operational framework for fiscal decentralization

OPERATIONAL FRAMEWORK FOR FISCAL DECENTRALISATION

BY SAKAJA JOHNSON

Table of Contents A. Fiscal Decentralisation – Introduction ............................................................................................ 4

1. The Case FOR Fiscal Decentralisation ......................................................................................... 5

B. Principles and Instruments of Fiscal Decentralisation ................................................................. 7

1. Assignment of Expenditure Responsibilities ............................................................................. 8

2. Assignment of Tax and Revenue Sources. Matching Expenditure and Tax Assignment ......... 9

3. Intergovernmental Fiscal Transfers. .......................................................................................... 12

a. Formulae Based Intergovernmental Fiscal Transfers ......................................................... 14

4. Sub National Borrowing ............................................................................................................. 16

C. Fiscal Decentralisation in South Africa ...................................................................................... 17

1. Fiscal Decentralisation in South Africa – Institutional Framework ...................................... 17

2. Assignment Systems of Fiscal Decentralisation in South Africa ........................................... 18

3. Assignment of Expenditure Responsibilities in South Africa ............................................... 19

4. Assignment of Revenue Responsibilities .................................................................................. 20

5. Intergovernmental Fiscal Transfers – South Africa ................................................................. 21

6. Fiscal Decentralisation in South Africa – Lessons for Kenya ................................................. 23

D. Fiscal Decentralisation in Kenya – Past and Present Frameworks ........................................ 24

i. The Special Rural Development Programme (SRDP) ......................................................... 25

ii. The District Focus for Rural Development (DFRD) ............................................................ 25

1. Constitutional Framework for Fiscal Decentralisation in Kenya .......................................... 26

i. Local Authority Transfer Fund (LATF) ................................................................................ 27

E. Fiscal Decentralisation in Kenya – Prospects in the Proposed Constitution of Kenya ..... 30

Objects and Principles of Devolution in the Proposed Constitution ........................................ 30

1. Operational Framework for Fiscal Decentralisation in the Proposed Constitution of Kenya ..................................................................................................................................................... 31

i. Expenditure Responsibilities .................................................................................................. 31

ii. Revenue assignments .............................................................................................................. 35

iii. Intergovernmental Fiscal Transfer ......................................................................................... 36

iv. Sub-‐‑national government borrowing .................................................................................... 38

F. Conclusion ........................................................................................ Error! Bookmark not defined.

Bibliography ............................................................................................................................................ 40

A. Fiscal Decentralisation – Introduction

Decentralisation can be defined as the devolution by central, (that is, national) government of specific functions, with all of the administrative, political and economic attributes that these entail, to democratic local (i.e. municipal) governments which are independent of the centre within a legally delimited geographic and functional domain”1.

The efficacy of a system of decentralisation depends on the structural and operational framework on which it is founded. The design of this framework, establishing the manner in which the devolved units and the Central Government relate to each other in matters of Fiscal and Political decentralisation and the nature of this relationship is critical to the success of the system.

The structural design of the system has a direct correlation to whether the intended objectives of decentralisation are met. This defines the number of levels of devolution, the number of units at each subsidiary level and the criteria for the creation of the same.

The operational framework must address the question of political and fiscal decentralisation by clearly defining the roles and functions of the different levels of government, the system and nature of representation at all levels of government, the system of revenue allocation between the central government and the devolved units and between the devolved units themselves and instruments of intergovernmental fiscal transfer and sub national government borrowing.

“Fiscal Decentralisation” refers to the percentage of total government expenditure executed by sub-‐‑national governments, considering the size and character of transfers, or the level of tax autonomy of sub-‐‑national governments, or both2. Fiscal Decentralisation can also be defined as the devolution of policy responsibilities from central government to local governments in respect of spending and revenue collection

1 Faguet, Jean-‐Paul. 2005. “Governance from below: a theory of local government with two empirical tests.” Political Economy and Public Policy Series 12, The Suntory Centre, London School of Economics and Political Science.

2 Yemek, E., 2005. Understanding Fiscal Decentralisation in South Africa. South Africa: IDASA- Budget Information Service.

decisions.3 It involves institutional and policy arrangements that provide for the transfer of financial resources and authority from the central government to the devolved units. This is either done collectively, where the Central government collects all revenue and allocates this to the units of devolution or through the assignment of tax powers to the devolved units.

With Fiscal Decentralisation, the sub-‐‑national authorities enjoy considerable autonomy from central government but are accountable to local citizens for the public goods and services that they deliver. As such, the communities and citizens are empowered through the fiscal empowerment of their local governments. These governments are given a very significant role and some discretionary authority in delivering services to their communities.

Not only is fiscal decentralisation a question of transferring resources to the different levels of local government it also about the extent to which local governments are empowered in their use and management of devolved financial resources. This authority is measured in terms of their control over:-‐‑

i. The provision of the basket of local services for which they are responsible; ii. The level of local taxes and revenues (base, rates and collection); and iii. The grant resources with which they finance the delivery of local public service.4

1. The Case for Fiscal Decentralisation

Several arguments have been developed in favour for fiscal devolution. Most common of these is the idea that the provision of public goods and its financing should be assigned to the lowest level of government with the capacity to achieve these objectives. Some of the advantages that come with fiscal decentralisation include increased economic efficiency, accountability and transparency in service delivery and better cooperation of taxpayers5

3 Neyapti, B., 2003. Fiscal decentralization and Deficits: international evidence. Ankara: Turkish Economic Association. 4 UNDP, 2003. Fiscal decentralization and Poverty Reduction, Washington DC: UNDP 5 Oates, Wallace E. An Essay of Fiscal Federalism, Journal of Economic Literature, Vol. 37, No. 3

Fiscal Decentralisation is based on the principle of subsidiarity and on the view that it results in improved efficiency in the delivery of public services, and hence a more efficient allocation of resources in the economy6. The needs of local communities are best identified and met through the subsidiarity7 principle which provides that, the responsibility for the provision of services should be at the lowest level of government compatible with the size of the benefit area associated with the services. In the decentralization theorem propounded by Oates8, Oates maintains that “each public service should be provided by the jurisdiction having control over the minimum geographical area that would internalize benefits and costs of such provision.” Most countries that have put in place fiscal decentralisation measures have witnessed significant improvements in the level of economic development. This is mainly as a result of the improved efficiency in the allocation of resources as the preferences and very direct and specific needs of the local communities within different devolved units are matched more efficiently in the allocation of resources.

Since the constituents of the devolved units, who are aware of the development needs and local priorities, are enabled to make fiscal decisions there is increased efficiency as the development programmes and expenditure are more relevant. Measures by the central government to achieve a similar level of relevance in development programmes and expenditure priorities are by far inferior to what can be attained by the devolved units. This is due to the fact that a “one size fits all” approach cannot deliver a basket of public goods that is optimal for all citizens. Central government’s provisions are uniform across jurisdictions, despite differing preferences for public goods across regions or individuals.9

6 Dabla-Norris, Era. 2006. “The Challenge of fiscal decentralisation in transition countries.” Comparative Economic Studies. 48, 100-131. . 7 Shah, A. 2004. “Fiscal decentralisation in developing and transition economies: progress, problems and the promise.” World Bank Policy Research Working Paper 3282, April.

Shah points out that the principle of subsidiarity was introduced by the Maastricht Treaty for for assignment of responsibilities among members of the European Union. According to this principle, taxing,

spending and regulatory functions should be exercised by the lowest levels of government unless a convincing case can be made for assigning the same to higher levels of government.

8 Oates, Wallace. 1972. Fiscal Federalism. New York: Harcourt Brace Jovanivich 9 Martinez-Vazquez, J. and McClure, Charles E. 2003. The Assignment of Revenues and Expenditures in Intergovernmental Fiscal Relations. Washington DC: World Bank

Fiscal Decentralisation provides for “tailoring levels of consumption to the preferences of smaller, more homogeneous groups”10. The sub-‐‑national governments are better placed to respond to the preferences of the local citizens in term of local public goods and are able to target services at the right people. It thus gives local constituents what they want and are willing to pay for and the opportunity for greater local responsiveness and political participation11.

