Manajemen | Fakultas Ekonomi Universitas Maritim Raja Ali Haji 00074910152669163

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THE NEW INDONESIAN EQUALISATION TRANSFER

Blane D. Lewis

To cite this article: Blane D. Lewis (2001) THE NEW INDONESIAN EQUALISATION TRANSFER, Bulletin of Indonesian Economic Studies, 37:3, 325-343, DOI: 10.1080/00074910152669163 To link to this article: http://dx.doi.org/10.1080/00074910152669163

Published online: 17 Jun 2010.

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THE

NEW

INDONES IAN

EQUALIS ATION

TRANS FER

BlaneD.Lewis*

ResearchTriangleInstitute,NorthCarolina

Thispaperexaminestheintergovernmentalgeneralpurposeequalisation transfer (DAU)thatbeganoperatingin2001.First,a description of themechanismhigh

-lightsthesignificant distributional roleplayedbythe‘balancingfactor’relativeto the‘formula’,andthekeydifferences indistribution proceduresfordistricts/mu

-nicipalities andprovinces.Second,theapproachandmethodsareempirically ana

-lysedandevaluated.ThesumsavailabletotheDAUappearmorethansufficientto meetregionalgovernments’ netexpenditurerequirements,atleastinaggregate,and givensomecaveats.Theallocationmechanismhassomedesignflawsinbothits structure andthe methodsituses tooperationalise expenditure needsandfiscal capacity.Third,anexamination ofthe‘equalising’effects ofthetransfer scheme showsthatconclusions aboutequalisation dependverymuchonhowonedefines and operationalises the concept;policy makersneedto beclearabout whatthey wanttheDAUtoaccomplishinrespectofequalisation.

INTROD UCTION

Indonesiahasembarkeduponanambi

-tiousprogramoffiscaldecentralisation.

Theeffort has its genesis in two laws,

bothpromulgated inMay1999,oneon

administrative mattersandtheotheron

fiscaland finance issues(Republik In

-donesia1999a,1999b).1_These_two_laws

have been supplemented by a large

number of implementing regulations.

Beginninginfiscalyear2001,provincial

and local governmentsassume major

newexpenditure responsibilities. Sub

-stantial functions for provinces have

been outlined in a 1999 government

regulation(RepublikIndonesia1999c).

Local government responsibilities, re

-grettably,havebeenonlyrathervaguely

definedviaa‘negativelist’,butarenone

-theless expected to be considerable.

Kabupatenandkota(districtsandmunici

-palities)essentially becomeresponsible

forallpublicservicesthatthecentraland

provincialgovernments donotdeliver,

at least in 11 important areas: public

works, health,education and culture,

agriculture, communications,industry

andtrade,capitalinvestment, environ

-ment,land,cooperatives andlabour.

Regionalgovernments havenot,un

-fortunately,beenawardednewauthor

-ity overany majortaxbases.2_Districts

and municipalities will instead be al

-lowedtocreatetheirowntaxesthrough

local by-laws, provided they satisfy a

numberof‘goodtax’criteria(Republik

Indonesia 2000d). Regional govern

-mentsalsonowgainaccesstosignificant

amounts of natural resource revenues

(fromfisheries,forestry,mining,gasand

oil)3_and,_in_addition,_receive_a_share_of

personalincometax.4_Furthermore, _two

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grants have been created: the Dana

AlokasiUmum(DAU,GeneralPurpose

Fund)andDanaAlokasiKhusus(DAK,

SpecificPurpose Fund). The latter has

notyetbeenmadefullyoperational,and

the2001fiscalyear’sallocationsarerela

-tivelyinsignificant. Thesetwotransfers

together replace the old system of

SubsidiDaerahOtonom(SDO,Autono

-mous Region Subsidy) and Instruksi

Presiden (Inpres,Presidential Instruc

-tion)grants.5

ThemaingoaloftheDAU,according

to existing lawsand regulations, is to

‘makeeven thefiscal capacities of re

-gionalgovernments tofinancetheirex

-penditureneeds’.6_It_has_therefore_been

widelyreferred to asan ‘equalisation’

grant. The DAU will be a significant

source of finance for regionalgovern

-mentsin2001andbeyond;itwillfund

approximately one-third of provincial

andbetweentwo-thirdsandthree-quar

-tersoflocalgovernmentexpendituresin

this firstyear.And itwill clearlyoffer

regionalgovernmentsmoreflexibilityin

its usethan existed undertheold sys

-tem.Forthefirsttime,regionalgovern

-mentswillhavecompleteauthorityover

howtheyspendthegrant.

