Intergovernmental Fiscal Transfers in Asia: Current Practice and Challenges for the Future Edited by: Paul Smoke and Yun-Hwan Kim Foreword In recent years, the issue of intergovernmental fiscal transfers has re- ceived increasing attention among policymakers for various reasons. These include (i) disparity in delivery of social services between regions, (ii) economic gap between growth centers and lagging areas, and (iii) progress in economic and political decentralization. While strengthening institutions, functions, and finances of state/local governments is becoming increasingly important, devel- oping a more productive and equitable intergovernmental transfer scheme has likewise become a priority issue. The issue of allocating national resources to local communities has been a major policy agenda as subnational governments play a stronger role in carrying out socioeconomic policies. For a long time, the governments in the Asia-Pacific region have made enormous efforts to minimize distortions and defects in the countries’ fiscal transfer schemes. However, existing disparities in production growth, fiscal bases, and the extent of public services call for greater governmental interven- tions including a reform in central-state fiscal relations. An expeditious reform aimed at addressing the underlying fiscal and economic imbalances and ensur- ing equitable delivery of public services across states would place powerful impetus to the long-term socioeconomic progress. The new focus on the greater fiscal role by local governments has been supported by international development agencies including ADB. ADB has stepped up its assistance for regional development projects in relation to in- creasing economic and political decentralization in its member countries. At present, fiscal strengths of subnational governments are assuming even greater importance in the operations of ADB as it places the emphasis of its operations on poverty reduction and the participation of local stakeholders, including lo- cal communities and low-level governments, in its projects and programs. This operational shift has been strengthened by a significant increase in loans and technical assistance to address poverty, education, health, regional development, and environment. All of these require sound backup of fiscal resources, covering both capital and recurrent expenditures, from subnational governments as well as their enhanced institutional capacity. Against this backdrop, ADB has undertaken cross-country comparative research to assess intergovernmental fiscal transfers. It included three country studies on India, Pakistan and the Philippines and a more general study on broad international experiences. The research has examined pertinent theories, international experiences, and evolution of fiscal equalization arrangements between the central governments and provincial or state governments, as well iv Foreword as the underlying rationale, problems and issues in those countries. A Confer- ence on Intergovernmental Fiscal Transfers for Equitable In-Country Growth, which was held in September 2001 through the support and generosity of the National Institute of Public Finance and Policy (NIPFP) in New Delhi, India, discussed draft versions of these four reports and received many valuable com- ments. The book brings together all these reports that were commissioned by ADB as well as two more reports on Cambodia and Indonesia which the au- thors have kindly contributed. The study is expected to reinforce ADB’s ongoing efforts to formulate better country assistance programs and provide critical inputs to public sector reform programs in Asian developing countries. Ifzal Ali Chief Economist Economics and Research Department Asian Development Bank Acknowledgement We are deeply grateful to all paper writers including Nuzhat Ahmad, Joseph Capuno, Blane Lewis, Leonardo Romeo, Larry Schroeder, Paul Smoke, D.K. Srivastava and Syed Ashraf Wasti and to Yun-Hwan Kim who initiated and managed this study. We are likewise indebted to the valuable contributions of David Mammen of the Institute of Public Administration at the Robert F. Wagner Graduate School of Public Service at New York University. We also thank Maria Blanco of the Institute for her careful review and editing of the manuscripts. Special thanks are extended to Jungsoo Lee, Gunter Hecker, M.G. Quibria, Brahm Prakash and Jean-Pierre Verbiest of Asian Development Bank (ADB) who provided support and encouragement. We thank the National Institute of Public Finance and Policy (NIPFP) in New Delhi, India and its Director, Ashok Lahiri, for collaborating with ADB in the conference to dis- cuss all papers included in this book. We are also grateful to all participants in the conference, including