subnational own-source revenue: getting policy and administr ation

Once countries decide to decentralize—whethergradually, as in Thailand and Vietnam, or with aninitial dramatic change, as in the Philippines andIndonesia—they must get the fiscal design right.Critical to effective fiscal design is the ability of localgovernments to adjust budgets and thus respond tocommunity preferences regarding the quantity andquality of public services. Ideally, and according totheory, subnational governments provide servicesto their constituents up to the point at which thecost—in terms of taxes—equals the benefit, interms of the value of the services. To satisfy this con-dition, local governments must have the authorityto exercise own-source taxation, and be in a finan-cial position to do so. This is the essence of account-ability and efficiency under decentralization, andthat is why decentralized revenue policy matters.

The design of a local revenue system includesthree central dimensions: the assignment of rev-enue sources among types of government, thedegree of autonomy with which subnational gov-ernments can exercise their assigned authority, andthe efficiency of the revenue administration system.For a decentralized system to meet expectations,policymakers must ensure coordination betweenthese dimensions.

107

6

Subnational Own-Source Revenue:

Getting Policy andAdministr ation Right

Robert R. Taliercio

This chapter follows this logic. It begins by ana-lyzing the links between revenue assignment andautonomy by country and type of revenue, andthen assesses the region’s revenue performance.The ensuing two sections take up the question ofrevenue administration and address the politics oflocal taxation, highlighting issues of policy imple-mentation. The last section offers final commentson the implications of these findings for both pol-icy and administration.

The chapter’s overarching conclusion is that EastAsian countries reveal many inconsistencies andcontradictions vis-à-vis commonly accepted criteriafor a “good” intergovernmental revenue system.However, this newly decentralized region is also see-ing rich experimentation and innovation, whichbodes well for further reform.

The Setting and Normative Framework

Except in the Philippines and perhaps Indonesia,subnational governments in East Asia make littleuse of own-revenues to finance local services (seetable 6.1). That is, the region is not characterized bysignificant fiscal decentralization. The implications

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108 East Asia Decentralizes

of this are considerable. The fact that subnationalgovernments have both limited powers to raise rev-enues and limited capacity to collect them posesprofound questions about the actual benefits ofdecentralization. Can local governments respond tolocal preferences in taxation and thus service deliv-ery, thereby achieving greater accountability andefficiency? Are fiscal tools and capacities sufficientto generate sustainable own-source revenues? Has areliance on transfers, in their myriad forms, madesubnational governments dependent on nationalgovernments and weakened subnational incentivesto improve own-source collections?

The three dimensions of revenue policy providea framework for addressing these questions:1

Which taxes should be authorized or assigned tocentral governments and which to subnational gov-ernments? The decision should be legal and trans-parent, occurring through both constitutional andlegislative processes. However, as discussed below,governments sometimes assume “authority” ille-gally. That such illegality and informality are unde-sirable will become clear; nonetheless, in somecountries, particularly China, these approaches arecommonplace. Focusing on assignment of revenuesources among governments stresses the impor-tance of understanding decentralization as anintergovernmental partnership.

Numerous public finance economists have pro-vided guidance on how to think about assigningtaxes between national and local governments, and

many of the resulting perspectives place a high prior-ity on economic efficiency. The first principle of rev-enue assignment—summed up by the “finance-follows-function” refrain—is that it should be basedon assigned expenditures. A second principle, giventhe matching of revenues to expenditures, is that localtaxation should avoid introducing economic dis-tortions by inappropriately taxing the factors of pro-duction.The third general principle—subsidiarity—holds that revenue-raising powers should beassigned to the lowest-possible level of government,except where such assignment would produce eco-nomic distortions or negative externalities.2

These three principles provide a general frame-work for assessing revenue assignment, which—when fleshed out with more specific considerations—offers a set of practical guidelines. According toNorregaard, governments should not levy “localtaxes” on very mobile factors lest they encouragetaxpayer migration (though what constitutes “verymobile” is largely an empirical issue) (Norregaard1997). Such taxes should not be unevenly distrib-uted among jurisdictions (as in the case of naturalresource taxation), should raise enough revenue toavoid large vertical fiscal imbalances, should not beexportable to nonresidents (which would weakenthe accountability link), and should be based on thebenefit principle. Taken one step further by Bird,these principles suggest a number of major taxsources usually prescribed for subnational govern-ments, “more or less in order of preference—usercharges, property taxes, excises, personal incometaxes, payroll taxes, general sales taxes, and businesstaxes” (Bird 2003b, 4–5). The following sectionsaddress each of these options.

Autonomy and Policy

The decentralization literature can be surprisinglyunclear about the fundamental question of whatconstitutes a subnational tax. However, if terminol-ogy is not clear as to what constitutes subnationalown-source revenue, policymakers will not havethe conceptual tools needed to design fiscal systemsand appreciate their consequences. Such a situationwill also obfuscate debate over the policy changesneeded to allow a jurisdiction to realize the effi-ciency benefits promised by decentralization.

Subnational revenues may be divided into cate-gories of decreasing local autonomy (see table 6.2).

TABLE 6.1 Estimated Own-Source Revenue of Subnational Governments(as percentage of total subnational government revenue)

Country Percentage

Cambodia (2003) � 5China (2003) � 5Indonesia (2002) 15.4Philippines (2002) 31.1Thailand (2002) 10.9Vietnam (2003) � 5

Sources: Indonesia (Ministry of Finance), Philippines (Department of Finance), and Thailand (World Bank 2004c). World Bank staffestimates for Cambodia, China, and Vietnam.Note: Most recent year available. Figuresinclude only official, legal revenues.

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Subnational Own-Source Revenue: Getting Policy and Administration Right 109

If subnational governments have total or significantcontrol over a tax, fee, or charge, as shown by con-trol over the tax rate (that is, if it is necessary andsufficient), it is a subnational tax. If, in contrast,subnational governments have no control over thebase and rate of a tax, as, for example, when thecentral government determines how to split rev-enues (“tax sharing”), it is not a subnational sourceof own-revenue.

This taxonomy of taxation serves the very usefulpurpose of setting out the basic definition of whatis and is not a source of own-revenue. Thus, forexample, the taxonomy makes clear that although ashared tax adds to subnational budget receipts,such revenue is not “own” taxation. Tax sharingoccurs when the base and rate of a tax are centrallyset and then some percent is returned, typically ona derivation basis, to the “originating locality.” Tobe an own-tax or revenue source, the subnationalunit must, at the very least, legislate the rate.

More nuanced is the practice whereby a centralgovernment restricts the rate of an own-revenuesource (such as the rate ceiling). This clearly limitssubnational autonomy, and some would argue thatonce the cap is reached it fully eliminates localautonomy, as the subnational government loses itsability to raise taxes at the margin. Such rate regula-tion is particularly common in East Asia.

A typical argument for rate ceilings is that theyprevent local governments from doing egregiouslyinappropriate things (though ceilings may simplybe a nontransparent mechanism for central con-trol). The practice, however, counters the accounta-bility and efficiency arguments for decentraliza-tion. One might make a case for centrally imposedrate ceilings during the transitional period fromcentralization to decentralization, as they mightallow local governments to develop policy andadministrative capacity, but such limitationsshould be short-lived. Subnational governmentsbuild capacity by using their assigned powers.

Autonomy and Administration

The third dimension of revenue policy—that sub-national governments must have some control overrevenue administration—matters for two reasons.First, control over some aspects of revenue admin-istration is instrumental for controlling revenues atthe margin, as this allows for changes in the effec-tive tax rate (a ratio of actual tax collected com-pared with the size of the legal tax base). Localgovernments can change the effective tax rate byboosting compliance through audits and enforce-ment, or by lowering compliance costs for tax-payers through better services (such as more

TABLE 6.2 Classification of Subnational Taxes by Degree of Central vs. Local Control

Local autonomy inrevenue policy

Limited autonomy

No local autonomy

Subnational government (SNG)sets tax rate and base.

SNG sets tax rate only.

SNG determines the tax base.

SNG sets tax rate, but withincentrally permissible ranges.

Tax sharing, whereby central/localrevenue split can change onlywith consent of SNG.

Revenue sharing, with sharedetermined unilaterally bycentral authority.

Central government sets rate andbase of “SNG revenue.”

Greatest access to own-source revenues.These usually include fees and charges.

Necessary and sufficient condition for“own-revenue.” Piggybacking and taxbase harmonization permitted.

Refers largely to local authority to grantexemptions that erode the local base.

In this case the center typically specifies ahigh/low tax range or caps the top rate.

Can result when a local authority collectsthe tax and remits it to the center.

