Academic journal article Journal of Southeast Asian Economies

Continuity or Change? Indonesia's Intergovernmental Fiscal Transfer System under Jokowi

Academic journal article Journal of Southeast Asian Economies

Continuity or Change? Indonesia's Intergovernmental Fiscal Transfer System under Jokowi

Article excerpt

1. Introduction

In 2001, Indonesia embarked on a far-reaching decentralization reform that devolved core responsibilities such as health, primary and secondary education and infrastructure to the districts. While the centre retained authority over foreign affairs, defence, law enforcement, justice, fiscal and monetary policy, and religion, control of all other functions was transferred to the regions--at least in principle (Sjahrir 2016). This implied a huge shift of expenditure from the centre to the regions (districts and provinces), which now spend around a third of the consolidated state budget. Yet, fiscal decentralization, which was accompanied by political and administrative decentralization, has remained largely one-sided. While local governments have authority over their spending, they rely heavily on transfers from the centre to finance their expenditure (Schulze and Sjahrir 2014). This particularly concerns districts, which received only 10-16 per cent of their revenue from own sources (tax and non-tax) between 2011 and 2016. Transfers to local governments accounted for around 30 per cent of central expenditure in recent years (Figure 1), making the design of the intergovernmental transfer system crucial for the success of the decentralization reform.

From a normative perspective, intergovernmental fiscal transfer systems should fulfil three basic functions. First, they should internalize externalities created by regional spillovers, such as public goods that benefit people from multiple local jurisdictions (Oates 1999), cross-border pollution or the erosion of tax bases in the presence of interjurisdictional competition (Wilson 1999). Second, they should incentivize local governments to mobilize resources and spend their resources efficiently. And third, they should have an equalizing function through which differences in economic development across regions are counterbalanced (Shah 2006; Boadway and Shah 2007). In the case of a one-sided fiscal decentralization, transfers of course have a major financing function (Boadway and Shah 2007). In short, intergovernmental fiscal transfers are an instrument that allow benefitting from the advantages of fiscal decentralization while minimizing its costs in terms of fiscal inequity or negative external effects (Boadway 2007). Yet, in practice, the allocation of transfers is often determined by political considerations like rewarding core voters or targeting swing voters (Gonschorek, Schulze and Sjahrir 2018; Weingast 2009, 2014). Moreover, transfer systems are often designed as a result of lobbying for regional interests. We, thus, cannot expect the system of intergovernmental transfers to fully follow normative criteria; the criteria may also be, in part, contradictory as efficiency considerations may run counter to equity considerations.

Indonesia has three main tiers of government--the centre, provinces and districts. Compared to district governments, provinces have limited responsibilities. They are responsible for supervision and cross-district cooperation, whereas districts are in charge of delivery of public services in education, health and infrastructure. Below districts are village governments, which have recently gained importance, after being entitled to receive their own transfers.

The structure of this paper is as follows. In the second section, we provide a systematic overview of the entire intergovernmental fiscal transfer system in Indonesia. While the country's transfer schemes have been analysed in the past, (1) the analyses are either outdated or only focus on individual components. We, on the other hand, describe the relative magnitude, allocation mechanism and economic rationale (if any) of the different transfer schemes and point out issues that these schemes may have. In the subsequent section, we describe reforms initiated under President Joko "Jokowi" Widodo (elected in 2014) and evaluate whether his administration has a different policy stance towards fiscal decentralization in general and the design of the transfer system in particular. …

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