GOVERNANCE
GOVERNANCE
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT
Fiscal Decentralization,
Local Public Sector Finance
And Intergovernmental Fiscal
Relations: A Primer
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Attribution—Please cite the work as follows: Jamie Boex, Tim Williamson, and Serdar Yilmaz.
2021. Decentralization, Multilevel Governance and Intergovernmental Relations: A Primer.
Washington, DC: World Bank.
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Contents
Acknowledgments 6
Preface 7
1. Fiscal decentralization and intergovernmental (fiscal)
9
relations
1.1 The four pillars of fiscal decentralization 10
1.2 An overview of intergovernmental finance and funding flows 11
1.3 Real-world obstacles, the political economy of fiscal
13
decentralization and entry points for the World Bank
2. Assignment of powers, functions and expenditure
14
responsibilities
2.1 Relevance of subnational expenditures 14
2.2 An overview of devolved (local government) expenditure
14
responsibilities
2.3 An overview of non-devolved expenditure assignments 16
2.4 Common obstacles in expenditure assignments: technical
17
challenges
2.5 Political economy considerations: common obstacles in
17
expenditure assignments
3. Revenue assignments and local revenue administration 20
3.1 Relevance of revenue assignments and own revenue sources 20
3.2 An overview of devolved (local government) revenue
20
assignments and administration
3.3 An overview of non-devolved revenue assignments 22
3.4 Common obstacles in domestic revenue mobilization and
23
subnational revenue administration: technical challenges
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Contents
3.5 Political economy considerations: common obstacles in
23
revenue assignments
4. Intergovernmental fiscal transfers 25
4.1 Relevance of intergovernmental fiscal transfers 25
4.2 An overview of intergovernmental fiscal transfers 26
4.3 An overview of non-devolved subnational funding flows 29
4.4 Common obstacles in intergovernmental fiscal transfers:
30
technical challenges
4.5 Political economy considerations: common obstacles in
32
intergovernmental fiscal transfers
5. Subnational government borrowing, debt and capital
35
finance
5.1 Relevance of borrowing and capital finance. 35
5.2 An overview of subnational government borrowing, debt and
35
capital finance
5.3 An overview of non-devolved borrowing and capital finance 37
5.4 Common obstacles in borrowing and capital finance:
37
technical challenges
5.5 Political economy considerations: common obstacles in
37
borrowing and capital finance
6. Implications for World Bank engagement: improving
39
the intergovernmental fiscal plumbing
6.1 Decentralized public sector finances, effective public sector
40
management and the localization development results
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Contents
6.2 Placing country practices within a spectrum of
42
intergovernmental institutional and fiscal arrangements
6.3 Improving the intergovernmental fiscal plumbing: general
43
guidance
6.4 Improving the intergovernmental fiscal plumbing: country
46
examples
7. Implications for World Bank engagement: operational
47
guidance
7.1 Identifying binding constraints: the GovEnable approach 48
7.2 Selecting an engagement modality for supporting
50
decentralization and localization
References and background readings 53
Annex. Assessing the strengths and weaknesses of a
country’s state of fiscal decentralization, local public 56
sector finance and intergovernmental fiscal systems
A.1 Assessment indicators: assignment of functions and
56
expenditure responsibilities
A.2 Assessment questions: revenue assignments and local
58
revenue administration
A.3 Assessment questions: intergovernmental fiscal transfers 60
A.4 Assessment questions: local government borrowing, debt and
61
capital finance
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Acknowledgments
Manager: This Practice Note was prepared under the guidance of Tracey
Lane (Practice Manager, EPSPA).
Authors: The note was drafted by Jamie Boex (Consultant, EPSPA), Tim
Williamson (Sr. Public Sector Specialist and Global Lead Subnational
Governance, EPSPF); and Serdar Yilmaz (Lead Sector Specialist and
Global Lead Subnational Governance, EEAG2)
Peer Reviewers: Fernando Blanco (Principal Economist, CELCE, IFC)
and Mike Roscitt (Public Sector Specialist, EAEG1)
Editor: Richard Crabbe
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Preface
The role that fiscal decentralization plays in public sector finance and public sector management around
the world is evolving rapidly. Fiscal decentralization, as part of broader decentralization reforms, has
traditionally been pursued in the context of governance reforms to increase political competition and to
bring the public sector closer to the people.
In recent years, greater recognition has been given to the fact that key public services and investments,
including in education, health, water and sanitation services, basic urban services, climate adaptation,
and local economic development, all take place at the local level. As such, fiscal decentralization and
intergovernmental finance—ensuring adequate level of financial resources for frontline services—are
increasingly understood not just as part of public sector governance reforms, but rather, as a means to
achieving inclusive and efficient service delivery at the local level.
This paradigm shift has been accompanied by progress in the understanding of the global decentralization
community of practice. While the study of fiscal decentralization has traditionally been the remit of
public finance economists, the question of how best to fund the localized delivery of public services and
sustainable development interventions is a matter of considerable interest to public financial management
(PFM) experts and sector specialists, as well as to practioners from a large number of other disciplines
represented among policy makers and development practitioners.
This note is one of a series to bring together the latest thinking on intergovernmental finance. They all
complement each other in providing a full picture of multilevel governance and intergovernmental fiscal
architecture. Therefore, it is recommended to read this note together with Decentralization, Multilevel
Governance and Intergovernmental Relations: A Primer (2022) and Conditional Grants in Principle, in
Practice and in Operations: A Primer (2022).
The objective of this primer on fiscal decentralization, local public sector finance, and intergovernmental
fiscal relations is to:
● Present the conceptual foundations of fiscally decentralized systems and establish a common
vocabulary by identifying the basic elements of fiscal decentralization and intergovernmental fiscal
systems—the so-called “four pillars of fiscal decentralization.”
● Provide foundational knowledge to World Bank task teams to enable them to systematically
identify the technical and political economy strengths and weaknesses of an intergovernmental
fiscal situation.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 7
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Preface
● Provide guidance on how to assess the institutional, physical, and organizational capacities at
different levels of government.
● Identify the options and instruments available to World Bank Task Teams to engage in strengthening
intergovernmental finance systems.
● Signal where to find additional knowledge and resources on for further learning.
This primer is primarily written to inform the perspective of World Bank Task Teams and Task Team
Leaders working in decentralized or decentralizing countries. Improving public service delivery in a
multilevel public sector requires bringing together a diverse set of stakeholders from across different
parts of a government. As such, a solid understanding of fiscal decentralization is required for those
specialists who work on decentralization reforms within the World Bank.
In addition to offering a useful frame of reference for World Bank Task Teams drawing from different
Global Practices, this primer further offers an introductory overview of fiscal decentralization for policy
analysts, government officials, sector experts, as well as civil society actors involved in multilevel public
sector reforms worldwide.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 8
1.
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Fiscal decentralization and
intergovernmental fiscal relations
An effective multilevel public sector requires public stakeholders at different levels of government
to work effectively—and work together effectively—in order to ensure that public spending is
transformed into resilient, inclusive, sustainable, efficient and equitable public sector programs
and results. A big picture look at decentralization requires consideration of the main dimensions
of decentralization, including political, administrative and fiscal dimensions. When the focus is
on a specific sector, it may further be appropriate to consider sector-specific issues as separate
from other aspects of public administration.
>>>
Figure 1.1 Fiscal decentralization and a Multilevel Public Sector
Source: Prepared by authors.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 9
Establishing effective multilevel governance systems requires line with the concept that “finance should follow function.”
action and coordination across different levels of government. This means that through the first pillar, understanding
It also requires an empowering intergovernmental architecture the assignment of powers, functions, and expenditure
and systems at the central government level; efficient, responsibilities within the public sector – the “expenditure
inclusive and responsive local governments and/or other assignment” – indicates the level of expenditure requirements
institutions at the local level; an efficient and well-managed or the “expenditure needs” of different administrative levels
system of frontline service delivery facilities or providers; and and different local or regional government units. However,
an engaged civil society, citizenry, and local private sector. public sector resources are scarce and need to be prioritized.
As a result, actual expenditures at all government levels often
The resulting assessment framework for decentralization, fall short of the “needs” or desired level of expenditures. To a
intergovernmental relations, and the local public sector (Figure large extent, the level and composition of local expenditures is
1.1) is formed by a 4 X 4 matrix representing the dimensions driven by the availability of resources to be examined through
and levels of an effective multilevel public sector. Figure 1.1 the remaining three pillars: local own source revenues (OSR);
locates fiscal decentralization within this framework. The intergovernmental fiscal transfers (IGFT); and borrowing
following sections of this primer will unpack four pillars of fiscal or other debt financing mechanisms (FIN).1 As such, the
decentralization (the last column in the figure) and discuss relationship between the four pillars in a balanced budget
how they relate to the constituent elements of a multilevel environment may be captured by the following notation EXP
public sector. = OSR + IGFT + FIN. The composition of funding sources is
different in different countries and in different sectors.
1.1 The four pillars of fiscal In general, decentralization of public policy making power
involves transfer of legal and political authority for planning
decentralization projects, making decisions, and management of public functions
from the central government and its agencies to subnational
The theoretical argument for fiscal decentralization is governments. The transfer of authority and responsibility over
formulated as: “each public service should be provided by the public functions from the central government to subordinate
jurisdiction having control over the minimum geographic area or quasi-independent government organizations covers
that would internalize benefits and costs of such provision.” a broad range of topics. There is also no prescribed set of
In a fiscally decentralized system, the policies of subnational rules governing the decentralization process that apply to all
branches of governments are permitted to differ in order to countries. Decentralization takes different forms in different
reflect the preferences of their residents. As such, designing countries, depending on the objectives driving the change
a fiscally decentralized intergovernmental system requires in the structure of government. While distinguishing among
focusing on four areas, which are referred to as “pillars”: different types of decentralization is useful for pointing out
its many forms, it is important to highlight the interlinkages
1. Expenditure assignment: the assignment of expenditure between the pillars of an intergovernmental fiscal system.
powers, functions, and service delivery responsibilities at
the various levels of government. There is no easy answer to the question of how to design a
2. Revenue assignment: the assignment of revenue decentralized system to promote transparency, accountability,
powers and division of responsibilities across revenue and efficiency in public service delivery. This primer presents
administrations. conceptual discussions on the design of an effective
3. Intergovernmental fiscal transfers. intergovernmental system, synthesizing academic and
4. Local government borrowing, debt and capital finance policy literatures as well as lessons learned from country
rules, responsibility, and accountability. applications. However, before the discussions on the pillars of
fiscal decentralization, it is helpful to provide an overview of the
Although these four pillars are a useful construct that help complex service delivery and fund flow arrangements at the
to discuss and explore the various dimensions of fiscal local level as they influence the design of intergovernmental
decentralization, they are closely related to each other in system in every country.
1. This nomenclature is especially relevant for devolved local government entities. The concept of the four pillars is the equally relevant for other (non-devolved) local-level
entities, such as deconcentrated local administration units or local service delivery providers, authorities or facilities. For non-devolved countries, the context and termi-
nology for the four pillars would have to be adjusted slightly to apply to the specific institutional setting.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 10
1.2 An overview of intergovernmental make it much more complex to understand and track. A more
detailed perspective on the interrelationship of the four pillars
finance and funding flows is provided in Figure 1.2, which presents a generic picture of
the key institutional stakeholders in a multilevel public sector
The distinct challenge of intergovernmental finance is the large and highlights the typical funding flows among them.
number of stakeholders and “nodes” in the system, which can
>>>
Figure 1.2 An overview of intergovernmental finance and funding flows
Source: Prepared by authors.
First, the assignment of powers, functions, and expenditure # 2). In practice, however, and for good reasons, as further
responsibilities is an important factor in determining the discussed below, the revenue-raising power assigned to
relative size and composition of the expenditures of the local and/or regional governments often falls (far) short of the
national government, local governments, national parastatals, expenditure needs of subnational jurisdictions. As a result,
authorities, or agencies like a National Road Fund, and intergovernmental fiscal transfers are provided to help fill the
other local-level entities or authorities (such as local water gap between local expenditure needs and local own source
utilities—indicated in the chart by Line # 1. Naturally, the revenues (Line # 3). Additionally, subnational borrowing and
ability of different stakeholders to fund their respective capital finance can play a useful role, particularly in funding
expenditure responsibilities is determined in the first instance subnational infrastructure. In practice, however, borrowing
by the assignment of revenue powers and the ability of and capital finance typically play a relatively small role in
government units at different government levels to effectively intergovernmental finance in most countries (Line # 4).
collect revenues from the sources assigned to them (Line
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 11
Traditionally, discussions of fiscal decentralization have of decentralization and localization modalities used, in different
tended to focus largely on devolved local government sectors these national entities can account for a large and
expenditures and revenues (Lines # 1A and 2A), along with often overlooked portion of sectoral funding.
intergovernmental fiscal transfers (Line # 3). Other mechanisms
of decentralization and localization are increasingly understood A final non-devolved channel of spending on local public
to be important as frontline public services tend to be delivered services is formed by semi-autonomous local service
through a combination of devolution, deconcentration, delivery providers whose finances are not included in the
delegation and centralized provision – often concurrently in local government budget (Line # 1D). This grouping includes
a complex and often messy mix of financing modalities. As local providers that typically form the “last mile” of service
such, Figure 1.2 explicitly takes these alternative mechanisms provision, and include municipal utility companies, urban
of decentralization and localization on board. development authorities, and so on. Note that Figure 1.2
only highlights local service providers and facilities that
The first of these three alternative channels of decentralization have a degree of institutional and budgetary autonomy; to
and localization includes the direct and deconcentrated public the extent that frontline facilities are operated “on budget”
expenditures by the central government in support of frontline by the local government, the revenues and expenditures of
services (Line # 1B). This category of localized expenditures these facilities are simply understood to be part of the local
includes a range of central government-led mechanisms government budget.
to localize public interventions, such as vertical sector
programs; deconcentrated service delivery; community-driven In different countries and in different sectors, local service
development programs; and direct cash transfer programs. delivery providers may have a degree of institutional and
These mechanisms all tend to involve direct delivery financial autonomy. While local providers are sometimes
and funding of public services through on-budget central corporate entities created, owned, or operated by local
government expenditures, although these expenditures governments—for instance, under a board appointed by
may have different implications for effective public sector mayor or municipal council—in many other cases, such
management and effective public financial management institutions are created or accountable to higher-level
(PFM) when compared to “regular” (headquarters-level) government authorities. As such, these local service delivery
central government spending.2 entities fund or deliver public services in coordination with –
or sometimes, in a parallel and duplicative manner to – local
A second mechanism for non-devolved decentralization and governments. Given the off-budget nature of these entities,
localization comprises spending on frontline services by any funding received by these entities—whether from local
parastatal entities, national authorities, national investment government budget, national entities, or from tariffs, fees, or
funds and similar entities (Line # 1C). The distinguishing other payments—has traditionally been overlooked by the
feature of this category is that these entities tend to be off- literature on fiscal decentralization.
budget at the central government level and outside the direct
hierarchical control of the central government. Examples of The subsequent four sections of this note (Sections 2, 3, 4
such national entities, authorities, and funds include traditional and 5, respectively) provide a brief technical introduction
parastatal entities such as a National Medical Supply Agency, to each of the four pillars of fiscal decentralization. Each of
a National Transit Corporation or National Water Authority, the sections will summarize the relevance of each pillar of
national hospitals, and national universities. There are others fiscal decentralization, provide an overview of devolved
such as a National Roads Fund Authority, National Health intergovernmental finances in relationship to each pillar,
Insurance Fund, Municipal Investment Fund, and other similar and present an overview of non-devolved intergovernmental
funds. These entities typically derive some or all of their finances in the context of each pillar.
funding from the central government ministries under whose
authority they operate, in addition to any direct or indirect
user fees and charges that the entity may be authorized to
collect.3,4 Depending on the exact combination or permutation
2. The diagram does not show deconcentrated administration units as a separate box, as deconcentrated spending units are ultimately an integral part of the central gov-
ernment budget. In specific instances, it might be useful to visualize expenditures by deconcentrated spending units as a separate box in the diagram. The flow of funds
between the central government and deconcentrated spending units would be considered subnational budget allocations, rather than intergovernmental fiscal transfers.
3. In developing and transition countries, such national entities, authorities and funds often derive part of their funding from the World Bank, other international financial
institutions, and development partners.
4. Since these national parastatals or authorities are part of the central government, funds flowing from the central government budgets are technically not considered
intergovernmental fiscal transfers.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 12
1.3 Real-world obstacles, the political
economy of fiscal decentralization
and entry points for the World Bank
Decentralization reforms and other public sector processes
are not just technical processes to be decided by technocrats;
rather, they reflect a political or institutional contestation of
power between different groups and individuals across and
within different government levels.5 As such, the design of
fiscal decentralization, or a country’s intergovernmental
fiscal architecture, should not only be considered through a
technical lens, but should also be understood in the context of
the political economy forces that help define it.
Beyond providing a technical overview of each of the four
pillars of fiscal decentralization—in the context of complex
intergovernmental fiscal systems that often rely on different
approaches to decentralization at the same time—this note
tries to identify some of the real-world obstacles encountered
by World Bank task teams in supporting (fiscal) decentralization
reforms and multilevel public sector strengthening. With this
in mind, as part of the discussion of each of the four pillars
of fiscal decentralization, each of the subsequent sections
highlights common obstacles encountered in policy practice
and a brief political economy perspective on each pillar.
In addition, Sections 6 and 7 specifically raise implications
for World Bank engagement in fiscal decentralization, both
in terms of helping to identify possible areas of technical
intervention in strengthening the intergovernmental fiscal
plumbing (Section 6), and laos identifying the most appropriate
modality to use (Section 7).
