Philippines Decentralisation RRL

Annex 1: Decentralization in the Philippines: Selected Literature Review on Fiscal, Political and Service Delivery Aspects HISTORICAL BACKGROUND The Local Government Code of 1991 (LGC) was landmark legislation that initiated the decentralization of governance in the Philippines and provides the overall framework for central-local relations. Enacted in the wake of the 1986 People Power revolution, the LGC consolidated and amended various existing laws that specified the parameters for local government (i.e. the Local Government Code of 1983, the Local Tax Code [P.D. 231], and the Real Property Tax Code [P.D. 464]) and laid the foundation for increased local autonomy and accountability through the assignment of service delivery and expenditure responsibilities and revenue mobilization powers to local government units (LGUs).1 The LGC also specified the basis for revenue sharing between the national government and LGUs and provided for the participation of civil society in local governance. Several factors are cited to explain the push for increased devolution of fiscal and service delivery responsibilities to LGUs that resulted in the enactment of the LGC. One explanation is the widespread sentiment to democratize after the change of government in 1986, which led to a strong determination to dismantle the mechanisms of central control instituted by Marcos.2 This coincided with an increasing demand for local autonomy from local politicians. Furthermore, decentralization has been cited as a way to respond to the armed resistance of the New People’s Army and the separatist movements in Mindanao. As in many cases of decentralization in developing countries (e.g., Latin America, Indonesia), the primary impetus seems to be political and the desire to improve government performance (e.g., service delivery) seems to be only a secondary motive. As the following sections on expenditure and revenue assignments indicate, the current intergovernmental fiscal arrangement is hardly conducive to efficient service delivery and LGU accountability. But more than 15 years since the passage of the LGC, the data on the level and the quality of public services provided by LGUs remain scarce, which has prevented researchers from establishing a solid empirical basis for assessing the effects of decentralization on service delivery.

1

Manasan, Rosario G. 2007. “Decentralization and the Financing of Regional Development.” The Dynamics of Regional Development: The Philippines in East Asia. Ed. Arsenio M. Balisacan and Hal Hill. Asian Development Bank Institute. Manila: Edward Elgar Publishing Ltd. and Ateneo de Manila University Press. 2 Rood, Steven. 1998. “Decentralization, Democracy, and Development.” The Philippines: New Directions in Domestic Policy and Foreign Relations. Ed. David G. Timberman. United States Agency for International Development. Manila: Asia Society.

FISCAL DECENTRALIZATION Expenditure Assignment:3 Prior to the enactment of the LGC, the responsibilities of LGUs were limited to the administration of basic local services and enterprises such as garbage collection, public cemeteries, public markets, and slaughterhouses. The LGC formally transferred from national government agencies to LGUs the principal responsibility for providing and financing services in the following areas:

o o

land use planning agricultural extension and research community-based forestry solid waste disposal system

o

environmental management

o o

pollution control primary health care

o

social welfare services

o o

o

hospital care

o

local public buildings and structures

o o

local public parks local services and enterprises (e.g. public markets, public markets, slaughterhouses, etc.) local infrastructure facilities (e.g. local roads and bridges, school buildings, health facilities, housing, communal irrigation, water supply, drainage, sewerage, flood control)

o

Municipalities and cities are primarily responsible for the frontline delivery of local public services, such as the operation and maintenance of local health centers, the collection and disposal of solid waste, and the construction and maintenance of public school buildings. On the other hand, provinces are tasked with responsibilities for functions that involve inter-municipal provision of services, such as the operation and maintenance of district and provincial hospitals. However, the provision of basic education was not devolved to LGUs and continues to be the responsibility of the national government’s Department of Education. While the national government continues to provide for and finance basic education, the responsibility for the construction and maintenance of public school buildings was assigned to LGUs. While the delineation of responsibilities between national and local governments are generally consistent with the normative assignments suggested by decentralization theory (with education being a prominent exception), the LGC includes provisions that compromise the apparent clarity of the expenditure assignments. Specifically, the LGC allows national government agencies to implement public works and infrastructure projects and supplement local service delivery when these are not available or are inadequately provided by LGUs. In addition, legislative allocations by congressmen and senators are commonly used to augment LGU spending, particularly on infrastructure. Finally, the center influences local expenditures through the enactment of laws that result in mandated 3

Manasan, Rosario G. 2004. “Local Public Finance in the Philippines: In Search of Autonomy with Accountability.” Discussion Paper, Series No. 2004-42. Manila: Philippine Institute for Development Studies.

