Local Government Form in Indonesia: Tax, Expenditure, and Efficiency Effects

Abstract

This paper examines the impact of local government form on fiscal outcomes in Indonesia. The form of local government, that is, whether it is headed by a popularly (directly) elected or parliament appointed (indirectly elected) executive, is exogenously determined and therefore tax, expenditure, and efficiency effects of interest are well identified. The paper finds that the direct election of local government executives has no influence on the generation of own-source taxes but that local governments with directly elected heads spend less, especially on infrastructure, and save more compared to their counterparts with indirectly elected executives. Local governments with directly elected heads also spend more efficiently in pursuit of service outcomes than local governments with indirectly elected officials. Efficiency effects are found to be robust across education, health, and infrastructure sectors. A plausible underlying argument is that districts led by directly elected executives are relatively less corrupt than are local governments with indirectly elected heads and that this reduced corruption leads to declining spending on rent-seeking intensive infrastructure projects and more efficient use of fiscal resources in general. The investigation provides general support for the continuation of direct local elections in Indonesia, which have lately come under attack by some national politicians