100% control by center; this is a source ofmisspecification of central vs. localrevenue. (For example, the InternationalMonetary Fund’s Government FinanceStatistics includes this category as a “local tax.”)

May accompany political decentralization.

Sources: Adapted from OECD 2002; Ebel and Yilmaz 2002.

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user-friendly tax forms and payment processing,and access to information).

This dimension is relevant in all cases, especiallyin China and Vietnam, where subnational govern-ments collect taxes whose rates and bases are deter-mined centrally. Second, and conversely, this con-sideration suggests that subnational governmentsneed not have full control over administration tocall a tax or fee an own-source revenue. Devolvedresponsibility does not necessarily imply fullydevolved administration, especially in the contextof weak local capacity. National governments, forexample, might take responsibility for certainadministrative functions, such as assessing prop-erty, or assist local governments with core functionsrelated to information and communications tech-nology. This opens up a much-needed discussionof the appropriate division of labor betweennational and subnational jurisdictions, and of theoptions for assisting low-capacity subnational gov-ernments with revenue administration (see below).

Review of Current Practice and Initial Evaluation

Whereas several East Asian revenue systems rely oncentral controls, countries are also showing a will-ingness to review the twin features of assignmentand autonomy. This represents an important policycrossroads: if, as shown, assignment and autonomycan be reinforcing, the opportunity to combine

political with fiscal decentralization promises moreefficient delivery of public services.

The Philippines has the region’s longest-runningrecord of an explicit decentralization policy andis also the most revenue decentralized of all thefocus countries. Yet, as the Philippines example alsoattests, the decentralization sorting-out processtakes time, and even the Philippines is a “young”decentralizing state. The country has clear oppor-tunities for further reform.

In the Philippines, primary responsibility forsubnational taxation rests with provinces, munici-palities, and cities (see table 6.3). Cities are the mostautonomous: they are authorized to impose the fullset of local taxes, while provinces and municipali-ties can levy only subsets. In some cases the rev-enues collected by provinces and cities are allocatedto municipalities and barangays. The latter are alsoresponsible for collecting miscellaneous taxes andfees and charges.

But again, whereas this assignment suggests awell-designed system of revenue decentralization,the Local Government Code is not fully consistentwith the autonomy criteria (see table 6.2). The cen-tral government sets tax rate ceilings, leaving localgovernments little control over one of the mainlevers for mobilizing revenue, including the prop-erty tax, which is a large revenue generator. Thecode also fixes maximum rates for most other taxesand nominal per unit amounts (as in the case of theprofessional tax). The code further specifies that


TABLE 6.3 Tax Assignment by Local Government in the Philippines

Revenue source Provinces Cities Municipalities Barangays

Real property tax ✓ ✓ ✓ 40% of provincial ✓ 25% of collections provincial or

30% of city collections

Transfer of real property tax ✓ ✓

Tax on sand, gravel, and other quarry resources ✓ ✓ ✓ 30% of provincial ✓ 40% of provincial

collections collectionsAmusement tax ✓ ✓ ✓ 50% of provincial

collectionsBusiness taxes ✓ ✓ ✓

Franchise tax ✓ ✓

Community tax ✓ ✓ ✓ 50% of collections

Source: Local Government Code (R.A. 7160), 1991.

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local governments can adjust tax rates only once infive years, and not by more than 10 percent.3

In Indonesia, subnational governments have theauthority within the framework of Law 34 of 2000on regional revenue to levy a number of importantbut minor revenue sources. The central governmentcontrols the most potentially productive localrevenues—those on real estate and personalincome—and shares the receipt.4 Less revenue-productive taxes are assigned to the provinces(motor vehicle registration, transfer and fuel taxes,and a water user fee, all of which are shared withcities and regencies), and cities and regencies (excisetaxes on hotels, entertainment, advertisement, streetlighting, mining of selected minerals, and parking).

The national government restricts this arrange-ment even further: subnational governments maynot impose surcharges on national taxes, and Law34 of 2000 sets maximum rates on those that areassigned.5 Evidence suggests that most regionsalready charge the maximum rate, and that somewould raise it further if allowed to do so.For example,the widely assessed hotel and restaurant rate is lim-ited to 10 percent, yet a World Bank report concludesthat some jurisdictions (such as Bali and Jakarta)could gain from rate increases (World Bank 2003a).

China overhauled its subnational revenue sys-tem under the 1994 Tax Sharing System reform.The tax structure now includes three tiers of taxes:those fully accruing to the national government,those shared between the national and subnationalgovernments, and those fully accruing to subna-tional units. Allowable subnational own-sourcerevenues include the urban land use tax, for whichthe local government can set the rate up to a ceiling;local option entertainment and slaughterhousetaxes; and a local option surtax on collective enter-prises, for which the subnational government caninfluence the rate (Bahl 1999).

Revenues in Thailand are national, local, orshared. Shared taxes include the value-added taxand sales tax, the special business tax, the naturalresource tax, excise taxes, and the vehicle tax, all ofwhich accrue to local governments. Own-taxationis limited to the house and land tax, land develop-ment tax, signboard tax, petrol tax, tobacco tax, andhotel tax. Local governments may also collect userfees, charges, permits, license fees, and fines.

Cambodia is still at an early stage of decentral-ization: it has not yet assigned functions or rev-

enues to communes. However, communes andsangkats (urban communes) may collect four typesof own-revenue. These include administrative feesfor civil registry functions, agency fees for functionsperformed on behalf of line ministries and others,contributions to development projects to meet thematching requirement imposed by transfers fromthe Commune Sangkat Fund, and user fees andcharges to cover the recurrent costs of providingservices (UNCDF 2004). Data on actual collec-tions are not available, but the amounts are thoughtto be quite small. Provinces—deconcentrated levelsof the national government—may also collect own-revenues, which accrue to governors’ budgets (theSalakhet).6 These revenues, which are not properown-source revenues, accounted for 48 percent ofthe total Salakhet, of which the tax on motor vehi-cles (17.4 percent), the excise on public lighting(12.3 percent), the wealth transfer tax (7.0 percent),and the business tax (6.8 percent) are the mostsignificant (World Bank 2003b).

Vietnam, as a transitional country, reveals somesimilarities with China. The Law on State Budget,which took effect in January 2004, establishesthree types of revenue assignments. These includerevenues assigned completely to the central level,those assigned completely to the local level, andthose shared between the central and subnationalgovernments. Shared revenues—which includethe value-added tax, enterprise (corporate) incometax, personal income tax, special consumptiontaxes, and gasoline and oil fees, among others—constitute the bulk of revenues at all levels. Own-source revenues are virtually nonexistent inVietnam. The only exception is user fees, such asroad tolls and select fees for schools and hospitals,which are not generally significant sources ofrevenue (World Bank 2000).

Own-Source Revenue Practices and Options

Revenue assignment in East Asia is consistent withthe framework’s principles and guidelines in someways and inconsistent in others. The next sectionfurther highlights specific regional practices foreach revenue source. This discussion serves to stressthat a well-designed subnational revenue systemshould rely on a mix of taxes, and also suggests fur-ther options for reform.


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As table 6.4 reveals, there is no own-sourcerevenue common to all six countries, though anumber of countries make use of user fees andcharge business taxes, excise taxes, and propertytaxes. As admirable as the user charge and propertytax package is, international experience has shownthat such taxes can be both difficult to implementand unlikely to provide an adequate fiscal base ifsubnational governments have major social spend-ing responsibilities (Bird 2003b). Accordingly,several options are available to further mobilizeown-source revenues.

Property Taxation

Given the role of property taxes as revenue genera-tors in the developing world, the fact that the prop-erty tax is not an own-revenue source in many coun-tries raises concerns about sustainable revenueflows, subnational autonomy, and thus the promisedbenefits of decentralization. In the 1990s, propertytaxes accounted for 40 percent of all subnationaltaxes in developing countries, but only 12 percent intransition countries (Bird and Slack 2002). Exceptfor the Philippines and Indonesia, East Asian coun-tries do not come close to the benchmarks of eitherdeveloping or transition countries, suggesting thatproperty taxes could yet serve as a greater source ofrevenue in the medium term, and an importantsource in the longer term.

Vietnam, Thailand, and Cambodia diverge themost from international practice. Vietnam has noproperty tax in the modern sense of the term. Thecountry does have taxes on land and housing, landrent, and transfers of land use rights, but local gov-ernments have little or no control over these taxes.Thailand imposes land taxes, but they account foronly about 5 percent of subnational resources, andsubnational governments lack authority over theirrates and bases. Cambodia’s land taxes are insignif-icant in revenue terms.

