Towards improving our current fiscal arrangement

– This article was originally published by Ashesh Shrestha in The Himalayan Times on August 19, 2018.

The fiscal arrangement under our federal structure will be one of the key determinants of success of federalism. Fiscal federalism relates to the assignment of various responsibilities and revenue rights to conduct those responsibilities among difference tiers of government. Furthermore, sharing and distribution of revenue among various levels of government is also studied under fiscal federalism. If we study and analyse the current fiscal framework of Nepal under federal structure, we can see various aspects that need to be addressed. This article is an attempt to identify some of those issues.

1.Distortionary transfers of resources
A sound fiscal structure should be such that it prevents distortionary transfer of capital and labour from one sub-national jurisdiction to the other. In order to prevent the distortionary transfer of such resources, the principle of fiscal federalism suggests that fiscal residuum of the people of equal economic status should be equal. Fiscal residuum is the difference between total tax payments and total benefits received out of the public services. However, the current federal structure and plans seem to have given no priority to this particular factor. Till date, government’s plan does not include equalization of fiscal residuum of the equals, which could lead to the distortionary movement of resources from the jurisdiction where the difference between benefits received and total tax payments is lower than the jurisdiction where it is higher. This might lead to unequal growth.

2.Disregard to vertical fiscal imbalance
The current framework of fiscal federalism seems to have disregarded vertical fiscal imbalance and has primarily focused on horizontal fiscal imbalances. Horizontal fiscal imbalance addresses the difference in needs and revenue generating capacity of sub- national governments of equal status, whereas vertical fiscal imbalance addresses such difference among the different tiers of government. Mismatch between the expenditure responsibilities and the total revenue generation (including the funds received from revenue sharing and equalization grants) could affect ability of the sub–national government in efficient and effective public service delivery.

3.Capacity of sub-national government
One of the major concerns for the proper implementation of federalism is the ability of the sub-national governments to raise revenue under assigned headings and to provide public goods and services efficiently. But in the current scenario, the state and local governments lack skilled human resources to collect the revenue and to conduct the responsibilities assigned to them. Hence, we cannot expect smooth functioning of the government in terms of providing public services. Therefore, one of the priorities of sub-national governments should be invest on development of their human resource capacity. The federal government should also assist them in doing so.

4.Federal government’s resistance
Even after federalization and formation of all three levels of government whose responsibilities and rights have been mandated by the constitution, the federal government still seems unwilling to give up the power which have now been assigned to the sub-national of governments. This view has been supported by the fact that the federal government still has not dissolved many of its department and agencies whose works have now been delegated away. For instance, Schedule 7 of the constitution clearly mentions that local infrastructure and agricultural roads are exclusive responsibilities of local government. However, Department of Local Infrastructure Development and Agricultural Roads (DoLIDAR), which is a federal government agency is still functioning. Even though the responsibility has been assigned solely to the local government, the federal continues to intervene. Such a behaviour will create conflicts in the days ahead which could adversely affect development and maintenance of local infrastructures.

5.Income tax administration could exclude Micro enterprises
Most microenterprises in Nepal are either informal or semi- formal in nature. Many of them are operating without formal registration at all concerned authorities. They are mostly only registered with the municipal government and many are not registered with the federal tax authority. Since they are not registered with the federal tax authority (the one who is responsible for collection of income tax), the problem of these enterprises falling outside the income tax bracket could still prevail in the new system. This again means more problems for the micro-enterprises and would continue to hinder their growth.

We do not have a perfect mechanism and maybe it is better that way in that it allows us to identify our own limitations and gives us a chance to work towards making them better. It also means that changes are organic and are owned by the people who are affected the most by these policies and laws. What matters now is that that is the spirit that policy/lawmakers work. They should, additionally, continue to enhance our legal frameworks in such a way that these frameworks empower sub-national governments and foster competitive among sub-national governments.