As government is brought closer to the people, transparency and accountability is enhanced. Government accountability is increased since local officials can be easily identified by voters and taxpayers. Fiscal Decentralisation also makes governments more responsive through inter jurisdictional competition for investment and taxpayers. Previously marginalized stakeholders such as the poor and minority ethnic groups are also involved in decision making.

B. Principles and Instruments of Fiscal Decentralisation The operational framework for Fiscal Decentralisation must be anchored on four basic building blocks. Effective decentralisation begins by clearly defining the roles and functions of the different levels of government. This helps determine the needs of each level of government. The framework must then provide for a clear definition of expenditure and revenue authority and responsibility between the levels of government. A stable and meaningful decentralisation requires a well defined institutional framework in the assignment of expenditure responsibilities among the different levels of government together with the sufficient budgetary autonomy to carry out the assigned responsibilities at each level of government.12

In its design, the operational framework must address, as basic principles, the assignment of expenditure responsibilities to the different levels of government (what are the functions of each level of government), taxation and revenue sources to the different levels of government (who has the right to tax? Which taxes can be levied at each level? etc), the basis of intergovernmental fiscal transfers/sharing of revenue between the centre and the devolved units and between the units themselves (what

10 Wallis, J.J. and W.E. Oates. 1988. “Decentralization in the public sector: an embirical study of state and local government.” In H.S.. Rosen (ed.) Fiscal Federalism: Quantitative Studies. Chicago: University of Chicago Press. 11 Bird, Richard. 1993. “Threading the fiscal labyrinth: some issues in fiscal decentralization” 12 Martinez-Vazquez, J. and McClure, Charles E. 2003. The Assignment of Revenues and Expenditures in Intergovernmental Fiscal Relations. Washington DC: World Bank

percentage of national revenue is allocated to the lower levels of government, and how is this divided amongst the units in that level) and how the sub-‐‑national levels of government can address budget deficits, when and if these arise, through borrowing.

The institutional authority to determine the criteria for intergovernmental fiscal transfers, (who will determine the formula for allocation of revenue and at what frequency), must also be clearly stipulated.

In summary the principles of fiscal decentralisation are as follows:-‐‑

i. Assignment of expenditure responsibilities to different government levels. ii. Assignment of tax and revenue sources to the different levels of government. iii. Intergovernmental fiscal transfers. iv. Sub national borrowing.

1. Assignment of Expenditure Responsibilities

This is the most basic principle of fiscal decentralisation as it defines who does what – which functions are assigned to different levels. Assignment of expenditure responsibilities relates to the government’s endeavour to satisfy the needs and specific preferences of tax payers. Expenditure assignment should be the first step in the design of a system of decentralization of intergovernmental finances. It is instructive to note that there is no single best assignment of expenditure responsibilities13 among different government levels as assigning expenditure responsibilities could in some cases be “multi dimensional” in nature in that different levels of government may need to be simultaneously involved in the same broad service delivery are (such as primary education), but in different ways (e.g. whereas the devolved units may be responsible for the direct provision of primary education, the central government may take a lead role in defining curricula and overseeing standards).

In consonance with the principle of subsidiarity, the responsibility for the provision of services should be at the lowest level of government compatible with the size of the benefit area associated with the services. If a small local government can efficiently provide certain services, then it should be assigned the responsibility to provide them.

13 UNDP, 2003. Fiscal decentralization and Poverty Reduction, Washington DC: UNDP

There are three types of functions that are best performed by central governments. These are14:-‐‑

i. Provision of public goods and services that benefit the entire nation e.g. defence;

ii. Income Redistribution and Stabilization or Social policies – the central

government must undertake certain expenditure to ensure equity and income equalization measures such as social welfare or low income housing. Expenditures undertaken for the stabilization of the economy are best handled by the central government; and

iii. Government activities that have spill over effects (benefits and/or costs) between

local governments

Depending on the absorptive capacity of the devolved units, the nature and number of responsibilities, as well as revenue collecting powers, assigned to them may vary. In such an “Asymmetrical” situation, more responsibilities may be assigned to specific devolved units than to others15.

2. Assignment of Tax and Revenue Sources.

After assigning the expenditure responsibilities, the sources of revenue to the different levels of government must be addressed.

Matching expenditure and tax assignments enables the different levels of government to shape the supply of public goods according to local preferences and willingness to pay16. Standard fiscal federalism theory suggests that taxes should be assigned to lower or sub-‐‑national governments as summarised by (Oates 1996) and Bird (2008) as follows:-‐‑

i. Lower levels of government should, as much as possible, rely on benefit taxation

of such mobile economic units as households and mobile factors of production. 14 UNDP, 2003. Fiscal decentralization and Poverty Reduction, Washington DC: 15 UNDP, 2003. Fiscal decentralization and Poverty Reduction, Washington DC: 16 Llanto, M. Gilberto., 2009. Fiscal Decentralization and Local Finance Reforms in the Philippines. Makati City, Phillipines: Phillipne Institute for Development Studies.

ii. To the extent that non-‐‑benefit taxes on mobile economic units are required, for example for redistributive purposes, only high levels of government should impose them.

iii. In any non-‐‑benefit taxes are imposed by lower levels of government, they should

be levied only on tax bases that are relatively immobile across local jurisdictions.

To better understand revenue assignment, the Fiscal functions of government are separated into three functions17:

i. Macroeconomic stabilisation, this includes government operations and policies that ensure price stability and achievement of employment targets. Macroeconomic Stabilisation programmes are most commonly within the domain of the central government as it is only the Central Government that has the ability to affect the macroeconomic conditions within the entire country (across all devolved jurisdictions) and the capacity to implement these programmes and measures. The devolved sub national governments lack the ability to affect these macroeconomic conditions and also do not have capacity to implement these measures. For example – they cannot print money and as such finance debt18. Also, it is the central government that is in the best position to control the taxes that are key in stabilizing measures i.e. the corporate and individual income tax. These are key as corporate income levels fluctuate more than the general economic conditions and individual income tax because of the stabilizing effects of graduated rates.19 Sub-‐‑national governments are as such better off relying on revenue sources that are relatively insensitive to macroeconomic conditions. These include consumption taxes such as general sales taxes, excises, and property taxes.

ii. Income redistribution – this function aims to ensure that there is equitable distribution of income within and between the devolved units. This is also assigned to the central level of government. This is due to the fact that the taxes which are mostly used to reduce differences in income are the corporate income tax and progressive individual taxes. The devolved governments’ use of these taxes may actually work against the intended goals of redistribution as they will

17 Musgrave, R. A., 1959. The Theory of Public Finance. New York: McGraw Hill. 18 Darby, J., Muscatelli, A. and Graeme, R., 2003. Fiscal Decentralisation in Europe: A review of recent experience. Glasgow: University of Glasgow. 19 Martinez-Vazquez, J. and McClure, Charles E., 2003. The Assignment of Revenue and Expenditures in Intergovernmental Fiscal Relations. Washington DC: World Bank.

further distort the geographical allocation of resources by repelling or attracting individuals and corporate investors to and from other regions. Local governments are most commonly assigned taxes that correspond to the services that they provide e.g. local land rates, business fees etc.

iii. Resource allocation – this function deals with equity in the allocation of revenue and resources to devolved units and ensures that these are used efficiently and relevantly. The conventional model of tax assignment (Tiebout-‐‑Oates-‐‑Musgrave model) posits that there are no productive taxes assigned to sub-‐‑national governments. The role of the sub-‐‑national government is strictly to provide sub-‐‑national public goods. This ensures that the governments address local expenditure priorities that reflect the local needs. Local governments are better informed and have a clearer scope on the needs of their residents.

