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Fiscal Decentralisation and Sustainable Development: Lesson from Local Government Levels in Indonesia ∗

Indonesia introduced fiscal desentralisation when the central government enacted Law No. 25/1999 on fiscal balance between the central government and the local governments. This law was later revised as Law No. 33/2004 and is widely known as the ‘new direction of fiscal relationship’ which guides the intergovernmental financial relationship between central and local government in Indonesia (Brojonegoro & Asanuma, 2003; Suharyo, 2009). According to the law, local governments have two major sources of revenues to finance their expenditures: own-source revenues and intergovernmental transfers. Own-source revenues are revenues raised by local governments from their local sources, consists of taxes, levies, proceeds from the management of regional assets set aside for the purpose, and other source of revenues. While intergovernmental transfers consist of Revenue Sharing from natural resources and taxes, General Allocation Funds (Dana Alokasi Umum, or DAU), and Specific Allocation Funds (Dana Alokasi Khusus, DAK). The fiscal desentralisation law established principles on the intergovernmental financial relationship between central government and local governments, which take the forms of devolution, deconcentration, and co-administration of tasks. Through those forms, most authority and responsibility of the central government was devolved to local governments, including the financial responsibility over the provision of public goods and services at local levels. This study examines the arguments in favor of the impact of fiscal desentralisation on the economic development at local levels through the public financing capacity. The methodological approach was qualitative and quantitative modes of inquiry. The analysis on the fiscal budget includes the revenues and expenditures assignments, the trends on the local government expenditures, revenue desentralisation and financing capacity, as well as the roles of intergovernmental transfers within the local budget. This study was undertaken upon the economic arguments on fiscal desentralisation to increase the revenues or fiscal autonomy of sub-national governments (Falleti, 2005) and provides autonomy to local governments in the provision and financing of public goods (Brueckner, 2008). Fiscal decentralisation exists when sub-national governments have powers given to them by the constitution or by legislation, to raise taxes and/or carry out spending activities within clearly established legal criteria (Tanzi, 2000). This study therefore seeks to examine whether fiscal desentralisation in Indonesia increases the financing capacity of local governments, thus promoting local economic development.The results from this study demonstrate that the practice of desentralisation in Indonesia has shown that various reforms have affected the political and administrative system in Indonesia and also the arrangements of authority and financial responsibility between the central government, and the local governments (province and district/city). Under desentralisation policy, the central government gives authority in most areas of governance to local governments. It is however, the central government that retains responsibility for national planning, control on national development, intergovernmental fiscal arrangements, the state administration and economic institutions system, training and human resource empowerment, utilization of natural resources, strategic high level technology, conservation, and national standardization. Such arrangements have changed the mechanism of accountability among central and local governments in Indonesia. Fiscal data analysis performed for provinces, districts and cities in Indonesia indicate that most local governments are still highly dependent on the fiscal transfers from the national governments in performing their public financing functions. As such, the sustainability of local development can be achieved in the long run.