Fiscal Decentralization Study
In Support of the National Strategy for Poverty Reduction of Kyrgyzstan
TABLE OF CONTENTS
LIST OF TABLES iii
LIST OF FIGURES iii
LIST OF TEXT BOXES iii
ABRREVIATIONS AND ACRONYMS iv
GLOSSARY OF TERMS iv
ACKNOWLDGEMENTS v
1. Introduction 1
1.1 Fiscal decentralization and poverty reduction 1
1.2 The desire to decentralize 2
1.3 Supporting activities in the sector 2
1.4 Objectives 3
1.5 Methodology of this study 3
2. Concepts of Fiscal Decentralization 5
2.1 Comparative advantages of local and national government 5
2.2 Delineation of functions 5
2.3 Transparency 7
2.4 The transfer systems 7
2.5 Deconcentration 11
3. Constitutional and Legal Framework for Intergovernmental Fiscal Relations in Kyrgyzstan 12
3.1 The Constitution 12
3.2 The law on local self-governance 13
3.3 Other defining legislation 13
3.4 Bishkek is Special 18
4. Overall Financial Structure 19
5. Resource Mobilization 21
5.1 General overview 21
5.2 Shared Taxes 26
5.3 Local Taxes and Fees 26
5.4 Local perspective 27
5.5 In-kind payment of tax obligations 29
5.6 Transfers 30
6. Resource Allocation 33
6.1 Process 33
6.2 Empirical Overview 34
6.3 Education spending 37
6.4 Health care spending by republican and local administration 40
6.5 Public Investment by regions 42
7. Findings and Recommendations for Fiscal Decentralization 44
7.1 A Vision for Fiscal Decentralization 45
7.2 Public Investment 54
8. Action Plan for Implementing the Fiscal Decentralization Vision 55
8.1 Objectives 55
8.2 Obstacles to implementation 55
8.3 Assistance to fiscal decentralization 57
8.4 Monitoring progress 58
8.5 Timeframe 58
Reading Materials 60
Appendix I: Persons consulted or participated in roundtable discussions 62
Appendix II: Questionnaire for Fiscal Decentralization from a Local Perspective 65
Appendix III: Statistical Analyses 67
Local taxes and fees 70
Equalization grants 71
LIST OF TABLES
Table 1: Levels of Government 20
Table 2: Distribution of Oblast and Bishkek Revenues (includes all grants), Expenditures and Equalization Grants 21
Table 3: Planned vs. Actual Revenues 22
Table 4: Poverty and Oblast Revenues 23
Table 5: Sources of Local Revenue 24
Table 6: Local Revenues as Percent of Republican Revenues 25
Table 7: Bishkek Revenues as Percent of Republican Revenues 26
Table 8: Actual versus Budgeted Categorical Grants in Chui 30
Table 9: Actual versus Budgeted Categorical Grants in Naryn 31
Table 10: Categorical Grants to Oblasts and Bishkek 31
Table 11: Local Expenditures as Percent of Republican Expenditures 34
Table 12: Oblast Expenditures per Capita in Percentages of National Average 35
Table 13:Total Spending in Issyk-Kul Oblast 36
Table 14: Education Spending from Republican and Local Budgets: by shares 37
Table 15: Education Spending in Issyk-Kul Oblast 38
Table 16: Public health Spending from Republican and Local Budgets 40
Table 17: Health Spending in Issyk-Kul Oblast 41
Table 18: Action Schedule 58
Table 19: Matrix of Correlations of Social, Economic and Fiscal Variables 68
Table 20: Regression Measure of Tax Effort: shared taxes 69
Table 21: Regression Measure of Tax Effort: local taxes 70
Table 22: Alternative Measure of Local Tax Effort 71
Table 23: Regression OUTPUT for Deficits and Poverty 72
Table 24: Regression OUTPUT for Equalization Grants and Poverty 72
Table 25: Incidence of Equalization Grants 73
LIST OF FIGURES
Figure 1: Subsidiarity Schematic 6
Figure 3: Major Revenue Sources for Local Government 25
Figure 4: Oblast Spending by Functions 35
Figure 5: Local Government Spending on Education in Issyk-Kul 39
Figure 6: Local Government Education Spending in all Kyrgyzstan 39
Figure 7: Local Government Health Spending in Issyk-Kul 41
Figure 8: Local Government Health Spending in all Kyrgyzstan 42
Figure 9: Relative per capita Public Investment 199-1999 43
LIST OF TEXT BOXES
Text Box 1: The Skhod 37
Text Box 2: Ashar and Self-Help 41
ABRREVIATIONS AND ACRONYMS
ADB Asian Development Bank
CDF Comprehensive Development Framework
CLC Congress of Local Councils
GDP Gross Domestic Product
GOSKOMINVEST State Planning and Investment Agency
IBRD International Bank for Reconstruction and Development (World Bank)
IMF International Monetary Fund
NATSTATCOM National State Statistical Agency of Kyrgyzstan
NPRSP National Poverty Reduction Strategy Paper
NSPR National Strategy for Poverty Reduction
PIP Public Investment Program
RAC Reciprocal Accounts Clearing
STI State Tax Inspectorate
UNDP United Nations Development Program
