Fiscal Federalism, Fiscal Disparity, and Financial Management Practices of Provinces

 

It has been eight years since Nepal adopted the Federal system and six years since its implementation began. The Constitution of Nepal, 2072 has provisioned the three layers of the governance system: Federal, Provincial, and Local in Nepal. Also, it provides for the distribution of state power and resources among these government units. Besides political and administrative aspects of federalism, the Constitution has also provided the model of Fiscal federalism as one of the major pillars of federalism. The Constitution has adopted the globally accepted principles of fiscal federalism as well. It provides the federal units with revenue rights, expenditure responsibility, revenue sharing, intergovernmental fiscal transfer, and also the bases for foreign assistance and internal loans.

Along with the transformation of the political, administrative, and economic structure brought about by federalism in the country, the previous unitary public financial system of the nation has decentralized into three layers of government. Accordingly, the resources, revenue, and expenditures that were completely managed by the central government in the previous system have now been shared among these three levels of government. Although the Constitution provides single and concurrent/shared functional and spending powers to each federal unit, the major revenue sources such as customs duty, excise duty, VAT, and income tax have been assigned to the central government as in the previous fiscal system. The provinces and local levels are assigned relatively lower tax-based sources of revenue mobilization. Thus, fiscal federalism in Nepal seems to be relatively decentralized in terms of expenditure assignment and more centralized in terms of revenue mobilization.

Source: Office of the Financial Comptroller General

If we look at the official data relating to public financial management, a concerning trend has emerged regarding the fiscal situation of the provincial governments, raising questions about the effective implementation of fiscal federalism. The data reveals a notable fluctuation in the provincial governments’ share in consolidated revenue and expenditure over the past few fiscal years. In the FY 2078/79, the share of provinces in consolidated expenditure was 10.93 percent which was 12 percent less than it was in the previous FY. Likewise, the share in consolidated revenue was just 6.83 percent which was around 17 percent less than that in the past FY. The most alarming aspect of this fiscal analysis is the existence of vertical fiscal imbalance and widening fiscal gap each year. Such a trend is contrary to the expectations associated with the effective implementation of fiscal federalism, whereas a balanced distribution of financial responsibilities and resources is typically anticipated.

Besides this there also exists horizontal fiscal imbalance and fiscal disparity in the revenue mobilization. Except for Bagamati province, the other six provinces have predominantly depended on fiscal transfers, particularly the direct transfer from the federal government. Among them, Karnali and Sudur Pashchim provinces face a different scenario, where internal revenue constitutes only about one-third of their total. Also, internal revenue and unused cash from last year have a substantial share. Thus, there is a considerable dependency on intergovernmental fiscal transfers from the central government to meet their need for public service delivery. This inter-state fiscal divergence is accounted for by several geographical, economic, and social factors. This shows the need for tailored fiscal strategies to address these divergent revenue mobilization patterns effectively. 

Provinces	Annual GDP Per capita	Per capita revenue	Per capita fiscal transfers	Per capita total expenditures	Revenue-GDP ratio
Koshi	157,284.00	2,924.26	3,732.12	6,039.90	0.28
Madhesh	106,299.00	2,494.01	2,469.72	3,640.55	0.31
Bagmati	297,288.00	5,471.24	2,562.67	6,211.51	0.66
Gandaki	177,069.00	4,580.70	5,625.34	8,937.60	0.23
Lumbini	136,141.00	3,026.10	3,074.05	5,867.67	0.29
Karnali	119,488.00	5,114.53	9,965.05	14,381.48	0.17
Sudur Pashchim	128,140.00	3,506.55	5,801.85	7,747.32	0.19

Source: Office of the Financial Comptroller General, National Statistic Office, FY 2078/79

Likewise, there also exists the inter-state disparity in income and expenditure. In FY 2078/79, Bagmati had the highest per capita income with Rs. 297288, around three times the per capita income of Madhesh, the province with the lowest per capita income. The revenue-GDP ratio shows the difference in the revenue-raising capacity of the provinces, among them Karnali had the lowest stake. Karnali ranked second in per capita revenue despite the lowest revenue base, mainly due to the low population concentration. There also exists a significant difference in per capita transfers. In terms of per capita fiscal transfers Karnali received the most whereas Madhesh province which had the lowest per capita income and revenue received the least, as such Madhesh province had the lowest per capita total expenditures. Surprisingly, Karnali is the second lowest-income province with a very low revenue mobilization but has the highest per capita total expenditures. The analysis of these fiscal and economic variables revealed that Madhesh province, which even has the lowest HDI is lagging behind among others. Therefore, the policymakers and the National Natural Resource and Fiscal Commission should rethink and redefine the bases used for determining the distribution of revenue and fiscal transfers addressing the disparities and ensuring a more balanced and equitable distribution of resources among the sub-national entities for sustained development and equitable access to public services.