The World Bank - SEPTEMBER NUMBER 43 PUBILIC SECTOR Indonesia!s decentralization after 21 599 crisis Ideal'ly, decentralization should be managed so that the devolution of fiscal resources occurs in line with the devolution of spending. In reality, politics determines the devolution of resources, often with little regard for spending respionsibilities. What can be done? Indonesia has a three-tier unitary govern- ture, while the Law on Fiscal Balance delin- ment structure, with 26 provinces and about eates the new division of revenue sources Indonesia offers 330 districts spread over some 13,000 islands and intergovernmental transfers, including containing more than 300 ethnic groups. sharing of oil and gas revenues. lessons for other Despite its diversity and size, Indonesia has This note discusses key issues for Indone- one of the world's most centralized fiscal sia's decentralization process, assesses the countries interested systems. In fiscal 1999 revenue collected by proposed implementation strategies, and the central government amounted to 94 offers lessons for other countries. It draws in ceding power to percent of general government revenue, on recent work by the World Bank, the and about 60 percent of subnational International Monetary Fund, and an inter- local governments spending was financed by central transfers. national conference-organized by the Since the early 1970s several proposals have IMF, the Bank, and the University of been made for fiscal decentralization, but Indonesia-called "Indonesia: Decentral- the key elements have never been imple- ization Sequencing Agenda," held inJakarta mented. Indonesia's overly centralized in March 2000. system results in tenuous links between local demands and decisions on local public The new decentralization laws services, weak mechanisms for local The two new decentralization laws cover all accountability, and ad hoc allocation of fiscal major aspects of fiscal and administrative resources across regions. decentralization. Under the laws, all public Today, however, Indonesia is on the verge service delivery functions except defense, ol a major decentralization. Triggered by foreign affairs, monetary and trade policy, the financial crisis of 1997, the resignation and legal systems will be decentralized to of the Soeharto government, and the weak subnational governments. Most public public support for the Habibie government, services, including education, health, and demands for political and fiscal decentral- infrastructure, will be delivered by districts ization increased in 1998. In April 1999 and cities, with provinces performing only Parliament hastily adopted two laws requir- the role of coordinator. The previous hier- ing that drastic decentralization measures archical relation between provinces and be implemented in fiscal 2001 in a "big districts or cities will be abolished. Any task bang" fashion. The Law on Regional Gov- not specified in the law will fall to districts ernance specifies the political and admin- or cities. The subnational share of govern- istrative responsibilities for each level of ment spending will reach more thaovn- F40 government under a decentralized struc- percent, up from 19 percent in fiscal 2000. XILEJrP FROM THE DEVELOPMENT ECONOMICS VICE PRESIDENCY AND POVERTY REDUCTION AND ECONOMIC MANAGEMENT NETWORK The central government will share * Decentralizing most functions of public revenue from natural resources with service provision to districts may not be subnational governments. Subnational gov- compatible with government capacities, ernments will receive 15 percent of onshore or in line with economic principles of oil revenue, 30 percent of onshore gas rev- scale and spillover. enue (including offshore gas within 12 * Political decentralization is incomplete. miles of the coast), 70 percent of forestry Although regional parliaments were revenue, and 100 percent of fisheries elected inJuly 1999, many regional heads revenue-all shared on an origin basis. In were appointed by the old government addition, the minister of finance has and will be replaced by elected heads granted 20 percent of personal income tax only when their terms expire. As a result revenue to provinces, though this is not the key element of local government Public service in the law. The central government must accountability may be missing for years also transfer at least 25 percent of its to come. responsibilities revenue after sharing to subnational gov- * The proposed sharing of oil and gas rev- ernments through a general-purpose enues would distribute significant rev- should align allocation; 10 percent of this will go to enue, most of which is not from royalties provinces and 90 percent to districts. The or taxes on resource rents, to a small with revenue and general-purpose allocation will be based on number of provinces and districts. This formulas aimed at equalizing the fiscal arrangement would exacerbate regional administrative capacities of subnational governments to disparities in revenue and is inconsis- meet their spending needs. tent with the objective of equalizing capacities at The laws reflect pressures from regions, transfers. In addition, highly volatile oil especially resource-rich regions, for increas- and gas revenues are not ideal sources each level of ing fiscal autonomy and, more generally, for of local revenue, and would create con- political and administrative freedom after siderable uncertainty for local budget- the government decades of authoritarian rule. Districts were ing. chosen as the main level for autonomy * The coincidence of administrative and fis- because of the military's strong objections cal decentralization renders nearly impos- to provincial autonomy. The military- sible the design of an objective equalization burned by regional unrest in the 1950s- scheme. Cost differences among regions feared that provincial autonomy would cannot be determined because most func- enhance rather than abate centrifugal forces. tions were financed through the central budget. Moreover, information is not avail- Risks of the new laws able on current costs for each function, IMF and World Bank experts found that impeding the determination of the aggre- Indonesia's decentralization process, as struc- gate transfers needed to finance the decen- tured by the two laws, contained serious risks: tralized functions. * The Law on Regional Governance is too * The Law on Fiscal Balance does not general in assigning spending responsi- provide regional governments with new bilities-and so threatens effective service taxing powers. Regions have only limited delivery. Rather than clarifying respon- autonomy over small taxes such as water sibilities, the implementing regulations use taxes and street lighting taxes. Thus for the law have confused regional local governments cannot cover addi- govcrnmcnts, because the regulations tional local spending through taxes on specify only the center's remaining local residents-compromising local responsibilities. Because of this lack of accountability. clarity in the assignment of functions, the * The timetable for implementing the new decentralization of revenue under the laws is extremely tight. International Law on