgeting systems are not effective. Medium and long-term planning is an exception, not the rule. Most local budgets are annual by-products of central or regional budgets, and are tools for imposing and tightly controlling sub-national budgetary decisions. Local governments exercise limited ownership of their budgets and rarely use them as effective management tools. xii. Borrowing. While sub-national borrowing is legally possible in most MNA-8 countries subject to central government approval, central governments restrict careless borrowing via administrative controls and through state-owned lending intermediaries. Local governments in Jordan, Morocco and Tunisia are very active borrowers, albeit the state intermediaries seem to be powerless in maintaining disciplined lending policies. There are no municipal borrowings in the other five countries, mainly due to administrative constraints, central government disfavor, low local administrative capacity, and/or poor municipal creditworthiness. This reality poses a challenge in meeting local investment finance needs and underscores the fact that local governments in MNA-8 are not able to achieve intergenerational equity in the financing of investments that will serve communities well beyond the period of construction and delivery of infrastructure. xiii. Intergovernmental Fiscal Transfers. MNA countries have long been using intergovernmental transfers. However, hardly any of these systems meet the generally accepted performance criteria. With the exception of Morocco, the transfer pools are rather unstable, non- predictable, and not buoyant, i.e. several depend on volatile oil or customs revenues. Moreover, the transfer pool and distribution of transfer revenues are not transparent or rule-based and often depend on annual decisions of the central governments. There is also anecdotal evidence of extensive bargaining, political motivations behind fund allocation and ex-post gap filling and bailing out of local governments. This resulting environment of perverse incentives and soft budget constraints tends to encourage local governments to understate their own revenues,

iv increase commitments and some time purposefully run deficits, with the expectation of central government bailouts or debt write-off. xiv. Fiscal Instruments to Combat Poverty Not Exploited. Equalization transfers, or allocations from central to local governments based on specified criteria of need are nearly absent altogether in the MNA region. Such instruments are often used to address imbalances across local governments in terms of local tax base, access to services, unemployment, and poverty incidence. Similarly, at the local level, there is very little evidence that local governments have the latitude, the strategies or the intent to specifically target poverty through their investment planning. Reliance on central government social funds and other social safety net mechanisms and programs tend to dominate as a means of addressing poverty. xv. Weak Intergovernmental Data Systems & Policy Analysis. Policy instruments such as the equalization grants noted above or performance-based block grants are dependent on reliable, comprehensive, and well maintained databases that provide information necessary to inform decision-making. Such efforts could improve targeting of assistance where there is a strong socio-economic rationale to do so or could promote improved local government performance through rules-based performance grants. In many of the countries surveyed, however, data was found to be outdated, not routinely collected and analyzed, not used for the purposes of informing policy decisions, or absent altogether. Generally speaking, central governments lack effective and well-maintained data on municipal finances, including in many cases information on local budget execution and service delivery performance, despite a high degree of oversight authority and control. Very little reliable data exists for instance to measure disparities between urban and rural communities and across various social groups in both service quality and quantity, nor is there evidence of effective feed back from citizens or local governments. The findings of the country studies indicated that for the most part centrally controlled fiscal systems tend to increase rather than decrease these disparities. Greater emphasis is therefore needed in regularly updating these data systems, ensuring appropriate data is captured and analyzed and then fed into policy formulation processes.

Governance and Accountability xvi. A system of checks and balances as the key driver of reforms. In a broad sense, public governance is defined as the mechanisms of exercising authority in the name of the citizens – who has influence? who decides? and to what extent are key values such as inclusiveness, accountability and transparency followed? Different public governance indicators indicate that there is a significant gap between MNA-8 and comparative countries worldwide with respect to public accountability. While MNA-8 performs somewhat better in terms of quality of administration, it is still below the average level in the region and that of low and middle income countries. However, MNA-8 countries with higher local government involvement (M,T,W) have consistently higher governance indices. xvii. Need to strengthen central government oversight and regulatory capacity. Governance and accountability are results of political, administrative and fiscal choices made by the central governments in any country. The unbalanced approach to local government reforms in MNA-8 countries has resulted in a situation where local governments have very little if any accountability for their decisions not only towards their constituents, but even towards the central governments. The mere lack of clarity in the division of responsibilities among the different levels of governments essentially means that there is no clear responsibility for which local government shall be held accountable.

v xviii. Incentives for good performance are further weakened by central government role in local government employment decisions. The appointment of local chief executives (i.e. mayors, council heads, directors) by and the implied reporting to the central government (E,I,J,W,Y) creates a disconnect between the elected local councils and their executives. The same is true of other LG employees (technicians) that are also often hired, promoted and fired by the central government (E,I,L,Y). As a result, the usual incentives for good individual performance are significantly weakened. Civil service hiring is also often dominated by personal connections and public employment imperatives leading to little correlation between performance and promotion (or demotion). xix. Need for increased public disclosure of information, particularly budgets. Two important pillars of external accountability are knowledge of and free access to information by citizens. There have been attempts to move towards more open public debate (I,J,L,M) and greater involvement of communities in decision making (E,L,W) in MNA-8. However, disclosure of and access to information is still very limited when compared with other countries irrespective of income levels. None of the country studies for MNA-8 identified existence of a clear legal framework for disclosure of information by local governments. Some local governments have voluntarily launched different forms of communication with their constituents although in an ad hoc and discretionary manner (I,J,E,L,W). As a result, citizens do not know when their local governments perform inadequately, and similarly do not know when they perform well either. This undermines the basis for exercising voice and judgment on performance when elections take place. xx. Opportunities for increasing local government autonomy. There is convincing evidence that local governments are willing and would be able to benefit from greater autonomy in decision-making powers and further devolution of authorities in MNA-8 countries. In turn, local governments could become less of a burden on the central budget and more effective in delivering services. For instance, local governments in larger Iranian cities and elsewhere demonstrate an ability to collect significant own-source revenues. Several new Egyptian towns that are exempted from the close central control and are led by elected councils and boards of trustees appear to be managed very well within the existing legal framework. In WBG, local governments predate the Palestinian Authority and have functioned effectively even in the absence of the significant donor aid flows that prevail today. xxi. Going Forward. Despite the noted shortcomings of the intergovernmental systems in the MNA countries surveyed, signs are encouraging that there is movement in the right direction. In addition to the increasing openness to electoral mechanisms demonstrated in recent years, steps are gradually being taken to deconcentrate if not to fully devolve powers to local governments. In Yemen, in the context of the 2000 Local Authorities Law and the principles of decentralization that it laid out, physical planning and authority to approve new private sector investments have been delegated to the local level on a pilot basis. In Jordan, the Greater Amman Municipality has had property tax collection devolved to it in 2003 by the Ministry of Finance and revenues have been steadily increasing ever since. In Morocco, a decentralization process that began with promulgation of the Communal Charter of 1976, which was substantially amended in 2002, has facilitated transfer of greater responsibilities for municipal resource mobilization to mayors and elected municipal councils, along with the authority to set tax rates as needed. MNA regional countries are also looking to models elsewhere that bear some resemblance to their challenges and may pose options for advancing their decentralization agendas. One model that appears to be of particular interest is that of Turkey, which represents an incremental approach to granting greater authorities to localities, while featuring many of the same structural elements that dominate the region today dating back to its Ottoman patrimony.

vi INTRODUCTION

1. Entering the 21st Century, the 1999-2000 World Development Report (WDR), identifies two main forces that are shaping the world in which development policy is being defined and implemented: (i) globalization—the increasing worldwide integration of private sector interaction and commercial relationships—and (ii) localization–a process of devolving fiscal and administrative roles and responsibilities from central to sub-national tiers of government. It goes on to note that these global-private and local-public pressures are not only reinforcing, but also challenging traditional paradigms and forms of intergovernmental systems (World Bank, pp 31- 32). A major driver of this trend toward devolution of power and resources both geographically and institutionally—alternately called decentralization—is the recognition that well-designed intergovernmental systems are critical for the accomplishment of a nation‘s broader objectives of growth, stability and the provision of pro-poor services at the local level, which figure prominently as Millennium Development Goal targets. Indeed, as the WDR-2004 notes, growth and stability alone are not enough -- services matter too.

2. Political decentralization, often associated with pluralistic politics and representative government, aims to give citizens more say in public policy and decision-making. Its advocates assume that decisions made with greater participation will be better informed and more relevant to diverse interests in society than those made only by national political authorities. The concept implies that the selection of representatives from local electoral jurisdictions allows citizens to know better their political representatives and allows elected officials to know better the needs and desires of their constituents. Administrative decentralization aims to redistribute authority, responsibility and financial resources for providing public services among different levels of government. It typically takes three forms: deconcentration, delegation and devolution. Fiscal decentralization vests greater autonomy and authority with local governments in matters of fiscal importance, empowering local governments to generate their own revenues—through taxes and user charges—as well as determining their expenditure priorities based on a clear assignment of functions and responsibilities. Over the last two decades, it has been estimated that more than 100 countries, most of them in the developing world, have experimented with various forms of decentralization.

Decentralization and Local Governance in MNA Countries

3. In line with such worldwide trends, many Middle East and North African (MNA) countries have initiated a process of re-examining power sharing relationships between the central and local governments, and in several instances elements of decentralization are beginning to take root, albeit at a varying pace in each country. Evidence of this process now underway in MNA countries may be understood by following regional and local discussions and debates on the topic (e.g., see the October 2002 Proceedings of the Mediterranean Development Forum, Amman at www.decentralization.org). The reasons for this are often rooted in the political economy of the individual countries. Some analysts have attributed this drive to the growing pressure of democratization. Others attribute it to mounting budgetary deficits that have forced some countries to reduce their public expenditures at the central level and shift the burden of providing public services to local authorities. Another reason cited is the push to concentrate power and resources in major cities instead of promoting ―regional‖ or ―equitable‖ development. In that context, decentralization offers these countries the opportunity to channel resources and efforts in specific locations that serve their vision of development. In the MNA region, decentralization is an early work in progress whose prospects remain ambiguous, at the best, in the short term, but whose future course is almost irrevocable in the long term.

1 Box 1: Morocco: New Impetus to Decentralization and Local Government Autonomy

While decentralization initiatives were launched quite some time ago in Morocco, more recently the Government decided to provide a fresh impetus to its decentralization program by granting greater local autonomy in decision-making.

In 2002, the Government revised the fiscal responsibility of local governments to revive their ability to promote local economic development. The revision of the ―Charte communale,‖ reflected the Government‘s decentralization objective and filled the gap of previous decentralization laws by clarifying the organizational structure of local governments. Adopted by Parliament in August 2002, and enacted soon after, the ―Charte‖ significantly develops and modernizes the role and responsibilities of the communes. It consolidates democracy at the community level, reinforces municipal autonomy through improved status of elected officials, rationalizes the functioning of municipal council, streamlines the administrative and financial processes, and strengthens the role of communes in the management of basic municipal services enabling them to better respond the higher expectations of a fast growing population.

In line with the country‘s traditions of citizen participation in public life, the Charte Communale expressly awards the Municipal Council the powers to promote the creation of district associations on urban issues or stimulating and sustaining the organization of social, cultural and sports associations. The charter also establishes a list of municipal competences in the following order: economic and social development, finances, tax issues and municipal goods, urbanism and territorial organization, local public services and collective equipment, environment and waste management, equipment and socio- cultural action, co-operation and association with local actors. Key to the new decentralization policy is the transfer of greater authority to set tax rates and the fundamental shift away from the almost systematic a priory controls to deconcentrated a posteriori reviews corroborated by regular audit of the newly established Cours Régionales des Comptes.

4. Indeed, the World Bank has been approached by many MNA countries to assist them in their emerging decentralization programs. Until now much of the Bank‘s work in this field has been country specific and piecemeal, mostly examining a particular aspect of decentralization or service provision often within the context of a specific service sector. This approach lacked both, a broad regional overview that lent some useful cross-country comparisons, and a strategic orientation that is critical to take a longer term temporal view. This study is the starting point for filling the gap in both areas.

5. Building on its existing country knowledge, and in close partnership with the countries in the region, in 2004 the Bank launched an initiative to review decentralization and municipal management experiences in the region. A desk study review was carried out and provided the conceptual underpinnings and key questions that would frame the research project. A key finding of this work is that a major knowledge gap exists with respect to understanding how decentralized governance can be linked to the service delivery concerns that matter critically to development outcomes (i.e. access to water, electricity, sewage, solid waste management and other urban services). Addressing this knowledge gap is critical to strengthen downward accountability, improve service delivery and strengthen pro-poor outcomes as embodied in the MDGs. There is also evidence that poorly designed and executed decentralization policies can lead to deterioration of services, collapse of social safety nets, and grave fiscal and financial crises. The necessary steps in identifying the most optimal policy options on this issue framed this inquiry.

2 Decentralization and Service Delivery in MNA Countries

6. Across countries, decentralization has increased subnational government participation in the provision and financing of urban roads, water, sewerage and solid waste management systems, transit, and education, as well as other public infrastructure. In principle, there are many advantages to local service provision: (i) sub-national governments are in a better position to identify local preferences for infrastructure technology or service quality; accountability is enhanced with local decision-making; and voters have more information on the price and quality of services, thereby increasing competition in the sector. Theoretically, decentralization can also improve equity in the distribution of services as smaller governments away from the political center gain more latitude and funding to serve their constituents.2 In practice though, the record is much more mixed. Decentralization itself does not guarantee improvements in service delivery; rather a complex set of issues that include institutional design factors and incentives facing decision-makers, which in turn depend on the financial, institutional, and political environments in which decentralization occurs, determine the quality of urban service delivery.

7. In MNA, decentralization trends in urban service delivery are muted. With some exceptions, in most MNA-8 countries, central government entities dominate service delivery although recent trends show greater promise of decentralization, mostly in the form of deconcentration.

8. Through a parallel initiative, a Service Delivery Survey (SDS)3 was carried out in five MNA countries with the aim of examining the extent to which the formal government structures and behavioral systems in the MNA-8 countries determine service delivery outcomes. The SDS diagnostic surveyed end-users for their perception of the quality and coverage of services, improvements that they have noted, and the deficiencies that still exist. Second, it gauged their understanding of the service delivery mechanism, i.e. whether the users feel private sector providers, local governments, central government agencies or other providers are the preferred provider; if so, why; and whether there are general principles that can be derived from the user feedback. Third, it also considered the costs of service provision under alternative arrangements, efficiency gains and inherent subsidies or losses that could be potentially averted under alternative institutional arrangements. The SDS study complements the institutional and policy review presented here, and together they provide a more complete basis for understanding the relation between decentralization, local governance and service delivery in MNA-8 countries.

