The World Bank1

Sharing of Natural Resource Revenues/Petroleum Revenue Decentralization

International Experience and Iraq

Presented to: Presented to: Extractive Industries: Legal and Fiscal Regimes, Revenue Management, and Good GovernanceMay 16-17, 2007, I 2-220Wednesday 2:30-3:15 pm

Presented by:Presented by:Monali Chowdhurie-Aziz, Senior Public Sector Specialist, MNSEDKai Kaiser, Senior EconomistPublic Sector Group

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Fiscal Decentralization and Natural Resources

• Prevailing Issues in Range of Countries– Nigeria, Russia, Indonesia, Iraq, Bolivia, Sudan, DRC, Malaysia,

PNG, etc.

• Challenges in applying developed country models for our clients– Weak Institutions and poor governance contribute to “resource

curse” at various levels of government– Recent price increases and new discoveries in range of countries

with pressures for decentralization– Claims to oil revenues highly contested with diverse states…

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Welcome to Southern Sudan

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Overview of Presentation

• Revenue Assignments in Decentralized/Inter-Governmental Settings

• Political and Economic Arguments around Sub-National Natural Resource-Revenue Allocation

• Some International Experience– How do we define Success?

• Illustrative Challenges from Iraq

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Natural Resource Revenues Must Be Seen Within the Context of Good Intergovernmental Design

Decentralization spans Political/Legal

Including Constitutional Assignments (e.g., DRC 2005)

Fiscal Shaped by country’s economic/revenue structure

Administrative

Natural-resources can add to the complexity…

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Five Fundamental Questions Facing Any Decentralizing System

• Expenditure Assignments/Responsibilities– Finance Follows Function Principle

• Revenues– Own Source Revenues (autonomy of bases/rate setting)

• Role of Sub-Nationals in Negotiating Exploitation/Revenue Streams

– User Fees

• Intergovernmental transfers– Derivation Based Revenue Sharing

– Transfers• Fiscal Equalization• Specific Purpose/Conditional Grants

• Subnational borrowing/debt• Capacity Development: Organizational, Institutional and Human

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Expenditure Assignment Considerations

• Macroeconomic stability– Takes on special importance with natural resource revenue

dependence

• Public Service Delivery– Effectiveness/Efficiency

– Public Management Innovation

• Poverty Reduction– Responsiveness

– Equalization

Expenditure assignments often span multiple tiers of government

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Rationales for Intergovernmental Transfers

• Vertical imbalances • Horizontal imbalances • Inter-jurisdictional spillovers (externalities)• Enhancing national objectives at the subnational level • Paying for national programs implemented by subnational

governments

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(Sub-National) Natural-resource revenue assignments tend to make inter-regional disparities prominent

• Assignment of Petro-Revenues to Sub-Nationals– Shared versus Own Source (i.e., incorporates effort)– How much is assigned to sub-nationals on derivation basis?

• Assignment of Other Revenues– Property Tax?– Income Tax? Other?

• Expenditure Needs– Ideally funds follow function

• Transfer Design– Vertical Shares/Pools?– Horizontal Allocation Criteria

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Revenue Structures Vary Significantly

Oil & Gas Revenues (Share of Total)M ost Recent Available Year

0

20

40

60

80

100

Gabon

Iraq (

Est.

Om

an

U.A

.E.

Kuw

ait

Nig

eria

Angola

Qata

r

Alg

eria

Congo,

Papua

Iran

Sudan

Syria

Yem

en

Mexic

o

Chad

Congo,

Indonesia

Kazakhst

Norw

ay

Russia

n

Mala

ysia

Austr

alia

Source:

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Arguments Around Natural Revenues Sharing

• Arguments for Greater Degree of Centralization– Stability: Natural Revenues Subject to high Degree of Volatility

– Disparities: Known and potential endowments highly unequal

– National Treasure: Belongs to all the people!

