UNIVERSITE LIBRE DE BRUXELLES NATIONAL ECONOMICS UNIVERSITY
Vietnam – French Community of Belgium Master Programmes
MASTERS IN PUBLIC MANAGEMENT AND ECONOMICS
THESIS
FISCAL DECENTRALIZATION: CASE STUDY OF VIETNAM
Prepared by: Dinh Duy Dong
Instructed by: Dr. Le Thanh Tam
Hanoi 2010
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ACKNOWLEDGEMENTS
I am thankful to everyone who has helped me along the way. I really
appreciate the constant support and encouragement I received from many people
throughout the process.
I would like to first thank my advisor, Dr. Le Thanh Tam, for her
tremendous help and support. I do not think that I would have been able to
complete this thesis without her belief in me, and her enormous support.
My gratitude is extended to my colleagues and coworkers, who helped me
with the collection of data for the research. I am also very grateful for the time and
information shared with me by all the employers involved in the survey.
I very much appreciate the encouragement and support provided by all the
professors and staff at the Vietnam - French Community of Belgium Master
Programmes and the Faculty of International Education. I also truly value the
friendship and assistance by the classmates of MPM5. Discussions and exchanges
with them have really helped improve my scientific thinking and research
methodology.
Last but not the least, I would like to thank my family and friends who
always believed in me, and have been there for me throughout this process.
LIST OF TABLES
Page
Number
Table 3.1: Assignment of Expenditure Responsibilities in Vietnam 24

Table 3.2: The number of sub-nations having low growth rate of
education and training, science and technologies expenditures
28
Table 3.3: Growth rate of the State budget balanced revenues in
2004-2010
31
Table 3.4: Domestic revenue sorted by descending quantity 32
Table 3.5: The sharing percentage of shared revenues for provinces 33
Table 3.6: Outstanding stock of provincial debt as of October 2010 42
LIST OF FIGURES AND DIAGRAMS
Page
Number
Figure 3.1: The ratio local expenditure to total expenditure 26
Figure 3.2: The ratio capital expenditure to local expenditure
(balancing expenditure)
27
Figure 3.3: The structure of domestic revenue 35
Figure 3.4: Share of local revenue in total revenue 36
Figure 3.5: Share of intergovernmental fiscal transfers in total local
revenues
40
Diagram 2.1: Four pillars of fiscal decentralization system 8
Diagram 3.1: Levels of territorial administration and budget 22
LIST OF ABBREVIATIONS
NA: National Assembly
VAT Value added tax
MOF Ministry of Finance
TABLE OF CONTENT
EXECUTIVE SUMMARY iii
CHAPTER ONE: INTRODUCTION 1

Rationale of the thesis 1
Objective of the thesis 2
Thesis questions 2
Scope of research 2
Methodology 2
Thesis Structure 3
CHAPTER II: LITERATURE REVIEW ON FISCAL
DECANTRALIZATION 4
2.1. Definition of Fiscal Decentralization 4
2. 2. Rationale for fiscal decentralization 5
2.3. Content of fiscal decentralization 8
2.3.1. Expenditure assignments 8
2.3.2. Revenue Assignments to Local Governments 12
2.3.3. Intergovernmental transfers 14
2.3.4. Sub-national Borrowing/Debt 16
2.4. Measuring level of fiscal decentralization 18
CHAPTER III: THE FACT OF FISCAL DECENTRALIZATION IN
VIETNAM 21
3.1. Current territorial administrative structure 21
3.2. Assignment of expenditure responsibilities 23
3.2.1. Current assignments 23
3.2.2. Significant issues 29
3.3. Revenue assignments 30
3.3.1. Current revenue assignments 30
3.3.2. Significant issues 37
3.4. The system of transfers 38
3.4.1. Current transfers system 38
3.4.2. Significant issues 41
3.5. Sub-national government borrowing 41
CHAPTER IV: RECOMMENDATIONS FOR IMPROVING FISCAL

