CHAPTER I
INTRODUCTION
1.1Introduction
Fiscal federalism is the study of how
expenditure side and revenue side are allocated across different layers of the
administration. It is concerned with understanding which functions and
instruments are best centralized and which are best placed in the sphere of
decentralized levels of government. It constitutes a set of guiding relations
between the national and sub-national (vertical) levels of the government. The
concepts of fiscal federalism are related to vertical and horizontal fiscal
relations.
In the case of Nepal, provincial
governments also would be required to increase economic growth and the per
capita incomes of their citizens. In the traditional theory of fiscal
federalism (e.g. Oates, 1999), the three main areas are (a) welfare gains from
decentralization; (b) assignment of resources and responsibilities between
different tiers of government; and (c) fiscal instruments for the resolution of
vertical and horizontal imbalances.
1.2 Objective of the
Paper
The study focuses on the financial
implications of the national-level policies, which comprise not only funding
and allocation of public and private resources for particular purposes but also
non-financial tools such as regulation or norms and standards. This study
provides a good example of employing public finance policies and instruments to
promote international cooperation as Nepal believes in the so-called “LPG”:
liberalization, privatization and globalization. Given its democratic set up with
a free press and independent judiciary, Nepal’s movement towards globalization
is based on general political consensus and has a bias for human development.
1.3 Major Issue
The analysis brings out the important features of federal fiscal arrangements in Nepal. The analysis
highlights a number of
shortcomings, which are due
not
merely to Constitutional
arrangements, but also to conventions, methods and working of institutions.
The
paper attempts to
identify the reform areas, both in policies and institutions.
Like in most other federations, the system of assignments has resulted in a significant degree of
vertical fiscal imbalance. The wide differences in per capita incomes among
the states will have
caused severe horizontal fiscal imbalances. Reforms in the transfer system
will have to begin with redefining the scope of
National Planning Commissions to avoid the overlap in their roles. Preferably, the entire transfers should be the responsibility of
the
Planning Commission should focus on physical
infrastructure.
Until the debt market for
the States is
fully developed, the Planning Commission
could
also administer loans to finance physical infrastructure.
For poorer States and those located close to international borders, they could even provide loans at concessional
rate of interest.
The
Planning Commission should
be
made a permanent body
with
well qualified
technical personnel providing information and
research base. Another important issue is the extent to which the Centre has been able to effect regional
redistribution. Market
based resource allocation can produced severely
skewed distribution of incomes across regions, unless the central
government undertakes
effective measures.
Under the
Planned
regime,
the
regional policy
of the
central government
is an
important
factor determining
regional resource
allocation.
1.4 Background of the Study
This is
particularly important in the context
of globalization as the states
with more developed markets and
infrastructure can reap higher benefits
from access to
domestic and international markets and
grow faster than
those with less
developed markets and
infrastructure. It is also important to regulate the competition,
provide a negotiating platform and resolve inter-state and centre-state
conflicts.
1.5
Literature review
Since
Tiebout’ article “A pure theory of local expenditure” was published, the field
of fiscal federalism has been substantially developed and many articles on
fiscal decentralization have been contributed. In Oates’ (2005) terminology,
the “first generation theory” of fiscal federalism was well established in
public finance. Tiebout (1956) argued that fiscal decentralization would result
in the improvement of production efficiency by altering perfect mobility of
citizens and overcome the free rider problem in public goods. Musgrave (1959)
in his text book on “Public Finance” described the role of the government
sector in terms of correcting the market failures. When private markets failed
to supply such goods then government should introduce policy measures
correcting such failures in the field of allocation, macroeconomic
stabilization, and income redistribution. He also emphasized that allocation
efficiency will be achieved when local tastes and preferences have been met. In
addition Oates (1972) argued that the regions have different tastes and
preferences for public goods so that local government will provide better
services for their citizens because they have better information than central
government about the preferences of the local citizens. Therefore, Oates’
decentralization theorem states that economic efficiency will be achieved
through the decentralized provision of public goods.
From
the more recent discussion on public economics literature one can conclude that
the central government should be responsible for national policy and provide
efficient levels of national public goods. The sub-national governments’ role
is the provision of efficient levels of regional and local public goods for
their constituencies. With a proper assignment and the necessary fiscal tools
at their disposal, regional and local agent can implement welfare maximizing
policies (Oates, 2005). Hence, the analysis will be focused on the
intergovernmental relations in order to address the problem and to meet the
demand of the study.
From
a polit-economic view the public sector bureaucrats show a rent seeking
behaviour. Oates (2005) argues that new literature on fiscal federalism draws
on two basic sources, that are a) public choice and political economy, which
focus on political processes and behaviour of political agents, and b)
information problems (asymmetric information). According to this view the
assessment of fiscal decentralization will have some different perspectives.
For instance in case of developing and transition countries, in a setting of
asymmetric information and control, incentives for budget maximizing behaviour
of the political agents are very strong. The main principle of the
public-choice approach is that public decision makers are utility maximizers
with their own objective functions. Niskanen (1971) has constructed a model,
which explained the budget maximizing behaviour of the public agents. Niskanen
listed a certain number of variables in their utility functions such as salary,
reputation, power and patronage. Brennan and Buchanan (1980) extended this view
and stated that the public sector is a monopolistic agent. Therefore fiscal
decentralization will be a mechanism to constraint the expansionary tendency of
the government (“Leviathan”) through the competition between regional and local
governments.
