Practice Area: Decentralization and Local Government Finance

Decentralization Reform. It is widely recognized that excessively centralized decision-making typically leads to an unresponsive public sector that is ineffective in delivering adequate public services. In an effort to make the public sector more participatory, responsive and accountable, developing and transition countries around the world are pursuing decentralization reforms. In addition, many countries are pursuing a more decentralized local public sector in order to promote local economic development, improve public service delivery and accelerate poverty reduction. Decentralization reforms results in new roles and responsibilities for subnational levels of government, but also for national governments as they shift from day-to-day control to a more regulatory role.

Supporting the process of decentralization reform is challenging, as successful reforms typically require support from a wide variety of actors, including not only local government stakeholders but also the ministry responsible for local government, the ministry of finance, line ministries, as well as the national political leadership and parliament. Our approach to supporting decentralization reform therefore combines well-thought out policy advice with a careful assessment of the political economy of decentralization. Comprehensive support during the implementation of decentralization reforms often requires legislative and regulatory reform at the national level, the introduction of participatory governance processes at the local level, and institutional capacity building and training at all levels, while maintaining an ongoing dialogue between the central and sub-national governments, as well as civil society.

Intergovernmental Fiscal Reform and Local Government Finance. Fiscal decentralization and the reform of intergovernmental financial systems is an important policy issue in many developing and transition economies. The design of an intergovernmental fiscal system involves four distinct pillars. First, expenditure responsibilities should be assigned to each level of government in accordance with the subsidiarity principle. Second, to the extent possible, subnational governments should be assigned own and shared revenue sources with which to fund their expenditure responsibilities. Third, a system of intergovernmental fiscal transfers should be put in place to supplement the own and shared revenue sources provided to the subnational level. Finally, whenever possible, a framework for subnational borrowing should be set up that would allow qualifying local governments to borrow for capital infrastructure purposes. While these pillars are an integral part of any decentralization reform process, the design of fiscal decentralization reforms should also be considered part and parcel of the Ministry of Finance’s fiscal policy framework.

The available evidence suggests that the success of fiscal decentralization reforms depends not necessarily on the extent of decentralization (the level of decentralized expenditures and revenues), but rather on the degree of local discretion over decentralized spending, the quality of the decentralized financing arrangements, and the institutional support structures in place. For instance, assigning local government revenues requires attaining a balance between the need for local revenue discretion on one hand and the local capacity to efficiently administer local revenues on the other hand. Because subnational governments often receive a large majority of their resources from intergovernmental fiscal transfers, the reform of intergovernmental fiscal transfer systems is arguably one of the most common -but perhaps also one of the most challenging- components of fiscal decentralization reforms.