1. Equalization grants International Experience Indonesia’s Options Bert Hofman, World Bank with thanks to Jun Ma, Ehtisham Ahmad

2. Equalization grants zImportance of grants zRationale for grants zTypes of grants zEqualization grants zExamples of equalization grants zIssues for Indonesia

3. Importance of Grants Percent of government spending financed by grants

4. Importance of Grants Percent of Government spending financed by grants

5. Importance of Grants

6. Rational for grants zVertical imbalance zHorizontal imbalance zSpill-overs zNational priorities zNation building

7. Vertical Imbalance

8. Types of grants zGeneral Grants zConditional/specific grants yMatching and Non-matching Grants yOpen Ended and Closed-Ended Grants zBlock grants zEqualization grants

9. Issues in equalization grants design zShould one equalize? zWhat to equalize zExpenditure needs zFiscal capacity zSource of fund zMinimum standards zCapital spending zEqualizing grant and other grants

10. Equalization zOperational definition: “enable similar levels of service delivery at similar levels of taxation” zPrinciple: zEqualization Grant=Expenditure Needs- Fiscal Capacity zPractice: zfiscal capacity only (Canada) zfiscal capacity and some needs (Germany) zfiscal capacity and elaborate needs (Australia)

11. Examples of Equalization zAustralia zGermany zJapan zKorea zChina

12. Australia zFederal Country zLarge Vertical Imbalance zStrongly Equalizing Grants System zRevenue Capacity: Tax Base * Average National tax Rate zExpenditure Needs: z14 categories (Health, Education, etc.) z25 “disability factors” (factors that increase standard costs), composed of multiple indicators zSpecial grants subtracted from grant entitlement zExcellent administration by the Grants Commission

13. Germany zFederal country zSubstantial tax sharing zVAT redistributed per capita--provides most of the equalization zFiscal Equalization through Finanzausgleich (Financial Settlement) zPrinciple: equalize needs-adjusted fiscal capacity zNeeds: “special burdens” for city states zEvery state obtains at least 95 percent of average revenues z“Rich states” are taxed--discourages tax effort yTax capacity over 110 percent of average tax with 80 percent zEastern, poor states receive additional grants from central government

14. Japan zUnitary country zLarge vertical imbalance zEqualization through “Local Allocation Tax”--both provinces and municipalities zConsiders fiscal capacity and needs zNeeds based on functions assigned to government

15. Japan Cont. zBasic need = modification coefficient * unit cost zmodification coefficients examples: zschool types zsize of region zpopulation density in region zcold area zurbanization of region zMOF Administers

16. Korea zUnitary country zSimilar to Japan’s system zFiscal capacity and needs z“Fiscal scarcity= standard need - standard revenue” zNeeds = standard fiscal need + supplemental need z 29 standard factors zSeparate education transfer zMinistry of Home Affairs Administers

17. China zSee Mr. Zhang’s speech

18. Overview of Equalization around the World

19. Indonesia: Law 25/99 zNatural resource sharing yoil & gas yother z25 percent of domestic revenues for general grant zDistribution according to ythe region’s needs ythe region’s economic potential

20. Resource sharing

21. Resource Sharing De-equalizing

22. Impact of Law 25/99

23. Issues in Indonesia’s Equalization Grants Design zDefining Expenditure Needs èDetermine expenditure assignments zDefining Revenue Capacity èLocal tax base expansion? zHow Much Equalization zData Requirements zConsultation & Discussion zGrants Administration zTransition Arrangements

24. Goal zNot z“Make every region happy” zBut z“Make Every Region Reasonably Unhappy”