2. For an introductory discussion on the political economy of decentralization, see “Section 3: Understanding the political economy of decentralization and intergovernmen-
tal relations” in the primer titled, Decentralization, Multilevel Governance and Intergovernmental Relations: A Primer (World Bank 2021).
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 13
2. >>>
Assignment of powers, functions
and expenditure responsibilities
2.1 Relevance of subnational expenditures
Many of the pro-poor public services that are required to achieve sustainable global development,
including education, health services, access to clean water and sanitation, are delivered at the
local level. In many countries, local public services and public sector investments in these areas
are the responsibility of elected local and regional governments. In 2016, subnational government
spending accounted for 24 percent of total public spending and close to nine percent of GDP
on average (unweighted) for a global sample of 106 countries with available data (OECD/UCLG
2019: 50).
Unfortunately, comparative figures are not available for the relative importance of other types of
local public spending, such as deconcentrated spending,6 delegated spending,7 or direct central
government spending on local services—spending through vertical sector programs. An analysis
of education and health finance in 29 developing and transition countries reveals that countries
typically rely on multiple models of decentralization at the same time, and that non-devolved
expenditures accounts for approximately two-thirds of all local public sector expenditures on
health and education (Boex and Edwards 2014).
2.2 An overview of devolved (local government) expenditure
responsibilities
The subsidiarity principle. In many countries, the main principle behind the assignment of
expenditure responsibilities is the subsidiarity principle. This principle suggests that—in
order for the public sector to be as allocatively and technically efficient as possible—public
6. Deconcentrated spending refers to spending by deconcentrated offices of sector ministries in localities.
7. Delegated spending includes spending mandate delegated by sector ministries to various governmental and quasi-governmental organizations including parastatal
organizations, state owned enterprises, and utility companies.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 14
sector functions should be performed by the lowest level into smaller pieces along several dimensions: not only can
of government that can perform the function efficiently. the responsibility for a service delivery function be divided
Conversely, functions should not be performed by a higher- into various sub-functions and tasks or along the lines of
level government if these functions can be dealt with effectively economic inputs required to deliver the service, but it is
by a lower-level government. While the subsidiarity principle is important to consider the responsibility for a function in a
widely regarded as best practice to be followed around the granular manner along four different dimensions, namely (a)
world, some countries have formally adopted it as a formal the responsibility for policy-setting, regulation, and oversight;
legal principle, because it was in the 1992 Maastricht Treaty (b) the responsibility for financing; (c) the responsibility for
that established the European Union. management and ensuring provision; and (d) the responsibility
for actual (frontline) service provision, sometimes referred to
The subsidiarity principle does not mean that all public functions as “production.”
should be performed at the local government level. In some
cases, scale economies in the provision of public services An example of an “unbundled” assignment of responsibility
may prevent a lower-level government from performing a for basic public health services is presented below in Figure
function or task efficiently. In other cases, the territorial scale 2.1. The example reflects a decentralized system in which
of provision would make it inefficient for a local government to the responsibility for ensuring provision of basic public health
perform certain functions. This occurs, for instance, when the services is assigned to local government authorities (LGA).
benefits area of a service exceeds the territorial jurisdiction of Through the LGA’s District Health Office (DHO), basic health
the government responsible for provision. For instance, while services are provided by local government-run public health
a local park or playground that benefits a local community facilities (PHFs), but – in this example – the Ministry of Health
can be efficiently provided by a local government itself as the (MoH) plays an important role in setting sectoral policies and
lowest government level capable of performing this function regulations. In addition, the ministry is extensively involved
efficiently, it would be inefficient to assign the responsibility for in the staffing of local DHOs and PHFs, with wage grant
national defense or the management of a specialized referral being provided by the central government, further provides
hospital to an individual local government unit. conditional grants for operation and maintenance (O&M), and
directly implements sectoral capital projects such as local
Unbundling functions. An important concept related to health facility construction. Other central-level stakeholders
the proper assignment of functions and expenditure assigned partial responsibilities over basic health services
responsibilities is the need to “unbundle” functions before in this example include the Medical Stores Department (a
applying the subsidiarity principle. Unbundling of broad parastatal entity), the Ministry of Finance (MoF), and the
sectoral functions or expenditure responsibilities (such as Public Service Management Department (PSM).
“health” or “education”) requires subdividing the function
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Figure 2.1 Unbundling the responsibility for a function: the elements of the provision of a function (example)
Source: Based on Boex (2015:15).
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 15
When the subsidiarity principle is applied to functions that are ● In practice, however, many public services are concurrent
properly unbundled, three types of public services emerge: (joint central-local) functions. This includes key social
exclusively national (central or federal) government services, sector services such as education and health, as well
exclusively local government services and functions of as sectors such as agriculture and water and sanitation.
concurrent (joint central-local) responsibility. Concurrent functions are functions for which local
governments are the lowest government level that is able
● Exclusively central government services—mainly to take care of some aspects of the function—typically
national defense, international relations, certain macro- provision and production. In such cases, it would be
economic stabilization functions, and possibly specific social inefficient to assign other aspects of the service – typically
protection programs—are public services where the national policy setting, regulation, and financing – to the local
government is the lowest-level government that can efficiently government level, and those would therefore have to be
perform all aspects of functional responsibility: policy-setting assigned to at a higher-level government. The effective
and regulation; financing; provision; and production. delivery of concurrent functions or services requires
● Exclusively local government services such as local parks, careful coordination between different government levels,
streets and street lighting, and solid waste management, are not only within the sectoral or administrative sphere, but
public services where local governments are the lowest- across political and fiscal decision making as well.
level government that can efficiently perform all aspects
of functional responsibility—policy-setting and regulation,
financing, provision, and production. This is generally the
2.3 An overview of non-devolved
case for basic local services which lack a strong redistributive
dimension or (vertical or horizontal) externalities beyond expenditure assignments
the local jurisdiction.8 To the extent that local governments
are assigned the authority and responsibility to deliver An incomplete picture of expenditure assignments may
exclusively local services, local governments are able to arise if one were to merely analyze central government
“manage local affairs” and function as an efficient platform expenditures and local government expenditure; in many
for local decision-making and service delivery without much countries and sectors, alternative (non-devolved) approaches
support from higher-level governments. to decentralization and localization are used (Figure 2.3).
>>>
Figure 2.3: Overview of decentralized/localized service delivery and funding arrangements
Note: Red boxes and arrows indicate central government budgets and funding flows; blue boxes and arrows indicate local government budgets and funding flows; grey boxes and arrows
reflect off-budget entity budgets and funding flows (or entities with indeterminate ownership).
Source: Based on Boex (2015:15).
8. When a local public service has a strong redistributive dimension or produces (vertical or horizontal) externalities, it is likely that higher-level government ought to be
involved in policy and standard-setting and/or financing in order to ensure an optimal level of public provision.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 16
In order to establish the extent to which stakeholders at each of expenditure responsibilities are not caused by technical
government level share the responsibility for service delivery or conceptual issues during policy design; instead, the
in practice, mapping out the institutional trajectory and volume main challenges are typically encountered during the policy
of the various funding flows—including different mechanisms implementation stage. Implementation obstacles include:
used for different economic inputs or sub-systems within (a) a gap between the de jure and the de facto assignment
each sector—forms an important starting point for further of functional responsibilities, as central ministries are often
policy analysis.9 It is not unusual for local government finance unwilling to let go of service delivery responsibilities; (b)
specialists to be largely unaware of non-devolved sectoral weak vertical and horizontal intergovernmental sectoral
funding flows, and sectoral experts are quite often more coordination, including coordination challenges with
familiar with centralized funding flows within the sector than parastatal entities and local-level (frontline) service delivery
with any devolved funding mechanisms. authorities; (c) the lack of “local political will,” or misaligned
political incentives for local governments to effectively deliver
services, especially concurrent services; (d) inadequate local
2.4 Common obstacles in expenditure government administrative capacity; and (e) underfunding of
local expenditure responsibilities.
assignments: technical challenges
Clarity in the assignment of service delivery responsibilities
across levels of government facilitates better delivery of services
2.5 Political economy considerations:
and establishes clear accountability linkages. However, it is not common obstacles in expenditure
unusual for countries or sectors (or World Bank TTLs) to face
assignments
an analytical challenge in answering the basic question: what
the actual or de facto assignment of functions within a country
The assignment of functions and expenditure responsibilities
or sector is as revealed by public sector expenditure patterns.
is not only an important technical aspect of decentralization,
This question requires assessing the volume and management
but the expenditure assignment decision—both in terms of
of local government expenditures in a country by sector or
legal assignment as well as the decision on “who does what”
function. Additionally, it requires considering service delivery
in practice—is often shaped by political economy forces.
expenditures made by central government through vertical
programs or deconcentrated spending; national and regional
Empowering intergovernmental (fiscal) systems: expenditure
parastatal entities, authorities and fund; and by local service
assignments. In fact, there is a considerable gap in some
delivery providers—for instance, from user fees or funding
countries—especially among developing and transition
flows not already identified. The assessment of expenditure
countries that are at the front end of their transition to a more
assignment also needs to take into account any limitations
decentralized system—between the assignment of functions
on the institutional powers or authority of local governments
and expenditure responsibilities that would be prescribed
vis-à-vis the role of stakeholders at higher government levels.
based on good technical guidance, versus the reality
For example, while local governments are often assigned de
dictated by political economy forces. Rather than applying
jure responsibilities for basic urban services such as solid
the subsidiarity principle and adhering to the mantra that
waste management, local water supply, or sanitation, even in
“finance should follow function,” in accordance with good
urban areas, the role of local governments in improving public
technical guidance, the political economy reality in many
service delivery performance may be limited (Boex, Malik,
countries is that “functional assignments and finances follow
Brookins and Edwards 2016).
political and institutional power”.
As the first pillar of fiscal decentralization, problems with the
The vertical assignment of powers, functions, and
assignment of functions and expenditure responsibilities tend
expenditure responsibilities is often a contentious area
to reverberate through the intergovernmental fiscal system. As
of (fiscal) decentralization reform, with central (sector)
discussed below, the biggest challenges with the assignment
ministries usually arguing that local governments are
9. As noted in Figure 2.3, it is not unusual for intergovernmental institutional and fiscal arrangements to differ for human resource expenditures (salaries and wages),
operation and maintenance spending, sectoral supplies, and capital infrastructure spending. The governance or management—coordination; oversight; community
engagement—associated with a public service could be considered a fifth input or sub-system.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 17
inadequately capacitated to perform sectoral key functions. In assessing local spending decisions, it is useful to keep in
Although local capacity issues are often a concern, it is not mind the duality of local governments. Local governments serve
unusual for capacity constraints to be used by central-level as platforms for local decisions-making and service delivery in
officials as a (sometimes thinly veiled) excuse to prevent areas of exclusively local interest, such as streetlights, local
the sector ministry from yielding its power and resources to parks. They also serve as a platform that can be leveraged by
the local government level. Likewise, it is not uncommon for higher government levels for national development objectives
planning ministries or public service management agencies or for concurrent functions, for which the social benefit of
to be motivated by narrow institutional self-interest in their service provision is often not fully captured or appreciated by
opposition to the decentralization of their powers, functions either local residents or local politicians. But, under a devolved
and resources to lower-level government entities. system, unless specific arrangements are in place to ensure
otherwise, local leaders should be expected to over-spend on
In fact, in countries that have initiated decentralization local projects with immediate benefits to the community, such
reforms, a gap between the legal (de jure) functional powers as livelihoods projects or community-based infrastructure,
and their de facto expenditure responsibilities—caused by the while underspending (relative to national priorities) on social
slow transfer of powers, functions and resources, is perhaps sector development and other concurrent functions.
the most typically and biggest challenge to the successful
decentralization reforms. Other political economy related Engaged civil society, citizens, and business community:
problems arise in the assignment of expenditure responsibilities expenditure assignments. Inclusion, participation,
as well. For example, it is not unusual for a central government transparency, and accountability in guiding and monitoring
to (knowingly or accidentally) assign function responsibilities public expenditures are widely understood to be important
to a government level that, according to the subsidiarity features of effective decentralization and good governance.
principle, is too small or too weakly capacitated to efficiently These principles represent important underlying values for
deliver public services. In some cases, such expenditure stakeholders at all levels, but political economy pressures,
assignment decisions are made in order to bypass regional such as pressure from political party officials or electoral
elites or administrative opposition at higher levels, while in pressures, may cause elected officials to set aside these
other cases higher level governments are avoided to minimize principles when they are under pressure to “get things
centrifugal forces or to limit local governments from being done.” A similar type of political economy incentive—the
used as a platform for political competition. desire to avoid negative scrutiny that comes with being
the bearer of bad news—may act on local administrators,
Efficient, inclusive and responsive local governance: facility heads, and frontline workers when it comes to
expenditure assignments. It is not just in the intergovernmental reporting on the performance of local expenditures. Mansuri
context that expenditure assignments and expenditure and Rao (2013) argue that decentralized, participatory
choices can be distorted by political economy forces; development is most effective when local institutions work
even when functions are assigned perfectly in accordance within an “accountability sandwich” formed by support from
with the subsidiarity principle, it is quite likely that political an effective central state and bottom-up civic action.
considerations will come into play when local expenditure
decisions are made. In fact, given that local governments are
expected to set local spending priorities within a hard budget
constraint, local government officials should be expected
to make their expenditure choices not only on the basis of
national policy commitment and technical considerations, but
rather, on the basis of their constituents’ preferences and in
line with spending priorities that are electorally or otherwise
politically rewarding to them.10
10. It is not unusual for central government hesitance to decentralize sectoral powers, functions and resources (and the resulting underfunding and weak local administrative
capacity in areas of concurrent responsibility) to serve as a justification for local politicians not to take ownership over challenging sectoral functions while focusing on
spending programs that are electoral “low-hanging fruit.”
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 18
Box 2.1 Background and resources on the assignment of powers,
functions and expenditure responsibilities
● Municipal Finances: A Handbook for Local Governments (Catherine Farvacque-Vitkovic and Mihaly Kopanyi);
World Bank, 2014.
● Measuring the Local Public Sector: A Conceptual and Methodological Framework (Local Public Sector Country
Profile Handbook); Local Public Sector Initiative, 2012.
● Measuring Fiscal Decentralization, Concepts and Policies (Junghun Kim, Jorgen Lotz and Hansjörg Blöchliger);
OECD Fiscal Federalism Studies, 2013.
● Self-rule Index for Local Authorities; European Commission 2015.
● The vertical assignment of functions and expenditure responsibilities (Jamie Boex); Local Public Sector
Initiative, 2015.
● Assigning responsibilities across levels of government: Trends, challenges and guidelines for policy-makers
(Dorothée Allain-Dupré); OECD, 2018.
● Revised Guidance for Subnational Government PEFA Assessments; PEFA, October 2020.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 19
3. >>>
Revenue assignments and local
revenue administration
3.1 Relevance of revenue assignments and own revenue
sources
Although revenue sources are often less decentralized than expenditure responsibilities, tax
revenues are an important source of income for subnational governments, accounting for one-
third of total subnational government revenue or roughly 3.3 percent of GDP on average (OECD/
UCLG 2019: 71, 77).11 Other (non-tax) own revenue sources such as user charges, fees, and
property income, account for another 11 percent of subnational revenue or approximately an
additional one percent of GDP. Naturally, the importance of subnational own source revenues,
and the breakdown between the different types of own source revenues, vary considerably from
one country to another.
3.2 An overview of devolved (local government) revenue
assignments and administration
The economics of local taxation under fiscal federalism. Unlike central government taxes (which
are generally defined as compulsory payments to the central government for which there is no
quid pro quo), local government taxes in a well-designed intergovernmental fiscal system are
more appropriately seen as quasi-user fees for locally-provided services. Indeed, in order to
maximize social welfare and improve the allocative efficiency of resources in a decentralized
public sector, the goal of local taxation is not to maximize the volume of local revenue collections,
but rather, to ensure that local taxpayers in different local jurisdictions only pay local taxes
commensurate to the level of locally-provided services that they demand from and get supplied
by their local government.12
11. According to the OECD definition used, tax revenue is not made up only of own-source taxes, but includes shared taxes as well. Even with this more expansive defini-
tion of subnational government tax revenues, subnational taxes account for only 14.9% of public tax revenues. As discussed further below, the main funding source for
subnational governments (on average) is formed by intergovernmental fiscal transfers.
12. In this sense, decentralized provision of locally-provided goods mimics market-provision of private goods, where consumers opt to consume a private good up to the
point where the marginal benefit from the good equals the marginal cost. Basic economic analysis (for instance, in the context of a representative agent or median voter
model) suggests that in addition to the local governments’ responsiveness to constituent preferences, other key determinants of the optimal level of local taxation include
the relative price (i.e., efficiency or inefficiency) of local service provision and the presence or absence of general-purpose grants.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 20
In line with the concept that “finance should follow function,” The only major revenue source usually seen as passing these
local taxes and user fees should be considered appropriate stringent tests for assignment to the local level is the property
funding sources to pay for exclusive local government tax; the second-largest category of local revenues in many
functions—where the benefits of local government services countries tends to be user fees and charges. In fact, for all
largely or wholly are received by residents of the local other high-yielding tax sources—including personal income
government jurisdiction itself. As noted in Section 3.3 below, taxes, corporate income taxes, value-added taxes or sales
to the extent that concurrent functions partially or largely taxes, and trade taxes—it could reasonably be argued that
benefit residents outside the local government jurisdiction, the central government is the lowest level of government able
it would be conceptually more appropriate to fund such to collect those revenue sources without causing inefficiency.
concurrent government functions in part or in whole through As a result, it is no surprise that the vast majority of revenues
intergovernmental fiscal transfers. in most countries is collected by the central government.
