Fiscal Decentralization in the Philippines
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  • 2. Fiscal Decentralizationin the PhilippinesUnited Nations Human Settlements ProgrammeNairobi 2011 Sec1:iii
  • 3. The Global Urban Economic Dialogue SeriesFiscal Decentralisation in PhilippinesFirst published in Nairobi in 2011 by UN-HABITAT.Copyright © United Nations Human Settlements Programme 2011All rights reservedUnited Nations Human Settlements Programme (UN-HABITAT)P. O. Box 30030, 00100 Nairobi GPO KENYATel: 254-020-7623120 (Central Office)www.unhabitat.orgHS/129/11EISBN Number(Series): 978-92-1-132027-5ISBN Number(Volume): 978-92-1-132414-3DisclaimerThe designations employed and the presentation of the material in this publication donot imply the expression of any opinion whatsoever on the part of the Secretariat ofthe United Nations concerning the legal status of any country, territory, city or areaor of its authorities, or concerning the delimitation of its frontiers of boundaries.Views expressed in this publication do not necessarily reflect those of the UnitedNations Human Settlements Programme, the United Nations, or its Member States.Excerpts may be reproduced without authorization, on condition that the source is indicated.Acknowledgements:Director: Oyebanji OyeyinkaPrincipal Editor and Manager: Xing Quan ZhangPrincipal Author: Gilberto M. LlantoEnglish Editor: Roman RollnickDesign and Layout: Peter Cheseretiv
  • 4. FOREWORD Ur b a n i z a t i o n provision of adequate housing, infrastructure, is one of the education, health, safety, and basic services. most powerful, irreversible forces The Global Urban Economic Dialogue series in the world. It presented here is a platform for all sectors is estimated that of the society to address urban economic 93 percent of development and particularly its contribution the future urban to addressing housing issues. This work carries population growth many new ideas, solutions and innovative will occur in the best practices from some of the world’s cities of Asia and leading urban thinkers and practitionersAfrica, and to a lesser extent, Latin America from international organisations, nationaland the Caribbean. governments, local authorities, the private sector, and civil society. We live in a new urban era with most ofhumanity now living in towns and cities. This series also gives us an interesting insight and deeper understanding of the wide Global poverty is moving into cities, mostly range of urban economic development andin developing countries, in a process we call human settlements development issues. It willthe urbanisation of poverty. serve UN member States well in their quest for better policies and strategies to address The world’s slums are growing and growing increasing global challenges in these areasas are the global urban populations. Indeed,this is one of the greatest challenges we face inthe new millennium. The persistent problems of poverty andslums are in large part due to weak urbaneconomies. Urban economic development isfundamental to UN-HABITAT’s mandate. Joan ClosCities act as engines of national economic Under-Secretary-Generaldevelopment. Strong urban economies of the United Nations,are essential for poverty reduction and the Executive Director, UN-HABITAT v
  • 5. vi
  • 6. ContentsFOREWORD iiiContents ivCHAPTER 1 INTRODUCTION 1 Objective of the Report 2CHAPTER 2 THE CONCEPT AND ELEMENTS OF FISCAL DECENTRALIZATION 5 Oates decentralization theorem 5 An adequate enabling policy environment 7CHAPtER 3 TAX-EXPENDITURE ASSIGNMENT 11 Local government tax revenues: trend and composition, 1989-2009 11 Local government expenditures: trend and composition, 1989-2003 19CHAPtER 4 iNTERGOVERNMENTAL FISCAL TRANSFERS 31 Instruments of intergovernmental fiscal transfers 31 Designing fiscal transfers 31 Philippine internal revenue allotment 33 Distributable resource pool 36 Distributive and allocative formula 38CHAPTER 5 LOCAL GOVERNMENT FINANCING48 40CHAPTER 6 CONCLUSIONS AND RECOMMENDATIONS 43Bibliography 44
  • 7. Fiscal Decentralization in the PhilippinesLists of Figures, Tables and boxesList of figuresFigure 1 Three Branches of the Philippine Government 1Figure 2 Philippine Local Government Units 2Figure 3 Total Income, all LGUs, 1989-2009 14Figure 4 Distribution of Total Income, all LGUs, 1989-2009 (%) 16Figure 5 Distribution of Income by type of LGU, 1990 17Figure 6 Distribution of Income by type of LGU, 2009 17Figure 7 Distribution of LGU Expenditures, All LGUs 1988-2003 20Figure 8 Distribution of Total Expenditures - All Provinces, 1988-2003 22Figure 9 Distribution of Total Expenditures - All Municipalities, 1988-2003 23Figure 10 Distribution of Total Expenditures - All Cities, 1988-2003 24Figure 11 Local Income vs. Total Expenditure - All LGUs, 1988-2003 28Figure 12 Total Income with IRA vs. Total Expenditure - All LGUs, 1989-2003 29Figure 13 Total Income with IRA vs. Total Expenditure - by Type of LGU, 1990 29Figure 14 Total Income with IRA vs. Total Expenditure - by Type of LGU, 1990 29Figure 15 Local Income vs. Total Expenditures, by type of LGU, 1990 30Figure 16 Local Income vs. Total Expenditures, by type of LGU, 2003 30Figure 17 Release Procedure of the Internal Revenue Allotment99 34List of tablesTable 1 Tax assignment in cities, provinces and municipalities 12Table 2 Distribution of Local Income, All LGUs, 1989-2009 (in million pesos) 15Table 3 Distribution of LGU Expenditures, All LGUs, 1988-2003 21Table 4 Number of Awardees per Award Category (1994 – 2009) 26Table 5 Fiscal transfers to local government units 34Table 6 Percentage Shares of LGUs in the Internal Revenue Allotment 35Table 7 Distribution Formula for the Internal Revenue Allotment 35List of BoxesBox 1 Assessment level by type of land 13Box 2 An assessment of tax assignment to local government units 18Box 3 The internal revenue allotment vis-à-vis other sources of local income 36viii
  • 8. chapter 1 IntroductionCHAPTER 1 INTRODUCTION Many developing countries, the Philippines bicameral and is composed of the Senate andincluded, have embarked on a major shift the House of Representatives. Senators arein policy and approach to development nationally elected while representatives areby decentralizing and devolving central elected by legislative districts. The judiciary isgovernment powers, functions and composed of the Supreme Court and the lowerresponsibilities to local government units.1 courts. As of 2011. the political subdivisionsIn 1991, the Philippine Congress enacted the are the 80 provinces, 138 cities, 1, 496Local Government Code, which devolved to municipalities, and 41, 945 barangays. Theylocal government units the great responsibility are collectively referred to as local governmentof providing the local populace with a range units. The barangay is the lowest tier of localof basic public goods and services. governance. A group of barangays comprise a municipality. The more urbanized and The Philippines has a presidential unitary developed barangays comprise a city. Theregovernment system. The national government are two types of cities: (a) highly urbanized,has three independent branches, namely, the which is independent of the province, andexecutive, the legislature, and the judiciary. (b) component cities (smaller cities). AThe executive is headed by a popularly elected cluster of municipalities or municipalitiespresident. The executive branch is functionally and component cities, comprise a province.organized into sectoral departments, each Each local government is headed by directlyheaded by a cabinet secretary appointed by elected officials, namely, a chief executivethe president. The legislature, or Congress, is and a legislative body called “sanggunians.”.1 In the Philippines, these comprise provinces, cities and Figure 1 shows the three co-equal branches of municipalities. In other countries, these local government units government in the Philippines. Figure 2 shows are commonly known as sub-national governments or sub- national units. Throughout this paper, I retain the conventional the structure or layers of local government term used in the Philippines, namely “local government units” (LGUs). units in the country.Figure 1. Three Branches of the Philippine Government EXECUTIVE BRANCH LEGISLATIVE BRANCH JUDICIAL BRANCH President Congress Supreme Court Vice President Court of Appeals Court of Tax Appeals House of Senate Representatives Sandiganbayan Cabinet Secretariat Regional Trial Courts Other Special Courts 1
  • 9. Fiscal Decentralization in the PhilippinesFigure 2. Philippine Local Government Units Provinces Highly Urbanized Cities Municipalities Component Cities Barangays Barangays Barangays The 1991 Local Government Code in 1986” (Tayao 2010)3. Brillantes and(Republic Act 7160) provided local Tiu Sonco II (2010) saw decentralizationgovernment units with powers to tax and as reframing “the discourse of governancelevy various fees and charges, and to borrow when local governments begun to play a keyfrom the financial markets in order to raise role in governance in a country long steepedrevenues for financing local development. A with a history of excessive centralizationkey element of fiscal decentralization is the and dominance by the center, the latest ofinter-governmental fiscal transfer called the which was the domination by the Marcos‘internal revenue allotment,’ which is a block dictatorship”. These political scientists calledgrant to local government units based on a attention to the substantial changes madeformula designed by the Philippine Congress. in the politico-administrative system of the Philippines. They viewed the Code as a force, This is a ground-breaking legislation because which redefined the “notion of governanceit has decentralized and devolved significant by providing the enabling framework forpower and authority to local government units, local government-business partnerships, andunleashing tremendous opportunities for self- also local government-NGO partnerships,development at the local level2. In the period including opening the door to direct peoplepreceding its enactment into law, the central participation in governance”.(national) government exerted control overvirtually all aspects of local governance. The1991 Local Government Code endows local Objective of the Reportgovernment units with fiscal autonomy andaccountability to the local population, which The objective of this report is to determineconstitute a major departure from firm direction to what extent fiscal decentralization hasand control by the national government. empowered local government units in the Philippines to efficiently discharge the greater Local political scientists have enthusiastically responsibility over governance, public serviceobserved that “decentralization has been delivery and local development mandated tothe single most significant political reform them by the 1991 Local Government Code.after the fall of the Marcos dictatorship More specifically, it provides a descriptive2 The Philippines has political decentralization because powers analysis of fiscal decentralization in the are devolved to political leaders who are directly elected by or accountable to the population as opposed to de-concentration 3 Tayao, Edmund (2010), “Decentralization in the Philippines: or administrative decentralization where power is devolved to Impact on Politics and Governance,” unpublished paper, appointees of the national government. December 09.2
  • 10. chapter 1 IntroductionPhilippines. It focuses on local government negates the advantages given to decentralizedfiscal policies and inter-governmental fiscal regimes of better local service delivery arisingtransfer and identifies local finance policy from closer matching of public services withreform issues, which policy makers should local preferences and greater efficiency in theaddress to enable local government units to provision of public goods. A recent paper byimprove their local revenue-raising effort.4 Llanto and Quimba (2010) provides someThe inability to raise adequate local revenues is empirical evidence that there has not beenat the core of the problem of local government a significant improvement in the deliveryunits in delivering local public services. A of health and education services despitereason behind this is the inadequate taxing devolution5. Their empirical analysis seems topowers assigned to local government units, indicate that decentralization has not resultedresulting in a vertical fiscal imbalance, which in an improvement in the delivery of localoccurs when the central government retains services, contrary to the popular notion, whichcontrol over major sources of tax revenues. tends to be based on anecdotal evidence. The intergovernmental fiscal transfer The report is organized as follows. Tocalled the internal revenue allotment (IRA) provide context to the discussion, Section 2significantly supplements or covers the provides a brief review of the concept of fiscalinadequacy in local revenue collection. The decentralization and its elements based onallocation or distribution formula for the recent literature. Section 3 discusses the tax-internal revenue allotment stands a close review expenditure assignment at the local level. Itand improvement even as it has become the first discusses the structure and compositionmost important source of revenue for many of local tax revenues, fees and charges andlocal government units, especially the poorer then describes the pattern of local governmentmunicipalities. The irony is that the internal spending with focus on health and education,revenue allotment may have had a disincentive major expenditure items for which data areeffect on local effort to raise revenues, making more readily available. A key finding is themany local government units dependent on it presence of an inefficient tax-expenditurefor funding local development and services. assignment, which has constrained theThe distribution formula for the IRA should envisaged development of local areas by localbe improved but Philippine local government people utilizing local resources. This confirmsunits must exert effort to raise local revenues earlier findings of Manasan (2007) who foundbecause failure to do so results in inefficient a mismatch between revenue resources andlocal service delivery and diminished expenditure needs of the various levels of localaccountability. The IRA received by local government.government units has not been adequateenough to finance comprehensive service An issue overlooked by many localdelivery and local development programs. researchers is the need for local government units to exert more effort to improve local A case can also be made about the need for expenditure management. The findings oflocal government units to improve local public Llanto and Quimba (2010) show that manyexpenditure management. Under-spending LGUs have been under-spending, which pointon vital local public goods and services outs out the need for more efficient localaffects the level of welfare of households and expenditure management. The key message of this section is the importance of providing4 In the Philippines, sub-national governments are called “local government units” (LGUs), which are comprised of provinces, 5 Llanto, Gilberto M. and Francis Quimba (2010), municipalities, cities and “barangays.” Barangays are the “Decentralization and Local Service Delivery,” paper prepared smallest political unit headed by a local elective officer called for the Local Government Foundation, unpublished. “barangay captain.” Municipalities and cities are comprised of several barangays , respectively. 3
