Roles and Expenditure across Levels of Government PREM/HD/INF Network Course on PUBLIC EXPENDITURE ANALYSIS AND MANAGEMENT Monday, March 21st, 2005, 1:00-2:30 pm Kai Kaiser Economist, PREM Public Sector Group (PRMPS) kkaiser@worldbank.org Recommended Background Readings Burki, Shahid Javed, Guillermo E. Perry, William R. Dillinger, 1999, Beyond the Center: Decentralizing the State, World Bank: Latin America & Caribbean Studies McClure, Charles E. & Martinez-Vasquez, Jorge, (2000), The Assignment of Revenues and Expenditures in Intergovernmental Fiscal Relations." (PDF 307K) Paper prepared for the core course on Intergovernmental Relations and Local Financial Management, World Bank Institute, Washington, DC: World Bank De Mello, L. (2004). Fiscal Decentralization and Subnational Expenditure Policy. OECD, (1997), Managing Across Levels of Government. Paris: Directorate for Public Governance and Territorial Development Shah, A. (1994). The Reform of Intergovernmental Fiscal Relations in Developing and Emerging Market Economies. Washington, DC, World Bank: 90.

Overview Intergovernmental Fiscal Systems Levels of Government Sub-National Expenditure Assignments Principles & Issues Empirical Evidence Intergovernmental Transfer Systems Vertical Imbalances and Own Source Revenue Mobilization Decentralization Challenges Design, Implementation, Diagnosis PEM versus Sectoral Lenses Top-down versus Bottom Up Accountabilities i

Decentralization: A World-Wide Phenomenon Underway in over 85 countries Political and economic rationales Varieties Deconcentration Delegation Devolution Privatization Spans political/legal, fiscal, administrative…

Four Pillars of Intergovernmental Fiscal System Expenditures Revenues Intergovernmental transfers Subnational borrowing/debt

Expenditure Assignments Macroeconomic stability Public Service Delivery Effectiveness/Efficiency Public Management Innovation Poverty Reduction Responsiveness Equalization

State Architectures Federal versus Unitary Tiers of Government Legal/Constitutional Status of Sub-Nationals? Tiers of Government # Levels Scale Devolved versus Deconcentrated Structures Territorial Organization Functional Agencies

Expenditure Assignment Issues Design Public goods, externalities, economies of scale, public sector competition Ideally, services should be provided at lowest level of government where benefits lie (subsidiarity) Revenue & Expenditure Assignment Design Will Differ Practice Ultimately, no single best assignment Provision “Technologies” May Change Over Time Preferences/Needs May Evolve Clarity in expenditure assignment often lacking dejure versus defacto Significant expenditure responsibility needed for autonomy Public provision doesn’t imply public production Contracting Out

Macroeconomic Stability Key factor is “hard budget constraint” Hierarchical versus Market Based Creates incentives for subnational fiscal discipline Limits risk of central government Can be “softened” through several channels (intergovernmental fiscal system, financial system, SOEs, borrowing, etc.) One often hears about the potential (and sometimes realized) risk of macroeconomic stability in decentralized countries. The critical factor influencing subnational fiscal behavior and central government liabilities is the presence of “hard budget constraints”. A hard budget cosntraint exists when the central government can and does refuse to provide additional resource to a sub-national government beyond a pre-agreed resource envelope. The problem often in decentralized countries is that despite local governments being”autonomous”, they will tend to overspend, under tax or overborrow if they believe that the central governent will provide additional resources to them (or “bail them out”) If central governments do bail out local governments, their discipline is compromised, national fiscal deficits can grow and this can ultiamtely be destabilizing. A budget constraint can be softened by a number of channels:

Allocative Efficiency (Subsidiarity) Matching local needs and preferences with local public expenditure patterns Assumes Substantial fiscal autonomy/budgeting Political decentralization Are elections held? How are candidates selected? Intra-party hierarchical control mechanisms? What do elections mean? “Bottom-up” Accountability

Decentralized Assignments Amount: Which Level of Government Decides Amount? Structure: Which Level of Government Defines Structure? Recurrent/Capital? Execution: Which Level of Government Executes the Expenditure? Supervision: Which Level of Government Supervises and Sets Standards? Country and Sectoral Contexts Provide for Significant Diversity in Arrangements