Itmaybehelpfultorecogniseatthe

outsetthatallocationproceduresdiffer

significantly betweendistricts/munici

-palitiesandprovinces.Thedistribution

mechanismfordistrictsandmunicipali

-tieswasdevelopedfirst,anditwassub

-sequently discovered that the same

mechanism could not be applied to

provinces.The particular reasons for

and consequencesof thiswill become

clearer below. Whilesome descriptive

referencesare made to provinces, the

empiricalfocus of the paperis onthe

DAUallocationmechanismsfordistricts

andmunicipalities.

ItisperhapsbesttothinkoftheDAU

allocation mechanism as being devel

-opedintwostages.Thefirstconsistsof

theproceduresgeneratedbytheMinis

-tryofFinance(MOF)duringtheperiod

upto15November2000,whentheallo

-cations were first approved by the

DewanPertimbangan OtonomiDaerah

(DPOD,RegionalAutonomyAdvisory

Co uncil) and (sem i-officially) an

-nouncedtodistricts/municipalitiesand

provinces.7_Soon_after_the_original_allo

-cations were announced, certain as

-sumptions in the draft state budget

(RAPBN,RancanganAnggaranPenda

-patandanBelanjaNegara)werealtered.

These changes (relating most impor

-tantlytothepriceofoilandtheforeign

exchangerate)resultedinanincreasein

thetotalamountofmoneyavailableto

theDAU, and this aggregateincrease,

ofcourse,necessitated achangeinindi

-vidualdistrict/municipalityandprovin

-cial allocations. The MOF took this

opportunity to make so me other

changestotheallocationsystemaswell.

Thesecondstage,therefore,comprises

theadjustments madetotheoriginalal

-locationproceduresthatresultedinthe

new distributions. These latter alloca

-tionswereapprovedbytheDPODand

ratifiedintheformofaPresidential De

-cision (R epublik Indo nesia 2001a)

signedbythethenpresidenton20De

-cember2000.

THEDAU

ALLOCATIONM ECHANISM

District/M unicipalityAllocations

District/municipalityDAU allocations

maybewritten:

DAUi=BFAi*+FAi+LSAi (1)

where BFA is the balancing factor

amount(andtheasterisk denotesad

-justmentstoitasdescribedbelow),FA

istheformulaamount,andLSAisthe

lumpsumamount.Thesubscriptire

-fers to district/municipality govern

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BalancingFactorAmounts.Thebalanc

-ingfactorwas,ingeneral,conceivedof

asamechanismto‘preventadownturn

inthecapacityofregionalgovernments

to finance their new responsibilities’

(Republik Indonesia2000b: article 17).

Inactuality, it attemptstodo two dis

-tinct things at once. First, it aims to

operationalise a‘holdharmless’condi

-tion:toassureeachdistrict/municipal

-itythatitreceivesthisyear(2001)atleast

asmuch(innominalterms)asitdidin

thelastfiscalyear(2000)inannualised

SDOandInpresgrants.8_Second,_it_seeks

toaccountforpossiblenewexpenditure

requirements thatresultfromthetrans

-ferofstaffandfunctions(i.e.salariesand

otherassociatedcosts)fromthecentral

government and its deconcentrated

agencies(kantor wilayahor kanwil and

kantordepartemenorkandep)todistricts/

municipalities. Thesenewrequirements

areassumedtobecoveredbya30%in

-crease in SDO and a 10% increase in

Inpresgrantsfromthepreviousyear.9

The basic balancing factor amount

canbewrittenas:

BFAi=1 3. ·SDOi+1 1. ·INPRESi (2)

whereSDO andInpres areannualised

nominalamountsfromFY2000.