9. Certain central themes and concerns cutting across different services and countries emerge from these discussions. For most part, these are not very different from views expressed by urban service users in many other parts of the world. At the same time, there are also themes and issues that are unique to MNA as well as those service-specific and country-specific. Viewed in composite, these views present a snapshot of the service sector in the region.

. Local governments matter, at least to the citizens: Despite limited decentralization, local governments are still seen, directly or indirectly, by citizens as the principal interlocutors when it comes to service delivery. This is important because it suggests that a mayor or a local government chief executive—who has less stature and power than a provincial

2 http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTPUBLICSECTORANDGOVERNANCE /EXTDSRE/0,,contentMDK:20246058~menuPK:2086246~pagePK:210058~piPK:210062~theSitePK:3902 43,00.html#3 3 See Municipal Management & Local Governance: A Service Delivery Perspective – Giving Voice to End-User Perspectives on Public Service Provision, World Bank, March 31, 2007.

3 governor or intermediate tier government official—is still credible and seen as an important interlocutor of local needs.

. Public feedback is limited: Mechanisms to hold providers accountable and systems for public information dissemination are still embryonic. There is clearly a greater appetite for such systems. Advances in e-government, along with more traditional avenues and systems of public information dissemination and citizen participation, provide new opportunities for strengthening the role of end users in service delivery.

. Institutional issues are at the heart of service delivery problems: Service provision is greatly constrained by lack of technical and managerial capacities within agencies and poor inter-agency coordination. Further, lack of effective coordination between various levels of government and different agencies is a serious impediment to efficient service delivery.

. Citizens support incremental reforms: Despite viewing service delivery systems as flawed in general end users in MNA prefer incremental changes to improve the system over wholesale and drastic changes. This may signal that the users are selective about the changes they would like to see introduced, or that the users don‘t expect radical changes given the political economy environment of their respective countries.

. Response to privatization is mixed and guarded: Appreciation for the efficiency and customer responsiveness that comes with private provision is balanced with concerns of job redundancies and tariff hikes. Interestingly, where private provision has been successful there appears a higher degree of interest in privatization.

. Price is a key concern for a large number of users: While the consumers of services are price conscious, there is willingness to pay more for better quality services. Concerns about also price are reflected in concerns about ―inflated‖ bills and uneven enforcement.

. High levels of coverage mask lower standards of availability and reliability: There appears to be a significant gap between access to services via network connection and receiving reliable services. This is particularly true for services like water supply. It also highlighted the need for setting service standards.

. Periodic maintenance and expansion of services are hampered: Service providers are strapped of revenues to expand services or undertake timely maintenance. Additionally, long-term planning and investment prioritization is lacking in most service delivery entities, and this is hindering capacity expansions as well as routine maintenance works.

. Irresponsible consumer behavior contributes to service problems: This includes free rider problems, illegal connections, vandalism and lack of awareness. Yet, when attempts are made to set out rules and enforce them, they generally prove to be quite effective.

Study Approach and Methodology

10. Policy and Institutional Analysis. Eight MNA countries out of a total of eleven were selected for an intensive stocktaking at the country level with the aim of constructing a broad overview of the policies, practices, and institutional arrangements characterizing the intergovernmental system in each of the selected countries. Particular attention was paid to trends in terms of system design or outcomes that may reveal the thinking of policy makers and their

4 priorities, and impact, where it could be discerned in the way services are provided at the local level, particularly with respect to the poor and their inclusion as stakeholders and beneficiaries of system design and intended outcomes. Surveys were implemented in all eight MNA countries, including review of key legal framework documents, interviews with informed sources, and data collection from government agencies. Country surveys were transformed into a country profile for the local government sector in each country, including a broad overview of the key sector issues.

11. The analysis took on a dual but complementary approach. While traditional emphasis was placed on examining structural/functional issues, i.e. organizational set-up, budgetary issues, resource adequacy and functional assignments among different service provider entities, etc., attention was also given to examining the formal and informal rules, policies and behavioral issues embedded in the intergovernmental systems, i.e. incentives and performance factors, that are often overlooked when examining such systems. Not unexpectedly, informal rules and practices of key stakeholders emerged as a key theme in this analysis as is further elaborated in this report, presenting a complex but not incomprehensible picture as to the many different factors that impact on service delivery. Whereas the main unit of analysis is sub-national government (e.g., municipalities, jurisdictions in which service delivery ultimately occurs) the initiative recognizes that to understand the nature and options for service delivery improvements, consideration must also be given to the central government‘s role as policy maker and sometimes as competing provider, as well as to the private sector.

12. This study reviews decentralization policies, institutions and practices across eight countries in the Middle East and North Africa Region (MNA) – Egypt, Iran, Jordan, Lebanon, Morocco, Tunisia, West Bank and Gaza (WBG), and Yemen4 – and attempts to place the region in the context of global experience. Key themes that have been examined in this study include (i) the status, evolution and key features of intergovernmental systems in selected MNA countries, including governance provisions, administrative structures and institutional arrangements in view of the need to strengthen the enabling environment for quality service delivery. Particular areas of focus included: assignment of expenditure functions and revenue authorities, features of intergovernmental transfer systems, local budgeting and public financial management, and mechanisms for planning long-term infrastructure improvements: (ii) private-public service delivery partnerships, actual and potential; and (iii) the match, if any, between levels of service delivery and local finance.

4 In this report, the countries will henceforth be referred to by the first letter of the country (E=Egypt, I=Iran, J, L, M, T, W, Y, etc.) to facilitate comparisons without needless repetition of the country names. Taken together, the sampled countries are referred to as MNA-8.

5 13. POLICIES, INSTITUTIONS AND PRACTICE

A. The Structure of Sub-National Government in MNA-8 Countries

14. In the past decade, the MNA-8 countries have taken noteworthy steps in modernizing their intergovernmental systems through a range of administrative and political reforms. For instance, local government elections have been held in all eight of the MNA-8 countries over the past six years, involving, in some cases, reinstating local elections that had been suspended for decades. In Lebanon and West Bank & Gaza, for example, local council elections have been restored after decades of postponement due to war and conflict. In others the initial steps toward a more decentralized system of government are now being taken, as is the case in Yemen, which recently promulgated a Local Authorities Law (2000). However, the mere existence of elected local governments does not mean that significant powers have been devolved from the central to local levels. Indeed for many of the surveyed countries, a complex and layered institutional and legal/regulatory environment creates an often contradictory and confused picture as to where responsibility for local services ultimately lies.

Figure 1: Sub-national Structure in MNA-8 Countries

Central Government

Intermediate governments Governor + Appointed executive council

Appointed Appointed Elected Executive Mayor Functional deconcentrated units deconcentrated Functional Elected ElectedCouncil Elected Council agencies of ministries + state service firms service + state of ministries agencies Council Council

15. Perhaps due to their common colonial legacy, several of the MNA-8 countries have similar intergovernmental systems and regulatory structures. For the most part, they are unitary countries with a highly hierarchic, intergovernmental system involving three-tiers of government—central, intermediate and local. A unique regional feature in most MNA-8 countries (E,I,J,L,Y) is that, in addition to their sub-national government system, there is a set of powerful and fairly independent networks of deconcentrated5 functional units—line ministry agencies or state-owned public service enterprises (Figure 1) that operate in parallel to local governments (LGs), which in some instances tend to marginalize or undermine the roles and responsibilities of LGs as service providers.

5 See Annex 1.

6 16. The local government (LG)6 tier is comprised of city, municipality, village, and/or district governments that are led either by elected (L,M,T,I) or appointed officials (E,J,W,Y). Most, however, have a dual-structured system. In two countries (E,L), local governments are comprised of an elected popular council which performs mainly an advisory role and an appointed executive council with effective executive power over the jurisdiction. In terms of the number of tiers of the intergovernmental system, the MNA average is roughly within the mean, in comparison to other regions. (See Table 1 below)

Table 1: Mean Number of Tiers of Government, Mid-1990s

SS Africa Asia Latin MNA E Europe & W Europe & America Former N America Soviet Union

Mean 4.1 3.7 3.3 3.5 3.3 3.6

Source: Treisman, 2002; data compiled by author from more than 200 sources. N = 154.

6 For the purpose of this note ―local government‖ is defined as a sub-national government unit that can be characterized by the parameters of ―delegation‖ and/or ―devolution‖ degrees of decentralization (see Annex 1) and meets at least two of the following three criteria: (a) LG council is elected through direct popular elections, (b) LG council has some independent sources of revenue and (c) LG has full discretion in provision of at least some of the local services.

7 Table 2: Sub-national Governments in MNA-8 Countries

Country Intermediate Tier Governments Local Governments Egypt 26 Governorates + City of Luxor 200 Cities 66 Sub-governorates (Markaz) 55 Districts 4,615 Villages Iran 28 Province (Ostan) 889 Cities (Shahr) 299 Sub-province (Shahrestan) 2,305 Rural agglomeration (Dehestan) and 794 Rural county (Bakhsh) 36,000 rural local councils Jordan 12 Governorates 99 Municipalities 20 Subgovernorates Amman municipality (Capital) 20 Liwa 36 Qada 52 Nahia Lebanon 6 Regions (Muhafazat) 745 Municipalities 26 subregions (Qada) Morocco 16 Regions 1,547 Municipalities 65 Prefectures 140 Urban 14 Communities Tunisia 23 Regions 257 Municipalities + (Cities/towns)

Yemen 21 Governorates 312 Municipalities (Districts) WBG 16 Governorates 121 Municipalities 251 Village councils 127 Project or village committees Examples of Sub-national Structures Worldwide

Industrial

Canada 32.8 10 provinces & 2 4507 municipalities territories France 70 22 regions & 96 36772 communes departments USA 295.7 50 states & FDC 39,000 counties & 44,000 special purpose districts Italy 58 22 regions & 93 8100 municipalities provinces Japan 127.4 47 prefectures 655 cities & 2586 towns Source: Country Studies

8 17. The central government maintains a presence in local affairs through a variety of means, including: (i) appointed chief executives (mayors / heads of councils / Governors in E, J and Y), or appointed councils (partially in J); (ii) a bicameral system with an appointed and an elected local council (in E); and/or (iii) tight control of the elected local councils and mayors by governors (in J, L, T). Some countries (E, M, T) have also introduced directly or indirectly elected councils at the regional level as well. (Table 2).

Table 3: Selection of Local Government (LG) Officials

LG Council Right to Recall Elected LG LG Executive Country Members Representatives Officer Egypt Direct elections C C Iran Direct elections C Elected by council / C c Jordan Direct elections / C a,b C C Lebanon Direct elections Elected by council d Morocco Direct elections C Elected by council Tunisia Direct elections C Elected by council e West Bank and Gaza Direct elections N/A Elected by council Yemen Direct elections C C f a C – central government. b ½ of council members are elected and ½ are appointed by the central government. c In cities >100,000 – elected, in cities <100,000 – appointed by the central government. d Except Beirut where 16 council members are elected and 8 are appointed by the central government. e Except Tunis, where the President of the commune is appointed by the central government. f Although, the law gives the local council the right to withdraw confidence to the appointed chief executive (Governor and Director). Source: Country Studies.

18. The situation in WBG and Iran warrant special mention. In WBG, the role of the central government at the local level is rather nominal despite the fact that both council members and executive officers have until very recently been appointed by the Ministry of Local Government. Most Palestinian municipalities and village councils have been in operation for quite some time— in some cases dating as far back as the 19th century (when the areas were under Ottoman rule), and in most other cases well before the creation of the Palestinian Authority (PA--which was established in 1994 after the signing of the Oslo Accords). From the very point of their creation, newly established central ministries were placed in a position of trying to define their roles and authority relative to the pre-existing local bodies, other traditional providers of public services such as NGOs and donors that frequently interacted directly with local governments and NGOs. Today, following a major PA reform effort launched in December 2004, most local councils are elected by direct popular vote.7

19. In Iran, LGs are defined by law as ―non-governmental organizations.‖ They have a limited and somewhat outsider role vis-à-vis the deconcentrated government agencies that operate at the local and regional levels. At the same time, Iranian LGs have elected mayors and local councils—in fact, local elections are considered to be the freest in the country where candidature is not subject to scrutiny by higher level bodies. Iranian LGs also deliver some key local services as well as raise significant amounts of local resources.

7 On PA relations with local governments, see World Bank (2000). On PA relations with NGO service providers see SED Group (1999).

9 20. The intermediate tier of government typically includes regions (e.g. governorate or province) and sub-regions (e.g. markaz, quada, liwa, nahia, county or prefecture). These intermediate governments often take the form of regional deconcentrated units of the central government. Their leadership and staff are employed by central government ministries. In some cases, such as Egypt and Yemen, the governorates are budget holders and have specific public service functions. In others, such as Jordan and West Bank/Gaza, governorates have a much more limited role, confined mainly to security and public order functions, as well as, at times, having a coordination function as the seat of the local deconcentrated unit representative. In the former instance, a Governor (or prefect, director) with the support of an appointed executive council, leads the regional government and maintains strong executive power over lower tiers of government under his/her jurisdiction.

21. Sector regulatory oversight, monitoring, supervision and fiscal fund allocation functions are in most instances carried out by the regional offices or representatives of the line ministries. In almost all MNA-8 countries, most local services are provided by state-owned service enterprises that function like the extended arms of ministries. These agencies typically bypass intermediate and local governments (Figure 1). To illustrate the point, it is worth mentioning that there are about 160 deconcentrated units and branch offices in Egypt, 30 in Iran, 14 in Jordan, and 32 in Yemen.

22. Central government involvement at the local level and the existence of large public service enterprises are not unique to MNA-8 countries. There are traditionally central government representatives in the sub-national governments in other developed and transition countries (for example, France and Romania). In such countries, however, the sub-national layers of governments are primarily responsible for public services and enjoy wide ranging degrees of autonomy. The public service networks can be in the hands of central governments, but the local delivery systems are typically owned directly by the sub-national governments who contract out or concession service provision to large national or multinational private service providers. What is worth noting, though, is that sub-national governments in other regions exercise strong regulatory, monitoring, and control functions, often in cooperation with national agencies.

