Fiscal Framework of Nepal: An Overview

This article was originally published by Ashesh Shrestha in The Himalayan Times on June 24, 2018.

In order to ensure optimal outcome from the federal structure, it becomes imperative to have a proper fiscal arrangement at place. In a system with multiple tiers of government, power and responsibilities, especially regarding fiscal matters should be allocated among various levels of governments. The success of federalism is heavily dependent upon the way in which the powers and responsibilities are assigned to these governments. Principally, the literature on fiscal federalism emphasize on determination of expenditure responsibilities followed by revenue assignments. Tax assignment should be followed by assignment of the expenditure responsibilities as tax assignment is generally guided by the spending requirements at different orders of government. The basic principle that guides the allocation of expenditure responsibilities is the “efficiency principle”. Each expenditure headings should be analysed and allocated in such a way that efficient provision of public services could be ensured.

Scholars with primary focus on “efficiency principle”, have designed a revenue- expenditure framework in order to ensure efficient provision of public services. No countries have exactly replicated such design, however, the design has provided a basic outline for assignment of revenue and expenditure among various levels of government in federal countries. Nepal is no exception. Nepal’s fiscal framework does not exactly match the design provided by the scholars, but we can see similarities. Issues of national and international importance such as defence, international trade, foreign affairs, citizenship and migration have been allocated to federal government. Policies affecting the entire nations such as fiscal and monetary policies are also exclusively handled by the central government. States have responsibilities of managing land, irrigation and drinking water supply, transportation, higher education, intra-state commerce, and state-level electricity. Local government is assigned to look after health, sanitation, local market management, local road, rural road, agriculture road, and irrigation.

The constitution has provided grounds for assignment of revenue rights among three tiers of government. Federal government can levy customs duty, excise- duty, Value Added Tax (VAT), corporate income tax, personal/ individual income tax and remuneration tax. States have exclusive right to levy Agro-income tax, whereas local government can levy wealth tax, house rent tax, land tax and business tax. House and land registration fees, motor-vehicle tax, entertainment tax and advertisement tax are jointly levied by state and local governments. Similarly, on the non-tax revenue headings, passport fee, visa fee, gambling and casino fees are prerogative of federal government. Service charge/fees, tourism fee and fines are jointly collected by federal, state and local governments. The revenue assignment is made in such a way that federal government is able generate higher percentage of the total revenue, which is estimated to be about 70 percent. The rest is generated by states and local government. As large share of revenue goes to central government’s coffer, vertical fiscal imbalance is inevitable. Additionally, as individual states and municipalities do not have same revenue base, horizontal fiscal imbalance can also be predicted.

In order to overcome horizontal and vertical fiscal imbalances, like other federal countries, Nepal has also made arrangements for inter-governmental fiscal transfers. Intergovernmental Fiscal Arrangement Act, 2017 has made provision of revenue sharing and fiscal- equalisation grant as two medium of fiscal transfers. It has been provisioned that the revenue generated out of Value added tax (VAT) and Excise is shared in 70- 15-15 percent basis among federal, state and local governments respectively. The distribution of these funds among the state and local governments are made by taking population, total area of the respective jurisdiction, Human Development Index (HDI), and low development indicators as the parameters. The weightage given to these parameters are 70 percent, 15 percent, 5 percent and 10 percent respectively.

Furthermore, sub-national government are also entitled to fiscal equalisation grant whose main aim is to reduce horizontal fiscal imbalances. The fiscal equalisation grant are distributed by the federal government to the sub-national governments on the basis of gap between need of expenses and capacity to generate revenue, Human Poverty Index, social and economic discrimination indicators, and indicators of infrastructure availability. The weightage assigned to these are 60 percent, 15 percent, 15 percent, and 10 percent respectively.

In addition to fiscal equalisation grant, there is also provision of conditional grants, complementary grant and special grant. The conditions for distribution of conditional grant is prescribed in the National Natural Resource and Fiscal Commission Act, 2017. The criteria for providing complementary grants and special grants have also been specified in the same act.