China has multiple taxes on property, often onthe same base, which do not rest on market orupdated property assessments. Thus, these taxes donot deliver on their revenue potential. Yet unlike inVietnam, local governments can set the tax rate onurban land use subject to legislated maximums andminimums (larger cities can set higher rates, forexample). In fact, the tax on urban land use is oneof only a small set of own-source revenues inChina. The tax base is the physical land area, not

the market value, as the country has no formalmarket for land transactions.

Indonesia provides another important exampleof limited local autonomy over the property tax.Subnational governments are not responsible fortaxing property (or property transfers). While thecentral government shares about 80 percent of prop-erty tax revenues with the originating region, anddistributes another 10 percent among all regions,policy and administration are firmly in centralhands. This has led to two negative developments: areliance on taxes that essentially substitute for prop-erty taxes, such as the street lighting tax; and theproliferation of nonbenefit taxes—user charges andservice fees not linked to the provision of services.

The Philippines is the only country where atraditional property tax is a source of subnationalown-revenue. The property tax accounts for nearly37 percent of subnational own-revenues. However,the central government limits control over taxrates and bases. For example, the national govern-ment sets the real property tax rate (includingthe Special Education Fund levy) at 2 percent forprovinces and 3 percent for cities and municipali-ties in metropolitan Manila. All provinces outsidethe capital region avail themselves of the maximumrate, while most cities are under the maximum.7

International experience suggests that subna-tional governments are likely to use discretion overproperty tax rates, so they vary widely. Bird andSlack report, for example, that the effective rateof property tax in the United States ranges from0.4 percent to 2.9 percent for residential propertyand 0.7 percent to 6.0 percent for commercialproperty (Bird and Slack 2002).

Property tax reform can offer a source of rev-enue, perhaps modest in transition countries, and asource of autonomy and accountability across theregion. Rationalizing land taxation in Vietnam—and moving toward a modern property tax withsome local discretion over rates and introducingmodest property taxes in Cambodia—would befirst steps in those countries. Devolving authorityover rates in China, Indonesia, the Philippines, andThailand is also a reform option.

Business Taxation

Some analysts regard business taxes as a potentiallyinefficient means of raising revenue. Often levied athigh rates, these taxes can distort firms’ investment

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TABLE 6.4 Own-Source Revenue Assignment

Cambodia China Indonesia Philippines Thailand Vietnam

Usercharges?

Propertytaxes?

Excisetaxes?

Personalincometaxes(PIT)?

Payrolltaxes?

Generalsalestaxes?

Businesstaxes?

Yes; these arenumerous, andsome have highadministrativeand compliancecosts. Some are“nuisance”charges.

No; revenuesshared withSNGs, but theyhave no controlover rates andlittle control overadministration.

Yes, on motorvehicles and fuel,though assignedto provinces.Also on minerals,raising equityissues.

No; a PIT is sharedwith SNGs, butthey have nocontrol over taxpolicy.

No.

No.

Yes, thoughofficially limitedto a few sectors.The number andtype of “businesstaxes” aregrowing, raisingconcerns about“nuisance”taxation.

Yes, provincesandcommunescan collectfor somebasicservices.

No, but minorprovincialtaxes onunusedland.

No, but taxeson motorvehiclesat theprovinciallevel.

No.

No.

No.

No, thoughbusinesslicensechargesand markettaxes areassessedat theprovinciallevel.

No, but “informal”or “illegal” localextrabudgetaryfees have proliferated in health,education, androads. Someare “nuisance”charges.

Yes, to an extent,in that SNGscan set the ratefor the urbanland use tax upto a ceiling.There are alsonumerous othertaxes on thesame propertyand land base.

No, but taxes onvehicle andvessel use.

No; a PIT isassigned toSNGs, but theyhave no controlover tax policy.

No.

No, but centralgovernment and SNGs sharevalue-added tax.

Yes; a businesstax on grossreceipts, anenterpriseincome tax, andother surchargesand surtaxes(e.g., urbanmaintenanceand constructiontax).

Yes; these arenumerous,and somehave highadministra-tive andcompliancecosts.Some are“nuisance”charges.

Yes; rates setby SNGssubject to amaximum.Administeredby SNGs withlittle centralassistance.

No; SNGs areprohibitedfrom levyingexcise taxes,includingon motorvehicles.

Not exactly,though thecommunitytax is in theform of a polltax.

No.

No.

Yes; relativelylarge revenuesource.

Yes, on trans-portation,publicutilities, andmarkets.

No, for the landdevelopmenttax and thehouse andland tax.The centralgovernmentsets rates.

No; centralgovernmentcontrolsmotor vehicleand otherexcise taxes.

No.

No, thoughbase ofnational PIT includespayroll.

No, but centralgovenrmentand SNGsshare value-added andsales taxes.

Yes, thoughlimited to asmall numberof sector-specificbusiness-typetaxes.

Yes, on roads,education,and health.

No; some taxeson land andhousing,land rent,and transferof land userights. ButSNGs haveno controlover ratesand littlecontrol overadministra-tion. Nomodernproperty tax.

No.

No, but centralgovernmentand SNGsshare PIT.

No.

No, but centralgovernmentand SNGsshare value-added tax.

No, but centralgovernmentand SNGssharecorporateincome tax.

Source: World Bank staff.Note: SNG � subnational governments. Own-source revenue defined as a legal tax or charge over whose rate an SNGhas some control.

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decisions (such as their debt-equity ratio). Thesetaxes might also serve as barriers to new firms and theexpansion of small ones. On the other hand, businesstaxes are potentially large revenue generators andmore elastic than other traditional subnational taxes(such as the property tax), although they may also bemore distortionary. Business taxes can be justifiedaccording to the benefit principle: firms are consum-ing benefits provided by subnational governmentsand thus should be charged for them.

This principle offers a rationale for differenti-ated business taxes at local and regional levels, suchas user charges along with some form of businesslicensing tax, and perhaps a low-rate tax on grossreceipts, either in place of or in addition to thoseoptions. At the regional level, the benefit caseargues for a broad-based levy that remains neutraltoward the factor mix, such as a value-addedincome tax or a business value tax (both options fortaxing value-added income). One further option isto levy both a payroll tax and a tax on capital. Pay-roll taxes are easy to administer and productive atlow rates. However, they can act as a barrier toemployment in the formal sector—a concern thatmight outweigh their benefits in economies strug-gling to boost rates of formal employment.

Table 6.4 shows that China and the Philippineshave formal business taxes, which are major sub-national revenue generators. The business tax inChina—levied on gross receipts not subject to thevalue-added tax—covers a wide range of sectors,including transportation, communications, andconstruction, and accounts for a large share ofprovincial tax revenues (22.6 percent, on average, in2001). The business tax in the Philippines is similar,in that it is also levied on gross sales and accountsfor a significant share of local revenues (29.8 percent,on average, in 2002, including business licenses).Giving subnational governments in China and thePhilippines control over rate setting could be bothrevenue-productive and autonomy-enhancing.

Cambodia and Indonesia do not have local busi-ness taxes per se. Indonesia relies on taxes on specificsectors, including hotels, restaurants, and advertis-ing. A growing number of subnational governmentsin Indonesia are also taxing specific sectors, mimick-ing business taxes. There is concern that the prolifer-ation of these taxes will result in distortions andinefficiencies at the local level. This suggests theneed to rationalize the taxes imposed on businessesto minimize distortions, such as by introducing a

simple low-rate, broad-based “single business tax”to replace sectoral and “nuisance” levies and fees.8

Cambodian provinces levy business licenses, thoughit might be more appropriate to transfer businesslicensing to the commune level and introduce astandard business tax at the provincial level.

Personal Income Taxation

No country in the region makes use of personalincome taxes as a source of subnational own-revenue. China, Indonesia, and Vietnam use suchtaxes as shared revenues, however. Such taxes wouldthus appear to be a potential new source of revenuefor Cambodia, the Philippines, and Thailand. Allow-ing regional (provincial) governments to piggybacktaxes on national personal income taxes is an impor-tant option for boosting local revenues, and poten-tially for increasing autonomy. This assumes thatsubnational governments could set the rates,and thatthe central government would administer the tax toavoid burdening local administrative capacity.9

User Fees and Charges

Official use of charges and fees is widespread in theregion.10 In Thailand, subnational governmentslevy user charges on garbage collection, public util-ities, mass transportation, and medical and child-care. The Philippines has more than 33 differenttypes of user fees and charges, ranging from animaland civil registration to garbage collection fees.Total collections from each major source are rela-tively small, reflecting the dispersion of revenuesources (see table 6.5). Moreover, a large number offees and user charges together generate less than0.10 percent of the total operating and miscella-neous revenue of subnational governments. It isimportant to note, however, that the main eco-nomic rationale for levying user charges is topromote efficient use of public resources throughthe pricing mechanism, not necessarily to raiserevenue. Still, eliminating these extremely low-yield fees would reduce the administrative andcompliance costs arising from the complexity of thesystem.