Assignment of own revenue sources. Public finance Tax autonomy and the assignment of shared revenue
theory prescribes a number of rather stringent conditions sources. Because the practical scope for autonomous
to determine which taxes and revenue sources should be subnational taxation—in a way that ensures efficiency—is
considered good candidates for assignment to the local or limited, some countries assign local governments the right to
regional level (Bird 2000). In fact, in line with the subsidiarity collect different revenue sources, while limiting the control of
principle, the only taxes and revenue sources that could be subnational governments over one or more aspects of these
suitably collected by subnational governments are revenue taxes. This results in a spectrum ranging from own source
sources that (a) can be administered efficiently at the local revenues fully under the control of local decision-makers
or regional level; (b) are imposed solely or mainly on local to tax sharing arrangements over which local governments
residents;13 and (c) do not raise problems of harmonization have no control (Table 3.1).
or competition between subnational governments or between
subnational and national governments.14
>>>
Table 3.1 A taxonomy of tax autonomy (OECD)
Class Nature and extent of tax autonomy – relative to higher-level government (HLG)
a.1 The recipient subcentral government (SCG) sets the tax rate and any tax reliefs without needing to consult a
HLG.
a.2 The recipient SCG sets the rate and any reliefs after consulting a HLG.
b.1 The recipient SCG sets the tax rate, and a HLG does not set upper or lower limits on the rate chosen.
b.2 The recipient SCG sets the tax rate, and a HLG does sets upper and/or lower limits on the rate chosen.
c.1 The recipient SCG sets tax reliefs – but it sets tax allowances only.
c.2 The recipient SCG sets tax reliefs – but it sets tax credits only.
c.3 The recipient SCG sets tax reliefs – and it sets both tax allowances and tax credits.
d.1 Tax sharing arrangement in which the SCGs determine the revenue split.
d.2 Tax sharing arrangement in which the revenue split can be changed only with the consent of SCGs.
d.3 Tax sharing arrangement in which the revenue split is determined in HLG legislation (less frequently than
once a year).
d.4 Tax -sharing arrangement in which the revenue split is determined annually by a HLG.
e. Other cases in which the central government sets the rate and base of the SCG tax.
f. None of the above categories of a, b, c, d, or e applies.
Source: Kim, Lotz, and Blöchliger (2013).
13. An efficient assignment of revenue sources should prevent the possibility of “tax exporting”, by which a local or regional government is able to impose a tax burden on
residents outside its jurisdiction. For this purpose, it is important to recognize that the burden of a tax may be borne by someone other than the person who pays the
tax. For instance, while import duties are paid by the importer, the actual burden of the tax is typically borne by the final consumer (because the cost of the import duty
raises the final sales price). As such, assigning the power to levy import duties to local governments (or the practice of charging an octroi on the trans-shipment of goods
through a local jurisdiction) would effectively allow local government to tax the residents of other local governments without providing commensurate services to them.
14. Tax competition between different subnational jurisdictions as well as duplicative taxation by different levels (resulting in cumulative high marginal tax rates) would have
the potential for economic distortion and inefficiency.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 21
For instance, central legislation might provide local typically excluded from measures of revenue decentralization,
governments with the power to collect a certain tax – a as traditional measures of revenue decentralization focus
corporate income tax, for example – while defining the base of exclusively on national government revenue collections and
this tax uniformly across the entire national territory in order to local government revenue collections. Any revenues collected
limit the administrative burden of local taxation on taxpayers. by off-budget entities at both the central government and local
Similarly, central legislation may limit the tax rates that local government levels are often simply overlooked.16
governments may impose on local taxpayers for different taxes
– for example, by setting lower and upper bounds – in order While the reliance on non-devolved revenue sources is likely
to prevent territorial or vertical tax competition. Alternatively, to vary significantly from country to country and from sector
central authorities may simply decide to share the revenue to sector, these revenues are likely to play a much more
collected from certain revenue sources with subnational significant role than commonly recognized. For instance,
governments. For example, this may be done on a derivation in the provision of public health services, how much do
basis (based on where the revenue is collected) without giving local health facilities collect in terms of user fees or private
subnational governments any control over the tax base, the or social health insurance payments in a way that is not
tax rate, or the sharing rate.15 captured by local government accounts? In turn, how much
revenue do national or local health insurance schemes collect
In addition to property taxation, another area of focus from the public? Similarly, to the extent that schools collect
for subnational revenue mobilization efforts could be on school fees from parents and/or to the extent that school
user charges and fees. The ability of local governments committees or parent-teacher committees, as quasi-public
to collect these types of revenues depends considerably entities, contribute to the provision of primary education, how
on the assignment of functional powers; local institutions’ significant is this funding?17
ability to deliver local services in way that provides value-
for-money; and on the capacity and willingness of users to In the provision of water and sanitation services, what is
pay for these services. the total revenue collected each year and subsequently
spent for recurrent operation and capital purposes by off-
budget urban water utilities? Similarly, in rural areas, what
3.3 An overview of non-devolved revenues are collected by water user committees which, in
many countries, serve as the de facto provider of rural water
revenue assignments services? Both of these questions should be answered fully to
get a comprehensive picture of water and sanitation revenues.
Traditionally, the discussion of revenue decentralization It is not unusual, however, for the accounting of water and
and the assignment of revenue powers has focused almost sanitation revenue and spending to focus exclusively on
exclusively on the local property tax and any other local tax and capital investment spending, and to ignore the revenues
non-tax revenue funds that are part of the local government and expenditures needed to operate and maintain water and
budget. Virtually no systematic attention has been paid to the sanitation infrastructure.
assignment of revenue powers to non-devolved actors in the
intergovernmental system. This includes any discussion or Likewise, to the extent that roads and other transportation
analysis of revenues collected by national parastatal entities, infrastructure may be operated in an off-budget manner by a
authorities and funds—revenues collected by entities that are national road fund (often funded by a fuel levy) or by dedicated
funders or providers of delegated services. Also overlooked transportation authorities or public-private partnerships
are revenues collected by local government-owned public (PPPs), what are the fuel levies or road tolls that are collected
companies, delegated service providers, and other “last mile” by these authorities or entities that operate and/or maintain
providers such as local water utilities, transit companies, or public sector roads or bridges?
fee-collecting local health facilities. All these revenues are
15. As noted in Section 3.3 below, economists consider that such shared revenues are in fact intergovernmental fiscal transfers. Nonetheless, it is not unusual for the domestic
Chart of Accounts to register such shared revenues as own source revenues rather than as intergovernmental revenues in order to give the appearance of tax autonomy.
16. Compared to other sectors, the health sector offers a positive example, as the World Health Organization’s accounting of Total Health Expenditures seeks to incorporate
different funding flows, including public sources (government spending); private (out of pocket) spending; social health insurance; and donor organization spending.
Despite the extensive guidance in the sector, however, it is often still difficult to entangle how much is being collected and spent of health services, and, by whom, at the
subnational level.
17. Boex and Vaillancourt (2014) point to the case of education spending in Madagascar. Primary education is formally a central government responsibility provided in a
deconcentrated fashion following a classic French model. In 2010-2011, centrally hired primary school teachers (either as permanent civil servants or contractual em-
ployees) accounted for only 32% of all public school teachers; of the remaining 68% (called FRAM teachers), 48% were hired and paid in part by parental committees
and in part by a subsidy paid directly to teachers by the central government and 20% were hired/paid by parent’s committees, often with in kind payment (rice).
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 22
3.4 Common obstacles in domestic As a result, most real-world interventions related to revenue
assignment and local revenues are intended to ensure that
revenue mobilization and subnational subnational governments administer the limited revenue
revenue administration: technical instruments assigned to them as efficiently as possible. As
such, efforts to improve local property tax administration
challenges (particularly in urban areas), often play on outsized role
in World Bank interventions related to local government
Local own source revenues are seen by many as a preferred
revenues (Kelly, White, and Anand 2020).
source of funding for local government services. This is not
only because there is a stronger conceptual link between
the benefits and costs of locally-provided services,18 but
also because local taxpayers are expected to exert stronger 3.5 Political economy considerations:
oversight over the efficient spending of their own local tax common obstacles in revenue
contributions. Furthermore, revenue decentralization gives
subnational governments a fiscal stake in the economic assignments
success of their jurisdictions. As a result of these factors, the
failure to decentralize revenue powers while decentralizing Empowering intergovernmental (fiscal) systems: revenue
expenditure responsibilities is generally assumed to result in assignments. Public sector revenues tend to be much less
greater local fiscal indiscipline and risk taking. decentralized when compared to public sector expenditures.
As noted in Section 2, when we apply the subsidiarity principle
But, the evidence on this point is mixed. Given the fact that to the function of public taxation and revenue administration,
the collection of most major revenue sources—with the most revenues are efficiently collected at the national level.
exception of property taxes—is generally assigned to the An additional reason for this pattern is that political economy
central government in line with the subsidiarity principle in forces cause revenues to be highly centralized. Most Finance
revenue administration, virtually every country in the world Ministers will be hesitant to give away high-yielding revenue
faces a significant primary vertical fiscal imbalance. In many instruments to subnational governments, and thereby reduce
countries, the assignment of shared revenue sources on a the ability of the national fiscus to ensure macro-fiscal stability.
derivation basis, or the introduction of local surtaxes or piggy-
back taxes is often able to reduce the vertical fiscal gap in Furthermore, it is common for central government
a way that provides resources to subnational governments politicians—ahead of their next election—to abolish local
without the potential inefficiencies associated with full revenue taxes that are unpopular with the electorate, allowing central
decentralization (Hunter 1977). politicians to cut taxes for voters without a negative impact
on their own (central) budget. More often than not, these
Nonetheless, lackluster collection of local taxes and other local revenue sources are reinstated after the election, when
own source revenues in many local jurisdictions is common, locally elected leaders appeal to the national party that
particularly in developing and transition countries. Analyses local revenues are an important foundation for the financial
of local revenue performance frequently attribute the lack of survival of local governments.
local revenue effort to an amorphous “weak local revenue
administration” which, in turn, is often attributed to a “lack of Efficient, inclusive and responsive revenue assignment. In
local political will.” Instead, weak local revenue performance response to news that local governments are collecting only x
is often caused by a combination of factors, including the fact percent of the revenue that they could be collecting (where x is
that local governments are assigned unpopular taxes that a small number, sometimes even as small as 10 percent), it is
are relatively costly to collect, and have weak enforcement not unusual for national-level politicians or policy researchers
powers and weak political incentives and/or the absence of studying local revenue administration to condemn local
hard budget constraints.19 government officials for lacking the political will to collect own
source revenues.
18. The link between local taxes and local expenditures and accountability at the local level is called Wicksellian connection. See Bird and Slack (2013).
19. National revenue authorities don’t necessarily do any better job when asked to collect local revenues (Fjeldstad, Ali, and Katera 2019).
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 23
Such criticism may or may not be warranted, and if nothing and taxpayers are satisfied to remain at an equilibrium of
else, it does not necessarily point to a problem with local low taxation and low service delivery performance, the tax
tax administration. It is useful to start by acknowledging the administration apparatus does not face strong incentives to
political economy argument that local revenue collections are improve its collection performance. Perhaps unsurprisingly,
not intended to be maximized, but rather, that local revenue then, most local revenue mobilization efforts focus on other
collections are optimal where the marginal cost to local local administration improvement efforts such as improving
taxpayers of additional taxation equals the marginal benefits land administration and property valuation, while basic revenue
from additional public services. In an effectively decentralized collection activities, such as billing systems and enforcement
system, if the chain of accountability is working, locally elected and collection of arrears, are frequently overlooked.
officials are the arbiters of the level of local taxation at which
this optimum is achieved. The “lack of political will” may simply Engaged civil society, citizens, and business community:
reflect a rational political response to a situation where it might revenue assignments. While the long term success of any
be politically easier for a mayor to get additional resources public sector depends on its ability to generate revenues
as a special grant from central government compared to from which to fund public sector expenditure, it is equally
collecting from local constituents. Local leaders may also important to consider the perspective of the (local) taxpayer
exhibit a lack of political will to collect own source revenues in determining the assignment of revenue sources and the
results if the efficiency or responsiveness of local government optimal level of taxation at different levels. In most countries,
spending is relatively low. A low level of lack of political will is even under the best of circumstances, taxpayers are unlikely
only a real concern if local politicians are setting effective tax to pay their (local) taxes if payment can be avoided without
rates – through a combination of formal tax rates and weak negative consequences. Tax collection and enforcement
revenue administration and enforcement – that result in a level issues aside, local taxpayers’ willingness to pay taxes in
of local taxation that falls below what is considered optimal by return for local public services is likely to be limited if the local
local constituents. government’s decision making is unresponsive, or if the local
government’s capacity to efficiently deliver services is weak.
A bigger concern may actually be when predatory local taxation,
the opposite of inadequate revenue mobilization, occurs.20 A final political economy consideration regarding local revenue
Another serious problem occurs when the local government collection is how the money gets spent. Wealthier taxpayers
administers local taxes and revenues in a patently inequitable might be willing to pay local taxes if they perceive benefits
mannerfor example, enforcing taxes on political opponents, from higher local taxes. However, the willingness of wealthy
but not on political supporters, or when pervasive inefficiency taxpayers to support pro-poor local services is often limited
or corruption exists in local tax administration. by the strength of local social contract. Thus, local revenue
compliance may decline over time when local governments
It is not just local politicians who are to blame at the local level for pursue redistributive policies beyond the level supported by
weak local revenue administration. As long as local politicians those contributing most to the local treasury.
Box 3.1 Background and resources on revenue assignments and local
revenue administration
● Subnational Taxation in Developing Countries: A Review of the Literature. Richard Bird: World Bank, 2010.
● Sub-central Tax Autonomy. Hansjörg Blöchliger and Maurice Nettley: OECD Fiscal Federalism Studies, 2015.
● Municipal Finances: A Handbook for Local Governments. Catherine Farvacque-Vitkovic and Mihaly Kopanyi: World
Bank, 2014.
● Property Tax Diagnostic. Roy Kelly, Roland White, and Aanchal Anand: World Bank, 2020.
20. The definition of predatory taxation is often in the eye of the beholder. However, most people would be concerned about the efficiency and equity of local revenue assign-
ments if a major share of local revenues would benefit tax collectors, or if these local revenues are mainly used to pay for the sitting allowance of local officials.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 24
4.
>>>
Intergovernmental fiscal
transfers
4.1 Relevance of intergovernmental fiscal transfers
Intergovernmental fiscal transfers are the primary source of revenue in a majority of countries
around the world, on average accounting for over slightly over half (51 percent) of total
subnational government revenues, or 4.2 percent of GDP (OECD/UCLG 2019: 70). However,
there are considerable variations in the magnitude of intergovernmental fiscal transfers across
countries, both in terms of absolute size as well as in terms of their share in total subnational
revenues. While intergovernmental fiscal transfers play an important role in both urban and rural
local governments, the role of transfers is often more dominant in rural local governments that
may have a limited taxable economic base of their own.
It is important to acknowledge that the importance of intergovernmental fiscal transfers is not
a coincidence or a temporary situation. Instead, in almost all countries, we should expect a
permanent “primary” vertical fiscal imbalance, a situation where subnational expenditure needs
exceeding subnational own source revenues, before intergovernmental fiscal transfers are
taken into account (Hunter 1977). This structural imbalance is due to the fact that the extent of
optimal expenditure decentralization is consistently greater than the optimal level of revenue
decentralization, when the subsidiarity principle is applied to both. As such, an important raison
d’etre for intergovernmental fiscal transfers is to help to reduce this vertical fiscal imbalance or
gap. Another reason for intergovernmental fiscal transfers is to ensure an equitable horizontal
distribution of resources, typically by making sure that localities with greater expenditure needs
or lower own revenue potential receive greater transfer allocations.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 25
4.2 An overview of intergovernmental Intergovernmental fiscal transfers or intergovernmental
expenditures are different from other “direct” government
fiscal transfers expenditures or outlays based on the fact that there is no
immediate quid pro quo. While the recipient government may
What are intergovernmental fiscal transfers? Intergovernmental (or may not) have to fulfill certain conditions to receive fiscal
fiscal transfers (IGFT) include a wide range of fiscal instruments transfers, the provision of transfers is generally not a final
by which funds are transferred from one government unit – often at payment for specific goods or services rendered—as is the
a higher government level – to another government unit often at a case, for example, with wage expenditures or the purchase
lower government level. Sometimes IGFT are referred to as grants of goods and services or capital infrastructure.21 On the
or intergovernmental expenditures by the “giving” government, revenue side, intergovernmental fiscal transfers differ from
and as intergovernmental revenues by the recipient government. other own revenue sources in that the recipient government
Many other (often country-specific) terms are used to describe does not have any control over the rate, base or collection of
different types of intergovernmental fiscal transfers, including intergovernmental fiscal transfers.
general allocations, equitable shares, subventions, and subsidies.
>>>
Figure 4.1 A typology of intergovernmental fiscal transfers
Source: Boadway and Eyraud (2018).
Types of transfer schemes. The actual nature of IGFT schemes or unconditional) transfers or grants, as well as categorically
varies greatly, both across and within countries. Some, earmarked transfers or “block grants” and specific/earmarked
such as revenue sharing schemes are accounted for on the grants (Figure 4.1).22,23
revenue side of the budget. But most transfer schemes are
recorded on the expenditure side of the central government In addition to the variations in transfer-related terminology, which
budget, which may include general-purpose (unearmarked often differs from country to country, there is no single consistent
21. In fact, in the case that one government unit directly purchases a good or service from another government unit, the nature of the transaction changes, so that such a trans-
action would no longer be classified as an intergovernmental fiscal transfer (U.S. Census Bureau 2006).
22. Despite shared revenues sometime being classified as own revenue sources in the Chart of Accounts of different countries, as noted above, public finance economists tend
to consider shared revenues as IGFT when the recipient government does not have any control over the rate, base, collection or sharing rate of the shared revenue source.
