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Issues in Program Design

Contributor: World Bank
Author: Decentralization Thematic Team
Contact: Jennie Litvack

Expenditure Assignment

Fiscal decentralization involves shifting some responsibilities for expenditures and/or revenues to lower levels of government. One important factor in determining the type of fiscal decentralization is the extent to which subnational entities are given autonomy to determine the allocation of their expenditures. (The other important factor is their ability to raise revenue.) This note outlines principles and best practice and highlights how country specifics will ultimately be the best determinant of expenditure assignments.

It is important to clarify where local governments can determine the allocation of expenditures themselves versus those where the center mandates expenditures and local levels simply execute those expenditures. When statistics on subnational finance are available (most notably in the IMF's Government Finance Statistics) these two types of expenditures are usually aggregated and one figure is provided on "percentage of subnational expenditures." Thus, analysts must be very careful when using this as in indicator of local autonomy, as autonomy will not be enhanced unless the funds are not tied by the center. (Of course, some countries do derive the benefits of local expenditure autonomy as a result of local governments' ability to access the funds and circumvent the central mandates!)

Unitary and federal governments provide different opportunities for fiscal decentralization. Unitary countries do not have sub-national governments that are constitutionally empowered to make decisions over a specified range of government functions and services; rather, they have multiple subordinate levels of the same government (e.g., central, provincial, district). Federal governments, on the other hand, have constitutionally protected sub-national governments and thus, the possibilities for independent decision making are clearly stronger under these systems. It is important to note that local governments (as opposed to state or province) may not necessarily enjoy constitutional protection under federal systems. In practice, however, the extent and nature of decision-making power exercised by lower tiers varies widely from country to country in both federal and unitary countries and may change (in either direction) from time to time. At the extremes, some nominally federal countries (e.g., Venezuela) may be considerably less decentralized in reality than in nominally unitary countries (e.g., Colombia).

Despite the complexity of the existing situation in many countries, both theory and experience suggest strongly that it is important to state expenditure responsibilities as clearly as possible in order to enhance accountability and reduce unproductive overlap, duplication of authority, and legal challenges. Many would argue that decision-making should occur according to the principal of "subsidiarity" -- that is at the lowest level of government consistent with allocative efficiency (e.g., the geographic area that internalizes the benefits and costs of decision-making for a particular public service). The optimal size of jurisdiction for each service could theoretically differ, but in practice economies of administration and transactions costs lead to "grouping" of roughly congruent services at local (e.g., street lighting, refuse removal), regional (rural-urban roads, refuse disposal), and national (intercity highways, environmental policy) levels. Decentralized decision-making enlarges possibilities for local participation in development. In addition, national allocative objectives may be carried by local governments responding to incentives created by national grants and regulations as well as interlocal or interregional agreements. National governments have obvious roles with respect to both stabilization and distribution, and due attention must be paid to possible local conflicts with these policies.

In most cases, it is desirable that the national government assume responsibility for national public services, international affairs, monetary policy, regulation, transfers to persons and businesses, fiscal policy coordination, regional equity, redistribution (in which all levels of government may play a role), and preservation of an internal common market. However, some central functions such as regulation of the financial sector, environment, etc., may be effectively shared with sub-national governments. State governments may have dominant responsibility for education, health, social insurance, intermunicipal issues, and oversight of local governments. All local services should be assigned to local governments. In areas of shared responsibilities, the roles should be clarified. Generally, the central government should be involved with overall policy, setting standards, and auditing; state governments should have an oversight function; and local governments should be involved with the provision of infrastructure and services.

Assignment of public services to local or regional governments can be based on various considerations such as economies of scale, economies of scope (appropriate bundling of public services to improve efficiency through information and coordination economies and enhanced accountability through voter participation and cost recovery), cost/benefit spillovers, proximity to beneficiaries, consumer preferences, and flexibility in budgetary choices on composition of public spending. Assignment of responsibilities to various local governments could be asymmetric based on population size, rural/urban classification and fiscal capacity criteria. Thus large cities may have responsibilities for some services which are provided directly by the center in other areas.

An illustrative representative assignment of expenditure responsibilities is depicted in Table 1, taking into account also the possible desirability in some instance of "decentralization" beyond formal government to civil society. An additional important consideration to be borne in mind is that accountability is often best promoted by establishing a clear and close linkage between the costs and benefits of public services, so that the overall amount of expenditure responsibility to be assigned to a particular level of government will ideally correspond to the amount of revenues that level has at its potential command.

This table provides a guideline of expenditure assignments based on the subsidiarity principal. In practice, it is unlikely that any country would or should follow precisely the division set out in the table. In many instances some functions should be shared between levels of government in the sense that higher levels of government may exercise a regulatory or policy role, while lower levels of government are responsible for service delivery. Even within service delivery though, there are aspects best conducted by different levels of government. For example, with regard to infrastructure, the technical specifications for bridge construction might come from a higher level of government, construction and maintenance at the local level. In health care, the center may continue to provide technical training for staff, procurement of pharmaceuticals to benefit from economies of scale and ensure quality, and fund public health services. Intermediate levels might conduct supervision of local level personnel, provide refresher training courses, and, together with the local level, decide the appropriate mix of curative services to offer as well as ensure adequate maintenance of facilities and satisfaction with the personnel.

In this connection, it should be emphasized that assigning responsibility for the provision of service to a specific level does not imply that the same government should be directly engaged in its production. Collection, transport, and treatment services in solid waste management, for example, can be assigned to different public and private entities depending on economies of scale, commercial viability, and externalities. Many other services can also be "unbundled." Production decision should result from evaluation of alternatives using efficiency and equity criteria.

Experience has clearly shown that effective decentralization requires complementary adaptations in institutional arrangements for intergovernmental coordination, planning, budgeting, financial reporting, and implementation. Such arrangements may encompass both specific rules (e.g., in the design of fiscal transfers) and provision for regular intergovernmental meetings and periodic reviews of intergovernmental arrangements. Detailed central control over local use of funds is seldom appropriate. Instead, what is needed is transparency and accountability to local constituencies supported by strengthened higher level monitoring and reporting of local fiscal performance.