Three essays on the economics of fiscal transfers for resource-rich districts in Indonesia

Abstract

This thesis examines economic aspects of fiscal transfers for resource-rich subnational governments, with quantitative analysis for a large number of districts in Indonesia. Despite the advantages of resource endowment, these districts face a variety of challenges in fiscal management, which intersect with vertical fiscal transfers. There can be difficulties in raising own-source revenue as natural resource revenue may discourage own-source revenue raising. In the expenditure dimension, the presence of environmental spending spillovers can lead to non-optimal environmental spending decision-making by local governments. A further dimension relates to fiscal incentives. The central government attempts to achieve national development objectives through subnational government level by attaching conditions to fiscal transfers, but subnational governments have the opportunity to substitute the assisted expenditures with tied fiscal transfers. This thesis investigates these challenges through three analytical studies. It contributes to knowledge by providing theoretical and empirical understanding of fiscal policies in resource-rich districts. The findings provide insights to policy makers to further revamp the fiscal transfer design for resource-rich districts. The first study examines the impact of shared mining revenue on own-source revenue in mineral-producing districts. Using fixed effect method and district level data from 2001–2012, this study finds that the shared mining revenue does not become a disincentive for mobilizing local own-source revenue. The absence of control over mining sector revenue management makes these districts unable to substitute their own-source revenue to mining sector revenue. Nevertheless, the higher poverty rate in mineral-producing districts is negatively correlated with retribution revenue, which contributes to the lower own-source revenue in these districts. Retribution is charges or fess collected by local governments to community for the use of local government service, including fees for license issuance. The second study investigates the presence of spatial interaction in environmental spending policy. Using data for all physically neighbouring districts in Sumatera and Kalimantan Island for the period of 2009–2012, the spatial econometric estimations find positive spatial interaction of environmental spending, suggesting a district will increase its own environmental spending in response to neighbours’ environmental spending. There appears strong evidence that pollution spillover produced by neighbouring districts serves as the channel of positive spatial interaction. The third study evaluates the existing fiscal incentive which is earmarked to education spending. Using a difference in difference approach for three periods of analysis, 2009–2010, 2009–2011 and 2009–2012, this study finds strong positive effect of this fund on recipients’ education spending. However, the econometric estimations find dissipating increment of education spending over the three periods. This suggests the potential presence of non-additionality fungibility, where recipients reallocate their own budget for education spending in response to regional incentive fund they receive. Three overall insights emerge from this thesis. Firstly, there needs to establish incentive in fiscal transfer design which drives own-source revenue raising in resource-rich districts. Secondly, there is a case for greater intervention by central government to promote greater environmental spending in resource-rich districts. Thirdly, the ability of the central government to achieve policy objectives through fiscal transfer is hampered by substitutability of funds at local level. This calls for innovative design of fiscal transfer, possibly in the form of output-based fiscal transfers. Show more