The central government is assigned to collect revenues from various sources like customs duty, Value Added Tax (VAT), excise duty, corporate income tax, and personal income tax which comprise around 80 per cent of the total tax revenue

Fiscal decentralization initiative of Nepal implemented in different time periods failed to overcome the problems of regional inequality through efficient public resource utilization, making a favourable environment for the private sector development and inclusive economic growth under centralized and unitary form of government in which powers are owned by the national government only.

Thus, the constitution of Nepal 2015, formally declared the country a “Federal Democratic Republic” in which powers are shared between the central government, province and local level.

The major challenges for any nation undergoing federal structure are allocation and distribution of adequate financial resources to every level of government.

Fiscal federalism is concerned with the division and sharing of public sector responsibilities among different tiers of government with proper alignment of fiscal instruments among these governments. To determine optimal jurisdiction authority in shaping the inter-governmental fiscal relations, political considerations, economic factors and historical events have to be taken into account that influence the design, adoption and implementation of federalism.

Nepal is also on the process of implementing fiscal federalism by delegating responsibilities downward to its provincial and local governments. The rationale for such fiscal decentralization follows competition among local governments creating political innovations, efficient lower level planning and administrative cost as citizens become more politically aware.

Further, the federal or central government can take assistance from local and state government for national economic development strategies.

The constitutional provisions define the framework of fiscal federalism within which the state of economic development, the pattern of income and resource distribution, fiscal transfer and bailouts, grants, borrowing and the institutional capacity of the federal system are devised.

The constitution has adopted the globally accepted principles of fiscal federalism. As stated in Article 228 of the constitution, the local government is empowered with the authority to impose tax for generating income and has access to loans from fiscal institution prescribed by the law.

Such functions of the local government should not have adverse effects on the national economic policy, capital and labor market, free transportation of goods and services and fiscal policies of the neighboring provinces or local levels.

There is also a provision of Local Consolidated Fund in every Village Council and Municipality in which revenues received from various sources, grants and loans received from the federal government and province government shall be deposited.

Furthermore, the central government is assigned to collect revenues from various sources like customs duty, Value Added Tax (VAT), excise duty, corporate income tax, and personal income tax which comprise around 80 per cent of the total tax revenue.

Likewise, the major sources of revenue for province and local level governments are entertainment tax, advertisement tax and registration charge for land and house simultaneously whereas property tax, land revenue, vehicle tax, business tax and house rent tax come under the jurisdiction of the local level.

Similarly, all three levels of government can collect certain service charges and fines and penalties concurrently.

Fiscal federalism deals with the fiscal responsibilities like expenditure assignment, tax and revenue assignment, inter-governmental fiscal transfers (subsidy) and sub-nationals government borrowing that are shared among central, state and local governments.

As per constitutional provisions mentioned in Article 60, the Government of Nepal shall make necessary arrangements to equitably distribute the revenue generated by it from its sources, transparency in distribution of fiscal equalization grants to province and local level entity on the basis of their expenditure need, their capacity in generating revenue and the efforts made by them.

The local government can understand the need and preferences of local people and are directly accountable to them. The direct involvement of people in formulating plans and policies to estimate resources, revenues and reserves help effective fiscal management.

Such action helps to reduce risk and uncertainties through the equalization system, mutualisation of risk and inter-governmental cooperation.

As Nepal’s economy is highly reliant on indirect taxes, international trade taxes, external grants and persistent fiscal deficits, it is a very challenging issue to devolve the concentration of fiscal decision-making power from the federal government to province and local government.

If the issues like political will and orientation, jurisdictional clarity, transitional management, sectoral coordination, governmental autonomy, technical competency, extensive revenue utilization, judicious allocation of resources, financial discipline, credibility and accountability etc. are considered properly, Nepal will successfully achieve the essential aspects of fiscal federalism  sharing functions among different levels of government in the supply of goods and services, redistribution of income, macroeconomic stabilization, taxation, welfare gains and inter-jurisdictional competition.