– Local Capacity: National governments better placed to manage

– Coherence in Natural-Resource Policy: Avoid distortion across regions

– Revenue Transparency: Easier if revenues accrue to one “account”

• Arguments for Decentralization/Derivation Based– Cost-Reimbursement: Including Environmental Costs

– Heritage Argument: Non-renewable resource

– Political/Conflict Resolution Arguments: • Often very important where legitimacy between central and sub-national

governments have been contested

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A “Good” Transfer System

• Transfers should be transparent and predictable– Preference for formula-based– Natural-resource revenue rich settings need to place special emphasis on

transparency

• Equalization transfers should include– A realistic measure of “need”

• Population, Area, Cost, “Backwardness”

– A realistic measure of “fiscal capacity”– Adequate sub-national revenue autonomy– Stable but flexible financing

• No Single Transfer May Meet All Objectives– But, avoid proliferation of different grants

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Managing Transfers Across Levels

• Hierarchical Models– 2nds tier has full autonomy over LG allocations

• Indonesian districts receive direct allocations• Pakistan (with some modification)• Nigeria: transfer allocations earmarked to locals, but concerns about state

interception

• National Models– Direct allocations to second & third tiers

• E.g., Indonesia’s provinces & districts• Guidelines for 3rd tier allocations

• Mixed/Asymmetric Models– Special autonomy in Indonesia (Aceh/Papua)

– North/South Sudan

– Iraq’s Regions/KRG

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Intergovernmental Revenue Management

• Addressing Petroleum Revenue Volatility– Transfers Based on Realizations or Actuals

• Sub-National Revenue Predictability– Ex Ante Rules

– Stabilization Accounts

• Addressing Petroleum Revenue Non-Renewability– Heritage Funds

• Who benefits and when?

• Transfer Transparency– Commissions for Dispute Clarification/Resolution– Reporting to Higher Levels– Revenue Transparency and Accountability

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The Challenge of Sub-National Accountability

• Natural-Resources Revenues May be Especially Prone to Weak Accountability– Weak Bottom-Up Accountabilities

• No Representation Through Local Taxation

– Beneficiary Regions Subject to Windfalls– Weak Top-Down Accountability

• Sub-National Allocation of Natural-Resources May Be Subject of Political Bargains

• Petroleum Revenues May Be Inherently “Centralized”– Allocation to Sub-National Governments May (Also) Fail to Trickle

Down

• Revenue-led Fiscal Decentralization Associated with Weak Accountability for Outcomes– Explore Linkages to Sectoral/Frontline Outcomes?

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Gauging “Performance” of Natural Resource Revenue Sharing in an Intergovernmental Context

• Glue or Solvent for National Cohesion?• Revenue Flows Translate Into Development Outcomes

– Finance Follows Function– Accountabilities Promote Service Delivery

• Revenue Assignments/Collection Consistent with Coherent Revenue Policy– Effective in attracting investment to best placed locations

• Consistent with Good PFM at all Levels– E.g., as benchmarked by PEFA

• Intergovernmental Arrangements Consistent with Fiscal/Macro-Economic Stability– “Overgrazing” undermines stabilization/heritage arrangements

• Natural-Resource Rents Don’t Subvert Country’s Institutional Development/Integrity– Corruption Further Corrodes Representative/Legitimate Institutions

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Fiscal Decentralization in Iraq

• Legacy of centralization– With some history asymmetric arrangements, notably Kurdistan

• High Dependence on Petroleum Revenues– >95 percent of domestic revenues in 2006/2007– Oil concentrated mainly in south– Debates around “old” and “new” oil

• 2005 Constitution with Federal Vision– Distinction between provinces and regions– Tendency to overlap regions with ethnic identify

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Prevailing Asymmetric Arrangements in Iraq

BaghdadMinFin/Central Bank/Line Agencies

KRGErbil/Dohuk, Sulaimania

Central Line Agencies

Provincial Councils

Governor’s Offices

Sub-National Government in Iraq’s 15 Governorates

MinFin Gov Treasuries * Basra CB

Regional Government

Municipal/Other Local Government

Municipal/Other Local Government

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Petroleum is Concentrated in the South

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(Illustrative) Fiscal Gaps in Iraq?