23. The MNA-8 country studies also show that there are no rule-based coordination mechanisms between parallel functional networks as well as across ministries. The coordination between the regional and functional deconcentrated units (i.e. regional representatives of line ministries) is mostly delegated to regions, governorates or equivalent. However, intermediate and local governments do not have a transparent and equitable relationship with the functional service organizations. Local governments generally exercise no regulatory, monitoring, or control functions vis-à-vis these large service provider entities, who are often reluctant to share even minimum information about their local plans and/or operations.

B. Intergovernmental Systems

Administrative Decision-Making

24. Information on the administrative division of tasks and responsibilities between central and local governments is rather fragmented and incomplete. However, available information suggests that the central government retains a rather significant role in LG human resource management. In a number of countries (E, J, and partially in I, M, T and Y), key personnel decisions such as hiring, promotion and dismissal of municipal employees, as well as their compensation systems come under the purview of the central government. Similarly, restrictions are placed on joint activities among LGs and on partnerships with the private sector (J, M, W).

10 Many of these rules are outdated, but remain on the books and constitute formal rules of engagement. Yet, at least in some countries their rigidity and obsoleteness has given way to greater practical autonomy and authority for the LGs with regard to critical aspects of administrative decision making and local level human resources management issues.

Table 4: Decision-making Authority over LG Administrative Issues

E I J L M T W Y Hiring/firing LG employees C a L/C C L,C L,C L C,L Approval of LG salary structure C C C C L C Approval of the LG bylaws C L/C C C Approval of LG partnerships L C C L,C d C C,L

Approval of individual L expenditure items and/or local C L,C b L,C c L,C e L,C C,L f C procurement decisions a C – primary responsibility and decision making lies with the central government, L – primary responsibility and decision making lies with the local governments. b Expenditures above JOD5,000 (US$ 7,052) require approval by relevant department of the central government. c LGs are required to obtain central government‘s approval for transactions above US$ 3,317 – 49,751 depending on the type of transaction. d The Prime Minister can decide to adjoin communes to a partnership. e Approval by central authority needed for acquisitions or sales of municipal owned land (domaine privé). f In Gaza central government approval is required for all procurement decisions, while in West Bank it is not. Source: Country Studies, World Bank

Human Resource Capacities in Local Governments

Figure 2: Population Served per Local Government Employee 2002

Source: Gouda (2003), Malkawi (2003), Atallah and Harb (2003), Sbihi (2003), Basti (2003), Jabr (2003), Al-akwa‘a (2003), Al-Sabry (2003), SIMA (population data).

11 25. Local governments are a significant employer in MNA-8 countries, and the number of local government employees has been steadily rising over the years. For example, in Morocco the number of municipal employees has increased steadily—from less than 30,000 in 1977 to 118,792 in 2000—although their share has remained at 26-27 percent of total state employees. Similarly, in Jordan, the number of local government employees went up by 30 percent from 2001 to 2002. Trends in other countries are not very different. Only in Lebanon, where the central government has put a freeze on local government hiring in recent years due to its budgetary difficulties, has there been an alternative to this trend. Moreover, in countries such as Egypt and Yemen, the number of persons served per local government employee is very low, at 21 and 48 persons per local government employee respectively. Yet, the quality of service delivery by local governments does not reflect this. This pattern reflects a fundamental disconnect between local government hiring and the provision of services. It is worth noting that hiring decisions in most cases are being made at the central level while the burden for covering the recurrent costs is borne by local governments.

26. Local administrative and management capacities are limited in MNA-8 countries. In most MNA-8 countries, incentives for improving performance and opportunities for promotion are limited for municipal employees. In recent years training of municipal employees has gained greater attention. For example, in Morocco, during recent years several education centers have been established for training municipal employees. In addition, there are also workshops, seminars and in-service training programs on different aspects of local development and administration. In Lebanese municipalities, several training programs have been initiated for the staff, as outlined in the Table below. Yet, the results vary widely. Whereas, in 2001, 64 percent of Lebanese municipalities had some of their employees attend training at the Centre for Legislative Development, only about 1 percent of all municipal employees receive training each year in Morocco. In Iran, training for local councils and municipal staff is undertaken by separate central government entities. In Iran‘s case, while training opportunities are generally available, there are questions about its contents and overall effectiveness. In fact, in many MNA-8 countries, existing training programs are not judged sufficient to address municipal needs.

Table 5: Description of Select LG Training Programs in Morocco

Organization Program Focus Centre for Legislative Financial and administrative issues. Development (CLD) UNDP, Council for Participatory tools and methodologies, including legislative and Development and participatory components and project design and Reconstruction, local NGOs implementation. International Development To support local planning and local development strategies Center (IDC) focusing on institutional strengthening, community participation tools and team building. Development and Municipality Studies, workshops and seminars. Study Center (DMSC) Source: Atallah and Harb (2003).

Intergovernmental Fiscal Relations

27. Fiscal decentralization in most MNA-8 countries is still a rather incomplete process. Country studies suggest that the MNA-8 countries have a basic, albeit incomplete and often ambiguous, legal framework governing intergovernmental fiscal relations. Many countries have recently made noticeable steps in modernizing their fiscal framework and gradually

12 deconcentrated, delegated, and to much lesser extent devolved8 financial decision-making and service provision to the lower tier governments.

28. At the same time, there are inconsistencies and gaps in the legal and institutional framework that hamper the further development of a sound subnational government system. In many parts of the world, decentralized revenue-expenditure assignments embody effective devolution—with broad decision-making authority—of certain functions to lower levels of government. In MNA-8 countries, however, central governments still exercise significant control in supervising local governments and providing local services. This is manifest in the micromanagement of local budgeting, in the deconcentration rather than devolution of services, and the limited local government control over their own-source revenues.

29. A sound intergovernmental fiscal system should, in principle, encourage local governments to evaluate the costs and benefits of their actions. This, in turn, should lead to more efficient decisions. The current structure of revenue and expenditure assignments and service delivery arrangements in most MNA-8 countries suggests that neither the key technical and institutional instruments, nor the right kind of incentives are in place for efficient, cost-effective and demand-responsive urban service delivery.

Table 6: Central Control over Local Financial Decisions in MNA-8 Countries

E I J L M T W Y Approval of LG budget C a L/C C C C C C C Approval of individual L, C C, L L,C L,C L,C L L,C expenditure items b c d Setting rates and basis for local C L C C, L C,L C C C fees and taxes Collection/administration of local C, L L C, L C, L C,L C C, L C, L fees and taxes Approval of LG borrowing C, L C C C L C C a C – central government, L – local government. b Expenditures above JOD5,000 (US$ 7,052) require approval by the regional office of the MMRAE and those above JOD100,000 (US$ 141,043) require the Minister‘s approval. c Approval by some level of central government is required for expenditures above $3,317 – $49,751 depending on the type of transaction. d Approval by central government required for acquisitions or sales of municipal owned land (domaine privé).

Source: Country Studies

30. However, anecdotal experience in the region, although limited, indicates that LGs are willing to manage local affairs and services successfully. A project undertaken by the Government of Lebanon, in cooperation with the World Bank, where LGs were made responsible for planning and implementation of investment projects, demonstrated that these LGs were willing and able to undertake large investment projects once they were presented with such an opportunity and provided with the required resources. Similar examples of greater local autonomy and improved local performance have been demonstrated in Egypt. In Iran, municipal governments in larger cities are assuming an increasingly prominent role, sometimes even outside the ambit of the law, in managing local affairs.

8 For definitions see Annex 1.

13 Box 2: Local Governments are doing Well in Hungary Overnight decentralization. The Local Government Act (1990) stipulates that local governments are responsible for all local services (free to decide how and by whom). They receive a share of personal income tax, can collect local taxes, set fees and charges freely within general national rules. Finally, all the assets respective to local services have been transferred from state to local ownership. Permanent modernization. Detailed legislation has subsequently replaced the initial simple rules. The central government still collects the bulk of the taxes and distributes unconditional shared taxes, and supports national policy objectives by earmarking current subsidies and addressed and targeted investment grants. The annual national budget act and the tax law provide rule-based control over fiscal spending. Remarkable results. The local governments implement about 40% of the total public investments (e.g. increased access to piped water from 70% of households to 99% in 4 years). Privatized but regulate and control all local electric and gas supply systems. A significant share of water, sewage, heating, and solid waste services is provided in public-private partnership. Local governments refurbished hundreds of schools, health and recreation facilities. As a reaction to ambitious spending and careless borrowing debt ceiling rules and a municipal bankruptcy code were introduced in 1996, since then 9 court and 80 out-of- court agreements protected insolvent municipalities, but no central bail-out was ever necessary. Source: (Kopanyi et al 2000).

31. Some of the MNA-8 countries have recently initiated programs for further fiscal decentralization. In Egypt, for example, the Law 145 allows local authorities in consultation with local communities, to plan and implement infrastructure and social development projects. The Government of Yemen is now implementing a major decentralization initiative set out in the Local Authority Law of 2000. The first step in this process was the launching of local elections in 2001. Presently in its initial stages of implementation, the spending provisions of the Law envisage greater decentralization at the regional level – 20 percent of the national budget expenditures are to be carried out by the governorates and districts in 2002. However, in contrast, the recent Tax Amalgamation Law (2003) of Iran has recentralized several of the tax assignments and administration back to the central government.

32. Local budgeting and financial management. Line-item budgeting is the predominant practice in MNA-8 countries. Local budgets appear to be primarily passive reporting and control instruments, rather than reflecting strategic local priorities or being the foundation of effective local financial management and decision-making. Some countries (E,M,T) use capital budgeting. There is, however, little evidence of program-based or performance-based budgeting. While line item budgeting in itself does not reflect an unsound budgetary format or practice, it is the absence of any performance orientation in the budgets and public expenditure system that is a cause for concern.

33. In MNA-8 countries, central governments not only collect local budget plans for national aggregation and harmonization purposes, but often control the local government budgeting process itself. Moreover, the budgets are not valid without approval by a central government representative (See Table 4). Furthermore, in most MNA-8 countries central approval is required in executing key elements of the already approved budget plans (E,J,L,M,T,Y).

Expenditure Assignments and Local Government Expenditures

34. In the MNA-8 countries, the current pattern of expenditure assignments between central and local governments is rather different from well-established worldwide models of expenditure assignments. In principle, it is advisable to assign functions with a high degree of externalities (such as defense and welfare) exclusively to central governments. By contrast, functions requiring

14 a high degree of political accountability and having high local public good characteristics such as primary education, health, and public security are considered to be best delivered by locally elected governments in many countries. The same is true in the case of infrastructure services such as local roads, public transport, public utilities (water, sewerage, solid waste collection) and public safety (protection of property and fire protection). Together, these make up the core of subnational responsibilities.9

35. The assignment of responsibilities for sectors and functions within sectors among the different levels of the governments in MNA-8 countries provides limited, if any, incentives10 for the different tiers of government to perform their functions efficiently and responsively. Local services are at best delegated. Where service delivery responsibility is delegated, the powers of the LGs to regulate, finance and monitor these are severely curtailed by higher levels of government. In most MNA-8 countries, with the exceptions of Yemen and Iran, local governments cannot appeal the decisions of central or deconcentrated government organizations/agents.

36. The legal framework in many MNA-8 countries does not provide a clear definition and assignment of responsibilities to the different levels of the government, thus leaving many ambiguities and possibilities for interpretation. In Morocco, although the new local government law (2002) addresses ―gray‖ areas, many expenditure responsibilities and functions are yet to be specifically defined.

37. Furthermore, there is a distinction between what is specified in law and what is practiced in the MNA-8 countries, as is evident from tables below. In most cases (particularly in J,L,M and T), provision of local services is assigned to local governments by law. In practice, however, most services are provided by the central government or its agencies. Local governments provide very few services – solid waste management, street cleaning, street lighting, and operation of slaughterhouses, markets, parks and recreation facilities (I,J,L,T,W). Some services such as issuance of construction permits (I,J,L,M,T,W) and construction and/or maintenance of local roads are either fully or partially carried out by LGs (I,L,T,W). Local governments also have limited responsibility for delivery of social services such as health, education and housing, and in such cases it is mostly limited to provision / maintenance of related facilities (L,T,W).

Table 7: Formal Assignment of Local Services in MNA-8 Countries

E I J L M T W Y Public Administration Spatial planning and zoning L11 C a L L C d L L L Issuance of construction permits L L L L L L L Local economic development L L L L L,C L Local environmental protection L L L L Social Services Basic health care services C C L,C b L,C b L,Cb L,Cb C Primary education C C L,C b L,C b L,Cb L,Cb C Housing C,L C L c C L C Public Safety

9 McMillan (1994), Bahl-Linn (1992) 10 ACIR. 1974. Governmental Functions and Processes: Local and Area-wide. Advisory Commission on Intergovernmental Relations, A-45, Washington DC. 11 Though functionally responsible, most cities and towns contract the General Organization of Physical Planning (GOPP)/Ministry of Housing to prepare masterplans.

15 E I J L M T W Y Fire protection L C L L L L Police C L L C C L C Physical / Utility Services Electricity C C L L L C L C Water / sewerage C C L L L L,Ce L C/L Solid waste management L L L L L L L Local transportation L L L L L C L Construction / maintenance of local C/L L L L L L L C/L roads Street cleaning / lighting L L L L L L L L Slaughterhouse and market operations L L L L L L L Parks and recreation L L L L L L L L a L = local government, C= central government; b LGs are mainly responsible for construction and maintenance of buildings. c Low income housing. d While local economic, social and cultural development and development plans are prepared and implemented by Governorates, LGs participate in developing these plans. According to the law LG opinions must be sought on any public project planned to be carried out by the Governorate in the municipality‘s territory. e LGs are mostly responsible only for construction and maintenance of sewerage networks.

Table 8: Actual Assignment of Local Services in MNA-8 Countries

E I J L M T W Y Public Administration Spatial planning and zoning C C a C d C L,C L,C C Issuance of construction permits L C b L L L L,C L,C L Local economic development L L Local environmental protection C L L C Social Services Basic health care services C C C L,C e C L,Ce C C Primary education C C C L,C e C L,Ce L,Ce C Housing C/L C C L,C C C Public Safety Fire protection C C C L C Police C C C C C C Physical / Utility Services Electricity C C C C L,C C L C Water / sewerage C C C L,Cf L,C L,Cf,g L C Solid waste management L L L L L L L Local transportation C/L L C L,C C C C/L Construction / maintenance of local C/L L,C c L L L roads Street cleaning / lighting L L L L L L L Slaughterhouse and market operations L L L L L L Parks and recreation L L L L L L L a L = local government, C= central government; b However, in an attempt to raise local funds many LGs sell ―air rights‖ to developers, i.e. rights to increase densities above those provided in the master plans developed by the central government. c LGs only implement urban development plans prepared by the central government. d Except Greater Amman municipality. e LGs are responsible mainly for construction and maintenance of buildings. f LGs are only responsible for network operations.

