Fiscal aspects of decentralisation in Indonesia

Abstract

In 1999 Indonesia embarked on a radical program of decentralisation intended to create a much stronger role for subnational governments, thus ensuring that power would be dispersed over three levels of government rather than concentrated at the centre. Once the key decisions had been made on the fiscal roles and authorities assigned to each level of government, and on the appropriate level of total fiscal transfers from central to subnational governments, it was necessary to design a set of rules for allocating this total among the latter. The laws on ‘fiscal balance’ do precisely this, but in a highly convoluted manner that leads to outcomes that appear to be at odds with economic rationality. Comparing transfers across jurisdictions reveals that the highest and lowest per capita amounts differ by a factor of the order of 100. No conceivable difference in the economic circumstances of individual jurisdictions could justify such pronounced departures from equal treatment of Indonesia’s citizens. It is recognised that the current transfer system needs modification, but its complexity is such that further revisions of the law on ‘balancing funds’ had been under consideration—without resolution—for about a decade at the time of writing. Previous attempts to improve the system focused on small, seemingly important matters of detail, whereas what is needed is a much more fundamental rethinking of the entire design. The unnecessary complexity of the current system is evident in its separation of total transfers into three components: a revenue sharing component, a general funds allocation and a special funds allocation. The first two components are untied, and so it is only their total amount that actually matters to recipient governments. Indeed, the existence of the revenue sharing component necessarily conflicts with the objectives of the general funds allocation component. The third component is tied to central government priorities, and has been expanding relative to the others as well as in sectoral scope—seemingly in conflict with the original intention to bring government closer to the people. An unfortunate consequence of the current system is that it has created a strong financial incentive for the splitting of jurisdictions, which has been a conspicuous feature of decentralisation; for the same reason, it has created a financial disincentive to amalgamation of jurisdictions. The transfer system should not distort important choices about the configuration of regional government boundaries in this manner. The extraordinarily wide variation in levels of per capita transfers is quite at odds with government policy in the fields of education and health, a key emphasis of which is equal access of all children and citizens. High per capita transfers are found to be associated with small populations, so small-population jurisdictions have the potential to provide much better access to education and health care—although by no means all small-population local governments use their relatively large funding entitlements to expand delivery of these services. Show more