DECENTRALIZATION IN VIETNAM 46
4.1. Orientation on fiscal decentralization 46
4.2. Recommendations 47
4.2.1. To enhance the budget expenditure assignments 47
4.2.2. To enhance the revenue assignments for local authorities 49
4.3. Improving transfers system 51
CONCLUSION 53
REFERENCES 55
APPENDIX TABLES 57
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EXECUTIVE SUMMARY
The issue of fiscal decentralization has begun to feature significantly in many
countries around the globe. Fiscal Decentralization may be defined in many ways,
but typically involves increased autonomy and responsibilities for lower-level
entities in one dimension or another.
Fiscal decentralization covers two interrelated issues. The first is the division
of spending responsibilities and revenue sources between levels of government
(national, regional, local etc). The second is the amount of discretion given to
regional and local governments to determine their expenditures and revenues (both
in aggregate and detail).
A design of fiscal decentralization systems is based on four pillars:
expenditure assignment, revenue assignment, intergovernmental transfers/grants,
and sub-national debt/borrowing.
Most studies empirically examining fiscal decentralization describe the extent
of fiscal decentralization as the local share of total government expenditure. This
indicator measures the degree of local expenditure responsibility in the public
sector. By the same taken, the local share of total government revenue is also
applied to measure the degree of fiscal decentralization. A vertical fiscal gap is
defined as the local revenue deficiency cause by the difference between local
government revenue capacity and its expenditure responsibility. Following some

fiscal decentralization indicators are focused to measuring level of fiscal
decentralization: (i) Local share of total fiscal expenditure; (ii) Local share of total
fiscal revenue; (iii) Local dependency on fiscal transfer; (iv) Local fiscal
autonomy; (v) Local expenditure discretion. Base on these indicators, fiscal
decentralization is classified into the following three types. First, the
intergovernmental fiscal relationship can be considered as highly decentralized.
Another type is that although local fiscal autonomy is limited, the discretion over
expenditure is relatively high. The third type is both local fiscal autonomy and
expenditure discretion are limited.
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Over the past decade, Vietnam has been implementing decentralization
program. A cornerstone of this program was the approval of the 1996 State Budget
Law, the result has been a substantial and growing level of decentralization, with
the share of sub-national government in total expenditure increasing from 26
percent in 1992 to 43 percent in 1998 ; and to 48 percent in 2002 (Socialist
Republic of Vietnam and the World Bank, 2005).
The 1996 State Budget law was the first legal document in Vietnam to
provide explicit regulation for public financial management. The law defined the
role and powers of each level of government in the budget process, reflecting the
incipient decentralization of public finance. The law created framework financial
relations between the national government and lower tier of government.
A revised State Budget law was approved by NA in December 2002 and
came into force in January 2004. This Law builds on the achievements of its
predecessor, strengthening the legal platform of budget management in four
important regards: (1) Clarifying powers and responsibilities; (2) Strengthening
decentralization; (3) Promoting administrative reform; (4) Strengthening
transparency and accountability.
Although Vietnam has reached some achievements through current fiscal
decentralization system as of January 2004, some weaknesses of Vietnam current
system of decentralization are necessarily improved in coming time:

(i) Assignment of expenditure responsibilities:
One main problem with expenditure assignment in Vietnam is deal with the
capital expenditure needs of sub-national government. Most sub-national
governments lack of capital funds to rehabilitate, replace or construct new
infrastructures.
Another significant issue is the lack of regulation of concrete explicit
expenditure assignments for the lower levels of governments of districts and
communes.
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One of the toughest issues is the overlap of power of deciding education and
training, sciences and technologies expenditures between NA and People’s
Councils.
(ii) Revenue assignments:
- The localities did not have significant autonomy of revenue sources.
- According to the State Budget Law, the commune budgets are entitled to
enjoy at least 70% of five items of revenue (included: land use right transfer tax,
agricultural land use tax collected from family households, house and land
registration fees). In fact, some communes achieved excess resources after
ensuring all spending tasks while others’ revenues can not cover their spending
tasks. The inability to reconcile these revenues caused difficulties in managing
budget.
- The VAT and special consumption tax raise the unfairness between
provinces and the growing gap in budget revenues, expenditures between localities
and encourage local government to get further involved in market activities, offer
special advantages to business.
- The 2002 State Budget Law does not contain regulation on remitting
revenue to the high-level budgets in the case of suddenly increased revenue items
of low-level budget. Therefore, in implementing process, some localities had
unexpected increase in revenue over the target in the first year of the budget
stability period, while some others had to face with the situation when there were

