Financial Relationship between the central government and local level

1 Marine and fisheries Fishery production, Fish consumption

2 Agriculture Rice productivity or other main local food per hectare, the agriculture contribution on PDRB

3 Forestry Rehabilitation of forest and critical land, 4 Energy and minerals

7 Trade affairs The contribution towards PDRB, Trade Net Export 8 Transmigration affairs The number of people who migrate

Source: Republic of Indonesia, Law 32/2004

3.2.3. Financial Relationship between the central government and local level In theory, the arrangement of authority among central, provincial and regency/city level depends on the characteristics of the issues. For example, there are four forms of financial transfer in the federal country: categorical grants, block grants, revenue-sharing and equalization grants (Hague and Harrop 2001:207). This is due to the situation today that federations are characterized by extensive intergovernmental relations in which federal, state (and local) governments work together, seeking to identify policies on which all participants can agree.

In Indonesia, the decentralization is marked by number of income sources that still dominate or belongs to central government. Not until 2001, the sources of local government‟s income really depended on the central. In general, the original income of the region only revolved 2 to 5 percent of the Regional Budget (APBD), while the rest of it came from the central government subsidy. In several regions that are possess high potential resources like Aceh, Papua and East Kalimantan, this

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63 dependence situation had caused the separatist movement emerged since the central government was considered unjust in distributing the sources of the financial.

The revision of the Republic of Indonesia Law No. 22/1999 regarding Local Government to Law No. 32/2004 and Law No. 25/1999 regarding Financial Balance of Central and Local Government to Law No. 33/2004 had become the milestone of the reform of regional autonomy implementation in Indonesia. The distribution of sources of finance between the central government and the regions was increasingly better but still some problems are existed. The problems aroused were originated from the chaotic various available kinds of finance balance and also by the lack of the constitutional guarantee in the Constitution (Prasojo et.al, 2007).

Fiscal decentralization is one of the transfer mechanisms of National Budget Revenue and Expenditure (APBD) which is aimed to realize a fiscal sustainability and also a stimulus for the society economic activity. It is expected that this mechanism will create regional equity on financial capability among regions which is adjusted to the size of government authority given to the autonomous region (Elmi 2002).

It is important to clarify the authority of each level of government since it will ease the making of model or formulation of intergovernmental transfer based on the principle of finance follow function (Bahl 1999). This principle is important for two reasons, that the central government must establish expenditure needs for each level of government before tackling the question of revenue assignment and that the economically efficient assignment of revenue requires knowledge of expenditure assignment. There are three groups of Regional Income sources in Indonesia: local revenue, fund balance and other legal local revenue (Table 3.5).

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In example, Local tax, levies, profits of locally owned enterprises, private companies and business group, so on

Grant, emergency funds for natural disaster countermeasures, tax revenue-sharing from provincial level, adjustment fund and special autonomy funds, subsidy

Source: Republic of Indonesia Law No. 33/2004

However, the process of handover the authority (decentralization) from the government at the upper to the lower level has not transferred well. There is still tension among the governments, either for the expenditure assignment or the administrative matters. Moreover, the financial relation between the central and the local government that based on the Republic of Indonesia Law No. 25/1999 is organized in four principles:

1. The matters of the central government tasks at the region which is conducted in the frame of deconcentration are financed from and at the expense of government in which implemented in the frame of co-administrative function is financed by the central government at the expense of National Budget

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65 Revenue and Expenditure (APBN) or by the upper local government level at the expense of Local Budget Revenue and Expenditure of the parties assigned.

4. As long as the potency of local financial sources is insufficient, the central government will provide some subsidies.

Furthermore, based on the Republic of Indonesia Law No. 32/2004 regarding the Local Government and the Government of Republic of Indonesia Regulation No.

65/2001 regarding Local Taxes and the Government Regulation No. 66/2001 regarding Levies, the local government is given the authority to collect 11 type of tax and 28 types of levies. In terms of local taxes and levies contributions, the distribution of tax authority between central and local government has occurred a relatively large discrepancy. It is reflected that from the amount of local taxes collected which only about 3.45 percent from the total tax revenue of local and central government (Sidik, 2002).

Fund balance as illustrated by figure 3.6 is the funds sourced from revenue of National Budget which is allocated for the region to finance the region‟s needs in the context of decentralization, it is aimed to reduce vertical imbalance between the central and local income. The pattern of revenue sharing is done by a certain percentage which is based on the origin region. Moreover, General Allocation Fund (DAU) is the funds sourced from revenue of the National Budget which is allocated for balancing the financial capability among regions to finance their expenditures in the context of decentralization. Finally, Special Allocation Fund (DAK) is the funds sourced from revenue of the National Budget which is allocated to help region in financing particular needs.

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Table 3-6 Fund balance revenue distribution

No Sources

Land & Building Transfer fee Forestry: land-rent Source: Republic Indonesia, Law No 33/2004

The particular needs meant here are the needs that cannot measure using the equation and also the need which is considered as the national commitment or priority, for example reforestation. Except for reforestation, the region which receives the DAK allocation should provide cohort fund sourced from the Region Budget and Expenditures Allocation. In some cases, the overlapping of fiscal decentralization distribution between the central and local budget expenditures cannot be avoided. For example, one school at the region can receive funds for renovation not only from the provincial government but also from co-administrative allocation and the local government budget. This overlap had caused an inefficiency of financial expenditures

Notes:

a. 9% of the revenue collected from property tax is defined as administration costs and distributed equally to all local governments

b. 10% of the revenue collected from property tax is allocated to all local governments based on the actual property tax revenue collection at the current year. 6.5% is distributed to all local governments, and 3.5%

is given as incentive to local governments which have revenues exceed the target of collection from the previous year.

c. Revenue sharing from reforestation is an ear-marked grant to rehabilitate forests in originating local governments.

d. 0.5% of the revenue sharing from oil and gas is allocated to Provinces and local governemnts as an additional fund for education (ear-marked grant).

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67 and the utilization of resources at the local level. Sadly, sometimes among the central, provincial and regency/city government, they fought each other just to pursue the authority that covers the activity which its budget has been provided but avoid the authority which has no money.

3.3. The challenges in implementing regional autonomy

Studies in several countries indicate that decentralized systems vary greatly across different countries and there are two main reasons of decentralization in developing countries (Bardhan and Mookherjee 2006). First, from the political perspective, 1) the dominant motive was the challenge to the incumbent at the national level posed by competing political forces or regional interest. 2) it accompanied a transition in the national political system toward democracy (Brazil, Indonesia and South Africa) and toward non-democracy (Pakistan and Uganda). Moreover, they also note that the decentralization in developing countries was also less common to be strongly motivated by external crisis, pressure from multilateral institutions, or ideological considerations. Only in the case of Brazil and South Africa did these play some role. Additionally, Prasodjo et.al (2007) argued that the changes of the government system in Indonesia are not only caused by domestic pressure but also as the global impact of the changes in the structure of the government in the Developing country and also the pressure from the international donors. Meanwhile from an economic perspective, the motive for decentralization is a response to the failure of a central planning model which according to Rondinelly (1983) it will reduce the dominant role of central government in formulating national planning; give greater authority for development planning and management to officials who are working in the field; reduce the problems of a complicated bureaucracy and corruption; increase the skills and knowledge of the local officials which will lead to enhance their responsiveness over socio-economic problems; and allow local leaders to locate services and facilities more effectively within communities.