In Indonesia, the most significant provincialcollections from user fees come from charges forhealth services. Collections from charges for build-ing licenses are second in importance. At the city anddistrict level, 62 percent of fee revenue comes frompublic service fees, 23 percent from licensing fees,


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TABLE 6.5 Highest-Yield Fees and Sources of Operating Revenues of Subnational Governments in the Philippines, 2000(pesos)

Pesos % of total

Market receipts 1,568,806,000 15Electrical light and power fees 738,108,000 7Mayors’ permit fees 659,004,000 6Hospital fees 657,528,000 6Rents 368,598,000 4Building permit fees 361,172,000 4Garbage fees 337,992,000 3Total operating and miscellaneous revenue 10,218,000,000 100

Source: COA 2001.

TABLE 6.6 Most Significant Charges by Local and Provincial Governments in Indonesia, 2002(million rupiah)

Share of total Local government Revenue (%)

Charges for health services 745,903 33.25Charges for building permit 240,547 10.72Charges for market services 194,134 8.66Charges for printing resident’s ID card and birth certificate 128,072 5.71Charges for use of regional property 96,259 4.29Garbage disposal/sanitation levies 92,160 4.11Bus terminal levies 87,353 3.89Disturbance permit levies 62,824 2.80Public roadside parking levies 60,387 2.69Motor vehicle inspection levies 46,347 2.07

Share of total Provincial government Revenue (%)

Charges for health services 311,133 45.42Charges for building permit 134,071 19.57Charges for use of regional property 46,384 6.77Motor vehicle inspection levies 36,259 5.29Regional production sale levies 20,451 2.99Wholesale market and shopping complex levies 15,607 2.28Public roadside parking levies 12,603 1.84Recreation and sports ground levies 11,774 1.72License allocation of land use 10,711 1.56Garbage disposal/sanitation levies 8,741 1.28

Source: Ministry of Finance.

and 15 percent from business service fees. All otherprovincial and local charges together contribute avery small percentage of total revenue. In fact,provinces levy 14 charges that generate less than1 percent of charge revenues, and local governmentslevy at least 30 such charges (with at least 93 different

local charges throughout the country in 2002). Manyof these low-yielding fees are levied on businesses,creating a heavy administrative burden and sug-gesting the need for rationalization (see table 6.6).

Bird and Tsiopoulos sum up the challenge ofuser charges as ensuring “that the right prices are

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charged for the right services” (1997, 33). They alsoargue that central governments need to provideguidance—perhaps in the form of an overarchinglegal framework—to subnational governments oncreating and managing user charges. Elements ofsuch a framework include clear and transparentparameters for setting prices and a process for con-sulting with local stakeholders. National govern-ments in countries with a particular concern in thisarea, such as China, Indonesia, and Vietnam, mightbe warranted in intervening—at least in the nearterm—with lists of allowable or prohibited charges.

Excise Taxes

East Asian countries are split on excise taxes. ThePhilippines, Thailand, and Vietnam do not usemajor excises, which suggests another reform optionfor these countries.11 Allowing local governments toimpose excise taxes or fees on motor vehicle regis-tration would give those governments an appropri-ate and potentially important source of revenue thatwould be relatively easy to administer.12

Significant Others: Fees, OtherTaxes, Charges, and the Problemof Illegal Proliferation

Illegal Activities

Lack of control over tax policy has encouraged localgovernments to seek other tax and nontax sourcesof revenue. In a number of East Asian countries,local governments have the authority to enact newtaxes and fees, though their authority is regulatedby law, and in some countries is subject to reviewby the central government. Central control hasencouraged local governments to become entrepre-neurial, with both positive and negative results. InChina, this situation has led to the proliferation of“illegal” extrabudgetary fees, some of which havedistortionary effects. Indonesia has seen the prolif-eration of nuisance taxes, which collect very little inrevenue yet impose high administrative costs onlocal governments and compliance costs on taxpay-ers. In the Philippines, local revenue codes yield atax system of great complexity, with a resulting lossof transparency and ability to monitor the system.Some subnational governments are avoiding col-lecting legal taxes and others are collecting “illegal”taxes, undermining the integrity of local gover-nance and thus public support.

The Chinese case is particularly acute given thelarge number of “unofficial” charges. Because of alack of autonomy, local governments have resortedto introducing fees not permitted by law, and theserepresent a significant percentage of local budg-ets.13 The fees include surcharges on householdutility bills, hospitals and school charges, roadmaintenance, advertisement, vehicle purchases andothers (World Bank 2002). While these fees mayintroduce distortions and raise compliance costsimposed on taxpayers, the World Bank has arguedthat “fears of run-away local governments arbitrar-ily creating a jungle of local fees and charges do notappear to be justified.” Yet the growth of extrabud-getary financing among local governments hasbecome a serious concern. The World Bank esti-mates that extrabudgetary funds and off-budgetactivities may represent 18 to 22 percent of grossdomestic product (GDP) (World Bank 2002).

The Chinese government has had a policy ofconverting informal fees into official taxes, but itis implementing this policy unevenly. In Gansuprovince, for example, provincial officials report-edly approve all local fees at the prefecture, county,and township levels. But no one knows the extentto which local governments are staying ahead ofprovincial authorities by implementing new fees.

Similarly, Cambodia has had serious concernsabout the proliferation of “informal” fees andcharges at the commune/sangkat level. In fact, thisproliferation seems to be impeding developmentof a system of own-source revenues for newlyelected subnational governments. Evaluations ofexisting practices have been only exploratory, butthere are reports of birth registration fees being“unofficially inflated” from US$0.10 to US$10(UNCDF 2003).

In China, fees and charges undermine the taxsystem because they are not officially on the books.In the Philippines, a similar argument can bemade—but with a variation. In the Philippines,numerous fees and charges on the books under-mine the system because they are either not col-lected, or are not collected in accordance with therevenue code. In the city of Bacolod, for example,the mayor’s business permit fee has more than 200different rates, which vary by type of establishment.This complexity adds greatly to administrativecosts. Thus, putting revenues on the books andlegalizing them does not necessarily solve the


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problem or eliminate the need to develop the localcapacity to manage user charges.

Overall, the proliferation of illegal, extrabud-getary revenues raises concerns about efficiencylosses stemming from distortions and relatively highadministrative (and possibly compliance) costs. Atthe same time, citizens of some localities may bewilling to pay for off-budget services from localgovernments (in these cases, efficiency losses wouldpresumably be lower). Some subnational govern-ments collect these off-budget sources in responseto limited autonomy, so the practice is somewhatunderstandable, if not justifiable. However, theselevies can undermine public trust in the tax system,which cannot be good for long-term compliance. Apolicy of reviewing and converting illegal fees intoofficial ones, as in China, is warranted.

Open Lists

One of the issues around the use and abuse of usercharges is the authority to enact new levies. In boththe Philippines and Indonesia, local governmentshave formal authority to introduce some new taxesand fees. In the Philippines, the Local GovernmentCode provides a range of tax and fee options forlocal governments, though the country should con-sider more options.The code gives local governmentsthe option to levy other taxes, fees, and charges, pro-vided that the code does not specifically prohibitthem and the National Internal Revenue code doesnot already include them.14 That all makes sensewithin the framework established above. But what isproblematic is if subnational governments abusethis “open list” approach by levying taxes and fees ina nontransparent, illegal manner. Monitoring andenforcement of tax law matter.

In Indonesia, besides formally assigned taxes,Law 34 of 2000 allows cities and regencies to levyadditional taxes if they follow a number of generalcriteria.15 To ensure that governments meet thesecriteria, the central government requires them tosubmit regional regulations to the Ministry ofHome Affairs for review. If the ministry, in consul-tation with the Ministry of Finance, finds that a taxviolates legal provisions, the ministry may cancelthe regulation, in which case the local governmentmust rescind the tax.16

As noted, the “open list” approach has its merits.However, countries might not want to seize on it as a

major reform option for at least two reasons. First,the positive list of taxes provided in Indonesia(Law 34 of 2000) does not include any taxes that cangenerate significant revenue. This prompts manysubnational governments to introduce taxes that donot necessarily generate much revenue either, as away to assert their autonomy. As a result, nuisancetaxes and charges abound. The Ministry of Financefound that more than 200 regulations submitted tothe central government between August 2001 andJanuary 2003 violated Law 34. Many are levied onagriculture, mining, and interregional trade. InLombok, for instance, three local governmentsjointly impose a 5 percent tax on 174 productsleaving the island (Ray 2003). Thus, the problemin Indonesia is not the open list itself but the factthat it does not include appropriate broad-basedtaxes.