  • 11. Fiscal Decentralization in the Philippineslocal government units with ample power transfers, which cover both conditional andand authority to raise the necessary revenues unconditional fiscal grants. The biggest part ofto finance local development but at the same the fiscal transfers is composed of the internaltime, local government units must exert utmost revenue allotment. The current discourse andeffort in improving local public expenditure proposals to increase the amount of the IRA,management. It is commonplace to hear in and at the same time change the formula for itsvarious forums in the country complaints distribution has to be enlightened by findingsabout the inadequacy of local resources to of systematic research and study that has yet toaddress various development challenges. be undertaken. Policy makers cannot simplyLlanto and Quimba (2010) indicate that there rely on the narrow metric of politics to decideis room for improving service delivery even on this significant issue. There is a cryingunder a regime of constrained resources. need to produce an evidence-based policy recommendation on how to improve the use Section 4 analyzes intergovernmental fiscal of this important fiscal tool.transfers, basically the major block fiscalgrant called the “Internal Revenue Allotment Section 5 summarizes the status of local(IRA).” The IRA is the single biggest revenue government units’ access to developmentitem for many LGUs and the section points out capital and identifies areas for policy reform.outstanding issues affecting the efficacy of this It looks at the outstanding constraints tofiscal tool for helping with local development. access to the capital markets and officialPopular discourse on this topic inevitably development assistance and sketches pathwaysgravitates around suggestions to increase the to reform6. The final section pulls together theIRA from its current share of 40% of national findings in preceding sections, and draws someinternal revenue taxes to 50 percent and even conclusions and policy recommendations.60 percent with apparent disregard about theimplications of the suggestion to the financingof the country’s overall national development 6 The major issues on access to capital markets were firstagenda. There is a need for an in-depth presented and analyzed in Llanto, Gilberto M., and others (1998), Local Government Units’ Access to the Private Capitalresearch and analysis of the Philippine Markets, Makati City: Philippine Institute for Development Studies. Some of those issues have been resolved, many othersexperience with intergovernmental fiscal have remained outstanding.4
  • 12. Chapter 2 THE CONCEPT AND ELEMENTS OF FISCAL DECENTRALIZATIONCHAPTER 2 THE CONCEPT AND ELEMENTS OF FISCAL DECENTRALIZATION7Oates decentralization theorem devolved vast powers to local government units, introduced a significant shift in the A working definition of decentralization policy and institutional framework foris that by Faguet (2005) who defines it as development. In their review of Philippine“the devolution by central, (that is, national) decentralization, local scholars (Brillantesgovernment of specific functions, with all of and Tiu, 2010; Tayao, 2010) noted thatthe administrative, political and economic the Philippine political and administrativeattributes that these entail, to democratic system has been dominated by the centrallocal (i.e. municipal) governments which are government since the time of the Spanishindependent of the center within a legally colonization. A long history of centralizationdelimited geographic and functional domain”. meant that policies, programs, funding,A common denominator behind policy allocation of resources, etc were controlledmakers’ decision to decentralize and devolve is and implemented by the central governmentthe belief that this paradigm shift can improve situated in Manila (somewhat derisivelythe allocation problem in the economy, called “imperial Manila”). Thus, 1991 Localimprove productive efficiency and bring about Government Code (Republic Act No. 7160)better cost recovery. In the last two decades, was a critical break point in the country’sdecentralization has been at “the center stage political and administrative framework. In hisof policy experiments in a large number of reading of recent Philippine political history,developing and transition economies in Latin Tayao (2010) called decentralization as “singleAmerica, Africa and Asia” (Bardhan 2003, most significant political reform after the fallpage 1) for a number of reasons. For example, of the Marcos dictatorship in 1986.”a motivation for decentralization in LatinAmerica was the disenchantment with military The thinking behind this is that greaterrule and dictatorships, which has created a involvement of LGUs or sub-national unitspolitical culture that places a premium on in service provision, including the provisiondecentralized decision making to prevent a of basic infrastructure such as local roads,return to the past. In China, decentralization farm-to-market roads, communal irrigationwas seen as a means for social cohesion, facilities, among others, will result in betterfaster economic growth and preservation of service delivery and accountability, providecommunist party rule (Shah, 1997). opportunities for people participation in development, and create an enabling In the Philippines, the enactment into law environment for local private sectorof the Local Government Code in October investments.10, 1991, which decentralized and and Proponents of decentralization claim that it7 The brief review of literature partly draws from Gilberto has provided a framework for responsive and M. Llanto, “Decentralization, Local Finance Reforms and New Challenges: The Philippines,” a paper presented at the accountable local governance. According to Third Symposium on Decentralization and Local Finance at the Institute for Comparative Studies in Local Governance Bird (1993) it has given local constituents what (COSLOG), National Graduate Institute for Policy Studies, Tokyo, Japan on March 10, 2009. they want and are willing to pay for, and the 5
  • 13. Fiscal Decentralization in the Philippinesopportunity for greater local responsiveness and the harnessing of local energy for localand political participation. It has demonstrated development, which could make governmentsa potential to lead to more appropriate and to be “more responsive and efficient;” at thebetter-utilized facilities, lower costs per unit same time decentralization offers a practicalof service and improved operations and avenue for “diffusing social and politicalmaintenance (Klugman 1994)8. Devolution tensions and ensuring local cultural andis based on the subsidiarity principle and political autonomy” (Bardhan 2003, page 1).rests on the view that it results in improvedefficiency in the delivery of public services, and Joumard and Kongsrud (2003) add that ithence a more efficient allocation of resources can strengthen the democratic process, allowin the economy (Dabla-Norris 2006)9. This governments to tailor the supply of publicperspective draws from the classic distinction goods to local preferences and introduce somegiven by Musgrave about the different tasks competition across jurisdictions, thus raisingof government in an economy: allocation public sector efficiency. At the same time, it(which is better done by local governments), must be recognized that it can entail efficiencystabilization and redistribution (which are losses, and make it difficult to implementbetter done by central government). redistributive policies and complicate macroeconomic management (ibid). A These views echo the decentralization theorem contrarian view is that “decentralization may(Oates,1972, page 55), which maintains that increase the participation of people at the“each public service should be provided by the local level but sometimes it is only a smalljurisdiction having control over the minimum privileged elite group who get to participate”geographical area that would internalize (Conyers 1990, page 18) quoted by Oatesbenefits and costs of such provision.” Oates (1993). Faguet (2005) pointing out that there(1993) later observes that decentralization is a is little agreement concerning the effects ofmechanism to make policy more responsive to decentralization in the empirical literature,local needs and to involve the local populace says that pessimists argue local governmentsin processes of democratic governance10. The are too susceptible to elite capture, and tooeconomic case for decentralization is the lacking in technical, human and financialenhancement of efficiency that it introduces resources, to produce a heterogeneous rangebecause locally provided public goods, of public services that are both reasonablywhich are more responsive to local taste and efficient and responsive to local demand.preferences are superior to centrally determinedgoods. Decentralization provides for “tailoring For political decentralization to belevels of consumption to the preferences of effective, it should be accompanied bysmaller, more homogeneous groups” (Wallis fiscal decentralization. Many years ago in aand Oates 1988, page 5). Decentralization paper prepared for the World Bank Annualhas laid down the foundation of a new, major Conference on Development Economics,“institutional framework” for the provision Tanzi (1996) observed that decentralization ofof a range of benefits to local constituents fiscal activities can improve the allocation of public spending by making it more consistent8 However, according to Klugman (1994) greater efficiency need not necessarily accompany decentralization, given the risk of with local preferences. Oates (1996) cites the loss of economies of scale, duplication and overlap.9 Shah (2004) points out that the principle of subsidiarity potential contribution of decentralization in was introduced by the Maastricht Treaty for assignment of responsibilities among members of the European Union. enhancing allocative efficiency by providing According to this principle, taxing, spending and regulatory a menu of local outputs that reflects the functions should be exercised by the lowest levels of government unless a convincing case can be made for assigning the same to higher levels of government.10 While a discussion of the opposing views may be interesting, this paper will not dwell on it because it is outside the scope and objectives of the paper.6
  • 14. Chapter 2 THE CONCEPT AND ELEMENTS OF FISCAL DECENTRALIZATIONvarying wishes and conditions in local areas11. placed on the marginal amount of services forFurthermore, it can provide “political glue for which recipients are willing to pay is just equalcountries with regional ethnic diversity” (Tanzi to the benefit they receive (Ebel and Yilmaz,1996, page 295)12. Fiscal decentralization 2002; Oates 1972, 2006 )14 To implementis not always seen as conferring unmitigated this, sub-national (local) governments must bebenefits to the local populace. Fiscal given the authority to exercise “own source”decentralization is not without its share of taxation at the margin and be in a financialcontroversy. Oates (2006) mentions some position to do so. This is the essence of fiscalanalysis that “reveals its dark side, especially decentralization (Ebel and Yilmaz 2002).in practice” and that “raises some seriousquestions about its capacity to provide an Following Smoke (2001), the key elementsunambiguously positive contribution to an that should be included in a good fiscalimproved performance of the public sector” decentralization program are as follows:(pages 2-3). Smoke (2001) alludes to potential (a) an adequate enabling environment; (b)macroeconomic dangers and growth retarding assignment of an appropriate set of functionseffects of fiscal decentralization, indicating to local governments; (c) assignment of anhowever that most of the evidence is anecdotal appropriate set of local own-source revenuesand relevant only under particular uncommon to local governments; (d) the establishmentcircumstances or focused on correctable rather of an adequate intergovernmental fiscalthan inherent problems. transfer system; and (d) the establishment of adequate access of local governments to This is not the place to expound on this development capital.interesting facet of fiscal decentralization aspointed out by Oates and others but certainlyit poses a challenge to fiscal decentralization An adequate enabling policyanalysts. Suffice it to say at this point that environmentthere is a need for more research and theproduction of comparative information on To begin with an enabling policythe extent to which and the conditions under environment for fiscal decentralization, whichwhich the alleged benefits and disadvantages is clearly stated in constitutional mandateof fiscal decentralization have been realized or law, defining some minimum level of(Smoke 2001).13 autonomy, rights and responsibilities for local governments is important. The return of The decentralization theorem argues that democratic governance in the Philippines aftersub-national governments can more efficiently the 1986 People Power Revolution followingprovide public services to identifiable a long period of martial rule in the 70s andrecipients up to the point at which the value 80s has provided an enabling environment for11 Oates, Wallace (1996), “Comment on ‘Conflicts and Dilemmas decentralization. The series of freely elected of Decentralization’ by Rudolf Hommes,” in Bruno, Michael and Boris Pleskovic, editors, Annual World Bank Conference on democratic governments since then have Development Economics, Washington, D.C.: The World Bank, continued to recognize that it is good for a pages 351-353.12 Tanzi, Vito (1996), “Fiscal Federalism and Decentralization: A functioning democracy to allow local leaders Review of Some Efficiency and Macroeconomic Aspects,” in Bruno, Michael and Boris Pleskovic, editors, Annual World Bank and people to have the power and responsibility Conference on Development Economics, Washington, D.C.: The World Bank, pages 295-316. of deciding what goods and services to13 Smoke, Paul (2001) “Fiscal Decentralization in Developing Countries: A Review of Current Concepts and Practice,” Democracy, Governance and Human Rights Programme 14 Robert D. Ebel, Robert and Serdar Yilmaz (2002), “On the Paper Number 2, United Nations Research Institute for Social Measurement and Impact of Fiscal Decentralization,” Policy Development, February. Professor Smoke declares that Research Working Paper 2809, The World Bank, March; anecdotal evidence and case studies provide some insights but Oates, Wallace (2006), “On the Theory and Practice of Fiscal there is a need for more policy experimentation and systematic Decentralization,” IFIR Working Paper No. 2006-05, May; research to understand the prospects for fiscal decentralization Oates, Wallace E. 1972. Fiscal Federalism. New York: Harcourt in developing countries. Brace Jovanovich 7