The balancin g factor was subse

-quentlyadjustedforsomelocalgovern

-mentsaftertheaggregateamountofthe

DAUincreasedasaresultofthealtered

assum ptio ns in the draft budget.

Clearly,theallocations themselveshad

tobeadjustedtoreflectthenewbottom

line, although the particular adjust

-mentsmadetothemechanismwerenot,

ofcourse, required bytherise intotal

DAU.Adjustmentsmadeto theorigi

-nal distributions include those to in

-crease the fundingfor newly created

districts/municipalities, for example,

and were implemented by arbitrarily

increasingthecoefficients ofSDOand/

orInpresinequation(2)above.10_Details

oftheseadjustmentsare notgenerally

available and theyarenotfurtherdis

-cussedhere.

Formula Amounts.In equationform,

theformulaamount(FA)fordistricts/

municipalities canbewrittenas:

FA DAU BFA FG

where DA U_T₁ represents the total

amountofDAUbudgetedfordistricts/

municipalities beforebasicassumptions

inthedraftbudgetwerechanged;BFA

isasdefinedabove;andFGisthefiscal

gap.

Thefiscalgapisdefinedasthediffer

-encebetween‘expenditureneeds’(EN)

and‘fiscalcapacity’(FC).Thatis:

FGi=ENi-FCi (4)

The DAU formula defines expendi

-tureneedsastheproductofaveragelo

-cal government expenditure and an

expenditure needsindex.Expenditures

areactualamountsfrom1999/2000lo

-calgovernmentbudgets(AnggaranPen

-dapatan dan Belanja Daerah, APBD).

Theneedsindexis afunctionofpopu

-lation,area,poorpopulation, andacost

element. Data for these variables are

from the most recent years available.

Variables, data yearsand datasources

arelistedintheappendix.

Morespecifically,expenditure needs,

asdefinedinthepertinentgovernment

regulation (Republik Indonesia 2000b)

canbeexpressedbytheequation:

(5)

whereAPBDEXPis local government

expenditure, Popisthepopulation, Area

issurfacearea,Povisthenumberofpoor

people,andCostisacostindex(defined

moreprecisely below).ThesubscriptT

indicatesthetotaloftheparticularvari

-ableinquestionacrossalldistricts/mu

-nicipalities, andnisthenumberoflocal

governments.11

Fiscalcapacityisdefinedinthegovern

-mentregulationastheaverageacrossall

localgovernments ofthe sumofactual

localown-sourcerevenues,propertytax,

andchangeinpropertytitletax,multiplied

byanindexoffiscalcapacity.Government

revenuesare actual amountsfrom the

1999/2000regionalbudget.Thefiscalca

-pacity index is a function of natural

resources sectoroutput, non-natural re

-sourcessectoroutput,andtheworkingage

population. Again,variables, years and

sourcesaredetailedintheappendix.

Inequationform,fiscalcapacitycan

bewritten:

where,OSRislocalown-sourcetaxand

non-taxrevenue,SPTissharedproperty

taxandsharedchangeofpropertytitle

taxrevenues,NRO is natural resource

sectoroutput,NNROisnon-naturalre

-sourcesectoroutput,GRDPisgrossre

-gionaldevelopment product,LFis the

workingagepopulation, andPopisthe

populationasbefore. Subscriptsareas

definedabove.12

Lump Sum Amounts. The difference

betweenthetotalsecondstageDAUand

thesumoftheadjustedbalancing fac

-tor and formula amounts might be

termedthe‘residual’:

Residual DAUT BFAi FAi

where DAU_T₂ is the total DAU after

changestothedraftbudget.The lump

sumamountreceivedbyeachlocalgov

-ernmentisgivenby:

LSA Residual

n

i= (8)

where, again,n is thenumberoflocal

governments.Table1summarisesaggre

-gatedistrict/municipality DAUtransfer

amounts by balancing, formula, and

lump sum elements before and after

draft budget assum ptions were

changed.

ProvincialAllocations

TotalannualisedSDOandInpresgrants

toprovincesinFY2000(Rp7.7trillion)

exceededthetotalamountofDAUavail

-abletoprovincesinFY2001(Rp6.1tril

-lion).Thismeantthatitwasnotpossible

to implement the same distribution

mechanism as that developed for dis

-tricts/municipalities and described

above.Adifferentsetofproceduresfor

allocating the DAU among provinces

wasthereforederived.

