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The Practice of Fiscal Federalism in Ethiopia: a Critical Assessment 1991-2012 an Institutional Approach

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The Practice of Fiscal Federalism in Ethiopia: a Critical Assessment 1991-2012 an Institutional Approach THE PRACTICE OF FISCAL FEDERALISM IN ETHIOPIA: A CRITICAL ASSESSMENT 1991-2012 AN INSTITUTIONAL APPROACH Doctoral Thesis Presented to the Faculty of Economics and Social Science at the University of Fribourg (Switzerland) By Ghebrehiwet Tesfai Baraki from Ethiopia In fulfilment of the requirements for the degree of Doctor of Economic and Social Sciences Accepted by the Faculty of Economics and Social Sciences May 10th, 2014 at the proposal of Prof. Dafflon Bernard (first supervisor) and Prof. Vaillancourt Francois (second supervisor) Fribourg, Switzerland, April 14, 2015 The Faculty of Economic and Social Sciences at the University of Fribourg (Switzerland) neither approves nor disapproves the opinions presented in this doctoral thesis: they are those of the author only (decision of the Faculty Council, January 23, 1990). Acknowledgements I owe a great deal to my advisor Professor Bernard DAFFLON; not only for his intellectual guidance but also for his painstaking corrections, comments, and suggestions. I benefited enormously from the wisdom and long years experience of Professor Bernard DAFFLON. His commitment to guide and assist my research with rigorous advice, and encouragement will surely remain in my heart for ever. Professor Vaillancourt, at Montreal University, provided remarks and suggestions on several issues in the last version of the thesis. My gratitude and warm thanks to both of them. There are many other people to whom I feel indebted. My gratitude goes to Prof. V.K.Padmanabham for his painstaking spelling and grammar corrections as well as for his valuable comments. Professor, Dr Feseha- Tzion Mengistu also deserves thanks for his comments on the first draft of the first three chapters. I am also indebted to Mr. Petros Michael and family who made me feel at home whenever I visited them in Genève, Mr.Kurt Pfister and family, founders of Green Ethiopia and friends of Poor Ethiopians, for their sincere concern and hospitality, and Dr Mengistu Arefain for his hospitability and interesting educational dialogue while I was in Fribourg. In addition, all these three friends exposed me to life in Switzerland. I also warmly thank to Mr. Samson Gonnetz, an old friend of mine since 1976, and to my beloved sister Shewanesh Ghebremariam for their truthful love, concern and encouragement. I am grateful to Addis Ababa University for financing my PhD study. I would like to express my sincere appreciation to all my informants and government agencies that provided me with information and make available relevant official documents. I also want to thank St. Justin administration (Fribourg, Switzerland) for granting me a partial scholarship for six months in 2012. Last but not least, I must express my indebtedness for the meaningful encouragement of my family - Mrs. Fiori, Danait, and Kaleb - who bore with fortitude my absence. Abstract The long statehood history of Ethiopia is known for its decentralized governance system with many autonomous regions and principals ruled by hereditary regional chiefs under various titles, but accountable to King of Kings at the centre. The autonomous regions were not only paying annual tribute to the king of kings, but also had to cooperate with the centre. Powers of the regional chiefs started to diminish at the turn of the nineteen century and had been completely abolished in the early twentieth century. The century old exclusive, suppressive and highly centralized governance system came to end in 1991 and a multi-ethnic federal arrangement has been adopted. The Federal Constitution of 1995 guarantees the right of self- determination of Nations, Nationalities and People (NNP) up to secession. Considerable political and administrative powers have been devolved to the states. Constitutionally speaking assignment of responsibilities to the states makes Ethiopia one of the most decentralized federations. The states have also access to a range of tax bases, except the custom duties related taxes. They have power to determine tax base, tax rate and administer. They have legislative power to levy and administer jointly over concurrent taxes. The Constitution also guarantees borrowing right of the states. The devolutions of all these powers to the States are political preferences of the ethnic-based political forces for having strong states. This dissertation examines the constitutional setting of the political decentralization, the devolution of assignment of responsibilities, taxation powers, the vertical intergovernmental transfer system and borrowing autonomy of the States as well as the Wereda (district) level decentralization vis-á-vis the practices at