16 g Some LGs still administer their own sewage systems, however they are gradually being taken over by the National Sanitation Office. Source: Country Studies

38. In Jordan, although the Law on Municipalities assigns 39 functions to municipal councils, in practice central government agencies and state companies provide most of these services. Further compounding this, local governments have neither regulatory power nor operational control over the state agencies and service providers.12 Their ability to address the most pressing service delivery needs of their constituents is thus highly constrained. Longer term strategic planning such as master planning and zoning, along with capital investment planning is mostly carried out by the central government. The only exception is WBG, where local governments have historically been providing most local services, including basic social services, electricity, water, and sewerage, as well as undertaking urban planning and local economic development.

39. The importance of sub-national governments in the provision of infrastructure services is reflected in the fact that the median share of public investment undertaken by sub-national governments in OECD countries was 71 percent in 1992.13 These patterns appear to be true in both federal and unitary countries (see Annex 5).

40. Total LG expenditures in MNA-8 countries range from 1 percent of GDP in Jordan to 4.7 percent in Egypt. This stands in stark contrast to worldwide averages of almost 40 percent in federal countries and 22 percent in unitary countries. The level of LG expenditures in MNA-8 countries is more in line with countries such as Panama, Nicaragua, Trinidad and Tobago, and Kenya.14

Figure 3: Share of Local Government Expenditures (% of total public expenditures)

Wordwide (federal)

EU countries

Worldwide (unitary)

EU accession countries

Egypt

Morocco

WBG

Iran

Lebanon

Tunisia

Jordan

0% 5% 10% 15% 20% 25% 30% 35% 40%

% of total public expenditures

12 It is quite common throughout the world that the local governments indirectly provide services through municipal enterprises or contract out with private providers. However, the local governments still remain responsible for the service coverage/quantity and quality, regulate, monitor, and control service providers in cooperation with national watchdogs. 13 Sewell (1996). 14 Kopanyi (2003).

17 NOTE: Data for Iran and Tunisia include only urban LGs. Source: IMF Government Financial Statistics Yearbook and country studies, various years.

41. The single largest expenditure item in LG budgets in MNA-8 countries is wages and salaries—with the highest at 75 percent in Lebanon and Yemen in 2000–2002 (Figure 3 next page). Investments, on the other hand, composed of 15–25 percent of the total expenditures in most countries, which is very much in line with the assignment of expenditures and division of service provision responsibilities between the central and local governments in MNA-8 countries, as discussed below. Exceptions are Iran and Tunisia, where data are for urban LGs only. In Iran, there is considerable emphasis on capital spending. The proportion of capital expenditures in the total share of all LG expenditures has recorded a steady increase from about 47 percent in 1997, to nearly 59 percent of by 2004.

Figure 4: Composition of Local Government Expenditures

LG Expenditure Structure (% of total LG expenditures)

100%

80%

60%

40%

20%

0% Egypt Iran Jordan Lebanon Morocco Tunisia Yemen

General operating Salaries Investment

NOTE: Data for Iran and Tunisia include only urban LGs. Source: Country Studies, World Bank, various years.

Revenue Assignments and Local Government Revenues

42. Financial responsibility is a core component of decentralization. If local governments are to effectively carry out functions assigned to them, they must have an adequate level of revenues—either raised locally or transferred from the central government. In general, local government revenues consist of own-source revenues, intergovernmental transfers and borrowings. The objectives of an intergovernmental finance system are to ensure efficiency, transparency and accountability in the allocation of financial resources and assignment of expenditures authorities and revenue powers across the different levels of the government to achieve greater equity among people and places, maintain national integrity and political stability. Achieving these objectives require, among other things, setting local revenues in harmony with local expenditure responsibilities,15 allowing local governments to set and manage local taxes, to

15 Experience in Latin America demonstrated that a one-sided focus on the revenue side and neglect of clear assignment of expenditure responsibilities led to weak decentralized systems and fiscally overburdened central governments. For instance, the Brazilian constitution (1988) forced the federal government to unconditionally share a fixed part of central revenues with states and cities. There was no corresponding expenditure assignments stipulated. Sub-nationals

18 collect own revenues and using central transfers for supporting national policy objectives and reducing vertical and horizontal disparities. The degree of revenue autonomy and incentives for tax collection efforts are critical to encourage accountability and increase efficiency of local government operations. The argument is that spatial considerations make local governments necessary conduits for setting up budgets that provide more efficient solutions that balance benefits and costs.16

demanded shared revenues and spent carelessly even in a bad economic cycle, which seriously overburdened the central budget and softened budget constraints. (Rodden, 2003)

16 Local governments thus become agencies that provide services to identifiable recipients up to the point at which the value placed on the last (marginal) amount of services for which recipients are willing to pay is just equal to the benefit they receive. This benefit model in public finance is particularly appealing to economists, but it faces two practical problems: it is often difficult to implement appropriate pricing policies and, since it requires acceptance of a ―hard budget constraint,‖ and can be politically difficult to achieve (Bird, 1993).

19 Table 9: Revenue Assignments in MNA-8 Countries

Country Revenue Assignment

Egypt There is a national tax sharing system combined with local tax and fee surcharges. Rates are set nationally and the central government collects a portion (25-50%) of local taxes into special national funds. Popular participation (down-payments of citizens) is the most important local revenue under the discretion of local governments.

Iran All local levies are required to be consistent with the government‘s annual budget and the National Five Year Development Plans and to be in line with the capacity to pay as determined by the Ministry of Interior (ceiling for local tax/local income ratio). With adoption of the Law on Tax Amalgamation (2003) revenue collection has been effectively re-centralized and almost all taxes are now collected by the central government. One of the main locally collected fees is the one-time land use change and density increase tax. Property taxes are assigned to LGs, but are insignificant in the overall revenue composition.

Jordan Jordanian LGs collect very few revenues themselves; most are collected by and transferred from the central government. The rates and bases for all revenue sources – the property tax, fees, charges, fuel tax transfer, intergovernmental grants, and borrowed revenues – are delineated by the central government.

Lebanon There are 22 local taxes and sur-taxes, but LGs administer very few of them. While taxes and tax bases are defined by the law, LGs have some, although limited, ability to vary the rates within the centrally set limits. A number of taxes are collected by different state agencies on behalf of LGs, however, LGs have neither the information on collections nor the ability to enforce payment due to them.

Morocco The three main taxes that compose 40 percent of local current revenues are collected by the central government and transferred to LGs. There are another 34 taxes and fees that are collected by LGs (construction and land related fees and taxes that are an important part of revenues in urban areas). LGs can set the tax/fee rates within centrally defined maximums on 11 of the 34 taxes/fees. Country study indicated that the present rates are already close to the maximum allowed leaving little room for increases. Annual inflationary adjustments are very limited. LGs have full discretion in setting rates for 7 of the 34 local charges, but the collection rates are very low.

Tunisia Although LGs can set and administer local taxes on developed real-estate, this right is not effectively exercised. Other taxes, fees, and charges are introduced by central government decrees and managed by central agencies.

WBG Of all the MNA-8 countries, the WBG revenue assignments provide the greatest autonomy to LGs. While LGs have a right to set taxes or create new ones, they need to do so by initiating amendments to the tax law. Many taxes and fees are collected and administered locally by LGs.

Yemen Central government sets both tax rates and base. LGs can make proposals for taxes and fees. Apart from the religion tax (‗zakat‘) most taxes are not collected in many districts, particularly in rural areas. Source: Country Studies, various years.

20 43. Country studies indicated a rather diverse level of LG revenues among the MNA-8 countries, from US$ 20 per capita in Jordan to US$ 190 in urban LGs in Iran in 2001 (Annex 4). The structure of revenues is also rather diverse, indicating a high share of local revenues in Iran and Lebanon contrasted with high reliance on central transfers in Egypt and Yemen (Figure 5. For more data see Annex 4).

Figure 5: Local Government Revenue Composition

Share of locally Generated LG Revenues (% of total)

100%

80%

60%

40%

20%

0% Egypt Iran Jordan Lebanon Morocco Tunisia Yemen

Locally generated Transfers Borrowing

NOTE: Data for Iran and Tunisia include only urban LGs. Source: Country Studies, various years.

Own-source Revenues

44. Most developed and many developing countries in assigning revenues follow a principle of allocating to local governments those revenue sources that are locally manageable, relatively immobile, provide significant revenue, do not induce territorial inefficiencies and do not compete with the central tax base. MNA-8 countries follow some of the above principles, but also subscribe to some less efficient practices. Country studies suggest that taxation systems are highly centralized and often combined with weak enforcement. As a result local governments obtain a significant share of their tax revenues from tax sharing or shared revenue tax services. At the same time, they have no significant power in decisions relating to revenue sharing rules.

45. Despite the long list of local taxes and fees that can be collected by LGs in the MNA-8 countries, there is little real autonomy when it comes to defining and administering local revenues. The rates and bases for all major revenue sources—property taxes, local fees and charges—are to a good extent controlled by central government. Exceptions are Iran, Lebanon, Morocco and Tunisia, where LGs have some albeit limited discretion to set the rates for local taxes and fees within centrally established limits. However, this possibility is rarely exercised in most of these countries. In Iran, the responsibility for setting base and rate is shared between central and local mechanisms for building permits and property taxes. For other own-source revenues such as business permits and user charges, LGs are often allowed some flexibility to centrally specified rate and base.

21 46. Many of the local revenue sources yield little return and as such could be considered nuisance taxes. There are 22 different taxes and fees collected by LGs in Lebanon; however, only three of them yield any significant revenues. Similarly, three local taxes in Tunisia account for 50–80 percent of LG revenues. In Morocco there are 37 different local taxes and fees, half of which provide less than $100,000 per year. Thus, there is an evident need for the LGs to focus on those sources that can provide substantial revenues and pay less attention to the many minor taxes they typically have access to.17

47. In several MNA-8 countries, local governments at least in larger cities have been seeking greater opportunities to collect higher own-source revenues. In Egypt, ―popular participation‖ (down-payment of local inhabitants and businesses) covered 63 percent of the cost of the 17,000 local investments in 2000/2001. In Jordan, the Greater Amman municipality started to collect and manage its own property taxes in 2002 and revenues have since been consistently increasing. In Iran, a special one-time charge called land use change and density increase tax provides for the bulk of local revenues in most cities (see box below). In order to stop the mushrooming of local fees and charges, the Iranian government has recently adopted a Tax Consolidation Law (2003). Although this was a well justified measure, it seems to have further constrained the local governments‘ tax sovereignty and own revenue capacity.

Box 3: Own-source Revenues in Iran: A Distorted Model of Self-sufficiency

Own-source revenues comprise more than 80% of total municipal revenues in Iran, a significant share even by international standards. This share is as high as 87% for the largest cities. This is, in large part, the result of Government of Iran‘s policy of municipal fiscal ―self-sufficiency‖ adopted in the late-1980s. To the extent of advancing efficiency and accountability in service delivery, this is a desirable policy. Yet, in Iran, the move towards ―self-sufficiency‖ has led to some undesirable policy outcomes and a distorted municipal finance structure.

Iranian municipalities have a relatively narrow range of revenue autonomy and authority. Their revenue powers are limited in scope and extent. Revenues accrued from land and building related sources form the most significant, stable and buoyant source of income for all but the group of smallest cities in Iran. These revenues constituted 50 percent of the total revenues, and 61 percent of the own-source revenues, between 1996 and 2004. Land and building related revenues comprise of permit charges for land development and building construction, and property taxes. Property taxes are only a very small share of this, and, in the overall revenue composition of municipalities. For example, in Tehran, which has among the largest share of property taxes, these are only about 2 percent of the total revenues. The ability of Iranian municipalities to determine the base and rate of property taxes is also very limited. Thus, larger municipalities, in the absence of other stable and substantial revenue bases (say, surcharge on personal income tax), limited revenue autonomy for existing ones (e.g., property taxes) and declining national transfers, have been relying overly on the one time charges for land development and/or density increases. This has led to a distorted revenue structure for municipalities, with serious implications on revenue accountability. In times of economic slowdown or crisis to the construction industry, municipal revenues in large cities take a severe downturn, as witnessed in Tehran a few years back. Further, the impact of this policy on land use decisions also merit serious deliberation.

Source: World Bank(2005).

17 Bahl-Linn (1992), Shah (1994).

22 Intergovernmental Transfers

48. Wide differences in socio-economic circumstances across local communities make even the best designed revenue allocation systems incapable of providing comparable or a minimum standard of service level for all the citizens in a country a mission impossible.18 Ideally, intergovernmental transfer systems should have three key objectives: offset fiscal capacity differences across local governments; supplement local own source revenues; and enhance local governments‘ ability to meet their expenditure responsibilities. Finally, transfers are key instruments for central governments to encourage local expenditures in accordance with national priorities (Bahl-Linn, 1992; Smoke, 2001).

49. While there are no standard transfer systems that are used in the developed countries (for examples see Annex 5), there are three key parameters that are used to assess the effectiveness of a transfer system in a country: (i) size and predictability – how the size of the pool is determined (whether the central government can decrease/increase the amount in the pool unilaterally without the consent of local governments); (ii) transparency and accountability – how the available amount in the pool is distributed (formula based vs. discretionary); (iii) flexibility – what and how LGs are allowed to spend on (i.e. whether the grants are conditional, if so, how much discretion LGs have). While there are great variations in the amounts of transfers and their shares in LG budgets in MNA-8 countries (Figure 4.), they also share many similarities when assessing the above parameters of their transfer systems.

Figure 6: Transfers and Local Government Expenditures (US$ per capita)

Transfers and LG Expenditures (US$ per capita)

90 80 70 60 50 40 30 20 10 - Egypt Jordan Lebanon Morocco Tunisia Yemen

Investment expenditures Transfers Total expenditures

Source: Country Studies, World Bank.

50. Size and Predictability. The transfer pools are rarely predictable (See Table 5.) as most depend on volatile oil or customs revenues and/or annual decisions of the central governments.

18 A unique property of the German constitution is that it stipulates the ―equivalence of living conditions‖ that obliges the Federal government to provide special bail-out transfers for under-financed states. (Rodden 2003).