Theadoptedprocedureisstraight

-forwardandbeginswiththerecogni

-ti o n t ha t, i n th e f i r st r o u n d o f

estimations for districts/municipali

-ties,thebalancingfactorandformula

amountsmadeupapproximately80%

and20% of thetotal district/munici

-palityDAU,respectively.Withaview

tobeingconsistent,itwasdecidedto

usethosepercentagefiguresintheal

-location of provincial DAU. It was

thereforeresolvedtodistribute80%of

totalprovincialDAUacrossprovinces

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Inpres grants and 20% as a function

ofthefiscalgap,asdescribedabove.

Inequationform:

DAU DAU

whereallvariablesareasdefined above,

andthesubscriptiandDAU_T₂nowap

-ply to provinces instead of districts/

municipalities.

D AUPOOLOFFINANCEAND

ALLOCATIONM ECHANIS M

D ES IGN

PoolofFinance

Bylaw,the totalpooloffinance avail

-abletotheDAUis,ataminimum,25%

ofdomesticrevenuesnetoftheportions

distributed toprovincialandlocalgov

-ernmentsthroughthe various revenue

sharingschemes.13 _In_2001, _total _DAU

amountsto Rp60.5 trillion. Intheag

-gregate,thissumappearstobesufficient

to cover the net expenditure require

-mentsofregionalgovernments.

This assertion requires alittle more

explanation. Strictly speaking,whatis

actually required by regional govern

-ments,intheformofDAU,isafunction

oftheirspecificserviceresponsibilities,

thelegitimatecosts related tocarrying

outthoseresponsibilities, andtheother

fiscalresources(i.e.revenuesfromown

sourcesandothertransfers)thatregional

governments mightreasonably be ex

-pected to have at their disposal to fi

-nance the delivery of such services.

Unfortunately,thesethreethingsarenot

knownwithanydegreeofcertainty.The

statementabovethattheDAUis,into

-tal, sufficient tocover netexpenditure

needsisbasedmerelyonacomparison

ofpastexpenditures (bothautonomous

regional government and deconcen

-trated agency expenditures), pastrev

-enues(own-sourceandsharedproperty

taxrevenues),andprojectednewshared

revenues andothergrants(fromnatu

-ral resources,incometax,andthespe

-cific-purpose transfer),and noton real

needs and capacities. Table 2 summa

-risesthepertinentdata.

Also by law,provinces receive 10%

anddistricts/municipalities receive90%

ofthetotalamountoftheDAU.14_In_2001,

these sharing arrangements meanthat

provinces and districts/municipalities

takeinRp 6.1trillion andRp 54.5tril

-TABLE1 SummaryofDistrict/MunicipalityDAUAmountsBefore(DAU_T₁) andAfter(DAU_T₂)DraftBudgetChanges

DAU DAU_T₁ DAU_T₂

Component (Rptrillion) (%) (Rptrillion) (%)

Balancingfactor 40.4 80.1 44.0 80.9 Formulaelement 10.1 19.9 10.1 18.5 Lumpsum n.a. n.a. 0.4 0.6 Total 50.4 100.0 54.5 100.0

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lion,respectively,inDAUdistributions.

Again,theseamountsappeartobesuf

-ficient to cover both provincial and

district/municipality expenditure re

-quirements,intheaggregate,andbythe

standards adopted above. This state

-mentismadewithsomewhatlesscon

-fidence for provinces than it is for

districts/municipalities.

Astable2shows,theDAU,together

with other sources of provincial rev

-enue, appears to be just adequate to

covertotal expected expendituresfor

provinces. Given the uncertainty sur

-roundingtheseestimates,itwouldnot

beverysurprisingifprovinceswereto

experienceanaggregateshortfallinfi

-nancing.Ontheotherhand,districts/

municipalities seem to have signifi

-cantlymorethanenoughintheaggre

-gate to cover their net expenditure

requirements.15_Even_the_uncertainty_of

thedatashouldnotthrowthisconclu

-sionintodoubt.Inanycase,thesecon

-c lu si o ns abo ut th e adeq uac y o f

provincial and district/municipality

DAU allocations are made with the

same caveat about the nature of the

dataas ismadeabove for overall ad

-equacyofDAUfunding.

