Nepal | February 21, 2019

Intergovernmental transfers: Fiscal issues in federalism

Laxmi Bilas Koirala

In the dawn of the federal system in Nepal, the National Natural Resources and Fiscal Commission can play a vital role in management of intergovernmental fiscal transfers and promote cooperation among vertical and horizontal governments

Illustration: Ratna Sagar Shrestha/THT

After the promulgation of the new constitution in 2015, the federal government system now is in the implementation phase. Federal, provincial and local governments are exercising their authority and power to complete the given responsibility.

In terms of population, economic growth, geographical structure, poverty situation and human resource and infrastructure development, the provincial and local governments have diverse potentials to accomplish their duties. The fiscal and natural resources are also unevenly distributed among the governments. However, the political participation, political authority, political status and responsibility of the provincial and local level governments are symmetrical.

In the federal system, all levels of government have equal responsibility to uplift the status of the people of their respected areas. It is obvious that in a federal system there are three levels of government, but, all governments serve the same people of one nation. Local governments are fundamental unit to collect revenue and implement programmes of all levels. All governments are free to make necessary law, annual budget as well as programmes. They are also open to levy and collect tax and to spend from the consolidated fund according to law within the geographical boundary of the governments. Moreover, fiscal federalism is a process which strengthens the economy of the country from the bottom level. It advocates for a representative government which works best for the people close to them. These ideas suggest that decision making should occur at the lowest level of the government in consistent with the goals and allocation efficiency of resources.

The capacities of collection of revenue, need of expenditure and allocation of revenue to the different layers of the governments are also covered. Similarly, it also studies the vertical and horizontal fiscal gap and a solution to resolve the fiscal imbalance among the governments.

The vertical fiscal imbalance means a gap or mismatch between transferring revenue raising authority and responsibility for expenditures between federal, provincial and local governments.

The vertical fiscal imbalance also means the different capacity of federal, provincial and local governments to accomplish their works. The horizontal fiscal gap deals with the gap between provincial to provincial or local to local governments. The intergovernmental transfer is a mechanism which uses equalisation grant to correct the fiscal imbalance. Equalisation grant are of two types. One is conditional and the other is unconditional. Unconditional grant is given in a block and the government will be free to allocate it. But, conditional grant is given to fulfil the federal or provincial priorities and the recipient government will not be free to spend the grant.

The central and provincial governments usually provide matching transfers to influence the local level priorities to support their interest. In practice, the local governments don’t prefer the conditional grant; however, the federal or provincial governments prefer would like it more.

Intergovernmental fiscal transfer is an instrument to remove or minimise the fiscal imbalance of the layers of government. The objectives of the transfer are to achieve social equality, economic development and macroeconomic stability.

Providing fiscal transfer to the governments enables them to work as per the mandate. The recipient government must be accountable for their decisional actions. The effectiveness of the fiscal transfer mainly depends upon transfer design.

Transfer design is basically based upon population, geographical structure and socioeconomic development. There are three ways the intergovernmental transfer can be achieved. First, a fixed proportion of central government revenue support in budgetary expenditure of provincial and local governments. Second, to develop a formula to reimburse a proportion of local expenditure of the governments. And third, to determine the total amount to be transferred.

Fiscal federalism argues that finance should follow functions because tax assignment is generally guided by spending requirements. It is desirable to decentralise taxation authority according to the spending requirements of local government. As a result, sub-national governments will not have to rely exclusively on equalisation grants from the higher level of governments.

If sub-national governments are not responsible for raising at least some level of their revenues, they may have too little incentive to provide public services to the people.

Visualising the need of separate institutions to manage fiscal resources the constitution has envisioned National Natural Resources and Fiscal Commission (NNRFC).

To manage the intergovernmental fiscal transfer and natural resources, it has to create a data base of natural resource and conduct an economic survey, develop a formula and a standard operating system to allocate the revenue and create a mechanism to promote cooperation among the vertical and horizontal governments. In the dawn of the federal government system, the NNRFC can play vital role in successful manage intergovernmental fiscal transfer.

Koirala is former joint-secy of Public Service Commission

 


A version of this article appears in print on September 11, 2018 of The Himalayan Times.


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