  • 15. Fiscal Decentralization in the Philippinesproduce and finance. The enactment into law Tax Code (Presidential Decree 231), and theof the 1991 Local Government Code signals a Real Property Tax Code (Presidential Decreemajor departure from the traditionally centrist 464).approach to governance and development indeveloping countries, which view the problem In the Philippines, the 1991 Localof development as one requiring the presence Government Code devolved to localof a strong central government that will lay government units the responsibility ofdown policy directions and allocate resources delivering local and basic public servicesaccordingly. It may be recalled that before the and raising local or own-source revenuesabove-mentioned period of martial rule, there for financing their expenditure assignment.were a series of policy reforms leading toward Under the Local Government Code, locallocal autonomy. government units have autonomy in deciding on the composition of local spending, taxing Atienza (2006) related the quest for and borrowing that they would need to meetdecentralization and autonomy in a recent local development objectives. Thus, localstudy15. The 1991 Local Government Code government units are now responsible for themay be a radical piece of legislation but it following areas: land use planning, agriculturalis not the first decentralization law in the extension and research, community-country and it passed after five years of debate based forestry, solid waste disposal system,in Congress (Uchimura and Suzuki 2009)16. environmental management, pollutionGuevara (2004) recounted that in 1959 the control, primary health care, hospital care,Local Autonomy Act (Republic Act 2264) social welfare services, local buildings andwas passed to grant fiscal and regulatory structures, public parks, municipal servicespowers to local governments. In 1967, the and enterprises such as public markets andDecentralization Act (Republic Act 5185) abattoirs, local roads and bridges, healthincreased the financial resources and powers facilities, housing, communal irrigation, waterof local governments. The 1973 Constitution supply, drainage, sewerage, flood control andof the Philippines mandated that the state inter-municipal telecommunications.“shall guarantee and promote the autonomyof local governments to ensure their fullest The Local Government Code also transferreddevelopment as self-reliant communities.” to local government units certain regulatoryMartial rule stymied those reform efforts. functions. The fiscal transfers to localThe 1991 Local Government Code, then, governments were likewise increased, with“institutionalized a systematic allocation of 40% of internally generated taxes allocatedpowers and responsibility between the national to local governments through the Internaland local governments” (Guevara 2004, page Revenue Allotment (IRA). In addition, the1)17. The 1991 Local Government Code was Code encouraged the local government unitsa landmark legislation that gave rise to a major to explore alternative sources of revenue byshift in local governance (Manasan 2007). exercising their corporate powers in partnershipThe Code consolidated and amended the with the private sector. An innovationLocal Government Code of 1983, the Local introduced by the Code is the provision of a framework for active participation of non-15 Atienza, Maria Ela (2006), “Local Governments and Devolution in the Philippines,” in Noel Morada and Teresa Encarnacion, governmental organizations and civil society editors, Philippine Politics and Governance: An Introduction, Department of Political Science, University of the Philippines. in local governance18. Indeed, the new16 Uchimura, Hiroko and Yurika Suzuki (2009), “Measuring Fiscal Decentralization in the Philippines,” IDE Discussion Paper No. 18 For a detailed discussion, see Brillantes, Alex, Gilberto 209, Institute of Developing Economies, July. M. Llanto, James Alm and Gaudioso Sosmena (2009),17 Guevara, Milwida (2004), “The Fiscal Decentralization Process “Decentralization and Devolution in the Philippines: Status, in the Philippines: Lessons from Experience,” http://www.econ. Triumphs, Tests and Directions,” Report submitted to the Department of the Interior and Local Government, unpublished i2004-revised2.pdf, date accessed August 29, 2011. paper, April 298
  • 16. Chapter 2 THE CONCEPT AND ELEMENTS OF FISCAL DECENTRALIZATIONinstitutional framework for local development The succeeding sections of this paperhas generated an enthusiastic response on the first outline the current status of (a)part of local government units (LGUs) to the tax-expenditure assignment, (b) thedeliver better public services to local citizens. intergovernmental fiscal transfer (IRA), andIt has promoted local autonomy by devolving (c) the access of local government units toexpenditure responsibilities and vested greater development capital through borrowing, andtaxing powers on local government units19. then highlight outstanding issues or problems which should be addressed by policy makers.19 The paper does not discuss the Organic Act of Muslim Mindanao, which transfers to the regional government of the Autonomous Region of Muslim Mindanao all powers, functions, and responsibilities heretofore being exercised by the central government except (a) foreign affairs, (b) national defense, (c) postal service, (d) fiscal and monetary policy, (e) administration of justice, (f) quarantine, (g) citizenship, naturalization and immigration, (h) general auditing, civil service and elections, (i) foreign trade, (j) maritime, land and air transportation and communications that affect areas outside the ARMM, and (k) patents, trademarks, trade names and copyrights. For a discussion see Manasan (2005). 9
  • 17. Fiscal Decentralization in the Philippines10
  • 18. Chapter 3 TAX-EXPENDITURE ASSIGNMENTCHAPTER 3 TAX-EXPENDITURE ASSIGNMENT A principal challenge faced by LGUs and Expenditures) from the Commission onis finding the means to raise adequate Audit’s Annual Financial Reports for Localfinancing for local development. The LGUs Government Units for the years 1989 to 2009.are a heterogeneous group with varyingadministrative, financial and technicalcapacities. There is also great variation in the Local government tax revenues:level of local development with the few highly trend and composition, 1989-2009urbanized cities enjoying bigger and morebuoyant tax bases. The rest of the LGUs are Table 1 summarizes the various taxes thatcomposed of smaller cities and municipalities are assigned to local government units bywith weaker local economies. Provinces are the Local Government Code. The Codealso a heterogeneous lot with great variation has empowered local government units toin economic, administrative, financial, and set local tax rates and collect own-sourcetechnical capacities. The rising expectations revenues. Only cities and provinces can levyof the local populace for more and better the real property tax. The former shares thequality public services has to be matched by proceeds with their barangays while provincesthe ability of local government units to find share the proceeds with the municipalities andsubstantial funding and to have better and barangays. Both provinces and cities are alsomore efficient implementation of programs authorized to impose a tax on the transfer ofand project for local development. The 1991 real property, sand, gravel, and other quarryLocal Government Code assigned taxing and resources; amusement places; franchises;spending powers to local government units. It professionals; delivery vans and trucks; andis an acknowledged principle that matching idle lands. On the other hand, municipalitiesexpenditure and tax assignments is desirable and cities, but not provinces, are allowed tobecause this will enable the local governments levy the community tax and the local businessto shape the supply of public goods according tax (i.e.,turnover tax levied on the grossto local preferences and willingness to pay receipts of businesses/traders)22.(Jourmard and Kongsrud 2003)20. The main sources of local incomes are To assess the fiscal performance of the LGUs, the IRA, property tax, the business tax, andtime series data covering pre-decentralization service and business income from various localperiod (1989-1991) up to the present were economic enterprises. However, Section 133 oftabulated21 Income data were obtained from the Code also provides a detailed list of taxes,the Statement of Income and Expenses (SIE) 22 The first tier of government is the central government which operates through departments (ministries). The second tierwhile expenditure data were from the SAAOB of government is composed of local government units (LGUs) and one autonomous region, the ARMM. In general, the local(previously called Schedule of Appropriations government structure is composed of three layers. Provinces comprise the first layer. In turn, the province is divided into20 Joumard, Isabelle and Per Mathis Kongsrud. 2003. “Fiscal municipalities and component cities, each of which is further relations across government levels.” Economics Department subdivided into barangays, the smallest political unit. At the Working Papers No. 375, Organization for Economic same time, independent cities (or highly urbanized cities) exist Cooperation and Development, December 10. at the same level as the provinces, i.e., they share the same21 Sources: Commission on Audit’s Annual Financial Reports for functions and authorities. Independent cities are divided directly Local Government Units into barangays (Manasan 2005). 11
  • 19. Fiscal Decentralization in the Philippineswhich are revenue-productive but which only taxes, customs duties, value-added tax, and thethe central government can impose. These excise taxes on alcoholic beverages, tobaccoinclude the individual and corporate income products and petroleum products.Table 1. Tax assignment in cities, provinces and municipalities Tax base Cities Provinces Municipalities Barangays Transfer of real property X X Business of printing and publication X X Franchise X X Sand, gravel and other quarry resources X X * * Amusement places X X * Professionals X X Real property X X * * Delivery vans and trucks X X Idle lands X X Business X X X Community tax X X * *shares in the proceeds of levy of province Local generated revenues are basically the Tax Revenues includes Property Tax, Businesstax revenues and non-tax revenues obtained Tax and Licenses and Other Taxes. Propertyfrom regulatory fees, service charge, income Tax is composed of real property tax, propertyfrom local enterprises and other receipts. The transfer tax, real property tax on idle lands,share of local own source revenues and non- special assessment tax and special educationtax revenues to total LGU income was at 62 tax. Under Property Tax, the major one is thepercent in 1989, decreasing over time. In real property tax. Provinces can levy a real2009, it stood at 33 percent. As IRA’s share property tax not exceeding 1% of the assessedin the total LGU income increased through value of the real property. For cities, the realthe years, tax revenues and non-tax revenues’ property tax rate should not exceed 2% of theshare decreased. Please see Table 2 and Figure assessed value of the real property. The Local3. From 38 percent in 1989 Tax Revenues Government Code defines the maximumshares dropped to 29 percent in 1992, and assessment level for each type of real propertyto 22 percent by 2009. As for the Non-Tax (Box 1). The assessment level varies from localRevenues, from 24 percent in 1989 it was government to local government based ondown to 13 percent in 1992. By 2002 Non- local ordinances passed by the legislative bodyTax Revenue was at its lowest at 7.5 percent, (“sanggunian”).then slowly picked up and was 11 percent by2009.12
