54684 No. 123 / February 2010 HOW TO NOTE: A Framework for the Assessment of Fiscal Decentralization System Fiscal decentralization provides the link between incentives for better performance of the local government and the elected support from the citizens and is, therefore, essential for an effective system of decentralization. The purpose of this note is to elucidate components of a well- designed fiscal decentralized system and is aimed to assist task teams and stakeholders to evaluate fiscal decentralization effort in any given country. There are two main components of fiscal decentralization system: a) discretion of the local government to make decision on fiscal matters (including revenue assignment for local goods, revenue generation, transfer of funds through a well-designed transfer system, and utilization of funds) and b) accountability including mechanisms that hold local government officials to other elected and non-elected officials and social accountability that allows direct monitoring of the local government officials by the citizens. Fiscal decentralization is a set of rules that defines discretion allowed to the local government to roles and responsibilities among different levels of perform fundamental fiscal functions and governments for fiscal functions including budget mechanisms that hold the local government preparation, budget execution, revenue generation accountable for appropriate use of this discretion. and public sector borrowing. Fiscal decentralization Fiscal discretion can be divided into four elements, lies at the heart of any local government system as namely, the assignment of expenditure its rules define the generation and distribution of responsibilities, revenue generation, inter- resources (both between and within different governmental transfer systems, and local government levels) that are utilized to fulfil citizens' government borrowing. The framework emphasizes demands. The ability of the government to make that an authority can be held accountable for fiscal decisions in the provision of local government performing a specific function only if it has the fiscal services is a precondition for the voters to assess the resources and the discretion to perform that performance of their elected representatives with function. Similarly, the framework argues that respect to the amounts and qualities of services they accountability is not an automatic outcome of are getting for the taxes that they are paying increased discretion and that governments need to (Mueller, 2006). Therefore, if local governments are make a conscious effort to create structures that denied the fiscal instruments and funding to make would hold local governments accountable. The two real use of their political and administrative essential elements of accountability include public autonomy, decentralization is likely to be ineffective. accountability, where responsible individuals are In this respect, the ability of the task team leaders held accountable by other elected or non-elected and other stakeholders to evaluate fiscal officials, and social accountability, where public decentralization system is necessary for an effective officials are answerable directly to the citizens. system of local governance. To that end, this note Figure 1 provides the graphical representation of provides a framework of evaluation by highlighting these relationships. the important components that form a well- designed fiscal decentralization system. The objective of this note is to explain the importance of each of these components of fiscal According to this framework, there are two primary decentralization. It also explains how these components of a fiscal decentralization system: components should be implemented. Challenges 1 and good practices in implementations are Uganda, Philippines, Kerala and Rwanda are used illustrated through examples. A detailed checklist as examples to elucidate the use of the checklist.1 We (Table A.1, A.2 and A.3 in the Annex) is prepared also provide a blank questionnaire which the reader that can act as an expedient tool in evaluation of the can complete for the country under review (Table decentralization reforms in any given country. A.4, A.5 and A.6 in the Annex). 2 1. Discretion Local governments in developed countries rely on a number of own source revenues including taxes (for 1.1. Expenditure assignment: Local government should have expenditure responsibilities of local example property taxes), fees (for example, for goods licenses and permits), rent on local government property (for example, building and equipment) and The ability of the local government to respond to the user fees (for example, market fees or tolls on roads demands of the citizens depends on the functions assigned to the local level and the extent of discretion and bridges owned by the local government). available to the local government to make their own Complete local revenue autonomy requires that local budgetary decisions for local public goods. This governments are able to assess and set the tax base, discretion of the local government also encourages set the tax rate and collect revenue from respective the citizens to participate in decision-making process. sources. It is also crucial that local government has Although no single expenditure assignment approach discretion over utilization of these funds. In our study fits all countries, Table 1 provides a worldwide countries, only the local governments in Rwanda standard of distribution of expenditure responsibility have the discretion to set tax base (except for taxes on among different levels of government across different vehicles) while in Kerala and Philippines local services. Among our study countries, Kerala and governments have full autonomy only over