23. Categorical or block grants are conditional grants that are required to be spent on a specific spending category, but otherwise allow the recipient a degree of discretion on
how to spend the grant resources. For instance, a cross-sectoral capital development grant or a local education sector grant can be provided as a categorical grant, allowing
the recipient government a degree of autonomy, as long as the resources are spent within the relevant sector or spending category. A specific or earmarked conditional grant
allows the recipient government little or no spending discretion. For instance, specific earmarked grants may be used to pay for specific infrastructure projects approved by
the central government, or pay for the wages of filled staff positions, as approved by the central government.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 26
approach or typology to classify IGFT schemes (Hunter 1977; 5. The existence of “performance-based” access conditions
Bahl and Linn 1992; OECD 2013; Boadway and Eyraud 2018). (or incentives) and other conditions relating to the
management of grants—for example, requirements
Most of the typologies used to classify different types of related to the planning, budgeting, and use—as well as
transfer schemes consider some combination of five elements the reporting on the use—of transfers).
of transfer design. These are:
While elements the last three listed types define the level of
1. The nature and manner of determining the size of the conditionality associated with transfer schemes, all categorical
transfer pool or vertical allocation—for example, rule- and specific grants impose some degree of conditionality and
based vertical allocation versus discretionary vertical are generally referred to as conditional grants.24
allocations, on-budget or off-budget, and revenue-sharing
versus budgetary transfers. Types of transfer systems. In addition to acknowledging
2. The manner or nature of determining the horizontal the wide range of IGFT schemes that can be designed and
allocation of the transfer resources—for example, implemented, it is useful to recognize that the composition
formula-based horizontal allocations versus discretionary of IGFT systems ranges widely around the globe. As shown
horizontal allocations; equalizing versus non-equalizing. below in Figure 4.2, these systems can be modulated by
3. The extent and nature of or earmarking imposed on the policy makers from a highly consolidated transfer system –
transfer—for example, unconditional or general-purpose comprising one large unconditional funding flow with extensive
grants versus more conditional or earmarked grants such subnational or decentralized decision-making power and
as categorical grants or specific grants. control – to a highly fragmented transfer system, with a large
4. The economic (incentive) nature of the transfer—for number of often highly conditional intergovernmental funding
example, matching grant or partial reimbursement versus flows allowing for extensive centralized control.
non-matching grant/full reimbursement.
>>>
Figure 4.2 A typology of intergovernmental fiscal transfer systems
Panel A: Consolidated (decentralized) grant system Panel B: Moderately consolidated grant system
Panel C: Relatively fragmented grant system Panel D: Fragmented (centralized) grant system
Source: Authors.
24. See Conditional Grants in Principle, in Practice and in Operations: A Primer (2022) for further information and guidance on conditional grants.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 27
There is no single, universal “better” international practice when it associated with the vertical allocation (the size) of transfers
comes to IGFT systems. In some cases, especially to the extent that unlocks the power of local governments, simply by
that subnational governments perform effectively as inclusive, providing local governments with greater financial resources
responsive, and accountable mechanisms for subnational to do more things that they could not afford based on their own
decision making and services delivery, a highly unconditional revenue sources alone. By providing a binding (“hard”) budget
grant system might result in effective public sector performance, constraint, a well-designed transfer system has the potential
as in Germany. The same transfer system under greater to greatly improve the allocative efficiency of the public sector.
institutional constraints with respect to political and administrative This is effected by strengthening public sector planning and
systems is likely to perform more poorly as experienced in transforming the planning process from the preparation of
Nigeria. Many countries, such as Indonesia, Kenya, and South unaffordable or poorly prioritized wish lists, to a system within
Africa try to avoid an excessive conditional grant system and opt which local officials are required to meaningfully prioritize and
for a mix of general-purpose and conditional grants. At the same plan their expenditures in a results-based manner.
time, some federal countries like the the United States that are In addition, transfers can further be used in more strategic
generally considered highly devolved rely on highly fragmented ways. For instance, different types of conditional grants –
and earmarked transfer systems. categorical or specific grants and matching grants – can
be used to encourage local governments to increase their
Fragmentation of the transfer system often results in a spending on specific functions, such as concurrent functions,
multiplicity of schemes—each often with their own minimum or tasks that might otherwise be underfunded. Also, well-
access conditions, spending requirements, disbursement designed transfer schemes—in particular, performance-based
triggers, and reporting requirements. This often strains the ability grants—can be used to provide specific carrots and sticks for
of local government officials and local financial management local governments, for instance, to improve local governance
systems to manage different funding flows. More often than not, arrangements, or to improve local service delivery outcomes.
development partner projects contribute to this fragmentation
and complexity rather than help resolve it. In addition, as further Universal principles. Over the years, experienced policy
discussed below, formal IGFT schemes often operate alongside practitioners and analysts of fiscal decentralization have
non-devolved vertical funding mechanisms, thus resulting in a arrived at a list of a dozen or so universally accepted principles
reality far beyond the neat linear funding arrangements implied of sound transfer design (Bahl and Linn, 1992; Shah, 1995;
by the diagrams in Figure 4.2 above. Martinez-Vazquez and Boex, 2001). Although the exact
number of points and the phrasing of the individual points vary
The key to unlocking the power of subnational governments. slightly among different sources, these universal principles
In public policy discussion of transfer schemes the horizontal are commonly accepted as important guidance in designing
allocation formula almost always gets most of the attention. an effective grant system (Table 4.1).25
But in reality, it is actually the increase in fiscal space
>>>
Table 4.1. Universal principles of sound intergovernmental fiscal transfer design
Principle Clarification
1. Clear objective The allocation should be guided by a clearly stated policy objective.
2. Revenue adequacy Transfers should provide adequate resources for purpose at hand (and avoid un-
funded mandates)
3. Preserving budget autonomy Conditions placed on transfers should balance national priorities and local
autonomy.
4. Enhancing equity and fairness The transfer mechanism should support a fair allocation of resources.
5. Stability The allocation should be stable and predictable over time.
25. Although subnational budget allocations in Egypt are technically not intergovernmental fiscal transfers, as governorates are deconcentrated entities rather than autonomous
local governments, much of the literature on intergovernmental fiscal transfer design applies.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 28
6. Simplicity and transparency The transfer mechanism should be simple and transparent.
7. Incentive compatibility The allocation approach should not provide negative incentives.
8. Focus on service delivery Transfer formulas should focus on the demand (clients or outputs) rather than the
supply (inputs and infrastructure) of local government services.
9. Avoid excessive equal shares Excessive reliance on the “equal shares” principle as a major allocation factor
should be avoided.
10. Avoid sudden large changes Avoid sudden large changes in funding for local governments during the introduction
of the new transfer mechanism.
4.3 An overview of non-devolved provision of sectoral block grants and other sectoral
transfers to the local level.26 This category of fund-flows
subnational funding flows also includes grants to service providers that are not
formally part of the public sector, such as grants from the
By definition, IGFTs include only the funding flows such Ministry of Forestry to Forest User Groups in Nepal, or
as general revenue sharing or grants-in-aid between two funding support by the central Ministry of Water to local
government units which, in many cases, means the central water user associations or committees. It is often difficult
government as the funder and a local government as the to disentangle how much national program spending
recipient. Indeed, virtually all discussions and analyses of actually reaches the front line.
IGFTs limit themselves to these transfers. In reality, however, 2. Deconcentrated spending on local public services.
as illustrated earlier in Figure 2.3, numerous different types A second non-devolved funding flow includes
of non-devolved vertical or intergovernmental funding flows deconcentrated spending on local services. As opposed to
operate alongside IGFTs. the previous example, under budgetary deconcentration,
the subnational departments or offices are separate
Although there is little available on systematic quantitative budget organizations, units or cost centers in the budget,
analysis of non-devolved funding flows, the most common and are therefore easier to identify. For example, in
non-devolved subnational funding flows (or quasi-transfers) Egypt’s national deconcentrated budget structure, the
are likely to include: funding provided for the basic services delivered by
governorate-level sectoral directorates are not contained
1. Centralized spending on local public services. In some in the central ministry budget, but rather, in separate,
countries, different aspects of local frontline services are dedicated budget votes for these directorates.27 In other
provided and/or funded directly by central government countries, deconcentrated funding streams operate
ministries, often through national vertical or sectoral alongside centralized and/or devolved funding flows. For
programs. For instance, in Bangladesh, the majority of example, in Bangladesh where, as noted, health programs
frontline health services—including the salaries of health are largely delivered in a centralized manner, Upazila
workers—are managed and funded under the central subdistrict Health Offices and Upazila Health Complexes
government’s budget vote by the Directorate General are operated and funded by the Health Services Division
of Health Services, Health Services Division. Even in in a deconcentrated manner, rather than as part of the
countries such as Sierra Leone, where local health Directorate General of Health Services.
services are de jure a local government function, it is not 3. Funding support from national parastatal entities,
unusual for frontline health workers to be employed by funds, and authorities. Sometimes, local governments,
the central government. In other countries like Tanzania, or alternatively local-level facilities or service delivery
where recurrent health services are provided in a devolved providers receive funding support from national parastatal
manner, the construction of new health facilities may be entities, funds and authorities. This may include resource
funded from the central ministry budget, alongside the allocations to local governments for road maintenance
26. In many countries, development partner-funded investments in sectoral infrastructure are made through centrally managed programs, even when the provision of sectoral
services is legally devolved to the local government level.
27. As such, deconcentrated budget systems have subnational budget allocations rather than proper “intergovernmental fiscal transfers”. Based on historical practices in de-
concentrated systems (when deconcentrated units had their own bank accounts or their own accounts within the central treasury system), the term “transfer” is sometimes
still used in deconcentrated system as the (real or indicative) cash-flow transfer received within the national treasury system (or into the external bank account) from which
deconcentrated units were able to incur spending commitments or make outlays. In many modern central treasury management systems, such “cash transfers” to depart-
mental accounts are no longer needed, as payments are settled electronically within the treasury system.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 29
from the Roads Funds, as in Tanzania; payments to local 4. Provision of frontline services by national
health facilities for maternal health services from the parastatals, funds, and authorities. In other cases,
National Health Insurance Fund (“Linda Mama”) in Kenya; national parastatals, funds, and authorities or even donor
or allocations from sectoral trust funds or investment partners may provide in-kind inputs in support of local
authorities, as with grants from the Water Sector Trust public services, rather than a flow of funds. For example,
Fund to county governments in Kenya. In these cases, rather than receiving funding from the Medical Stores
the funding entity is typically an extrabudgetary entity at Department (MSD), local governments may receive a
the central government level, while the receiving entity notional budget or account from MSD against which they
may be either be a local government or a non-devolved can “purchase” medicines, which are then delivered in-
local entity. Due to the partial or full off-budget nature of kind. Similarly, local agriculture departments may get
these transactions, depending on which data sources are seeds and fertilizer through in-kind distributions, rather
being used (central or local), it may be easy to overlook than fiscal transfers.
these transfers or grants.
Box 4.1 Grants funded by international financial institutions and
development partners
As discussed further in Section 6, intergovernmental fiscal transfers are generally a good entry-point for international
financial institutions and development partners to support improved subnational governance or improved subnational service
delivery. Development partners need to design project funding modalities to align their fund-flows with the country’s transfer
system whenever possible and ensure that the funding mechanism being introduced is a sustainable part of the country’s
long-term intergovernmental fiscal architecture.
When possible, development partners should provide funding support in an on-budget manner as a top-up to existing grant
schemes, rather than introducing parallel funding streams that contribute unnecessarily to the fragmentation of the grant
system and increase the administrative burden on local officials. When this is not possible, the second-best option is to provide
create a new on-budget grant modality—for example, a sector grant supported by a multi-donor trust fund under a sector-
wide approach. Only as a last resort should development partner grants bypass the national government and be deposited
straight from donor-controlled project accounts into local government accounts or, even worse, pay local contractors directly for
services rendered to the local government, thus bypassing central and local public sector systems altogether.
Because most “devolved” countries actually rely on a should be recognized that, in practice, transfers are actually
combination of devolved and non-devolved service delivery a relatively blunt policy tool, as local governments and local
institutions and funding approaches, it is critical to consider government officials—as rational economic agents—tend
and analyze the reliance on non-devolved grants and (quasi-) to respond to receiving different types of grants, sometimes
intergovernmental fiscal transfers in order to achieve a solid in helpful ways, and sometimes in ways that undermine the
understanding of the intergovernmental fiscal context. performance and accountability of the public sector.
For example, when local governments are provided with
4.4 Common obstacles in additional unconditional grant resources to a local government,
it is common for local leaders to react by reducing local tax
intergovernmental fiscal transfers: collections in response to the increase in grant resources, doing
technical challenges so in response to the preferences of their local constituents.28
This means that for every hundred dollars in unconditional
Intergovernmental fiscal transfers are a relatively blunt grants provided, spending will increase by less than a hundred
instrument of intergovernmental finance. The importance dollars. Furthermore, it is unlikely that the local government will
of IGFT to intergovernmental finances notwithstanding, it direct these resources towards central government priorities.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 30
In fact, it should be expected that local officials will spend any poor manner to local governments by using the number of poor
additional general-purpose resources on local priorities. While residents in each locality as an allocation factor, and expects
such political responsiveness may not be appreciated by the local governments to spend these resources on pro-poor
national fiscus, this is simply a rational economic choice for programs. In reality, however, the inclusion of a poverty variable
elected local government officials in response to an expanding in the allocation formula has no bearing on whether local
budget constraint.29 governments will spend these resources in a pro-poor manner.
Similarly, whereas sectoral (block) grants or specific grants A third misalignment in expectations takes place when central
may be provided by the central government in order to government designs a conditional grant scheme – for example,
achieve a specific national policy objective, it is important a performance-based grant program that requires the
to be aware that local governments may decide to reduce recipient to abide by numerous central government conditions
their own spending from general-purpose funds in support – but then provides inadequate funding to give a meaningful
of this function when a conditional grant is introduced—for fiscal incentive to local administrators and decision-makers
example, in favor of spending programs deemed to be in to adequately implement the conditional grant program. The
higher need of the marginal dollar. Likewise, unless spending local government may accept the grant while resenting the
from conditional grants is carefully monitored, it would not conditions being imposed, and the central government will
be unusual for local governments to “accidentally” spend end up complaining that local governments are incompetent
resources outside the menu of permitted expenditures. Again, or dragging their feet.
given that the public sector is often underfunded, and given
that performance metrics are often difficult to validate, which Beyond the concerns noted above, there are a number of
is true in every country, but especially in countries with weaker common challenges, including:
public administration, it should not be surprising if local ● The structure of the transfer system is unclear or
public officials over-report certain data, such as enrolment, a is excessively fragmented and conditional. It is not
number related to health attendance. if doing so would help unusual for the grant system to lack a clear link between
them attract greater funding for the purpose of improving the functional responsibilities to be funded and the
local service delivery. For performance-based grants: results composition and size of the various transfer mechanisms.
results may be overstated for the same reason.30 A failure to achieve an appropriate balance between
unconditional and conditional grant instruments places
Another concern in the design of IGFT is a misalignment of unnecessary restrictions on local budget autonomy, often
expectations associated with the grant system. Expectations resulting in reduced allocative efficiency.
can misalign in a number of different ways. A first common ● The process or timing of intergovernmental budget
misalignment in expectations is known as the “tragedy of the formulation process. One of the most important
commons,” which occurs when a local government is allocated benefits of fiscal decentralization is that it requires local
an unconditional grant and, in response, every central sector governments to plan and prioritize in the context of a hard
ministry expects that the local government will allocate these budget constraint. But, if the central government fails to
resources to fund its (ministries’) sectoral services and set grant ceilings in a timely manner as part of the central
programs. When this happens, a strain will be put on the government’s budget formulation process – or if the central
intergovernmental (fiscal) system as a whole: sector ministries government changes grant ceiling after issuing the local
will under-provide conditional sector grants, local government budget circular – local governments are unable to prepare
services will be underfunded across the board, and local their plans and budgets in an in effective, inclusive, and
governments will systematically fail to achieve the results that accountable manner.
are set by central government ministries. ● Problems with vertical and horizontal allocation.
The vertical allocation of resources may be inadequate
A second misalignment in expectations takes place when the to achieve the required service delivery objectives. The
central government allocates unconditional grants in a pro- horizontal allocation of resources may also be fair or
28.. In some cases, the local council may actually reduce the local tax rate in response to receiving additional general-purpose grants. In other cases, the reduction in local tax
collections may happen more gradually.
29.. In fact, it is quite possible that a lot of “lack of political will” to collect own source revenues is actually caused by a combination of (a) low demand for local public services by
local constituents and (b) the availability of transfer resources. The impact of the transfer system on own revenue collections should be expected to be especially negative
or perverse if local governments are provide with a soft budget constraint and/or deficit grants.
30.. Naturally, there is an additional incentive for over-reporting of performance achievements if frontline staff themselves benefit from better performance in the form of perfor-
mance bonuses. For instance, this performance-bonus structure was the basis for (alleged) extensive cheating by teachers and educators under the No Child Left Behind
Act in the United States in the 2010s (Strauss 2015).