Cremer,
Estache and Seabright (1996) argue that central government fails to get
information about the local tastes and preferences. Hence, fiscal decentralization
will have a positive impact because it allows regional and local government to
provide an efficient supply of local public goods for their constituents. Qian
and Weingast (1997) state that decentralization is the mechanism for
controlling over intrusive and expansive tendencies of the public sector and
supports effective operation of the private markets. So, from the public choice
and political economy perspective, the fiscal decentralization will constrain
the budget expansion through competition and enhance controlling and
accountability, which results in an efficient supply of regional and local
public goods and support the private markets. However, local political agents
are keen to expand their programs and expenditures beyond the mean and also try
to increase local public goods by the expense of other jurisdictions. Rodden
(2003) argues that it is a matter of fact, which form fiscal decentralization
takes. If fiscal decentralization relies on own tax sources, smaller
jurisdictions result and if transfers are financed by the central government an
overall increase in the budget occurs. The public choice perspective does not
examine the structure of fiscal institutions, which is an important component
for fiscal decentralization and the effect of fiscal decentralization will
certainly depend on the fiscal institutional structure.
From
the economic and political science perspective, the fiscal decentralization has
many benefits, however, decentralization is not a panacea, and it also does have
16 costs. The decentralization can result in the loss of economies of scale and
control over the scarce resources; inefficiency in service delivery and
complexity in policy coordination may happen if decentralization is implemented
in a wrong way (World Bank, 2007).
Alexis de Tocqueville more than a century ago
observed that, “The federal system was created with the intention of combining
the different advantages which result from the magnitude and littleness of
nations” (1980, Vol. 1, p. 163). The gains
from the magnitude and littleness can be realized only when the functions of
different levels of governments and various units within each of the levels are
clearly specified according to their comparative advantage. The system allows reaping gains from the
common market and economies of scale in the provision of national public goods.
This is achieved by providing of public services according to the diversified
preferences of people. Similarly, Bird (2000) makes a distinction between fiscal federalism
and federal finance. In his formulation, under fiscal federalism everything
-boundaries, assignments, and the transfers is malleable, under federal finance
these must be taken to be fixed at some earlier (constitutional) stage and not
open to further change under normal circumstances. As Stated by Wallace Oates,
“...the term federalism for the economist is not to be understood in a narrow
constitutional sense. In economic terms
all governmental systems are more or less federal: even in a formally unitary
system” (Italics in the original; Oates, 1977; p. 4).
CHAPTER II
SUBJECT MATTER
2.1
Overview of Nepal’s federal structures and fiscal situation
Fiscal federalism can potentially provide the framework for
unlocking this potential by ensuring peace and harmony, and providing a means
of expression for ethnic and regional preferences and priorities. Fiscal
federalism is an idea which asserts that in a multi-tier structure of
governance, central and sub-national governments work as economic players,
competing, cooperating and coordinating with each other within a set of rules
to promote the welfare of the citizens by equitable and efficient delivery of
services.
In the case of Nepal, provincial governments also would be
required to increase economic growth and the per capita incomes of their
citizens. In the traditional theory of fiscal federalism (e.g. Oates, 1999),
the three main areas are (a) welfare gains from decentralization; (b)
assignment of resources and responsibilities between different tiers of
government; and (c) fiscal instruments for the resolution of vertical and
horizontal imbalances.
At the moment, the central
government controls more than 97 percent public revenue and expenditure. The
extremely centralized government’s finance is the principal hindrance to
economic development because the public sector economy contributes more than
one third to gross domestic product (GDP) in Nepal. Government finance matters
in national economy.
CHAPTER
III
CONCLUSIONS
AND RECOMMENDATIONS
3.1
Conclusions
This paper has sought to examine several
dimensions of economic reform in Nepal, in the context of the country’s federal
system and of globalization. In our analysis, we have explicitly recognized
that the national government has sub national governments below it, and that
all these layers of government simultaneously interact with foreign governments
and corporations in a global economy. We have been able to identify some areas
in which the states may be able to achieve positive reforms acting
independently, and other areas where coordination between the central and the
state governments in designing and implementing reform policies may be more
appropriate. Furthermore, we have highlighted the challenges of greater
openness to the world economy, and of growing regional disparities. The former
requires urgent attention to the financial position of the government in
particular, as well as of the financial sector as a whole.
3.2 Recommendations
There are a
variety of motivations for having a federal form of governance. In some cases different countries come
together to form a confederation for a common interest which may eventually
evolve as a federation to reap the gains from common security and common market
inside in the country and globally as well.
In other cases, the dissatisfaction with the existing centralized
administrations in dealing with economic, social, political and linguistic
diversities and a feeling of exclusion in terms of the opportunities can be a
motivating factor. In a rapidly growing
economy where employment and income earning opportunities expand; the feeling
of being excluded is less.
In the case of
Nepal, the motivation for adopting federal system of governance comes from both
relatively slow growing economy where opportunities do not expand fast enough
and the feeling of exclusion from various groups. It is hoped that adoption of federal
governance will help to accelerate the pace of economic growth to expand the
opportunities. It is necessary to
underline the fact that calibrating policies and creating institutions to
accelerate the inclusive development of the economy must complement the
creation of federal governance system for the stability and sustainability of
the federation.
REFERENCES
Budhatoki, Nandakaji (2012), “Economics of Fiscal
Federalism in Nepal”, IIDS Policy Brief No.4.
Tocqueville, Alexis de (1945), Democracy in America, New
York: Vintage Books Random House: first published 1838.
Bird, Richard, M (2000), “Fiscal Decentralization
and Competitive Governments” in Galeotti.
Rao,
M. Govinda, H. K. Amar Nath and B. P. Vani (2004), “Rural Fiscal Decentralisation in
Karnataka”, in G. Sethi (ed) Fiscal Decentralization to Local Governments, Oxford University
Press, New Delhi.