an increase in district budget and a decrease in province budget but they could not
regulate the budget from district to province level.
(iii) By using stability periods, the current methodology provides more
predictability in local budgets but, this approach also carries some risks especially
if, as announced, the stability periods are to be expanded to larger number of years.
Since the balancing transfers are fixed in nominal terms at the beginning of each
stability period, sub-national government may fall short of adequate funding in
high inflation scenarios or if their ability to raise revenues falls and their
expenditure needs rise sharply during the stability periods.
v
To improve fiscal decentralization is an indispensable way to increase the
activeness, self-control and flexibility in budget management of government
authorities at all level to effectively meet the requirements of socio-economic
development of Vietnam.
The local budget self control should be strengthen and enhanced step by step
to actively and efficiently assist the performance of the functions and tasks of the
local authorities, basing on the on-going improvement of management capability,
transparency and financial explanation responsibility of local authorities.
On the basis of specific factors and disciplines to enhance the assignment of
state budget, from my point of view, the orientation to improve the fiscal
decentralization in the coming time should focus on the following contents:
Firstly, to better separate state budget in to specific levels, heading to a more
adequate budget assignment system in which local authorities at each level
possesses bigger decision making power of budget and be independent from
superior authorities.
Secondly, to grant local authorities with higher decision making power
regarding revenue sources management. In order to be self-control in budget
management, local authorities should be granted with the decision making power
and management of revenue sources so that they can adjust the size of local budget
through using their own revenue sources, including taxes. The increase in self-

control power is an objective requirement for hierarchy of state budget and in the
mean time, creates adequate revenue sources for the local budget expenditure
tasks.
Thirdly, to increase the decision making power of local authorities regarding
expenditures. Local authorities should be granted a reasonable power over
expenditures in their intended order.
Fourthly, to increase the financial transparency and explanation responsibility
at local levels. The desired target of budget assignment shall only be achieved if it
is attached with the enhancement of financial transparency and explanation
responsibility at local levels. Suitable regime should be applied in order to increase
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the transparency and accessibility in budget management at local levels. Moreover,
the control and supervision activities of authorized agencies should be taken to
ensure the effectiveness of budget management, the roles of people agencies and
State audit body should be appreciated. Budget explanation responsibility of each
levels should be intensified not only before superior level but also before the
People council and people of respective levels.
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CHAPTER ONE: INTRODUCTION
Rationale of the thesis
The budget is increasingly being seen as a tool to promote government
accountability and effectiveness, rather than simply as a vehicle for allocating
resources and controlling expenditure. Therefore, the management of fiscal
decentralization is a challenge in many countries around the world. It relates to not
only the budget management but also the organization of the State apparatus and
socio- economic issues of each country. Based on the specific conditions, each
country decides the way to decentralize its state budget. Decentralization of fiscal
authority presents some major opportunities: local government of the budget can
result in better mobilization and allocation of resources, and in delivery of services
which are more appropriate and responsive to the needs and wishes of local people

