Donor Partner Working Group on
Decentralization and Local
Governance (DPWG-DLG)
Hosted by: EuropeAid & Swiss Agency for
Development and Cooperation
Brussels
18-20 May 2011
Fiscal Decentralization and
Linkages to PFM
Outline
• A. The Global State of Local
Government Finances (GOLD II)
• B. General Relationship of PFM to
Decentralization Reforms
• C. Constraints on Linking PFM and
Decentralization Reforms
• D. Subnational PFM Reform &
Decentralization: Diagnostics and
Approaches
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A. The Global State of Local Government
Finances (GOLD II)
• There have been significant improvements in
local finance systems in many developed and
developing countries, including:
– Increased local expenditure functions/efficiency
– Enhanced local revenue opportunities
– Adoption of local governance innovations, such as
participatory budgeting
• Outstanding challenges in local finance systems,
however, remain pervasive globally, albeit in
different forms and to different extents given the
great diversity across countries
Expenditure Assignment and
Management
• Lack of clarity in expenditure assignment
• Inappropriate/insufficient/unenforced
expenditure assignment
• Unfunded mandates/offloading of
expenditure mandates
• Budget approval and control by higher
level authorities (sometimes ad hoc)
• Lack of incentives for local expenditure
efficiency
Local Revenue Generation and
Autonomy
• Vertical fiscal imbalances
• Low revenue autonomy
• Problems with what is often recommended as a
main local tax (property tax)
• Inadequate diversification of the local tax base
• Neglect of fees and user charges
• Political constraints on increasing local revenues
• Weak revenue collection capacity; balancing
local and central roles in revenue collection
Intergovernmental Transfers
• Getting appropriate tax/revenue sharing systems
in place (based on objective criteria)
• Lack of attention to horizontal fiscal imbalances
across local jurisdictions
• Equalization transfer design challenges
• Conditional or specific transfer design
challenges
• Limited use of innovative transfer mechanisms
(e.g. performance based grants)
Local Government Borrowing and
Investment Finance
• Local government borrowing and fiscal
responsibility frameworks are often poorly
developed and implemented
• Local governments often have poor and
unreliable access to credit
• Special institutions commonly been set up to
lend to local governments rarely perform well.
• Central government practices such as bailouts
and automatic intercepts have disrupted the
normal development of local credit markets
• Other aspects of the local finance system are
sometimes not conducive to borrowing
B. General Relationship of Fiscal
Decentralization to PFM
• PFM reforms are needed to assist with many
of the documented fiscal decentralization
problems and challenges
• More generally, a functioning PFM system is
central to attaining the expected benefits of
decentralization
• PFM is expected to play a role in enhancing
transparency, managerial efficiency, and
subnational government accountability both
to higher levels of government and local
constituents
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General Relationship of Fiscal
Decentralization to PFM
• Despite the important interrelationships between
them, PFM reform is often managed entirely
separately from decentralization and local
governance reform
• Central issue: how can PFM reforms be
operationally linked to decentralization
reforms—at what stages, in which sequence and
in what specific ways?
• How can PFM and decentralization reforms be
linked a way that recognizes the considerable
diversity/challenges of decentralization
forms and contexts?
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C. Constraints on Linking PFM and
Decentralization Reforms
• Differences in the fundamental nature of the
two reforms
• Differences in the objectives (and their
priority) of the two reforms
• Differences in institutional management and
perspective
• Differences in starting points and reform
trajectories
• The role of international development
partners, particularly in aid dependent countries
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Differences in the Nature of Reforms
• PFM is on balance more technical in nature
and reforms are generally relatively
standardized
• Decentralization involves a greater variety of
types of reforms—political, fiscal and
administrative—that must work together for
decentralization to be effective.