23 Table 10: Intergovernmental Transfers in MNA-8 Countries

Transfer Characteristics Source Allocation Rules

E General development grants: mutual National budget. No rule-based allocation nor plus earmarked (service & development, formula. Discretionary grants land, housing, cleanliness, road). and donations.

I Transfers to urban LGs are negligible, Oil revenues. No formula. Allocation rules particularly in the larger cities. decided annually by the Parliament. Development transfers: 60% earmarked 30-40% discretionary.

J No earmarked transfers. Pool of shared taxes. Main source Formula based. – The is the ―fuel tax‖ (6% from Government has been revenues) and the rest is from experimenting with a new other sources (e.g. vehicle fees transfer formula that includes and VAT).

L Transfers are unpredictable and are not Pool of 13 different surtaxes and Formula based, but LIMF earmarked. fees (a significant portion is from funds are allocated also to custom duties that are being finance deconcentrated phased out) channeled into the agencies and different Independent Municipal Fund investment projects. (IMF).

M Not earmarked (very flexible). 30% of the proceeds of the VAT Formula based on population collected by the Ministry of and compensation (poor / rural Finance. LGs).

T Earmarked: operating grants through LG National budget. Formula based – 10% flat rate, Common Fund (FCCL), development 45% size of LG, 45% grants managed by Fund for Loan and according to average property Support for LG (CPSCL); sector based tax. transfers; Regional Development transfers.

W Current transfers and grants are not Car licensing fees, rental No formula. earmarked. revenues, foreign aid.

Y 30% of grants from extra-budgetary Shared revenues from 28 taxes, No formula, but Council of funds are earmarked, others are not. mainly – Zakat. Ministers uses non-binding guidelines – population density, financing gap, degree of deprivation, performance in revenue collection. Source: Country Studies.

51. Transparency and Accountability. A number of MNA-8 countries use some type of a formula for the transfer allocation. Formulas in Jordan and Tunisia take into consideration the fiscal capacity and revenue disparities among the LGs (See Table 10). In Lebanon and Morocco formulas are rather complex yet ineffective. There are no allocation formulas in the other countries (E, Y, WBG) and, hence, the transfers are presumably allocated based on discretionary decisions of the central government. The system of intergovernmental transfers in Iran is governed by the Tax Amalgamation Law and the annual budget law, which together specify the

24 proportion of total tax that is earmarked for municipalities. The allocations follow some broad guidelines specified in the Five Year Development Plans, for instance targeting cities with a population under 30,000, or focusing on cities with traffic problems, and so on, depending on the type of national revenue transfer.

52. Flexibility. Local governments in Jordan, Lebanon, and Morocco have noticeable spending flexibility. However, in the other countries (E, I, T, W and Y) the bulk of the development grants are earmarked. (Table 6.).

53. Soft budget constraints. The above systems of intergovernmental transfers indicate that the budget constraints imposed on LGs are soft in most MNA-8 countries that may result in understated local revenues and incentives for running local budget deficits. For example, in Morocco, the system of transfers to municipalities between 1988 and 1992 was structured such that central government financed municipal deficits. Borrowing was costless to municipalities, since both principal and interest payments on loans increased the budget-balancing grants they received from the central government. This resulted in ever increasing local government deficits.19 The disincentives of such deficit financing became apparent to the Moroccan government in 1992, when it replaced the then existing transfer arrangement with a formula- based one. To reinforce the institution of the hard budget constraint, lenders to the municipalities were explicitly told by the central government not to count on financial bail-outs in the event of financial failure by municipalities.20

54. Understated revenues. In Jordan, even with limited service responsibilities, four-fifths of Jordanian municipalities were insolvent in 2000. A recent World Bank report on Jordan found that ―in the absence of the right incentive structure, municipalities understate their own revenues, increase their commitments on expenditures and run deficits in the expectation that the central government will bail them out‖. 21

55. Incentives for budget deficits. If Lebanese municipalities end the fiscal year in deficit, the central government provides a corresponding advance against future transfers (intercept) and at a substantial interest rate (22 percent in 1999). Such forced lending provides possibilities for negotiations between the Ministry of Finance and municipalities on the amount of the intercept and often settled by subsequent debt pay-off, which is effectively a soft budget constraint.22

56. The above findings support the conclusion that the transfer systems in most MNA-8 countries, except Morocco, are unpredictable, non-transparent, do not support local accountability, and, with a few exceptions, appear quite rigid. Country reports provide anecdotal evidence of extensive bargaining, political allocation of funds, ex post gap filling and bailing out insolvent local governments. In addition, various deconcentrated agencies and offices manage a very significant amount of transfers without adequate coordination amongst themselves and with recipient local governments.

57. The efficiency of the intergovernmental system is contingent on a stable and transparent implementation method that takes fiscal conditions of sub-national governments into

19 ―Morocco and Tunisia: Financing Local Governments – the Impact on Infrastructure Finance,‖ p.158. 20 Bird and Vaillancourt, ―Fiscal Decentralization in Developing Countries: An Overview,‖ p. 7. 21 Concept Note on Intergovernmental Fiscal Relations and Municipal Financial Management in Jordan, 2003. 22 Attachment 3, BTOR by Bob Ebel to Mr. Jean-Claude Villiard, ―Fiscal Decentralization and Municipal Finances in Lebanon‖, December 1997, 26.

25 consideration. An efficient system of intergovernmental transfers should have transparent criteria of distribution among sub-national governments, encourage sub-national governments to manage and increase their own revenues, to use resources efficiently and maintain balanced budgets.

Local Government Borrowing

58. Local governments in most developing countries overwhelmingly rely on central transfers, while central governments tend to put controls on local borrowing. Some fully prohibit sub-national borrowing, others issue discretionary individual permits for sub-national borrowers; or more flexibly impose administrative constraints (borrowing limits such as debt service ratios— DSCRs); or believe that state-owned intermediaries (municipal funds) provide sufficient protection against careless borrowing.

59. The largest sub-national layers such as states and provinces under federal governments (e.g. in Brazil, Columbia), as well as large and medium cities in many developing countries (Czech Republic, India, Hungary, Poland, Slovakia) are able to directly access credit markets. Central governments allow sub-national borrowing under simple administrative constraints with the presumption that the lenders are sensitive to the risks of lending to sub-nationals. Hungary, South Africa and Latvia have all introduced legislative frameworks for resolution of local government insolvency which have proven to be effective (Jokay et. al. 2000, Peterson 2000, Petersen and Crihfield 2000).

60. Limited municipal borrowing in MNA-8. Sub-national borrowing is legally possible in all MNA-8 countries. Yet, borrowing is limited in much of MNA-8 countries. Central governments restrict borrowing via administrative control and through state-owned financial intermediaries. Local governments in Jordan and Tunisia are very active borrowers, while the state intermediaries appear to be rather powerless in maintaining disciplined lending policies In contrast, the state intermediary is a rather conservative lender in Morocco. There are negligible municipal borrowings in the rest of MNA-8 countries, mainly due to administrative constraints, central governments‘ apparent disfavor, low local administrative capacity, poor creditworthiness and limited availability of lenders.

26 Box 4: Arguments for Sub-national Borrowing

There are three primary reasons why sub-national borrowing can be considered as an appropriate tool for sub-national public finance:

Intergenerational equity: The benefits of certain investment projects, such as infrastructure and education, are spread over time, which means that not only present residents of a locality, but also future residents will consume the services provided by the projects. Therefore, the benefit principle of taxation suggests that future residents should also contribute the cost of investment. Borrowing allows payments for capital investment projects to be spread over the life of the project and helps align them more closely with the stream of future benefits.

Economic Development: Delaying infrastructure investments will likely have a negative impact on sub- national economic performance. Such a negative impact will have a direct effect on residents‘ life in terms of less employment opportunities and decline of earning levels. Therefore, borrowing is an appropriate tool for sub-national governments to invest in infrastructure projects that can stimulate their regional economies.

Synchronization of Expenditure and Revenue Flows: Access to financial tools offers an opportunity for sub-national governments to synchronize their expenditures and revenue. For a variety of reasons, expenditure incurred and tax intake may not be fully synchronized for a particular year. In such a situation, borrowing allows sub-national governments to smooth out the mismatch and provide services without disruption.

Source: Oates, 1972.

61. Egyptian local governments are eligible to borrow for both commercial and infrastructure investment purposes, but their indebtedness should not exceed 40 percent of their annual own revenues. Borrowing, however, should be projected in their approved annual budget plan. In addition, for each borrowing item under the plan they should receive a permit from the popular council of the governorate. LGs cannot exceed their 40 percent borrowing limit or accept foreign aids/grants without the approval of the prime minister.

62. The Iranian local governments are free to borrow commercially. However, there is little borrowing by local governments to finance current or capital expenditures. The only borrowing that takes place is in the form of limited loans that are passed on by certain central government entities to local governments in purchasing capital equipment. Since Iranian local governments are in a strict legal sense not considered ―government‖ entities, they do not enjoy any implicit government guarantees.

63. Jordanian local governments can easily access financing from a state intermediary called Cities and Villages Development Bank (CVDB). Borrowing for infrastructure development, commercial investments, and for refinancing overdue debts has been nearly automatic. CVDB is authorized to screen a local government‘s creditworthiness and lend accordingly. No well-defined legal framework exists to support disciplined borrowing, apart from the rule that CVDB can even replace a local government if it is unable to continue debt service. This proved to be a moral hazard and, in 2000, led to an extensive crisis whereby 80 percent of Jordanian local governments declared insolvency. The central government resolved it with an unprecedented bail-out along with the amalgamation of small local governments. This experience however seems to have hardly dampened the unsustainable borrowing practices of LGs, since the new municipalities continued to borrow intensively for infrastructure development again in 2002.

27 64. The Lebanese local governments have been legally eligible to borrow with central permission since 1977. However, central government policy has prevented them from borrowing. In previous years, local governments had borrowed from the Central Bank at high interest rates. This was basically advancement on their expected future transfers from the Independent Municipal Fund (IMF). Commercial borrowing is not allowed.

65. Moroccan local governments can borrow exclusively from the state intermediary—the Communal Equipment Fund (CEF). The fund has a reputation of being a very rigid lender. It is mandated to provide funding to local governments in an amount not to exceed 10 percent of their total budgets. The CEF financing has constantly been far below this target. It follows quasi- market principles—interest rates and repayment conditions depend on the nature of the projects, nearly half of which finance infrastructure and the rest commercial investments. CEF issues bonds in the local market and pools internal and external funding. Lack of LG expertise in project design and implementation seriously constrain their borrowing capacity. As a result, a large part of lending has been channeled to better off communities in the central and northwestern parts of the country.

66. Tunisian local governments have long been eligible and quite active borrowers. Since 1992, the Fund for Loans and Support to Local Collectivities (CPSCL) has been the sole provider of loans. CPSCL uses its funding capital but also acts as a wholesale intermediary. It pools municipal demands, borrows or issues bonds in domestic markets and on-lends the proceeds to the local governments. Municipalities can borrow for both infrastructure and commercial investments but infrastructure and environmental projects are favored (e.g. lower interest rates and longer maturity). In Tunisia, municipal lending has increased by about 15 percent per annum from 1992 to 2002. Municipal indebtedness has also increased substantially. For example, the debt to operating revenue ratio jumped from 3.7 to 15.4 percent by 2002. Further, a group of municipalities are facing solvency problems. A reform program is underway aimed at supporting troubled municipalities (2002-2007). CPSLC provides state grants for the most indebted 71 municipalities, preferential loans for the less troubled 61 municipalities, while it continues to serve the better off municipalities under its regular lending scheme. One can conclude that this implicit bail-out hampers disciplined lending, creates moral hazards, and raises questions about its long-term sustainability.

67. Borrowing rules in Yemen are unclear since one rule suggests that local governments cannot borrow for investment purposes. However, they can apply for a permit to pledge municipal assets. In WBG, local governments are eligible to borrow. However, there is very limited evidence that this is taking place currently. WBG municipalities have borrowed from commercial banks for financing both infrastructure and commercial investments (e.g. Nablus Commercial Center—US$ 26 million from Arab Bank). The major constraint on borrowing is that lenders may not assume central government backing, although troubled local governments could receive discretionary support from central government.

Governance and Accountability

68. While there are several definitions of public governance, they all have a common emphasis on the process of ―exercising authority in the name of people‖ (World Bank, 2003e) or ―..who has influence, who decides, and how decision makers are held accountable‖ (Plumptre and Graham, 1999). A number of international institutions have also attempted to develop a framework for good governance that emphasizes inclusiveness, accountability and transparency (see Box 5. below).

28

Box 5: The Main Principles of Good Governance

. Legitimacy and voice (participation and consensus orientation). . Inclusiveness and fairness (guaranteed equal basic rights and rule of law, i.e. fairness of legal framework and its impartial enforcement). . Accountability and transparency (answerability of the government and government officials to the people and full access to information). . Performance (responsiveness to all stakeholders, and effectiveness and efficiency in meeting needs while making the best use of resources). Source: Graham et al (2003; UNDP), UN Habitat (2001) and World Bank (2003e).

69. While defining and measuring governance is a rather difficult task and is oftentimes subjective, a number of indices have been developed such a corruption perception index by Transparency International, 6 governance indices consolidated by Kaufmann et al23 and 3 indices developed by the World Bank.24 Quality of governance in MNA-8 tends to increase with incomes which is a trend throughout the world; however, it is consistently below that of other countries with comparable income levels (Tables 7 and 8).

70. Based on Kaufmann et al (2002, 2003) and World Bank (2003e) the largest gap between MNA-8 and comparative countries worldwide appears to be in respect of public accountability,25 which is the case for the MNA region as a whole. While MNA-8 performs better in terms of the quality of administration,26 it is still below the average level in the region and that of lower middle income countries (LMIC). Moreover, there is great variance among the countries (see Annex 9.4). Countries with higher LG involvement (M, T, W) have consistently higher governance indices than those with limited LG role (E, I, L, Y). The one possible exception is Jordan, where local government involvement is rather limited. However, in terms of governance indicators it outperforms not only other MNA-8 countries, but also the LMIC group as a whole. On the other hand, Lebanon with GNI per capita at the level of the upper middle income countries (UMIC) underperforms not only UMICs,27 but even LMICs.

