dana perimbangan acde

Fiscal Transfers to Regional Governments in Indonesia

Fadliya&

Ross H. McLeod

Indonesia ProjectAustralian National University

22 February 2011

Think of a number…

• X• Double it• 2X• Add 6• 2X+6• Divide your answer by 2• (2X+6)/2 = X+3• Now take away the number you first thought of• The number you are now thinking of is 3. Wow.• Remember this exercise for later…

Context is ‘decentralisation’, starting in 2001, which saw devolution of wide range of government functions from

centre to regional governments—mainly local.

Our focus here is purely on the financial aspects of this.

Fiscal transfers from centre to regions

• Transfers largely determine regional governments’ capacity to serve their citizens

• Focus here on local governments (districts/ municipalities) rather than provinces– In 2010: 33 provinces and 491 local governments

• What kind of pattern would we expect to see (in per capita terms) across districts and municipalities?

• Should we expect to see considerable uniformity, or great variation?

• Here’s what the pattern looks like:

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Ranking of Districts by Annual Per Capita Trans-fers

(Rp million)Supiori

Boven Digoel

Bandung

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25

Ranking of Municipalities by Annual Per Capita Transfers

(Rp million)

Sabang

Bekasi

Bontang

Pattern of Transfers

• The extent of variation seems extraordinary, especially among districts

• On the face of it, this does not seem reasonable

• The motivation for this research is to analyse the design of the fiscal transfer arrangements, with a view to improvement, if this seems necessary

• The basic problem is that the whole system is extremely complex, and probably few people understand it

• We begin by comparing the apparent relative importance of the three components: DBH, DAU and DAK

Composition of Fiscal Transfers

• Fiscal equalisation transfers have grown considerably since decentralisation in 2001

• By far the largest component is the general funds allocation (DAU)

• Also significant—at least at first glance—is shared revenue funds (DBH)

• The special funds allocation (DAK) component was almost negligible to begin with, but has expanded considerably since then

2001 2002 2003 2004 2005 2006 2007 2008 2009 -

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100

150

200

250

300

DAKDBHDAU

Fiscal Equalisation Funds 2001-2009(Rp trillion)


• In terms of proportions, the expansion of DAK has been at the expense of DAU

• The share of DBH has been roughly constant over the entire period

• Relative importance is more readily apparent if we look at percentage shares

Fiscal Equalisation Funds 2001-2009(%)

2001 2002 2003 2004 2005 2006 2007 2008 2009 -

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DAKDBHDAU


• Let us now look at the details of the major components, DBH and DAU

• Based on Government Regulation No. 55/2005• Ignore various changes to the arrangements in

earlier years– i.e. main focus is scheme as it is now, rather than its

evolution

Shared revenues (Dana Bagi Hasil, DBH)

• There are two main components– Certain taxes– Natural resource revenues

• And each of these has further subcomponents…• Each item has a different pattern of allocation

between– The centre– The source province– The source local government– Other local governments in the source province– Other local governments in other provinces

• Basic idea is to return a significant share to the region where the revenue was generated

Centre Source province

Source district/

municipality

Other districts/

municipalities within source

province

All other districts and municipalitie

s

Territory and Building Tax (PBB)*

3.5 16.2 64.8 0 6.5

Land and Building Title Transfer Fees (BPHTB)

0 16 64 0 20

Personal Income Tax (PPH)

80 8 8.4 3.6 0

Allocation of Shared Revenue Funds Sourced From Taxes (%)

*A further 9% flows to the Ministry of Finance, and the source province and local government.

The first two of these items are in the process of becoming local taxes.


