Fiscal Decentralization in Thailand: Tax Sharing and Grant Allocation

1. Fiscal Decentralization in Thailand:Tax Sharing and Grant Allocation  Direk Patmasiriwat National Institute of Development Administration At Thammasat University, Faculty of Economics 15 December2010   1 TU Faculty of Economics 15 December 2010

2. Why chose to focus on these topics: tax-sharing and grant allocation A. The shared taxes and intergovernmental grant are the important sources of local government revenues (i.e., they combine to account for roughly 90% of LAO total revenues). B. The tax-sharing rule fails to match the revenue assignment and the expenditure assignment, in other word, there exists a vertical fiscal imbalance (between the central- and local-governments). C. The grant allocation fails to perform an ‘equalizing function’, in the opposite, the allocation rule added more fiscal disparities between LAOs. 2 TU Faculty of Economics 15 December 2010

3. A brief review of the progress of decentralization Thailand’s decentralization has undergone a major transformation after 1999. Brief summary: the Constitution 1997 laid a foundation for decentralization, it was the Decentralization Act 1999 that actually ignited the whole process of devolution of functions in accordance with the “Decentralization Plan” (2 phases, 5+5 years). Consequence: LAOs command of fiscal resources increased continually, now accounts for 25-26% of the central government revenues (429 billion baht). This was an “admirable achievement” considered the fact that the initial fiscal command was less than 10% before 1999. 3 TU Faculty of Economics 15 December 2010

4. Decentralization in retrospect: through the lens of an “incomplete contract” framework Constitutional mandates: devolution of responsibilities, the Decentralization Plan, and the National Decentralization Committee (NDC). Involved institutions: 245 functions to be transferred from ministries and departments; 7,853 units of local authorities (LAOs) The Principal-Agents model may be adopted as tool to analyze the transition; herein, NDC the “principal”, and LAOs and central agencies the “agents”. Decision-makings under uncertainty; they are revisable / adaptable over time The criterion for evaluation: are service deliveries now performed by LAOs better or at least as equal to the past (under central agencies); the fiscal transfer; “value for money” 4 TU Faculty of Economics 15 December 2010

5. Incomplete contract as framework for decision-makings under uncertainty It is natural for NDC to adopt an “incomplete contract” strategy; we assume that NDC trusted that decentralization would be efficient (or at least as efficient). A quote from Professor Anwar Shah (2006) “responsive governance”, “responsible governance”, and “accountable governance” “yes I trust, but you must later prove your worth” An incomplete contract model predicts “policy-commitment” based on trust but monitoring on the way and set conditions for renegotiation at midway. And to decide whether or not to continue contract or terminate, or to adjust the terms. 5 TU Faculty of Economics 15 December 2010

6. Future of fiscal decentralization: 2 scenarios It seems to me that the model may be applicable to our case study. The future is always difficult to predict: two possible scenarios are discussed as follow: 1. Should the fiscal transfer to support LAOs slow down or standstill at this level (25-26% of the central government revenues; 1.65 trillion baht the central government revenue; and 30% amount to 429 billion baht) 2. A new phase of fiscal decentralization to achieve the targets most local people love to see (two specifications: 245 functions, and the share of LAO revenue not less than 35% as stated in the Decentralization 1999 – but failed to achieve) 6 TU Faculty of Economics 15 December 2010

7. A new tax sharing rule and the “Local Revenue Act” Why do we need new tax sharing rule? Tax sharing rules in use today are written in many tax laws (e.g., alcohol tax, tobacco tax, value added tax, natural resource taxes…). Basically the rule divides the revenue according to 90: 10 formula, whereby 90% goes to the center, and 10% to local authorities. Under the “centralized” regime, the old rules may be appropriate—but invalid today. LAOs are under pressure from “unfunded mandates”. “revenue assignment” does not match “expenditure assignment”. Another way of expression a “vertical fiscal imbalance” (Boadway and Shah 2009) 7 TU Faculty of Economics 15 December 2010

8. Agreements and Disagreements in the Local Revenue Act My hypothesis: The future of fiscal decentralization depends crucially on an enactment of the Local Revenue Act (still in drafted form). The NDC has appointed a task force (Dr. Somchai Ruechupan, a chairman) to draft the law on her behalf. The task force agrees to define the term ‘shared taxes’ (???????????) to inform public that local governments have a power to tax (just like the central government). And a new sharing of 70:30 will be applied for VAT, excise taxes. In question and debatable: should LAOs be entitled to share the personal income tax and the corporate income?? There are both pros and cons to this proposal (of tax-sharing reform). 8 TU Faculty of Economics 15 December 2010

9. Law enactment, how and when? It is not clear whether the Cabinet will opt for the narrow definition of tax-sharing or the broad definition of tax-sharing. And whether or not the Parliament approve the bill. And when? The sooner is the better for the progress of decentralization. If the broader definition is used, the vertical fiscal imbalance will be largely resolved, if the narrow definition is adopted then the demand for intergovernmental grant is still high. Another proposal for tax reform is related to raising local tax capacity: these include property tax, environmental tax, and inheritance tax. The property tax is high on an agenda—but the chance of passing the legislation approval not high. 9 TU Faculty of Economics 15 December 2010

10. Fiscal disparities Fiscal disparities are not uncommon. The capacity to taxation vary widely from one region to another; so we observe rich LAOs and poor LAOs. Table 4 in my paper presents empirical evidences based on data (the fiscal year 2009, Oct 2008 – Sep 2009). Two variables are noted: the tax per capita and the grant per capita. They are highly correlated (the correlation coefficient of 0.6 ). Intergovernmental grant can be design to serve redistributive purpose, the so-called “equalization grant”. A book by Boadway and Shah provides a comprehensive review of theories and the practices around the world. And the book by Nobuo Mochida (2008) that highlight the case of Japan is quite interesting. TU Faculty of Economics 15 December 2010 10

11. Equalization grant to redress fiscal disparity There are different ways of revising our grant allocation formula to redress fiscal disparity: A) we learn from the practices in many countries: “the fiscal gap” which is defined as “the fiscal needs” of LAOs subtracted by “the potential revenue capacity”. This may look “academics” but in fact they are not difficult to handle. We need to develop the database that are comprehensive and timely; i.e., all LAOs included (7,853 units). B) we may offer a compromised solution that combines the status quo (say 50% weight) and an equalizing grant (say 50% weight). TU Faculty of Economics 15 December 2010 11

12. Options for policy reform …  C) an equalization formula can be gradually built in for a given time frame (says 3-5 years). We realize the difficulty in driving policy reform as there are always pros and cons to change; we must admit the fact that there are those who want to keep the status quo, an ad hoc formula and untransparent rule as they (politicians and high-rank officials) have full discretion and a control over resource allocation (for instances, the specific and project based grants). Anyhow the chances for policy reforms are possible and a quantum leap can happen when conditions are right. A words of wisdom from Professor Prawes Vasee who plays instrumental role of pushing “Reform Agenda for Thailand”. TU Faculty of Economics 15 December 2010 12

13. Being optimistic “moving the mountain” is possible with a) knowledge; b) public education on the benefit and cost of policy change so that the majority of population are convinced; and c) legislative cooperation. academicians can play an important role in Thailand through knowledge creation; collaborating with policy practitioners in policy design; communicating with the grassroot and never tire of explaining the public so that the subject is clear to the majority of people; and learning from local people; “home-based theories” can be conceived from field and not always imported. TU Faculty of Economics 15 December 2010 13