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 31
inefficient. For example, some local governments may resources is provided through more discretionary allocation
receive relatively more resources than needed for their mechanisms rather than rules-based and formula-based
expenditure needs compared to other localities. transfers, which would allow them greater control over the
● Disbursement problems. Transfers should be allocation of resources by lobbying the Minister of Finance or
disbursed in a complete, consistent and timely manner. other relevant ministries, such as the ministries responsible
It is not unusual, however, for central governments to for local government or urban development. Representatives
fall short in this regard, due to poor planning or weak of politically weaker jurisdictions may prefer a formula-based
cash management. In other cases, the complexity of approach, which—while limiting their own discretionary
disbursement procedures causes delays. In fact, it is not power—could ensure a more favorable distribution of
unheard of for grant releases to be made on the last day resources for their constituencies. The Minister of Finance
of the financial year. The failure of the central government may prefer to have discretionary control in setting the total
to disburse committed resources in a timely manner can pool of funds transferred to subnational governments from
cause considerable downstream problems such as low year to year, rather than using a predictable vertical sharing
budget performance, unpaid local government staff, and rule, which would provide more stability for local governments,
delays in contracting. but would give the Minister fewer tools to ensure macro-
fiscal stability. Similarly, central sector ministries may prefer
conditional sectoral grants over unconditional grant schemes,
4.5 Political economy especially if the grant is located within the ministerial budget
votes, and gives ministry officials the power to approve or
considerations: common obstacles in decline disbursements based on whether conditions have
intergovernmental fiscal transfers been met. Therefore, as a result of the political economy
forces, there is a tendency for transfer systems to become
Empowering intergovernmental (fiscal) systems: increasingly fragmented over time, as national actors and
intergovernmental fiscal transfers. While the design of many development partners have a desire to exercise control
IGFT systems and schemes is a highly technical exercise, and oversight over funding flows to the local level through
the issue is highly political at the same time. After all, there is conditional grants.
nothing more political than the allocation of public resources
to competing demands. In fact, political economy forces Once the structure and nature of the grant system has been
permeate not only specific decisions regarding the vertical and decided, the actual vertical allocation of resources, typically
horizontal allocation of resources, but also the design of the determined as a part of the central government’s annual budget
grant system as a whole. This includes decisions regarding the formulation process, is again subject to political economy
mix of conditional versus unconditional grants and the choice of forces. Determining the size of the various transfer pools
formula-based versus discretionary grant schemes). should be informed by the desire to provide adequate funding
based on the policy objectives of the grants in a way that
While a neutral observer would balance the pros and cons balances the financial needs of local governments with those of
of conditional versus unconditional grants or judge the central ministries. But, in most countries, the vertical allocation
technical merits of formula-based versus discretionary decision is ultimately a policy decision made by Cabinet—by
grant schemes, central government officials are likely to political representatives leading central government ministries.
have an institutional or even personal stake in deciding In order to (partially) counteract potential bias in the vertical
on the nature of the grant system. While formula-based allocation of resources, some countries have constitutionally
grants may be preferred on technical grounds – due to their or legally put in place different intergovernmental institutions,
objectivity, predictability, transparency – the choice of grant such as India’s Finance Commission, Kenya’s Commission
instruments itself may be determined by a contestation of on Revenue Allocation (CRA), or Nepal’s National Natural
power, both within and between political parties as well as Resource and Finance Commission (NNRFC), to be a more
within and between different ministries. Powerful members neutral arbiter of vertical fiscal balance.
of parliament or powerful mayors may prefer that the bulk of
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 32
Even when a formula-based approach is selected, rather depends on the exact nature of the transfer or transfers provided
than a more discretionary horizontal allocation approach, it is to the local government level—unconditional, conditional, or
important to recognize that the presence of a formula-based performance-based. How local governments respond to fiscal
allocation mechanism does not assure that the horizontal incentives provided by higher-level governments depends on
allocation of resources is necessarily objective or fair. After how elected local officials, local administrators, and frontline
all, it is typically central government bureaucrats who prepare service providers balance the various demands placed on them
the proposals for grant allocation formulas, while central from different directions, and in some cases, on the nature of
government politicians hold the power to enact or reject the the intergovernmental fiscal transfers. For instance, if wage
formula-based allocations of transfer resources. For instance, grants are provided as part of a sector block grant, this may
if powerful politicians from wealthier jurisdictions have a provide local governments an incentive to hire workers that
stronger voice in parliament, equalizing grants may face a provide high value-for-money, and to replace non-performing
higher political hurdle, while matching grants, which may workers. The decision to terminate weak performing staff may
cause wealthier local jurisdictions to receive greater transfers. be different if wage grants are explicitly tied to the salaries of
would be more favorably received. workers being sent from the sector ministries. Thus, terminating
an underperforming worker would result in a decrease in the
A number of studies have been done on the political economy wage resources made available.31
of transfer allocations over the years, looking specifically
at the horizontal incidence of IGFT across different local A final observation regarding the political economy of IGFT
governments. The collective findings of the literature suggest deals with an argument made by some observers that local
that while normative considerations and voter choice governments are more likely to spend transfer resources in
considerations are often significant forces in the distribution a more frivolous manner when compared to funding that was
of transfers, political factors are consistently a major driving collected from local taxpayers. While this may be true in certain
force in determining the horizontal incidence of IGFT in fiscally cases, local government leaders may also waste own source
decentralized systems around the world (Boex and Martinez- revenues unless political accountability mechanisms are
Vazquez 2004). Recognizing the fact that the development of strong and effective. In the end, the effective use or misuse of
grant allocation formulas is not merely a technical exercise— intergovernmental fiscal transfers will depend on the vertical
but that politicians have to approve the resulting grant formulas, as well as the horizontal context within which these resources
and that they will view the formula through a political economy are placed.
lens—requires policy analysts and technical experts to “think
political.” This means that though the mandate of policy
analysts and development practitioners is purely technical, it
would be counterproductive to ignore who the main “winners”
and “losers” would be from the introduction of a new grant
program or from the change in an existing allocation formula.
Efficient, inclusive and responsive local governance:
intergovernmental fiscal transfers. In almost all cases, IGFT
are provided to encourage changes in the choices made by
local government officials. In some cases, transfers have
the intended effect; for example, a sectoral block grant may
result in improved service delivery outcomes. In other cases,
grants may have unintended consequences; for example, an
unconditional grant may lower own source revenue collections.
The exact impact of IGFT on the political and budgetary
decisions at the local level is highly context-specific, and
31. Under either scenario, however, the choice faced by the local health administrator (or the health facility head) to terminate an under-performing health worker is not just
a technical decision, but needs to balance the demands of the community or facility’s governing committee; whether or not the decision will be seen favorably by the local
elected leadership; and/or whether doing so would have ramifications for his or her own promotion within the sector’s service cadre.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 33
Box 4.2. Further background and resources on intergovernmental fiscal
transfers
● Intergovernmental Fiscal Transfers: Principles and Practice. Robin Boadway and Anwar Shah: World Bank 2007.
● Fiscal Equalization in OECD Countries. Hansjörg Blöchliger, Olaf Merk, Claire Charbit, and Lee Mizell: OECD Fiscal
Federalism Studies 2007.
● Fiscal Equalization: Challenges in the Design of Intergovernmental Transfers. Jorge Martinez-Vazquez and Bob
Searle, eds.: Springer 2007.
● Designing Sound Fiscal Relations Across Government Levels in Decentralized Countries. Robin Boadway and
Luc Eyraud: IMF 2018.
● Conditional Grants in Principle, in Practice and in Operations: A Toolkit. World Bank 2022.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 34
5. >>>
Subnational government
borrowing, debt and capital
finance
5.1 Relevance of borrowing and capital finance.
The fourth and final pillar of fiscal decentralization is comprised of subnational government
borrowing, debt, and capital finance. The volume of this pillar of fiscal decentralization is often
the smaller compared to the others; on average, borrowing and other sources of finance account
for approximately 5 percent of total subnational revenues (OECD/UCLG 2019: 71).
Despite its relatively small overall volume, the topic of subnational borrowing and capital finance
attracts considerable interest due to its potential to “punch above its weight,” to the extent that
it enables subnational governments to mobilize relatively sizable resources for the purpose of
financing specific capital investment projects. Unlike the earlier pillars of fiscal decentralization
(revenues and transfers), however, borrowing or other forms of capital finance, does not actually
increase the amount of money that is available to subnational governments over time (Figure
2.3). Instead, financing mechanisms such as loans or bonds merely shift access to funds over
time, as loans contracted today have to be repaid over time and thus reduce the resources
available for public expenditures in the future.32
5.2 An overview of subnational government borrowing,
debt and capital finance
Local and regional governments in many countries face a balanced-budget requirement. This
means that, in principle, subnational governments should balance their budgets each year and
32. Sometimes this is referred to as the difference between “funding” and “financing”: funding is the money available to a subnational government (often derived from a
variety of sources, including taxes, fees and transfers), whereas financing is the process of raising loans or capital (in the form of loans or bonds), typically for capital
investment purpose.
33. In fact, even with balanced budget requirements in place, subnational governments may actually incur a recurrent deficit when actual spending exceeds planned spending, or
when actual revenues and transfers fall short of projected revenues and transfers. In some cases, local governments are able to borrow for short-term (cashflow) purposes.
However, it is not unusual for subnational governments to deal with such budget imbalances by accumulating budget arrears with vendors and contractors.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 35
ensure that they are able to cover their planned expenditures allowed to borrow at scale, subnational governments may also
with available own and shared revenues and transfers. crowd out central government borrowing and private sector
Problems arise when local income (revenues and transfers) investment, posing potential macro-fiscal risks.
and expenditures are not balanced at the end of the year.33 If
allowed at all, subnational governments often face limitations Due to potential risks, central governments impose restrictions
on their power to borrow. In many countries, borrowing is only on subnational borrowing. Such limitations may range from
permitted for the purpose of financing capital investments, requirements for subnational governments to meet certain
rather than borrowing for financing unsustainable recurrent borrowing standards. These may include debt-to-revenue
spending or deficits. ratios; preapproval from the Ministry of Finance for loans; only
permitting subnational governments to borrow from domestic
There are a number of advantages to allowing subnational banks, from the central government itself, or centrally-approved
governments to prudently engage in borrowing and financial intermediaries—such as national investment banks,
accessing capital finance. Access to borrowing and other municipal development funds or local government loan boards
capital financing – whether through loans, bonds, or other (Box 5.1). Although such financial intermediaries have been
financing arrangements, such as public-private partnerships used successfully in many countries with robust decentralized
– allows subnational governments to finance “lumpy” long- systems, the governance of such institutions in weaker
term capital investments without the need to fund the entire governance contexts has yielded mixed results.
investment upfront from recurrent revenue sources. Because
the benefits of long-term investments are spread out over At the cutting edge of subnational borrowing capital finance
time, financing thus allows for inter-temporal matching of are more sophisticated financing instruments—such as public
the benefits and repayment costs of the capital investment. bond issuances or advanced public-private partnerships.
Subnational borrowing could thus speed up subnational These are typically only suitable for larger subnational
capital investments and thereby improve public services and jurisdictions that have a robust economic base, are politically
catalyze economic growth. But there are also fiduciary risks stable, are administratively well-capacitated, and manage
associated with subnational borrowing. For example, when their finances in a prudent and transparent manner (in order to
subnational governments borrow excessively, select capital ensure creditworthiness).
investments poorly, or when they fail to repay their loans. If
Box 5.1 Municipal Development Funds
Municipal Development Funds (MDFs) are parastatal institutions that lend to local governments for infrastructure
investments. These are essentially financial intermediaries that provide credit to local governments, and are usually seen as
an intermediate step in the way towards self-sustaining municipal credit systems that can access domestic and international
capital markets for financing.
There are two main types of MDFs. The first type, currently more widely used in the developing world, functions as a
substitute for government capital grants to local authorities. These MDFs provide capital at below-market rates, combining
subsidized loans with grants. Usually, these MDFs exploit the favorable terms of their loans to impose strict standards of
project preparation and implementation.
A second type of MDFs categirizes those that are used to serve as a bridge between local governments and the private
credit market. These MDFs lend at market rates, allocate capital according to decisions of private lenders, transfer all credit
risk of municipal loans to private lenders, and keep a record of municipal creditworthiness.
Source: World Bank (2011).
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 36
5.3 An overview of non-devolved limited own revenue sources and weak financial management
practices result in the lack of creditworthiness of local
borrowing and capital finance governments. Therefore, relatively few local governments
are actually in a position to borrow or issue debt. A second
As presented earlier in Figure 1.2, it is not only local problem in many developing and transition countries is the
governments that can engage in borrowing for the purposes weakness of the suppliers of credit—financial institutions and
of financing capital investments. Central governments, capital markets. When one or only a few cities in a country
centrally state-owned enterprises or parastatals and, in some are creditworthy, domestic lending institutions may not have
cases, local service delivery entities, can engage in borrowing experience in issuing loans to local governments. Likewise,
in order to finance capital investments. In other cases, formal markets for municipal bonds and other debt instruments
parastatals or off-budget entities serve as lenders to local may be weak or absent.
government or local service delivery entities. Similar to non-
devolved fiscal transfers, these non-devolved financing flows If local government borrowing the domestic and international
are often overlooked in analyses of fiscal decentralization (private) sources is prohibited, the only alternative local
and intergovernmental finance. This is especially the case governments have is to borrow from a financial intermediary,
when both the provider as well as the recipient are off-budget such as a municipal bank or urban development fund,
entities—for example, a loan from a parastatal or national fund especially set up for this purpose. Setting up such funds is not
to municipal utility company. free from technical or political economy challenges.
Given the challenges that local governments or local service
providers often encounter in securing private sector finance
for capital infrastructure, higher-level governments use 5.5 Political economy considerations:
parastatal organizations, national authorities or funds, state- common obstacles in borrowing and
owned enterprises, or some other special-purpose vehicle to
capital finance
function as an intermediary to provide local governments with
access to financing. The World Bank and other development
As was the case for the previously discussed three pillars of
institutions also sometimes set up mechanisms to facilitate
intergovernmental finance, there are strong political economy
on-lending to the local government level. As already noted,
dimensions to the often weak reliance on local government
municipal investment banks or municipal development funds
borrowing and other financing instruments.
(MDFs) are one kind of such funding mechanism, often
lending at concessionary rates or providing a mix of loans
Efficient, inclusive, and responsive local governance:
and grants. Other more targeted funds may also provide
borrowing and capital finance. The most significant obstacle to
local governments with access to financing. For instance,
allowing local governments to rely on debt and capital finance
the Green Climate Fund (GCF) can structure its financial
is not a technical problem, but rather, the “moral hazard”
support through a flexible combination of grants, concessional
problem associated with borrowing. This is the risk that local
debt, guarantees, or equity instruments to leverage blended
officials will engage in excessive borrowing when they do not
finance and crowd-in private investment for climate action in
bear the full consequences of their choices. The moral hazard
developing countries (GCF 2021).
concerns are typically exacerbated in weak governance
environments.
5.4 Common obstacles in borrowing The most obvious moral hazard aspect of local government
and capital finance: technical borrowing is that local political leaders who engage in
borrowing receive most of the political benefits of borrowing,
challenges while doing so incurs financial liabilities that will have to be
borne by taxpayers and other local officials in future years.
Perhaps the most prevalent obstacle to borrowing from private Trouble ensues when an incoming local mayor or local
sector sources in developing and transition countries is that
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 37
council defaults on local debt contracted by the previous local challenges associated with local government debt largely
administration, on the argument that the new administration play out at the local government level itself, higher-level
and local taxpayers should not be held responsible for the governments are not always insulated from similar challenges.
repayment of funds that were spent unwisely by previous local This is especially true when the higher-level government is
administrations. In order to prevent such scenarios, higher- seen to implicitly or explicitly guarantee the debts incurred by
level governments tend to restrict the level and scope of—or local governments. For example, central government officials
simply to prohibit altogether—local government borrowing. may choose to extend “deficit grants” to cover the budget
In the United States, some states require local governments deficit of local government jurisdictions that are politically or
to obtain the permission from the voter directly—through a institutionally favored, while declining the same funding to
referendum—before contracting debt. other local jurisdictions.
Moral hazard concerns related to local fiscal balance and A similar situation arises when the higher-level government
borrowing grow exponentially when local governments and controls the financial intermediary that lends funds to local
their creditors believe that local government debt is guaranteed governments. This may be the case of a municipal development
by higher-level governments. As such an implicit or explicit fund controlled by the Ministry of Finance, or a Local
guarantee would reduce the risk for banks and other lenders Government Loans Board operated by the Ministry of Local
for extending credit to local governments that would otherwise Government. Depending on political circumstances, central
be a credit risk. government entities may relax the repayment requirements
for such funds—for instance, in the run-up to an election—
Empowering intergovernmental (fiscal) systems: borrowing which can spell the financial downfall of the institution, if future
and capital finance. While moral hazard or political economy borrowing depends on the repayment of existing loans.
Box 5.2. Background and resources on local government borrowing, debt
and external finance
● City Creditworthiness Initiative (World Bank): citycred.org.
● Municipal Finances: A Handbook for Local Governments. Catherine Farvacque-Vitkovic and Mihaly Kopanyi: World
Bank, 2014.
● Guidebook on Capital Investment Planning for Local Governments. Olga Kaganova: World Bank, 2011.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 38
6.
>>>
Implications for World Bank
engagement: improving the
intergovernmental fiscal
plumbing
Within the range of analytical tools at the disposal of TTLs within the World Bank, this section
aims to: (a) establish a clear link between decentralized public sector finances, effective public
sector management and the localization of development; (b) help TTLs place a country’s
intergovernmental governance and fiscal arrangements within a spectrum of international
experiences that allows them to prioritize areas for potential Bank engagement; and (c) based
on the reform environment, identify specific interventions that might improve the country’s
intergovernmental fiscal “plumbing.”
Sections 1 – 5 of this primer provide an overview of decentralization and localization; present
an introduction to the four basic pillars of intergovernmental finance; and consider the political
economy context in which decisions are made with respect to decentralized finance at the
national, local and community level. All of this serves as an introductory context for World Bank
Task Team Leaders (TTLs) within the Governance Global Practice as well as in sectors working
on services to be delivered at local levels by subnational entities.
