Equalization grants

International Experience
Indonesias Options
Bert Hofman, World Bank
with thanks to Jun Ma, Ehtisham Ahmad

Equalization grants

Importance of grants
Rationale for grants
Types of grants
Equalization grants
Examples of equalization grants
Issues for Indonesia

Importance of Grants
Percent of government spending financed by grants
United States
United Kingdom
Switzerland
Sweden
Spain
Norway
New Zealand
Netherlands
Luxembourg
Ireland
Germany
France
Finland
Denmark
Canada
Belgium
Australia

10

15

20

25

30

Importance of Grants
Percent of Government spending financed by grants
Zimbabwe
Tunisia
South Africa
Malawi
Kenya
Paraguay
Mexico
Colombia
Chile
Brazil
Bolivia
Thailand
Pakistan
Israel
Indonesia /b
India /b
Romania
Poland
Hungary

10

15

20

25

30

Importance of Grants
PROVINCES
TAXES TRANSFERS NON-TAX
%
%
REVENUE
%
Argentina
Australia
Brazil
Canada
France
Germany
Mexico
Peru
Spain
U.K.
U.S.

36
36
67
67

57
40
17
20

7
24
9
14

68
7
3
19

19
81
94
78

13
12
3
3

50

22

28

TAXES %

55
19
41
48
32
18
15
52
16
41

MUNICIPALITIES
TRANSFERS NON-TAX
%
REVENUE
%
17
67
44
34
32
64
57
36
72
37

28
14
15
18
36
18
28
12
12
22

Rational for grants

Vertical imbalance
Horizontal imbalance
Spill-overs
National priorities
Nation building

Vertical Imbalance
Central share of Spending

100
Indonesia (1990)

90
80
70

United
Kingdom

60
Germany
Australia

50
40

Canada

30
30

40

50

60

70

80
90
100
Central share of revenues

Types of grants
General Grants
Conditional/specific grants
Matching and Non-matching Grants
Open Ended and Closed-Ended Grants

Block grants
Equalization grants

Issues in equalization
grants design

Should one equalize?

What to equalize
Expenditure needs
Fiscal capacity
Source of fund
Minimum standards
Capital spending
Equalizing grant and other grants

Equalization
Operational definition:

enable similar levels of service delivery at

similar levels of taxation
Principle:
Equalization Grant=Expenditure Needs- Fiscal
Capacity
Practice:

fiscal capacity only (Canada)

fiscal capacity and some needs (Germany)
fiscal capacity and elaborate needs (Australia)

Examples of Equalization

Australia
Germany
Japan
Korea
China

Australia
Federal Country
Large Vertical Imbalance
Strongly Equalizing Grants System
Revenue Capacity: Tax Base * Average National tax Rate
Expenditure Needs:
14 categories (Health, Education, etc.)
25 disability factors (factors that increase standard
costs), composed of multiple indicators
Special grants subtracted from grant entitlement
Excellent administration by the Grants Commission

Germany

Federal country
Substantial tax sharing
VAT redistributed per capita--provides most of the equalization
Fiscal Equalization through Finanzausgleich (Financial
Settlement)
Principle: equalize needs-adjusted fiscal capacity
Needs: special burdens for city states
Every state obtains at least 95 percent of average revenues
Rich states are taxed--discourages tax effort
Tax capacity over 110 percent of average tax with 80 percent
Eastern, poor states receive additional grants from central
government

Japan
Unitary country
Large vertical imbalance
Equalization through Local Allocation
Tax--both provinces and municipalities
Considers fiscal capacity and needs
Needs based on functions assigned to
government

Japan Cont.
Basic need = modification coefficient *
unit cost
modification coefficients examples:

school types
size of region
population density in region
cold area
urbanization of region
MOF Administers

Korea

Unitary country
Similar to Japans system
Fiscal capacity and needs
Fiscal scarcity= standard need - standard
revenue
Needs = standard fiscal need + supplemental
need
29 standard factors
Separate education transfer
Ministry of Home Affairs Administers

China
See Mr. Zhangs speech

Overview of Equalization
around the World
Comparison of the Grant Systems
Australia

Canada

UK

Germany

Japan

Korea

Equalizing
fiscal
capacities

Yes

Yes

Yes

Yes

Yes

Yes

Adjusting for
Expenditure
needs

Yes

No

Yes

Weakly

Yes

Yes

Sources of
equalization
fund

Central
government
revenue

Central
government
revenue

Central
government
revenues

VAT sharing,
inter-regional
transfers (from
rich to poor
states)

fixed
percentages of
5 central taxes

fixed
percentage of
total national
tax revenues

Data
requirement

Data on local
tax bases and
detailed
expenditure
factors

Data on
subnational
tax bases

Data on
properties
(provided by
localities) and
detailed
expenditure
factors
(provided by
various
agencies)

Data on local
tax bases and
expenditure
factors

Data on local
tax bases and
detailed
expenditure
factors

Data on local
tax bases and
detailed
expenditure
factors

Grant
administration

Grants
Commission

Dept. of
Finance

Dept. of
Environ.

Ministry of
Finance

Ministry of
Autonomy

Ministry of
Home Affairs

China

Indonesia: Law 25/99

Natural resource sharing
oil & gas
other

25 percent of domestic revenues for

general grant
Distribution according to
the regions needs
the regions economic potential

Resource sharing
East Timor
East Nusa Tenggara
West Nusa Tenggara
Irian Jaya
Maluku
Central Sulawesi
North Sulawesi
South East Sulawesi
South Sulawesi
East Kalimantan
South Kalimantan
Central Kalimantan
West Kalimantan
Bali
East Jawa
D.I. Yogjakarta
Central Jawa
West Jawa
DKI Jakarta
Lampung

Own resources (est.)

Bengkulu
South Sumatra
Jambi

Original Allocation

Riau
West Sumatra

Natural resources

North Sumatra
D.I. Aceh

100

200

300

400

500

600

700

800

Resource Sharing
De-equalizing
Transfers (000 Rupiah per capita)
800
700
600

After Natural
Resource Sharing

500
400
300
Before Natural
Resource Sharing

200
100
0
0

1000

2000

3000

4000

5000

6000

7000

Non-Oil GDP Per Capita 9Rp.'000

8000

9000

10000

Impact of Law 25/99

Central government
Domestic revenue
Expenditure and transfer
Transfers
General allocation
Special allocation
Resource Sharing
Deficit

Existing Policy
142,204
219,604
29,267
23,637.0
5,630
77,400

Fiscal Balance
Law
142,204
231,518
41,181
35,551
5,630
3,064
92,378

Provinces
Revenue and transfer
Own and shared revenue
Resource shares
Transfers
Expenditure
Deficit

10,065
4,657
5,408
10,065
-

10,510
4,657
613
5,240
10,065
(446)

Districts and lower

Revenue and transfer
Resource shares
Transfers
Expenditure
Deficit

29,205
23,505
29,205
-

43,618
2,451
35,467
29,205
(14,414)

Sources : MOF; staff estimates.

Issues in Indonesias
Equalization Grants Design
Defining Expenditure Needs
Determine expenditure assignments

Defining Revenue Capacity

Local tax base expansion?

How Much Equalization

Data Requirements
Consultation & Discussion
Grants Administration
Transition Arrangements

Goal
Not
Make every region happy
But
Make Every Region Reasonably
Unhappy