and more efficient given local conditions and circumstances (Socialist Republic of
Vietnam and the World Bank, 2005).
Over the past decade, Vietnam has been implementing decentralization
program. A cornerstone of this program was the approval of the 1996 State Budget
Law, the result has been a substantial and growing level of decentralization, with
the share of sub-national government in total expenditure increasing from 26
percent in 1992 to 43 percent in 1998 ; and to 48 percent in 2002 (Socialist
Republic of Vietnam and the World Bank, 2005).
After five years of implementation, Vietnam NA approved a new State
Budget Law in 2002, which allowed significant continuity in fiscal
decentralization. Nevertheless, there are still limitations and difficulties during the
implementation of decentralization process. I believe that it is indispensable to
have solutions to improve the prevailing regime of fiscal decentralization in order
to increase further both the efficiency and equity of the system. This explains why
“Fiscal Decentralization: Case study of Vietnam” issue is chosen to my research
topic.
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Objective of the thesis
- This thesis, thus, attempts to review the theoretical concepts as a basis to
analyze the practical of fiscal decentralization in Vietnam to provide a description
of the strengths and weaknesses of the system.
- Base on significant issues of fiscal decentralization in Vietnam, to propose
to improve the prevailing regime of fiscal decentralization in order to increase
further both the efficiency and equity of the system.
Thesis questions
Within this context, the thesis has an attempt to address the following major
questions:
- What are the theoretical and rationales behind fiscal decentralization?
- What are the strengths and weaknesses of Vietnam’s current system of
fiscal decentralization?

- What is needed to be done to further improve Vietnam’s system of fiscal
decentralization?
Scope of research
The issues examined in this research rest inside the following boundary:
- Scale: Vietnam Government Sector.
- Focusing on analyzing and clarifying the mechanism of fiscal
decentralization to local governments as of the effect of the 2002 State Budget
Law (implemented from 01/01/2004).
Methodology
This thesis substantially builds on the theories of fiscal decentralization and
various other available official publications and case studies to bring qualitative
and quantitative analysis, logics and analytical review methods to the examination
of practice of fiscal decentralization in Vietnam. Most data used for this study is
derived from the MOF.
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Thesis Structure
The thesis is structured in four main parts.
The first part, Chapter two: Literature review on Fiscal Decentralization is
dedicated to all the theories related to the research theme.
Chapter three: The fact of fiscal decentralization in Vietnam, provides a
description of strengths and weaknesses of Vietnam’s current system of fiscal
decentralization.
Chapter four: Recommendations for improving fiscal decentralization in
Vietnam, recommendations are offered to improve Vietnam’s system of fiscal
decentralization.
The final part, Conclusion, recaps the thesis.
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CHAPTER II: LITERATURE REVIEW ON FISCAL
DECANTRALIZATION
2.1. Definition of Fiscal Decentralization

The issue of fiscal decentralization has begun to feature significantly in many
countries around the globe. Members of the Executive Board of the IMF asked the
Fiscal Affairs Department to organize a conference to inform them about the latest
methodological developments, and to draw lessons from experiences of different
countries and regions. A conference was held in Washington in November 2000,
bringing together leading academics and “practitioners” from various countries
(Ehtisham Ahmad and Vito Tanzi, 2002).
Decentralization may be defined in many ways, but typically involves
increased autonomy and responsibilities for lower-level entities in one dimension
or another (Jonathan Rodden, Gunnar S. Eskeland, and Jennie Litvack, 2003).
Fiscal decentralization generally refers to the devolution of taxing and
spending powers from the control of central government authorities to government
authorities at sub-national levels (regional, provincial, municipal, etc). In a much
decentralized system, local governments have considerable power to mobilize
resources, through taxing authorities accompanied by strong tax bases (Niña
Boschmann, 2009).
Therefore, Fiscal decentralization covers two interrelated issues. The first is
the division of spending responsibilities and revenue sources between levels of
government (national, regional, local etc). The second is the amount of discretion
given to regional and local governments to determine their expenditures and
revenues (both in aggregate and detail).
These combined dimensions have a significant impact on the reality of
decentralization in its broader political and administrative sense. How much power
and responsibility regional and local governments actually exercise depend
substantially on
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(1) What range of public services they finance;
(2) Whether their revenues are commensurate with these responsibilities;
(3) How much real choice they have in allocating their budget to individual
services;

