Thursday, 7 December, 2023

Key Issues In Fiscal Relations

Mukti Rijal


The issues of fiscal federalism have dominated the discussions in intergovernmental relations in Nepal. Indeed, the methodology governing the distribution of fiscal resources has been the mainstay of a federal polity. Needless to say, no federal institutions can function effectively unless adequate financial resources and functionaries are provisioned. Another main issue for a federation is the way how the functional assignment is designed, made to operate and produce results. The functions allocated need to be financed and executed properly. Principally, it is accepted that the functions that have their impact on economic stabilisation and income redistribution should be performed and carried out at national level. But the functions related with provision of public goods and service delivery should be carried out at the sub-national level. According to Anwar Shah, renowned fiscal federalism expert "when government decisions are made closer to citizenry rather than in national capital, the public is likely to keep track of the decision about government services and taxes to finance them"
In fact, the way taxing and spending decisions are made and inter-governmental transfers are structured determines the efficiency and effectiveness of the federal governance system. However, in many federal countries assignment of tax and expenditure between national government and sub-national levels is not equitably instituted. And sub-national governments have diminished volume of resources that do not match their needs and requirement. In several cases, local governments are endowed with enlarged and broad-based set of unfunded functions leading to poor execution of functions and delivery of services.
Moreover, local governments are subjected to various financial and capacity constraint .As a consequence, the local government cannot utilise the resources allocated to them nor can they discharge their functions and responsibilities in an effective way. This is more or less the case of Nepal. At one end, some local governments are faced with shortage of funds whereas others are showing tardiness in utilising resources. Recently, federal government has taken decision to freeze the fund allocated to the sub-national governments to indict their lackluster performance in utilisation of resources.
Article 228 of the constitution provides for taxing authority of local government. According to the provision, local governments can generate income through tax, levy fee on services and get loans from banks and financial institutions .The provision empowers the local government to levy tax without creating adverse effects on national fiscal policy, free movement of goods and services, capital and labor market and so on. Article 229 of the constitution provides for consolidated fund in Gaupalika and Nagarpalika. In the consolidated fund, all income like grant transfers from the federal and provincial government, own source revenue, loan and income from other sources need to be deposited. The expenditures from the consolidated fund should be allocated according to the procedure prescribed by the local government operation act.
According to constitution local governments can raise integrated property tax, fee and charges for local services, certain fines and penalties etc. Major income sources of the local government include own tax sources, shared taxes and revenues and inter-governmental transfers. These sources of income contribute local government budget that makes disclosures of the anticipated income for financial year and plan and non-plan expenditures.
Like all government budgets, local government budgets consist of two sides namely an operating/recurring budget which covers the running cost and capital cost which covers the costs for infrastructure development and purchasing new equipment. Local governments are not generally allowed to plan deficit financing unless they have definite source of income that compensates for the deficit and shortfalls. Most importantly the constitution provides for creation of National Fiscal and Natural Resource Commission to devise methodology for distribution of financial resources and natural resources among the three levels of the government.
The commission is entitled to work out an elaborate mechanism and process for distribution of fiscal resources among three tiers of the government. The commission is mandated to work out the design of intergovernmental fiscal relations. Article 251 of the constitution provides a list of roles and functions of the Commission. The major functions of the fiscal commission include reviewing and setting the finances of the government in accordance with the functional responsibilities. The commission prepares an elaborate design for sharing revenue of the divisible pool in the federal consolidated fund, to recommend process for sharing and distribution of equalisation grants to provinces and local government, to create basis for sharing of the tied and conditional grants among provinces and local government.
The commission is also mandated to analyse overall economic indicators to fix upper limit of the internal borrowing for federal, provincial and local government, to review the basis of revenue sharing and suggest measures for effective reform. It works out modality for distribution of natural resources and suggests ways and means to resolve disputes arising out of natural resources distribution and benefit sharing. The commission is thus enjoined with extensive roles and responsibilities. However, it is yet to be fully constituted and made competent enough to function effectively. The chief of the commission has been appointed but other members are yet to be filled in. The government should appoint the members soon. It rests on the commission to ensure that the country's fiscal governance is set on right track to ensure that the multi-level federation envisaged according to the new constitutional arrangement delivers effectively and contributes to the wellbeing of the people.

(Rijal, PhD, contributes regularly to TRN and writes on contemporary political, economic and governance issues. He can be reached at