rate Philippines have the most decentralized expenditure setting, collection and utilization of taxes. On the assignments (See Table A.1). In Rwanda, on the other other hand, local governments in Uganda only have hand, central government participates in expenditure full autonomy over collection of taxes and only assignment of almost all local goods. partial authority over setting the tax rate and utilization of tax revenue (Table A.2). It is also important to ensure that roles and responsibilities among different levels of government In addition to the discretion of local governments to and elected and non-elected branches of government collect own source revenues, it is necessary to assess are clearly delineated. In many countries, for example local governments' capacity to perform this function. China, Vietnam, Indonesia and Pakistan there are It has been observed in some cases that even when ambiguities regarding roles and responsibility of each local governments are given own revenue raising level of government. These confusions can prevent powers, they are not able to use it effectively. A the local government from functioning effectively. number of reasons have been suggested for this inability, including, unwillingness of the local officials 1.2. Own-source revenue generation: to enforce the tax laws, the limited capacity of the Local governments should have the discretion to local government officials to effectively administer a raise their own revenue. Table 1. Expenditure assignment ­ Worldwide Standards Social Services Transportation Utility and other services Social Welfare C Urban Transportation C,P,L Electricity C,P,L Hospitals C,P,L Railroads C,P Waste Collection L Public Health Water and Sewerage C,P,L Airports C,P L Universities Fire Protection C,P,L Ports and Navigable Waterways C L Secondary Education Irrigation C,P,L Urban Highways C,P,L L Primary Education Police C,P,L Interurban Highways C,P C,P,L Housing C,P,L C: Central Government P: Provincial/Regional Government L: Local Government N/A: Not applicable Source: World Bank (2009) 3 revenue system, and weak administration procedures 2) The rules that govern the allocation of such as poor maintenance of tax rolls (World Bank distributable pool among local governments. 2004). 3) The purpose of the transfer system--an unconditional general purpose grant versus a The disadvantage of the low discretion of the local conditional specific transfer. government to raise own-revenues (or the inability of the local government to collect revenues when they 4) Management of the intergovernmental transfer have the discretion) is the excessive reliance of the system including participation in devising rules local government on transfers from central for the transfer system government authorities. Excessive reliance on central A rule-based transfer system brings greater stability government transfers may discourage local and predictability, and thereby promotes good governments from exploiting their own resources. It planning and efficient service delivery effort. On the also creates incentives for the local government to other hand, if the distributable pool is determined by respond to the demands of the central authorities the central government in an ad hoc and opaque rather than their own constituencies, since by manner, it creates allocative inefficiency2 and gives responding to the preferences of the centre, the local rise to uncertainty at the local level regarding the government officials have access to resources that receipt of the transfer revenues. This uncertainty otherwise could be denied to them (See Box 1). leads to poor budgeting practices and weaken the accountability linkage between local governments 1.3. Inter-governmental transfer system: and citizens. Similarly, restrictions on the use of funds The mechanisms that determine the amount of transferred to the local government also diminish the distributable pool and allocation among local governments should be rule-based and local ability of the local governments to respond to the governments should have discretion to utilize preferences of the citizens. The conditional grants also the transfers. allow the departmental ministries or departments to maintain control over the local governments. Four elements of the intergovernmental transfer system have important local government discretion In many developing countries, however, inter- and accountability implications (Yilmaz and Bindebir, governmental transfer systems are weak and possess 2003): undesirable characteristics. For example, in Uganda, 1) Rules that determine the total amount of Pakistan and Philippines, significant portions of the transfer--the distributable pool. transfers from central to local governments are Box 1. An example of arbitrary intergovernmental transfer system and its implications The case of province Punjab in Pakistan illustrates how arbitrariness can increase avenues for elite capture and politics of patronage. The primary transfer to the local government from the provincial government is formulabased through the Provincial Finance Commission (PFC). However, revenues are also distributed directly from federal to the local government, for example through Khushal Pakistan Program, the federal Education Sector Reform and the President's Program for improvement of Watercourses. The province also makes direct transfer from the provincial retained funds most of which are tied to local or are conditional grants for education health under the provincial Education Sector Reform Program and Health Sector Reform Program. Additional funds for the social infrastructure improvement are also transferred to local governments on an ad hoc basis under the Chief Ministers Accelerated Program for Social Development. In addition to