The next section of this note (Section 7) will consider specific intervention mechanisms available
to World Bank TTLs.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 39
6.1 Decentralized public sector governments. But it is important to realize that once the
public administrative system of a country is decentralized,
finances, effective public sector ensuring conformity with the rules and regulations, control of
management and the localization expenditure, and monitoring performance become increasingly
complex. Therefore, fiscal decentralization reforms should be
development results designed and implemented within the context of of broader
public expenditure reforms.
An effective, efficient, transparent, and rules-based public
financial management (PFM) system is an essential tool for
Public expenditure reforms that aim to improve resource
a government in the implementation of fiscal decentralization
allocation and budget formulation and implementation processes
program. PFM reforms support the fiscal decentralization
have an impact on three levels of public sector outcomes: (a)
process by promoting transparency and accountability in the
aggregate fiscal discipline; (b) resource allocation based on
use of public resources, ensuring allocation of public resources
strategic priorities; and (c) efficiency and effectiveness of
in accordance with citizens’ priorities, and supporting aggregate
programs and service delivery (PEFA 2005). They cover a wide
fiscal discipline.
range of issues from budget preparation to institutions of public
expenditure management and public accountability which are
A closer look at the evidence indicates that decentralization
fundamental to policy decisions and economic management.
does not consequentially translate into better outcomes because
A key challenge for countries in decentralizing public sector
of waste, corruption, and inefficiencies. In some countries, the
finances is to develop coordinated budgetary and financial
money does not often reach the service delivery units (Reinikka
management reform policies across levels of government to
and Svensson 2001); in others, the quality of services is very
ensure correspondence with national macroeconomic objectives
poor (Chaudhury and Hammer 2003). Furthermore, studies on
for inflation, growth, and fiscal and monetary stabilization (Ter-
the impact of decentralization on macro-fiscal indicators cannot
Minassian 1997). These objectives have guided considerable
unequivocally argue for better economic outcomes (Davoodi and
efforts to improve PFM practices for central governments around
Zou 1998; deMello 2000; Fukasaku and deMello 1998; Martinez-
the world. But relatively little effort has been exerted to consider
Vazquez and McNab 2006; Jali, Harun, and Mat 2012; Palienko,
the extent to which the design of the intergovernmental fiscal
Oleksii, and Denysenko 2017; Albehadili and Hai 2018).
system, as a whole, supports the achievement of each of the
three policy objectives of an effective PFM system, or risks the
There are several reasons cited in the literature for the mixed
central government achievements of these goals.
results of decentralization programs. Some of these reasons
are related to the intergovernmental fiscal framework (IGF),
Decentralizing public finances aims to move away from
such as misaligned responsibilities, badly designed transfer
a centralized system, with ex ante controls, to a more
system, and soft-budget constraint. Others are related to
decentralized system, with emphasis on ex post monitoring.
PFM arrangements—for example, political capture, weak
Without having an effective PFM system at both central and local
accountability links, waste, and the lack of safeguarding
levels, unintended consequences of a fiscal decentralization
measures against abuse, misuse, fraud, and irregularities.
program can be fiscal imbalance, weak accountability, political
In designing a decentralization program, sequencing and
capture, and deterioration in public services. In many countries,
implementation of both intergovernmental fiscal and PFM
subnational governments lack a coherent PFM structure. Even
reforms are extremely important.
if they do have one, it might be at odds with the national design.
Therefore, as a public administration system becomes more
Decentralizing public sector finances has profound implications
decentralized, there is a need for better coordination of PFM
for intergovernmental institutions, budgetary processes, and
functions across levels of government. This coordination should
financial arrangements underlying central-local relationship
aim to achieve the following objectives:
in a country. With the implementation of a decentralization
program, the legal and political authority to plan projects,
● First, public sector resources are distributed
make decisions, and manage public functions is transferred
efficiently across the vertical dimension of the public
from central government and its agencies to subnational
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 40
sector. Here, the bulk of public sector resources reach resources are efficiently transformed from resources
the service delivery facilities responsible for frontline into service delivery and development results. The
public service provision, rather than getting stuck at the exact requirements for improving public sector efficiency in
central ministry level or at an intermediate administrative different countries and in different locations within a country
level. It is impossible to talk about allocative efficiency in depends heavily on the specific country context, and care
a situation where financial resources get stuck at higher should be taken not to assume that centralized spending is
government or higher administrative levels. by definition more efficient than devolved spending.35 It is
universally true that a public sector which does not optimally
● Second, public sector resources are distributed transform its public sector resources into development
efficiently and equitably across the national territory. results in different places across its national territory—in
This ensures that places with greater public expenditure a way that is responsive to different conditions in different
needs receive proportionately greater resources. A public locations—fails to achieve operational efficiency.
sector that does not optimally distribute its financial
resources across the national territory in proportion In order to ensure that fiscal decentralization is structured
to subnational expenditure needs,vwhether through in a way which enables sustainable development outcomes,
centralized or decentralized mechanisms, is at risk of it is possible to analyze each of the four pillars of fiscal
underfunding public sector services in certain locations decentralization in the context of these three elements:
and thereby failing to be allocatively efficient.34 vertical fiscal balance across different government levels;
horizontal fiscal balance among subnational jurisdictions
● Third, the intergovernmental fiscal and financial at different levels; and the efficient use of resources at the
framework should ensure that once funds arrive at the subnational level to attain sustainable development outcomes
regional or local level (through any mechanism), these as highlighted below in Table 6.1.
>>>
Table 6.1 Fiscal decentralization and results-based public sector management: implications for the pillars
of fiscal decentralization
Assignment of Revenue assignment/
Intergovernmental Borrowing and capital
functions/ expenditure own source revenues
fiscal transfers (IGFT) finance
responsibilities (OSR)
Devolved functions Primary role of IGFT
Vertical fiscal Revenues are typically SNG borrowing provides
raise subnational is to improve vertical
balance (between more centralized than access to finance, but
expenditure needs; fiscal balance, but can
center and expenditures not to funding (does not
centralized functions be used to encourage
subnational (based on the alter LT vertical fiscal
require more central priority spending on
levels) subsidiarity principle) balance)
funding certain functions
The horizontal incidence Revenue
Unconditional or
Horizontal fiscal of expenditure needs decentralization often Poorer regions and
conditional grants can
balance (among differs considerably benefits areas (incl. localities are less
be equalizing; the mix
subnational across functions (and urban areas) with creditworthy and have
and incidence of IGFTs
jurisdictions) between recurrent / strong economies / limited funding access
is often politically driven
capital) natural resources
The production function
Efficient use Under right conditions,
of public services The IGFT system may
of resources devolved finance offers Private capital finance
differs across sectors provide disincentives
to attain accountability and may impose a degree
and localities, and so for OSR collection and
development links revenues and of market discipline
do appropriate levels of expenditure efficiency
outcomes expenditures
devolution
34. One example of this is the economic loss associated with underfunding public education in rural areas, which can result in “lost Einsteins” and slower economic growth
(Bell et al 2018).
35. For instance, in many developing and transition countries, public sector payrolls (for teachers and healthcare workers) are largely controlled or managed in a central
fashion. In these cases, to the extent that public sector salaries represent the largest category of central government spending, to what degree do absenteeism and other
human resource challenges result in inefficient service delivery in different locations?
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 41
6.2 Placing country practices within more decentralized.36 No two countries are exactly alike
when it comes to the nature of their state of decentralization
a spectrum of intergovernmental or intergovernmental arrangements. In addition, there is
institutional and fiscal arrangements nothing automatic about the evolution of intergovernmental
arrangements as economic and social development takes
Although decentralization and localization are not linear place in a country. Nonetheless, it might be useful to specify six
processes, and even though each country’s decentralization different generic types of decentralization and localization that
trajectory is unique, it is useful to consider that the general reflect a typical” state of institutional and fiscal arrangements
nature and composition of intergovernmental institutional or expenditure approaches along the intergovernmental
and fiscal arrangements tends to evolve over time and with spectrum (Figure 6.1).
a country’s state of development from more centralized to
>>>
Figure 6.1. A typology of intergovernmental institutional and fiscal arrangements
Source: Authors.
The generic typology in Figure 6.1 presents six “textbook” that within a country, and even within the same sector, there
types of intergovernmental arrangements. These range is a messy and simultaneous mix of central implementation,
from evolving from a highly centralized institutional and delegation, deconcentration, and decentralization happening
fiscal system, where the central government is paramount all at once.
and the public sector’s budgetary resources are contained
in the budget of the central government without any further At the lowest state of development, when the central public
decentralization or localization, to gradually more decentralized sector has an extremely limited capacity, as in an immediate
or localized institutional and fiscal approaches, which typically post-conflict scenario, the public sector tends to organize
form intermediate steps on a long-term trajectory from more itself in a highly centralized manner in order to use its scarce
centralized to more decentralized public sector institutions and human and financial resources as efficiently as possible.
expenditures. As suggested by the typology, it is often the case However, highly centralized and concentrated public sectors
36. For further background and details, see: Decentralization, Multilevel Governance, and Intergovernmental Relations: A Primer (World Bank 2022).
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 42
tend to have major challenges in effectively localizing public capacity of subnational governments from scratch at the
services and achieving community engagement. Under such same time as functional responsibilities were transferred. The
conditions, a first step in improved public services and the decentralization process in these countries posed significantly
legitimacy of state institutions can be achieved through the greater challenges—and risks to service delivery outcomes—
development of an effective field administration, along with the when compared to more sequential reforms. For example, the
introduction of vertical sector programs and community-driven district-level local government organizations empowered by
development interventions (CDD), and/or delegation of service the “big bang” decentralization reforms in Indonesia in 2001
delivery functions to dedicated service delivery authorities. built on previously established (territorially deconcentrated)
district administration units. This meant that despite a
In turn, each next step in the typology resolves a common considerable change in the local political system, the basic
(binding) constraint in the preceding intergovernmental management of local administration and local service delivery
arrangement as countries tend to progress toward a more continued largely uninterrupted.
decentralized and localized public sector as social and economic
conditions evolve with the overall level of development. For
instance, there tends to be a somewhat natural progression in
6.3 Improving the intergovernmental
the nature and organization of the central public sector over
time, where at each stage of decentralization, the public sector fiscal plumbing: general guidance
tries to resolve the main binding constraint of the previous one.
This sees the sector move from a fully centralized institutional Once a public institutional and expenditure review has been
and fiscal structure to administrative deconcentration, to conducted in order to identify the exact status and nature of
vertical (sectoral) budgetary deconcentration, and eventually, decentralization and localization of a country’s public sector, and
horizontal (territorial) deconcentration. In turn, a well- once the status can be placed on the spectrum of international
functioning system of horizontal deconcentration is also often experiences as per Figure 6.1, national governments need to
considered a precondition for effective devolution (Bahl and consider two possible directions for decentralization reforms.
Martinez-Vazquez 2013). First, it might be possible to shift towards a more decentralized
intergovernmental disposition if there is political momentum
Similarly, the nature and level of spending by devolved local for wholesale reform of the entire system of intergovernmental
governments tends to be associated with where countries are relations. An example is the post-conflict revision of constitutional
on the development spectrum. In low-capacity development arrangements. This was the case in the major decentralization
contexts, devolution efforts are likely to focus on community- reforms in Indonesia, Kenya, the Philippines, and South Africa.
level local jurisdictions – for example, communes or villages – In such cases, it is possible to come up with general guidance
and often involve a limited set of functional responsibilities. As with regard to possible areas where the World Bank might
the institutional potential of local governments tends to grow contribute in terms of strengthening intergovernmental (fiscal)
along with the state of development, local governments in more arrangements (Table 6.2).
advanced development contexts are able to incrementally take
on a more prominent role in public infrastructure development Alternatively, in the absence of such momentum or whether the
and service delivery. country is merely trying to improve the functioning of the public
sector at the margin. Making the existing system work better—
While it is possible to “jump” one or more stages of the by taking where a country is on the decentralization spectrum
decentralization process, doing so does typically complicate the and improving intergovernmental the system—may involve
decentralization or localization reforms. For instance, in recent tweaking or clarifying functional assignments or expenditure
years, both Kenya and Nepal started their constitutionally- management arrangements; improving the collection of local
driven devolution reforms with subnational government entities own source revenues; reducing the fragmentation of the
that were created de novo rather than relying on preexisting transfer system, or improving the ability of local governments
territorial-administrative jurisdictions. This meant that they to access capital financing as appropriate, in line with the
had to “build the car while driving it”—building the institutional discussions in Section 2-5 above.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 43
However, where policy forces align to not just “improve in public sector in a multilevel governance framework, including
place” but take a step toward more effective public sector through better deconcentration and delegation, and by
management and greater decentralization, Table 6.2 can being a better intergovernmental coordinator. Naturally, the
provide useful—although generic—guidance on what steps general guidance contained in Table 6.2 should be adjusted
might be taken at different stages of decentralization and and operationalized based on a careful assessment of the
development progress. In interpreting the guidance in Table country’s situation and based on the specific policy objectives
6.2, it should be noted that forward progress may entail not for pursuing decentralization or localization. In particular,
only improvements in devolved intergovernmental finance decentralization and localization reforms may be pursued in
and strengthening local government financial management. order to achieve one or all of the following:
Additionally, it should involve improving the role of the central
>>>
Table 6.2 General guidance on strengthening of intergovernmental (fiscal) relations (depending on state of play and
direction of reform)
Nascent Limited Partial Decentralization
Centralization
decentralization Decentralization decentralization by devolution
Nature of Residual functions
Field admin (admin Sectoral deconcen- Territorial
central gov. / Centralized only
Current Status of Decentralization
decon.) tration deconcentration
deconcentration Vertical coordination
Delegation to Delegation to
Nature of Limited (e.g., parastatals parastatals Delegated functions
delegation community Facilities Facilities shifted to local
None / limited
and last-mile management of embedded embedded governments where
provision local facilities) in sectoral in territorial possible
deconcentration deconcentration
Nascent (e.g.,
Limited devolution Devolution of Devolution of
Nature and grants to
to village/ exclusively local exclusively and
extent of None community groups
community-level functions to local concurrent functions
devolution or quasi local
local governments governments to local governments
governments)
Move toward Transition line
Support specific
sectoral budget ministries to policy/ Ensure empowering
General guidance localization and Move from sectoral
deconcentration backstopping role intergovernmental
re: central gov. administrative to territorial
Establish/ Mitigate central environment (incl.
General Guidance
reforms deconcentration deconcentration
strengthen opposition to data)
reforms
delegate modalities devolution
Support (modest
Achieve “high
Support or full) devolution
General guidance Establish basic performing” LG
development reforms Support (full)
local government (community-level) organizations
of quasi-local Increase role of devolution reforms
reforms local governments Increased facility-
governments elected subnational
level autonomy
council
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 44
Pursue effective
Introduce and Pursue effective Devolve as per
sectoral (budget)
strengthen: territorial (budget) subsidiarity
deconcentration Clarify functional
Functions and - Field deconcentration principle
Allow community- assignments
expenditure administration Devolve Ensure that
level LGs Ensure effective
assignment - Vertical sector exclusively local de facto exp.
to manage vertical coordination
programs functions to local assignments match
community-level
- Delegation governments de jure
priorities
Community
Revenue Advanced
Community contributions and Ensure basic own Strengthen own
assignment (customer-oriented)
contributions to user fee payments source revenue source revenue
Specific Guidance
and own source revenue
CDD schemes to facilities/ administration administration
administration administration
community groups
Strengthen
(performance-
based) local Ensure adequate
Inter- CDD schemes Establish basic development fund sectoral funding Ensure effective mix
governmental (set up as quasi- local development Ensure formula- (sectoral grants?) of unconditional and
fiscal transfers transfer schemes) fund based distribution as functions conditional grants
of deconcentr. devolve
sectoral resources
Allow limited local Advanced borrowing
Subnational borrowing (e.g., and capital finance
-- -- --
borrowing through national possible (bonds,
intermediary) etc.)
1. Improve the overall (allocative and technical) efficiency are inter-related with the political and administrative aspects
of the public sector; this is especially relevant in cases of decentralization. Something that appears as a technical
where the central public sector is considered to be challenge in the fiscal space—for example, local budget plans
under-performing. consistently favoring community-implemented infrastructure
2. Ensure a more inclusive, responsive and democratic or livelihoods schemes over sectoral investments—may be
public sector. caused by problems in the intergovernmental political or
3. Ensure a stable and legitimate public sector, where administrative (planning) context. Likewise, it is critical to
political economy forces are balanced in a way that review any decentralization or localization reform proposal
prevents (violent) conflict. through a political economy lens. Who are the winners and
4. Promote the improved and results-based delivery of losers in the proposed reforms, and will key stakeholders,
public services and achieve development in a socially, through the narrower lens of their own political or institutional
economically, and environmentally resilient, inclusive, interests, agree to the proposed reforms?
sustainable, and efficient manner.
In pursuing fiscal decentralization and localization
reforms, it is important to remember that the four pillars of
intergovernmental finance are not only interrelated with each
other, but that in turn, key aspects of fiscal decentralization
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 45
6.4 Improving the intergovernmental have important fiscal elements. It is not unusual for these
projects to try to strengthen institutional arrangements at
fiscal plumbing: country examples two or more key levels aimed to: (a) strengthen the national
capacity to manage (fiscal) decentralization; (b) strengthen
Table 6.3 presents a number of examples of local governance the institutional capacity of local governments, including their
support projects implemented by the World Bank over capacity for planning and management of local government
the past 10 – 20 years. Although the project development finances; and (c) strengthen the ability of citizens to participate
objective (PDO) of many of these projects is not limited in local governance—including participatory planning and
to fiscal aspects of effective decentralization; most of them expenditure oversight.