(4) Whether they can determine the rates of their taxes and charges (both
allowing them to vary their level of spending and making them answerable to the
payers).
The term "local government" will be used to describe both upper (regional,
county, and district) and lower (city, municipal, settlement) tiers of self-
government (Kenneth Davey, 2003).
The varieties of fiscal decentralization may exist, corresponding to the degree
of independent decision making exercised at the sub-national level, the general
description of the term fiscal decentralization encompasses the political, economic,
and institutional underpinnings of intergovernmental fiscal relations, and ranges
from examining the efficiency of public institutions and developing sustainable
infrastructure finance, to rationalizing fiscal transfer mechanisms and supporting
the social safety net.
Therefore, a carefully designed fiscal decentralization policy should not only
enhance local autonomy where sub-national governments are allowed to act
independently within their own sphere of competence in designing revenue and
expenditure policies but also promote political accountability, economic efficiency
and transparency (Robert D. Ebel and Serdar Yilmaz, 2001).
2. 2. Rationale for fiscal decentralization
Fiscal decentralization has many proponents, in particular as a strategy to
improve service delivery at local level. Commonly accepted objectives for fiscal
decentralization include those of an efficient allocation of resources via a
responsive and accountable government, an equitable provision of services to
citizens in different jurisdictions, and preservation of macroeconomic stability and
promotion of economic growth (Niña Boschmann, 2009).
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Decentralization is believed having a potential to increase efficiency with
regard to the use of public funds mainly through improved governance as a result
of (i) increased ownership, (ii) better fine-tuning to local circumstances, and (iii)
increased and more direct mechanisms of accountability. First, decentralization is

associated with increased efficiency, as lower spheres of government are more
likely to assess demand and to know peoples’ priorities. Second, decentralization
may lead to stronger democracy, as it makes local government more accountable
for its actions.
Arguments related to efficiency advantages through decentralization in
particular refer to higher consumer efficiency, competition, lower transaction costs
and more efficient revenue rising. Consumer efficiency relates to the assumption
that consumers’ preferences differ within a country; and, therefore uniform levels
of services in all municipalities are inefficient. In this sense, decentralized service
delivery increases efficiency, as services can be provided according to local
preferences (Niña Boschmann, 2009).
Oates (1972) formulated the decentralization theorem as "each public service
should be provided by the jurisdiction having control over the minimum
geographic area that would internalize benefits and costs of such provision".
The decentralization theorem is based on the assumption that central
government can only provide goods and services uniformly across jurisdictions.
Therefore, according to the argument, there are potential efficiency gains from
fiscal decentralization. Efficiency gains from decentralization can be allocative and
managerial:
(1) Efficient Allocation of Resources
Decentralization will increase efficiency because local governments have
better information about their residents’ needs than the central government.
Decisions about public expenditure that are made by a level of government that is
closer and more responsive to a local constituency are more likely to reflect
people’s choices than decisions made by a remote central government (Robert
D.Ebel and Serdar Yilmaz, 2001).
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(2) Competition among Local Governments
An interesting argument asserts that a primary economic rationale for
decentralization is to improve the competitiveness of governments that is,

decentralization will make local governments try to satisfy the wishes of citizens
(Breton, 1996). Vertical and horizontal competition between different governments
units can work as an incentive for cost-efficient service delivery, as competition
restricts the possibility to endlessly increase taxes. Moreover, transaction costs
may be significantly lower when services are provided locally, since local
knowledge can be used and decisions can be implemented faster. Lastly, especially
in developing countries a large portion of the economy falls outside the tax net.
Since sub-national governments are more likely to have reliable information about
the tax base, they might be able to capture more individuals for tax-paying (Niña
Boschmann, 2009).
Another rationale for decentralization is that good governments are those
closer to the people (Roy Bahl, Decentralization Policies in Asian Development,
2009). This line of argument comprises several related strands of discussion,
including accountability, participation, checks and balances and a greater variety
of choices. First, local government is more likely to be accountable to its
constituency, since information flows are better in a geographically confined area,
and people can more easily control whether local authorities consider their needs.
Second, decentralization can increase participation of the local population when
immediate beneficiaries (either directly or through representation) are involved in
planning for allocation of public resources, it is assumed that interventions were
likely to better suit local needs and priorities as compared to a situation where the
Central Government plans and delivers on their behalf – hence increasing
effectiveness. The presumed positive effects of dispersing responsibility to lower
spheres of government may be foiled, however, if inappropriate forms of
decentralization are implemented. Within a democratic system, we generally
extend this model to include devolution of power to “the people,” which they can
then exercise via locally elected government. Decentralization may, at the least, be
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important for political reasons, and it may also improve the welfare of the
populace (Niña Boschmann, 2009).

