Decentralization and Fiscal Autonomy at the Subnational Level in Indonesia.

AuthorVidyattama, Yogi
  1. Introduction

    As a large, diverse archipelagic country, the idea of a decentralized government and autonomy for provinces and local governments has long been discussed in Indonesia. Although the country is a unitary republic, some degree of autonomy for lower levels of government is provided for in the constitution. During the 1970s, the country became more centralized, when subnational governments were reduced to performing administrative tasks on behalf of the central government. This greater degree of centralization, along with substantial inter-regional developmental inequalities, sparked dissatisfaction among more remote provinces. These feelings grew in intensity when the 1997-98 Asian Financial Crisis struck.

    Following the end of the New Order, the country embarked on a transformative decentralization process, which consisted of devolving much greater authority to municipalities and regencies--collectively referred to as local governments--in the areas of education, agriculture, industry, trade and investment, and infrastructure (Alm, Aten and Bahl 2001). The implementation was based on two important laws which were implemented in 2001--Law 22/1999 on local government and Law 25/1999 on fiscal decentralization (Holtzappel 2009; Abidin 2009). Insofar as the second law, subnational governments receive a much larger proportion of both income tax and the revenue generated by mining activities in their territories, in addition to complete control of certain transfers from the central government.

    Although provinces in Indonesia have long sought greater autonomy and responsibility, most provincial governments have remained weak following the 2001 reforms. In contrast, more authority and resources have been handed over to local governments. Given separatist movements active in Aceh, East Timor and Papua, it is possible that the central government and military did not want to increase the power of the provinces in case this incited further demands for independence (McLeod 2005).

    The transfer of authority to the local level has brought its own challenges, not least because bureaucracies at this level, which are relatively small and inexperienced, have had to undertake substantial new responsibilities. On the one hand, this was seen as an opportunity to improve service delivery through the increased proximity between the government and end-users. Yet, on the other, there is no guarantee that this will lead to improvements in services.

    As the number of municipalities and regencies has increased substantially (referred to as "blossoming" or proliferation [pemekaran]), resulting in more and smaller local governments, these concerns have only deepened. Consequently, there have been legitimate doubts about whether governments at this level have the required capacity and capability to effectively manage their new resources and responsibilities (Bahl, Martinez-Vazquez and Wallace 2002). Many of these fears pertain to finance. First, there may be insufficient capacity at the local level to absorb and manage these funds. Secondly, many worry that this decentralization may lead to profligacy with accompanying large deficits and the misallocation of services to elites (Bardhan and Mookherjee 2006).

    There is a substantial body of work on decentralization in Indonesia, which also includes fiscal issues (such as Vidyattama, Sugiyarto and Sutiyono 2020; Lewis 2003, 2015; Pepinsky and Wihardja 2011; Skoufias et al. 2011). Much of this literature goes deep into the impact of decentralization on a specific administrative area. As the implementation of decentralization passes the two-decade mark, this study takes a step back and evaluates the results at a macro level. This article focuses on the autonomy of local governments to manage their budgets, which involves focusing on the size of the budget as well as the control of revenue and expenditure that local and provincial governments have (see Bird and Smart 2002; Hunter 1977). Besides looking at overall trends and patterns, there are two research questions that structure this article. The first is whether decentralization allows greater autonomy for subnational governments to establish their own initiatives. The second is whether these reforms enable subnational governments to generate their own revenue sustainably, as opposed to them depending almost exclusively on transfers from the central government.

    After this introduction, the second section will lay out the Indonesian context before introducing the decentralization reforms. The subsequent sections will set out the methodology and data that will be examined. This is followed by the results and a concluding discussion.

  2. The Dynamic of Fiscal Decentralization in Indonesia

    Although the World Bank (2005) has famously called Indonesia's 2001 decentralization reforms a "Big Bang", the idea of subnational autonomy was not new. It is stated in the explanatory statement for Article 18 of the country's constitution that Indonesia consists of autonomous regions. (1) Muhammad Hatta, the first vice-president of Indonesia conceptualizes these autonomous regions as "not only running their democracy through elections but can make their own decisions to fulfil the needs of local people" (1957). He further states that this "autonomy is an instrument for individual sovereignty and freedom without diminishing the importance to achieve social justice among regions." The term region, or daerah in Bahasa, has been further defined in the Indonesian Constitution. The explanatory text for Article 18 determined that these regions should not be sovereign states but instead should be provinces that consist of smaller jurisdictions, latter known as the local governments.

    The 1966 change in leadership from Indonesia's first president, Sukarno, to Soeharto did not change this relationship, and provinces and local governments were initially allowed a considerable level of autonomy. However, Indonesia's polity centralized significantly in the early 1970s. The country's House of Representatives passed a decree in 1973 which stated that the country would follow a "deconcentration" strategy to maintain political stability, particularly in a context where natural resources are distributed unequally. This decree emphasized the delegation of government functions to subnational governments rather than the devolution of authority.

    This was confirmed by a 1974 law on regional autonomy. The law stated that decentralization is defined as the delegation of government functions or activities from upper levels of government to lower levels. The law further stated that any regulation from local or provincial governments needed to be certified by the central government and could also be revoked if necessary. At the time, there were 26 provinces and 282 local governments, which only slightly increased to reach 26 provinces and 294 local governments by 1999.

    Remaining in force for more than two and a half decades, the 1974 Law had far-reaching consequences. It stated that local governments were only involved in administrative matters if they were so requested by the level of government above them. In addition, the law also authorized the central government and line ministries to deliver public services at the local level. This meant that service providers from health to education were centrally funded and supervised staff were posted throughout the country. Consequently, subnational government expenditure as a proportion of the overall government budget was relatively low, and the involvement of provincial and local governments in service provision was limited.

    The law also laid out the fiscal arrangements for subnational governments. Local government revenue consisted of intergovernmental transfers, self-generated revenue, and other revenue. The main intergovernmental transfer was called the transfer for autonomous regions and arranged by the central government. Of this, 90 per cent was allocated for salaries and personnel costs. The local government self-generated revenue consists of local taxes, service charges and income from enterprises owned by local governments. These revenues were redefined in Law 18/1997 which specified that the local government could tax only hospitality and entertainment activities, billboards, certain mining activities and the utilization of water resources. The law also specified the service charges to only be applicable to general services, business services and certain permits.

    Given these changes, Shah et al. (1994) argued that Indonesian fiscal arrangements had become very centralized. Beyond the central government retaining the bulk of revenue, implementation was heavily skewed to the centre, with even tasks that were meant to be carried out by local governments delivered by central agencies. Shah et al. (1994) further concluded that not only was revenue-raising authority overly centralized, but that this structure created accountability issues.

    Seen from this vantage point, the 2001 decentralization reforms did indeed constitute a Big Bang. Law 22/1999 devolved most functions of government from the centre to the local level, leaving only defence, security, foreign affairs, fiscal affairs, money and banking, religious affairs and forestry at the centre (Hill and Vidyattama 2016). Consequently, local governments then became responsible for many aspects of government, including public infrastructure, health, education, culture, transportation, industry, inter-regional trade, investment, environment and the regulating the labour market (Vidyattama 2000).

    Based on the 1998/1999 national budget, Vidyattama (2000) estimates this transfer meant that the proportion of government expenditure managed by local governments increased from around 12.4 per cent to 36.5 per cent of the total. This was mainly done by moving salary costs and expenditure on goods and services from the centre to the local level.

    This transfer has not been...

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