• Decentralization may play out in diverse ways
in different contexts, with varying degrees of
functional empowerment, fiscal self-sufficiency
and autonomy across levels of government
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Decentralized System “Prerequisites”
• Enabling Framework: constitutional/legal
• Fiscal Requirements
– Clear assignment of service functions/ revenues (some autonomy)
– Appropriately structured shared taxes/transfers
– Fiscal responsibility and borrowing framework
• Political Requirements
– Elections and other types of accountability mechanisms
– Transparency in subnational processes and decision
– Sufficient autonomy to facilitate responsiveness to citizens
• Administrative/Managerial Requirements
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Institutional structures/relationships appropriately defined
Planning, budgeting & PFM systems and procedures
Civil service system (some degree of local control)
Contractual framework for partnering with private sector/NGOs
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Differences in the Objectives of Reform
• Countries normally undertake PFM reform with
the relatively straightforward objective of
improving the efficiency and transparency of
public sector finances
• Decentralization is often formally justified for
similar reasons (plus democratization, citizen
empowerment, etc.), but the range of actual
objectives is commonly broader and often
political, and particular objectives can have
more or less importance in different cases
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Differences in Institutional Management
• PFM reform is normally managed by the Ministry of
Finance and/or National Treasury, and these
agencies normally have considerable authority over
other government institutions by virtue of their control
over national budgeting, disbursement and financial
management
• Decentralization reforms are usually managed by a
Ministry of Local Government (e.g. Uganda and
Kosovo), a Ministry of Interior (e.g. Cambodia), or a
Ministry of Home Affairs (e.g. Indonesia), which
rarely have much authority over other government
agencies that have critical roles to play in reform
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Differences in Starting Points and
Reform Trajectories
• Although PFM systems can be in varying states in terms
of the extent to which they are following internationally
accepted standards of good practice when new reform
processes begin, the path to achieving the objectives
is normally relatively straightforward (even though
there may be considerable obstacles to following the
desired path)
• In contrast, decentralization may be occurring in
extremely diverse base situations—e.g. where local
governments exist but are performing poorly, where local
administrations (deconcentrated) are being transformed
into local governments (devolved), or where no local
administrative units or local governments have
previously existed—and this requires highly diverse
and complex reform paths and capacity building
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Role of International Development
Partners
• International development partners (and sometimes their
constituent departments) are also diverse and have
their own objectives, priorities, modalities, and
preferred counterpart agencies in the countries
where they work
• In pursuing their respective objectives, they may
generate new tensions or reinforce existing tensions
between government agencies in charge of various
aspects of public sector reform, including PFM and
decentralization, and contribute to the development of
public sector systems with inconsistent components
and processes
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D. Subnational PFM Reform and
Decentralization: General Diagnostics
• Assess honestly the options for adopting
decentralization and PFM reforms in the
prevailing political and institutional context
individually and in relationship to each other
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Receptivity to reform (at various levels)?
Reforming existing or adopting new systems?
Initial status of both systems?
Any positive features of existing system to build on?
Levels of capacity (at various levels)?
Motivation for improved performance (from above or
below)?
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Approaching Subnational PFM Reform
• Look for ways to link and embed technical
PFM reforms in decentralization reforms as
much as possible
• Consider the relative incentives and urgency
of the various reforms in determining
sequencing—the common presumption that
PFM reform is a prerequisite to decentralization
may be politically infeasible
• Be careful of undermining achievements that
have already been realized, such as using new
PFM reforms to quickly replace systems and
procedures that were just recently developed
under decentralization reforms.
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Approaching Subnational PFM Reform II
• Resist normatively purist or borrowed
approaches to reform and to the extent possible
proceed strategically:
– Link PFM reforms to specific local functions
that are going to be undertaken under
decentralization, such as service delivery or
revenue generation, rather than pushing
comprehensive reform
– Start with reforms that can be executed with a
high probability of success and build on
them in successive rounds of reform
• Look for creative ways to coordinate the actors
responsible for the reforms
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Approaching Subnational PFM Reform III
• Build capacity in a way that relates to the
implementation strategy
– Target capacity building to immediate functions/
tasks rather than provide only broad, generic training
– Providing as needed periodic, on-site follow-up
technical assistance
– Recognize the need for capacity building that is
both technically (training local governments to meet
their functional responsibilities) and governance
(training/facilitating citizens, elected officials and LG
staff to work with each other) oriented
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Approaching Subnational PFM Reform IV
• Consider potential roles for innovative
mechanisms that may help to facilitate
successful implementation:
– Asymmetric approaches that allow some degree of
local government choice in defining and pursuing
reform trajectories
– Enforceable accountability mechanisms, such as
central government contracts with local governments
– Financial incentives for adoption of reforms and
improvements in performance, such as compliance or
performance based grants
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