all the transfers listed above, funds are transferred arbitrarily amongst different levels of government through development/special grants, executive's discretionary funds, and parliamentarian funds. For example, in 200607 the nonPFC development transfers to local government in Punjab totaled to Rs. 14.5 billion which is larger than the local government's allocation through PFC (which was Rs. 11.8 billion). There is also some evidence that discretionary transfers are linked to the degree of embeddedness of the mayor of the local government unit in formal and informal political network of the province indicating that the elements of discretionary transfers encourage patronage politics. Moreover, most of these funds are earmarked for specific purposes, thereby, diminishing the ability of the government to allocate expenditure according to the preferences of the local constituency. 4 highly discretionary; funds are also sometimes ear- 2.1 Public Accountability marked for specific services or reserved for recurrent Public accountability: An effective, efficient, transparent, expenditure (personnel salary for staff recruited and and rules-based public financial management system hired by the central government) (World Bank, includes setting standards for control on 2009). This haphazardness undermines the stability intergovernmental transfer revenues, monitoring transfer and predictability in the local policy making and figures, observing clear rules for responsible local also makes the system more prone to political borrowing, providing public access to borrowing pressures. Kerala, on the other hand, presents an information; and setting clearly defined rules for hard example of rule-based intergovernmental fiscal budget constraints on local governments. transfer system where not only transfers are largely rule based but the local governments also have full Maintenance of documentation that adheres to generally control over the management of transfer systems. accepted standards of accounting: Since information is the basis of monitoring maintenance of proper documentation is necessary. However, many 1.4. Local government borrowing: Local developing countries do not adhere to proper governments should be allowed to borrow with documentation purposes. Among our study restrictions and strict accountability countries also, only Rwanda keeps proper Local borrowing can act as a significant source of documentation of budgetary documents even when revenue for local governments, especially in Kerala and Philippines have de jure requirement for countries where own source revenues and doing so. The most crucial cause of this absence of intergovernmental transfers fall short of responding documentation is the lack of capacity and training at to local investment needs. However, irresponsive the local level. This incapacity is highlighted when borrowing practices or excessive reliance on the budget process becomes complex and requires subnational borrowing can put macroeconomic multiple bank accounts to manage funds coming stabilization at risk. The option of local defaults and from a number of different sources. This situation is bail-outs by the central government creates a moral particularly seen in Ethiopia and Tanzania. hazard problem for the local governments and results in inefficiency and over-spending at the local Parliamentary Committee: A parliamentary committee level. Therefore, local government borrowing, if comprising elected council members can act as an allowed, should be adequately overseen by the effective monitor of fiscal functions of the local central government by devising precise rules and government. They should report their findings to procedures of borrowing. Consequently, in the local council regarding performance of the local developing countries, many central governments government along with their recommendations. The limit, control, or prohibit the issuance of debt by local council should then follow up with required local governments. Local governments in our corrective actions or sanctions. In our study example countries also only have partial discretion countries, only Philippines and Uganda have such over borrowing. parliamentary committees 2. Accountability Audit committees: Audit committees that oversee the Accountability is not an automatic outcome of fiscal functions of the local government including increased discretion of the local governments. budget and expenditure statements can be very Specific mechanisms should be designed to ensure effective in ensuring fiscal accountability of the local that citizens and higher officials are able and willing government. In addition to identifying discrepancies to hold local governments accountable for their in budget and expenditure documents, the audit discretion. The notion of fiscal accountability can be committees should also have the authority to make divided into public accountability and social recommendations to the local council (See Box 2 for accountability. more detail on audit procedures). 