increases in spending on the part of LGUs without any corresponding financial support from the national government. Examples of these so-called unfunded mandates include the salary standardization law, the Magna Carta for Health Workers, and the requirement for LGUs to pay for the health insurance premiums of their indigent residents. Revenue Assignment:4 The following table summarizes the various taxes that were assigned to LGUs by the LGC. Cities have the widest range of taxing tools available while provinces and municipalities either have no access to certain tax measures or are required to share the proceeds with sub-levels of LGUs. In addition to local taxes, LGUs are allowed to levy user fees and charges on businesses and occupations commensurate with the cost of regulation, inspection, and licensing of business entities and individuals. Several key tax bases are reserved for the national government, including the personal and corporate income tax, custom duties, the value added tax, and excise taxes on alcoholic beverages, tobacco products, and petroleum products. Local Tax

Cities

Provinc es X

On Real Property Transfers X On Business of Printing and X Publication On Franchises X On Sand, Gravel, and other X Quarry Resources On Amusement Places X On Professionals X On Delivery Vans and Trucks X On Real Property X On Idle Lands X On Businesses X On Community Tax X * Shares in the proceeds of the higher level

Municipaliti es

Baranga ys

X

*

*

X X X X X

*

X X

*

X X LGU that collects the tax.

* X *

Local tax assignment is generally consistent with the traditional criteria for assessing appropriateness: economic efficiency, equity, and administrative feasibility. However, the assignments are weak in terms of providing local fiscal autonomy for LGUs. The majority of the productive tax bases are restricted to the national government and among the local tax bases, only the real property tax and business tax bases provide substantial local revenues. The LGC also limits the power of LGUs to set tax rates by specifying floors and ceilings on the tax rates that can be imposed and, in some cases, fixed rates on local taxes. Furthermore, the LGC allows LGUs to adjust tax rates only once every 5 years and by no more than 10 percent. Importantly, cities are generally allowed to set higher tax rates compared to provinces and municipalities. The broader range of taxes and higher rates 4

Manasan, Rosario G. 2004.

available to cities coupled with the requirement for provinces and municipalities to share real property tax collections, typically a primary source of local revenues, results in wide disparities in local revenue mobilization between cities, on one hand, and municipalities and provinces, on the other. This has created a strong incentive for municipalities to convert into cities. The vertical fiscal imbalance is further exacerbated for provinces given their lack of access to business taxes, which only cities and municipalities can collect. This is illustrated in the following table, which shows the shifts in the shares of own-source revenues among the three levels of LGUs.5 Distribution of Own-source Revenues of LGUs by Level of Government, 1985-2003 (%) Year All LGUs Provinces Municipalitie s 1991 100.0 18.4 38.9 1995 100.0 14.8 31.7 2001 100.0 11.9 23.3 2003 100.0 10.1 22.1 Average 1985-91 100.0 19.9 37.1 1992-2003 100.0 12.5 27.3

Cities 42.7 53.5 64.8 67.9 43.0 60.2

Intergovernmental transfers. The LGC institutionalized the internal revenue allotment (IRA), which is the primary transfer of shared revenues from the national government to LGUs.6 In principle, the IRA is supposed to be automatically and unconditionally released by the national government to LGUs on a quarterly basis, although the LGC provides conditions for the national government to withhold a portion of the IRA during periods of national fiscal distress. The IRA is essentially an unconditional grant that LGUs can utilize at their discretion. The only restriction imposed by the LGC is for LGUs to set aside 20 percent of their IRA allocation for a local development fund. In practice, the IRA formula has been adjusted for various reasons, including the proper interpretation of the stipulated IRA formula7 and reductions in annual IRA transfers to LGUs as a result of fiscal austerity measures of the national government.8 Some of these issues have been brought before the Supreme Court, although many remain unresolved. What is clear is that the IRA represents the primary source of income for the vast majority of LGUs and research has indicated that the relatively large transfers from the center have had a disincentive effect on local tax effort.9 5

Manasan, Rosario G. 2007. Manasan, Rosario G. 2004. 7 Capuno, Joseph J. 2003. “Philippines.” Intergovernmental Fiscal Transfers in Asia: Current Practice and Challenges for the Future. Ed. Yun-Hwan Kim and Paul Smoke. Manila: Asian Development Bank. 8 Manasan, Rosario G. 2004. 9 Manasan, Rosario G. 2007. Mullins, Daniel R., Amitabha Mukherjee, Signe Zeikate, and Jung-Joo Lee. 2006. “Subnational Government Finance in the Philippines: Findings on the Efficacy and Distributional Implications of the Internal Revenue Allotment, and Health and Education Spending - A Subtext for Reformed 6