Decentralization Trends Subnational Expenditure Shares Subnational Tax Shares Developing Countries 1970s 13.0% (48) 10.4% (43) 1980s 13.2% (43) 7.7% (35) 1990s 13.8% (54) 9.3% (28) Transition Countries 26.1% (23) 16.6% (14) OECD Countries 33.8% (22) 18.7% (22) 32.3% (23) 32.4% (23) 19.1% (23) Source: International Monetary Fund. Government Finance Statistics Year Book , various years, Country Tables

Differences Across Regions Subnational Share of Expenditures Subnational Share of Revenues Note: Simple average of most recent observations in available countries. Numbers in parenthesis indicate number of countries represented. Figure do not typically include deconcentrated spending. Source: International Monetary Fund. Government Finance Statistics Year Book 1998, Country Tables.

International Diversity

Decentralized Social Sector Expenditures Source: IMF GFS

Comparative Assignments

Rationales for Intergovernmental Transfers Vertical imbalances Horizontal imbalances Inter-jurisdictional spillovers (externalities) Enhancing national objectives at the subnational level Paying for national programs implemented by subnational governments

Local Revenue Issues Own resources typically inadequate to carry out assigned functions Striking variations in size and capacity – one size doesn’t fit all Local revenues often inelastic, and not adequately responsive to changing needs Local revenue mobilization strengthens accountability Link taxes with benefits derived from local government services Simplest and most effective form of tax autonomy: discretion to set tax rates

A “Good” Transfer System Transfers should be transparent and predictable (formula-based) Equalization transfers should include A measure of “need” A measure of “capacity” Adequate sub-national revenue autonomy Stable but flexible financing Avoid a proliferation of conditional grants

Equity Extent of fiscal equalization Expenditure Needs Fiscal Capacity Ways and means for targeting poor places and poor people Add comment that experience with local solidarity will depend, amongst other things, on social capital and homogeniety of local populations.

Decentralization Challenges Balance responsibilities with resources, capacity and accountability Subsidiarity Finance follows function Responsibility with capacity (learn by doing) Accountability through political channels, own source revenues, participation and transparency Create incentives for implementation to match formal arrangements

Positive or Negative Outcomes? If designed well, decentralization can Move decision making closer to people (subsidiarity principle) Enhance efficiency and responsiveness of service delivery Enhance State Legitimacy/Accountability Improve economic growth Potentially alleviate poverty

But, good design is complicated Decentralization spans Political/Legal Fiscal Administrative policies and institutions…

Overarching Considerations Strategies Objectives? Champions Early design has long-run implications Sequencing/Priorities (esp. w/ low starting capacity) Monitoring & Evaluation / Base-lining Managing Change/Long Run Process New modes of operating Expectations Credibility that LGs can deliver services? Capacity, Accountability, & Resources? Post-Conflict Context Phasing

Common Dangers Elite capture (by ethnic/racial/social groups) Opaque or arbitrary decision-making Constituents, villagers, communities unable to hold representatives accountable due to incomplete information Corruption Patronage politics Excessive discretion to reward friends, punish rivals Central civil servants over-rule local representatives

Public Expenditure Management Lens Clarity in expenditure assignment? Adequacy of resources? Formula-based transfer system? Hard budget constraint? Budgeting and reporting systems Uniformity vs. flexibility Carrots vs. sticks Procurement E.g., Contracting Out

Service Delivery Lens Decentralization “Technology” Allocative efficiency effects Intergovernmental fiscal framework Sufficient capacity “Technology” School autonomy/community participation Purchaser/provider split in health Incentives for service providers Institutional structures Civil service, budgeting and financial management processes, performance incentives Resources reach front-line service providers (PETs) Accountability

Decentralized Accountability Mechanisms Top Down Central Supervision Reporting “Minimum Standards” Bottom Up Accountabilities Electoral Insufficient Proximity versus Scale/Capacity

Leveraging Transparency Sectoral Differences Health versus Education Public LG meetings, citizen fora Participatory Budgeting Publicize voting records Mobilize own source revenues Financial disclosure (improved budgeting) E.g., Annual Review Reports Freedom of Information Acts and/or other public disclosure laws (assets, affiliations) Monitoring by vigilance committees, NGOs, CBOs, media Media

Further Resources Decentralization Thematic Group Website Sign-up for Decentralization TG Decentralization & Local Financial Management Course March 29-30, 2005 AskGov