State restructuring and fiscal federalism

Convergence is a big challenge

All major political parties, except one, have already come forward with the number of states

under the proposed state restructuring. Suggestions showing diverse bases and criteria such as caste,

ethnicity, language, culture, remoteness, ecological diversity, population, socio-economic conditions, resource endowment, etc are most common.

Parties like UCPN (Maoist), who are champions of federalism, have come up with proposals based on more scientific criteria like population by land and area, majority of linguistic groups, historic alienation and suppression at the regional level etc. Notwithstanding the uphill task of bringing consensus on determining the number of states and their boundaries, it seems there will be an interrelated serious problem of bringing convergence between various components of fiscal federalism and state restructuring in an integrated manner.

Generally, issues associated with expenditure and revenue assignments, interstate resource transfers, resource sharing and devolution of economic power and authority in each level or tiers come within the orbit of fiscal federalism. Theoretically, more and more public services assigned to the local governments may be appropriate from the point of view of delegating more expenditure power from the center to the local governments. But, in Nepal’s context the initial conditions complicate the matter. The institutional setup and the absorptive capacity at the local level vary quite distinctly. Similarly, the large variation in socio-economic conditions among different classes, various castes and ethnic groups complicate the problem of expenditure targeting at the local level. The interrelated problem arises as a result of the initial condition reflecting a very large gap in the level of socio-economic development between urban and rural areas as well as remote and more accessible regions or areas.

An emerging view across the political spectrum and respective committees in the Constituent Assembly seems that such a problem could be resolved through the means of revenue assignment, interstate resource transfers and resource sharing. The authority to impose more and more taxes at the local level does not solve the problem either. The resource mobilization at the local level again is based on the existing level of socio-economic development and future revenue potentials. The latter is additionally linked to, among others, the resources in general and natural resources in particular at the disposal of the proposed sub-national or local government which will vary widely. Although a priory right of the state or local governments in the resources within the boundary could be an appropriate approach, this will not be sufficient. Now countries are adopting a technique of equalization in transfers. There are two means generally practiced. Australia has embraced a system of equalization funds with aims at ensuring equal ability of the states to provide a standard level of public services at an average level of taxation. Canada transfers equalization fund to the provinces/states based on their relative tax capacity and not on the basis of their expenditure needs. Although the Australian approach could be more appropriate, in a situation of too much regional developmental variation, it will be still inadequate. The needs of the states or local governments in our context have to be considered taking broad long term socio-economic developmental perspectives including resource potentials into account. This is

the most complicated issue to be dealt with.

Although most of the parties are in favor of three tiers, it is essential to fix additional tiers within the local government. There are also issues linked to the treatment of villages and towns and municipalities. The interrelated governance issues associated with institutional capacity enhancement and strengthening of absorptive capacity at the state and local level are very critical as they are the catalyst of successes in a federal system of government.

It is obvious that the more a formal federal system operates in practice as a unitary system, the less is the system’s capacity to fulfill the economic rights demanded by the most exploited or deprived. Without overhauling a system that continuously prevents equal economic right, access to resources and opportunities depending on the character, mere adoption of a federal structure will be self defeating as many countries’ experience suggests. In Nepal’s context, it is a matter of satisfaction that precautions are being taken to ensure that full fledged federal structure is introduced from economic perspectives as well.

The issues on fiscal federalism have so far been addressed either in isolation or less comprehensively taking long term needs and prospects into account. There is indeed a necessity of devolving an integrated framework of fiscal federalism in a way that facilitates a process of balanced inter-state long term development that could contribute to bring about prosperity of the downtrodden.