Based on Statement of Income and Expenditure data for 2006 from the Bureau of Local Government Finance of the Department of Finance, the IRA represented 79 percent, 74 percent, and 40 percent of provincial, municipal, and city income, respectively. Furthermore, the current formula is inconsistent with the distribution of expenditure responsibilities among the three main levels of LGUs, thus exacerbating the vertical fiscal imbalance. The current formula also does a poor job of compensating for the varying levels of fiscal capacities of LGUs, often worsening the horizontal imbalance that exists within each level of LGU.10 Finally, there is evidence of uneven and distortionary effects of the IRA on expenditure on local services. Analysis has shown that disparities in health spending among LGUs are substantial and not directly related to the distribution of dependent/need populations.11 LGU structural and fiscal factors are what primarily determine levels of health spending, with spending strongly paralleling IRA allocations. Hence, rather finance following function in health spending, it is the other way around. Non-IRA Transfers: LGUs also benefit from ad hoc grants from national government agencies, legislative funds, and foreign donors and creditors to support various local services. A study conducted to analyze the quantity and composition of non-IRA transfers to LGUs in 2003 estimated that the aggregate total for these transfers represented over 20 percent of the total IRA transfer for that year.12 The largest component of this total, comprising 61 percent, was funded by Priority Development Assistance Funds (PDAF) of legislators and the funds were mainly used to finance local infrastructure. Unlike the IRA, these transfers are distributed to LGUs through a wide variety of mechanisms, ranging from ad hoc grants from legislators to matching grants from national government agencies and donors. There is generally less transparency in the non-IRA funding systems, which has adverse effects on LGU planning and budgeting, and less information available for these miscellaneous transfers. Finally, very little is known about transfers between different layers of LGUs.13 The LGC provides for revenue-sharing between levels of LGUs for various taxes, as discussed in the earlier sub-section on Revenue Assignment. Furthermore, the LGC also allows inter-local grants from one LGU to another. However, the extent of inter-local transfers and the processes these entail have not been studied in depth. An exception was a case study of the Provincial Development Council of Davao del Norte conducted in 2000, wherein the provincial government organized a multi-sectoral council (including representatives of all component LGUs) that collectively

Intergovernmental Resource Allocation (Detailed Findings).” Manila: World Bank. 10 Capuno, Joseph J. 2003; Manasan, Rosario G. 2007; Mullins, Daniel R., Amitabha Mukherjee, Signe Zeikate, and Jung-Joo Lee. 2006. 11 Manasan, Rosario G. 2007; Mullins, Daniel R., Amitabha Mukherjee, Signe Zeikate, and Jung-Joo Lee. 2006. 12 Steffensen, Jesper, Ma. Cecilia G. Soriano, E.P. Makayan, and J.B. Nisperos. 2005. “Assessment of NonIRA Transfers and Other Funds for Devolved Services in the Philippines.” Manila: World Bank. 13 Capuno, Joseph J. 2003.

determined the unmet basic public service needs of the province and allocated provincial funds accordingly.14 Sub-national Borrowing:15 The LGC also provided LGUs with greater flexibility to utilize credit financing, including bank credit, bonds, and build-operatetransfer (BOT) arrangements. In 1996, the Department of Finance developed the LGU Financing Framework (LFF), which provides for a segmented approach to capital financing: lower-income LGUs would have access to subsidized loans and grants from the Municipal Development Fund (MDFO), those in the middle tier could access credit from government financial institutions (GFIs), while upper-tier LGUs could access private commercial finance. To improve access to private capital markets, the LFF recommended the increased use of BOT schemes, development of an LGU bond market, improved LGU access to private banks, and optimization of GFIs role in LGU financing. The progress of implementation of the LFF has been uneven.16 There has been some progress with the involvement of the private sector in infrastructure investments, mostly through management contracts, but few efforts to use BOT arrangements. The LGU Guarantee Corp. was created to guarantee debt issues of LGUs financed from private sources, but the rate of bond issues has not accelerated. While GFI credit to LGUs has substantially increased, LGUs have not yet accessed financing through private banks, primarily because these have not been allowed to become depository banks for LGUs. Furthermore, the subsidized interest rates offered by the MDFO acts as a disincentive to the relatively creditworthy LGUs to access funds from the private capital market. Finally, LGUs have generally tended to avoid debt; with resource-rich LGUs not needing to borrow while resourcechallenged LGUs not meeting requisite creditworthiness criteria. DECENTRALIZATION AND GOVERNANCE While the case for decentralization is typically rooted in the theory that it enhances the accountability of local officials by aligning government decision-making more closely to local preferences and emphasizing competition among regions to attract capital and labor,17 existing research indicates that the effects of decentralization on local governance in the Philippines is ambiguous, at best. There were positive early assessments of the impact of the LGC (based on case studies, anecdotal evidence, and local surveys) that cited the increased accountability of local officials, leading to innovations in local governance and management, increased participation of 14