5 Box 2. Different approaches to audit Kerala and Rwanda In Rwanda, internal auditors are placed at the district level. These agents belong to the Government Chief Internal Auditor's staff, who was appointed in 2004. Monthly internal audit reports are required for each of the local government districts. The quality of internal audit is likely to have improved with the appointment of the Government Chief Internal Auditor. The internal audit regulations are reinforced by external oversight mechanism through the Office of the Auditor General (OAG) which is an independent institution that is answerable to the parliament and is constitutionally required to audit state, local governments, public enterprises and parastatal organizations to ensure that they conform to the law and demonstrate sound management. Institutions and public officials at the receiving end of the audit are obliged to implement its recommendations by taking appropriate measures in respect of the irregularities and other shortcomings which are disclosed. On the other hand, Kerala has devised a more encompassing audit system which is called performance audit. According to this new system, performance audit authority at the state and the regional level is responsible for carrying out comprehensive audits which cover not only scrutiny of the financial statements of the local bodies but also function of the panchayat including works undertaken, issues related to tax collection, resource mobilization, debt position and timeliness of various reports including annual reports. Detailed procedure for performance audit has also been developed. However, experience does not vindicate the efforts made in developing exhaustive procedures for audit; accountability could not be ensured as envisaged, basically because performance of local bodies has remained lackadaisical. Performance-based transfers: Central government can participatory budgeting practices and initiating also make the provision of some components of independent budget analysis and participatory public inter-governmental transfers conditional on pre- expenditure tracking programs that monitor budget defined performance measures. This aligns the execution and leakage of funds. incentives of the local government with that of the central government. For example, in Uganda under Information sharing and dissemination: Information the Local Development Grant program, only the sharing and dissemination in formats that are local governments that meet certain minimum understandable to general public is an essential governance criteria (for example adequate financial component of any social accountability mechanism. management capacity) can access funds for capital Different ways can be employed to achieve this investments in development projects. The top objective. Public meetings where local government twenty percent of the districts receive twenty explains its budgeting and expenditure activities can percent increase in funds for the subsequent year be useful. Disseminating information through radio while bottom performers are penalized by twenty and other regularly used medium of communication percent for the next year's budget. There are in a locality can also prove effective. indications that Local Development Grant mechanism has met with significant success since its Citizens monitoring committees to perform independent inception and has improved planning, financial budget analysis and public expenditure tracking management, accountability and transparency in programs: Effective accountability can be instituted development projects, including greater when different groups of citizens come together to communication of decision to stakeholders of the monitor various aspects of the budget and system. expenditure process. 2.2 Social Accountability Participatory budgeting: Participatory budgeting Social Accountability: A crucial requirement for any allows the citizens to present their demands in terms social accountability mechanism to operate is to make of allocation of budget through discussions and information accessible to the public (including budgets negotiations with the local government officials. and end-of-year financial statements); allowing strong This practice does not only ensure that citizens' public involvement in the budgetary process through preferences are included in decision making but also 6 Box 3. Social fiscal accountability participatory budgeting in Rwanda A promising instrument for social accountability in the financial domain can be found in the Ubudehe process. The primary purpose of this innovation is to promote participatory planning and budgeting at the village level. Ubudehe has its roots in traditional collective working in the fields, but has been adapted to modern ways of planning and budgeting. It builds on the concept of poverty reducing strategies (PRS) and participatory poverty assessment (PPA). The ubudehe for poverty reduction has taken several forms. In some areas, it has been used to create a benefice like access to water, a transport service, and a few credit programmes. In other areas it has been used for livestock rearing. The various forms reflect different priorities in different villages. All forms have a common denominator of collective community planning and budgeting. The success of the ubudehe is to a large extent dependent on the Government's program of training of trainers ­ local NGOs have trained one or two members from communities, these in turn are training other community members to plan, budget, and prioritize in a collective way. Ubudehe projects generally include a decentralized financing mechanism that operates more quickly than comparable disbursements from line agencies. Furthermore, the services delivered are costeffective compared with the delivery of smallscale works by public agencies. It is a unique policy of nurturing citizens' collective action in partnership with a government committed to decentralization. allows the citizens to become active participants in active propositions for solving commonly-perceived community problem-solving (Rocamora, 2004). problems in engagements within state institutions. After its start in Porto Alegre, Brazil, in 1988, participatory budgeting has been taken up 3. Conclusion voluntarily by more than 140 municipalities in A well-designed fiscally decentralized system Brazil. In Kerela, participatory budgeting is made should provide adequate discretion to the local mandatory and is regulated by legislation. Similarly government in terms of expenditure