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October 17, 2011

Empowering Local Government in the Philippines Through Fiscal Decentralization

Posted by Chita Marzan

Today, some countries are still hesitant about implementing fiscal decentralization. This may be due to limited resources and inadequate PFM capacity at the local government level. Decentralization is not easy and the gestation period is indeed quite long. However, as developed countries have proven, the long wait and patience eventually pays off. What is required to make fiscal decentralization a success in developing countries?  I hope that this article will provide some insights in how low and lower middle income countries like the Philippines can implement fiscal decentralization.

It was a milestone in the history of governance in the Philippines when the first Local Government Code was passed in 1991. This law recognized that the essence of decentralization is to support local government units (LGUs)[1] in becoming more self-reliant, by giving them more powers and full autonomy in the delivery of basic services such as health, education, agriculture, environment and natural resources, local public works, etc. This Code also provided a new scheme of revenue and expenditure assignments which made the decentralization process possible.

Devolving responsibilities and resources

In the Philippines, the national government devolved to local governments, the delivery of basic services by giving them their share of the national income and the authority to generate their own revenues from various sources. These sources of funds are the following:

1.  Local Taxes and Fees

From the time they are legally established, LGUs are given authority to levy their own taxes, fees and other sources of revenues, consistent with the basic policies in the Code. LGUs could, however, not survive just by local taxation and other income alone. For the last 3 years (2008-2010), this source of income grew only slightly by an average of 6% per annum (in nominal terms) and its share in the total revenues has stagnated.  In 2010, these taxes and fees accounted for only 26% of the total revenues of all LGUs.[2]

2.  Internal Revenue Allotment

Before 1991, LGUs relied mainly on local taxation because all internal revenue income from national taxes accrued to the national government. These resources were in part spent in the regions by regional branches of national government. These regional branches/offices of the line ministries were in charge of delivering basic services. Only a small amount of transfer payments was budgeted and released to LGUs submitting local project proposals.

Under the 1991 Local Government Code, the Internal Revenue Allotment (IRA) scheme was established. At least 40% of the country’s  internal revenue income has been allocated to the LGUs in the following manner:

(a) Provinces - Twenty-three percent (23%);

(b) Cities - Twenty-three percent (23%);

(c) Municipalities - Thirty-four percent (34%); and

(d) Barangays  - Twenty percent (20%)

The revenue share of each province, city and municipality is determined on the basis of the following very simple formula:

(a) Population - Fifty percent (50%);

(b) Land Area - Twenty-five percent (25%); and

(c) Equal sharing - Twenty-five percent (25%)

The IRA became one of the key items in the national government budget, allocating to LGUs the bulk of their local resources. From 2008-2010, IRA’s share to total receipts of LGUs averaged 65%.[3] In recent years, the dependency on the IRA allocation has decreased as more own revenues are developed. In 2006, the IRA contribution was 77%. Areas outside the National Capital Region or Metro Manila, relied more from IRA. Some low income areas depend on the IRA for as much as 90%. In Metro Manila, where there are more high income earners,  the local tax revenue is higher than the IRA, thus making them less IRA-dependent. In 2010, the IRA’s share of Metro Manila was only around 16% of total income.[4]

To ensure the release of the IRA on time, the lawmakers added a provision that it shall be automatically released to the LGUs on a quarterly basis and shall not be subject to any lien or holdback that may be imposed by the national government for whatever purpose.

The IRA has been successful in covering the main costs of the devolved services. It was an issue initially because the amount of IRA devolved was not commensurate with the expenditure assignments that were devolved. Through the years, the IRA has increased significantly, however, even enabling each local government unit to pay their staff at the same pay scale as the national government.

3. Grants, Loans

Under the Local Government Code, LGUs in the Philippines were also authorized to seek grants and contract loans, credits, and other forms of indebtedness with any domestic private bank and other lending institutions. Borrowed funds can be used to finance the construction, installation, improvement, expansion, operation, or maintenance of public facilities, infrastructure facilities, housing projects, the acquisition of real property, and the implementation of other capital investment projects.

However, it seems that LGUs are not yet inclined or skilled in mobilizing resources through grants and borrowings as these sources of funds accounted for a small portion - only .1% and 2%, respectively, as shown in a budget report in 2010. In the 2008 and 2009 audit report of the Commission on Audit, the government auditing office indicates that the total assets of the local governments far outweighed their liabilities.

To facilitate resource mobilization, the Local Government Academy in Manila offers a regular training program on Resource Mobilization, Financial Management and Analysis for Local Governance.[5] In addition, the Academy with support from Canadian and Spanish governments developed a Resource Finder Handbook which presents a comprehensive directory of available financial and technical assistance to local governments.

One of these sources of financial assistance is the Priority Development Assistance Fund, a lump-sum appropriation in the annual General Appropriations Act to fund the priority development programs and projects of Local Government Units.  