The best candidates for sub-‐‑national taxes are levies that are on relatively immobile bases, especially when the base is relatively evenly distributed and when yields are likely to be relatively stable20. Sub national taxation of potentially mobile tax bases as trade, labor and capital can be distorting and welfare reducing. There are very few taxing powers which can be transferred to sub-‐‑national governments without raising concerns about efficiency and/or distribution. An opposing view would be that in taxing mobile factors, sub national governments would be more tax competitive and limit the greed of the central government.

Competition between such governments can limit the grasp of the Leviathan21, that is, the central government which tends to arrogate for itself the bulk of resources and power22. The Leviathan model potrays the government as a Leviathan that maximises the revenue by exploiting the tax base to the maximum extent. Brennan and Buchanan (1980) pose that “total government intrusion into the economy should be smaller, ceteris paribus, the greater the extent to which taxes and expenditures are decentralised….23. According to Zhu and Krug (2005), Fiscal decentralisation is thus a powerful response

20 Ter-Minassian, T. 1997. “Intergovernmental fiscal relations in a macroeconomic perspective: an overview,” in T. Ter-Minassian, ed., Fiscal Federalism in Theory and Practice. Washington, DC: International Monetary Fund. 21 Bird, Richard. 1999. Rethinking Sub-national taxes. Working Paper/99/165. International Monetary Fund 22 Llanto, M. Gilberto., 2009. Fiscal Decentralization and Local Finance Reforms in the Philippines. Makati City, Phillipines: Phillipne Institute for Development Studies. 23 G. Brennan and James Buchanan. 1980. The Power to Tax .Cambridge: Cambridge University Press

to the grasp of the Leviathan because it provides an institutional constraint to the reach of the state24

Appropriate taxes for each level:-‐‑

Central Government Local Governments

1 Value Added Tax 1 Business Fees

2 Corporate Income Tax 2 Real Estate Property Taxes

3 Import/Export Taxes 3 Retail Sales Taxes

4 Personal Income Taxes 4 Motor Vehicle fees

5 User Charges

Fig. 1. Tax Assignments.

An appropriate tax assignment system could follow the following basic principles25,26:-‐‑

a. Financing follows function and thus, tax assignment depends on assignment of spending responsibilities

b. Local governments should have the power to determine their “own-‐‑source” revenues and should be able to set their own tax rates.

3. Intergovernmental Fiscal Transfers. Intergovernmental fiscal transfers are a very important pillar and instrument of fiscal decentralisation due to their impact on local government financing. These transfers are used to control vertical and horizontal fiscal imbalances that occur when the tax assignments to the devolved units do not match the revenue sources.

24 Zhu, Z. and B. Krug. 2005. Is China a Leviathan. ERS 2005-087-ORG, Erasmus Research Institute of Management, Erasmus University, Rotterdam, December. 25 Bird, Richard. 2008. “Tax assignment revisited.” Institute for International Business Working Paper Series No. 17, Rotman School of Management, University of Toronto. August.

26 McLure, C.E. 2000. "Tax assignment and subnational fiscal economy," Bulletin for International Fiscal Documentation, December, 626-‐35.

Intergovernmental fiscal transfers have a huge impact on allocative efficiency, distributional equity and macroeconomic stability27. Indeed, in developing countries and transition economies, 60% of sub national expenditures are financed by intergovernmental fiscal transfers. Intergovernmental fiscal transfers account for a third of such expenditures in OECD countries, 29% in Nordic Countries and 46% in non-‐‑Nordic Europe.28 Intergovernmental fiscal transfers can also be used to achieve fiscal equalization.

Due to the disparities in the population, geographical sizes and economic capacities of sub-‐‑national governments, the central government must find an equitable formula of revenue allocation so as to prevent horizontal imbalances among the devolved units. These imbalances can also be caused due to the high dependence of the devolved units to the national government’s transfers and grants especially when the local governments have limitations with regard to other sources of revenue. The principles of equity and need should drive the distribution of shared revenues between different subnational governments.29

In designing a system of intergovernmental fiscal transfer, the central government must then address the following issues:-‐‑

i. The Vertical Fiscal Imbalances caused by the gap between the fiscal needs and resources available to the different levels of government. To achieve vertical balance between the different levels of government, the central government must assign financial resources to the local levels and develop a system of national shared taxes. The government should also increase the volume of resources dedicated to equalisation30 at the national level.31

ii. The Horizontal fiscal imbalances between devolved units at the same level of government. This can be achieved through an equitable revenue allocation formula that takes into account factors such as population and

27 Llanto, M. Gilberto., 2009. Fiscal Decentralization and Local Finance Reforms in the Philippines. Makati City, Phillipines: Phillipne Institute for Development Studies. 28 Shah, A. 2006. “A practitioner’s guide to intergovernmental fiscal transfers.” World Bank Policy Research Working Paper 4039, October 29 Yemek, E., 2005. Understanding Fiscal Decentralisation in South Africa. South Africa: IDASA- Budget Information Service. 30 The Proposed constitution of Kenya establishes an equalization fund that will also contribute to achieving Vertical and Horizontal Balance 31 UNDP, 2003. Fiscal decentralization and Poverty Reduction, Washington DC: UNDP

human development. It can also be achieved through equalisation grants and formulae not based on the source of collection.32

iii. Providing for the funding of national projects that cut across the devolved units. E.g. vision 2030, Economic Stimulus package etc.

iv. Incentive for increased performance and output from local governments. Performance oriented transfers can provide these incentives to the sub national governments to be more accountable for results. According to Shah33, output-‐‑based fiscal transfers should to some extent link grant transfer with service delivery performance.

A sound intergovernmental fiscal transfer system34 should have the following features:-‐‑

Ø Promotes budget autonomy at the Sub-‐‑National level. This is done by providing for lump-‐‑sum versus conditional transfers. Indeed, where preference is towards local choice, there should be fewer restrictions on sub national governments regarding how these resources are used;

Ø Provides predictability of allocations with respect to timing and amounts so as to facilitate proper planning at the sub national level;

Ø Provides adequate revenue to sub-‐‑national governments; Ø Provides positive incentives to encourage higher tax effort and performance of

devolved units, promote expenditure efficiency and discourage fiscal deficits; Ø Enhances equity and fairness; Ø Overall transfers should increase with fiscal expenditure needs and decrease

with revenue capacity

a. Formulae Based Intergovernmental Fiscal Transfers

In order to achieve proper horizontal balance between sub-‐‑national governments, strict formulae should guide the transfer system. Formulae based grants35 are an important component of intergovernmental fiscal relations as they provide stability, equity and efficiency in implementing intergovernmental fiscal transfers.

32 UNDP, 2003. Fiscal decentralization and Poverty Reduction, Washington DC: UNDP 33 Shah, A. 2006. “A practitioner’s guide to intergovernmental fiscal transfers.” World Bank Policy Research Working Paper 4039, October 34 Compilation done by Rey Chang, Dunstan Decena and Felipe, PA 332, University of the Philippines National College of Public Administration and Governance. 35 The World Bank’s Public Expenditure and Financial Accountability assessments favour formula based transfers.

The rules and modalities of intergovernmental fiscal transfer need to be clear and transparent and should not encourage the sub national governments to remain poor so as to receive more funds. The allocation formula provides an overall allocation to the sub national governments which in turn should fine tune the allocation to local circumstances.

In defining an appropriate allocation formula for intergovernmental fiscal transfers, the following guidelines could be useful:-‐‑

i. The formula should be as simple as possible; ii. The computation and entire process should be objective and free from

manipulation by any of the involved parties through manipulation of the data to be used.

iii. The variables to be used should have an unequivocal relation with the purpose of the grant and should not be related.

iv. Variables that create a disincentive to enhance performance on either revenue or expenditure should be avoided.