Burton, E.M. 2000. Baseline Study on the Indicators of Good Governance in Davao del Norte Province. Paper submitted to the Philippine Center for Policy Studies - Governance Project. Quezon City: PCPS. 15 Manasan, Rosario G. 2007. 16 World Bank and Asian Development Bank. 2004. “Decentralization in the Philippines: Strengthening Local Government Financing and Resource Management in the Short-term.” Report No. 26104-PH. Manila: World Bank and Asian Development Bank. 17 Campos, Jose Edgardo, and Joel. H. Hellman. 2005. “Governance Gone Local: Does Decentralization Improve Accountability.” East Asia Decentralizes: Making Local Government Work. Washington, DC: World Bank.

citizens and civil society, and socio-economic benefits.18 More recent reviews of the Philippine experience have emphasized the scarcity of comprehensive empirical analysis on the long-term impact of decentralization. A wide range of quantitative indices, customer satisfaction surveys, and qualitative performance measures have been developed over the years to assess the quality of local governance.19 Yet these are not uniformly available for all regions, much less for all LGUs, and focus on various governance concerns, from inputs and processes to outputs and outcomes, that are not necessarily comparable across datasets. Hence only broad comparisons can be made. According to theories, a postulated benefit of fiscal decentralization is a better alignment of the government’s policy priorities and local preferences because of the sub-national governments’ presumed “proximity” to the local residents and their realities on the ground. A survey-based analysis cast doubt on the validity of this assumption in the Philippines, at least as of the late 1990s when the study was conducted. In a statistical analysis of survey results, Azfar et al (2000) found that LGU officials were not able to predict local preferences very accurately.20 The survey asked provincial and municipal government officials and members of households in the respective jurisdictions how hypothetic extra resources should be allocated among different public service options. The municipal officials were able to identify “roads” as the top priority of the residents in their jurisdictions, but failed to predict other priorities.21 The preferences of the provincial officials and those of the provincial residents were negatively correlated. In addition, the same survey asked the provincial and municipal officials how they learned about local preferences but the analysis found that none of the methods had a statistically significant effect on the officials’ abilities to predict local preferences. The study found that people’s knowledge of local politics was limited as well. When asked to name the vice president (of the national government), the mayor and the vice mayor of their own localities in a test of people’s knowledge of national and local politics, 41 percent of the respondents were able to name the vice president but only 1 percent knew who their vice mayor was. One plausible reason for the local resident’s limited knowledge of local affairs is their tendency to rely on national media for information and the media’s tendency to focus on national affairs in their news coverage. Households are much more likely to obtain information about local affairs from friends and family and local officials themselves, which may be relatively unreliable as sources of objective information. Overall, based on data from the late 1990s, the evidence is thin that decentralization really 18

Rood, Steven. 1998. Capuno, Joseph J. 2007. “The Quality of Local Governance and Development under Decentralization.” The Dynamics of Regional Development: The Philippines in East Asia. Ed. Arsenio M. Balisacan and Hal Hill. Asian Development Bank Institute. Manila: Edward Elgar Publishing Ltd. and Ateneo de Manila University Press. 20 Azfar, Omar, et al. 2000. Decentralization and Governance: An Empirical Investigation of Public Service Delivery in the Philippines. Department of Economics, Center for Institutional Reform and the Informal Sector. Maryland: University of Maryland. 21 Poor roads would be among the most visible public service deficiency and for those living in the locality it should be quite easy and obvious to identify them as a priority. 19

brought the government “closer to the people,” at least in the sense that the expressed preferences of the government were close enough to those of the people. Overall, improvements in local governance since the enactment of the LGC have been uneven. There has been an observed upsurge in public participation and a growing number of cases of innovative practices by LGUs.22 In addition, there was evidence of a decline in overall perceptions of corruption and improved service delivery standards during the 1990s.23 However, the link between these outcomes and the accountability of local officials is weak and local officials continue to be subject to the risks of state capture and clientelism. Despite the development of an active local civil society network, countervailing institutions at the local level generally lack the capacity and independence to mitigate these risks.24 Weak electoral accountability is evident in the existing research, though still limited in number and constrained by data limitations. Elections seem to be effective at rewarding outstanding local leaders but have clearly been ineffective at punishing poor performers. In a rare attempt at empirical analyses of these questions, Capuno (2007) shows weak correlation between LGU performance (as measured with the proxy of human development index at the provincial level) and the electoral performance of the governors standing for re-election in 2001. Furthermore, citing another empirical analysis of correlation between changes in poverty rates and the share of vote obtained by incumbent governors re-elected, Capuno also argues that “in economically depressed provinces, new governors often commence their administration with a lower level of support than the re-elected incumbent governors. This indicates the difficulty of replacing incumbent provincial leaders in economically depressed areas. Together these results reflect the persistence of patronage politics at the local level” (2007, p. 232). Changes in HDI Score, 1994-2000 and Gubernatorial Election Outcome in 2001 (no. of governors) Change in HDI Governors Standing for Re-election Score Re-elected Defeated >20% 1 10-20% 6 6 0-10% 24 9 0% (no change) 2 1