Districts and municipalities

Within source province

Source Non-source

All All

Forestry

Forestry permit operating levy (IHPH)

20 16 64

Forestry resources commissions (PSDH)

20 16 32 32

Reforestation fund 60 40

General mining

Source from district/city

Mining sector land rent

20 16 64

Mining sector royalties

20 16 32 32

Source from province

Mining sector land rent

20 80

Mining sector royalties

20 26 54

Allocation of Shared Revenue Funds From Natural Resources (%) (1)


Districts and municipalities

Within source province

Source Non-source

All All

Oil

Source from district/ municipality

84.5 3.1 6.2 6.2

Source from province 84.5 5.17 10.33

Natural gas

Source from district/municipality

69.5 6.1 12.2 12.2

Source from province 69.5 10.17 20.33

Geothermal energy

Central share deposit 20 16 32 32

Land rent and production

20 16 32 32

Fisheries

Fisheries operations 20 80

Fisheries production 20 80

Allocation of Shared Revenue Funds From Natural Resources (%) (2)

Shared revenues (DBH)

• Obviously, the system is very complex, and must generate a huge amount of work for bureaucrats at all three levels of government

• As we shall see, this is almost entirely a waste of time…

• Before we can understand why this is so, we need first to look at the second component, DAU

General funds allocation (Dana Alokasi Umum, DAU)

• Basically a new name for what was previously known as SDO—Subsidi Daerah Otonom —or subsidy to autonomous regions, plus INPRES

• It still covers the bulk of regional government spending

• DAU amount for any regional government is equal to a basic allocation, +/- an amount equal to that government’s fiscal gap

• This is the gap between its fiscal need and its fiscal capacity

• We will look at fiscal need later

• Fiscal capacity is the sum of own source revenue (OSR) plus the DBH entitlement

DAU = BA + FG

Base Allocation(to cover spending

on personnel)Fiscal Gap

Fiscal Needs Fiscal Capacity

Population Own source revenue

Area Shared revenue funds

Construction prices

Human development

GRDP

Components of DAU Formula

General funds allocation (DAU)

• This part of the overall arrangements is quite complicated

• It will be easier to follow using simple algebra

• Analysis is based on Government Regulation 55/2005

DAU in Algebra

DAU = BA + FG Art. 40 (1)= PS + FG Art. 40 (5)= PS + (FN – FC) Art. 45 (1)= PS + FN – (OSR + DBH)= PS + FN – OSR – DBH (subject to DAU ≥ 0)

WhereBA = basic allocationPS = personnel spendingFG = fiscal gapFN = fiscal needFC = fiscal capacityOSR = own source revenue

Implications for Total transfers

• We now have an algebraic expression for DAU• This allows us to see the very important

implication for total fiscal equalisation funds:

D ≡ DBH + DAU + DAKSoD = DBH + (PS + FN – OSR – DBH) + DAK

= PS + FN – OSR + DAK

NB: The DBH entitlement is totally irrelevant in cases for which DAU ≥ 0.

Think of a number…• X• Double it• 2X• Add 6• 2X+6• Divide your answer by 2• (2X+6)/2 = X+3• Now take away the number you first thought of• The number you are now thinking of is 3. • Did the policy makers intend deliberately to fool

the resource rich regions?

Implications for Dana Perimbangan

The threshold value of DBH at which DAU falls to zero is given by

DAU = PS + FN – OSR – DBH* = 0orDBH* = PS + FN – OSR

(the ‘resource-rich case’)How many such cases are there? Almost

none!

Region did not receive

Type of government DBH DAU DAK 2008 2009

Provinces 33 33

26 29

Ö 6 3

(DKI Jakarta) Ö Ö 1 1

Districts 363 386

358 382

Ö 5 4

Municipalities 88 91

88 91

Regional Government Access to Fiscal Balance Transfers, 2008–2009

Regional Government Access to Fiscal Balance Transfers

• Hardly any regional governments have so much DBH that they miss out on DAU

• In 2009 these were– Jakarta special province

– Four districts• Bengkalis, Rokan Hilir, Siak (in Riau province)

• Kutai Kertanegara (in East Kalimantan province)

– And no municipalities

Size of Fiscal Balance Transfer (D)

Share of Total Transfers, 2009

General case PS + FN – OSR + DAK 93.5%

‘Resource-rich’ case

DBH + DAK 3.2% (4 Districts); 3.3% (Jakarta)

Summary of Possible Outcomes for Fiscal Balance Transfers

NB: The total is all that matters, not the individual components.

