Literature shows, “fiscal federalism” is linked with the division of revenue and expenditure responsibility among different tiers of government. Hence, allocation of tax and expenditure function of the various levels of government is the key issue of fiscal federalism. This is the area Nepali planners should elaborate to make proposed policies compatible with new state structuring plans.
Fiscal federalism is a set of principles that can be applied to all countries attempting ‘fiscal decentralization’. In fact, fiscal federalism is a general normative framework for assignment of functions to the different levels of government and can subsume appropriate fiscal instruments for carrying out these functions.
Allocation of tax and expenditure function to the various levels of government is the key issue of fiscal federalism. This is the area Nepali planners should elaborate to make proposed policies compatible with new state structuring plans.
While fiscal federalism is a guiding principle that helps in designing financial relations between the national and sub-national levels of the government, fiscal decentralization on the other hand is a process of applying such principles. As unitary and federal governments differ in their political and legislative structure, their applications also differ.
Although there is consensus among majority of the political parties representing Nepal’s Constituent Assembly with regards to the institution of federalism, many still consider Nepal too small a country to opt for a federal political structure. But available data shows that the size of the country is not a problem. For example, the size of Austria, a federal country, is just 0.08 million square kilometers. The issue is not whether we can or cannot adopt federalism, rather it is about embracing the most appropriate working model of federalism. We know, the institution which is most suitable in one place may not necessarily be the best suited at other place.
WHY FISCAL DECENTRALIZATION
The following arguments have been put forward in favor of a decentralized expenditure system. Anwar Shah and others (1990) recommend decentralized expenditure on the following grounds. One, local government is more aware about the needs and tastes of local people than central government. Two, decentralization generates more fiscal responsibility as decision is made in close contact with people for whom service is being provided. Three, it enhances competition and innovation.
Contrary to decentralization, even within the federal structure, a case for centralized system has been applicable. For example, it is the externality and economies of scale that necessitate considering centrally-monitored financial flows. The construction of highway, for example, in one region may also benefit the people outside that region. In such a case, when peripheral states benefit, it may be justifiable if the construction work is taken up by the central government.
DEPENDENCY OF LOCAL GOVERNMENTS
Available data from the Office of Auditor General shows that 45 districts (60 percent of the total districts) are incapable of generating revenue to finance their total expenditures. Consequently, their tendency of depending on the center for grants is likely to continue. Regional analysis shows that 80 percent of the districts of the Mid-Western Region are capable of meeting less than 5 percent of their expenditure through revenue collection. A similar situation is observed in Far-Western Region where 67 percent of the districts finance less than 5 percent of their expenditures through collected revenue.
The grants transferred to the local bodies from the center have been increasing over the years. In FY 2059/60, total grant was Rs. 2.3745 billion. In FY 2063/64, this increased to NRs 4.3836 billion. During this period, grants to VDCs have been increasing continuously while there are fluctuations in grants provided to municipalities.
The scenario elaborated above raises two critical issues that need to be addressed. One, how countries practicing federal system have succeeded to generate sufficient resources at the local level and develop policy for revenue sharing between the center and the states? Two, how to maintain efficiency and equity under the proposed federal structure?
A wide variation is evident between resource rich and poor local bodies, which creates difficulties in balancing the adequacy and quality of basic service delivery. The local-level dependency is increasing but allocation for local development is extremely low, which undermines the vision of decentralization to ensure that people at all levels get opportunities to engage in gainful employment. An analysis of FY 2064/65 reveals that appropriation of 7.74 percent of the national budget to the local governments, which also includes funds for local development ministries, departments and central level committee and boards, is insufficient.
Resource generation at the local level depends on the improvement of local economy. Although local units have limited tax base and weak administrative capacity, some efforts can be made to generate additional resources. For example, local bodies could initiate specific projects yielding high rate of return, which may require adequate capital expenditure. The center with its overall guidance can create “Matching Fund” for the viable and locally-prioritized projects.
bishwambher@yahoo.com
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