The Key Elements of Fiscal Decentralisation

The rule ‘finance follows function’ would be the best way of showing that fiscal decentralisation had taken place in a devolved system. The substance of ‘finance follows function’ is assigning a set of functions which is adequately matched with the assigning of own source revenues or transfers. In addition, adequate and reliable resources to carry out the given functions are part of the requirements of effective decentralisation. Hence, it is worth noting the key elements of fiscal decentralisation in the decentralisation of functions:

An appropriate set of functions for sub-national governments
This element addresses the question of ‘who does what?’ or ‘what are the functions and expenditure responsibilities of each level of government?’ (Bird and Vaillacourt: 1999, Boeix, 1999). An ideal method of examining the adequacy of assigning functions to lower levels of government is to analyse how well the actual assignment of responsibility fits the fundamental rules of expenditure functions given to sub-national governments (Vasquez, 1999). In addition, Smoke (2001) emphasises that recognising a clear, gradual, and pragmatic strategy is necessary to set the functions more appropriately to lower levels of government.

Why is such assigning of expenditure responsibilities important for ensuring that fiscal decentralisation is implemented in a decentralised government system? In responding, Boeix (1999) notes that the assignment of expenditure responsibilities has a multi-dimensional component, that is, the responsibility to provide, finance, and regulate a certain government function. In this regard, it notably underlines the need to recognise certain functions in order to minimise disputes and potential conflicts amongst tiers of government. Henceforth, fiscal decentralisation should ideally be preceded by political and administrative decentralisation (Braun and Grote, 2002).

An appropriate revenue-resource responsibilities
The ideal way to assign revenue responsibilities is to bring about revenue mobilisation and revenue-raising powers (Bahl, et al, 1999). Therefore, it is necessary to have tax-autonomy to match the assigned functions. As a result, taxpayers may increase their demands on a highly public service provision.

This argument can be derived from the OECD (2004): that ‘when sub-national expenditure is financed predominantly with resources mobilised locally, sub-national jurisdictions face stronger incentives to evaluate the benefits of an increase in spending against the costs of incremental taxation’. Therefore, the argument would be best exercised using the principles of tax-autonomy to sub-national governments, thus enabling the rich regions to finance the service provision from their own revenue and collecting revenues from local residents in order to provide the benefits to local people (Bird and Vaillacourt, 1999).

A well-designed intergovernmental fiscal transfer system
There is growing concern over the contribution of intergovernmental fiscal transfer which until recently still constituted the primary source for local budgets2. The likely reason is that since revenue assignments did not provide sufficient revenues for funding local expenditures, intergovernmental transfer had to ensure the enough revenue at the local level (Boeix, 1999).

Transfers can be formulated in some cases, depending on purpose. They can be unconditional or conditional, or can also form matching or non-matching grants. The principle is that transfers should be generous enough to ensure that sub-national governments can afford to implement the decentralisation of functions.

Adequate access to development capital
Access to development capital is vital for enhancing local discretion over financing local expenditures. The purpose of giving substantial access to financial institutions and markets is mainly to accelerate development generating increased local revenues (Devas, 2006). This gives sub-national governments alternatives in financing their expenditures, particularly capital investment, which is assigned by central government. However, considering that such access would create potential problems due to overall macroeconomic stability, it is, therefore, important to set conditionality above local borrowing.

An adequate enabling environment for fiscal decentralisation
The political will which enables government to establish constitutional and legal mandates for fiscal decentralisation is also essential, since it implies a strong foundation for fiscal decentralisation.

Such an internal driving-force for decentralisation, rather than external driving-forces (i.e., pressures from donors) fosters successful fiscal decentralisation. Uganda and Ethiopia, for instance, initiated their fiscal decentralisation when they experienced a strong national commitment to decentralise (Smoke, 2001). Indeed, instruments of fiscal decentralisation were then vigilantly introduced, with robust and clearly defined constitutional and legal provisions.


While Prud’Homme (2003) almost agrees with these provisions, he holds the presence of accountability mechanism to be a critical value in enforcing fiscal decentralisation. Letting an effective fiscal decentralisation instrument also relates to central government controls, guidelines and constraints upon local government. In this sense, such control would relate to upward accountability to the centre, which would make an accountability mechanism possible between tiers of government.