2.3. Content of fiscal decentralization
The design of a decentralized system requires "sorting-out" of public sector
responsibilities among different types of governments and the process of sorting
out entails transfer of some decision-making powers from central to sub-national
governments (Ebel, Varfalavi and Varga, 2000). Ideally, to achieve the relevant
policy objectives, intergovernmental fiscal system should be designed based on
each country’s specific circumstances. The policy objectives should include not
only the public finance goals of efficiency, transparency, and accountability but
also should aim at maintaining national integrity and political stability and being
equitable to different people and places. Such a design is based on four pillars:
expenditure assignments, revenue assignments, intergovernmental transfers/grants,
and sub-national debt/borrowing (Bird, 2000).
Diagram 2.1: Four pillars of fiscal decentralization system
2.3.1. Expenditure assignments
Expenditure assignment is the first step in designing an intergovernmental
fiscal system. Designing revenue and transfer components of a decentralized
intergovernmental fiscal system in the absence of concrete expenditure
responsibilities would weaken decentralization process (Martinez-Vazquez, 1998).
FISCAL DECENTRALIZATION
EXPENDITURE ASSIGNMENTS
REVENUE ASSIGNEMTS
INTERGOVERNMENT
TRANSFERS
SUB-NATIONAL DEBT
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The lack of clarity in the definition of sub-national responsibilities has a
negative impact on three important respects. First, if the responsibilities are
imprecise, the necessary corresponding revenues will remain poorly defined.
Second, without clear responsibilities, sub-national government officials might
prefer to invest in populist projects which benefit them in the short run rather than

in projects with long term impact on the region’s economy (such as infrastructure,
education, etc.). Third, there will be confusion whether sub-national expenditures
represent local priorities or centrally determined programs (Robert D. Ebel and
Serdar Yilmaz, 2001).
A report prepared by the US Advisory Commission on Intergovernmental
Relations (ACIR) on Governmental Functions and Processes (1974) lists four
principles in regards to setting the right incentives for efficient and equitable
delivery of public services. These principles are economic efficiency, fiscal
equity, political accountability, and administrative effectiveness. They suggest that
expenditure assignments should be made to governmental units that can: (1)
supply a service at the lowest possible cost; (2) finance a function with the greatest
possible fiscal equalization; (3) provide a service with adequate popular political
control; and (4) administer a function in an authoritative, technically proficient,
and cooperative fashion.
The principles of expenditure assignment provide a framework to determine
whether each function could be best performed by central government or any other
level of governmental unit. In more specific terms they relate economic, political,
and administrative considerations to the geographic and population size
considerations:
1
(1) Economic Efficiency: Functions should be assigned to jurisdictions
(a) That is large enough to realize economies of scale and small enough not
to incur diseconomies of scale; [economies of scale]
1
ACIR (1974)
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(b) That is willing to provide alternative service offerings to their citizens and
specific services within a price range and level of effectiveness acceptable to local
citizenry; [public sector competition]
(c) That adopts pricing policies for their functions whenever possible. [public