Itisimportanttostressthatthenew

spendingrequirementsofprovincesand

TABLE2 EstimatedRegionalGovernmentFinances,2001a (Rptrillion)

All Provinces Districts/Municipalities

Expenditure

Routine 31.6 8.4 23.2 Development 15.0 5.5 9.4

Ex-kanwil/kandep 18.2 3.2 15.0

Total 64.8 17.1 47.6 R evenue

OSR 10.5 6.5 4.1

SPT 5.6 2.3 3.4

SNRR 11.5 2.7 8.8

PIT 3.1 1.2 1.9

DAK 0.7 n.a. 0.9

Total 31.7 12.7 19.0 Revenue– expenditure –33.1 –4.4 –28.7

DAU 60.5 6.1 54.5

S urplus 27.5 1.6 25.8

a_{‘Routine’}_and_{‘Development’}_are_based_on_actual_expenditures_by_regional_governments _in

1999/2000.‘Ex-kanwil/kandep‘isfromplannedroutineexpendituresbythedeconcentrated agenciesinFY2000.‘OSR’isown-sourcerevenueand‘SPT’issharedrevenuesfromprop

-ertytaxandtransfer oftitleonpropertytax, bothderivedfrom 1999/2000.‘SNRR’and ‘PIT’areestimatedsharedrevenuesfromnaturalresourcesandpersonalincometax,re

-spectively,bothfor2001.‘DAK’isthe2001budgetedamountforthespecificpurposegrant. Allfigureshavebeenannualisedandadjustedforexpectedincreasesinsalaryandinflation whereappropriate.

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districts/municipalities include only

ro utine-side expenditures o f the

(form er) deconcentrated agencies

(kanwilandkandep).Thatis,onlykanwil

andkandepstaffcostsandassociatedrou

-tineexpenditures(DaftarIsianKegiatan,

DIK)haveofficiallybeenturnedoverto

provincesanddistricts/municipalities.

Regionaldevelopmentspending(Daftar

Isian Proyek, DIP) has not explicitly

been decentralised yet. This regional

DIPspendinginFY2000amountedto

approximately Rp 25 trillion (in

annualised amounts). Under the as

-sumptionthatresponsibility fordevel

-opment activities formerly carried out

bydeconcentratedagencieshasnotbeen

devolved, one reasonable conclusion

hereisthatthecentralgovernmenthas

transferred too much revenue to local

governments, givenothersourcesoffi

-nance available. Among other things,

thisimpliesanaddedandunfortunate

pressure onan alreadyoverburdened

central government budget.16 _In _addi

-tion,theanalysis suggests thatthear

-rangem ents for s haring the DAU

between provinces and districts/mu

-nicipalities may not be appropriate,

giventheextenttowhichtheirrespec

-tivenet expenditure requirementsare

coveredbygeneraltransfers.

AllocationM echanismD esign

There area numberofdesignand op

-erational flaws in theDAU allocation

mechanism,andsomeofthemoresig

-nificantarediscussedbrieflyhere.

HoldHarmlessProvisions.Typically,a

holdharmlessprovisionwouldbestruc

-turedintoanallocationmechanismwith

a view to assuring local governments

thattheywillreceivenolessthanacer

-tainamount.Inthecurrentcontext,that

guaranteedamountisintendedtobethe

sum of last year’s SDO and Inpres

grants.Buttheparticularholdharmless

mechanismemployed hereassures all

regions(at bothprovincialanddistrict

level) that they receive that pledged

amountplussomeadditionalallocation

(derived from the formula). This sug

-geststhestrongpossibilityofsignificant

‘overfunding’ forsome regions,above

thelevelatypicalholdharmlessprovi

-sionwouldimply.

NewandOldExpenditureRequirements.

