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Fiscal Decentralization: Intergovernmental Transfers

A good transfer system requires many attributes but five attributes are most cited by experts.

 

  • First, the transfer system should have a clear objective to be pursued so that the design of the grants can be made accordingly.
  • Second, it should be transparent so that sub-national governments have an idea of how the system works, that is, what resources to be distributed (vertical pool) are allocated and how the distribution is made among sub-national governments (horizontal distribution). For the first two attributes, simplicity is an important characteristic to be considered.
  • Third, it should be stable, predictable and work in a timely matter so that sub-national governments know what revenues they can expect in the future to develop their strategic planning.
  • Forth, it should be equitable, addressing the vertical imbalances of the different tiers of government and implementing some equalization mechanism to address horizontal regional disparities.
  • Lastly, it should provide adequate incentives for sub-national governments to make a right decision.

In South Asia 

 

These five attributes are observed with various degrees across countries. For instance,

 

  • Pakistan has a quite transparent vertical and horizontal distribution of resources through the National Finance Commission (NFC) award to the provinces and the newly Provincial Finance Commission (PFC) awards from the provinces to the local governments. However, the system contains neither an efficient equalization mechanism nor adequate incentives for a fiscal effort.
  • In India, the transfers system varies greatly from state to state, but overall the complex system with hundreds of different transfers lacks a clear objective in structure and formula. Moreover, when we evaluate the transfers to the rural levels, most attributes described above are violated as the systems become more ad-hoc regarding distribution, as a consequence, grants do not reach rural governments in a predictability and timely manner.
  • In Nepal, the transfer system is ad hoc in most of its components with the exception of the general block grant to District Development Committees (DDCs). Overall, this system creates perverse incentives in local government performance regarding fiscal efforts.

The lack of transparency and poor design of many intergovernmental transfer systems in South Asia is weakening, rather than strengthening, revenue mobilization, administrative capacity, planning, and budgetary management at the sub-national level.

 

In fact, the level of dependency of sub-national governments on central transfers is overwhelming.

  • In Pakistan, transfers account for roughly 85% percent of sub-national revenues.
  • In Nepal, it is around 87 percent.
  • In India, there are varying degrees of dependency , but rural governments present the more acute case.
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