The Role and Challenges of Intergovernmental Fiscal Transfers in Asia

A. Introduction Intergovernmental fiscal transfers are an important tool of public sector finance in both industrialized and developing countries for three principal reasons. First, central governments have advantages over subnational governments in raising revenue from many types of particularly productive sources, while subnational governments have advantages in providing many types of public services. This reality invariably results in a mismatch between the costs of expenditures that subnational governments are expected to undertake and the resources locally available to them. Second, there are often substantial disparities in revenue-raising capacity across decentralized levels of government. If subnational governments were left to rely exclusively on their own resources, wealthier jurisdictions would be able to spend more on public services than lower-income jurisdictions. Such a situation has not only equity implications but efficiency implications as well. If decentralized governments are responsible for infrastructure and services that are essential production inputs, areas with lower resource levels may be unable to support local economic development. Third, resources from the central level can be used to ensure that basic national priorities will be met in all subnational jurisdictions. Typical priority sectors include health and education, but often extend to roads, water, and other services. Providing these services may promote both efficiency (if externalities are involved) and equity, and also support poverty reduction efforts. Asian Development Bank (ADB), like other international development agencies, has been focusing more attention on supporting the reform of local government finance in recent years. This has occurred as part of a broader