Fiscal Balance could exacerbate experience indicates that at least two macroeconomic imbalances. years are needed to prepare detailed PREMNOTE 43 SEPTEMBER 2000 regulations for functional devolutionof Lessons from Indonesias major services and to establish a system experience for administering grants. Hasty Because of the fluid nature of Indonesia's implementation could interrupt impor- decentralization, it is difficult to draw defin- tant local public services. itive conclusions on the benefits and draw- Preparations for implementing the laws backs of the various approaches proposed or have been slow because of the political taken by the government. Nevertheless, the transition and lack of coordination among current policy debate has made clear the key ministers. For example, lacking a clear importance of process design in minimizing definition of regional functions-which the risks of decentralization. Several lessons should be provided by the Ministry of Home can be drawn from Indonesia's experience. Affairs, Ministry of Regional Autonomy, and First, simultaneous political, administra- other ministries-the Ministry of Finance tive, and fiscal decentralization is difficult- A well-designed was not able to propose detailed financing if not impossible-to manage. From an arrangements and simulate their likely economic perspective, decentralization process can distributional impact. The coordinating should be managed so that the devolution bodyfor decentralization was finallycreated of fiscal resources occurs in line with the help minimize in April 2000-a year after the two laws were devolution of spending, avoiding macro- promulgated-but not all regional mem- economic instability and disruption in local the risks of bers have been appointed. As a result the service delivery. But the political process Regional AutonomyAdvisory Council is not determines the pace and manner of decentralization yet operational, and consultations have been resource devolution, often with little regard regional. There has been little progress on for spending responsibilities, especially in identifying additional taxing powers for local a new democracy. governments, and little effort has been Second, even if rapid fiscal decentral- made to strengthen district governments. ization is politically imperative, it may still And with a recent cabinet reshuffle, the Min- be feasible to avoid a disruption in service istry of Regional Autonomy was merged with delivery by taking a phased approach to the Ministry of Home Affairs, and the cham- decentralization. That is, spending respon- pion of decentralization was assigned a sibilities cani be devolved to a level of different task. government in line with its administrative Given the practical difficulties in manag- capacities. As lower level governments ing this process, a different approach- increase their capacities, responsibilities can devolving key functions, at least initially, to be devolved further. Of course, to deter- provinces rather than districts-attracted the mine the appropriate level for each service, attention of some policymakers. When first one needs to take into account the area of suggested, this approach gained political benefits and economies of scale as well. momentum. But it petered out after strong Third, every effort should be made to opposition from the Ministry of Regional avoid delays in establishing regulations Autonomy, the champion of decentralization. that detail the responsibilities of various It was argued that the central government levels of government, including for service was tainted by the past-a decentralization delivery, minimum standards, and per- law passed in 1974 was never implemented sonnel management. Accurately pricing because of delays by the center-and itwould each local responsibility-and so mapping be impossible to delay or phase decentral- out resources and responsibilities-is ization this time. "The regions want the almost impossible in the early stages of power and the money now," an official of the decentralization. But not assigning spend- Ministry for Regional Autonomy said when ing responsibilities can exacerbate vertical asked whether an alternative strategy for imbalances and compromise account- decentralization was possible (Financial Times, ability. A practical short-term solution is 26 April 2000). to transfer to local governments central PREMNOTE 43 SEPTEMBER 2000 government personnel who are perform- Indonesia's Ministry of Finance staff and ing public services under the deconcen- involved academics, it is feasible and desir- trated arrangement, in parallel with their able to establish a general transfer system financing. that takes into account both local revenue Fourth, local governments should be capacities and spending needs. But attention assigned one or a few substantive taxes over needs to be paid to the fact that the move which they have some rate autonomy, to to a new, formula-based system may drasti- ensure local accountability and fiscal disci- cally lower transfers to overstaffed local pline. Indonesia, for example, should move governments. To avoid radical civil servant toward a system that assigns property taxes retrenchment-and to increase the politi- to subnational governments by fiscal 2001, cal acceptability of the new transfer and should expand other local revenue bases. scheme-the assessment of spending needs Local governments This is an essential component of a sound can take into account the number of civil local fiscal system, and helps avoid local pres- servants in the initial stage, and reduce the should be assigned sures for increasing financing resources that weight attached to this factor over a number lead to illegal revenue-raising activities. of years. one or a few Fifth, in an economically and ethnically Finally, recognizing the inherently polit- diverse country like Indonesia, the central ical nature of decentralization, it is neces- substantive taxes government has to maintain sufficient fiscal sary to establish as the first priority a political resources to ensure reasonable equalization forum in which decentralization can be over which they and minimum service standards across discussedaamongrepresentativesofalllevels regions. Sharing natural resource revenues of government. have some rate with producing regions-especially when they include consumption and corporate This note was written by Jun Ma and Bert autonomy income tax revenues from natural resource Hofman (both SeniorEconomists, PREM Sector production, and when they are concen- Unit, EastAsia and PacficRegion). The authors trated in a few provinces-could generate received supportfrom PREM's Decentralization substantial inequality across regions. If such Thematic Group and from EASPR 's teams on an arrangement is adopted, its unequaliz- decentralization and subnational economics. ing impact will have to be offset by a for- If you are interested in similar topics, consider mula-based general transfer system. joining the Decentralization Thematic Group. Sixth, given the reasonable data avail- ContactJennie Litvack (x80519) or click on ability and technical sophistication of Thematic Groups on PREMnet. 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