ground. The study finds that (i) the decentralization processes have been guided by specific circumstances of political, economic and historical realities of the country; (ii) The Federal Constitution aims at creating strong states. In practice, however, the political decentralization is not only more visible than the taxation and borrowing powers but also there are gaps between the de jure and de facto; (iii) the states hardly exercise their constitutional taxation powers. The uniformity of ‘choices’ has jeopardized the state’s tax autonomy; (iv) there is little relation between the degree of decentralization and the states’ borrowing autonomy. Generally speaking, the two decades of fiscal decentralization practices show that the intention of the Federal arrangement to have strong states has less congruence with the de jure. Author’s short curriculum Ghebrehiwet Tesfai Baraki received his BA degree in Economics from the University of Asmara, Eritrea in 1988 and was awarded his MA in Regional and Local Development Studies from Addis Ababa University (Ethiopia) in 2003. He has worked for various public and private bodies before he joined the Addis Ababa University as a lecturer in September 2005. Ghebrehiwet served the University as an Associate finance officer and as an acting director for the Institute of Federal Studies until he joined the University of Fribourg, Switzerland for his PhD study in 2008. Currently, he serves the University as the Chair person of the Centre for Federal Studies. His research interest includes fiscal federalism, decentralization, local financing and budgeting, regional and local development. Contents Chapter 1 1 Introduction 1 1.1 Statement of Research Problem 2 1.2. Research Objectives 4 1.3 Research Questions 5 1.4 Research Methodology and Source of data 5 1.5 Relevance of the study 6 1.6 Time period considered 7 1.7 Organisation of the dissertation 7 Chapter 2 9 Decentralized Versus Centralized Governance Brief Historical Perspective 9 2.1 Governance System during the Ancient and Medieval Periods 10 2.2 Unification of Ethiopia: (De) Centralized State Building Strategies 13 2.2.1 Emperor Tewodros II Reign (r1855-1868) 13 2.2.2 Yohannes IV Reign (r1871-1889) 15 2.2.3 Menelik II Reign (r 1889-1913) 15 2.2.4 Haile Selassie I Reign (r 1930-1974) 17 2.2.5 The Military (Degrue) Regime (1974-1991) 32 2.2.6 The Emerging of Ethnic-Based Movements 34 2.3 Conclusion 36 Chapter 3 39 The Constitutional Designs of the Multi-ethnic Federal Arrangement 39 3.1 The Federal Constitutional Setting 40 3.2 Creation of the States (Kilils) and Local Governments 47 3.2.1 The Making of the Kilils (1992-1994) 47 3.2.2 Remaking of the States of the Federation (1994) 49 3.2.3 Redemarcation of the Local Governments (1995) 52 3.3 Debates on the feasibility of the federal arrangement 59 3.3.1 Non-Economic Arguments 59 3.3.2 Economic Arguments 71 Chapter 4 93 Assignment of Responsibilities-Theory 93 4.1 Theories of Fiscal Federalism on Assignments of Responsibilities 95 4.1.1 Macro-economic Stabilization Function 95 4.1.2 Redistribution function 99 4.1.3 Allocation of Resources 103 4.2 (De)Centralization Matrix for Assignment of Responsibilities 110 4.2.1 Subsidiarity principle 113 4.2.2 Minimum national standard of public service delivery 114 4.2.3 Administrative capacity 114 4.2.4 Institutional capacity 115 4.2.5 Accountability and transparency 116 4.3 Conclusion 117 Chapter 5 119 Assignment of Responsibilities in Ethiopia 119 5.1 Vertical Separation of Powers in Ethiopia 120 5.2 The Criteria for Assignment of Responsibility in Ethiopia 147 5.2.1 Macroeconomic management responsibility 147 5.2.2 Political economy of redistribution policy 152 5.2.3 Residents’ Preferences 158 5.2.4 Cost of information and decision making 162 5.2.5 Economies of Scale 164 5.2.6 Inter-jurisdictional externality/ spill over effect 166 5.2.7 Institutional (political) preference 168 5.2.8 Minimum national standard of public service delivery 170 5.2.9 Principle of Subsidiarity 171 5.3 Budget Autonomy of the States and Local Governments 173 5.4 Conclusion 177 Chapter 6 180 Theories of Tax Assignment 180 6.1 General Principles of Tax Assignment 180 6.2 Tax Assignment Decision Matrix 189 6.3 Tax externality, tax competition and tax harmonization 197 6.3.1 Tax externality and vertical tax competition 197 6.3.2 Horizontal tax competition 198 6.3.3 Tax Harmonization 200 6.4 Financial autonomy and Tax autonomy 203 6.4.1 Financial autonomy of Sub national governments 203 6.4.2 Tax Autonomy (Tax sovereignty) 206 6.5 Conclusion 212 Chapter 7 214 Tax Assignment in Ethiopia 214 7.1 The Constitutional Context of the Tax Assignment 214 7.2 Some Distinctive Features of the Tax Assignment 228 7.2.1 No tax immunity on profit making enterprises 229 7.2.2 Undesignated power of taxation 229 7.2.3 Concurrent powers of taxation 230 7.2.4 Tax Assignment on tax bases is seldom applied 233
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