Indonesia’s Fiscal Decentralization Revisited: “Bagi Rata” and its Implications Norio Usui ∗ Faculty of Economics, Kansai University 1. Introduction In the midst of political turmoil subsequent to the 1997 financial crisis, Indonesia’s political pendulum has swung toward decentralized democracy from centralized autocracy. After the fall of ‘New Order’ Soeharto, long standing frustration with central control, along with ethnic and religious unrests, erupted into secessionist moves in some regions. The new government, led by President Habibie, sought a solution for its weak presidential mandate and power base to decentralize the country in order to bolster political support from regions. Key decentralization laws (No.22/1999 and No.25/1999), which were enacted in 1999, came into force in 2001. The decentralization program targeted more than 300 local governments (Kabupaten or Kota) rather than provinces: most functions were delegated to the local governments, while provinces’ roles were restricted to coordinating functions and management of deconcentrated central functions. Although politically motivated, a key objective of the decentralization is to achieve efficient public goods allocation by bringing decision makings close to people. Intergovernmental fiscal relations should be established to guarantee a reasonable balance between expenditure responsibilities and revenue instruments available to regions. A basic principle is that expenditure responsibilities should come first, and revenue instruments should be assigned next. However, the opposite occurred in Indonesia. While devolved functions were only vaguely defined, relatively clear revenue instruments were assigned to the local governments. Two key central transfers before decentralization, subsidies to regions (SDO) and presidential instructions (INPRES), have been combined into a discretionary grant (DAU) with the aim of equalizing regions’ fiscal capacities. Scope of revenue sharing was expanded to personal income tax and natural resource revenues from traditional property taxes (PBB and BPHTB). The special allocation fund (DAK) was introduced as an earmarked grant. Further, local governments are allowed to create new taxes, if they meet some criteria and have central approvals. As a result, regional revenues in the aggregate have approximately doubled after decentralization. It is quite beyond dispute that the most serious challenge of Indonesia’s fiscal decentralization lies in the fact that the new revenue assignments were prepared without any expenditure needs assessment. Aside from this key challenge, various weaknesses are raised. Newly introduced sharing of natural resource revenues has widened regional fiscal inequalities. However, the DAU could not have fully counteracted the unequalizing effects due to various shortcomings of its allocation methods and political interventions. Further, the high dependence on central transfers could adversely associate with local accountability by breaking the cost and benefit linkages in public service deliveries. New local tax law has induced proliferation of nuisance taxes due to inappropriate central approval procedures. Central line ministries have retained control of regional development funds. In this paper, we analyze allocation methods of DAU and DAK and sharing arrangement of property taxes after decentralization. A detailed review of their distribution mechanisms is not our major target. What we wish to focus a spotlight is a lump-sum arrangement or ‘bagi rata’ which appears mysteriously in all of these distributions. We will show that this anomaly has significant negative implications on Indonesia’s new intergovernmental fiscal system. ∗
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2. General Allocation Fund (DAU) The key role of DAU is to equalize fiscal capacities across regions to finance their expenditure needs. Although a “fiscal gap” allocation formula has been established, the Government hesitated to distribute all DAU based on the formula, and instead made some adjustments to actual allocations. DAU allocation is currently based on four factors: 1) lump-sum allocation: 2) balancing allocation: 3) hold harmless allocation: and 4) formula allocation. In FY2001, after the Government calculated the DAU allocation to each region based on the draft budget, that budget was revised following parliamentary debate. The lump-sum allocation was introduced to equalize distribution of the increased amount of DAU following the revision. However, in FY2002, the Government retained the lump-sum allocations both for provinces and local governments: It was not clear why the Government retained this component for FY2002, since the lump-sum factor was introduced just to reallocate the increased amount of DAU due to the budget revision in FY2001. Further, even in the FY2003 DAU allocation, the Government retained it, although its allocation shares were dropped. It is clearly evident that the lump-sum allocations could serve as an incentive to create new local governments, and in fact, number of local governments jumped from 298 in FY2000 to 432 in FY2003. Further, with the balancing and hold harmless allocations, the lump-sum provisions have undermined the equalization effect of DAU. 3. Special Allocation Fund (DAK) Matching funds play a major role in the intergovernmental fiscal relations in many decentralized countries to internalize spill-over effects across regions and to finance nationally prioritized projects in regions. Indonesia initiated DAK projects for education, health, and infrastructure in FY2003. There were two critical issues in determining its allocations: 1) identification of eligible local governments: and 2) matching rate setting. There were two steps in the screening process. First, all local governments were ranked according to their fiscal capacity, and those whose fiscal capacity were below the national average gained eligibility. Second, the Government reviewed sectoral indicators to check the eligibility of local governments. However, sectoral indicators were mainly used to determine allocation amounts, not for the eligibility test, because all local governments that survived the fiscal capacity screening could receive DAK allocations. In practice, the Government first determined a minimum allocation, or lump-sum allocation, to all eligible governments, and, the remaining funds were subsequently allocated on the basis of formulas established by sectoral indicators. Since DAK is a matching grant, it is required to set a matching rate for each type of project. In general, the matching rate can be determined based on two key factors: 1) differences in fiscal capacities across local governments; and 2) differences in financial return of projects. Local governments with higher fiscal capacities can bear higher burdens in their counterpart funding provisions. Lower matching rates can be applied to non-profitable projects. However, the matching rate of 10 % was applied to all (eligible) local governments and to all types of projects, irrespective of the differences in fiscal capacity and project profitability. The DAK allocation procedures show a lack of understanding of the chief objective of matching grants by the Government. DAK seems to merely supplement the equalizing performance of DAU through its lump-sum allocations across all relatively poor regions. It is well recognized that the current DAU allocation method fails to attain the expected equalizing impact because of various weaknesses in its allocation formula and political interventions in some regions. Its poor equalization performance should be resolved by revising the DAU allocation procedure itself and not by allocations from DAK. DAK can be a powerful policy tool to foster the linkage between central and regional development plans and budgets.
