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Business and Entrepreneurial Revierv, October 2005, page 48-56 r s s N 0 8 5 3 - 9 I 8 9

I N T R O D U C T I O N

Externalities have played an important role in the public economic literature. For example, roads, public transportation, recreatiorr, and cultural facilities are visited, and therefore crowded by residents in nearby jurisdictions. Crirne fighting in one jurisdiction could either lower regional crime or push criminals into neigh-boring communities. Air pollution controls and sewage t r e a t m e n t e n h a n c e t h e e n v i r o n m e n t q u a l i t y o f borderingjurisdictions. Radio and TV broadcasts can be seen away from the local border. Educational and job training expenditures may translate in productivity gains in workplaces outside the communify.

In the case of the efficiency of local public goods provision, benefit spillovers or inter-jurisdictional externalitiesarea widespread feature of many services provided by local govemments (Wilson, 1986, 1999). The significance of spillovers is widely recognized in the fiscal federalism literature (see: for example O a t e s , 1 9 7 2 ; 1 9 9 9 ) . T h e g e n e r a l c o n c l u s i o n o f t h i s strand of literature is that externalities tent to cause a

V o l . 5 . N o . I

divergence between private and social costs and benefits, and thus lead to suboptimal decision-making. Some authors have also worried about the equity con-sequences of spillovers (see, e.g., Ladd and Yinger, 1994), but also relating to the design of'needs-based' equalization grants (Bramley, 1 990). The general policy prescribed to deal with them is to delegate the authority of decision making to the lower layer ofgovemments.

I n d o n e s i a p r o v i d e s a unique opportunity to exam i ne the nature of inter-j uri sd ictional externalities within a country consisting of central, provincial, and local levels of government. Since her independence in 1945, the administration ofthe country's regional public services operated through a hierarchical and parallel system of de-concentrated central govern-m e n t a g e n c i e s a n d o s t e n s i b l y a u t o n o m o u s s u b -national governrnents. Throughout most of its history Indonesia's system ofregional government adminis-tration has been among the most centralized in the w o r l d ( s e e for example Davey, 1989) and then d r a s t i c a l l y d e c e n t r a l i z e d s i n c e 2 0 0 1 . Given the si gnifi cance of inter-regional redistribution performed

Fiscal Competition Among Local Governments after

Fiscal Decentralization

HARYO KUNCORO

Faculty of Economics, UPI YAI Jakarta

Jf. Salemtra Raya Jakarta Pusat, Mobile: 0817267325,emai|: haryo_kuncoro@hotmail.com

Accepted on May 2"d2005, Approved on August 7,h2005

Abstract: Spatial interaction among local governments in fiscal setting decisions is receiving

increasingly attention in the applied public economics literature. Spatial interaction models rely on the

presence ofan externality from local budgetmaking, that is external effects originate from inter-jurisdictional

resource flows due to tax competition for a mobile base, or from local public expenditure spillovers into

neighboring jurisdictions. Similarly, the intergovernmental grants competition exists when there is a rivalry

among local governments to get them from central government. This paper attempted to identify how

great the fiscal competition among local governments in Indonesia. Using spatial statistics, we concluded

that the fiscal competition among municipalities was greater compared to the pre fiscal decentralization

period. It seems that the local tax setting and expenditures decisions in particular municipality can be

attributed to the mimicking behavior to neighbor regions. Also, we found that the fiscal competition

among municipalities could be attributed negatively to the fiscal disparity. Those imply that in the

regional autonomy era the local governments tend to increase their local own revenue intensively and

demand for intergovernmental grants in order to finance their expenditures. In the long run, they could

lead to the high cost economy, worsening fiscal dependency, and inefficiency of local government

expenditures. Those findings above suggest that the distribution of intergovernmental transfers among

regions should consider the local tax efforl and the services minimum standard plays an important role to

achieve the efficiency oflocal government expenditures.

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by the tax transfer system and equalization payments, w h e t h e r a p a r t i c u l a r l o c a l g o v e r n m e n t e n g a g e s a strategic interaction with anotlier local governments in the surrounding areas is a political and economic issue.

Strategic interaction in setting local taxes and expenditures are two forms of tlie fiscalcompetition among local governments beside intergovernmental grants competition. Basically, tax setting and expen-diture policies in a region might affect to other regions policies. The root problem of those phenomena is the existence of spatial correlatiott among local govern-m e n t s . I n t h e b r o a d e r s e n s e , i n t e r - j u r i s d i c t i o n a l competiti-on can be defined as rivalry among govem-ments in which each government is tryingto win some scarce beneficial resource or in wh ich each government seek to avoid a particular cost (Kenyon, 1997).