Table 11: Governance Indicators (2002)

Gap from LMIC Gap from MNA-8 a MNA-15 MNA-15 (2-3) LMIC (2-5) IGQ b 32c 37 -5 41 -9 IPA d 36 32 4 54 -18 IQA e 38 47 -9 41 -3 a Due to lack of data for WBG weighted average based on the population for seven countries (E,I,J,L,M,T,Y) is used as a proxy. b Index of governance quality (for explanation see Table 8 below)

23 Voice and accountability, political stability, government effectiveness, regulatory quality, rule of law and control of corruption (see Kaufamann, Kraay and Zoido-Lobaton (2002) and Kaufmann and Kraay (2002)). 24 Index of governance quality (IGQ) that is further broken down into index of public accountability (IPA) and index of quality of administration (IQA) (World Bank 2003e). 25 ―Index of public accountability‖ in World Bank (2003e) and ―voice and accountability‖ in Kaufmann et al (2002, 2003). 26 ―Index of quality of administration‖ in Word Bank (2003e) and ―government effectiveness‖, ―rule of law‖ and ―control of corruption‖ in Kaufmann et al (2002, 2003). 27 IGQ and IQA for UMIC is 56 and IPA is 65 versus 32, 35 and 42 for Lebanon respectively (World Bank 2003e).

29 c 0 – 100, the higher the number the better governance. d Index of public accountability (for explanation see Table 8 below) e Index of quality of administration (for explanation see Tab le 8 below) Source: World Bank (2003e)

Table 12: Kaufman Governance Indicators (2002)

Worldwide MNA-8 gap Governance Indicator MNA-8 average (2-3) Voice / accountability -0.74a 0.56 -1.30 Political stability -0.62 0.67 -1.29 Government effectiveness -0.25 0.47 -0.72 Regulatory quality -0.47 0.70 -1.17 Rule of law -0.20 0.61 -0.81 Control of corruption -0.30 0.48 -0.77 Average -0.43 0.58 -1.01 a Scores are assigned in the range from –2 to 2. The higher the score the better governance. Source: Calculated by author based on Kaufmann et al (2003). For individual countries see Annex 9.4.

71. Governance and accountability are results of political, administrative and fiscal choices made by the central governments in MNA-8 or in any country (World Bank 2003b and Parker 1995). While countries have made different choices leading to different results as discussed above, the common characteristics of MNA-8 is the high focus on organizational reforms and tight level of control by the central government.

Box 6: . Reforming Incentive Structure in Colombia In mid-1980s Colombia embarked on a broad LG reform program that included all the key areas of municipal affairs – selection of mayors through popular elections; enhanced citizen participation through adoption of specific legal norms and implementation of national participation programs; more decision making devolved to LGs in financial, technical and personnel issues; and increasing budget transfers to poor communities and access to credit facilities. In order to assess the results of these reforms surveys were carried out in 16 municipalities in 1994. The results showed a significant improvement in the financial situation of municipalities, the quality of local services, particularly in the rural areas of municipalities, and greater satisfaction of the population with improved services. Piped water coverage increased in a number of municipalities from 60–70% in 1988 to 90–95% in 1994. The share of local roads in good quality increased from 30% in 1990 to 60% in 1993 in one municipality, and in another, the road coverage increased from 40km to 170km. While local tax revenues increased by an average of 94% from 1989 to 1993, in individual LGs it ranged from 13 to 232 percent, well above the population growth over the same period. However, some municipalities experienced also difficulties, particularly, mobilization of local resources and provision of education services. Source: World Bank (1995).

72. Management Capacity. In recent years, governments and international organizations have started paying increasing attention to local government capacity building. Different training programs for LG employees have been introduced and training institutions established. However, hands-on training, experience exchanges, and learning from best practices appear to be just as important for building LG capacity in service delivery as conventional ―class room‖ style general

30 training, as illustrated by the Colombian experience (World Bank, 1995). This evolution in thinking is placing new responsibilities on central governments, who view it, not infrequently, as a burden. They increasingly feel compelled to initiate new programs, but with very limited capacity or resources to do so, as in the case of Egypt and WBG.

73. However, very little, if any, attention has been devoted to reforming the incentive framework for local governance and improving downward accountability through tools such as public disclosure, participatory budgeting and civil society involvement. As they make decisions and deliver services, personnel within government organizations are affected by and respond to the environment of incentives around them. Recent experience in Latin American countries has demonstrated that reforming incentive structures, encouraging citizen participation, delegating/devolving decision making to LGs, improving financial management, and other incentive measures can have a notable positive impact on service delivery and financial soundness of LGs (see Box 7 below).

74. A sound incentive framework is one where the division of responsibilities is clear; decision making is delegated along with accountability; and a transparent framework for budgeting, financial management, public procurement and disclosure of information exists.

Box 7: Results of Municipal Reforms in Brazil and the Philippines

The governments of Brazil and the Philippines in co-operation with the World Bank introduced municipal fiscal reform programs in pilot areas.* Subsequently an extensive evaluation of the effects of these reforms were assessed and evaluated over a period of 1990 – 1996. The data enabled both ―with- without‖ reforms and ―before-after‖ reforms comparisons. The results showed that municipalities that participated in reform efforts in Brazil and the Philippines outperformed non-participants in terms of both financial autonomy and soundness.

The program required that municipalities applying for investment loans under the World Bank facility submit financial action plans and comprehensive reform packages, including institutional development aspects. The results proved that the sequencing of the projects – reform before lending – were critical for success.

Brazil. Own revenues of participating municipalities rose as a share of total revenues by 2% in Rio Grande, while those of non-participants in the same region declined by 5%. Property tax collection by municipalities measured on a per capita basis increased by 92% annually on average in participating municipalities in Rio Grande versus 73% in non-participants in the same region.

The Philippines. While all municipalities in the Philippines saw a decline, the shares of participant municipalities declined by 12 – 20% versus a decline of 37% in non-participants. Per capita property tax collection over the same period increased in participating municipalities by 48 – 87% versus 32% in non-participants. In addition, participating municipalities generally moved into budget surplus while non-participants remained in deficit. ______* The First and the Second Municipal Development Project in the Philippines and Municipal Development Projects in the states of Parana and Rio Grande do Sul in Brazil. Source: OED (1999).

31 75. Clear Division of Responsibilities. In nearly all of the MNA-8 countries, with the possible exception of Morocco, there is a need to update and clarify the legal framework to define responsibilities and to delegate/devolve authority with accountability. Indeed, a number of country studies have identified considerable ambiguities and contradictions in the legal framework (I, J, M, T, W). One example of this is where responsibilities for services such as water, electricity, education and others are dually assigned to LGs and line ministries. In addition, there is a wide gap between law and practice—where law delegates or devolves responsibility to LGs in service delivery, in practice these have been usurped by central agencies (J, L, M, T, Y); and where law severely constrains the power of LGs in personnel matters, many LGs have sought practical flexibility often stepping beyond the confines of law (I). In this respect, WBG is an outlier since LGs perform most or even more public services than prescribed by the law. This is a result of long-standing, autonomous LGs and a history of local provision of services – a tradition that predates the establishment of a central government apparatus.

76. Clear framework for budgeting, financial management, public procurement and disclosure of information. There is incomplete information on the framework for budgeting, financial management and procurement procedures in MNA-8. Yet, it is well-known that measures of internal accountability and performance orientation of budget management in MNA region as a whole is well behind comparators such as the Republic of Korea and Brazil (Esfahani, 2000). While Lebanon has adopted a number of laws on LG budgeting, they are not implemented, as a number of lower level directives referred to in the laws have not been prepared. Recently Iran has started moving towards some form of performance based budgeting system in which explicit goals of public expenditure policy would be stated and performance toward these goals would be monitored (World Bank 2003e). With regard to fiscal and financial matters, medium or long term planning also does not appear to be practiced by LGs in MNA-8. International experience shows that if appropriate incentive structures are in place, LG finances could be improved notably without additional resources from the central government (see Box 7 above).

77. None of the country studies for MNA-8 identified the existence of a clear legal requirement for disclosure of information. However, in recent years LGs have launched different forms of communication with their constituents although in an ad hoc and discretionary manner (I, J, E, L, W; see below).

Table 13: Illustrations of Involvement of Civil Society in MNA-8

Egypt National Program for Integrated Rural Development – approval of priority development activities and village development plan through participatory approach Lebanon LGs often involve NGOs in service delivery and implementation of projects. A survey of local governments in Lebanon also indicated that 21 percent of LGs involve civil society in LG committees. Furthermore, some LGs also hold general assemblies to inform people about its activities and projects. WBG Some LGs communicate their policy to the people and solicit people‘s view on policies as well as publish some reports although on an ad hoc basis. (UNDP / PAPP; 2003) Iran Degree of citizen participation in urban policy making varies by city. In active cities, councils hold regular meetings with residents of neighborhoods and occasionally more general public meetings. In some cases, to compensate for their lack of a formal legal role, municipalities try to play a constructive role by informally coordinating with deconcentrated service providers in the city and, through informal social consultation to determine how local priorities can be reflected in the plans. Source: Country studies.

32

78. Delegated decision making along with accountability includes measures such as making LGs responsible for staffing, imposing hard budget constraints, public disclosure of information and involvement of civil society.

79. There are multiple approaches for ensuring accountability that are constantly evolving. These include popular elections, disclosure of public information, including budgets, financial accounts and main policy decisions, public debates, different feedback mechanisms, options to choose competing service providers (called ―external‖ or also ―downwards‖ accountability) and judiciary system, separation of powers, monitoring and audits (―internal‖ or ―upwards‖ accountability). (World Bank 2003e.) While some degree of accountability to central government through a national regulatory framework and checks and balances appears to be appropriate in any structure of municipal service delivery, there is no universal prescription as to the extent to which a system of municipal service delivery should rely on internal and how much on external accountability. (Dillinger 1994). However, MNA-8 appears to have an unbalanced approach and much higher emphasis on internal than external accountability.

80. As LGs in MNA-8 have very little discretion in decision making, still they are mostly made by or require approval of the central government, the responsibility for the results are essentially assumed by the central government as well. Consistent with that is the central governments‘ policy of providing financial support to financially weak municipalities (E,J,L,Y).

81. The appointment of local chief executives (i.e. mayors, LG Presidents, Directors or equivalent) by and the implied reporting to the central government (E,I,J,W,Y) creates a disconnect in reporting between elected local governments and their executive branches. The same is true regarding other LG employees that are also hired, promoted and fired by the central government (E, I, L, Y), while working for the locally elected councils. As a result, the usual incentives for high-quality individual performance are significantly weakened. In addition, country studies found that public employee compensation is significantly lower than that in the private sector (Y, E).28 That may lead to contra-selection of local government staff.

82. Civil service hiring in the MNA region has also long been dominated by personal connections and public employment imperatives leading to little correlation between performance and promotion (or demotion). In Egypt, long-standing government hiring practices to employ university graduates has resulted in a bureaucracy whose very size makes it difficult to monitor performance. The direct link between university education and a guaranteed job has recently been severed, but the overhang of a massive group of underpaid and unmotivated bureaucrats with job assurance for life remains and provides little incentive for good performance and little room for accountability. (World Bank 2003e)

83. Knowledge and free access to full information by citizens (i.e. transparency) are important pillars for ensuring external (downwards) accountability. There have been attempts to move towards more open public debate (I, J, L M) and involving communities in decision making (E,L,W) in MNA-8. However, disclosure of and access to information is still very limited when compared with other countries irrespective of income levels. Often media face considerable government control and restrictions (WB2003e) and involvement of civil society is mostly sporadic and discretionary rather than a system-wide approach (See Table 13).

28 In Yemen public sector salaries were 11 percent of that in the private sector in 1996. The country is currently working on civil service reform. (Al-akwa‘a, 2003).

33 LOOKING FORWARD

84. In many MNA countries where urbanization has been advanced but the role of cities has been hitherto unrecognized and decentralization has been limited, there is greater recognition of the importance of urban economy and a gradual shift towards localization. Most MNA countries are middle income and highly urban. A substantial share of the non-oil economy originates in cities. In countries as diverse as Morocco, Iran, Egypt, Yemen and Jordan there is increasing recognition of the local government‘s importance. This shift is gradual and driven by pressures of democratization as much as globalization and competitiveness. Decentralization is still embryonic in most countries in the region, save for Morocco and a few other exceptions. Its pace and process are still unclear and occasional setbacks are likely. Nevertheless, deconcentration is gradually giving way to more robust forms of decentralization. LGs are emerging from strong central controls and taking upon more service responsibilities, trying to raise more resources locally and creating more jobs in the economy.

85. As decentralization is an ongoing process with each country charting out its own approach, it would be almost presumptuous of this report to make sweeping recommendations regarding the course each country should adopt with regard to its decentralization policies, regulations, institutions, and practices. This report attempts at a more modest approach based on three principles. One, it identifies five key areas of reform that can define decentralization and municipal strengthening in MNA-8 countries. Two, it outlines a set of core principles that can guide the development of decentralization strategies for individual MNA-8 countries within the five identified areas of reform. Finally, as much as there is a positive list of reform principles, this section also draws conclusions about what to avoid, given the unique circumstances of MNA-8 countries.

86. The five key areas of reform are: (i) strengthening downward accountability; (ii) assigning service responsibilities between the different tiers of government and devolving resources to undertake those responsibilities; (iii) creating administrative and technical capacity at local level; (iv) improving local information systems and strengthening knowledge networks; and (v) clarifying legal and regulatory frameworks to provide the shell for the above four.

87. Strengthening downward accountability. For local autonomy and authority to take roots, their success will depend on effective channels of accountability that place citizens at the center. Accountability extends both vertically—wherein there are a number of organizational, institutional, and structural mechanisms for reinforcing local government‘s accountability to other levels of government—and horizontally—wherein local governments become answerable to their local constituents by strengthening citizen voice mechanisms.

88. Vertical accountability mechanisms include hard budget constraints, other aggregate fiscal controls, public financial management systems, reporting and auditing systems and so forth. These need substantial strengthening in MNA-8 countries. Strengthening accountability mechanisms between service providers and policymakers will require ex ante controls and ex post audits. The foundations of such an accountability framework should lie in performance rather than mere compliance, outcomes and outputs rather than only inputs; and strengthening client focus within the government and service providers rather than adding additional layers of bureaucratic controls.