The transfer formula should reflect the purpose of the grant and should aim to address the following objectives36:-‐‑

i. Differences in expenditure needs. The formula should reflect the differences in expenditure needs between jurisdictions. Incorporating several indicators in the formula will address this. These indicators include:-‐‑ a. Population; b. Physical factors that could have a bearing on the cost of service

delivery such as area, topography, levels of urbanisations etc; c. Indicators that reflect ‘high costs populations’ such as the poverty

index; and d. Indicators that reflect different needs for both recurrent and/or

investment costs for infrastructure. A Human Development Index would sufficiently address this.

ii. The need to achieve fiscal income equalisation. The formula should also attempt to allocate more resources to districts having a weaker tax raising potential.

iii. The need to include a premium for good performance. In aiming to provide an incentive to the sub-‐‑national governments to increase their revenue collection, the formula should include a variable that gives a

36 Boschman,N. 2009. Fiscal Decentralization and Options for Donor Harmonisation. Development Partners Working Group on Local Governance and Decentralization DPWG-LGD. Berlin, December

premium for improved performance in respect to local revenue mobilisation.

4. Sub National Borrowing

Sub National borrowing is the final component of Fiscal Decentralisation. In the event that a local government has a fiscal deficit or debt, it may be necessary to engage in local borrowing for certain types of spending. Sub national deficits occur when the expenditure needs of the local government are not properly matched with the resources available. When the fiscal balance37 of a local government is negative, it may then be appropriate for the local government to borrow or issue bonds so as to finance its expenditure responsibilities.

It should be clear that sub national borrowing should be limited to financing only certain types of spending such as long-‐‑term capital development projects but not to recurrent expenditure e.g. salaries etc.

Local borrowing should be regulated so as to ensure responsible spending and that the sub national governments do not end up in unnecessary debt and arrears. Tight regulations should be put in place by the central government to ensure that local governments borrow responsibly as the risk of major defaults can have serious ramifications for macroeconomic conditions (e.g. interest rate fluctuations). The presumption that the central government will fund the deficits of the local governments or guarantee their arrears provides an excuse/incentive to local governments to run budget deficits.38

37 The “Fiscal Balance” of a sub national government is defined by the UNDP as the difference between its expenditure responsibilities, on the one hand, and its own source revenues and transfers on the other hand. 38 UNDP, 2003. Fiscal decentralization and Poverty Reduction, Washington DC: UNDP

C. Fiscal Decentralisation in South Africa

South Africa presents us with a very good case of fiscal decentralisation within the context of a unitary state. The post apartheid government of South Africa has been faced with massive of economic and social challenges. Apartheid policies in S.A. caused severe economic and social disparities that left many South Africans living in dire conditions, without the most basic of needs. South Africa’s intergovernmental fiscal system aspires to meet these socioeconomic challenges and correct horizontal imbalances by providing equity through redistribution of national revenues and ensures that public services are provided efficiently by properly matching expenditure with regional priorities.

The South African intergovernmental fiscal system provides a framework of fiscal arrangements aimed at ensuring that government responsibilities are met, while the right level and mix of public services are delivered to enhance the socioeconomic rights of citizens, especially the disadvantaged39

1. Fiscal Decentralisation in South Africa – Institutional Framework The Constitution of South Africa establishes three levels of government. These are:-‐‑

i. A National Government ii. Nine Provincial Governments iii. 284 Local Governments40

The National Government is overly responsible for the management of affairs that cut across the provinces and that generally affect the entire country while the sub national governments deliver the most basic services. The responsibilities between the Provinces and the Local governments are also defined. Some responsibilities are shared between different levels of government. Local governments have a larger responsibility for the provision of certain services that are deemed local e.g. sanitation, water etc.

39 Yemek, E., 2005. Understanding Fiscal Decentralisation in South Africa. South Africa: IDASA- Budget Information Service. 40 Department of Provincial and Local government, South Africa. www.dplg.gov.za

In addition to shared expenditure responsibilities, South Africa’s fiscal decentralisation framework also provides for shared revenue responsibilities between the national and sub national governments.

The constitution of South Africa clearly provides for and deals with various aspects of fiscal decentralization. The constitution addresses issues such as the allocation of revenue to sub national governments, the assignment of expenditure responsibilities to sub national governments and provides a clear framework of intergovernmental fiscal relation.

The Constitution also creates a nonpartisan Financial and Fiscal Commission (FFC) that advises parliament41 and sub national governments on matters of intergovernmental fiscal relations including taxation, allocation of revenue between tiers of governments and sub national borrowing.42

2. Assignment Systems of Fiscal Decentralisation in South Africa

The assignment systems in South Africa’s Fiscal Decentralization system aims at ensuring that residents in various jurisdictions have opportunities to exercise choice in terms of public service level and taxes.43 As noted earlier, the primary aim of Fiscal Decentralization in South Africa is to mobilise resources for the effective and efficient delivery of services to its citizens, especially the poor and vulnerable. It endeavours to reduce interregional inequalities and improve the social indicators inherited from the policies of the apartheid government.

It is for these reasons that South Africa has been progressively increasing the roles and responsibilities of sub national governments in providing public services through increased allocations. Between the 08/09 and 11/12 financial period, allocations from National to Provincial governments increased by 11% (from R246 Billion to R336 Billion) while allocations to local government have gone up by 13.3%. Indeed, the constitution of South Africa, much like Kenya’s Proposed Constitution, stipulates that

41 Section 214 of the Constitution and section 9 of the Intergovernmental Fiscal Relations Act (1997) require the FFC to make recommendations in April every year, or soon thereafter, on the division of revenue for the coming budget.

42 Section 9 and 10(4) of the Intergovernmental Fiscal Relations Act of South Africa. 43 Yemek, E., 2005. Understanding Fiscal Decentralisation in South Africa. South Africa: IDASA- Budget Information Service.

all citizens are entitled to adequate housing, health care, food, water, social security and basic and further education.44 In South Africa’s context, this is more sufficiently done at the sub national level in consonance with the subsidiarity principle as discussed in earlier sections.

In South Africa, national revenue is centrally collected by the South Africa Revenue Service (SARS). The sub national levels are then allocated a proportion of this revenue through an inclusive process involving parliament, the government (through the National Treasury) and the Financial and Fiscal Commission. The sub national governments have the legal autonomy to formulate their budgets and make independent decisions on their expenditure. However, in as much as the sub national governments are empowered to determine their own resource allocation decisions, these have to be within the context of the government’s broad medium-‐‑term strategic objectives.45

In addition to the National transfers, the sub national governments in South Africa generate revenue from their own sources. While the national transfers to municipalities mainly take account their fiscal capacity, those to the provinces are limited by the nature of provincial functions.46

3. Assignment of Expenditure Responsibilities in South Africa

The assignment of expenditure functions in South Africa is designed in line with the principle of subsidiarity and aims to achieve the following objectives:-‐‑47

i. An efficient allocation of resources via a responsive and accountable government;

ii. An equitable provision of services to citizens in different jurisdictions; and iii. Macroeconomic stability and economic growth.

44 Sections, 26, 27 and 29 of the Constitution of the Republic of South Africa. 45 Yemek, E., 2005. Understanding Fiscal Decentralisation in South Africa. South Africa: IDASA- Budget Information Service. 46 Yemek, E., 2005. Understanding Fiscal Decentralisation in South Africa. South Africa: IDASA- Budget Information Service. 47 Yemek, E., 2005. Understanding Fiscal Decentralisation in South Africa. South Africa: IDASA- Budget Information Service.

The National government performs expenditure responsibilities that have a national dimension, affect macroeconomic stability and have redistribution implications. These include defence, tertiary education, foreign affairs, correctional services, water, pensions and unemployment compensation. Sub national governments have expenditure responsibilities for delivery of goods and services with local benefit areas (provincial and local) to them.