  • 20. Chapter 3 TAX-EXPENDITURE ASSIGNMENTBox 1. Assessment level by type of land Assessment level on lands % (maximum under Local Government Code) Residential 20% Commercial 50% Industrial 50% Mineral 50% Timberland 20% The Local Government Code defines community tax, amusement tax, tax on sand“assessed value” (AV) as the fair market and gravel and other quarry products, etc.value of the real property multiplied by the Non-Tax Revenues on the other hand consistsassessment level. It is synonymous to taxable of Service Income, Business Income, Othervalue. The assessment level is the percentage Income and Capital Revenues. Service Incomeapplied to the fair market value to determine is classified as Government Services andthe taxable value of the property. On the other Operating and Service Income in earlier years,hand, “fair market value” is defined by the and Service Income + Permits and Licenses inLocal Government Code as fair market value” later years. Business Income includes incomeas the price at which a property may be sold from local economic enterprises or LEESby a seller who is not compelled to sell and such as markets, slaughterhouses, waterworksbought by a buyer who is not compelled to and transportation systems, and hospital feesbuy. The real property tax (RPT) is computed among others. Other Income consists of LGUas follows: Shares from National Wealth, Economic Zones, EVAT and Tobacco Exise Tax, and RPT = AV x rate. other miscellaneous income. Capital Revenues Buyers of real property pay a one-time are mainly income from the sale of assets butproperty transfer tax when title to a real in later years it also included receipts fromproperty passes on to them. The special the sale of confiscated goods and properties,education tax is an additional 1% tax on the disposed assets, securities and gains fromassessed value of real property in addition foreign the basic real property tax. A special The Property Tax has been the largestassessment tax on real property may be levied contributor when it comes to own-sourceto address a local development goal23. On the revenues with a share of 22 percent in 1989,other hand, the real property tax on idle lands followed by Business Taxes and Licenses andhas generally not been implemented by local Business Income both at 10 percent but latergovernment units due to political constraints. years especially after devolution, show that Business tax and licenses, or taxes on goods IRA has become a dominant source. Pleaseand services in other years, includes business see Figure 4. The local government unitstax, franchise tax, occupation tax, printing depended more on the IRA and this hasand publication taxes, tax on fishing vessels eroded the effort of local government units toand tax on delivery trucks and vans among collect own-source revenues. For many localothers. Under the category of Other Taxes are government units, it is much easier to just rely on the IRA transfer than it is to collect real23 Recently Quezon City, one of the largest highly urbanized cities imposed a special levy of 0.5 percent on residential lots with property taxes and business taxes24. an assessed value of Pesos 100,000.00 (approximately US$2, 325.00 at the current exchange rate of Pesos 1 to US$ 1) to finance the construction of housing for informal settlers in the 24 The disincentive effect of IRA is discussed in succeeding city.. paragraph below. 13
  • 21. Fiscal Decentralization in the Philippines In general, there is a general downward percent and 6 percent in 1989 to 2 percenttrend in the contribution of total local tax and 1 percent in 2009 respectively. Businessand non-tax revenues to LGU income. By Tax, Service Income and Other Income did2009 Property Tax is only at 11 percent not change that much through the years. It isof total LGU income while Business tax important to note that this general situation isdropped to 9.6 percent from its level of 10.5 true for provinces and municipalities but notin 1990 before the 1991 Code. Other Taxes for cities as indicated below.and Capital Revenue also went down from 4Figure 3: Total Income, all LGUs, 1989-2009200,000180,000160,000140,000120,000100,000 80,000 60,000 40,000 20,000 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2008 2009 Total Tax Revenues Total Non Tax Revenues IRA14
  • 22. Table 2. Distribution of Local Income, All LGUs, 1989-2009 (in million pesos)   1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2008 2009 Property Tax 21.9 22.9 21.4 16.3 13.3 13.0 13.6 14.2 14.2 13.9 12.8 12.7 13.4 12.4 13.4 13.4 13.6 12.5 11.8 10.7 Business Tax 11.5 10.5 10.0 9.3 13.3 8.8 9.5 10.9 10.3 10.3 10.0 9.4 10.1 10.0 10.0 10.7 10.8 10.8 10.9 9.6 Other Taxes1 4.7 3.6 3.5 3.5 5.7 2.8 3.2 2.7 2.7 2.8 2.4 2.4 2.0 1.7 1.9 1.7 1.7 1.6 1.6 1.5 TOTAL TAX REVENUES 38.1 37.0 34.8 29.1 32.3 24.7 26.3 27.8 27.2 27.1 25.1 24.4 25.5 24.1 25.3 25.8 26.1 24.9 24.3 21.8 Service Income2 4.0 3.4 3.1 3.8 3.1 3.0 2.9 3.2 3.0 2.8 2.7 2.6 2.8 2.6 2.7 3.0 3.3 3.3 3.5 3.3 Business Income3 11.6 12.2 11.3 6.7 5.8 5.7 5.2 5.7 5.4 5.5 4.8 4.6 4.7 3.2 3.2 3.9 3.8 3.9 3.9 4.1 Other Income 2.6 3.0 2.2 1.1 1.2 1.0 1.8 1.2 1.0 0.9 0.8 1.2 1.1 1.7 2.3 2.5 2.1 3.0 3.7 2.7 Capital Revenue 6.1 1.3 1.2 1.2 0.1 0.0 0.1 0.4 0.7 0.3 0.1 0.1 0.2 0.0 0.0 0.3 1.0 0.0 0.8 0.8 TOTAL NON TAX REVENUES 24.2 20.0 17.7 12.7 10.2 9.7 10.0 10.5 10.1 9.4 8.4 8.5 8.7 7.5 8.3 9.7 10.2 10.1 11.9 10.9 IRA 37.7 43.0 47.4 58.1 57.5 65.6 63.7 61.7 62.6 63.5 66.5 67.2 65.8 68.3 66.4 64.5 63.7 64.9 63.8 67.3 TOTAL LOCAL INCOME 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 Source: Annual Financial Reports 1989-2009 1 - Includes Shares from National Wealth, Economic Zones, EVAT and Tobacco Exise Tax, PAGCOR/PCSO  2 - Includes regulatory fees and permits and licenses 3 - Includes receipts from local enterprises such as markets, slaughterhouse, transportation system, waterworks system, and hospital fees TAX-EXPENDITURE ASSIGNMENT Chapter 315
  • 23. Fiscal Decentralization in the PhilippinesFigure 4: Distribution of Total Income, all LGUs, 1989-2009 (%) 2009 2008 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 -10 0 10 20 30 40 50 60 70 80 Property Tax Business Tax Other Taxes Service Income Business Income Other Income Capital Revenue IRA16
  • 24. Chapter 3 TAX-EXPENDITURE ASSIGNMENT Figures 5 and 6 compare the source of amounts of IRA individually because there areincome of LGUs before (1990) the passage of fewer of them to divide the pie, so to speak.the 1991 Code and after several years (2009). This has motivated municipalities to of gettingThe broad taxing powers benefited more the higher amounts of IRA individually becausecities than provinces and municipalities. They there are fewer of them to divide the pie, sohave been dominant in all types of local taxes to speak. This has motivated municipalitiesand the internal revenue allotment. The cities to convince legislators to pass special lawshave also the advantage of getting higher converting them into cities.Figure 5: Distribution of Income by type of LGU, 1990 80 70 60 50 40 30 20 10 0 Property Business Other Service Business Other IRA Total tax tax taxes Income Income Income Income Provinces Cities MunicipalitiesFigure 6: Distribution of Income by type of LGU, 2009 80 70 60 50 40 30 20 10 0 Property Business Other Service Business Other IRA Total tax tax taxes Income Income Income Income Provinces Cities Municipalities 17
  • 25. Fiscal Decentralization in the Philippines An examination of revenue figures over the are most dependent on IRA. In an extremeperiod 1989-2009 indicates a significant decline case, the IRA allocations sometimes accountin the share of provinces and municipalities in for 95 percent of local revenues and, in at leasttotal LGU own-source revenue. This contrasts one case, 114 percent of total expenditureswith the continuous increase in the share (ADB 2005)26. The dependence on IRAof cities in total LGU own-source revenue. results in weaker local fiscal autonomy, whichAn outstanding problem faced by provinces creates opportunities for greater control by theand municipalities is how to raise substantial central government, contrary to the envisagedrevenues when they do not have very productive situation of local governments able to respondtax bases to begin with. The 1991 Code have to local needs and to match local outputsput certain limits on their taxing powers. with local preferences. To wean themselvesCities are more fortunate because they have away from central government control localbroader taxing powers than municipalities and government units should strive for greater fiscalprovinces. Please see Table 1 above. autonomy by working to significantly improve own-source revenues. Improving the collection Because of an inefficient tax assignment, of real property and local business taxes is anit is only the cities, which have the capacity important step to boost local fiscal raise the needed revenues. As Manasan(2007) has observed the distribution of Limits on sub-national governmentown-source revenues is in favor of cities, discretion to determine tax rates and tax basesand partly in favor of municipalities away significantly reduce local fiscal autonomyfrom provinces25. The cities have larger tax (Joumard and Kongsrud 2003).bases and consequently, buoyant revenuesources but the majority of local government Various researchers such as Manasan, Cuenca,units, that is, the municipalities have weaker Uchimura and Suzuki, Capuno, and Llanto,tax bases and thus, do not raise sufficient among others have noted the inefficiency inown-source revenues. They have remained tax assignment to local government units independent on fiscal transfers, principally the the Philippines. Manasan (2005) provides ainternal revenue allotment (IRA) for funding good summary27 as shown in Box 2.local development activities. 26 Asian Development Bank (2005), Decentralization in the Philippines: Strengthening Local Government Financing & The dominance of IRA as revenue source Resource Management in the Short Term, Mandaluyong City:is very obvious. Provinces and municipalities Asian Development Bank 27 Manasan, Rosario G. 2005. “Local Public Finance in the Philippines: lessons in autonomy and accountability.” Philippine25 Manasan, Rosario (2007), “Decentralization and Financing Journal of Development. Second Semester 2005, Vol. XXXII of Regional Development,” in Balisacan, Arsenio and Hal Hill, No. 2: 32-102. editors, The Dynamics of Regional Development: The Philippines in East Asia, Quezon City: Ateneo de Manila University Press. Box 2. An assessment of tax assignment to local government units • The Philippine tax assignment appears to be largely consistent with the traditional view of tax assignment. • It scores low on the autonomy criterion because (a) the Code fixes the tax rate of some of the taxes that are assigned to LGUs; (b) the Code sets limits (floors and ceilings) on the tax rates that LGUs may impose and maximum allowable rates are rather low; (c) in terms of real property assessment levels, the Code sets maximum assessment rates for different classes of property; (d) the Code mandates that tax rates can only be adjusted once in five years and by no more than 10 percent.18
  • 26. Chapter 3 TAX-EXPENDITURE ASSIGNMENT • Future Code amendments should consider giving LGUs greater discretion in setting tax rates by raising the maximum allowable tax rates. • There is a need to move away from tax rates that are not indexed to inflation. • There is a need to simplify the structure of local business tax because different categories of firms are subject to different rate schedules. • There is a need to improve the tax administration machinery of local governments, e.g., employ certified public accountants to improve tax audit capability; use automation to improve revenue performance, etc. • There is a need to revise the schedule of market values for real property purposes because many provinces and cities have done a general revision of such schedules only once since 1991. • There is a need for many LGUs to revise their tax codes since only a few have made revision since 1992 even if some tax rates are not indexed to inflation. There are current legislative bills to modify 1992. In 1993 it dropped to 40 percent andthe taxing powers of LGUs, e.g., Senate Bill maintained this level in the following years.1458, which recommends transferring themandate to tax sand, gravel, and other quarry The second largest local governmentresources to cities and municipalities. House expense is on Economic Services with a shareBill 1607 seeks to give additional sources of of 35 percent in 1989 which steadily declinedrevenue to provinces by requiring component through the years, with only 22 percent sharecities to share their collection from real to total LGU expenditures by 2003. property taxes with the provinces. These Economic Services refers to activities directedproposals should be carefully examined in towards the promotion and enhancementview of the inequities in tax assignments and and the attainment of desired economicthe IRA allocation formula. growth. Included in this category are agricultural, veterinary and natural resource services, architectural and engineeringLocal government services, operation of local enterprises suchexpenditures: trend and as markets, slaughter house, transportationcomposition, 1989-200328 and waterworks among others, cooperative programs, livelihood projects and other Table 3 and Figure 7 show that local economic development programs.governments spent most of their resources onGeneral Public Services. General Public Services Rounding up the major components of LGU(GPS) include the essential requirements to expenditure are education and health servicesrun the government such as the executive and housing and community development.and legislative services, treasury, assessment, Education, Culture, Sports and Manpowerbudgeting and auditing services, property Development covers expenditures for theand supply administration, and information support of schools and education facilities,services. GPS is highest in the late 80s thru planning and manpower development, sports,early 90s, reaching its peak at 49 percent in cultural preservation and enrichment. Health Services pertains to expenditures for national28 The period covered does not include the following years: 2004-2009 because of noise in the latter years. There is a need health programs including medical, dental and to review the Schedule of Appropriation, Allotment, Obligation and Balances (SAAOB) for local government units especially in nutrition services. Housing and Community view of the recent shift to the New Government Accounting System (NGAS). Development includes expenditures for the 19