>>>
Table 6.3 World Bank Project examples: Improving intergovernmental fiscal architecture and systems
Commitment
Country Project Name Approval Last Update
(US$ mn)
Indonesia First Development Policy Loan 300.00 2004 2018
Uganda Local Government Development Project 125.00 2003 2013
Tanzania Local Government Support Project 52.00 2004 2013
Sierra Leone Decentralized Service Delivery Program 20.00 2009 2013
Bangladesh Local Governance Support Project 111.50 2006 2013
Somalia Recurrent Cost & Reform Financing Project, Phase 2 144.00 2015 2020
Burkina Faso Local Government Support Project 70.00 2017 2021
Malawi Governance to Enable Service Delivery Project 100.00 2020 2021
Many, although not all, local governance projects that aim to
strengthen local government institutions also pursue some
type of local infrastructure development objectives at the
same time. In most cases, a formula-based, performance-
based grant scheme is used as a mechanism for funding
the project interventions at the local level through a Capacity
Building Grant and/or Capital Development Grant. These grant
schemes serve not only as a project-specific funding vehicle,
but often also serve a purpose as a prototype development
grant or nascent sectoral block grant.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 46
7. >>>
Implications for World Bank
engagement: operational
guidance
There are various mechanisms through which local public services are funded and delivered. The
options include centralized public service delivery in which central government entities are responsible
for service delivery; devolution—assigning responsibility for public service delivery to elected local
or regional governments; and deconcentration and delegation.37 Notwithstanding the choice of
public administration arrangements, the provision and quality of public services are determined not
only by the institutional capabilities, processes, and procedures at the subnational level, but by the
institutional arrangements that connect the central government to frontline service delivery.
The vertical or intergovernmental aspects of service delivery are often poorly understood and form
the “missing middle” when it comes to ensuring effective public service delivery.38 However, the ability
of frontline service delivery facilities to achieve desired service delivery outcomes in a multilevel
public sector is determined by the strength of the intergovernmental institutional arrangements. The
exact nature of these vertical or intergovernmental relationships varies from country to country and
from sector to sector, and in fact, frequently even within a sector.
This primer is primarily written to inform the perspective of World Bank Task Teams and TTLs working
in decentralized or decentralizing countries to identify entry points for strengthening intergovernmental
institutions for local service delivery. The Governance Global Practice has developed a framework,
GovEnable, to improve the design and implementation of governance engagements, including
multilevel governance (MLG) engagements, to enable more concrete development results. The
Guidance Note on GovEnable for Multilevel Governance and Local Service Delivery (2022) sets out
the GovEnable approach from the standpoint of a MLG engagement. It complements this primer by
supporting task teams to conceptualize, design, implement and monitor MLG engagements in a way
to enhance developmental results and service delivery improvements in client countries. In this
37. See Decentralization, Multilevel Governance, and Intergovernmental Relations: A Primer (World Bank 2022) for detailed discussion.
38. See Guidance Note on “GovEnable for Multilevel Governance and Local Service Delivery” (World Bank 2022).
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 47
closing section, we briefly summarize the note, but it is highly reform design. Second, GovForResults seeks to design and
recommended to read this primer together with the full guidance implement governance and sectoral operations that address
note. After the brief introduction to the GovEnable approach, identified bottlenecks and enable service delivery, value for
we discuss options for engagement modalities. Broadly, there money (VfM), and development results. Third, GovFacilitate
are two categories of interventions or engagement modalities aims to facilitate more effective reform implementation through
available to World Bank TTLs for supporting decentralization improved dialogue, open-ended technical assistance, flexible
or localization in partner countries: (a) technical assistance/ implementation, and capability building.
analytical support/advisory support; and (b) operational support
using one of the three lending instruments—Investment Project The GovforResults framework offers an approach to link World
Financing (IPF), Program-for-Results (PforR), and Development Bank governance operations more closely to service delivery,
Policy Financing (DPF). The choice of instrument depends on presented below in Figure 7.1. As noted at various points in this
a client’s needs and the nature of the development challenge to primer, there can be numerous governance bottlenecks that
be addressed. Each of these modalities have their advantages undermine service delivery. The GovforResults framework, a
as well as their limitations. process for deciding on appropriate remedies to address them
when designing reforms, sets out an approach for identifying,
assessing, and prioritizing multilevel governance problems
7.1 Identifying binding constraints: that hamper service delivery. In a country like Uganda, for
example, financing of service delivery may be an important
the GovEnable approach bottleneck. The World Bank can use its resources to alleviate
the constraint. In another country, financing may not be the most
GovEnable consists of three separate dimensions. GovEnable important binding constraint. Task teams are therefore advised
is not a new diagnostic tool. Rather, it is an organizing framework to use analytical tools to identify bottlenecks, such as financing
for thinking about how to engage on service delivery problems delays, inequitable allocations, or poor incentives to improve
by providing an overview of common problems across sectors; service delivery performance. The GovforResults approach
proposing potential approaches to identifying and addressing distinguishes itself from traditional approaches by starting with
problems at the country level; and highlighting examples from service delivery problems and then identifying aspects that
existing World Bank engagements across the world. The first are demonstrably linked to multilevel governance issues, as
dimension of the GovEnable process, GovBottlenecks, aims to a way of strengthening the link between service delivery and
identify governance constraints to service delivery and facilitate reform results. The approach can be divided into four steps as
beginning the process of developing viable policy solutions in illustrated and summarized in Figure 7.1.
>>>
Figure 7.1: The Four Step Approach for GovBottlenecks
Source: Guidance Note on GovEnable for Multilevel Governance and Local Service Delivery (World Bank 2022).
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 48
The process of identifying binding constraints to effective sector is balanced and consistent across different aspects
service delivery in a multilevel public sector has proved to be of public sector management in a way that supports effective
an art as much as it is a social science. The question is not service delivery. The GovEnable approach endorses the
whether a country’s local government system is sufficiently use of various analytical tools to help identify these binding
devolved or not. Rather, it is whether the vertical distribution constraints (see Box 7.1).
of powers, capabilities, and resources across the public
Box 7.1: Tools for assessing the multilevel governance context
Multilevel Governance Tools
● Smoke and Löffler’s (2021) Intergovernmental Perspective on Managing Public Finances for Service Delivery
assesses the neglected challenge of the intersection of decentralization, sectoral service delivery and PFM (using the
health sector in four countries as an illustration). The study proposes a problem-driven analytical approach to identify
and work towards resolving constraints in effectively financing subnational public services.
● The Boex-Yilmaz (2010) analytical framework for assessing decentralized local governance and the
local public sector, which guides policy analysts through a SWOT analysis of the different dimensions of a multilevel
governance system.39
● The Local Governance Institutions Comparative Assessment (LoGICA) framework provides a high-level
framework to score the local and intergovernmental systems, processes, and institutions that contribute to effective local
governance and localized service delivery performance.
● OECD’s framework for Making Decentralization Work proposes ten guidelines for implementing effective
decentralization.
Bottlenecks Tools
● Financing for Health (FinHealth), Financing for Education (FinEd) and the Human Capital Public Expenditure and
Institutional Review (HC PEIR) take a debottlenecking approach to PFM in sectors and Human capital outcomes
respectively.40
● The Infrastructure Governance Framework Assessment (InfraGov) also takes a problem-based approach to country
specific infrastructure challenges.
● The Country Level Institutional Assessment and Review (CLIAR) involves benchmarking exercise to identify institutional
strengths and weaknesses; the linkage of institutional weaknesses to development challenges; a problem-driven
analysis unpacking the causal mechanisms connecting institutional performance to development outcomes.
An important point for task teams to pay attention is ensuring providers are also critical and including them in both reform
strong and active participation from the client throughout diagnosis and design helps build ownership. Box 7.2 below
the GovEnable exercise. When assembling the team, it is sets out an activity plan for a typical GovEnable process.
important to include government officials from the center,
including ministry of finance, agencies responsible for
subnational governments, and institutions as this will be vital
for generating buy-in to the bottlenecks identified and their
underlying causes – and subsequently the reforms proposed.
Consultations with subnational governments and frontline
39. This framework builds on Local Government Discretion and Accountability: Application of a Local Governance Framework (World Bank 2008), which is suitable for more
in-depth analyses.
40. Hadley, Hart and Welham (2020) provide further information on health diagnostics.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 49
Box 7.2. Activity Plan for GovEnable / GovBottlenecks Process
It is critical that a GovBottlenecks process is carried out in a collaborative way, to build the authorizing environment, reform
teams, and coalitions during the process. The Bank can help to facilitate the consultative process, broker agreement, and
provide technical inputs to the analysis, but it is key that client stakeholders themselves own, discuss, and agree on the
challenges, their causes, and the solutions. A typical GovBottlenecks process might look as follows:
Step 1: Map out Institutions, Systems, and Financing
● Discussions with client on process to agree scope and approach: Initial discussions with the client entry point on scope
and areas for discussion and approach.
● Initial mapping: Bank task team carries out initial mapping and collection of data and holds discussions with key central
institutions. Mapping is updated after bottom-up and top-down investigations (below).
Step 2: Identify Challenges and Prioritize Bottlenecks
● Joint field missions for bottom-up investigation: Joint mission with central government representatives (sector
ministries, ministries of finance, planning, public service, etc) and Bank task team to local level to identify challenges
from the bottom up (frontline providers, local governments, etc).
● Top-down investigation: Bank task teams team holds subsequent discussions with central government/national
stakeholders for top-down problem identification.
● Initial technical workshop to agree and prioritize bottlenecks to delivery: Hold initial workshop convening central
government actors and local actors consulted where (a) findings from mapping and investigations are presented; and (b)
stakeholders identify service delivery challenges, and associated bottlenecks and stakeholders involved. Conduct initial,
technical level prioritization. Bank team facilitates discussion using fishbone diagrams populated during workshop.
● High level meeting to agree priority bottlenecks and form reform teams: Client representatives from technical
workshop participants report to senior managers at high level meeting/workshop of key authorizers to present and
agree prioritization of bottlenecks to be addressed, and institutions involved.
Steps 3 and 4: Understand the Underlying Causes and Agree Solutions, Stakeholders, and Results
● Reform team meetings: Form initial groups of stakeholders based on key institutions involved. For each group,
hold a series of meetings/workshops to (a) first identify the root causes of bottlenecks; and then (b) agree potential
solutions, stakeholders, steps, and results. Again, Bank task team facilitates discussion using fishbone diagrams,
and bottlenecks analysis and reform plan templates populated during workshop.
● Technical Workshop on reform plans: Compile proposals from groups into a reform plan and convene groups in a
technical workshop to report back to each other on their plans, identify commonalities, and ensure consistency.
● High level meeting to review reform plans: Report bank to senior management on reform proposals and
incorporate feedback.
Source: Guidance Note on GovEnable for Multilevel Governance and Local Service Delivery (World Bank 2022).
7.2 Selecting an engagement strengthening of local governments or the local public
sector institutions as part of the country’s governance
modality for supporting reform agenda. This may involve strengthening local
decentralization and localization governments, or local administration bodies, as the case
may be, to become more resilient, inclusive, sustainable, and
Determining the specific development objective. There are efficient (RISE) local entities, and/or for central government
several different—albeit potentially closely related—general stakeholders to strengthen the intergovernmental systems
development objectives that might be pursued, which the World that allow the local entities to operate in a more inclusive
Bank focuses on to support decentralization or localization. and responsive manner. Interventions of this sort often
● The first development objective would be to support the narrowly focus on the local governance sector, including
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 50
the Ministry of Local Government (or equivalent) and local Matching country needs with other development partner
governance entities themselves. interventions: where can the World Bank maximize added
● The second general entry point for involvement in the value? Based on the tentative formulation of a development
area of decentralization is its support for decentralization objective, it is likely that the World Bank’s value-add is
reforms as a way to promote sustainable development and maximized in areas (a) that are deemed to be a binding
the attainment of pro-poor development goals, such as constraint in the intergovernmental (fiscal) system; (b) where
specified in the 2030 Agenda for Sustainable Development, there is an effective government counterpart; and (c) the
or the SDGs. More often than not, interventions that are policy area(s) that are not or are insufficiently covered by other
based on this premise seek to strengthen the role of local interventions or development partners.
public sector actors (including local governments and/or
frontline service delivery providers) to achieve specific Development partner interventions in decentralization and
service delivery targets or results. This may involve localization can be mapped using the same columns and rows
support for sectoral decentralization processes within of the decentralization assessment framework presented
key sectors – particularly education and health, or water in Section 2. Doing so has the benefit that by overlaying or
and sanitation – as well as other interventions aimed at superimposing the development intervention matrix on top
strengthening the ability of local governments to deliver of the public sector assessment matrix, the assessment
key pro-poor public services. framework is able to identify (a) whether all obstacles noted in
● A specific combination of these first two development the public sector matrix are being addressed by development
objectives is relevant to urban areas, where the Bank may interventions; (b) which decentralization or local governance
be interested in promoting the dual objectives of effective policy obstacles are inadequately being addressed by the
urban institutions and effective urban infrastructure and current portfolio of development activities; and (c) how the
service delivery, with the recognition that enhancing urban partner government, supported by the World Bank, could align
infrastructure and services often requires effective urban its portfolio(s) of activities to optimize the effectiveness of the
local governments. (local) public sector.
● A final subset of interventions may be to pursue the
improvement of the intergovernmental dimension of PFM Selecting a modality. Table 7.1 presents a rudimentary
systems. This would require not only improvements in the decision-tree to guide TTLs toward the most suitable
budget formulation, approval, and implementation cycle at intervention modality.
each level, but also better inter-connectivity in the budget
processes at each level.
>>>
Table 7.1 Suitable intervention modalities: decentralization and localization
Current state of Policy objective
Intergovernmental
multilevel public clear?
systems in place/ Intervention modality
sector mgmt. Consensus about
functional?
satisfactory? way forward?
Yes -- -- None needed.
Advisory services (ASA) to help identifying policy objectives
No No --
for reform.
Combining advisory services to further clarify policy
No/Partial:
objectives with an operational intervention (IPF/PforR) to
No Partial Downstream
improve downstream service delivery systems at the local
constraints
level.
Combining advisory services to further clarify policy
No or Partial:
objectives with an operational intervention (DPF) to help
No Partial or Yes Upstream
government take policy and/or institutional action to
constraints
address constraints in the intergovernmental system.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 51
For instance, if the current state of multilevel public
sector governance (or related service delivery outcomes)
is unsatisfactory, but there is no consensus within the
counterpart government (and/or within the Bank’s CMU) about
the way forward with respect to the intergovernmental (fiscal)
dimension of public sector governance challenges, advisory
services and analytics can serve an important intervention
to support the government in identifying binding constraints
and achieving a coherent vision on intergovernmental
challenges and solutions. In contrast, if there is a greater
degree of clarity and consensus surrounding the desired
approach to decentralization and localization, project
operations (including both IPF or PforR projects) can be a
useful tool for resolving downstream constraints, while DPF
is generally more suitable for upstream constraints in the
intergovernmental (fiscal) architecture.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 52
>>>
References and background readings
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References and background readings
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EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 55
>>>
Annex. Assessing the strengths and weaknesses of a country’s state of fiscal
decentralization, local public sector finance and intergovernmental fiscal
systems
An assessment of the strengths and weaknesses of a different pieces of legislation, or are there contradictions—
country’s state of decentralization—including the state of its for example, Local Government Act versus sector
intergovernmental fiscal architecture and intergovernmental legislation?
fiscal systems—requires a solid understanding of each of the ● In practice, what is the share of public sector expenditures
four pillars of fiscal decentralization, as reflected in each of the that is devolved to subnational governments (on a
four sections of this annex. function-by-function basis, if possible)?
◦ What amount or share is devolved for exclusive local
For each pillar, leading questions or assessment indicators functions?
are grouped to reflect three perspectives. First, are ◦ What amount or share is devolved for concurrent
empowering intergovernmental systems in place? Second, functions?
within their intergovernmental context, do local governments ◦ What is the share of centralized, deconcentrated,
(or local administrations) act in an efficient, inclusive, and and/or delegated spending, if known?
responsive manner? And third, are citizens and civil society ● In practice, do local governments have meaningful
engaged in a constructive manner with the local public expenditure discretion over their functions and expenditure
sector in a way that ensures the people’s empowerment over responsibilities, or are they merely a “post office” for
the public sector and in a way that promotes inclusive and spending that is determined at a higher government
sustainable development? level? For exclusive and concurrent functions, do local
governments (or local administrations) have authoritative
control over the different sub-system expenditures
A.1 Assessment indicators: related to their powers and functions, including:
◦ Salary and wage expenditures, as well as the
assignment of functions and resources necessary to engage in staff development?
expenditure responsibilities Can local officials hire, promote and fire staff without
higher-level authorization.
Effective assignment of function and expenditure ◦ Non-wage recurrent spending, including procurement
responsibilities – empowering intergovernmental of good and services, as well as supplies used in the
systems delivery of services?
◦ Capital/development or infrastructure investment
● What is the nature of the vertical or intergovernmental decisions?
structure of the public sector? How many government ● Does the de facto assignment of functional authority match
levels or administrative tiers exist? Do local entities have the de jure responsibility of local governments, in a way
the characteristics of a local government, or should they that allows local governments (or local administrations) to
be considered a local administration?41 be accountable for their performance?