0

500

1,000

1,500

2,000

2,500

3,000

Oil

Shared

Own

Potential Per Capita Revenues (PC USD)

Figures from Jakarta, Metropolitan Capital of Indonesia

Projectopms by Peloquin (April workshop)

Sources: PC Oil Revenues are drawn from April workshop Module 3, Estimates for Baghdad Own Source and Shared Revenues are proxied by Jakarta, Indonesia

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Political Economy of Management, Regulation and Development of Hydro-Carbon Revenues

• In a Low Trust Environment Kurds view the development of their oil fields as having been

historically under-resourced. Historically Denied their share of revenues from the center Currently revenues are not transparent and are poorly managed at

the centre

• Suggested solutions Distinction between “old Fields’ and ‘new field” in the Constitution Contracting for “new field” in Kurdistan by KRG Allocate share of “actual” revenues to region based on population

Variant of this has already been in place by allocating 17% of national budget, minus a series of “sovereign” expenditures

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Political Economy of Management, Regulation and Development of Hydro-Carbon Revenues

• Problems with Suggested Solutions Contradictory rules for oil exploration Optimal resource development requires policies for that

development of old and current are coordinated (and distinction itself may be difficult in practice)

Coordination is important if stabilization is left to the subnational

Incentive for the one with the smaller budget to run a pro-cyclical fiscal policy while the one with the larger budget absorbs the costs of the counter-cyclical policy

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Petroleum Revenues and The Future of Iraq

• On-Going Constitutional and Legal Debates– Revisions to 2005 Constitution– Parallel to debates on Hydrocarbon Law, Revenue Sharing Law,

Law on Local Governments, and Revenues Sharing Law• Concerns about lack of transparency

– Future of Development Fund for Iraq (DFI)

• Significant Pressures to Increase Revenue Flows to Provinces/Regions– Allure of concentrated oil wealth may increase incentives to create

regions around ethnic lines (Shiastan, Sunnistan)– But also uncertainty about location of actual oil reserves behind “veil

of ignorance” and various myths of manna– Need to come to some arrangements that accommodate all main

actors

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Areas of On-Going Engagement in IraqAround Natural-Resource Sharing

• Clarify options of intergovernmental sharing and transfers to executive and legislative counterparts– Emphasize that revenues should need to follow functions, not vice

versa, as well as principles of (rule-based) equalization– Identify options for revenue management and revenue assignment,

as well as institutional arrangements to mediate these in practice across interests of various regions

• Promote sub-national PFM capacity– …in advance of new roles, responsibilities, and financing– Promote bottom-up and top-down accountabilities– Promote Revenues Arriving at Frontline Service Delivery

• Schools, Clinics, Communities around “outcomes”

• Limited Incentives for Revenue Diversification

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New institutional arrangements will have to mediate respective concerns…given prevailing realities

Prospective but underappreciated institutions• Public Commissions for Revenue Management

• 2005 Constitution Art. 106), including audit functions, to be regulated by Law (pending)

• Public commission for “interest of regions” • (Art. 105) (pending)

• Asymmetric arrangements may be the most practical solution– Overcentralization may itself be recipe for secession, less

transparency– Question is whether decentralization dynamics work for or against

resource curse?• E.g., contestation for revenue transparency, or overgrazing to maximize

own returns

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Q&A

Selected References

ESMAP (2005). Comparative Study on the Distribution of Oil Rents in Bolivia, Colombia, Ecuador, and Peru. Washington, DC, ESMAP (Joint UNDP/World Bank Energy Sector Management Assistance Programme: 142.

ODI, 2006. Sub-National Implementation of the Extractive Industries Transparency Initiative (EITI). London, Prepared for the EITI Secretariat and DfID, London, Issues Paper, April.

Fiscal Decentralization and Sub-National Public Financial Management in Iraq, Washington, DC: MNSED (mimeo)

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Annex: Alternatives Forms of Structuring Intergovernmental Grant Programs

Horizontal SharesMethod of allocating

The divisible pool

Among eligible units

Specified share of National or state Government tax

Ad Hoc Decision Reimbursement Approved Expenditures

Origin of collection of tax A NA NA

Formula B F NA

Total or partial reimbursement of costs

C G K

Ad Hoc D H NA

Source: Adapted from Roy Bahl (2006)

Vertical Shares: Method of determining the total divisible pool