  • 27. Fiscal Decentralization in the Philippinesprovision of housing and sanitary services, of their budgets to general public services.promotion of community development, slum Expenditure for economic services follows asclearance, zoning and pollution control. the second biggest item of expense. There is a need to review local public expenditure Education, Culture, Sports and Manpower management for more efficient allocation ofDevelopment experienced a rise and fall trend resources. It seems that there is a relativelystarting with an 8 percent share in total small allocation of investment in humanexpenditure in 1988, dropping to 4 percent capital (education, health and nutrition) andin 1991 and then back at 8 percent in 1992. infrastructure relative to other expenditureA steady decline followed until it reached its items. General public services are basically forlowest point in 2002 at 5 percent. Though general administration needed for the dailyHealth Services also experienced a decline from routine of running a local government. A1988 to 1992, it posted a 7 percent increase recent paper by Llanto and Quimba (2010)from 4 percent in 1992 to 11 percent in 1993. hypothesizes that local governments haveShare of Housing and Community Development under-spent for health and education. Whilein the total expenditure did not change that the common view is that local governmentsmuch posted a 5 percent share in1988 are so cash-strapped that they do not have the Figures 8, 9 and 10 indicate how the funds for better service delivery, it may be thatdifferent type of LGUs allocated their a more efficient expenditure management maybudgets. All of them allocate a bigger portion be able to address the lack of service delivery among the local population.Figure 7: Distribution of LGU Expenditures, All LGUs 1988-2003100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Other Purposes Economic Services Social Services Housing and Community Dev’t Social Security, Labor & Welfare Employment Health, Nutrition & Population Control Education, Culture, Sports General Public Services20
  • 28. Table 3. Distribution of LGU Expenditures, All LGUs, 1988-2003   1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 GRAND TOTAL 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 GENERAL PUBLIC SERVICES 40.88 43.19 47.32 44.53 49.32 41.77 40.02 38.36 39.44 39.20 39.87 39.93 40.41 40.66 44.42 41.25 EDUCATION,CULTURE, SPORTS 8.01 6.78 3.94 3.58 8.09 7.35 7.11 7.16 7.54 8.06 8.59 7.45 7.35 7.59 5.24 6.30 HEALTH, NUTRITION & POPULATION CONTROL 5.53 4.94 4.55 4.19 4.34 11.15 11.60 11.41 12.43 12.18 12.66 12.22 11.58 11.43 11.43 10.85 SOCIAL SECURITY, LABOR & WELFARE EMPLOYMENT 0.74 0.64 0.71 0.70 0.12 0.03 0.08 0.07 0.07 0.08 0.05 0.03 0.04 0.02 0.03 0.02 HOUSING & COMMUNITY DEV’T 5.37 5.31 4.58 4.83 5.76 5.96 6.12 5.78 4.84 4.35 4.23 4.39 4.28 5.11 3.92 4.79 SOCIAL SERVICES 1.67 1.95 2.21 2.13 1.66 2.32 2.15 2.06 2.19 2.18 2.22 2.19 2.34 2.45 2.29 2.42 ECONOMIC SERVICES 34.96 32.84 32.24 35.76 25.49 25.48 26.29 27.62 26.60 25.95 24.09 25.19 25.04 24.56 22.30 22.36 OTHER PURPOSES 2.83 4.36 4.45 4.27 5.22 5.95 6.63 7.52 6.89 8.01 8.28 8.60 8.96 8.19 10.37 12.01 TAX-EXPENDITURE ASSIGNMENT Chapter 321
  • 29. Fiscal Decentralization in the PhilippinesFigure 8: Distribution of Total Expenditures - All Provinces, 1988-2003 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 0 10 20 30 40 50 Other Purposes Economic Services Social Services Housing and Community Dev’t Social Security, Labor & Welfare Employment Health, Nutrition & Population Control Education, Culture, Sports General Public Services22
  • 30. Chapter 3 TAX-EXPENDITURE ASSIGNMENTFigure 9: Distribution of Total Expenditures - All Municipalities, 1988-2003 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 0 10 20 30 40 50 60 70 Other Purposes Economic Services Social Services Housing and Community Dev’t Social Security, Labor & Welfare Employment Health, Nutrition & Population Control Education, Culture, Sports General Public Services 23
  • 31. Fiscal Decentralization in the PhilippinesFigure 10: Distribution of Total Expenditures - All Cities, 1988-2003 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 0 10 20 30 40 50 Other Purposes Economic Services Social Services Housing and Community Dev’t Social Security, Labor & Welfare Employment Health, Nutrition & Population Control Education, Culture, Sports General Public Services24
  • 32. Chapter 3 TAX-EXPENDITURE ASSIGNMENT A joint study by the Asian Development units is an empirical question. There has beenBank and the World Bank in 2005 pronounced an improvement in public service delivery butthat overall the devolution of expenditure perhaps not in a significant way for all localresponsibilities to LGUs is consistent with the government units. Llanto and Quimba (2010)principle of subsidiarity (ADB 2005)29. The report recent findings of a survey conductedreport also noted that few devolved activities by the Philippine Institute for Developmenthave spillover benefits outside LGU territorial Studies, namely that:jurisdictions and that the Code allowed LGUs • For health, despite more than 10 yearsto regroup into larger cooperative units when after devolving this function to localthey deem appropriate. As proof, it cited government units, there is still an overlap inseveral cases of inter-LGU cooperation in the provision of services by LGUs and thecoastal resource management, solid waste national government. LGUs still have notmanagement, water supply development fully built capacity to provide better healthand distribution, and construction of inter- care services. Finally, LGUs and the centralmunicipal roads. Metropolitan arrangements government’s Department (Ministry) ofhave also appeared in several places. Loehr Health have not clearly identified cost-and Manasan (1999) find that the devolution sharing and assignment of functionsof expenditure responsibilities to LGUs is regarding delivery of health service.generally consistent with the decentralizationtheorem. The devolved activities are those “that • For education, the School Basedcan be provided at lower levels of government Management approach which centers on. . . and few of them have benefits that spill giving the authority to school principals andover outside the territorial jurisdiction of involving parents and other stakeholders inthe LGUs with exception of those related to school decisions is a good start for properenvironmental management” (Manasan 2005, phasing and right-sizing of functions yetpage 37)30. to be devolved. However, there is need for clear and proper delineation of functions, During the period after the enactment of capacities and funds between local andthe Local Government Code, there seems to national a marked increase in LGU spending asmore resources had been made available to • For LGUs to better manage their ownLGUs. A JICA study (2008) notes that the top water resources there is a need for a clearthree service areas where improvement with delineation of powers, functions, anddevolution was noted in sample provinces, responsibilities, institutional development,cities and municipalities are: 1) social welfare; and source of financing.2) health and nutrition; and 3) agriculture Pending better data and the conduct ofand fisheries. Undoubtedly the changes more systematic and in-depth studies, therebrought about the passage of the 1991 Local seems to be at best only anecdotal evidenceGovernment Code have resulted in an increase supporting claims of improvement in servicein LGU spending. delivery in several local government units. On the other hand, whether there has been an For example, Klugman (1994) reportsoverall improvement of public service delivery, a Philippine study by Jimenez and othersgovernance and local development now that (1988) that for given levels of enrolmentthese functions are with local government and quality, schools which rely more heavily29 Asian Development Bank (2005), Decentralization in the on local funding are more efficient. There Philippines: Strengthening Local Government Financing & Resource Management in the Short Term, Mandaluyong City: is a lower cost of delivery of education Asian Development Bank30 An exception is education (Manasan, 2005). services. They also find that students at 25
  • 33. Fiscal Decentralization in the Philippinesschools which relied more heavily upon local According to Brillantes and Tiu Sonco, sincefunding had better ‘achievement scores’. A its establishment in 1994, Galing Pook hasspecial education fund, a surcharge on taxes received over 3000 nominations. Close toon real property is administered by the 250 programs coming submitted by somelocal school board composed of the school 152 local governments have been awarded.principal, local government representative These initiatives range from the protectionand parents. The ADB (2005) noted a of the environment, delivery of health andgrowing number of examples of excellence sanitation, agricultural and educationalin service delivery, which seem to indicate services, local economic development, culturethat well-performing local governments may and tourism and livelihood generation. Tablebe distinguished by their ability to access 4 shows the number of Galing Pook awardsresources more effectively, and manage given since 1994.them more transparently and accountably.Table 4. Number of Awardees per Award Category (1994 – 2009)31Rank Award Category No. of Awardees1 Environmental Protection 512 Local Economic Development 403 Health and Sanitation 344 Local Administration and Management 245 Sustainable Agriculture 216 Livelihood/Income Generation 197 Culture and Tourism 148 Local Governance 149 Social Welfare and Development 1410 Public Infrastructure 1211 Socialized Housing 1212 Education 1013 Peace and Security 1014 Integrated Area Development 815 Multi-sectoral Cooperation 716 Disaster Management 617 Child and Welfare Protection 518 Gender Sensitivity 519 Inter-LGU Cooperation 520 Protective Services 521 Power and Telecommunication Program 422 Information Technology 323 Water Supply 324 Capability Building 225 Justice System 226 Population 227 Advocacy 128 Sports Development 1 Source: Galing Pook Foundation 2010.31 Table prepared by Giana Aira Barata and Joebert Sayson, undergraduate students under the guidance of Prof. Jose Tiu Sonco II.26
  • 34. Chapter 3 TAX-EXPENDITURE ASSIGNMENT There is a need to have a closer look at the 17 (f ) and Executive Order 53 to implementexpenditure assignment of local government projects involving devolved activities onunits. An ADB (2005) report indicates the justification that those projects supportthat surveys done to assess satisfaction national objectives.with public services point to mixed resultson local government performance in the Section 17(c) and Section 17 (f ) of thePhilippines. Local areas continue to suffer 1991 Code have provided the opportunity forfrom a myriad of problems — uncertain access central government line agencies to continueto potable water and electricity, declining to implement devolved public works andliteracy rates, environmental degradation, infrastructure projects and other facilities,rising unemployment rates, lack of low- programs and services. Funding is madecost housing, and unreliable police and fire available under (a) the central governmentdepartment services. There is a need to invest budget provided under the Annual Generalin infrastructure and social services. Recent Appropriations Act, (b) special laws, (c)studies have also pointed out the mixed results executive orders and (d) foreign sources suchon local government performance in the as official development assistance (ODA).country (e.g., Capuno, 2007 and Brillantes, In sum, how should one characterize theLlanto, Alm and Sosmena, 2009). current status of tax-expenditure assignment? The examination of the expenditure In general, local own-source revenues areassignment of local government units inadequate and cannot effectively coverindicates a room for improvement. Section 17 the LGUs expenditure assignment. The(b) of the 1991 Code provides an explicit and experience in the almost twenty year periodclear expenditure assignment across levels of after the enactment of the law shows agovernment with the exception of environment significant mismatch in the tax-expenditureand natural resources management. However, assignment33. Uchimura and Suzuki (2009)the following section 17 (c) allows national succinctly declare the issue as a case of(central) government agencies to continue expanding local expenditure responsibilitywith the implementation of devolved public while the local fiscal capacity is notworks and infrastructure projects, and strengthened. There is an obvious need for another programs and services. The national appropriate matching of tax and expendituregovernment has also issued Executive Order assignments if local governments are to53, which empowers national government efficiently deliver public services.agencies to manage and control all foreign- The 1991 Code looked at fiscal transfers asassisted and nationally funded projects, even if instruments to close the fiscal gap. As shownthose projects may involve devolved activities. in the following section, there is much room In addition, Section 17 (f ) allows the for improvement in the distribution formulanational government to or the next higher for the internal revenue allotment.LGU level to “provide or augment the basic Total LGU expenditure is consistently largerservices and facilities assigned to a lower than the total local income and revenueslevel of local government unit when such (except 2002) as depicted in Figure 11. Incomeservices or facilities are not made available, generated from local taxes and other operatingof if made available, are inadequate to meet income are not enough to finance all of thethe requirements of its inhabitants.32” Loehr local government activities and to implementand Manasan (1999) observed that national 33 The 1991 Local Government Code was enacted into law ongovernment agencies have exploited Section October 1991.32 See Manasan (2007) for an extended explanation. 27
  • 35. Fiscal Decentralization in the Philippinesits programs and projects. The gap between for provinces (Figure 13). The 1991 Codetotal expenditure and total local income provided for a huge share of local governmentwidens as the years go by. In 1989 total income units in the national internal revenue more than half of the total expenditures but The IRA was increased to 40 percent thus,by the mid-90s it is only about a third. It is enabling the local government units to financethe substantial amount of the IRA that made all their local expenditure requirementsit possible for local government units to cover although the provinces still face fundingtheir expenditure needs (Figure 12). Without constraints (Figure 14). The other figures (15the fiscal transfer, local development would and 16) re-enforce the observation made herehave been at a standstill. that were it not for a substantial increase in the IRA, local government units would have faced Looking at the three types of LGUs, before a huge funding constraint. The inefficient tax-the passage of the 1991 Code, IRA made expenditure assignment has to be supportedup for the shortfall of local tax and non-tax by the internal revenue allotment.revenues for cities and municipalities but notFigure 11: Local Income vs. Total Expenditure - All LGUs, 1988-2003 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Total Income Local Income28