The constitution of South Africa lists the expenditure responsibilities for national and provincial governments. Schedule 4 of the constitution lists education, health, housing, agriculture, casinos and other gambling, and public transport as concurrent areas of competence for the national and provincial governments. Part B of the schedule lists local government expenditure responsibilities including air pollution, building regulations, child care facilities, fire fighting, municipal airports, municipal health and municipal public transport. The constitution also lists, in Schedule 5, the expenditure responsibilities that are in the exclusive domain of the provinces. These include services such as abattoirs, ambulances and provincial libraries while local government responsibilities include beaches, cemeteries, cleansing and local sports facilities.

4. Assignment of Revenue Responsibilities

The different levels of government in South Africa each have different responsibilities with respect to revenue generation. Different levels are allowed to use different tax instruments and borrowing mechanisms to generate revenue.

The National government relies on a number of tax instruments to generate revenue. The National Government levies broad based taxes such as income tax, corporate tax, Value-‐‑added tax, customs and excise taxes and fuel levies.

Sub national governments have lower fiscal autonomy and mainly rely on fiscal transfers from the national government. Transfers from the national government form the largest part of revenues for these governments. This is due to the fact that the provincial and local governments are limited in their taxation and borrowing powers.

The provinces are allowed to impose taxes, levies and duties other than income tax, VAT, sales tax, rates on property or custom duties. They area also allowed to levy flat-‐‑rate surcharges on the tax base of any tax, levy or duty imposed by national legislation apart from corporate income tax, VAT, rates on property and customs duties. The revenue raised from these taxes and levies, is minimal. This creates a gap between the expenditure responsibilities and revenue abilities of the provinces thus creating the need for central government to address the vertical imbalance through fiscal transfers.

Local governments in South Africa, on the other hand, have greater revenue raising potential and powers. This is due to the fact that the Local Governments can raise more revenues through property and business taxes. The LGs also raise significant revenue through the imposition of fees for services such as water, sewerage and electricity. Urban local governments additionally, receive revenue through regional services council levies. As such, there is better balancing of expenditure and revenue responsibilities to the local governments when compared to the Provincial government.

5. Intergovernmental Fiscal Transfers – South Africa

Intergovernmental Fiscal Transfers (IGFs) are a critical component of fiscal decentralisation in South Africa. These transfers take the form of revenue sharing or grant allocation and are executed in four stages48:-‐‑

i. From National Government to Provincial; secondly, ii. From Provincial Government to Local governments third, iii. From National Government to Local Governments; and fourth, iv. From Local Governments to Local Governments.

The National government, bearing the greatest responsibility and authority for the collection of revenue, divides revenue among national and sub national government. The main objective of these transfers is to enable the sub national governments meet their expenditure service responsibilities and perform other functions as assigned in the constitution. This ensures vertical balance between the levels of government i.e. the sub 48 Yemek, E., 2005. Understanding Fiscal Decentralisation in South Africa. South Africa: IDASA- Budget Information Service.

national governments are able to match their expenditure responsibilities which are extensive whereas their revenue raising capabilities are limited. The national government also uses this transfers to address horizontal imbalances between the provinces and fund programs dealing with regional/sectoral equalisation.

Arrangements for the intergovernmental fiscal transfers are clearly provided for in the Constitution of South Africa. It provides that programs are funded primarily through the equitable sharing between the three spheres of government, of the revenues raised at a national level. This share consists of two components:-‐‑

i. The Provincial Share – this provincial portion of the revenue to be allocated to sub national governments is shared equitable between the nine provinces and the local government share is shared equitably among the 284 municipalities.

ii. The Equitable Share -‐‑ this share is divided among the sub national governments based on formulas49 with variables considering the specific needs of each level of government. As shown in the figure below, South Africa’s provinces vary greatly in size and population. These variances are taken care of through an equitable formula for division of the equitable share of revenue. These specific needs are social, economic and institutional. Economic backlogs and special regional and sectoral needs are addressed through the allocation of conditional grants. The constitution provides that national revenue be divided into equitable shares for national, provincial and local governments. These equitable share enable the Provincial Governments provide the services mandated to it.

PROVINCES POPULATION

(MILLIONS) LAND AREA(Sq. Km)

GDP

1 The Eastern Cape 6.9 168, 966 8.1%

2 The Free State 2.9 129, 825 5.5%

3 Gauteng 9.5 16, 548 33.3%

4 KwaZulu-‐Natal 9.9 94, 361 16.7%

5 Limpopo 5.6 125, 755 6.7%

49 The formula is proposed by the FFC for the division of resources over a 3 – 5 year period.

6 Mpumalanga 3.5 76, 495 6.8%

7 The Northern Cape 1 372, 889 2.2%

8 North West 3.4 106, 512 6.3%

9 The Western Cape 4.7 129, 462 14.4%

In order to address the fiscal deficits that may arise in the sub national government budgets in South Africa, sub national governments can borrow additional funds from other governments. Borrowing by sub national governments is highly regulated and controlled by the National government. Provinces, for instance, can only borrow for capital and bridging finance.

6. Fiscal Decentralisation in South Africa – Lessons for Kenya

The South African experience of fiscal devolution provides key lessons for Kenya. The main objective of fiscal decentralisation in South Africa has been to address the history of horizontal imbalances and impaired social policies. Its design and framework has emphasized the principles of good governance50 with efficient, effective and consistent institutions. It is by these principles that the successes and challenges of fiscal decentralisation in South Africa can be measured.

Through fiscal decentralisation in South Africa, sub national governments have been enabled and equipped to be efficient, transparent and accountable to the citizenry. This has been done to ensure that public goods are managed and produced efficiently and effectively. Over the years, the South African government has worked hard to ensure that there is greater transparency, predictability and accountability in the decision making processes of the institutions responsible for the delivery of public goods. This has been done through legislation51 and extensive mechanisms for monitoring and evaluation of programmes.

Just like the case of South Africa, Kenya’s units of devolution vary greatly in size and population. However, despite these variances, South Africa has been able to develop an 50 Good governance can be defined as the ability of the government to respond to the needs and wishes of citizens. 51 The Public Finance Management Act of 1999 addresses the role that good governance plays in the socioeconomic development of South Africa.

equitable system of fiscal transfer that takes into account these variances in the division of the equitable share of revenue allocated to the Provincial Governments. This is done through the Finance and Fiscal Commission (FFC) of South Africa.

A key lesson, from the experience of South Africa and indeed many more countries where fiscal decentralisation is in place, is that – fiscal decentralisation does not automatically guarantee the improvement of public service delivery and horizontal balancing. Fiscal decentralisation also brings with it a number of political challenges that may hinder its noble endeavours. For fiscal decentralisation to be successful there must be deep political commitment and responsible leadership at all levels of government.

Also, unless there are adequate revenue capabilities for sub national governments, whether by their own sources or by intergovernmental fiscal transfers, efficiency in the delivery of services will still be a problem. There must be proper matching of the expenditure and revenue responsibilities of the sub national governments.

D. Fiscal Decentralisation in Kenya – Past and Present Frameworks

Since independence, Kenya has had certain elements of fiscal decentralisation in practice. This began with the “majimbo” system where “Jimbos” (Regions) and Local Authorities were granted significant revenue and expenditure authority. Local authorities had the responsibility of maintaining schools, health facilities and minor roads. The local authorities also collected certain taxes. The Majimbo system only lasted until 1965 when Kenya adopted a centralized system following the merger of the ruling party Kenya African National Union and the opposition party Kenya African Democratic Union.

Despite moving to the centralized system in 1965, the government developed the Sessional Paper No. 10 of 1965 on African Socialism and its Application to the Planning in Kenya. Among other things, the Sessional paper expressed the government’s objective of ensuring political equality, social justice, human dignity, freedom from want, equal opportunities, and equitable distribution of resources.