sector pricing]
(2) Fiscal Equity: Appropriate functions should be assigned to jurisdictions
(a) That is large enough to encompass the cost and benefits of a function or
that are willing to compensate other jurisdictions for the service costs imposed or
for benefits received by them; [economic externalities]
(b) That has adequate fiscal capacity to finance their public service
responsibilities and that are willing to implement measures that insure
interpersonal inter-jurisdictional fiscal equity in the performance of a function.
[fiscal equalization]
(3) Political Accountability: Functions should be assigned to jurisdictions
(a) That is controllable by, accessible to, and accountable to their residents in
the performance of their public service responsibilities; [access and control]
(b) That maximizes the conditions and opportunities for active and
productive citizen participation in the performance of a function. [citizen
participation]
(4) Administrative Effectiveness: Functions should be assigned to
jurisdictions
(a) that is responsible for a wide variety of functions and that can balance
competing functional interests; [general-purpose character]
(b) That encompass a geographic area adequate for effective performance of
a function; [geographic adequacy];
(c) That explicitly determines the goals of and means of discharging public
service responsibilities and that periodically reassess program goals in light of
performance standards; [management capability]
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(d) That are willing to pursue intergovernmental policies for promoting inter-
local functional cooperation and reducing inter-local functional conflict;
[intergovernmental flexibility] and
(e) That has adequate legal authority to perform a function and rely on it in
administering the function. [legal adequacy]

There is wide diversity between individual states in the scale of the tasks
devolved to local government. In most countries local government is responsible
for what are often called "communal services": local roads and lighting, water
supply and sanitation, waste management, parks and sports facilities, cemeteries,
social housing. What varies greatly is the extent of local responsibility for the
social sector, chiefly comprising education, health and social assistance. In some
cases the whole service is funded by the State Budget, in some costs are split
between levels of government, in some local budgets meet all costs except central
supervision. Cost splitting may be by function (e.g. the State paying for secondary
education, hospitals, social benefits and local government for basic education,
primary health care and social services) or by cost factor (e.g. the State providing
professional salaries while local government pays all other operating costs)
(Kenneth Davey, 2003).
Other functions usually can be provided better at the central government
level, such as: National defense, Border controls, International affairs, and
Education standards. Expenditures undertaken for the stabilization of the economy
such as massive investment or unemployment compensation are by their scale
naturally ascribed to the central government. Expenditures undertaken by
government for equity or income equalization reasons, such as social welfare or
low income housing should fall under the domain of the central government. On
the other hand, implementation of social programs can very well be left to local
governments, which may have informational and other comparative advantages
(Niña Boschmann, 2009).
It is normal to distinguish between current and capital expenditure. Current
expenditure covers such operating costs as salaries, repairs, energy and other
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utilities, travel, materials and debt service. Capital expenditure covers investment
in new construction, major renovations, and purchase of land and substantial and
durable equipment. It is also normal to distinguish between the financial sources
for these two types of expenditure. Operating costs are normally covered by a

combination of local taxes, user fees, intergovernmental transfers comprising
either grants/subventions or shares of State taxes. These will be described in turn
(Kenneth Davey, 2003).
2.3.2. Revenue Assignments to Local Governments
The essence of decentralization is that sub-national governments have the
authority and responsibility to own-finance local services at the margin. Complete
fiscal autonomy over revenues requires that in principle local governments can
change tax rates and set tax bases. The general principles of revenue assignment to
different levels of government are listed in fiscal federalism and local government
finance literature as (Oates, 1972; Bird, 2000):
1. The tax base assigned to sub-national governments should be immobile in
order to allow local authorities some freedom to vary rates without the base
vanishing. Inter-jurisdictional mobility of tax base makes taxation of mobile
factors difficult to sub-national governments.
2. Redistributive taxes should be assigned to the central government. Taxes
imposed on mobile factors for redistribution purposes might result in inefficient
jurisdictional allocation of the factors of production. Uniform redistributive taxes
minimize locational distortions of economic activities.
3. Services provided by sub-national governments should to the extent
possible be financed through user charges and other local fees and taxes that are
related to benefits. Efficient allocation of resources requires sub-national
governments recover their expenses from the beneficiaries of their services.
Examples of benefit related revenues include taxes levied on motor vehicles and
fuels and construction fees.
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