UNDP/DP Decentralization Project
USAID United States Agency for International Development
TA Technical Assistance
TACIS Technical Assistance for the Commonwealth of Independent States (EU)
VAT Value-Added Tax
GLOSSARY OF TERMS[1]
ail village or group of villages
ail head head of the ail okmotu
ail okmotu Ail level local government administration
akim head of the rayon (district) administration
gorod city
governor head of the oblast (regional) administration
Jogorku Kenesh National Parliament
kenesh council (elected)
local government refers to all government not comprising republican government:; includes oblasts, rayons, ail okmotus, and all cities
oblast region and regional government administration
rayon district, subordinate to oblast
republican budget includes all revenues, financing and expenditures of the central government
skhod town meeting
state refers to all levels and institutions of the state, including republican and local government
ACKNOWLDGEMENTS
Many people deserve credit for their part in helping bring this report to fruition, especially the persons interviewed, listed in Appendix I, who provided information, feedback, new ideas and insights, comments, and criticisms.
Some people must be singled out, however. The team greatly benefited from guidance and logistic assistance provided by Mrs. Lubov I. Ten. Mr. Arzbek Kojoshev’s assistance was invaluable in facilitating the team’s visits with local governments, ensuring access to information and in discussing findings and recommendations.
This study benefited from the leadership and encouragement provided by Ms. Isabel Ortiz, and from the support provided by Mr. J.C. Alexander. Valuable input, comment and other help was provided by Mr. Jon Cook, Mr. Wolfgang Schwegler-Rohmeis, Mr. Sandy Cuthbertson, Mr. Donald Browser and Mr. Robert Stryk.
The fiscal decentralization team benefited from two roundtable discussions: one, hosted by the UNDP, included participants from the UNDP, the UNDP-funded Decentralization Project, the Council of Local Communities, and the Urban Institute. A second roundtable was held with officials from the Ministry of Finance, the Ministry of Health, the Ministry of Education, and representatives from local governments.
CURRENCY EQUIVALENT
(as of September 6, 2000)
Currency Unit = Som
US$1.00 = Som 50
FISCAL YEAR
January 1 – December 31
43
Fiscal Decentralization Study
In Support of the National Strategy for Poverty Reduction of Kyrgyzstan
43
Fiscal Decentralization Study
In Support of the National Strategy for Poverty Reduction of Kyrgyzstan
1. Introduction
1.1 Fiscal decentralization and poverty reduction
Widespread poverty is a relatively new, yet devastating phenomenon in Kyrgyzstan. During the Soviet era, few people were poor but almost everyone had access to basic services, housing, and adequate nutrition. With the collapse of the Soviet Union, the major mechanism for the coordination of the country’s resources and economic activities also collapsed. There was no alternative system in place to coordinate the decisions essential to a well-functioning economy.
The country is not particularly lacking in resources, neither human nor natural, as is the case with poor countries of the developing world. People are well educated, illiteracy is low, and babies survive their first year of life with considerable success. Diseases that plague the other poor countries of the world, such as leprosy and malaria are not generally found in Kyrgyzstan. Poverty in Kyrgyzstan is not due to lack of wealth. This is a poor but wealthy country.
During Soviet times, people produced bread, milk, shoes and meat according to plan. These plans were mainly formed in Moscow and the Republican Government of Kyrgyzstan was responsible for implementation of these plans throughout Kyrgyzstan. Today’s Republican Government has no Moscow-developed plan and alternatives are still being developed.
Strengthening government, but ensuring its proper role within a newly developing market society, is extremely important to fostering economic growth and helping to reduce poverty. Government should mainly focus on regulatory functions and the provision of an atmosphere that will encourage private sector economic activity. At the same time, government needs to either provide or ensure the provision of basic, essential services, such as law and order, national defense, and a system for adjudicating conflict and to ensure private property.