It also provided that planning would be decentralized to subsidiary levels i.e. the provinces, districts and municipalities as it recognized the horizontal disparities between different provinces and districts. In cognisance of this fact, provinces were categorized as developed and underdeveloped. The strategy for ensuring equity in

development, according to the paper, was to concentrate investment of national revenues first to the developed areas with the greatest potential of yielding high returns due to their natural resource endowment and later redistribute.

Following the Sessional Paper No. 10 of 1965, the government developed the 1966 -‐‑ 1970 National Development Plan. In this plan, the government committed itself to protecting infant industries and supporting import substitution. The general direction was to concentrate efforts in developing only certain areas of the economy. This strategy proved to be unsustainable and called for the development of a development strategy that would focus on all aspects of the economy. This set the stage for the introduction of two policy programs that would re-‐‑introduce decentralized planning and address development in the rural areas with the aim of accelerating development and access to basic services in these areas.

These policy instruments were:-‐‑

i. The Special Rural Development Programme (SRDP) SRPD was established in 1971 following the 1966 Kericho Conference with the main objective of focussing development in the rural areas by increasing rural incomes, employment and welfare. Through the SRDP, which was managed by the Ministry of Finance and coordinated by the National Rural Development Committee, the government attempted to identify critical gaps and bottlenecks as well as testing new ideas and projects.

Through this, the government extended decentralized planning to all districts in Kenya through the creation of the office of District Development Officer (DDO) and the formation of District Development Committees and District Planning Units. This effectively laid the framework for decentralised planning in Kenya. The SRDP contributed greatly to Kenya’s agricultural and rural development through effective and equitable policies.

ii. The District Focus for Rural Development (DFRD) The DFRD was established in 1983 as a result of the Ndegwa Report (Commission of Inquiry on Public Service Structure). The Ndegwa report highlighted the fact that the planning processes and mechanisms in Kenya extended only to the provincial level and

as such there was need to extend this to lower levels. It also revealed that there was little or no integration between the field units of government ministries and those of the provincial administration52. The DFRD was established to address these challenges. Its DFRD strategy sought to improve the coordination of development activities, in both the planning and implementation stages, in the rural areas.

The DFRD program has had several successes and challenges. In as much as it has provided a framework for planning and implementation of development at all levels, it has still not provided for participatory planning for the wananchi. Its institutional framework does not allow for meaningful local participation in decision making. Other challenges that the DFRD has faced are as follows53:-‐‑

i. Lack of adequate capacity in participatory planning among civil servants ii. Financial allocations by ministries headquarters that justify continued control of

their field units as opposed to local expertise; iii. Civil Service dominance in planning. DFRD has a high composition of

government officials especially from the provincial administration who serve as chairpersons at all levels.

iv. Lack of people’s awareness and participation in planning and implementation of strategy.

The DFRD has not met its objective of democratising local development.54

1. Constitutional Framework for Fiscal Decentralisation in Kenya

Currently, there is no constitutional framework for fiscal decentralisation in Kenya. The only legal framework through which certain elements of fiscal decentralisation, detailing the fiscal arrangements between the central government and local authorities, exists in the Local Government Act Cap 265, Local Authorities Transfer Act, No 8 of 1998 and Local government Loans Act Cap 270. These acts address certain elements of the principles of fiscal decentralisation earlier covered, namely; expenditure

52 Alila, P., and Omosa, M., 1995. Rural development policies in Kenya. In Ng’ethe, N. And Owino, W., ed. 1996. From Sessional Paper no. 10 to Structural Adjustments: Towards Indigenizing the Policy Debate. Nairobi. Institute of Public Policy Analysis. 53 Chitere, P. And Ireri, O., 2004. DFRD: Its Limitations as a Decentralisation and Participatory Planning Strategy and Prospects for the Future. 54 Wachira, K., 2010. Fiscal Decentralisation: Fostering or Nurturing National Development in Kenya? In Mwenda, A., Devolution in Kenya: Prospects, Challenges and the Future. Nairobi. Institute of Economic Affairs.

responsibilities, revenue assignments, intergovernmental fiscal transfers and sub-‐‑national borrowing55.

i. Local Authority Transfer Fund (LATF)

LATF was established in 1998 through the Local Authority Transfer Act No 8 of 1998. The LATF Act provides for fiscal transfers from the central government to all local authorities so as to supplement their “own sources” in matching their expenditure responsibilities56. LATF was established as part of the reform measures outlined by the Kenya Local Government Reform Programme (KLGRP). This was due to the fact that before its conception, most of the local authorities in Kenya were barely meeting their financial and service delivery obligations. Indeed, most were almost collapsing due to huge debts and mismanagement.

The design of the LATF Act aimed at providing a mechanism through which central government can transfer funds to the local authorities while ensuring that the local authorities are properly managed and the funds are accounted for. The LATF Act also provides for proper planning and budgeting by the local authorities together with clear articulation of service delivery action plans.

According to the Act, 5% of national income tax is allocated to LATF. 0.5% of this is applied to the costs of administering the fund. Thereafter, the funds are allocated and disbursed to Local Authorities on the basis of population size. The government ensures transparency and proper management of funds through conditionalities for the release of funds. This is done in the following manner:-‐‑

i. 60% of the funds allocated to the Local Authority are disbursed upon submission of the council’s budget. This also depends on whether the council meets statutory creditor obligations.

ii. 40% of the allocated funds are allocated upon submission of:-‐‑ • The Council’s Revenue enhancement plan • Abstract of Accounts • Statement of Actual Revenues and Expenditures

55 Wachira, K., 2010. Fiscal Decentralisation: Fostering or Nurturing National Development in Kenya? In Mwenda, A., Devolution in Kenya: Prospects, Challenges and the Future. Nairobi. Institute of Economic Affairs. 56 The expenditure responsibilities of local governments are outlined in the Local government Act, Cap 265.

• Statement of debtors, creditors and debt repayment plan. • Local Authority Service Delivery Action Plan (LASDAP)

Other requirements for the release of funds are that the Local Authorities should57:-‐‑

• Not spend more than 55% of their total expenditure on personnel; and • Allocate a minimum amount to the capital budget (equivalent to 65% of the

LATF Service Delivery amount)

Through this, LATF has transformed local authorities in Kenya. Through LATF, service delivery and transparency of local authorities has improved greatly. Its population based formula for allocation ensures equity in allocation of funds to local authorities. Despite this, LATF still faces a number of challenges.

The greatest challenge lies in the disbursement of service delivery funds based on planned expenditures as opposed to actual expenditures. The LATF capital ratio regulation stipulates that each local authority should allocate at least 65% of their service delivery budgets to capital projects. However, most local authorities spend much less than this. The challenge lies in the fact that since LATF Capital Ratios are calculated based on the planned and not actual expenditures, most Local Authorities divert funds that were budgeted for capital projects and are not penalised in any way for this.

Secondly, there still exist challenges in implementation of the fund as there is no allocation of monies for capacity building of the locals involved in the planning and execution of projects. Thirdly, in the legal framework does not provide for a fiscal transfer mechanism that motivates local authorities to raise the levels of local revenue collection so as to match their local revenue collection with the transferred amounts.