Second, the review mechanism does not seem towork very well without adequate monitoring. Forexample, Lewis estimates that subnational govern-ments send just 40 percent of all regional tax- andcharge-related regulations to the Ministry of HomeAffairs for review, so many potentially harmfultaxes and charges remain in effect (Lewis 2003).

Revenue Assignment between Subnational Levels

Revenue assignment between local governments inEast Asia often seems to create incentive problems.These occur between provinces and subprovinciallevels in China and Vietnam; between provinces,cities and municipalities, and barangays in thePhilippines; and between provinces, cities andregencies, and villages in Indonesia. In China andVietnam, the lack of formal revenue assignmentcreates unpredictability and reduces accountability.In the Philippines and Indonesia, the transfer ofsignificant shares of collections from province tosubprovincial levels may reduce provincial incen-tives for collecting own-revenue.

In China, provincial governments may assignrevenues to local governments within their jurisdic-tion (see box 6.1). Most, if not all, provinces seem tofollow the traditional hierarchical approach, assign-ing revenue between the province and the first layerof local government (cities and prefectures), andleaving each layer to work out arrangements withthe one below it. As mentioned, while the lack of


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formal assignment may have some advantagesfor provinces, the disadvantage for subprovincialgovernments in terms of uncertainty would seem tooutweigh the potential advantages.

Revenue Performance

Own-source revenues in Indonesia and thePhilippines have risen in nominal (and real) terms,but have not fared as well as a percentage of GNP.In the Philippines, own-source revenues rose sig-nificantly right after decentralization, but havebeen stagnant as a percentage of GNP—at 0.91 in2001—ever since. In Indonesia, own-source rev-enues rose from 1.1 percent of GNP in 1995 to1.4 percent in 2002. In China, in contrast, localtaxes, which are predominantly shared revenues asopposed to own-source revenues (in fact, officialown-source revenues are minimal), grew signifi-cantly as a percentage of GNP since the Tax SharingSystem reform, from 5.0 percent in 1994 to 7.0 per-cent in 1999. Moreover, estimates of buoyancy inthe post-reform period—a measure of revenue pro-ductivity as a result of economic growth—showthat it is quite high.17 Overall, these results indicate

that despite policy, administrative, and politicalchallenges, own-source collection shows some pos-itive signs, which augurs well for the future.

However, in most cases, own-source revenuescompose a small percentage of total subnationalrevenue and their share has either not improvedmuch or has actually declined. This means thatsubnational governments have not reduced theirdependence on central government transfers.The next sections analyze that result for severalcountries.

Composition of Own-Source Revenues

From 1992 to 2002, own-source revenues in thePhilippines composed 34 percent, on average, oftotal resources available to local governments.However,own-source revenues declined from 38 per-cent in 1992 to 31 percent in 2002. Thus, theserevenues,although nominally growing,have not keptup with the growth in transfers from the centralgovernment (the Internal Revenue Allotment).

In the Philippines, as in numerous developingcountries, property taxes account for the largestsingle component of local revenues. In 2002, the


BOX 6.1 Revenue Assignment across Subnational Governments inChina’s Gansu Province

Gansu province is centralized, in that the provin-cial level retains a relatively large share of alllocal taxes and rebates. For example, theprovince retains the entire amount of the value-added tax shared with subnational governments(that is, 25 percent of total national collections).A number of important features characterizesubprovincial revenue assignment:

• Revenues from the enterprise income tax andthe value-added tax are allocated to the levelof government that “owns” the enterprise.

• The city maintenance tax is shared 30 per-cent with the province and 70 percent withprefectures and cities.

• The resource tax is shared 70 percent withthe province and 30 percent with prefecturesand cities.

• The urban land tax is shared 40 percent withprovinces and 60 percent with prefecturesand cities.

• For all other local taxes, prefectures andcities have full discretion over sharingarrangements.

• For certain local taxes, counties have full dis-cretion over sharing arrangements withtowns and township governments. Thesetaxes include the farmland occupation tax,the land appreciation tax, the housing prop-erty tax, the vehicle license tax, and animalhusbandry charges.

• Given discretion at each level of government,a variety of other arrangements exist. Forexample, in some counties the prefecturegovernment received a share of the countyvalue-added tax despite the provincial rulethat allocates the tax by ownership.

Source: World Bank 2002, pp. 57–58.

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real property tax accounted for 36.5 percent of sub-national own-source revenues, while business taxesand licenses accounted for nearly 30 percent, andoperating and miscellaneous revenue accounted for22 percent (see table 6.7).18 These percentages haveremained stable over time.

In Indonesia, own-source revenues accountedfor about 39 percent of total revenue at the provin-cial level, but only 7 percent at the city and regencylevel (see table 6.8). Moreover, the percentage ofown-source revenues to total revenue at the city

and regency level declined from 12 percent to 9 per-cent from 1995 to 2000, and dropped further to6 percent in 2001, after decentralization. Transfersrose in relative importance over the same period,from 84 percent to 87 percent of total revenues.

Trends in Own-Source Revenues

Both the Philippines and Indonesia show a cleartrend: own-source revenues have risen slowlybut steadily. In the Philippines, nominal and real


TABLE 6.7 Own-Source Revenue Composition by Type of Local Government in the Philippines, 2001(percentage distribution)a

Sources All SNGs Provinces Cities Municipalities

Real property taxes 36.5 47.3 36.8 30.3Business taxes and licenses 29.8 0.3 36.3 26.3Other taxes 11.2 22.4 10.0 9.0Operating and miscellaneous revenue 22.3 29.2 16.9 34.3Capital revenue 0.1 0.7 0.0 0.1

Source: COA 2002.Note: SNGs � subnational governments. Totals may not sum to 100 percent because of rounding.

TABLE 6.8 Composition of Regional Revenue in Indonesia, 2002(millions of rupiah; percentage of total revenue)

Provinces Cities/regencies

Own-source revenues 14,207,830 7,454,62938.46% 7.19%

Taxes and charges 12,500,929 5,109,50133.84% 4.93%

Other 1,706,901 2,345,1284.62% 2.26%

Grants 7,393,745 64,100,11220.02% 61.83%

Revenue sharing 8,084,119 17,310,42821.89% 16.70%

Carryover 6,307,652 9,752,99417.08% 9.41%

Other 944,849 5,052,4252.56% 4.87%

Total 36,938,196 103,670,588100.00% 100.00%

Source: Ministry of Finance. Note: Figures are projections based on data for 28 provinces (including Jakarta) and 324 cities and regencies.

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collections have grown steadily in all major cate-gories: property taxes increased nearly fourfoldfrom 1993 to 2000, while taxes on goods and serv-ices rose fivefold. Taxes on goods and servicesrecorded the highest average annual increase,followed by the property tax. Growth rates for allcategories slowed during the latter part of theperiod.

In Indonesia, decentralization spurred a 40 per-cent nominal rise in local own-source revenuesbetween fiscal years 2000 and 2001.19 While rev-enues from taxes and charges grew by 21 percentand 32 percent, respectively, the largest increaseoccurred in the category of “other,” which rose by155 percent (see table 6.9). In 2001, locally raisedtaxes contributed 43 percent of own-source rev-enues, while charges raised 33 percent and the shareof “other” revenues grew to 21 percent.

Between 2000 and 2001, provincial tax revenuemore than doubled in Indonesia. Several factorsmay explain this sudden jump. One factor seems tobe that provinces received additional taxing powersunder Law 34 of 2000 (even though the law abol-ished some nuisance taxes). Another factor is thattax collections, especially from the vehicle transfertax, rose considerably. Third, changes in revenue-sharing arrangements may have created strongerincentives for provincial governments to increasecollections.

Fuel and motor vehicle–related taxation domi-nate provincial own-source revenues in Indonesia.Provinces also appear to levy taxes that are formallyassigned to local governments, such as the hoteland restaurant tax and the street lighting tax.Despite their insignificant expenditure respon-sibilities, provinces raise almost twice the own-source revenues as cities and regencies. In 2001, forexample, revenues from local taxes and charges

were less than half those from provincial taxes andcharges.

Street lighting and hotel and restaurant taxesaccount for over two-thirds of own-source collec-tions among cities and regencies. “Other” taxes—which most likely include a large number of nui-sance taxes that local governments have introducedsince Law 34 of 2000—represent only 6 percent oftax revenue, indicating that the new taxes do notgenerate significant additional revenue.