Government also needs to ensure the provision of certain services. It may directly provide these services or it can facilitate access to these services by funding the demand side of the equation, i.e., pay for patients to get health care services rather than directly fund the health care budget of hospitals and clinics.
Strong, efficient, and well-focused government is needed. One mechanism for developing this capable government is through a decentralized fiscal system. A decentralized fiscal system can play an important role in the new coordination mechanism that can lead to increased private sector economic activity and reductions in poverty. Local government is better positioned to understand the local aspects of social needs, such as the provision of mundane services such as trash haulage, or through activities that will encourage private investment, job creation and wealth accumulation.
Fiscal decentralization can be an important component of poverty reduction and improved governance. In the transition to market economies the collapse of the state-centered economy has usually led to increasing rates of poverty. Measures to include the poor in the benefits that the market system can bestow require special efforts. The decentralization of the fiscal system has been shown to be a viable strategy especially as it can lead to improved governance, transparency and better targeting of fiscal resources.
Decentralized government based on democratic principles, with local determination with respect to resource mobilization and allocation, can help to focus a part of a nation’s resources to meet the most acute needs. Local governments can be instrumental in providing leadership and leveraging resources for local self-help activities. Research has shown that strong local self-government is often much more efficient, compared to central government, in the management or implementation of small to medium sized infrastructure projects, such as road building, bridge construction and community clinics and schools construction and maintenance. There are many reasons for this, including: closer proximity to the work site, closer supervision, “ownership” by those most to benefit from the project, and greater accountability of local officials to local constituents.
Once a government has decided to decentralize its fiscal system, it should take the appropriate steps to ensure that this decentralized fiscal system will meet the goals established for it. This means, the decentralized fiscal system must be representative, have real power at the local level, autonomy from central government, and have real, effective control over resources. At the same time, such a system must be accountable to the people at both the local and national levels. It must be open and transparent, and it should be focused on what the proper role of government is in a fledgling, market economy.
1.2 The desire to decentralize
The Government of Kyrgyzstan has chosen fiscal decentralization as a mechanism for strengthening its system of public governance to encourage private sector growth and to reduce poverty. The Minister of Finance, Mr. S. Mederov (2000) expressed the need to fully develop a decentralized fiscal system. The Mayor of Bishkek, Mr. Kerimkulov (2000) expressed the reinforcing nature of state and local self-government development. The Governor of Batken Oblast, Mr. Ailbalaev (2000), expressed the desire to further decentralize the state, to extend the capabilities and powers of local councils (keneshes), and to have more power transferred to the people at the local level. He said that “The Kyrgyz Republic has had two big tasks since the day of its independence in 1991: to build a developed market economy and to transform the centralized statehood in a de-centralized democratic system of power, based on the principles of local self administration.”
1.3 Supporting activities in the sector
There are already a number of activities that are ongoing that support fiscal decentrallization and local self-government. The UNDP, with Danish trust funds, is supporting the Decentralization Programme. The Decentralization Programme is implemented by the Congress of Local Communities, a Kyrgyz NGO, and supports local government development in pilot ail okmotus of six rayons in three oblasts. The Decentralization Programme also supports policy reform at the national level to create an enabling environment in which local self-governance can thrive.
USAID is supporting a number of activities that are directed toward fiscal decentralization and to some extent, local government strengthening. One project is implemented by the Urban Institute, which works with self-governing cities to strengthen their management capabilities and to increase local participation in local government decision making. Also, USAID is funding a project implemented by a company called The Barents Group. This project is helping the Government of Kyrgyzstan improve its overall fiscal management, including taxation and budgeting. The Barents Group project has provided some assistance in program budgeting directly to the City of Bishkek Admiistration.
Another USAID project complements a loan and other assistance provided by the World Bank that is helping the Ministry of Finance decentralize the provision of health care services. This decentralization is not geared toward local government, but rather directly toward health care providing institutions, and it is meant to provide greater choice to consumers by creating competition among decentralized health care providers.
The European Union has provided, through TACIS (Technical Assistance to the Commonwealth of Independent States), assistance in analysis and training in budgeting and intergovernmental fiscal relations. The purpose of this training has been to improve the overall management of the fiscal system.
1.4 Objectives
The objectives of this study are to identify the constraints that the current practice of intergovernmental fiscal relations and local government finance impose on the modernization of the fiscal system and hence on the road to private sector development and poverty reduction, and to propose steps needed to reduce these constraints.
This study reviews the fiscal system with regard to its degree of centralization and provides recommendations for how the system can be improved to enhance local governance, improve transparency and direct national fiscal resources through a decentralized system to better benefit the poorer regions and districts of the country.