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4. Property Taxes (PBB and BPHTB) Although local revenues have drastically jumped, their revenue mobilizing capacities have been limited since any significant tax has not been transferred. More than 80 percent of their revenues are from central transfers, and less than 10 percent are locally generated revenues. At the central level, there has been continuous debate on transferring property taxes (the land and building tax or PBB, and the transfer of land and building tax or BPHTB) to local governments to strengthen their tax authority. These taxes are national taxes shared with regional governments. Local officials in some regions reacted unfavorably to the proposed transfer because they expected to bear high administration costs. They also argued that the transfers would have reduced their revenues. Under the current system of sharing, after distributing 64.8 percent of PBB and 64 percent of BPHTB to the source districts, central shares are divided equally between all local governments irrespective of its derivations. Local governments with small tax bases derive larger revenues from this lump-sum arrangement. For a possible transfer of property taxes, the Government must realize that the current lump-sum arrangement to redistribute the central share has generated negative local perspectives along with their concern for tax administration costs. Given that dependence on central transfers has negative implications for local accountability, local tax authorities should be strengthened through the decentralization of these taxes with transitional administrative supports from the central government. 5. Concluding Remarks This paper has thrown some light on the lump-sum arrangements in Indonesia’s new intergovernmental fiscal relations. Equal sharing through the lump-sum arrangements in the DAU, DAK, and property taxes made various negative impacts on the intergovernmental fiscal system. This anomaly reflects policy makers’ lack of understanding of key policy targets assigned to each policy instrument. It is strongly recommended that each component of the new central and local fiscal relations are carefully reviewed in the overall context of intergovernmental fiscal system in order to clarify the policy objectives assigned to each policy instrument. Indonesia’s decentralization was initiated to accommodate the enormous difficulties in maintaining national unity. As a result, decentralization policy was embarked upon without a clear consensus on the state structure required to guide the basic design of decentralization policy. The anomaly we found in this paper is rooted in this lack of consensus among policy makers, as are other major challenges overshadowing Indonesia’s decentralization. The first three year’s experience shows that the Government needs to step back at this stage and try to build a clear vision of decentralized Indonesia. Decentralization, by its nature, must be a long process, and the expected goals will only achieved after a long process of trial and error. It should, therefore, come as no surprise that Indonesia’s drastic program has some shortcomings at its initial stage. Nevertheless, it is the role of the responsible government to pursue a consistent decentralization policy with a clear vision and a carefully thought-out strategy. References [1] Usui, N., and Armida, S. Alisjahbana, “Local Development Planning and Budgeting in Decentralized Indonesia: Update” presented at the International Symposium on Indonesia’s Decentralization Policy: Problems and Policy Directions, Jakarta, Indonesia, 4-5 Sep., 2003. [2] Usui, N., Catur Sugiyanto, and Awaluddin, “Indonesia’s Decentralization Policy from a Local Perspective: Lessons from Lombok Tengah” presented at Lombok Tengah Socialization Workshop for Indonesia and Japan Joint Study on Indonesia’s Decentralization, Lombok, Indonesia, 26 Feb., 2004. [3] Usui, N., “Indonesia's New Block Grant Transfer: Its Equalization Performance and Remaining Challenges”. Review of Economics (Kansai University) (6) 1-25, Mar.,2004.
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