Own-Source Revenue Administration

Arrangements for tax administration vary through-out the region, ranging from highly decentralizedin the Philippines to highly centralized in Vietnam,with Indonesia and China between these twopoles. Yet in all cases the relative roles of local andnational governments have not been well designed,resulting in both capacity and incentive challenges.The Philippines, for example, is highly decentral-ized with respect to tax administration. The Bureauof Internal Revenue (BIR) administers nationaltaxes, while each local government administers itsown-source revenues according to the LocalGovernment Code and local revenue codes. More-over, the law provides for little formal cooperation:the BIR operates independently of local tax admin-istrations, and the national government provideslittle support to local governments.20 Meanwhile,local tax administrations usually operate independ-ently of one another.

At the other extreme is Vietnam. The GeneralTaxation Department—operating under theMinistry of Finance, with offices at the provincialand district levels—is responsible for collectingall internal revenues. Local governments have no


TABLE 6.9 Annual Nominal Growth in Local Own-Source Revenue in Indonesia, 1996–2002(percent)

Annual increase 1995/1996 1996/1997 1997/1998 1998/1999 1999/2000 2001 2002

Regional tax 31 22 20 48 26 21 23Regional charges 18 14 11 �12 20 32 32Profits—enterprises 18 33 �2 20 26 10 89Other 40 0 15 75 �1 155 93Total 24 16 14 20 20 40 42

Source: BPS and Ministry of Finance.

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tax administrative responsibilities. However, taxadministrators operate under a system of dual sub-ordination, in that they are responsible to theirministerial management as well as to representativesof local governments.21 Thus, the system is charac-terized by built-in tensions. Martínez-Vázqueznotes that administrative centralization may reduceincentives for revenue collection, as central officialshave fewer incentives to collect local revenues com-pared with local administrators, who would havegreater incentives to collect local revenues. Onthe other hand, he notes, provincial authoritieshave been known to pay bonuses to tax adminis-trators who improve their collection performance(Martínez-Vázquez 2003). In this sense, subnationalgovernments have some administrative control atthe margin.

In Indonesia and China, the central governmentadministers all shared taxes, while local govern-ments administer revenues assigned to them. InIndonesia, local revenue agencies administer thetaxes for which they are responsible, with littlesupport from the central government. As in thePhilippines, the result is that administrative capac-ity and collection costs vary widely by locality.China’s Tax Sharing System reforms of 1994 cre-ated two separate tax administrations—one at the

national level to administer national and sharedrevenues, and a provincial tax administrationtasked with all subnational revenues. According tothe World Bank, “de facto dual subordination” ofcentral tax administrators to local governments isstill a problem, owing to old allegiances and the factthat local governments provide bonuses and assesspenalties to stimulate collection, thus creatingpotential conflicts of interest (World Bank 2002).

Local Revenue Administration: Models and Options

Tax administration can also be assessed from theperspectives of autonomy and efficiency. Vehornand Ahmad (1997) offer four models for taxadministration in decentralized polities. Theseinclude central tax administration with revenuesharing, central tax administration with assignmentof taxing powers to different levels of government,multilevel administration with revenue sharing,and self-administration by each level of govern-ment. Mikesell (2002) stresses another dimension:the extent to which national and subnationalauthorities cooperate or operate independently.Table 6.10 reveals a great deal of diversity in theregion on the administrative side, with transition


TABLE 6.10 Tax Administration Models in East Asia

Models Countries Observations

Central administration with Vietnam Highly centralized, but dual tax sharing Cambodia subordination of tax

administrators gives SNGs some control at the margin.

Multilevel administration China Formally separate with tax sharing administrations for national

and provincial levels, though dual subordination in practice.

Indonesia Formally separate administration, though some cooperation between central and SNG tax agencies, including on property tax.

Thailand Formally separate administration at the national, municipal/city, and subdistrict levels.

Self-administration by each Philippines Separate provincial, municipal/city, level of government and barangay administrative levels;

little cooperation between central and SNG tax agencies.

Source: World Bank staff.Note: SNG � subnational government.

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economies closer to the centralized pole andIndonesia, the Philippines, and Thailand closer tothe decentralized pole.

Guidance from the literature on good practice intax administration in decentralized contexts is lessclear. No consensus has developed on the principlesof devolved administration.

The efficiency criterion would argue for reducingtotal administrative and compliance costs by takingadvantage of economies of scale and scope. ThePhilippines, for example, includes hundreds ofsmall-scale tax administrations collecting revenuesthroughout the country. Their ability to attract andretain qualified personnel is limited, as is theiraccess to information technology. This limitedcapacity has direct consequences for taxpayers interms of higher compliance costs. Variations in localcapacity also mean that taxpayers do not receiveuniform treatment throughout the country.

The key question is whether it is possible to cen-tralize some administrative functions to reducecosts while not curtailing local autonomy. That is,to what extent is local tax administration a sine quanon of autonomous local governance? One couldargue that since some functions of tax administra-tion effectively control marginal revenues, subna-tional governments must have control over thesefunctions in order to have—by definition—own-source revenues. Looking at administration as abundled set of functions rather than a homoge-neous process allows one to think about differentialtreatment of administrative functions. For exam-ple, the level of enforcement activity will have adirect bearing on the level of tax arrears collections.Thus, a subnational government that controlsenforcement activities would be able to increaserevenues at the margin. The same holds for tax-payer registries, which can be managed more or lessaggressively, and taxpayer services. The argument isless true for other functions. Take property valua-tion. If valuation relies on market methods, there isnot much scope for differences in implementation.The point is that administrative as well as policylevers can affect marginal revenues (though someadministrative effects might be quite small).

Local governments do not, in theory, need tocontrol all tax functions directly if they control theadministration of those functions. The law requirestax administrators, as bureaucrats, to do as theirpolitical principals say. One definition of a good tax

administration is one that simply follows the taxcode, leaving aside the question of whether the lawis good policy. In the Philippines, bureaucrats areemployees of the local government and thereforeagents of local executives. But bureaucratic agentsof higher-level governments could also be responsi-ble to the local chief executive. The point is that taxadministrators do not need to be local governmentemployees to ensure accountability to local govern-ments. Devolved responsibility does not necessarilyimply devolved administration, especially in thecontext of weak local capacity.

A number of options would preserve local auton-omy while improving efficiency. These options neednot be universal for all subnational governments ina given country. Rather, subnational governmentscould consider the options on a case-by-case basis,which would imply asymmetrical treatment.Depending on local conditions, asymmetry mightmake sense, and would likely generate useful pilotsfor more comprehensive reforms.

A similar approach would encourage local gov-ernments with greater capacity to perform, for afee, some functions for other local governmentswith less capacity. That occurs with Lima’s TaxAdministration Service, which collects propertytaxes for two other Peruvian municipalities (Ateand La Victoria) for a 5 percent commission. Thecritical issue is whether subnational governmentswould control administration at the margin.

Another option would be to establish a taxagency that would assist local governments—on acase-by-case basis, for a fee—with core administra-tive functions: registration, collection, and compli-ance. Such a subnational tax agency would alloweconomies of scale and scope, which could loweradministrative and compliance costs. At presentthere are no known examples of this approach.

Yet another approach is for the national govern-ment to take responsibility for functions such asproperty assessment, or to help local governmentswith core functions. National governments assistwith core functions in many countries. In Colombia,the central government maintains the property reg-ister and updates property valuations. In Cyprus,Estonia, Jamaica, Malawi, and Pakistan, the centralgovernment is responsible for assessing propertyand collecting taxes, even though property taxes areassigned to local governments (Vehorn and Ahmad1997; McCluskey and Williams 1999, cited in


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Mikesell 2002).22 To add a dynamic element to thisapproach, one could envision local governmentsprogressively taking over more functions as theydevelop capacity in these specialized areas. All localgovernments would not necessarily perform all taxadministration functions, as some undoubtedlymake more sense administered centrally.

Some East Asian countries have already takenadvantage of economies of scale and scope. Respon-sibilities for administration vary among subnationallevels of government, with larger jurisdictionallevels having some responsibility for collections for

smaller jurisdictions in many countries. For exam-ple, in Indonesia and the Philippines, provinces col-lect and transfer some revenues to lower levels. Thisoption—provided that higher jurisdictions aregiven adequate incentives—is worth exploring as away to rationalize administrative arrangementsbetween national and subnational governments, andbetween subnational governments themselves.

Though there are some success strories in theregion (see, for example, box 6.2), the administra-tive capacity of subnational governments is weakin many cases, and is the binding constraint on


BOX 6.2 Improving Tax Administration in Quezon City, Philippines

Quezon City—the largest city in metropolitanManila in land area and population—faced a seri-ous budget deficit in 2001. The administration ofMayor Feliciano Belmonte, Jr., who assumed officein July 2001, inherited outstanding obligations ofP=1.4 billion and bank debt of P=1.2 billion. The citydecided to improve its revenue collection.