89. More importantly, a credible system of downward accountability towards citizens needs to be institutionalized in all MNA-8 countries. Currently there are limited voice and exit mechanisms for citizens to record their preferences. Downward accountability measures at the

34 local level include local elections, establishment of elected local councils where they do not exist and strengthening of local councils where they exist as nominal bodies, greater citizen involvement in prioritizing and planning of municipal expenditures, public disclosure of municipal budgets, public hearings to discuss new capital investment projects, mechanisms for redressal of complaints, and so forth. In several areas, among them, preparation of urban development plans, delivery of urban services and LED, structures for participation of and feedback from city residents will have to be strengthened where they already exist (formal or informal) and put in place where they currently do not exist. While some of these reforms are currently being introduced some countries, they remain exceptions rather than the rule. Such accountability measures, if pursued in earnest, could lay the foundation for a smoother and possibly more rapid transition to more decentralized systems in the region.

90. Assigning service responsibilities and devolving resources. A rational revenue- expenditure assignment framework is the cornerstone of a good intergovernmental system. At the heart of this is the assignment of expenditure responsibilities—service sectors and functions within sectors—to local governments in line with the type of service, scale economies, fiscal equity, capacity of local governments, administrative effectiveness, and political accountability. Where feasible, there is a case for strengthening the expenditure authority and autonomy of municipal governments. This will be different from one country to another among different MNA-8 countries, and may, additionally, call for a differentiated approach between cities within each country.

91. Once expenditure responsibilities have been delineated, local governments should be provided with sufficient resources to undertake their responsibilities. The revenue regime should promote accountability and transparency by identifying source of financing best suited for each type of expenditure responsibility, both sectorally and functionally. Specifically, the following general principles merit consideration:

. Assign taxes and charges that are economically efficient (for example, do not lend well to tax exporting), stable, buoyant, and easy to administer;

. Strengthen user fee regime in service delivery;

. Promote private sector participation in service delivery, where feasible and capacities exist;

. Gradually put in place a system for responsible local borrowing; and

. Establish a system of equalization grants across municipalities in order to ensure minimum service delivery standards and reduce horizontal fiscal disparities.

92. Yet, devolving fiscal powers and responsibilities is a major challenge that should be undertaken prudently. Weak capacity at the local level combined with a history of bailouts by central governments could present moral hazard risks, especially given the absence of standards and oversight mechanisms by regulatory bodies. Given this, it is critical to focus on building systems for accountability, developing standards for service provision and mechanisms to monitor these, and strengthening local budgeting and public financial management systems in a way that will truly prepare local governments, particularly the weaker ones, to embrace the fiscal and financial responsibility that real devolution will demand of them.

35 93. Such reforms cannot be imposed in a top-down manner, but require a partnership with central and local governments in meeting the needs of their citizens. As in all other cases, effective partnerships depend on clear rules, and roles and responsibilities established in such a way so as to enable each party to fulfill its obligations. To enable this it is important to put in place systems—rules and institutions—to govern both, vertical coordination—across the different tiers of government, and horizontal cooperation—between local governments, to ensure the most efficient allocation of resources and responsibilities among different constituent elements of the intergovernmental framework. Such agreements, in the form of compacts or other mutually- agreed or legally binding arrangements, form an essential part of intergovernmental relations.

94. It is worth noting that MNA-8 countries have undertaken a number of important measures over recent years, mostly in the early stage areas of reform. These measures have been focused largely on initiating or re-launching electoral reforms and aim at increasing voice and participation in response to citizen demands. However, such measures if not coupled with efforts to realign and reassign functional responsibilities and expenditure assignments to the local level, where appropriate, could create expectations and demand overload for intergovernmental systems in transition that will be difficult to respond to at the local level.

95. Creating administrative and technical capacity at local level. Local institutional capacity is one of the most important factors contributing to a well-functioning decentralized civil service system. Where local institutions already exist—such as in Morocco or Iran—the challenge will be to reinforce them institutionally and legally as well as to strengthen their personnel management capacities. Where local government institutions are embryonic or exist only at an informal level—such as in Yemen or Egypt—the necessary institutional and legal framework will have to be created before any type of reform of the administration is undertaken.

96. While the broad outlines of a policy to strengthen local management capacities will be national in scope and focus, to capture the required externalities, specific operational strategies and implementation programs should be left to municipalities with a provincial coordination and oversight role. A comprehensive human resources strategy will become the foundation for real administrative devolution. While, specialists in all aspects of urban planning and management are required, in particular, attention should be paid to develop a cadre of professional city managers. This is fundamental to make local autonomy and authority work.

97. Improving local information systems and strengthening knowledge networks. Reliable and timely data should inform policy formulation and decision making. The central government has a key role in setting up systems and standards for data collection and analysis. It should also provide the required technical expertise at the local level till such capacities take roots locally. It should also facilitate sharing of knowledge and experience among local governments by strengthening peer networks. Partnerships with national and international agencies, including universities, research and training institutes, professional forums and networks, and the private sector will enable exchange of policies and practices from around the country and the world.

98. Clarifying legal and regulatory frameworks. A medium to long-term need in many MNA countries will be to initiate a nation-wide consultative process on power-sharing arrangements and other aspects of governance to agree on a set of politically feasible policy objectives, coupled with an agreement on principles governing intergovernmental relations. This should serve as the basis for subsequent and comprehensive efforts to rationalize and streamline the legal and regulatory frameworks affecting the subnational tier of government. Furthermore, it should be done with the aim of providing a clearer delineation of responsibilities and authorities

36 among different tiers of government. Steps have already been taken in some MNA countries, such as Morrocco in that regard.

37 ANNEXES

Annex 1 – Conceptual Framework

Intergovernmental relations conceptually can be looked at from two major perspectives: three spheres and three degrees of decentralization are often distinguished. The allocation of decision making power and competencies can be made on the sphere of (a) Public administration, (b) Fiscal-financial relations, and (c) Political relations. The degree of decentralization could be (i) deconcentration (minimal); (ii) delegation (intermediate), and (iii) devolution (substantial).

Table A-1.1. Spheres and Degrees of Decentralization

Administrative Fiscal-financial Political  Local government has full  Local government sets  Local government is led by discretion in local decisions, spending priorities; determines locally elected politicians

employs local staff, and how best to fulfill service tasks expected to be accountable to primarily reports and is in view of national standards; the local electorate accountable to the local citizens regulates and monitors service  Citizens‘ participation can be (devolved functions: utilities, providers strong, albeit may be subject to Devolution basic health, primary-secondary  Funding can come from local capture by elites, social education, certain social revenues, shared revenues, and polarization, and clientelism benefits) transfers from the central  Local providers act as agents  Central sets spending  Local government may be

of the central; functions are priorities, program norms and led by locally elected officials,

assigned by and fulfilled on standards; Locals have some but still accountable fully/partly behalf of the central (even in authority to use resources in to the central decentralized systems birth, view of local circumstances;  Citizens‘ participation is marriage, death registration, Delegation  No independent local more local and proximate, but unemployment, housing, land revenue source decisions can be overruled by records) the central  Units are regional/local  No local discretion on how  Local leadership vested in

representatives of the central the services are provided and local officials (governor, mayor)

 Employees belong and how the budget allocation spent who are appointed by and accountable to the central (even  Funds come from the center accountable to the center. in decentralized systems, through central or ministries‘  Citizens‘ participation treasury offices and monitoring budget (voice) remote and weak and supervision of health,  No independent local

education, environment revenue Deconcentration protection)  Employees often paid by the central Source: World Bank (2003f).

The framework above outlines a range of different options and degrees of decentralization that are in practice in countries around the world. Essentially centralized societies have deconcentrated administrations, and/or representatives of the central government with strong voting power in locally elected councils. Societies that have been traditionally decentralized (Switzerland, USA, Brazil) plus some that have recently changed (Hungary, Poland, Latvia) illustrate wide-scale devolution of functions in all administrative, fiscal and political spheres, hence high degree of local government autonomy.

In a static sense the degree of decentralization can be measured by the composition of the above factors. In a dynamic sense, however, decentralization symbolizes a process where major

38 government functions are gradually devolved following the principle to allocate decision competencies to the layer of government that most closely represent the beneficiaries of the function in question (Ter-Minassian 1997). So key functions such as national defense, fiscal and monetary policy, taxation, higher education, social insurance, pension, interstate transport, telecommunication etc. should remain central services. Secondary education, specialized hospitals, regional development etc. are typically provided by the intermediate layers of governments. Local utilities, basic health and primary education etc. are typically provided by municipal or village local governments often in cooperation with the private providers (see also Annex 9.3.).

Table A-1.2. Framework of Fiscal Decentralization

Expenditure Allocation of service responsibilities to various government layers. Assignment Administrative framework: planning; preparation, implementation and revision of budgets; financial reporting; accounting; auditing; monitoring and regulation of service provision Revenue Allocation of rights for rising revenues, levy taxes and collecting fees. Assignment Policy goal: assignment of own-source revenues for each level of governments Transfer System Reduction of vertical imbalances and horizontal disparities. Policy function: decision on transfer pool and allocation rules. Instruments: tax sharing, general purpose and earmarked grants, discretionary grants should be exceptional Public Debt Regulation of sub-national borrowing rights and rules. Management Instruments: administrative control, rule-based control, joint responsibility, market control Institutional Rules and organizations for resolution of fiscal and political issues. framework Budget harmonization, central government monitoring functions, internal and external audit, rules for resolution of financial distress, court procedures.

In well decentralized countries, each government tier has some public governance and service delivery functions. The central government is responsible for providing national public services; developing the legislative framework; setting up national policy objectives and supports them with general guidelines and through earmarked and targeted subsidies. The regional/local deconcentrated units of the central government are not by definition a part of the elected local governments, rather these independent offices are used for monitoring and control of the fiscal system, enforce sector rules, and maintain standards. The sub-national governments ideally should have autonomy in revenues, expenditures, and setting local development priorities; they are the legislative, enforcement, and regulatory bodies within and in the context of their jurisdiction; they are responsible for developing, financing, and delivering most local services directly or in partnership with the private sector or other local governments. Since they collect significant local revenues, they are acceptable to their citizens about the sensible use of scarce local resources.

No matter whether a system is centralized or decentralized, in order to be effective, it should provide the right incentives for economic efficiency, fiscal equity, political accountability, and administrative effectiveness in fulfilling key public functions. This is the conceptual basis for analyzing or comparing various intergovernmental systems.

39 Fiscal autonomy refers to that local government that attains full competency and decision autonomy in local expenditures, revenues, and borrowing, nonetheless they should meet national standards and obey rules. Expenditure autonomy entails ability to set priorities, draw and implement development plans including the form, area, and size of local services, but also independently prepare and execute local budget. Revenue autonomy means that a significant portion of the local budget is financed from own-source revenues which include locally managed taxes, fees, charges and proceeds from assets. Financial autonomy entails sovereignty in borrowing and attracting private equity.

The worldwide movement of decentralization is based on key efficiency expectations and proven positive outcomes. These suggest that successfully decentralized systems result in better administrative capacity, accountability, and transparency. These systems attain stronger fiscal capacity, better resource mobilization and allocation, and they are more successful in attracting private debt and equity, and hence enable the countries to grow faster29. Decentralization could lead to better political accountability, transparency and responsiveness. Decentralization could play a key role in providing efficient, effective, and sustainable services. These all could have an ultimate impact, inter alia, in increasing income and productivity, increased literacy and life expectancy, decreasing infant mortality, improving inclusiveness of the people and growth of civil society (Parker 1995)30.

29 During the transitional recession (GDP dropped by 20-30 %) local services remained stable or even continued improving due to the innovative adaptation of the local governments in the most progressive transition economies (Hungary, Poland, Czech Republic), while services collapsed in countries that did not decentralize (Bulgaria, Caucasus or Central Asia countries). 30 It is important to mention that there are numerous cases of mismanaged and failed decentralization attempts. These suggest that decentralization can entail significant costs in terms of distributional equity and macroeconomic management (Prud‘homme 1995, Tanzi 1996, Ter-Minassian 1997)

40

Annex 2 – Average Annual Exchange Rates (local currency / US$)

Country Currency 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Egypt EGP 0.81 1.42 2.96 3.32 3.35 3.39 3.39 3.39 3.39 3.39 3.40 3.47 3.96 4.50 Iran IRR 72 68 67 66 319 1,749 1,748 1,751 1,753 1,752 1,754 1,762 1,754 4,999 Jordan JOD 0.57 0.66 0.68 0.68 0.69 0.70 0.70 0.71 0.71 0.71 0.71 0.71 0.71 0.71 Lebanon LBP 494 672 925 1,534 1,743 1,683 1,624 1,574 1,542 1,519 1,511 1,510 1,509 1,508 Morocco MAD 8.49 8.23 8.69 8.53 9.30 9.19 8.54 8.72 9.52 9.60 9.80 10.62 11.29 11.00 Tunisia TND 0.95 0.88 0.92 0.88 1.00 1.01 0.95 0.97 1.11 1.14 1.18 1.37 1.44 1.42 WBG ILS 1.91 2.02 2.27 2.45 2.83 3.01 3.01 3.19 3.45 3.79 4.14 4.08 4.20 4.74 Yemen YER N/A N/A 12 12 12 12 N/A 94 129 136 156 162 169 176 Source: SIMA.

41

Annex 3 – Local Government Data in MNA-8

Table A-3.1. LG Expenditures Characteristics in Selected MNA Countries Egypt Iran Jordan Lebanon Morocco Tunisia WBG Yemen Weighted (2001) (urban; 2001) (2001) (2000) (2000) (urban; 2002) (2002) (2003) average Total LG Expenditures US$ million a 5,577 N/A 90 322 1,007 290 136 673 US$ per capita 86 N/A 18 74 35 44 42 36 61 % of GDP 4.7% 1.6% 1.0% 2.0% 3.0% 1.4% 2.8% 4% b 3.0% % of total public expenditures 18% 8.5% 3% 6% 9% 4% 11% 15% 12% LG Investment Expenditures US$ million 911 N/A 20 81 148 109 41 101 US$ per capita 14 N/A 4 19 5 17 13 5 11 % of total LG expenditures 16% 71% 22% 25% 15% 38% 30% 15% 35% LG Operating Expenditures US$ million 4,667 N/A 70 241 860 181 95 572 US$ per capita 72 N/A 14 56 30 28 30 31 50 Operating expenditures as % of 84% 34% 78% 75% 85% 62% 70% 85% 66% total LG expenditures Salaries as % of total LG 61% 16% 50% 75% 37% 62% 37% 75% 44% expenditures (2000)b a For exchange rates used for conversion see Annex 8.2. b Estimate. Source: Country studies, SIMA, World Bank (2003d and 2004).

