Revisiting fiscal balance
In so far as the process of granting more authority to the provinces and regencies is concerned, amendments to the 1999 law on intergovernmental fiscal balance, which were approved by the House of Representatives last week, are not as significant as the new legislation on regional administration.
While the new law on regional autonomy transfers the power to elect provincial governors, regents and mayors from regional legislative councils to the local people, the new legislation on fiscal relations between the central government and regional administrations does not grant additional taxing power to local administrations.
This does not, however, dilute the significance of the new law on intergovernmental fiscal balance which will replace Law No. 25/1999. The most important elements of the new legislation lie in its elaborate, clear-cut provisions on budget transparency and accountability and domestic borrowing by regional administrations.
The new law increases the regions' take of several centrally administered categories of state revenues, but even this raise is only incremental. For example, total general grants to regions which are now set minimally at 25 percent of total state internal revenues (as envisaged in the central government budget) will increase to 26 percent and the regions' share of oil and natural gas revenues will rise by 0.5 percent to 15.5 percent and 30.5 percent, respectively.
Even these incremental increases will not be effective immediately. Some of them will only be realized beginning in the 2008 fiscal year. But seen from a fiscal sustainability standpoint, especially on the part of the central government, the gradual, small increase in transfers from the central government is very wise. Sharply raising the regions' take of tax revenues may erode the central government's ability to provide equalizing grants to poor regions.
Also similarly rational is the rejection by both the House and central government of the demand from several regional administrations for more taxing power. Granting regional administrations a broader taxing power now could kill the goose that lays the golden egg because local revenue officials, faced with weak institutional capacity, may prefer "hunting in the zoo" or squeezing existing taxpayers, instead of broadening the taxpayer base.
More important elements of the new law are the emphasis it places on the aspect of financial accountability on the part of local administrations. The legislation stipulates elaborate and clear-cut provisions designed to enhance budget transparency and accountability through a better accounting system and stronger procedures for planning, implementing, reporting and auditing regional budgets.
To comprehend how urgent and imperative is the need for higher standards of budget accountability, just look at how rampant corruption has been in the regional budgets. Hundreds of former legislative councillors in dozens of provinces, regencies and municipalities are currently either under investigation or prosecution on charges of corruption related to regional budget implementation.
Similarly important are the clearly-defined provisions in the law that allow regional administrations to take short, medium and long-term domestic loans, including floating municipal bonds, all within strict rules, which include a debt ceiling and require prior approval from regional legislative councils.
Issuing bonds not only will enable regional administrations to build better infrastructure that will stimulate investment. A much greater impact will be the influence of the bonds on budget transparency. Since bond issues have to meet capital market regulations, regional administrations intending to issue bonds are required to fulfill stringent financial criteria. They will have to publish audited budget reports.
Rating agencies also will put regional administrations under close scrutiny in light of rating municipal bonds and this process will further accelerate the development of good governance.
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