  • 36. Chapter 3 TAX-EXPENDITURE ASSIGNMENTFigure 12: Total Income with IRA vs. Total Expenditure - All LGUs, 1989-2003 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Total Income Total IncomeFigure 13: Total Income with IRA vs. Total Figure 14: Total Income with IRA vs. TotalExpenditure - by Type of LGU, 1990 Expenditure - by Type of LGU, 1990 Cities Municipalities Provinces Cities Municipalities Provinces Total Expenditures Local Income + IRA 29
  • 37. Fiscal Decentralization in the PhilippinesFigure 15: Local Income vs. Total Figure 16: Local Income vs. TotalExpenditures, by type of LGU, 1990 Expenditures, by type of LGU, 2003 Cities Municipalities Provinces Cities Municipalities Provinces Total Expenditures Local Income + IRA Total Expenditures Local Income30
  • 38. Chapter 4 iNTERGOVERNMENTAL FISCAL TRANSFERSCHAPTER 4 INTERGOVERNMENTAL FISCAL TRANSFERS Intergovernmental transfers are traditionally to achieve the grantors’ objectives and upholdviewed as instruments to close the vertical local autonomy at the same time, while input-fiscal gap between revenue and expenditure based conditionality is deemed to promoteat the local level that naturally arise in a the culture of opportunism and rent-seekingdecentralized government. However, this (Shah 2007). Conditional grants may or maysimplistic notion fails to take account of not be matched by local funds (cost-sharing).the other uses of transfers such as a toolfor horizontal fiscal equalization and forthe attainment of national objectives.34 By Designing fiscal transfersand large, intergovernmental transfers are a Regardless of form, intergovernmentalnecessary complement to decentralization – transfers should be determined in a systematicas it serves as a powerful instrument to realize manner. However, there is a no “one-size-the benefits from decentralization, while fits-all” pattern of transfers that is universallyminimizing without undermining national appropriate. Bird (2001) lists three criticalobjectives of efficiency and equity. aspects of intergovernmental transfer design: (1) role of conditionality and matching grants; (2) distributable pool; and (3) basis forInstruments of intergovernmental distributing transfers.fiscal transfers The form of intergovernmental transfer that There are two main types of is most appropriate to use depends largely onintergovernmental transfers or grants, namely, its effects on grant objectives and its impact ongeneral-purpose (unconditional) and specific- local government behavior. The grant objectivepurpose (conditional) transfers.35 General- should be unambiguously and accuratelypurpose transfers are general budget support defined, and should have singular focus togiven to local governments with the simple guide grant design: design follows objective.objective of enhancing overall welfare, whilepreserving local autonomy. In contrast, If the main objective is to close the verticalspecific-purpose transfers are conditional fiscal gap, that is, the difference betweengrants aimed at targeting specific types of own-source revenues and expenditures, thenexpenditure (input-based conditionality) or unconditional (formula-based) transfers seemattaining specific results in service delivery proper but only as a last resort because such(output-based conditionality). Both types transfers weaken accountability (Shah 2007).of transfers may either be mandatory or Accountability warrants that local governmentsdiscretionary in nature. at least raise some revenues to fund expenditures which have been devolved to them. Between the two types of conditionalgrants, output-based conditionality is thought In Shah (2007)’s opinion, it is crucial to pull the stops to the sources of the vertical fiscal34 See Boadway and Shah (2007) for a complete discussion of the role of transfers. gap through a combination of policies such35 The succeeding discussion on the instruments of intergovernmental transfers is taken mainly from Boadway (2007). as the reassignment of tax and expenditure 31
  • 39. Fiscal Decentralization in the Philippinesresponsibilities, tax decentralization, and unanticipated changes in the fiscal conditiontax-base sharing. In the latter case, local of local governments. Bird (2001) favorsgovernments levy supplementary rates on a transferring a fixed percentage of central taxesnational tax base. or current revenues that is adjustable every few years to local governments.36 Yet again, unconditional (formula-based)transfers can also be used to equalize fiscal The distributable pool should be allocatedcapacities (that is, the ability to raise own- according to a formula that is simple andsource revenues) to an explicit standard across transparent. The formula should incorporatejurisdictions as Shah (2007) has expounded. objective measures that are not easily manipulated and should be disseminated widely to help To the extent that the goal is to compensate garner acceptability and support. In principle,for expenditure need differentials that stem the formula for general-purpose transfers shouldfrom differences in demographics, age include measures of fiscal capacity and needs –distribution, and poverty incidence across that is, any preferred degree of fiscal equalizationjurisdictions, the equalization payment should could be built into the formula.37be in the form of conditional non-matchingtransfers. The equalization transfers should Fiscal capacity is estimated using eitherpartly compensate only intrinsic deficiencies macroeconomic variables 38 such as grossin fiscal capacity and need, discounting domestic product and factor income, or thedifferences in costs that emanate from representative tax system approach,39 whichconscious policy choices or differences in the uses measures of potential revenue-raisingefficiency in resource utilization (Bird 2001). capacity and not actual revenues. Most developed and transition economies have When the central government prioritizes equalization components in their formulas,certain service areas, and requires that while only a few developing countries includeminimum national standards for quality, specific capacity measures in their formulas dueaccess, and level of services be met, it is to data constraints and weak local autonomyappropriate to make transfers conditional with respect to local taxes. Expenditure needson output results. Conditional output-based are either determined in an ad hoc fashionnon-matching transfers foster innovative using simple measures or estimated using theand competitive ways to service delivery, representative expenditure system approach40.without undermining local autonomy andbudget flexibility. Service areas that generate Canada uses arbitrary measures ofexternalities or spillovers are better handled by population, location, urbanization, andconditional open-ended matching transfers, social assistance, among others (Shahwhich place no limit on the funds provided. 1994) to quantify needs, while AustraliaInfrastructure deficiencies are best dealt by determines fiscal need using the representativeusing capital grants with matching local funds. 36 Another way of determining the distributable pool is through a system where governments at the same level establishConditional matching transfers promote local a common fund, which are distributed among them. Thisownership of the program. system of revenue pooling is practiced in Germany, the Russian Federation, and other countries. 37 In contrast, conditional matching transfers contain indicators The total pool of resources for distribution specific to the financed projects and activities. 38 In general, macroeconomic indicators do not reflect the abilityshould be determined in a predictable yet flexible of local governments to raise revenues from own sources (Boadway 2007). Moreover, the availability of accurate andmanner to help local governments effectively timely data at the local level proves problematic. 39 The representative tax system approach measures fiscalplan their expenditure program. A transfer capacity by the revenue that the local government could raise if it employs all of the standard sources at the nationwide averagemechanism should be able to provide medium- intensity of use.term projections of funding availability, 40 The representative expenditure system approach determines what each local government would have spent if it had nationalwhich could be adjusted to accommodate average fiscal capacity but actual need factors.32
  • 40. Chapter 4 iNTERGOVERNMENTAL FISCAL TRANSFERSexpenditure system approach as part of its to their citizens for the actions they undertakefiscal equalization program. – at least at the margin of decision-making is crucial. The basic challenge in transfer design Clearly, ad hoc or discretionary transfers are is thus how to provide local governmentsnot advisable. In Canada and Germany, both with sufficient fiscal transfers or block grantsthe resource pool and its distribution are based to carry out responsibilities devolved to themon a formula, as opposed to the arbitrary without generating perverse incentives to localdetermination of the distributable resource government behavior. There is good case forpool by the central government through an matching transfers with local contributionsact of parliament in Australia and Switzerland or counterpart funding to create a sense of(Shah 2007). ownership and thus, encourage accountability As a general rule, there is room for both of local governments. Moreover, a well-general-purpose and specific-purpose transfers designed transfer system should be able to(Smart 2007). General-purpose transfers accord budgetary flexibility and autonomy inmay incorporate fiscal equalization: transfers setting priorities to local governments.should be inversely proportional to fiscalcapacity and vary directly with fiscal needfactors. However, only a handful of countries Philippine internal revenuechoose to implement a comprehensive fiscal allotmentequalization program, despite the general Fiscal decentralization leads to the transferconsensus in the academic literature that of responsibility for delivery of certain publicit enables local governments to provide a goods to local government units, whichstandard package of public services with a typically may not be adequately covered bystandard level of taxes on the bases at its local revenues (Bird and Rodriguez, 1999)41.disposal. Most countries only opt for a fiscal The enactment of the 1991 Local Governmentcapacity equalization program due to its relative Code has resulted in a remarkable increase intransparency and achievability. Fiscal need the size and composition of central governmentequalization, though important, necessitates transfers to local government units. The localusing subjective judgments and inexact governments in the Philippines heavily reliesanalytical methods. Rather than implement it on the internal revenue allotment (IRA)as part of a comprehensive fiscal equalization or central government transfers to LGUs,program, fiscal needs compensation is better to close the vertical fiscal gap. Figure 17achieved through conditional output-based shows how the internal revenue allotmentnon-matching transfers for merit goods, (the intergovernmental fiscal transfer) isas practiced in many industrial countries transferred from the central government to the(Boadway and Shah 2007). local government units. The point made by Boadway and Shah (2007)on the basic tasks in transfer design aboutmaking local governments fully accountable 41 Source: Department of Budget and Management website ( 33
  • 41. Fiscal Decentralization in the PhilippinesFigure 17. Release Procedure of the Internal Revenue Allotment99 Bureau of Internal Revenue submits to Department of Budget and Management (DBM) certification of collections made and 40% share of LGUs. DBM verifies with Bureau of Treasury the collections remitted and computes the share of LGUs based on formula as provided under Section 285 of RA No. 7160, the Local Government Code. DBM Central Office (CO) programs the amount and releases the allotment comprehensively to the DBM Regional Office (RO) at the start of the year. DBM CO issues the Notice of Cash Allocation (NCA) monthly for deposit with the Government Servicing Banks of DBM ROs. Subsequently, the DBM RO issues the funding check for credit of IRA share to the individual bank account of the LGUs. The Local Government Code of 1991 was revenue taxes was 20 percent. The total amountrevolutionary in its impact on decentralization. of the internal revenue allotment is based onIt assigned greater responsibilities for service the collection of national internal revenue taxesprovision to local governments and also entitled in the third year preceding the current one at athem to receive 40 percent of national internal rate of 40 percent.revenue taxes. The internal revenue allotment is Philippine intergovernmental fiscal transfersdistributed on the basis of a formula. Prior to are of three types: (a) the internal revenuethe 1991 Code, the share in national internal allotment (IRA), a formula-based grant, (b)42 Bird, Richard M. and Edgard R. Rodriguez (1999), and a share in national wealth and (c) ad-hoc “Decentralization and Poverty Alleviation: International conditional grants. Table 5 shows these three Experience and the Case of the Philippines,” Public Administration and Development, No. 19, pages 299-319. types of transfersTable 5 . Fiscal transfers to local government units Fiscal transfers Before the Code After the Code Revenue share Internal revenue allotment Internal revenue allotment Specific tax allotment Share in national wealth LGU revenue stabilization fund Share in tobacco excise tax Budgetary aid to LGUs Barangay development fund Grants Calamity fund Calamity fund Municipal development fund Municipal development fund Countryside development fund Local government empowerment fund Countryside development fund DECS school building program I focus on the internal revenue allotment, be mentioned in passing and will not bewhich comprise the biggest and most discussed in detail43.important type of fiscal transfers. The othertypes of fiscal transfers (a) share in national 43 These should be studied in the near future for their allocativewealth and (b) conditional grants will only effects, among others.34