Note: ‘Resource-rich’ is defined by DBH ≥ PS + FN – OSR.

In the general case, all DBH ‘received’ is taken away again because of an equal reduction in the DAU entitlement. Natural resource revenue is actually irrelevant to all but a tiny handful of local governments. DBH for Jakarta Province is mainly from income tax, not natural resources.

General RRLGs Jakarta All, excl. Jakarta

All RGs0

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True Component Shares of Fiscal Equalisation Funds, 2009

(%)

DAKDBHDAU

Some important (dis)incentive effects

• General case:

D = PS + FN – OSR + DAK

• Regional governments have no incentive to – Economise on personnel

– Collect more revenue (unless they can hide it?)

• Because this results in an equal reduction in DAU

• But they are subject to heavy central government control on personnel numbers, so perhaps this is not a problem

Fiscal need

• So far we have ignored the details of FN and their impact on total transfers, D

• Assume DAK = 0 for simplicity, then

D = PS – OSR + FN

• For convenience, assume PS and OSR proportional to GRDP

PSj = b Gj Pj

OSRj = c Gj Pj

Fiscal need

• Fiscal Need defined as average regional government spending multiplied by the weighted average of 5 modifying factors reflecting ‘need’ (Art. 44 (1))

where S is the average level of spending, are the weights, and (for convenience)

Component 2005 2006–09

Population 40 30

Area 10 15

Construction price index 40 30

Human development index 10 10

GRDP per capita - 15

Weights of Fiscal Need Components 2005–09 (%)

Fiscal Transfers in Total

• We can now put all this together for government j:

• And express it in per capita terms…

• And then take partial derivatives with respect to each ‘modifying factor’ to see how it affects per capita transfers…


• Impact of population

• Transfers per capita decrease with increases in population– Two regions identical in all respects except population

receive different per capita transfers, with the one with greater population receiving less

– Seems unreasonable (although there is an economies of scale argument)

– And looks unreasonable…

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Per Capita Transfers and Population (Districts)(Rp million; thousand)

Population

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Per Capita Transfers and Population (Municipalities)(Rp million; thousand)

Population

Incentive to Split Jurisdictions

• Number of local governments has grown from 336 to over 490

• Number of provinces has grown from 26 to 33• Various explanations, one of which is financial• Defining non-personnel spending as NPS, the

budget constraint for a regional government is

• So

Incentive to Split Jurisdictions

• Consider the financial implications of splitting region j into two regions a and b

• Assuming construction prices, HDI and per capita GRDP are identical in the two new regions, total non-personnel spending for the two new regions combined increase from NPSj to


• Impact of area

• Transfers per capita increase at a constant rate with increases in area– This tends to compensate regions facing above average

infrastructure and transport costs because of their above average physical size

– Seems reasonable


• Impact of construction prices

• Transfers per capita increase at a constant rate with increases in construction prices– This tends to compensate regions facing above average

construction costs– Seems vaguely reasonable…– … but better simply to raise/lower each government’s

allocation in proportion to its construction price level– e.g. 10% higher costs, receive 10% more funding– The actual relationship is linear, but not proportional:


• Impact of Human Development Index

• Transfers per capita increase at a constant rate with increases in the HDI– This is precisely the reverse of equity-oriented income

redistribution through intergovernmental funds transfers (i.e. trying to reduce the variation of average incomes across jurisdictions)

– That is, better off jurisdictions receive greater, not smaller, per capita transfers from the centre, making them even better off

– Seems highly undesirable

– Possibly a consequence of careless tinkering with the formula?