The mayor’s first step was to convene a searchcommittee, headed by the dean of the College ofPublic Administration of the University of thePhilippines, to recommend candidates for treas-urer. The mayor settled on Dr. Victor Endriga, whoquickly implemented reforms over the next 18months designed to reverse the city’s fiscal course.Treasurer Endriga adopted a “carrot-and-stickapproach.” The “sticks” include the following:

• Property auctions for delinquent propertytaxpayers. The city conducted three auctionsin 2002—the first postcode auctions inQuezon City. (Although delinquent taxpayershave sued the city, they do not phase thetreasurer: “it’s part of the game.”)

• Delinquency letters sent to recover the esti-mated P=10.7 billion owed the city. (Each staffmember must send out at least 20 lettersdaily, as staff had sent few before.)

• The use of presumptive minimum levels ofgross sales for the business tax and for markets.

• A requirement that all business establish-ments with gross receipts over P=500,000 sub-mit their previous year’s financial statement,as well as information on monthly tax pay-ments from the Bureau of Internal Revenue.

• A requirement that all payments of real estatetaxes include confirmation of payment of

other taxes, including the business tax andmayor’s permit fees.

• Direct withholding of taxes from city contrac-tors and suppliers, which rose from 12 per-cent to 75 percent of gross collections.

The “carrots” include the following:

• An increase in the discount on early paymentof property taxes, from 10 percent to 20 per-cent for annual payers, and from 5 percent to10 percent for quarterly payers.

• Improved taxpayer facilities, including mod-ern air-conditioned lounges with automaticqueuing systems, free coffee and tea, freelocal telephone calls, and televisions.

• Plaques from the mayor presented in a publicceremony to the 10 most “outstanding”taxpayers.

The city also computerized its property and busi-ness tax registries and collection processes, hiredan outside firm to input all paper records, insti-tuted new security features, raised tax rates, andreassigned employees within the treasurer’soffice to avoid familiarization. The city nowrewards (such as with overseas trips) and pun-ishes revenue examiners based on actual collec-tions, and conducts house visits of delinquenttaxpayers.

This reform program has paid off. Own-source revenues rose from P=2.3 billion in 2001 toP=3.9 billion in 2002, and the city closed the yearwith a surplus of P=0.5 billion.

Source: Endriga 2003.

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improving revenue performance throughout theregion (see box 6.3). As Bahl has argued regardingChina, “Tax administration shortcomings plagueChinese fiscal policy” (1999, 66). The principalproblems include the following:

• The prevalence of stop filers, nonfilers, and latefilers, owing to low local capacity to register tax-payers. This results in delinquent payments andthe accumulation of arrears, especially in thePhilippines.

• Infrequent audit and enforcement (temporaryclosures and property auctions), resulting in lowcompliance. This seems to be a problem in bothIndonesia and the Philippines.

• The limited availability of taxpayer services,although some local governments in Indonesiaand the Philippines offer important examples ofgood practice.

• The low professional qualifications of staff in allthree countries.

• Inadequate support from and coordination withthe national government.

Overall, the East Asian experience suggests thatthe multilevel administration model (with tax shar-ing) may hold the most short-term promise. Theadvantage of this model is the possibility that dif-ferent levels of administration could assume differ-ent functions, and it could also facilitate assistanceto subnational governments. Assigning complextasks with economies of scale (such as property val-uation) to either a central government agency or anagency dedicated to subnational support wouldreduce administrative costs and likely improveservice quality. East Asian countries could furtherexplore the idea of a subnational tax supportagency, funded by subnational governments andunder their control. Other solutions, such as forsubnational governments to contract out to otherlocal governments or piggyback on national taxes,are also worth consideration.

The Politics of Local Taxation

While policy and administrative constraints on localtaxation are critical, political constraints also affectperformance. Several local governments in thePhilippines, for example, reported that “politicalintervention”underlay their limited use of the powerto auction or close businesses. Other governments

reported that instead of confrontation, mayors usedtheir “charisma” to persuade businesspeople to paytaxes. One government reported active oppositionfrom the chamber of commerce to the GeneralRevision of Assessment, and another reportedintense lobbying from the private sector againstincreases in tax rates, which resulted in compromise.Other localities report that businesses have takenlegal action against property auctions and taxincreases. Taxpayers sued Quezon City, for example,over “confiscatory” tax rates.

While no one knows the precise impact ofpolitical constraints on local taxation, a numberof hypotheses—focusing on incentives—may beposited. One possibility is that politicians simplyweigh the net impact, or political tradeoff, of higherrevenues against greater expenditures. Simply put,officials decide to increase taxes (either throughhigher rates or better administration) when the dis-counted benefits of greater expenditures are higherthan the discounted costs of higher taxes. Manyofficials seem to decide that the political costs ofhigher taxation are greater than the expected bene-fits. There are several possible reasons. First, theexpected marginal benefit is small compared withthe political cost of unhappy constituents. Ineffi-ciencies in delivering services (such as patronage orpadded projects) might also outweigh the impactof greater revenues, “wasting” the tax increase.

Another possibility is that the incidence ofbenefits and costs—in terms of expenditures andrevenues—might undercut local elites. Increasesin property tax collections would most likely harmthe wealthy from a distributive standpoint, whileincreases in service delivery would most likely favorlower-income groups. However, politicians maynot weigh these impacts equally, and may be reluc-tant to use higher tax collections to fund pro-poorservice delivery.

Other explanations focus on the timing of bene-fits and costs, the extent of executive control overspending, and the electoral strength of the incum-bent. Term limits on local executives—whichlimit them to two terms of three years each in thePhilippines, for example—might also make themreluctant to invest in tax improvement programsthat would yield fruit over the long term.

Property tax collection by local governments inthe Philippines may be particularly problematic. Asin most former Iberian colonies, landholding in


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BOX 6.3 Local Revenue Administration in Action in East Asia

Evidence from Indonesia:

• Revenues are administered according to amultilevel model:– The central government administers

national taxes.– Local tax agencies, generally known as

DIPENDAs, play a minor role in administer-ing the property tax.

– Vehicle and vehicle transfer taxes are jointlyadministered by the provincial DIPENDA,the national police (as the coordinator),and a state-owned insurance firm.

• Own-source revenues are administereddirectly by DIPENDAs of the cities, regencies,and provinces, except for street lighting andfuel taxes. However, by issuing permitsand licenses, local departments actuallycollect the user charges coordinated by theDIPENDAs.

• The administrative performance of theDIPENDAs varies widely.

• DIPENDAs have few cooperative agreementsor information exchanges with other agen-cies within the same government, except forproperty tax field offices of the DirectorateGeneral of Taxation.

• DIPENDAs may use a certain percentage oftotal tax revenues to pay allowances to staff,though these bonuses are not usually basedon performance.

• The quality of tax administration varies. MostDIPENDAs receive taxes directly in theiroffices, while others use partially government-owned regional development banks.

• One of the highest priorities of most DIPENDAsis developing the ability to professionally audittaxpayers, considered the weakest link in thesystem. The approach to taxpayer auditingvaries by local government. DIPENDAs tried tointroduce information technology in the early1990s, but few local governments are stilloperating the computer systems because oflack of training.

Evidence from the Philippines:

• Principal constraints on taxpayer registrationinclude:– A lack of regular maintenance and validation

of the property tax and business registers.

– A lack of automated registers.– Low-quality record keeping.

• Business tax registers are known to be incom-plete, given frequent changes in registeredestablishments, which results in low levels ofcontrol and compliance.

• Problems undermining property tax collec-tions include:– Collection efficiency for property taxes is

low, resulting in the hemorrhaging of themost important source of local revenues.Local governments seem to be in a weakposition to collect the taxes. Improving theefficiency of collection can raise these rev-enues significantly.

– Property assessments have not kept upwith changes in market values. Most localgovernments have not performed the Gen-eral Revision of Assessment since 1991,resulting in significant undercollection ofproperty taxes.

– Noncompliance with the requirement forregular assessment requires urgent atten-tion. The country could revise the code toallow the national government to do theassessments for local governments that donot comply.

• The compliance function seems inadequate.Major constraints include: – Infrequent exercise of local audit authority.– Infrequent exercise of local enforcement

authority, in the form of temporary clo-sures of firms and auctions of property.

• The difficulties of local governments inenforcing compliance suggest the need forpresumptive taxation in some cases, espe-cially for the business tax and some fees andcharges.

• The principal constraint on taxpayer servicesis their limited availability. The lack of eventhe most basic taxpayer services and writtenmaterials means high compliance costs arelikely to be the norm across the country.