  • 42. Chapter 4 iNTERGOVERNMENTAL FISCAL TRANSFERS The share in national wealth comes from LGUs. The money for LGSEF was carved outmining taxes, royalty from mineral reservation, of the IRA, which diminished block grant toforestry charges, energy resources production LGUs. The government later discontinuedand tobacco excise tax and does not accrue the LGSEF. Through the congressionalto all LGUs. Conditional grants come from insertions or pork barrel, the legislator(i) lump sum allocations under the central substitutes his own preferences to those ofgovernment budget, (ii) allocations made by the local government units, which have theircentral government sector agencies from their own preferences. Because of the informationown budgets and (iii) lump sum and/or line advantage, the LGUs would have a betteritem appropriations for pork barrel funds of idea of what programs, projects and activitieslegislators. The problem with conditional that would lead to higher local welfare. Ingrants is that they become available depending this light, congressional discretionary fundson the fiscal position of the central government and the enjoinment to spend those fundsand/ or political objectives of legislators and according to the wish and whim of legislatorsthe central government. For example, the would be welfare-reducing.Local Government Service Equalization Fund(LGSEF) created by Executive Order 48 Table 6 shows the relative shares of differentof 1998 during the Estrada administration local government units in the IRA before andwas funded from the aggregate IRA share of after the Code.Table 6. Percentage Shares of LGUs in the Internal Revenue AllotmentType of LGU Before the Code After the CodeProvinces 27.0 23Cities 22.5 23Municipalities 40.5 34Barangays 10.0 20Total 100.0 100 As Table 6 shows, the biggest gainers in terms to Congress to convince legislators to pass aof relative share from the internal revenue law converting them into cities. Thus, evenallotment are the barangays. Provinces and those municipalities, which do not qualify tomunicipalities have lower shares after the become cities have begun to pull legislativepassage of the 1991 Code. The cities gained the strings for the favor.most because of an increase in IRA allotmentbut also because there are fewer cities than The distribution of the IRA to individualprovinces and municipalities. This has created local government units follows the weightedan incentive among municipalities to troop formula shown in Table 7.Table 7 Distribution Formula for the Internal Revenue AllotmentFactors Before the Code, % weight After the Code, % weightPopulation 70 50Land area 20 25Equal sharing 10 25Total 100 100 35
  • 43. Fiscal Decentralization in the Philippines The internal revenue allotment is the single on IRA as a significant source of revenue, tendbiggest dominant source of local revenues for to have weak fiscal autonomy. In addition,local government units. As shown in Table any change or fluctuation in the size of7 above, as of latest data available, the IRA the IRA can pose a danger to local revenueaccounts for 67 percent of total local income. stability as pointed out by Manasan (2007)For provinces, it is as much as 82 percent of and Uchimura and Suzuki (2009). Thelocal income and 78 percent for municipalities. amount of the IRA for distribution to localIn contrast around 47 percent of local income governments depends on the fiscal position offor cities comes from the internal revenue share. the national government. Weak collection ofClearly, the IRA is skewed toward the cities, national internal revenue taxes by the nationalwhich ironically have the bigger and more government can lead to a reduction in the sizebuoyant local tax bases. Thus, the combination of the IRA. In times of fiscal stress felt at theof bigger and more buoyant tax bases and a national level, there could be delays in therelatively larger share of the IRA result in greater release of the internal revenue allotment (IRA)fiscal autonomy for cities than for the other to local government units.types of local governments. It is no wonderthat cities can provide better services to the The formula-based revenue sharing led tolocal populace than other local governments. local governments largely substituting the new revenues from the central government for own- Provinces and municipalities are much more source revenues, especially the local propertydependent on IRA than cities. In any case tax. The situation on the IRA is summarizedlocal governments, which continue to depend by a JICA (2008) study. Please see Box 3. Box 3. The internal revenue allotment vis-à-vis other sources of local income • For the period 2002-2006, IRA has been the biggest source of revenue of LGUs, contributing, on the average, 63% of the total revenue. • Locally-sourced revenue consisting of tax and non-tax sources contributed, on the average, 32% of the total revenue. Its share to the total revenue indicated a slightly increasing trend from 31% in 2002, to 33% in 2006. • Revenues from the real property tax and business tax represent 24% of the total revenue. • Except for a slight decline from the real property tax in 2004 and from the business tax in 2006, tax collection performed well during the period, recording their highest growths of 23% and 30%, respectively in 2005. The principal issue is how to make the IRA Distributable resource poolwork better for local government units. Oates(2006) underscores the need for proper design Intergovernmental fiscal transfers in theand proper use, which must provide a set of Philippines come in three forms: (1) internalincentives consistent with the objectives of the revenue allotment or IRA (formula-based);fiscal transfer and stresses the need for a grant (2) share in national wealth (origin-based);system to be transparent and predictable. and (3) ad hoc conditional transfers.44 TheAccording to Oates, there needs to be a well 44 The share in national wealth, which is obtained from mining taxes, royalty from mineral reservation, forestry charges, energyunderstood set of rules such that the system resources production and tobacco excise tax, are not conferred to all LGUs. Conditional grants are sourced from the following:cannot be “gamed” to one’s own advantage (i) lump sum allocations under the central government budget;(page 27). (ii) allocations from the budgets of central government sector agencies; and (iii) lump sum and/or line item appropriations from discretionary congressional funds (Llanto 2010).36
  • 44. Chapter 4 iNTERGOVERNMENTAL FISCAL TRANSFERSIRA is the major transfer bestowed by the should be distributed to local governmentscentral government to the LGUs as a fixed according to performance. Policy makersshare (40 percent) of actual internal revenue have yet to agree on what the performancetax collections of the central government three indicators would look like.years prior to the current year. This tax-sharingarrangement45 adopted in the Philippines has An alternative to tax sharing could bethe advantage of guaranteeing LGUs a sure tax base sharing, in which several levels ofsource of revenue, while leaving room for fiscal government share the same tax base. However,autonomy46. Just as important as increasing tax base sharing can lead to tax disharmony,the size of the IRA, its predictability helps higher compliance costs, and distortions inLGUs program and manage their expenditures fiscal policy progressivity, and if the sharingeffectively. is not properly designed. Hence, revenue decentralization (through tax base sharing) to On the downside, this type of revenue enhance accountability comes at the price ofsharing, that is, the IRA creates disincentives efficiency and equity. This alternative needsto both the central government and the local careful study.government. Manasan (1995) finds that theIRA substituted for local tax revenues in each The upshot is that tax harmonization schemestier of local government in 1992 and 1993, could be instituted without stripping LGUs ofwhile it had a neutral effect on local revenue the accountability to decide on the amountperformance prior to the Code (1985). of own-source revenues to be raised. While such harmonization would not completely On the part of the central government, eliminate unhealthy tax competition or taxthe IRA represents a substantial cut from exporting, it would certainly diminish thethe resources that are finally made available complexity of the tax system and thwart moreto it after deducting payments for principal detrimental forms of fiscal competition suchand interest charges of various foreign loans. as sector-specific taxes or subsidies. CanadaThe relatively low tax effort on the part of the has been successful in harmonizing its taxcentral government leaves a relatively thin system because tax abatement at the centralmargin of resources for financing national level gave room to sub-national governmentsgovernment development programs and to levy supplementary rates on the nationalprojects. tax base. Therefore, the proposal by the Senate to The choice of the appropriate type of revenue-widen the distributable pool by tapping into sharing system has to consider issues of impactall national taxes and not only the internal on fiscal autonomy, incentives, efficiency,revenue taxes (Senate Bill 118) should be and equity. Under a tax-base sharing system,weighed in the light of its effects on local it is important that the central governmentautonomy and incentives, and also on central regulate intergovernmental competition forgovernment fiscal behavior. The emerging the sake of efficiency and equity in resourceview is that the percentage share will be allocation. Although tax base sharing couldincreased from 40 percent to 50 percent of only be used for destination-based taxes, itnational internal revenue taxes. One variation is instrumental in getting to the bottom ofof this view is that the incremental 10 percent both vertical and horizontal fiscal gaps, while allowing LGUs fiscal autonomy. Tax base45 Tax sharing is a type of revenue sharing where the central sharing that incorporates an equalization government collects and shares its revenue (the IRA in the case of the Philippines) with the LGUs. The second type is tax base formula is less targeted than unconditional sharing in which the higher-level government sets the tax base and lower levels either piggyback or charge supplementary transfers (from tax sharing). rates on higher-level government taxes.46 Assuming that the local government units will be serious about raising own-source revenues. 37
  • 45. Fiscal Decentralization in the PhilippinesDistributive and allocative LGU territory arising from the combinationformula of the land and municipal coastal waters. The proponents believe that a redefinition of Two of the most contentious issues in the “land” to include coastal waters will lead to anIRA debate are the proportion of national increase in their share of the IRA.revenues (the IRA) to be shared by the nationalgovernment with LGUs, and the formula for As pointed out by several analysts, the IRAthe allocation of transfers. formula lacks an equalizing feature, that is, measures of fiscal capacity and fiscal need. On the first issue, there are proposals to Legislators may have chosen proxy indicatorsincrease the size of the IRA from 40 percent such as population, land area and equal sharingto 50 percent of national internal revenue to stand for fiscal need. Size of the populationtaxes by the various leagues of government, or and land area tend to bias the share in the IRAto even as high as 60 percent by the Senate in favor of cities, which as earlier shown, enjoy(Senate Bill 8). These proposals have to take broader taxing powers and a more revenueinto account the disincentive effect of simply buoyant tax base.increasing the size of the IRA transfer fromits current level. Simply increasing the size A proposed change to the IRA distributionof the IRA will not automatically close the formula is to increase the weight given tovertical fiscal gap because of the demonstrated equal sharing, which has increased from 10incentive of LGUs to substitute it for own- percent to 25 percent under the 1991 Code.source revenues, which will erode the gains The proposal ignores the heterogeneity offrom an increased transfer. A variant of this local government units with vast differences inproposal is to award incremental IRA over resources available and needs.and above the current levels conditional to At present, the IRA formula does not includelocal government performance. A conditional fiscal capacity measures either, promptingtransfer of incremental amounts could be a proposal to include fiscal effort into thetied to some measure of performance, e.g., equation. Fiscal effort is hard to measure,demonstrated increase in local own-source and even if it could be calculated in a reliablerevenue effort, better local expenditure fashion, incorporating it in the IRA equationmanagement, and others. A matching effort would pose some difficulties (See Shah 2007to improve governance, make more efficient for a complete treatment). An example wouldprocurement, better management of the local be the incentives it would have on LGUs,environment by the local governments may especially the poor ones47, to impose higherbe used to justify a share in the envisaged taxes so as to profit from larger transfers.incremental IRA. The poor LGUs have smaller or weaker tax Currently, the IRA is distributed to LGUs bases because of weak local economies, andaccording to this formula: population (50 emigration of the local population, mostlypercent); land area (25 percent); and equal the young and educated to the richer (that is,share (25 percent). There are proposals to higher income) LGUs and to foreign countriesinclude additional variables in the formula where job opportunities are present. Thissuch as poverty index, municipal waters as does not mean that the design of the fiscalpart of the LGU “territory”, which will be in transfer should exclude fiscal or tax effort as aaddition to “land” as an item in the formula, determinant. It is certainly useful to considerrevenue capacity, and fiscal effort. Adding 47 The ‘poor’ LGUs are those belonging to the 4th to the 6th“municipal coastal waters” to the distribution income class and are mostly municipalities. The Bureau offormula is a ploy to increase the size of the Local Government Finance of the Department of Finance has six income classification of local government units.38