Finally, although part of the objectives of LATF was the reduction of outstanding LA debt, the level of indebtedness of Local Authorities has remained very high. This continues to happen despite the LATF regulations that require the local authorities to

57 Wachira, K., 2010. Fiscal Decentralisation: Fostering or Nurturing National Development in Kenya? In Mwenda, A., Devolution in Kenya: Prospects, Challenges and the Future. Nairobi. Institute of Economic Affairs.

present a debt repayment plan before funding. This shows a weakness in the LATF framework as there is no mechanism through which LAs are denied funding if they continue to incur debts that they do not repay.58

Apart from the fiscal decentralisation arrangements between the central government and local authorities, there are several funds that have been created to address poverty eradication, roads maintenance and local development. These are:-‐‑

i. The Constituency Development Fund (CDF). Established by CDF Act No. 11 of 2003. Its main objective is to ensure that a specific portion of the national annual budget is devoted to the constituencies for purposes of development, and fighting poverty at the constituency level.

ii. Constituency Education Bursary Fund (CEBF). This was established in 1994 and aims to increase affordability and accessibility of secondary education through bursary grants to students from poor families. The fund also targets orphans and the girl child.

iii. Free Primary Education fund (FPE). Established in 2003 with the objective of increasing enrolment and quality of basic education in Kenya through public schools. It involves the allocation of funds to districts based on the number of primary school pupils.

iv. The Rural Electrification Programme Levy Fund (REPLF) this was established in 1998 the Electric Power Act of 1997 with the main aim of financing electrification of rural and other marginalised areas. This program is managed by the Rural Electrification Authority together with the KPLC and the Ministry of Energy.

v. The Roads Maintenance Levy Fund (RMLF). The RMLF was established in 1993 through the Roads Maintenance Levy Fund Act and mainly caters for the maintenance of public roads and unclassified roads. This fund is collected from levies on petroleum collections and transit toll station collections and is administered through the Kenya Roads Board.

58 Republic of Kenya, 2007. Independent Study on the Impact of Local Authority Transfer Fund (LATF) in Kenya. Nairobi: Ministry of Local Government.

E. Fiscal Decentralisation in Kenya – Prospects in the Proposed Constitution of Kenya

The Proposed Constitution provides for a very elaborate and comprehensive framework for fiscal decentralisation in Kenya. It clearly addresses all the components and principles of fiscal decentralisation i.e. expenditure responsibilities, revenue assignments, intergovernmental fiscal transfers and sub-‐‑national borrowing.

Objects and Principles of Devolution in the Proposed Constitution The Proposed Constitution sets out the objects and principles of devolution59. The objects of devolution are:-‐‑

i. To promote democratic and accountable exercise of power; ii. To foster national unity by recognising diversity; iii. To give powers of self-‐‑governance to the people and enhance the participation of

the people in the exercise of the powers of the state and in making decisions affecting them;

iv. To recognise the right of communities to manage their own affairs and to further their development;

v. To protect and promote the interests and rights of minorities and marginalised communities;

vi. To promote social and economic development and the provision of proximate, easily accessible services throughout Kenya;

vii. To ensure equitable sharing of national and local resources throughout Kenya; viii. To facilitate the decentralisation of state organs, their functions and services,

from the capital of Kenya; and ix. To enhance checks and balances and the separation of powers. The Proposed Constitution creates 47 sub-‐‑national County governments that are the units of devolution and vests the principles of devolved government in these governments60. These principles are that:-‐‑

i. County governments shall be based on democratic principles and the separation of powers;

ii. County governments shall have reliable sources of revenue to enable them to govern and deliver services effectively; and

59 Article 174 of the Proposed Constitution of Kenya, 2010. 60 Article 175 of the Proposed Constitution of Kenya, 2010.

iii. No more than two-‐‑thirds of the members of representative bodies in each county government shall be of the same gender.

1. Operational Framework for Fiscal Decentralisation in the Proposed Constitution of Kenya

The Proposed Constitution of Kenya (PCK) has clearly set out the operational and institutional framework for fiscal decentralisation. It creates the Commission of Revenue Allocation whose functions are to make recommendations concerning the basis for the equitable sharing of revenue raised by the national government.

The PCK provides for two levels of government; the National Government and 47 County Governments.

Each County Government will consist of a county assembly and a county executive .The membership of the county assembly will consist of both elected representatives of the people and other nominated members representing minority and special interest groups.61 The elected representatives, councillors, will be drawn from the wards within the counties. The legislative authority of the county will be vested in the county assembly which is mandated to make laws necessary for the effective performance of the functions and exercise of the powers of the county government.

The County Executive Committee, which will be headed by a popularly elected County Governor and his deputy, will have administrative control of the counties with respect to the planning and implementation of service delivery projects. The executive committee will implement both national and county legislation within the county. The committee may also prepare and propose to the county assembly legislation incidental to the performance of its functions.

The PCK clearly sets out the expenditure responsibilities of the central and county governments as well as the revenue sources for each. In addition to this, the PCK comprehensively provides for the system for fiscal transfer between governments and sets out the parameters for sub-‐‑national borrowing.

i. Expenditure Responsibilities

In sharing of functions between the National government and the County Governments, the PCK has adhered to the principle of subsidiarity. The National government is involved mainly in the formulation of national policies and standards

61 Article 176 and 177 of the Proposed Constitution of Kenya

and the management of national resources while the county governments are involved in formulation of policy and delivery of services at the local level.

The functions of the national government are as follows62:-‐‑

1 Foreign affairs, foreign policy and international trade 2 The use of international waters and water resources 3 Immigration and citizenship 4 The relationship between religion and state 5 Language policy and the promotion of official and local languages 6 National defence and the use of the national defence services 7 Police services 8 Courts 9 National economic policy and planning 10 Monetary policy, currency, banking (including central banking), the

incorporation and regulation of banking, insurance and financial corporations. 11 National statistics and data on population, the economy and society generally. 12 Intellectual property rights. 13 Labour standards. 14 Consumer protection, including standards for social security and professional

pension plans. 15 Education policy, standards, curricula, examinations and the granting of

university charters. 16 Universities, tertiary education institutions and other institutions of research and

higher learning and primary schools, special education, secondary schools and special education institutions.

17 Promotion of sports and sports education. 18 Transport and communications, 19 National public works 20 Housing policy 21 General principles of land planning and the co-‐‑ordination of planning by the

counties 22 Protection of the environment and natural resources 23 National referral health facilities 24 Disaster management 25 Ancient and historical monuments of national importance 26 National elections 27 Health policy 28 Agricultural policy

62 Schedule four of the Proposed Constitution of Kenya, 2010.

29 Veterinary policy 30 Energy policy 31 Capacity building and technical assistance to the counties 32 Public investment 33 National betting, casinos and other forms of gambling 34 Tourism policy and development.

The functions of County Governments63 are as follows:-‐‑

1 Agriculture, including— a. crop and animal husbandry; b. livestock sale yards; c. county abattoirs; d. plant and animal disease control; and e. fisheries.

2. County health services, including, in particular—

a. county health facilities and pharmacies; b. ambulance services; c. promotion of primary health care; d. licensing and control of undertakings that sell food to the public; e. veterinary services (excluding regulation of the profession); f. cemeteries, funeral parlours and crematoria; and g. refuse removal, refuse dumps and solid waste disposal.

3. Control of air pollution, noise pollution, other public nuisances and outdoor advertising.

4. Cultural activities, public entertainment and public amenities, including—

a. betting, casinos and other forms of gambling; b. racing; c. liquor licensing; d. cinemas; e. video shows and hiring; f. libraries; g. museums;

63 Schedule four of the Proposed Constitution of Kenya 2010.

h. sports and cultural activities and facilities; and i. county parks, beaches and recreation facilities.

5. County transport, including—

a. county roads; b. street lighting; c. traffic and parking; d. public road transport; and e. ferries and harbours, excluding the regulation of international and national

shipping and matters related thereto.

6. Animal control and welfare, including—

a. licensing of dogs; and b. facilities for the accommodation, care and burial of animals.

7. Trade development and regulation, including—

a. markets; b. trade licences (excluding regulation of professions); c. fair trading practices; d. local tourism; and e. cooperative societies.

8. County planning and development, including—

a. statistics; b. land survey and mapping; c. boundaries and fencing; d. housing; and e. electricity and gas reticulation and energy regulation.

9. Pre-‐‑primary education, village polytechnics, homecraft centres and childcare facilities.

10. Implementation of specific national government policies on natural resources and environmental conservation, including—

a. soil and water conservation; and b. forestry.

11. County public works and services, including—

a. storm water management systems in built-‐‑up areas; and b. water and sanitation services.