42

Table A-3.2. LG Revenue Characteristics in Selected MNA countries

Egypt Iran Jordan Lebanon Morocco Tunisia Yemen Weighted (2001) (urban; 2001) (2001) (2000) (2000) (urban; 2002) (2003) average Total LG Revenues US$ million a 6,439 7,948 100 317 1,106 328 664 US$ per capita 99 190 20 73 39 50 36 109 Locally Generated LG Revenues US$ million 1,556 5,961 45 168 681 193 121 US$ per capita 24 143 9 39 24 30 7 62 % of total LG revenues 28% 75% 45% 53% 62% 59% 18% 50% Transfers US$ million 4,097 1,987 44 66 338 104 543 US$ per capita 63 48 9 15 12 16 29 42 % of total LG revenues 73% 25% 44% 21% 31% 32% 82% 48 Borrowing US$ million 785 N/A 12 83 88 32 N/A US$ per capita 12 N/A 2 19 3 5 N/A 9 % of total LG budget 14% N/A 12% 26% 8% 10% N/A 12% a For exchange rates used for conversion see Annex 8.2. b 39 percent if Tehran is excluded. c There has been no borrowing by Tehran municipality, however, no information is available on other LGs. d Includes only borrowing from FEC.

Source: Country Studies, SIMA, World Bank (2003d and 2004).

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Table A-3.3. (9.2.2.) Population per LG Employee Country (year) Number of LG Population Population per employees (million) LG employee Egypt (2001) 3,103,664 65.18 21 Jordan (2001) 17,864 5.03 282 Lebanon (2000) 8,414 4.33 514 Morocco (2000) 118,792 28.71 242 Tunisia – urban (2002) 23,572 6.53 277 WBG (2002) 11,442 3.21 281 Yemen (2002) 390,861 18.60 48 Weighted average Source: WB calculations based on Country Studies.

Table A-3.4.(9.2.4.) Characteristics of Water and Sewerage Services in Selected MNA-8 Cities Iran Jordan Lebanon Morocco Tunisia WBG Yemen Good practice (Teheran) (Amman) (average) (Casablanca) (Tunis) (Gaza) (Sana’a) (Range) Unaccounted-for water losses 35% 52% 40% 34% 21% 31% 50% 15-20% Per capita water use (liters / day) b 80 110 80 70 50 120-150 Employees / 000 connections c 6 6 10 7 10 4-6 O&M cost recovery No No Yes No (Yes) Yes a Including coverage from standpipes, but excluding private piped systems (in Sana'a) b Estimated amount from public network actually used by the consumer, net of physical losses c Comparisons have to take into account the varying degree of sewerage coverage Source: Saghir, Schiffler and Woldu (2000)

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Annex 4 – Inter-governmental Relations in Countries around the World

Tables A-4.1 (9.3.1.) Expenditure Shares of Central and Sub-national Governments in Unitary Countries

Defense Education Health Housing Police Recreation Welfare Subsidies Other C L C L C L C L C L C L C L C L C L Albania 100% 0% 20% 80% 70% 30% 68% 32% 100% 0% 65% 35% 81% 19% 63% 37% 75% 25% Azerbaijan 100% 0% 17% 83% 16% 84% 2% 98% 100% 0% 55% 45% 99% 1% 100% 0% 84% 16% Belarus 98% 2% 18% 82% 21% 79% 0% 100% 81% 19% 42% 58% 97% 3% 92% 8% 74% 26% Bulgaria 100% 0% 39% 61% 44% 56% 32% 68% 98% 2% 65% 35% 94% 6% 90% 10% 82% 18% Croatia 100% 0% 81% 19% 99% 1% 63% 37% 99% 1% 31% 69% 99% 1% 54% 46% 64% 36% Czech Republic 98% 2% 82% 18% 95% 5% 23% 77% 83% 17% 35% 65% 93% 7% 98% 2% 41% 59% Denmark 100% 0% 53% 47% 5% 95% 69% 31% 88% 12% 43% 57% 46% 54% 65% 35% 73% 27% Estonia 100% 0% 45% 55% 97% 3% 1% 99% 99% 1% 61% 39% 91% 9% 56% 44% 62% 38% Iceland 100% 0% 47% 53% 99% 1% 31% 69% 92% 8% 45% 55% 78% 22% 82% 18% 78% 22% Kazakhstan 86% 14% 22% 78% 57% 43% 0% 100% 75% 25% 55% 45% 73% 27% 66% 34% 79% 21% Latvia 99% 1% 28% 72% 95% 5% 20% 80% 93% 7% 53% 47% 94% 6% 91% 9% 66% 34% Lithuania 100% 0% 30% 70% 98% 2% 0% 100% 97% 3% 61% 39% 91% 9% 99% 1% 78% 22% Mauritius 100% 0% 100% 0% 100% 0% 77% 23% 99% 1% 79% 21% 99% 1% 100% 0% 91% 9% Moldova 100% 0% 32% 68% 40% 60% 23% 77% 85% 15% 64% 36% 95% 5% 93% 7% 57% 43% Mongolia 100% 0% 28% 72% 13% 87% 38% 62% 51% 49% 61% 39% 99% 1% 31% 69% 56% 44% Norway 100% 0% 37% 63% 23% 77% 13% 87% 83% 17% 35% 65% 81% 19% 85% 15% 66% 34% Poland 100% 0% 43% 57% 88% 12% 18% 82% 96% 4% 45% 55% 95% 5% 88% 12% 62% 38% Slovak Republic 100% 0% 100% 0% 100% 0% 40% 60% 95% 5% 72% 28% 99% 1% 96% 4% 73% 27% Slovenia 99% 1% 76% 24% 99% 1% 22% 78% 94% 6% 55% 45% 99% 1% 77% 23% 81% 19% UK 100% 0% 33% 67% 100% 0% 59% 41% 48% 52% 35% 65% 80% 20% 91% 9% 78% 22% C= Central Government, S= State or Provincial Government, L= Local Government Source: International Monetary Fund (1998)

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Table A-4.2.(9.3.2.) Expenditure Shares of Central and Sub-national Governments in Federal Countries

Education Health Housing Police Recreation Welfare Subsidies Other C S L C S L C S L C S L C S L C S L C S L C S L Australia 28% 72% 0% 52% 47% 1% 23% 44% 33% 13% 83% 3% 20% 46% 34% 90% 8% 1% 58% 33% 9% 46% 46% 8% Bolivia 57% 37% 6% 38% 47% 15% 23% 31% 46% 100% 0% 0% 24% 14% 62% 93% 6% 2% 30% 39% 30% 78% 5% 17% Indonesia 93% NA 7% 91% NA 9% 98% NA 2% 99% NA 1% 100% NA 0% 100% NA 0% 14% NA 86% 100% NA 0% Russian Federation 14% NA 86% 15% NA 85% 7% NA 93% 73% NA 27% 15% NA 85% 90% NA 10% 89% NA 11% 64% NA 36% Switzerland 10% 55% 36% 57% 25% 19% 14% 23% 63% 7% 67% 26% 13% 31% 56% 78% 14% 8% 33% 44% 23% 39% 28% 33% USA 5% 43% 52% 57% 32% 11% 72% 9% 20% 18% 28% 55% 24% 11% 65% 69% 22% 8% 64% 26% 9% 69% 13% 19% C= Central Government, S= State or Provincial Government, L= Local Government Source: International Monetary Fund (1998).

Table A-4.3. (9.2.3.) LG Revenue Structure – Turkey Locally collected revenues Transfers Borrowing Total US$ per capita % of LG budget US$ per capita % of LG budget US$ per capita % of LG budget US$ per capita Turkey (2000) 72 39 92 50 20 11 184 Source: World Bank (2002).

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Table A-4.3. (9.3.3.) Intergovernmental transfer systems in selected countries Sources of funds for transfers Description Belgium Fixed share of national revenues The full proceeds of radio-television fees collected by the federal government; a share of personal income tax (apportioned according to a historic breakdown of the amounts and indexed according to the GNP); a share of VAT Colombia Fixed share of national revenues There are three components of the transfer system: the situado fiscal (SF), the participations municipals 24.5 percent of national revenues to (PM) and the sistema nacional de cofinanciacion (SNC). The SF consists of 24.5% of national current departmental governments (second revenues, it is transferred to departments to finance education and health expenditures. The PM consists tier); 22 percent of national revenues of a percentage of national current revenues, increasing annually to a scheduled maximum of 22 percent, to municipal governments (third tier). it is transferred to municipalities for ―social investments.‖ The SNC finances specified sub-national projects on a matching basis. Turkey Fixed share of national revenues In addition, central government provides additional support for certain projects in the form cost 6 percent of national tax revenues reimbursement from different funds; such as Local Authorities Fund, Municipalities Fund, Traffic Services Development Fund, Tourism Development Fund. Japan Fixed share of national revenues The main source of transfer pool is local allocation tax (LAT)—an unconditional transfer system that is a LAT: Fixed percentages of 5 taxes tax-sharing arrangement. LAT is distributed according to a uniform formula based on basic financial need and basic financial capacity of sub-national governments. It is paid annually to sub-national governments and varies across them inversely with their local fiscal capacity. LAT is not a traditional transfer but a shared-tax system that is similar to surtax on the national income tax base. Approximately 60 percent of prefect oral and 40 percent of municipal tax revenues are from the LAT (see annex 4). Spain Fixed share of national revenues The major unconditional transfer source is the central government‘s general revenues and PIT collected in each sub-national government jurisdiction. USA Annual Budget/ Cost Reimbursement There are more than 600 different federal transfer programs to state and local governments, most of which are conditional transfers. The largest portion of the amounts of federal transfers is used to fund healthcare programs administered by the states. Source: Serdar Yilmez

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Annex 5 – Governance Indicators

Table A-5.1. (9.4.1.) Kaufmann Governance Indicators (2002) Egypt Iran Jordan Lebanon Morocco Tunisia WBG Yemen MNA-8 World average Voice / accountability a -0.87 -1.04 -0.41 -0.54 -0.30 -0.83 -1.08 -0.88 -0.74 0.56 Political stability b -0.35 -0.62 -0.44 -0.59 -0.14 0.24 -1.69 -1.36 -0.62 0.67 Government effectiveness c -0.32 -0.46 0.36 -0.41 0.07 0.65 -1.04 -0.87 -0.25 0.47 Regulatory quality d -0.45 -1.28 0.10 -0.47 0.02 -0.02 -1.02 -0.60 -0.47 0.70 Rule of law e 0.09 -0.58 0.33 -0.27 0.11 0.27 -0.31 -1.23 -0.20 0.61 Control of corruption f -0.29 -0.38 0.00 -0.34 -0.04 0.35 -0.99 -0.69 -0.30 0.48 Average -0.37 -0.73 -0.01 -0.44 -0.05 0.11 -1.02 -0.94 -0.43 0.58 a Measures the extent to which citizens of a country are able to participate in the selection of governments, including indicators measuring the independence of the media. c Measures perceptions of the quality of public service provision, the competence of civil servants, the independence of the civil service from political pressures and other factors. e Measures the extent to which agents have confidence in and abide by the rules of society. These include perceptions of the incidence of both violent and non-violent crime, the effectiveness and predictability of the judiciary, and the enforceability of contracts. f Measures perceptions of corruption. Despite this straightforward focus, the particular aspect of corruption measured by the various sources differs somewhat, ranging from the frequency of ―additional payments to get things done,‖ to the effects of corruption on the business environment, to measuring ―grand corruption‖ in the political arena or in the tendency of elite forms to engage in ―state capture‖. This broadly corresponds to the Corruption Perception Index of Transparency International as well (see table 9.4.3. below). Source: Kaufmann et al (2003).

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Table A-5.2.(9.4.2.) World Bank Governance Indicators Egypt Iran Jordan Lebanon Morocco Tunisia Yemen MNA-8 MNA-15 LMIC Governance Indices IPA b 30 c 44 45 42 39 35 19 36 32 54 IQA d 38 30 51 35 52 54 34 38 47 41 IGQ e 30 30 44 32 43 43 23 32 37 41 TOTAL 98 104 140 109 134 132 76 106 116 136 Gap with MNA-15 IPA -2 12 13 10 7 3 -13 4 IQA -9 -17 4 -12 5 7 -13 -9 IGQ -7 -7 7 -5 6 6 -14 -5 TOTAL -18 -12 24 -7 18 16 -40 -10 Gap with LMIC IPA -24 -10 -9 -12f -15 -19 -35 -18 -22 IQA -3 -11 10 -6 11 13 -7 -3 6 IGQ -11 -11 3 -9 2 2 -18 -9 -4 TOTAL -38 -32 4 -27 -2 -4 -60 -30 -20 a Due to lack of data for WBG, it is not included in the table and also in the calculation of the weighted average for MNA-8, MNA-15 and LMIC. b The index of governance quality (IGQ) aggregates all indicators available for MNA-8 countries and measures the overall quality of governance processes. c 0 – 100. the higher the number the better governance. d The index of quality of administration (IQA) assesses the capability of the public administration to formulate and implement the sound policies and the respect for institutions that govern interactions between citizens and government. Broadly, it measures the relative strength of internal accountability in the public administration by aggregating 10 indicators that measure the risk and level of bureaucratic corruption, black market activity, the degree and extent to which certain rules and rights are protected and enforced, the quality of the budgetary processes and public management, the efficiency of revenue mobilization, the overall quality of the bureaucracy, and the independence of civil service from political pressures. e The index of public accountability (IPA) assesses the process of selecting and replacing those in authority. It measures the quality of governance according to the inclusiveness of access to basic political and civic rights and the relative strength of external accountability mechanisms. It aggregates 12 indicators that measure the level of openness of political institutions in a country and the extent to which political participation is free, fair, and competitive; civil liberties are assumed and respected; and the press and voice are free from control, violation, harassment, and censorship. It also captures the transparency and responsiveness of the government to its people and the degree of political accountability in the public sphere. f While Lebanon would qualify as Upper Middle Income Country and Yemen as Low Income Country, for simplicity of comparison they are both compared with indicators for the Lower Middle Income Countries. Source: World Bank 2003e and author‘s calculations.

Table A-5.3. (9.4.3.) Corruption Perceptions Index (2003) a Egypt Iran Jordan Lebanon Morocco Tunisia WBG Yemen Finland Bangladesh (highest) (lowest) 3.3 3 4.6 3 3.3 4.9 3 2.6 9.7 1.3 a Corruption Perception Index – perceptions of the degree of corruption as seen by business people, academics and risk analysts, and ranges between 10 (highly clean) and 0 (highly corrupt). It is assessed based on 17 different polls from 13 independent institutions. Source: Transparency International (2003).

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