  • 46. Chapter 4 iNTERGOVERNMENTAL FISCAL TRANSFERSit but designing a distribution formula that There is a need for a thorough study ofresponds to fiscal need especially of the all those proposals to arrive at the mostlower income (poor) LGUs and at the same appropriate formula given the country’s socio-time motivates them to mobilize significant economic-political context. A haphazardamounts of own-source revenues is a very formula without the benefit of an empiricalchallenging task. study may do more harm than good compared to the present distribution formula. 39
  • 47. Fiscal Decentralization in the Philippines40
  • 48. Chapter 5 LOCAL GOVERNMENT FINANCING CHAPTER 5 LOCAL GOVERNMENT FINANCING48 The 1991 Code provides substantial48 Land Bank of the Philippines, (the dominantborrowing powers to local government units. lending institution), Development BankThis is a radical departure from the pre- of the Philippines and two specializedCode situation where they would need the credit institutions, the Local Water Utilitiespermission of the Department of Finance to Administration (LWUA)49 and the Municipalincur borrowings. The liberalization of LGU Development Fund Office (MDFO)50. Itcredit markets has spurred lending by both is noted that these government lendinggovernment and private financial institutions. institutions have mostly used loans providedThe 1991 Code has also allowed local from official development assistance bygovernment units to float debt instruments donor institutions such as the World Bank,such as bonds and a few local government Asian Development Bank, and the Japanunits have actually ventured into tapping the International Cooperation Agency to financecapital markets to finance revenue-generating LGU programs and projects.projects. The LGU credit markets is dominated by However, despite the liberalization of LGU loans from government lending institutionscredit markets, policy makers imposed certain but recently it is reported that a few privatelimitations to LGU borrowing powers: (a) commercial banks have started to lend to alocal government units cannot issue general select group of local government units, that ispurpose bonds, (b) debt service should not those belonging to the first and second incomeexceed 20 percent of their regular income, class. Available data from the Bureau of Local(c) they must budget for due debt service, Government Finance and government lending(d) final clearance on bond flotation must institutions indicate total LGU outstandingbe given by the central bank, which under debts of around Peso 68.02 billion as ofthe New Central Bank Act must render September 2010, of which close to 86 percentan opinion on the impact of the proposed are from government lending flotation on monetary aggregates, theprice level, and the balance of payments, (e) There have been a few LGU bonds issued tothe central government does not provide a the public. This mode of financing failed tosovereign guarantee to LGU borrowings. To catch on due primarily to the underdevelopedborrow from any lending institution, local nature of the Philippine domestic bondgovernments have to get a certification of their market, and also because the governmentborrowing and debt service capacity from the lending institutions, using ODA funds, haveBureau of Local Government Finance of the managed to provide lower cost credit to localDepartment of Finance. government units. Data from the Local Government Unit Guarantee Corporation The principal sources of credit financing (LGUGC), a private corporation that insuresare government financial institutions: the bond issuances of local government units,48 A more detailed discussion is given in Llanto, Gilberto 49 LGUs, which organize water districts, can borrow from LWUA. and others (1998). Local Government Units’ Access to the 50 The MDFO is a unit under the Department of Finance, which is Private Capital Markets. Makati City: Philippine Institute for used to channel official development assistance (ODA) to local Development Studies. governments. It caters mostly to the lower-income LGUs. 41
  • 49. Fiscal Decentralization in the Philippinesindicate a total of Pesos 3.25 billion pesos The main issue is the reluctance ofworth of bonds issued by sixteen LGUs from government banks to move from their1999 to 201051. monopoly (or more accurately, oligopoly) position in LGU credit markets. They have Overall, local government units have a discovered that LGU lending is very profitablesmall appetite for credit financing with and almost risk-free because of the IRA-the exception of a relatively small number, intercept wherein LGUs can pledge theirwhich have tapped both loans and bonds for IRA as security for a loan. If they default onfinancing various local projects. The emerging their loan amortization, the government bankLGU bond market has been effectively stifled can seize the IRA. This privilege is accordedby the availability of cheaper loans provided only to government banks because they areby government lending institutions. On the designated depository banks for localthe other hand, the interest expressed by a government units. There have been calls tofew private commercial banks in lending to allow private banks to also be designated aslocal governments belonging to the first and depository banks, which will start a financialsecond income class is a good signal because relationship between them and the localcompetition in credit markets is bound to government units. The financial relationshipbenefit the local government units in terms of will help deal with the information problemlower cost credit and better service by lenders. that private banks have with local government units, and thus encourage private bank51 The LGUGC was organized by the Development Bank of the lending. This is a policy issue that should be Philippines (a government bank) and several private commercial banks in 1997. addressed by policy makers.42
  • 50. Chapter 6 CONCLUSIONS AND RECOMMENDATIONSCHAPTER 6 CONCLUSIONS AND RECOMMENDATIONS In conclusion, decentralization and has somewhat diminished the taxing power ofdevolution have ushered a radical approach provinces in favor of cities. There is a needto steering Philippine development. to review the tax assignment in view of theDecentralization was done both on the vertical and horizontal fiscal gaps as shown bypolitical and fiscal fronts. This paper the data.provided an overview of the situation of fiscaldecentralization in the Philippines. There is also a great need to review the policy and distribution formula for Local governments have been given broad intergovernmental fiscal transfers, basicallytaxing, spending and borrowing powers, which the internal revenue allotment. It is not anthey have utilized to discharge the functions efficient formula in the sense that it fails toand responsibilities that have been devolved address issues of local fiscal capacities andto them. Overall, it seems that there have fiscal needs. Performance-based grantsbeen some improvements in service delivery seem to open pathways for instilling greateras indicated by the increase in local spending accountability on the part of local governmentfor various public goods and services. The units. At present, the central government andexpenditure assignment seems appropriate donors are collaborating on the installationalthough there is a room for reform when it and implementation of performance-basedcomes to the need for a clearer delineation of grants, which seems to have found resonancepublic expenditure responsibilities between among the more progressive local governmentthe central government and local government units.units, especially in the fields of health,education, environment and natural resource There is a case for policy reforms in LGUmanagement. There is also a case of more financing and credit markets to make it moreefficient local public expenditure management. competitive. Official development assistance could be used to catalyze greater participation The tax assignment is also in order but the of private commercial banks in the LGU creditdrawback is that the more productive taxes markets. Addressing risks and informationhave not been assigned to local government asymmetry will build confidence in LGU debtunits. The 1991 Code has set certain limits instruments.on the taxing powers of local governments and 43
  • 51. Fiscal Decentralization in the Philippines44
  • 52. BIBLIOGRAPHYBibliography Asian Development Bank (2005), Decentralization in the Philippines: Strengthening LocalGovernment Financing & Resource Management in the Short Term, Mandaluyong City: AsianDevelopment Bank Atienza, Maria Ela (2006), “Local Governments and Devolution in the Philippines,” in NoelMorada and Teresa Encarnacion, editors, Philippine Politics and Governance: An Introduction,Department of Political Science, University of the Philippines. Bird, Richard M. and Edgard R. Rodriguez (1999), “Decentralization and Poverty Alleviation:International Experience and the Case of the Philippines,” Public Administration and Development,No. 19, pages 299-319. Bird, Richard M., and Michael Smart. 2001. “Intergovernmental Fiscal Transfers: SomeLessons from International Experience.” Canada: University of Toronto. Boadway, Robin B., and Anwar Shah. 2007. “Intergovernmental Fiscal Transfers: Principlesand Practice.” Public Sector Governance and Accountability Series, Washington: World Bank. Brillantes, Alex, Gilberto M. Llanto, James Alm and Gaudioso Sosmena (2009),“Decentralization and Devolution in the Philippines: Status, Triumphs, Tests and Directions,”Report submitted to the Department of the Interior and Local Government, unpublished paper,April 29 Ebel, Robert and Serdar Yilmaz (2002), “On the Measurement and Impact of FiscalDecentralization,” Policy Research Working Paper 2809, The World Bank, March; Guevara, Milwida (2004), “The Fiscal Decentralization Process in the Philippines: Lessonsfrom Experience,”, date accessed August 29, 2011. Joumard, Isabelle and Per Mathis Kongsrud. 2003. “Fiscal relations across government levels.”Economics Department Working Papers No. 375, Organization for Economic Cooperation andDevelopment, December 10. Llanto, Gilberto M., Rosario Manasan, Mario Lambert and Jamie Laya (1998), LocalGovernment Units’ Access to the Private Capital Markets, Makati City: Philippine Institute forDevelopment Studies. Llanto, Gilberto M. (2009) “Decentralization, Local Finance Reforms and New Challenges:The Philippines,” a paper presented at the Third Symposium on Decentralization and LocalFinance at the Institute for Comparative Studies in Local Governance (COSLOG), NationalGraduate Institute for Policy Studies, Tokyo, Japan on March 10. Llanto, Gilberto M. and Francis Quimba (2010), “Decentralization and Local Service 45
  • 53. Fiscal Decentralization in the PhilippinesDelivery,” paper prepared for the Local Government Foundation, unpublished. Loehr, W. and R. Manasan (1999), “Fiscal Decentralization and Economic Efficiency:Measurement and Evaluation,” CAER II Discussion Paper No. 38, Harvard Institute forInternational Development, Cambridge, M.A. Manasan, Rosario G. 2005. “Local Public Finance in the Philippines: lessons in autonomyand accountability.” Philippine Journal of Development. Second Semester 2005, Vol. XXXII No.2: 32-102. Manasan, Rosario G. 2007a. “Decentralization and the Financing of Regional Development.”The Dynamics of Regional Development: The Philippines in East Asia. Ed. Arsenio M. Balisacanand Hal Hill. Asian Development Bank Institute. Manila: Edward Elgar Publishing Ltd. andAteneo de Manila University Press. Manasan, Rosario G. 200b7. “IRA Design Issues and Challenges.” Policy Notes No. 2007-09.Philippines: Philippine Institute for Development Studies, December. Oates, Wallace (1996), “Comment on ‘Conflicts and Dilemmas of Decentralization’ by RudolfHommes,” in Bruno, Michael and Boris Pleskovic, editors, Annual World Bank Conference onDevelopment Economics, Washington, D.C.: The World Bank, pages 351-353. Oates, Wallace (2006), “On the Theory and Practice of Fiscal Decentralization,” IFIR WorkingPaper No. 2006-05, May; Oates, Wallace E. 1972. Fiscal Federalism. New York: Harcourt BraceJovanovich Tanzi, Vito (1996), “Fiscal Federalism and Decentralization: A Review of Some Efficiency andMacroeconomic Aspects,” in Bruno, Michael and Boris Pleskovic, editors, Annual World BankConference on Development Economics, Washington, D.C.: The World Bank, pages 295-316. Tayao, Edmund (2010), “Decentralization in the Philippines: Impact on Politics andGovernance,” unpublished paper, December 09. Smoke, Paul (2001) “Fiscal Decentralization in Developing Countries: A Review of CurrentConcepts and Practice,” Democracy, Governance and Human Rights Programme Paper Number2, United Nations Research Institute for Social Development, February. Uchimura, Hiroko and Yurika Suzuki (2009), “Measuring Fiscal Decentralization in thePhilippines,” IDE Discussion Paper No. 209, Institute of Developing Economies, July.46
  • 54. THE GLOBAL URBAN ECONOMIC DIALOGUE SERIESThis report examines the fiscal decentralisation experience inPhilippines. Since 1991, the central government has devolvedsignificant spending, taxing, and borrowing powers to localgovernments. This paper discusses fiscal decentralization in thePhilippines. It reviews the tax regimes in view of the verticaland horizontal fiscal gaps. Local governments receive inter-governmental fiscal transfer or block grants called the ‘internalrevenue allotment’ based on a formula that has population, landsize and equal sharing as criteria. In contrast, performance-basedgrants seem to open pathways for instilling greater accountabilityon the part of local governments. To make financing moreaccessible and competitive to local governments, it demonstratesthe need to pursue further reforms in credit markets.HS/129/11EISBN Number(Series): 978-92-1-132027-5ISBN Number(Volume): 978-92-1-132414-3UNITED NATIONS HUMAN SETTLEMENTS PROGRAMMEP.O.Box 30030,Nairobi 00100,Kenya;Tel: +254-20-7623120;Fax: +254-20-76234266/7 (Central office)