Fiscal Decentralization in Indonesia: Status and Directions for Reform Bert Hofman Lead Economist, World Bank

Indonesia’s Fiscal Decentralization zBig Bang Decentralization zHigh Dependency on Grants zLimited Own Tax Base zLarge Fiscal Disparities

Big jump in spending share

Largely financed by grants

More revenues are shared

And some own tax base

More than enough on aggregate

And development spending increased

But some are more equal than others Rp./Capita

The DAU is hardly helping

Although it reduces variation in revenues

The center still spends a lot

The center spends a lot on local functions

Local government has its problems zHigh share of spending on wages zLots of legal and illegal taxation zWeak financial management and accountability zWeak coordination with the province

Directions for reforms “Rich regions must fend for themselves, poor must be assisted by the center”  Central government should spend less on local functions  Resources can be devolved though  Own tax base for regions  DAK  DAU

Directions for reforms  Own taxes could be:  Property tax (center can still administer)  Business tax (Hotel and restaurant tax already)  Personal Income Tax Surcharge (Opcen)

Conditions for reforms  Better financial management in regions  More clarity on functions/obligations  Restrictions on what taxes regions can raise (“Closed list” in Law 34)  Civil service reform  More equalizing DAU