Rationalizing Spending

The Local Government Code emphasized that the financial affairs, transactions, and operations of local government units shall be governed by the same fundamental principles of the national government budgeting, accounting and auditing rules and regulations. The local budget is approved through a local ordinance and provincial governments submit their budget to the national Department of Budget and Management for approval. Moreover, to avoid spending too much on salaries and administrative costs, the Code further provides that LGUs shall appropriate in their annual budget no less than twenty percent (20%) of the annual IRA for development projects.

For the last 3 years, the LGUs did not incur deficits. As to expenditure type, the share of social services in LGU expenditure has been constantly increasing. In 2010, expenditure on social services reached 42% compared to 2008 of only 22%.[6] It is definitely an improvement from the picture in 2006 when less than 10% was allocated to health and education services. From 2001-2008, the local government units contributed around 7% of the national government budget for education.[7]

This increasing concern to allocate more funds to social programs such as poverty reduction, health and education has contributed to the improved Millennium Development Goals (MDG) indicators of the country. Of the 48 MDG indicators, 14 indicated a high probability that the goals will be achieved by 2015 and at least 6 indicators showed improvements although the pace of progress is considered only moderate.[8]

Through the IRA, the LGUs were able to invest more on fixed assets. As of end of 2009, property, plant and equipment accounts for 67% of their total assets.[9] However, with priority going to social services, economic sectors such as transportation, communication, public works, trade and industry received fewer amounts of resources. It is in these areas where the national government agencies and the private sector have stepped in to provide nation/region-wide facilities.

Ensuring good PFM

Local accountants and treasurers maintain separate books and depository accounts, respectively, for each fund in their custody. They submit regular reports to the Bureau of Local Government Finance, an agency attached to the Department of Finance. Its website provides access to information on receipts and expenditures of local governments and rules on local finance administration. The local governments produce financial statements which are audited by the Commission on Audit and for transparency, the latter publishes the annual audit reports.

The Department of Budget and Management includes data on local government expenditures and sources of financing in its publications. The DBM also publishes in its website the status of allotment releases pertaining to financial subsidy to LGUs. The National Statistical Coordination Board is providing one-stop-shop access to local level statistics. The Department of Interior and Local Government provides guidelines to LGUs in the harmonization of their plans and budgets with that of the national government.

As part of performance-based planning and budgeting, the Philippine government, with the support of the Philippine-Canadian Local Government Support Program, has developed the Local Governance Performance Monitoring System (LGPMS) where the scorecards of local governments on the various aspects of governance are reported online to the public.

With limited resources, local officials and communities are constantly searching and doing innovative things to improve governance. The Local Government Academy website features a list of Best Practices in Local Governance on a wide range of topics, among them are on revenue generation, allocation and utilization of resources, as well as financial accountability and transparency. Small innovations they may be, but when put together, they can mean a lot, particularly to the poor communities.

It is evident in the Philippines that there are real gains from fiscal decentralization. Hard as they may be to achieve, these gains should serve as a driving force to continue to improve. The allocation scheme of the IRA and its utilization, and especially their impact on poor communities, are worth revisiting. There could be a more forceful approach to solving common and persistent audit issues. LGUs capacity in performance management should be developed further to become less dependent on the national government. Civil society’s participation in planning and decision-making at the local level should be strengthened. After all, community development is a function of the whole community.

[1] LGUs in the Philippines refer to provinces, cities, municipalities and barangays (villages).

[2] Department of Budget and Management, Budget of Expenditures and Sources of Financing, 2010, www.dbm.gov.ph

[3] Department of Budget and Management, Budget of Expenditures and Sources of Financing, 2010, Table F.3, www.dbm.gov.ph

[4] Dr. Romulo Virola, Statistically Speaking: Disparity in Local Development, National Statistical Coordination Board, www.nscb.gov.ph,

[5] Local Government Academy, www.lga.gov.ph

[6] Department of Budget and Management, Budget of Expenditures and Sources of Financing, 2010, Table F.3, www.dbm.gov.ph

[7] Manasan, Rosario G.,Cuenca, Janet S.,Celestino, Alicia B, Study on Mobilizing LGU Support for Basic Education: Focus on the Special Education Fund, Philippine Institute of Studies, www.pids.gov.ph  

[8] National Statistical Coordination Board, MDG Watch, www.nscb.gov.ph

[9] Commission on Audit, Audit Report for Local Governments, 2009, www.coa.gov.ph

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy.


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Inspiring... Could it also be the case that the relatively small share of loans and grants is due not only to the lack of capacity by LGUs to mobilize them but also to the usual tight conditions that the local finance laws in some countries tend to place on them therefore limiting the ability of LGUs to borrow, hence resorting to other financing mechnisms? Two other interesting points about the Philippines experience: (1) the early decision to devolve responsibilities and resources - in most low and lower middle income countries the devolution of resources comes years later and often in pieces; (2) fiscal decentralization reforms take long to mature - not sure the Philippines is the best example of what can be achieved over a period of 20 years of fiscal decentralization reforms but it tells a lot about the nature of the process.

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