The DAUallocation mechanism treats

newandoldexpenditure requirements

quite differently. As explained above,

newexpenditure requirements, thatis,

thosethatderivefromthedecentralisa

-tionofnewserviceresponsibilities, are

estimated asthesumof30% and10%,

respectively, of last year ’s SDO and

Inprespaymentsforallregions.Thedis

-tribution mechanism guarantees this

amounttoeachregion,regardlessoffis

-calcapacity.Ontheotherhand,oldex

-penditure requirements areaccounted

forintheformulaelementofthemecha

-nism;thatis,theyarefirstoffsetbypo

-tentially available revenues and then

thatnetamountrelative tothesumof

allsuchamountsisusedtoallocatere

-sidualDAU.Themore consistentway

tohaveaccountedfornewexpenditure

needswouldhavebeentoincludethese

estimated requirements intheformula

term.

Inaddition,theaccuracyofthesepar

-tialSDOandInpresdistributions asan

estimate of new expenditure require

-mentscanatleastbequestioned. Anal

-ternative proxy that might have been

used for estimating those needs was

deconcentratedagency(kandep)routine

(DIK)anddevelopment (DIP)expendi

-tureonthosefunctionstobetransferred

tolocalgovernments. Whileitmustbe

admittedthat region-specific informa

-tion on deconcentrated development

coststobetransferred wasoftensome

-what suspect, reliable deconcentrated

expenditure dataontheroutinesidedid

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thetimetheallocationtoolswerebeing

designedandoperationalised.

Specification of Cost Index. The main

problemwiththecostindexconcernsits

specification, more particularly the

methodbywhich itinfluencesaverage

expenditures in the determination of

expenditure requirements. Usually a

costindexwouldbeappliedtothemeas

-ure of expenditure directly (that is,

multiplicatively).So,forexample,ifthe

costfactorinoneregionwere10%higher

thanthebase(typicallysetequalto100),

expenditurerequirements wouldbead

-justedby10%inthemoreexpensivere

-gion,allotherthings remainingequal.

Inthecurrentcase,thecostfactorinflu

-encesaverageexpenditures afteritsef

-fects have been averaged with three

other index variables. So, to continue

withtheexample,ifaparticularregion’s

costsare10%higherthanthebase,ex

-penditure requirements are adjusted

upwardbyonly2.5%,otherthingsbe

-ingequal.

WeightsofVariousFactorsAffectingthe Expenditure NeedsIndex.Theoverallex

-penditureneedsindex iscalculated as

the unweighted average of the indi

-vidualindexvariables.Thatis,eachin

-dex variable is assumed to be equally

importantin determining expenditure

requirements.Thisisaquestionable no

-tion.International experienceandcom

-mon sense suggest that population is

probably moreimportantthan areaor

poverty, for example, in determining

overallspendingneeds.Ifthisisthecase,

then the population variable should

havereceived alargerweightthanthe

otherindexvariablesindeterminingthe

overallindex.

Specification ofAverageRevenuePoten

-tial.Ascanbeseeninequation(6),fiscal

capacity is defined as average (own

-sourceplusproperty-related)revenues

multipliedbyacapacityindex.Thedefi

-nitionpositsthatbothown-sourceand

sharedrevenuepotentialaredetermined

byconditionsintheparticularjurisdic

-tionand,moreover,suggeststhatlocal

governmentshavesomecontroloverthe

extent towhich collection matchespo

-tential.But,inreality,localgovernments

have much influence only over their

own-sourcerevenues.Sharedrevenues,

including those basedontheproperty

tax,aredeterminedbythecentralgov

-ernment.Thisfactsuggeststhatamore

appropriate formulation wouldbeone

thatpositsfiscalcapacityasaseparate

function of potential own-source rev

-enues,ontheonehand,andsharedrev

-enues, on the other. That is, fiscal

capacity would be set equal to own

-sourcerevenuecapacityplussharedrev

-enues, where the latter are the exact

amountsasdeterminedbycentralgov

-ernment.

Specification of Fiscal Capacity Index

Factors. Average revenue as defined

aboveisadjustedforregion-specificca

-pacityvariablesinordertocomeupwith

anestimateofeachregion’sfiscalcapac

-ity.Therearetwocriticismsthatmight

bemadeaboutthespecification ofthese

fiscalcapacityindexvariables.Thefirst

concerns the selection of variables.