• One main cause of underperformance isweak administrative capacity, owing partly tothe low professional qualifications of staff.Inadequate coordination with the Bureau ofInternal Revenue, and low levels of supportfrom the Bureau of Local GovernmentFinance, which might establish information-sharing protocols, are also factors.

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that country has been concentrated. This legacypits powerful landowners—some of whom havediversified their wealth into other assets—againstweak local governments, some of which have beenrun by local elites for generations. Not surprisingly,the ability of local governments to enforce compli-ance with local revenue codes is weak in the face ofelite resistance.

Conclusions and Implications

This review of experiences in Cambodia, China,Indonesia, the Philippines, Thailand, and Vietnamfinds that local governments have limited authorityand ability to raise their own revenues at the mar-gin. As a result, own-source revenues are low as ashare of total subnational resources, and in somecases have been declining as a share of totalresources. Limited revenue-raising power andcapacity raise questions about the supposed bene-fits of decentralization in improving accountabilityand allocative efficiency. Reliance on transfers intheir myriad forms creates dependence on thenational government and may weaken subnationalincentives to improve own-source revenue. Fourkey messages merit emphasis.

First, local governments have limited controlover tax policy, including the ability to set rates anddefine the tax base. Decentralization is thus morepolitical than fiscal. Lack of control over taxationat the margin breaks the tax-accountability link,undermining the expenditure efficiency promisedby decentralization. While the general limit onown-source revenues is not the only constraint,policy autonomy is essential for significantimprovement to occur over the medium term.

Second, the lack of authority over tax policyseems to have spurred local governments to seekunofficial tax and nontax sources of revenue, withdeleterious consequences. In a number of coun-tries, local governments have the authority to enactnew taxes and fees and thus engage in entrepre-neurial behavior, yielding both positive and nega-tive results. The resort to informal and illegal feesis even more unfortunate considering that subna-tional governments in the region are unable to availthemselves of many taxing options open to govern-ments in other regions.

Third, despite the lack of opportunity to raiserevenues and the apparent interest in “unofficial”

avenues, subnational governments do not appear tohave exhausted all their options. In some countriesand for some taxes, local governments appear toprefer a lax collection strategy (property taxation inthe Philippines, for example). Moreover, to theextent that the quality of local tax administrationreflects both capacity and interest (according tothe “revealed-preference” line of thought), thenmany subnational governments “prefer” weakadministration.

Incentives thus play a role in determining collec-tion levels of own-source revenues. This chaptersuggests that two kinds of incentives play a role.The first is the systemwide incentive. For example,inherent in the intergovernmental fiscal transfersystem are incentives that affect own-source collec-tions. In Indonesia, the fact that the principal inter-governmental grant is based on the differencebetween fiscal needs and revenue capacity, ratherthan actual revenues, gives subnational govern-ments incentives to raise collections to close thegap. The opposite is the case in Vietnam, whichbases transfers on the difference between expendi-ture needs and forecasted revenues, which arebased on previous collections. This formula couldprovide negative incentives, since higher collectionsresult in lower transfer amounts (World Bank2004b). Second, rational politicians might not pre-fer to increase own-source collections under cer-tain circumstances.

Fourth, improvements in local tax administra-tion would greatly strengthen subnational financesystems. Tax administrations vary throughout theregion, ranging from highly decentralized in thePhilippines to highly centralized in Vietnam, withIndonesia and China between these two poles. Yetthe relative roles of local and national governmentshave not been well designed, resulting in bothcapacity and incentive challenges. Local govern-ments tend to underperform on own-source collec-tion and administration, reducing the credibility ofthe local tax system and contributing to a culture ofnoncompliance by raising compliance costs for tax-payers. Local administrative capacity is thus quiteweak in many cases, and the binding constraint onimproving revenue performance.

This chapter points out that the lack of develop-ment of significant own-source revenues in manycountries is limiting the extent to which subna-tional governments can finance decentralized service


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delivery and make decisions about taxation andservice levels. However, it must be noted that localgovernments in some East Asian countries receiverelatively large shares of national income. Thusany efforts to boost own-source revenues wouldneed to occur in the broader context of matchingtotal resources—including transfers and sharedrevenues—to expenditure responsibilities.

Challenges remain for improving local tax policyand administration. The lack of autonomy under-mines the ability of local governments to realize thebenefits of decentralization by tapping significantrevenue sources to satisfy local preferences regardingthe level and quality of services. Fiscal sustainabilityrequires improvements in own-source revenue col-lection and administration more generally. Weakadministration undermines local tax systems by con-tributing to high rates of noncompliance, high com-pliance costs for taxpayers, and high administrativecosts for local governments. Getting the relationshipbetween the national and local governments right—in both policy and administrative terms—is pivotal.

Endnotes

1. For further discussion, see Bird 2003b; and Martínez-Vázquez 2003.

2. For further discussion, see Mikesell 2002. Many of thesepapers and others are available at www.decentralization.org.

3. Local Government Code, Sec. 191.4. The percentage split for the Land and Building Tax (exclud-

ing mining and plantations) is: center (9 percent), which isintended to cover administrative costs of the deconcen-trated revenue offices; provinces (16 percent); originatinglocal government (65 percent); 6.5 percent equally acrossregions; and 3.5 percent to regions that exceed their previ-ous year’s revenue target. A Land and Building Transfer taxis also shared: provinces (16 percent), originating local gov-ernment (64 percent), and the remainder to all local gov-ernments. The personal income tax is 80 percent central,8 percent provincial, and 12 percent originating local gov-ernment. See Law 25/1999, GR 115/2000, GR 104/2000.

5. Reference to Indonesia’s“regions”generally means provincesand regencies and cities, while the term “local governments”refers to regencies and cities.

6. The Salakhet refers to the portion of the provincial budgetthat is under the control of the provincial governor, not thebudgets of the deconcentrated line ministries at the provin-cial level. Nationally, the Salakhet represents about 20 per-cent of the total provincial budget allocation.

7. Only 7 cities charge the maximum 3 percent rate, and only21 cities charge rates greater than or equal to 2.5 percent(outside the National Capital Region). No cities or provincesin the NCR charge the maximum allowed.

8. For example, countries could impose the business tax on grossreceipts or rely on a subtraction method value-added tax. Notethat this will require interjurisdictional apportionment of thetax base. However, the process need not be complex as in

Pakistan, where small towns (tehsils) adopted levies on grossreceipts in 2002 (and contracted out collections).

9. It is noteworthy that the region has no cases of piggybacktaxation with local rate setting.

10. User charges are defined here, following Bird and Tsiopoulos(1997, 39), as “charges levied on consumers of governmentgoods and services in relation to their consumption,” whenconsumption is voluntary (such as public water charges).Fees are defined, in contrast, as cost recovery for a mandatedpublic service (such as automobile licensing).

11. In fact, provincial councils will set the rate for Thailand’svehicle tax as of 2005.

12. However, the Local Government Code in the Philippinesprohibits local excise taxes (Sec. 133 (h)) as well as levies onmotor vehicle registration and driving (Sec. 133 (l)).

13. Ahmad et al. (2000), report that extrabudgetary funds rep-resented nearly 40 percent of all local revenues in 1999.

14. R.A. 7160, Sec. 186.15. For any taxes not listed in Law 34, local governments can

decide on appropriate tax bases and rates, as the centralgovernment establishes only general principles.

16. The regional parliament must pass these regulations toauthorize the introduction of a new tax or charge.

17. The World Bank calculated the buoyancy coefficient oflocal taxes at 1.6 for the 1994–1999 period (2002, 55).

18. However, a significant share of property tax revenues isearmarked for education spending. On average, over theperiod 1992–2000, the Special Education Fund, which isearmarked for education, accounted for 44 percent of totalproperty tax collections, which is quite high consideringthat property taxes are the main source of subnationalown-revenue. Earmarking is another form of reduced sub-national autonomy.

19. This is based on annualized data for fiscal year 2000 (whichlasted nine months). In general, observers agree that thequality of fiscal year 2000 data is questionable, since—besides being shorter—this year was the transition to decen-tralization. Thus, it would not be appropriate to place muchemphasis on comparisons involving fiscal year 2000 data.

20. The only notable exception, in some ways, to this rule isthat subnational treasurers are employees of the Depart-ment of Finance.

21. Still, the General Taxation Department is responsible forappointing, promoting, and transferring departmentalstaff. To what extent local officials have input into theseprocesses is unknown.

22. See also Mikesell 2002 on intergovernmental tax adminis-tration compacts in the United States.

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subnational own-source revenue: getting policy and administr ation

Documents