K.C. Pant, Deputy Chairman, and N.J. Kurian, Advi- sor, Planning Commission, Government of India; R.J. Chelliah, Amaresh Bagchi and Om Prakash Mathur, Professors, NIPFP; and J.L. Bajaj, Chairman, UPSERC, Lucknow. We likewise thank Frank Polman, former Country Director for ADB’s India Resident Mission, who graced the opening of the conference. Special acknowledgement goes to the project staff, Sally Mabaquiao, Pat Baysa, Ludy Pardo and Jennifer Simon for overseeing the production of the book. We ap- preciate the contributions of Ma. Priscila del Rosario who proofread the entire manuscript. Lastly, we gratefully recognize all the efforts and contributions of those who, one way or another, provided assistance in making this technical assistance project meet its fruition. Table of Contents Foreword iii Acknowledgement v List of Abbreviations viii List of Tables and Charts x Chapter 1 The Role and Challenges of Intergovernmental Transfers in Asia 1 Yun-Hwan Kim and Paul Smoke Chapter 2 Intergovernmental Fiscal Transfers: Concepts, International Practice and Policy Issues 20 Larry Schroeder and Paul Smoke Chapter 3 Cambodia 60 Leonardo G. Romeo Chapter 4 India 83 D. K. Srivastava Chapter 5 Indonesia 138 Blane D. Lewis Chapter 6 Pakistan 176 Nuzhat Ahmad and Syed Ashraf Wasti Chapter 7 Philippines 219 Joseph J. Capuno List of Abbreviations ACA additional central assistance BFA balancing factor amount CDC Commune Development Committee CDD centrally directed discipline CDF Countrywide Development Fund CF Calamity Fund CHCA Comprehensive Health Care Agreement COA Commission on Audit CODEF cost of devolved functions CSF Commune/Sangkat Fund CSO Civil Society Organization DAK Dana Alokasi Khusus (Special Allocation Fund) DAU Dana Alokasi Umum (General Allocation Fund) DECS Department of Education, Culture and Sports DILG Department of Interior and Local Government DOH Department of Health DOLA Department of Local Administration DPWH Department of Public Works and Highways EFC Eleventh Finance Commission FA formula amount FC Finance Commission GCS general category states GSDP gross state domestic product GRP gross regional product HIS high-income states INPRES Instruksi Presiden (Grants by Presidential Instruction) IRA Internal Revenue Allotment LDF Local Development Fund LGC Local Government Code LGEF Local Government Empowerment Fund LGU local government unit LIS low-income states LPP Local Planning Process LSA lump-sum amount MBD market-based discipline MDF Municipal Development Fund MMDA Metropolitan Manila Development Authority ix List of Abbreviations MOEF Ministry of Economy and Finance MOI Ministry of Interior MTPDP Medium-Term Philippine Development Plan NALGU National Assistance to Local Governments NCSC National Committee to Support the Communes NFC National Finance Commission ODA Official Development Assistance PSDP Public Sector Development Program RTS representative tax system SCS special category states SDF standard distance formula SDO Subsidi Daerah Otonom (Regional Autonomy Subsidy) SFC State Finance Commission SFRF States Fiscal Reform Facility SRA Social Reform Agenda STA Specific Tax Allotment TFC Tenth Finance Commission List of Tables and Charts List of Tables Chap 2 Table 1. Alternative Forms of Intergovernmental Transfer Pro- grams Chap 3 Table 1. Classification of Eligible Expenditures Table 2. Budgetary Rules Chap 4 Table 1. Indian Macroeconomy: Key Developments in the 1990s Table 2. Center and States: Aggregate Budgetary Balance Table 3. Tax Buoyancies: Combined, Center and States Table 4. Profile of Recovery Rates Table 5. Growth Rates of Per Capita GSDP (at 1980–1981 Prices) Table 6. Real Per Capita GSDP: Growing Disparities Table 7. Per Capita Current Expenditure on Services: Relativities Between Low and High Income Group States (Average 1996–1997 to 1998–1999) Table 8. Macro Scenario before and after Restructuring Over the Period 2004–2005 Table 9. Restructuring of Public Finances: Main Features Table 10. Transfers as Percent of Gross Revenue Receipts of the Center Table 11. Inter-Se Sharing of Income Tax: Phase I Table 12. Inter-Se Sharing of Union Excise Duties: Phase I Table 13. Inter-Se Sharing of Union Taxes: Phase II Eighth, Ninth and Tenth Finance Commissions Table 14. Criteria and Relative Weights for Determining Inter-Se Shares of States: Tenth and Eleventh Finance Commis- sions Table 15. Parameters Affecting Growth Rates of Revenues/Expen- ditures Used by the Eleventh Finance Commission Table 16. Per Capita Nonplan Revenue Grants: 2000–2005 Table 17. Capital Expenditure in Government Budgets Table 18. Dispensation of Plan Assistance: Normal State Plan Table 19. Gadgil Formula: Alternative Versions Table 20. Share of Plan Grants Across States Table 21. Assistance as Percent of GDP: Selected