WhileGRDPisclearlyimportantinde

-terminingpotentiallocalrevenues, the

rationale for usin g both NRO and

NNROasseparatefactorsisnotclear.17

Theuseoflabourforcesizeasavari

-ablethatinfluencesfiscalcapacityisalso

somewhat unusual. Typically, one

thinksoflabourasaninputinthepro

-duction process, that is,as a determi

-nant ofoutput and income.From this

perspective,theDAUfiscalcapacityfor

-mulation employs both input (labour

force)andoutput(GRDP)measuresto

determine potential local government

revenues.

Thesecondproblemconcernstheac

-tualstructureofthesub-indexesthem

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each individual indexwas formed by

takingthevalueofthevariableanddi

-viding by theaveragevalue across all

regions.This has some logic to it, of

course.Onthefiscalcapacityside,how

-ever,theindexesareformedthroughthe

useof ‘location quotients’. Here,what

becomesimportantisaregion’sshareof

NRO (and NNRO) in total GRDP as

comparedtonationalNRO(andNNRO)

asa shareof total GRDP across allre

-gions.Thisisatleastinconsistent with

methodsusedfordefiningtheexpendi

-tureneedsindex.

Natural Resource Revenues in Fiscal

Capacity.Perhapsthegreatestproblem

intheestimationoffiscalcapacitycon

-cernstheissueofnaturalresourcerev

-enues. Put simply, natural resource

revenuesarebasicallyignoredinthede

-terminationofcapacity.Inessence,DAU

distributions are awarded on top of

thesesharedresources.Thisisasignifi

-cantwindfall gainforthose localgov

-ernmentsthatreceivelargeamountsof

sharedrevenuesfromnaturalresources.

And,ofcourse,itdiminishestheDAU

allocations thatallotherregionswould

otherwise havereceived. Clearly such

shared revenues should have been

addedtoown-sourcerevenuepotential

alongwithallsharedrevenuesinthede

-termination offiscalcapacity.18_Indeed,

reasonableestimatesofthesesharedrev

-enuesexistedatthetimetheDAUallo

-cationmethodswerebeingdiscussed.

D AUEQUALISATION

PERFORM ANCE

The above critique of the allocation

mechanismhassuggestedtheexistence

ofdesignandoperational flaws.Some

of these shortcomings have possible

negativeimplications fordistributional

equity.Forexample,totheextent that

the(augmented)hold harmless condi

-tionassuressomelocalgovernments of

levelsoffundingthatexceedtheirneeds,

thenotherplacesmightwellreceiveless

thantheyrequire.Asanotherexample,

recall the argument thatphysical area

hasbeen undulystressed indetermin

-ingexpenditurerequirements,andnatu

-ral resource transfers inadequately

accountedforinmeasuringfiscalcapac

-ity.Asitturnsout,manyregionswith

largeareasalsotendtoberichinnatu

-ralresourcerevenues;19_their_local_gov

-ernm ents have therefore had their

expenditure needs overestimated and

their fiscal capacities underestimated.

Th e negative impact of this on the

equityofdistributions shouldbeclear.

Below,twoseparatestandardsareused

toexaminetheimpactofsuchpotential

problemsonachievement ofthegoalof

equalisation.20

Since the equalisation goal of the

DAUtransfer scheme, asstatedin the

law and relevant government regula

-tion,isto‘makeeventhefiscalcapaci

-tiesofregionalgovernments tofinance

theirexpenditure needs’,itisclearthat

apropertestofthemechanism’sequali

-sationeffectswouldrequire,inthefirst

instance,goodmeasuresofexpenditure

needsandfiscalcapacities.Buttheabove

examination oftheDAU formula sug

-gests thatcurrent methodsof estimat

-ingneedsandcapacitiesaresomewhat

flawed.

The analysis proceeds therefore by

firstprovidinganalternativemeasureof

fiscalcapacity.Theargumentisthatthis

revisedmethodisareasonablysensible

one,ingeneral,andclearlybetterthan

that currently employed. Deriving a

soundmeasureofexpenditure needsis