assignments for in Uganda, local government is required by the local goods, collection and utilization of own constitution to make the budget process democratic revenue, and utilization of inter-governmental and participatory. In the Philippines, also, NGO grants. A well-designed fiscal system also requires network Barangay-Bayan Governance Consortium that inter-governmental transfers are rule-based and (BBGC) has initiated participatory budget process in discretion of the central government is kept to a 2500 villages. See Box 3 for details of participatory minimum. These responsibilities, however, should budgeting mechanism in Rwanda. be adequately matched by establishing strong accountability structures. Proper documentation of Training communities for participation in budget budgetary and other fiscal documents is a necessary monitoring: Public financial management processes condition for operation of any mechanism of public are generally technical; therefore, citizens, especially accountability. Parliamentary committees and audit at the local levels and public require a particular committees can also provide effective monitoring of skill set to scrutinize these processes. Therefore, the fiscal function of the local government. Similarly, training communities is an important initiative that mechanisms to share information with the citizens in can significantly strengthen social accountability an easy-to-comprehend format, citizens monitoring processes in fiscal domain. Philippines has taken groups, participatory budgeting practices and such an initiative. Rocamora (2004) reports that this training of communities to enable them to perform initiative generated new perspectives in citizen accountability function are indispensible elements of participation and local politicians are able to devise a well-designed fiscal system. 7 Table 2: Some challenges and recommendations Challenges Recommendations Capacity of the local government to There should be a clear and precise strategy of building capacity at the local carry out their responsibility, for level through trainings and other methods. Lack of capacity at the local level example own-revenue generation and should not act as an excuse for inadequate discretion. effective information dissemination, is generally lacking. Capacity of the citizens to monitor fiscal Special initiatives should be taken to train communities and to provide them processes due to their inherent technical with the skill set that is essential for scrutinizing the fiscal performance of the nature of the fiscal processes. local government. Strong social accountability capability of the local government does not only improve the performance of the local government but also reinforces the citizen involvement. Unclear expenditure assignments and Other than the expenditure assignments, public finance management laws division of responsibilities result in should be clear and precise so that there is no room left for manipulation. A confusion within the local government distinct effort should be made to ensure that fiscal decentralization laws and adversely affect accountability. conform to the other laws in the country. Capture of the local government by the There should be clear rules to determine distributable pool. Moreover, the center through flow of funds distorts the major portion of the transfer should be rule based. Increasing the capacity of allocative efficiency. the local governments to generate their own revenue and decreasing their dependence on inter-governmental transfer can make the system more efficient and would allow the local government to respond more effectively to the demands of the citizens. Appendix: Checklists to assess Fiscal Decentralization Framework Country Examples and Questionnaire Table A1. Expenditure assignment-Country examples Function Kerala Philippines Rwanda Uganda Social Services Social Welfare L L C,L C Hospitals R C,L C,L C Public Health L C,L C,L C,L Universities C,R,L C L C Secondary Education L C C,L C Primary Education L L C,L C,L Housing L C,L C,L N/A Transportation Urban Transportation C,R,L C,L C,L C,L Railroads C,R C C N/A Airports C,R C C C Ports and Navigable C,R C C C Waterways Urban Highways C,R,L C, L C,L C,L Interurban Highways C,R,L C, L C C,L Utility Services Electricity L C,L C,L C Waste Collection L L L L Water and Sewerage L L C, L L Other Services Fire Protection L L C,L L Heating N/A N/A N/A N/A Irrigation L L C,L L Police R C,L C,R,L L C: Central Government R: Regional Government L: Local Government N/A: Not applicable 8 Table A2. Own-source revenue generation, intergovernmental transfer systems and ability to borrow- Country examples Function Kerela Philippines Rwanda Uganda Own-source Revenue Generation How much control do local Rate Base Rate Base Rate Base Rate Base Collection Collection Collection Collection governments have over setting setting setting setting setting setting setting setting Property tax Full None Full Partial None Full Full Full Full Partial None Full Taxes on vehicles Full None Full None None None None None None None None None Fees (for example on sale of animals, market fees, fees for Full None Full Partial None Full Full Full Full Partial None Full license and permits) Rents (for example on land, buildings, equipment, Full None Full Partial None Full Full Full Full Partial None Full machinery owned by the local government) User fees (for example toll on roads and bridges owned by Full None Full Partial None Full Full Full Full Partial None Full the local government) How much control do local governments have on budget Full Full Full Partial utilization from own source revenue? What is the percentage of own revenues of total local 31.5% (2002) 10% (2008) government revenue? Intergovernmental Transfers How are the