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Transfers to Districts and HDI, 2008(Rp million per capita)

HDI

Transfers

average 2.34

average 68.0

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Transfers to Municipalities and HDI, 2008(Rp million per capita)

HDI

Transfers

average 1.88

average 73.9


• Impact of per capita GRDP

• Transfers per capita increase at a constant rate with increases in per capita GRDP– Again, this is precisely the reverse of what is required if

intergovernmental funds transfers are intended to reduce the variation of average incomes across regions

– Better off jurisdictions receive greater, not smaller, per capita transfers from the centre, making them even better off


• Impact of per capita GRDP – This impact is considerably more severe than is the case

with the Human Development Index...

– ... because GRDP per capita is far more variable than HDI

– Seems highly undesirable

– Careless tinkering again? GRDPpc only in formula since 2006

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Transfers to Districts and GRDP Per Capita, 2007(Rp million per capita)

GRDPpc

Transfers

average 2.2

average 6.6

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Transfers to Municipalities and GRDP Per Capita, 2007

(Rp million per capita)

GRDPpc

Transfers

average 1.8

average 12.0

Population dominates the pattern

• The charts suggest a very clear relationship of per capita transfers with population

• But the relationships with HDI and GRDP are not at all clear

• Econometric testing of the equation for per capita transfers is the next step

• Seems clear that a thorough redesign of the system would be beneficial

But what should the system seek to equalise?

• Should focus be on individual government budgets?

• Or should it be on some measure of how well-off are the people in individual jurisdictions (on average)?– i.e. Should transfers to poorer regions be more

generous?• If budgets, what about governments

– With bloated bureaucracies (high PS)?– Which make little effort to generate revenue (low OSR)?– Implies reward for poor performance…

• Some other basis?

3 Main Conclusions

• Natural resource revenue sharing is largely a myth

• System creates bad incentives– Jurisdiction splitting– No economising on personnel– No point in raising additional revenue

• System seems to work against income redistribution in favour of the poor

Fiscal Transfers to Regional Governments in Indonesia

Fadliya&

Ross H. McLeod

Indonesia ProjectAustralian National University

22 February 2011

Ratio of Per Capita Transfers to Districts to National Average Per Capita

GRDP (%)

Maximum Minimum Average

2005 104 2.9 13

2006 280 4.0 30

2007 331 4.7 34

District Personnel Spending and Own Source Revenue, 2007

(Rp million per capita)

Personnel spending

Own source revenue

Maximum 4.5 2.0

Minimum 0.2 0.0

Average 0.8 0.1

Average top 10% 2.1 0.3

Average bottom 10% 0.3 0.1

Top 10%:bottom 10% 8.1 6.4

Some observations on DAK

• We already noted the increasing amounts in this category

• There has also been a steady proliferation of sectors attracting DAK transfers from the central government

• At first, only reforestation funding came in this category

• Then five core sectors were added in 2003

• Additional sectors have been added in almost every year subsequently– While reforestation has been reclassified as a DBH item

Sector 2001

2002

2003

2004

2005

2006

2007

2008

2009

Reforestationa Ö Ö Ö Ö Ö

Early core DAK activitiesEducation Ö Ö Ö Ö Ö Ö Ö

Health Ö Ö Ö Ö Ö Ö Ö

Roads Ö Ö Ö Ö Ö Ö Ö

Irrigation Ö Ö Ö Ö Ö Ö Ö

Governance infrastructure

Ö Ö Ö Ö Ö Ö Ö

Creeping proliferation of DAK activitiesMarine & fisheries Ö Ö Ö Ö Ö Ö

Water & sanitation Ö Ö Ö Ö Ö

Agriculture Ö Ö Ö Ö Ö

Environment Ö Ö Ö Ö

Family planning Ö Ö

Forestry Ö Ö

Rural infrastructure Ö

Trade Ö

Proliferation of DAK sectors 2001–09

a Reforestation was re-classified as a (natural resource) revenue sharing (DBH) item from

2006.

Some observations on DAK

• Seems inconsistent with objective of decentralisation– i.e. reduce control by the centre/bring government

closer to voters