● According to the legal framework, are functions and ● Have minimum service delivery norms or standards for
expenditure responsibilities assigned to different local service delivery been formulated for different local
government (or administration) levels in line with the government services? Are these norms affordable within
subsidiarity principle? the general resources available to local governments, or
● Is the legal framework clear with the assignment of are the norms and standards set by the higher government
functional responsibilities? Is there consistency between level primarily aspirational? Are unfunded mandates
41. As noted in footnote 2, local governments are often understood to be defined by four characteristics: (1) the entity is a separate legal entity or body corporate (can sue
and be sued in its own name; can own and transact property; etc.); (2) the entity has authoritative decision-making power over public functions in a local jurisdiction (i.e.,
its own political leadership); (3) the entity has control over its own officers and staff; and (4)the entity has the power to prepare, approve and execute its own budget.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 56
imposed on subnational governments by the higher-level Effective assignment of function and expenditure
governments? responsibilities – efficient, inclusive and responsive local
● Are effective intergovernmental budget formulation governments / local administrations
processes in place to empower subnational governments
to exercise meaningful discretion in expenditure ● Do local governments (or local administrative bodies, as
prioritization? Or are individual local governments’ the case may be) generally follow a timely and orderly
budgets scrutinized (and subject to revision) by higher- annual budget formulation, approval and execution
level government officials as part of the budget approval process?
process? ● Are local government budgets structured appropriately,
● Do local governments receive their final, authoritative allowing the allocation and use of resources to be tracked
grant ceilings – for example, as approved by parliament – by function and department down to the facility level—for
with adequate time to prepare their own budgets? Or do example, with each facility as a cost center?
local governments only receive preliminary grant ceilings ● Do local governments prepare strategic plans, other
as part of the budget formulation process, while the final periodic plans, such as a medium-term development
grant allocations are not approved by parliament until plan, and/or sectoral development plans? If so, is there a
local governments have already substantively completed connection between local plans and local budgets?
their budget formulation process? ● As they develop their annual budget, to what extent do
● Is an effective intergovernmental framework in place local officials have the ability to allocate budget resources
for local budget execution that empowers subnational across/within program categories—do subnational
governments to execute their budgets in an effective, governments have the flexibility to shift expenditures
responsive, and accountable manner? An effective within their budgets? Alternatively, are they prevented
intergovernmental framework for local budget execution from doing so because of excessively conditional grants,
would ensure that local governments have access to or would they need higher level approval to do so?
suitable local financial management processes and ● If the local budget is results-based, are appropriate service
systems, including accounting systems; internal controls; delivery norms used to prepared the budget estimates
financial reporting systems; payroll and human resource and to allocate the available resources? Are the service
management systems; and procurement systems.42 delivery targets realistic given the available resources?
● Beyond the regular (central-local) intergovernmental ● Does the local government have the basic capacity to
budget processes, are there effective mechanisms in manage the different aspects a well-functioning local
place to coordinate (during budget formulation and financial management system, including accounting /
execution) with relevant public sector institutions at recording of financial transactions; commitment controls;
different government levels to ensure that these support monthly bank reconciliation; internal controls and/or
rather than duplicate or compete with effective frontline internal audit; human resource management/payroll
service delivery? Such “other” institutions may include management systems; and procurement management
different types of national authorities, including parastatal systems?
entities, state-owned enterprises, and national or regional ● Does regular and timely within-year financial reporting
investment banks as well as local or frontline service to the local chief executive, chief finance officers and/or
providers with some degree of budget/expenditure council take place? Does regular and timely within-year
autonomy. These may be owned and/or operated under financial reporting to higher government levels take place
the purview of higher-level governments, the local as appropriate?
government itself, or by the community. ● Is there regular—monthly or quarterly—local government
● Do the national audit office and the national accounts political oversight over budget implementation, for
committee, as relevant, perform their functions with instance, by the local council’s account committee? Is
respect to local expenditure oversight in an effective and there appropriate local government and/or community
timely manner? oversight over local procurements?
42. Depending on the size (scale), scope and institutional capacity of local governments or other local entities in a country, it may be appropriate to give considerable dis-
cretion to local governments with respect to budget execution, as long as certain fiduciary standards are met. In other countries, local governments lack the size, scope
or capacity to develop and implement their own PFM systems, and may need to be supported by national-level systems in order to operate efficiently.
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 57
● Are local budgets and finances generally managed in a via facility user committees?
participatory and transparent manner? For example, are ● Does the local government, through the local administration
monthly/quarterly budget oversight hearings public? and/or through dedicated council committees, monitor the
● Are local governments expenditure out-turns consistent performance of local service delivery departments? Does
with the original approved budget, in aggregate, and/or by the local government use participatory and transparent
main functional department? oversight mechanisms such as Community Score
● Are local governments required to comply with a standard Cards?
Chart of Accounts as well as clear and uniform accounting ● Do the elected leadership of the local government,
standards? Do they? separate from any complaint process of the service
● What is the quality and timeliness of annual financial delivery units themselves, have an effective mechanism
statements? in place to receive and resolve complaints about local
● Does the local executive/local administration and/or the services?
local council follow up to resolve audit findings in an
effective manner?
A.2 Assessment questions: revenue
Effective assignment of function and expenditure
responsibilities – local facilities /providers assignments and local revenue
administration
● Do local facilities/providers have their own planning and
budget formulation process? Are they appropriate and Revenue assignments and local revenue administration –
fit-for-purpose? Does the planning and budget process empowering intergovernmental systems
allow adequate facility-level discretion in order to respond
to community needs within the facility’s catchment area/ ● Is there a clear assignment of revenue sources to each
provider’s service delivery area? level of government?
● Do local facilities/providers have their own bank ● What share of revenues is collected by each government
accounts and/or financial management processes? Are level? If the country is primarily deconcentrated, are local
they appropriate and fit-for-purpose? Is there adequate revenues retained in local accounts, or are they deposited
oversight by local government? Is there adequate into the central treasury?
oversight by higher-level government regulators? ● To what extent does the central government assign
revenue sources to subnational governments in a way that
Effective assignment of function and expenditure matches the assignment of functional responsibilities—
responsibilities – engaged citizens and civil society in line with the correspondence principle? Revenue
assignment could be considered to include shared
● Is the local government budget formulation process revenues; local piggyback taxes collected on national tax
inclusive, participatory, and transparent while ensuring base; and local taxes or local user fees.
coherence of plans and budgets across the local ● Is the overall assignment of revenue sources efficient and
jurisdiction? For instance, is the local executive’s budget in line with good revenue assignment principles such as
proposal made public and discussed in public hearings the subsidiarity principle, as applied to revenue authority
before local council approval is sought? and administration?
● Is the local government’s budget execution process ● Within the own revenue space assigned to the local level,
inclusive, participatory, and transparent? Are budget are local governments free to create/define their own
documents transparent and publicly available, preferably local revenue instruments—for example, can they specify
online? Is there regular public reporting on budget new user fees, adopt new revenue instruments, or modify
execution? existing local revenue instruments?
● Are citizens and civil society included in financial ● Within the own revenue space assigned to the local
management oversight where appropriate, for example, level, to what extent do local governments have the right
EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 58
and authority to set the tax base and/or tax rate for their revenue due; invoicing; revenue collections; and follow-
revenue instruments? up on arrears, as relevant.
● To what extent are local governments responsible for ● Does the local government track revenue compliance and
setting tariffs and fees for local services, including services revenue collection performance in a granular manner for
directly or indirectly under the local governments purview, instance, by neighborhood?
such as health fees and water and sanitation fees? ● In line with modern revenue administration practices, are
● To what extent are local governments given meaningful overall collection efficiency, and customer service orientation
and effective revenue enforcement powers or mechanisms of local revenue administration understood as critical?
for instance, compared to the national revenue authority? ● Does the local government have an effective follow-up
mechanism for the collection and enforcement of tax (/
Revenue assignments and local revenue administration revenue) arrears?
– efficient, inclusive and responsive local governments /
local administrations Revenue assignments and local revenue administration –
local facilities /providers
● Do local officials recognize the value of revenue collection
as an instrument for funding local public services in line ● Do local facilities or providers collect any facility-level
with priorities expressed by local constituents? To the revenues from clients – for example, tariffs, user fees, or
extent that local officials have control over local tax rates, community contributions? Are these revenues recorded
do local officials set local tax rates in line with the relative as local (on-budget) revenues?
demand for (exclusive) local public services? ● Do local facilities hold these revenues in their own
● Does the local government budget accurately project accounts external to the local government’s budget/bank
local revenue collections as part of the budget formulation accounts? If so, is there an appropriate local control
process, or do local governments systematically and oversight mechanism in place to ensure that local
overestimate (or underestimate, as the case may be) their facilities/providers manage these resources as intended?
own source revenue collections? ● To the extent that facility-level revenues (earmarked
● For non-tax revenue instruments that fund specific revenues) are deposited in local government accounts,
services or activities, do local officials set tariffs and are adequate mechanisms in place to ensure that the
charges and fees in a manner that ensures (recurrent or funds are returned by the local provider/service delivery
total) cost recovery, where relevant? unit to be used for improved service delivery?
● Do local governments (or local administrative units) ● Do local facilities or providers receive any direct payments
effectively and equitably collect property tax revenues? from other off-budget sources – for example, from
This would involve the effective registration of taxpayers/ national parastatals, national investment funds, national
maintenance of a property cadaster; regular valuation and health insurance funds – in a way that bypasses local
of properties, as relevant; annual invoicing of property government accounts? If so, is there an appropriate local
taxes; an appropriate process for administering revenue control and oversight mechanism in place to ensure that
collections; and follow-up for arrears. local facilities/providers spend the resources as intended
● Do local governments (or local administrative units) and follow any conditions?
effectively and equitably collect other (tax and non-tax)
own source revenues (OSRs)? This would involve the Revenue assignments and local revenue administration –
effective registration of taxpayers; assessing the amount engaged citizens and civil society
of revenue due; invoicing; revenue collections; and follow-
up on arrears, as relevant. ● If the local government has a degree of rate-setting
● Do local utility companies and/or local service delivery authority over local taxes or non-tax revenues, is there
providers effectively and equitably collect tariffs, fees a discussion of local tax rates and user fee as part of the
and charges? This would again involve the effective budget formulation process? Is there a local forum for
registration of customers; assessing the amount of discussions on local revenue policy?
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● Do local taxpayers generally understand the importance transfer flows) be reallocated across/within program
of local taxation as their financial contribution to local categories? Do subnational governments have the
public services? flexibility to shift grant resources within their budgets, or
● Are there electoral mechanisms for ensuring citizen do they need higher level approval? Given the strengths
empowerment of local taxation or rates. For example, do and weaknesses of political, administrative and fiscal
local tax rate increases require voter approval? institutions at all levels, does the transfer system provide
● Do local governments proactively communicate the an appropriate mix of general-purpose (unconditional) and
service delivery benefits of local taxation for instance, conditional grants? Or is the transfer too unconditional or
through a Citizen’s Budget, or through billboards at road too conditional?
construction sites, parks, and other service delivery sites? ● Does the central government rely on allocation formulas
● Do local service providers such as local utility companies in the horizontal distribution of shared revenues and
proactively communicate to their users how tariffs and/ transfer resources? Is this true for all types of transfers
or user fee revenues are used to fund the provision of and grants? Does the grant system generally achieve an
services? equitable horizontal allocation of resources?
● Does the local government have an effective dispute ● Does the structure or nature of transfer schemes create
resolution mechanism regarding local revenue (unintended) negative incentives for subnational behavior?
administration – for instance, property valuation appeals For instance, is it possible to increase future transfers
– as appropriate? by overspending, under-taxing, etc.? Alternatively, do
● Is the property tax administration process transparent, transfer schemes provide incentives to spend their
allowing taxpayers to see that their tax payments (and available resources inefficiently – for example, rewarding
other taxpayers’ payments) have been collected? For spending on capital infrastructure?
property taxes? For other local government revenue ● Does the structure or nature of transfer schemes provide
sources? For tariffs, user fees, and off-budget local positive marginal incentives for subnational behavior, for
revenues? instance, through performance conditions, or through a
matching requirement?
● Does the legal structure and timing of the
A.3 Assessment questions: intergovernmental transfer systems effectively empower
subnational governments to plan with a clear hard
intergovernmental fiscal transfers budget constraint and exercise meaningful discretion
in expenditure prioritization? For instance, are transfer
Intergovernmental fiscal transfers – empowering ceilings authoritatively determined in a timely manner at
intergovernmental systems the beginning of the budget formulation cycle in a way
that empowers local governments to prepare their budget
● Does the transfer system achieve a degree of vertical plans in a participatory manner?
fiscal balance? For instance, do local governments ● Does the national budget document (or related
receive adequate general-purpose (unconditional) documentation) clearly specify when transfers will be
and/or conditional grants/transfers from a higher-level disbursed to local governments, and the conditions (if
government to support local administration and to provide any) of their release?
basic local services for all residents?43,44 ● During the budget year, do local governments receive
● Is the vertical allocation of (transfer) resources stable over transfers from the higher-level government in a complete
time? For instance, is the subnational share of transfers and timely manner, without unnecessary administrative
fixed by a sharing rule in the constitution or by law? Or impediments?
is there a tendency for the central government to reduce ● Can financial reporting requirements for (conditional)
local-level resources when the central budget has limited grants be met using regular local financial management
fiscal space? systems, or do they require duplicate (off-system)
● To what extent can transfer resources (from different reporting?
43. Note that shared revenues should be considered general-purpose transfers when the recipient government has no control over the tax base, rate, administration, or
sharing rate.
44. Even though deconcentrated budget allocations do not meet the definition of an intergovernmental fiscal transfer, many of the same questions can be asked to assess
the soundness of subnational resource allocations in a deconcentrated system.
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Intergovernmental fiscal transfers – efficient, inclusive and oversight, for example, as part of conditional grant
and responsive local governments / local administrations requirements, or as part of a performance standards being
considered under a performance-based grant scheme?
● During the budget formulation process, do local ● Is performance information submitted for performance-
governments plan and budget their fiscal resources based grants publicly available without any barriers? Is
covering both own source revenues as well as transfer performance information validated by the community,
resources as part of single, integrated budget process? where relevant?
● During the budget execution process, do local
governments manage their grant resources in efficient and
integrated manner as part of a single, integrated financial
A.4 Assessment questions: local
management process? Do local governments apply fund
accounting for conditional grants or donor resources? Do government borrowing, debt and
local governments have mechanisms in place to ensure capital finance
grant conditions are followed during budget formulation
and execution, where relevant? Local government borrowing, debt and capital finance –
● If required by higher-level authorities, do local governments empowering intergovernmental systems
regularly report on the utilization of (conditional) grant
resources in a transparent and timely manner, as part of their ● Do local governments or other local entities generally have
regular financial management systems and processes? access to credit from public or private financial institutions
● If required by higher-level authorities, do local (or from bonds) to fund local capital infrastructure
governments regularly report on the receipt and utilization expenses?
of extrabudgetary grants and fund flows, such as grants ● To what degree does the central government have the legal
and receipts of local utility companies and frontline authority to limit local government borrowing? For instance,
providers? does the central government have the authority to:
◦ Ban all borrowing, or require central government
Intergovernmental fiscal transfers – local facilities / approval on a case by case basis?
providers ◦ Ban foreign borrowing?
◦ Limit the magnitude of borrowing, for example, by
● Do local governments receive any intergovernmental placing limits on annual borrow and/or debt size, for
fiscal transfers from higher-level governments that have instance, in proportion to local revenues?
to be partially or fully passed on to facilities or providers? ◦ Limit how debt can be used—for example, specify that
If so, is there an appropriate administrative mechanism in borrowing can only be used for investment purposes?
place to ensure that these funds are transferred onward to ● Is there a formal mechanism to coordinate public sector
the facility level in a complete and timely manner? borrowing across different government levels?
● Do local facilities or providers receive any direct ● Are there public sector financial intermediaries for
intergovernmental fiscal transfers from higher-level local governments and authorities such as a Municipal
governments. bypassing local government accounts? If so, is Investment Bank? Municipal Development Fund? Local
there an appropriate local control and oversight mechanism Government Loans Board? If so, are these financial
in place to ensure that local facilities/providers spend the intermediaries run in an efficient, transparent, and
resources as intended and follow any grant conditions? accountable manner?
● If there are credit ratings, do they correspond to real fiscal
Intergovernmental fiscal transfers – engaged citizens and outcomes, or do they reflect the creditworthiness of the
civil society public sector as a whole?
● Does the central government legally or formally guarantee
● Are transfer schemes effectively leveraged—when the debt of local governments, in case a local government
needed or appropriate—to ensure community participation fails to repay its debt? Do creditors believe that local debt
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is ultimately guaranteed by the central government? local governments submit their borrowing plans to a local
● Are there perverse incentives for subnational fiscal referendum?
imbalance? For instance, does the central government ● Do local governments have to worry about reputational
provide ad hoc deficit grants? risks within the community or the business sector? For
● Are there formal (intergovernmental) rules or regulations instance, do local governments have any reason to worry
regarding the timely payment of contractors and suppliers? about credit ratings? If so, are such issues communicated
● Are there any formal, legislated rules about local to constituents?
government bankruptcy?
● Does the central government monitor subnational debt?
Is the information gathering system dynamic; can it pick
up and signal an evolving or emerging fiscal crisis?
Local government borrowing, debt and capital finance –
efficient, inclusive and responsive local governments /
local administrations
● Do local governments occasionally or regularly run up
arrears to public or private suppliers and/or personnel? If
so, how frequently and how much?
● Do local governments borrow from the central government/
higher-level public financial institutions? If so, how much?
● Do local governments borrow from (domestic) private
banks? Do local governments borrow from local public
enterprises or local (publicly-owned) banks?
● Do local governments issue domestic or international
bonds?
● Do subnational governments borrow abroad?
● Do local governments repay their loans on a regular basis
and timely manner, or are local government loans defaults
common?
Local government borrowing, debt and capital finance –
local facilities /providers
● Are local facilities/local service delivery providers able to
borrow separately from their parent government?
● If so, do local facilities/local service delivery providers
borrow prudently, with appropriate control and oversight
by their parent government?
Local government borrowing, debt and capital finance –
engaged citizens and civil society
● Does the local government consult with the community
before contracting debt? Or do local governments need
voter permission before contracting debt? In practice, do
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