12. Fire fighting services and disaster management.

13. Control of drugs and pornography.

14. Ensuring and coordinating the participation of communities and locations in governance at the local level and assisting communities and locations to develop the administrative capacity for the effective exercise of the functions and powers and participation in governance at the local level.

ii. Revenue assignments64

The PCK also establishes the revenue assignment between the levels of government. The revenue assignments follow the functions allocated to each level. County governments have been enabled to have their own revenue sources from which they can finance their activities. The national government has the sole authority of levying certain taxes. These are taxes that have an impact on the macroeconomic stability of the country. The PC provides that only the national government may impose such taxes.

These exclusive taxes are:-‐‑

a) Income tax; b) Value added tax; c) Customs duties and other duties on import and export goods; and d) Excise tax.

County governments are allowed to impose the following taxes:-‐‑

a) Property rates; b) Entertainment taxes; and c) Any other tax that it is authorised to impose by an Act of Parliament.

64 Article 209 of the Proposed Constitution

The PCK also clearly provides that the taxation and any other revenue-‐‑raising powers of a county government shall not be raised in a way that prejudices national economic policies, economic activities across county boundaries or the mobility of goods, services, capital or labour. While this provision may limit the competitiveness between counties, it ensures economic stability.

iii. Intergovernmental Fiscal Transfer

From the above, it is clear that the tax revenue sources of the county governments are limited and are not a sufficient match to their expenditure responsibilities. It is with this in mind that the PC provides for an intergovernmental fiscal transfer arrangement that will ensure that the county governments can adequately meet their expenditure responsibilities.

The PCK provides for a very elaborate system of fiscal transfer between the national and county governments. It establishes that revenue raised nationally shall be shared equitably among the national and county governments. It also provides that county governments may receive additional allocations form the national government’s share of revenue, either conditionally or unconditionally. Further to this, it clearly sets the minimum amount of equitable share of national revenue between the national and county governments.

The PCK provides that in every financial year, the equitable share of the revenue raised nationally that is allocated to county governments shall not be less than fifteen per cent of all revenue collected by the national government. This ensures a certain measure of predictability in the minimum allocation for each county government.

The PCK provides for the institutional framework for implementing this in the creation of the Commission of Revenue Allocation (CRA). The CRA’s principal function is to make recommendations concerning the basis for the equitable sharing of revenue between the national and county governments and among the county governments. The criterion for this is defined and communicates the aspirations of the constitution to address horizontal imbalances between counties while safeguarding the national interest and flexibility.

Once every five years, the senate is mandated to determine the basis for allocating among the counties the share of national revenue that is annually allocated to the county level of government. This will be based on input from CRA, county governors, the national treasury, members of the public and professional bodies.

Annually, a Division of Revenue bill and a County Allocation of Revenue bill shall be introduced in parliament. The division of revenue bill shall divide revenue raised by the national government among the national and county levels of government in a ratio determined by the National Assembly as recommended by the CRA. The minimum ratio is set out as 85:15 between the National and County levels respectively. The County Allocation of Revenue bill shall divide among the counties the revenue so allocated to the county level of government on the basis determined by the Senate as recommended by the CRA. This will necessitate the development of a Formula Based Intergovernmental Fiscal Transfer System that takes the constitutionally set criteria into account. The criteria that shall be taken into account in determining the equitable shares of revenue between the National and County governments and among the county governments is as follows:-‐‑

a) The National interest;

b) any provision that must be made in respect of the public debt and other national obligations;

c) the needs of the national government, determined by objective criteria;

d) the need to ensure that county governments are able to perform the functions allocated to them;

e) the fiscal capacity and efficiency of county governments;

f) developmental and other needs of counties;

g) economic disparities within and among counties and the need to remedy them;

h) the need for affirmative action in respect of disadvantaged areas and groups;

i) the need for economic optimisation of each county and to provide incentives for each county to optimise its capacity to raise revenue;

j) the desirability of stable and predictable allocations of revenue; and

k) the need for flexibility in responding to emergencies and other temporary needs, based on similar objective criteria.

To further address the horizontal imbalances that exist in Kenya, the PCK has established an equalisation fund into which shall be paid one half per cent of all the revenue collected by the national government each year. This fund shall be used to

supplement the allocations from the equitable share of national revenue and shall be targeted at the provision of basic services including water, roads, health facilities and electricity in marginalised areas to the extent necessary to bring the quality of those services in those areas to the level generally enjoyed by the rest of the nation, so far as possible.

iv. Sub-‐‑national government borrowing

The authority for the counties to borrow money for the financing of their activities is limited. Counties cannot borrow money at their own discretion. This PC provides that a county government may only borrow if the national government guarantees the loan and if the county assembly approves the loan. The national government can thus ensure that the county governments are only borrowing when necessary and to fund capital projects with the potential of increasing the revenue base and collection of the county.

The national government can also use this role to ensure that counties that are heavily indebted do not engage in further borrowing that is not necessary. The PC provides that an act of parliament shall prescribe further terms and conditions under which the national government may guarantee loans. The national government will also publish a report annually detailing the guarantees it has given during that financial year.

F. Conclusion and Recommendations

Fiscal decentralisation is a positive and key plank of progressive economic reforms in a country. Fiscal decentralisation has improved the implementation of the allocative task of local government and has provided a framework for responsive and accountable local government. Indeed, a well designed public sector, performing clearly defined core functions and using resources productively, offers citizens opportunities to break out of the poverty trap by giving them affordable access to essential services and protecting their basic human rights65.

The potential economic turnaround that the introduction of real Fiscal Decentralisation portends for Kenya is immense. With increased economic efficiency, accountability and transparency in service delivery, fiscal decentralisation will ensure better cooperation of taxpayers thus increasing the tax base without necessitating an additional burden to the taxpayer.66 The sub-‐‑national governments are better placed to respond to the

65Yemek, E., 2005. Understanding Fiscal Decentralisation in South Africa. South Africa: IDASA- Budget Information Service. 66 Oates, Wallace E. An Essay of Fiscal Federalism, Journal of Economic Literature, Vol. 37, No. 3

preferences of the local citizens in terms of local public goods and are able to target services at the right people. It thus gives local constituents what they want and are willing to pay for and the opportunity for greater local responsiveness and political participation67.

In as much as the Proposed Constitution of Kenya provides an elaborate framework for fiscal decentralisation, subsidiary legislation and the regulations and standards that will be set by the institutions so created (the Commission on Revenue Allocation and the Senate) will be instrumental in ensuring the success of Fiscal Decentralisation. This includes the basis and formula for the division and allocation of revenue between the national and county governments and among the counties. The transfer formula should reflect the differences in expenditure needs between jurisdictions by incorporating several variables including:-‐‑

a. Population; b. Physical factors that could have a bearing on the cost of service delivery

such as area, topography, levels of urbanisations etc; c. Variables that reflect ‘high costs populations’ such as the poverty index; d. Variables that reflect different needs for both recurrent and/or investment

costs for infrastructure. A Human Development Index would sufficiently address this.

e. Indicators that will serve as a premium for good performance and provide an incentive to the county governments to increase their revenue collection. A good indicator for this would be the County GDP as is the case in India.

It is important to note that fiscal decentralisation does not automatically guarantee the improvement of public service delivery and horizontal balancing. It should be expected that there will also be a number of political challenges as well. For fiscal decentralisation to be successful in Kenya, there must be deep political commitment and responsible leadership at all levels of government. This means that the calibre and integrity of leaders from the lowest levels i.e. councillors must be high.

Finally, for fiscal decentralisation to be successful there must be concerted efforts to increase the institutional, political and technical capacity at all the local levels of decentralisation. This must be done aggressively at the onset of fiscal decentralisation. This capacity must then be affirmatively and progressively increased through creatively designed methods of fiscal transfer.

67 Bird, Richard. 1993. “Threading the fiscal labyrinth: some issues in fiscal decentralization”

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