following decided? Distributable pool Formula based Formula based Formula based Formula based, ad hoc Distribution across local Formula based Formula based, ad hoc Formula based Formula based, ad hoc governments Purpose of transfers Unconditional block grant, Conditional earmarked grant, Conditional earmarked grant, Unconditional block grant Conditional earmarked grant Unconditional block grant Unconditional block grant Does the local government have control over management of Full Partial Partial Partial transfer system Ability to Borrow Do local governments have Partial Partial Partial Partial discretion to borrow? Table A3. Public Financial Accountability Kerela Philippines Rwanda Uganda Do the following exist? De jure requirement for the publicity of budget Yes Yes Yes No documents Proper documentation of budgetary documents No No Yes No Legislation (rules) prescribed for the budget Yes Yes Yes Yes preparation process Parliamentary Committee to oversee the budgetary No Yes No Yes process Table A.4. Expenditure Assignment Function Country Social Services Social Welfare Hospitals Public Health Universities Secondary Education Primary Education Housing Transportation Urban Transportation Railroads Airports Ports and Navigable Waterways Urban Highways Interurban Highways Utility Services Electricity Waste Collection Water and Sewerage Other Services Fire Protection Heating Irrigation Police 10 Table A.5. Own-source revenue generation, intergovernmental transfer systems and ability to borrow Function Country Own Source revenue generation How much control do local governments have over Rate setting Base setting Collection Options: Full, None, Partial Property tax Taxes on vehicles Fees (for example on sale of animals, market fees, fees for license and permits) Rents (for example on land, buildings, equipment, machinery owned by the local government) User fees (for example toll on roads and bridges owned by the local government) How much control do local governments have on budget utilization from own source revenue? Options: Full, None, Partial What is the percentage of own revenues of total local government revenue? Intergovernmental Transfers How are the following decided? Distributable pool Options: Formula based, ad-hoc Distribution across local governments Options: Formula based, ad-hoc Purpose of transfers Options: Unconditional block grant, conditional earmarked grant Does the local government have control over management of transfer system Options: Full, None, Partial Ability to borrow Do local governments have discretion to borrow? Options: Full, None, Partial Table A.6. Public Financial Accountability Do the following exist? Country Options: Yes, No De jure requirement for the publicity of budget documents Proper documentation of budgetary documents Legislation (rules) prescribed for the budget preparation process Parliamentary Committee to oversee the budgetary process References Faguet, Jean-Paul. (2008) "Decentralization's effects on public investment: evidence and policy lessons from Bolivia and Colombia" Journal of Development Studies, Vol. 44 (8), p: 1100-1121. Mueller, D. (2006) "Federalism: A Constitutional Perspective," in Congleton, Roger D and Swedenborg, Birgitta (eds) "Democratic Constitutional Design and Public Policy," p: 205-228, MIT Press, Cambridge, MA Oates, W. (2005) " Toward A Second Generation Theory of Fiscal Federalism," International Tax and Public Finance, Vol. 12 (4), p: 349-373 World Bank (2004) "World Development Report of 2004: Making Services Work for Poor People" Washington DC World Bank (2008) "Local Government Discretion and Accountability: A Local Governance Framework". Economic and Sector Work Report No. 40153. Washington, D.C. World Bank (2009) "Local Government Discretion and Accountability: Application of a Local Governance Framework" Economic and Sector Work Report no. 49059-GLB, Social Development Department, World Bank, Washington, DC Yilmaz, S., and Bindebir, S. (2003) "Intergovernmental Transfers: Concepts and Issues." Paper Presented during the Workshop on Intergovernmental Fiscal Reforms in the EU Member and Applicant Countries, November 6­8, 2003, Ankara. This note is prepared by Serdar Yilmaz, Ghazia Aslam and Asli Gurkan, as part of How-to Notes and Case-study learning series and is derived from SDV's Economic and Sector Work Report (2010) on local governance and accountability. The series is an attempt by the Governance and Accountability Team of the Social Development Department (SDV) to provide guidance on select approaches to improve governance and accountability in World Bank operations. The authors would like to thank Jamie Boex and Sanjay Agarwal for their valuable comments. For questions and comments please contact ESW team members: Ghazia Aslam at gaslam@worldbank.org, Serdar Yilmaz at syilmaz@worldbank.org, Asli Gurkan at agurkan@worldbank.org. 1The choice of countries is based on the variety of decentralization structures found in these countries. 2 Ad-hoc transfers from central (or provincial) to the local government create allocative inefficiency by providing an incentive to the local government to respond to the preferences of the centre in order to get access to funds, rather than to their constituency. Central governments may also purposefully discriminate among different local governments to the extent that transfers may become a political decision. Moreover, in situations where discretionary transfers are a possibility, and central governments cannot make a credible commitment to a hard budget constraint, central government may act as a ready "bail-out" for the local governments. These options provide virtually irresistible incentives for decentralized governments to extend public programs beyond efficient levels (Oates, 2005; Faguet, 2008).