I n d e v e l o p e d c o u n t r i e s , a n u m b e r o f e m p i r i c a l studies concerning the issue have been conducted ( s e e fo r e x a m p l e : G o r d o n , l9 B 3 : W i l d a s i n , 1 9 8 6 ; Salmon, 1 987; Case et al., 1 993 ; Kelej ian and Robinson, 1 9 9 3 ; B e s l e y a n d C a s e , 1 9 9 5 ; B r u e c k n e r , 1 9 9 8 ; Heyrdels and Vuchelen, 1998; Figlio, et al., 1999; and Bivand and Szymanski, 1997; 2000). Unfortunately, they tested the fiscal competition parlially focusing on either tax or expenditr-rre aspects. In contrast, the similar studies focusing on similar issue in developing countries are rarely.

Some studies in Indonesia have been generally concentrated to the fiscal imbalance between central and local governments (see for example: Uppal and Suparmoko, 1986; Bawazier, 1988; Akhmad, 1990; Kuncoro, 1995; Indonesia Forum, 2000, Sidik, 2001). I n a q u i t e s i m i l a r s p i r i t , o u r a p p r o a c l i h a s t h r e e significant differences. First, we employ spatial statistics method to identify the fiscal interdependency includingta4 expenditures, and subsidies among munici-palities in a comprehensive way. Second, instead of using a single fiscal regime, we compare the fiscal interdependency among local governments in pre-and post-decentralization periods. Finally, we identiS' the relationship between fiscal inter-dependency and fiscal equity (disparity) across local governments. The rest of this paper is organized as follows: Section 2 briefly summarized the existing literature while Section 3 highlighted the previous results. The methodology is described in the next section and to report the main empirical results followed. Finally, some concludins remarks are drawn.

M B T H O D S

The earliest idea of inter-jurisdiction competition ( l J C ) w a s d e l i v e r e d b y T i e b o u t ( 1 9 5 6 ) . T h e k e y

actors in his rnodel are individuals (consumer-voters) who decided which (of many) local governments to l o c a t e in , b a s e d o n t h e i r n e e d s fo r g o v e r n m e n t services and the public service/tax packages offered by the various governments. Tiebout assumes that individuals have complete knowledge of the various government revenue and expenditure packages; that individuals free to choose among a large number of communities; and that individuals are fully mobile. F u r t h e r m o r e , h e a s s u m e s t h a t t h e r e i s n o intercommunity spillover effects occured and that each community is able to attain its optimal amount at which the average cost of production on particular package of pLrblic services is minimized.

To the extent on Tiebout's rather restrictive conditions are met, goods and services provided by suburban local governments will exhibit both locative efficiency and productive efficiency. In Tiebout's model, local taxes are benefit taxes, proportional to the benefits from government services received by households, rather than taxes based on ability to pay. No redistribution of income takes place in his system of local governments. The Tiebout's model can be criticized for its restrictive assumptions. A crucial shortcorning of liis model is that it does not include business firms, so that it is not particularly helpful in illuminating the phenomenon of IJC for economic development.

The Oates-Schwab model ( l99l ) focuses on the mobility of capital rather than households. They assume that the local government's objective is to maximize the welfare of its constituents, subject to the applicable budget constraints. They also assume that no beneficial or negative spillovers occurred and that a sufficient number of local governments exist to approximate a competitive market. Furthermore, t h e y a s s u m e th a t c o m m u n i t i e s h a v e c o m p l e t e information about the wage benefits provided by the location of business firms in their communities and t h o s e f i r m s c a n c o r r e c t l y e v a l u a t e t h e t a x a n d e x p e n d i t u r e p a c k a g e s o f f e r e d b y t h e v a r i o u s communities. An implicit assumption in their model i s t h a t e c o n o m i c d e v e l o p m e n t e f f o r t s b y l o c a l governments are costless.

The major result of the Oates-Schwab model is that taxes on both households and business firms become taxes beneficial. In the case of business firms, communities neither subsidize them to locate in their communities, nor tax them in excess of the costs of public services provided to them. Instead firms pay exactly the cost of the public services to them. In this benefittax equilibrium, communities will have no incentive to further increase subsidies to businesses. If communities were supposed to do so,

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5 0 K U N C O R O

the cost in terms of forgone tax revenues or higher public service costs would exceed any benefits in the forrn of increased jobs or income. Like the Tiebor.rt m o d e l , t h e O a t e s - S c h w a b m o d e l i s d e v o i d o f redistribution by local governments. No ability{o-pay taxes are levied only benefit taxes. Inter-jurisdiction c o m p e t i t i o n m a y n o t b e e q u i t a b l e in the Oates-Schwab world but it is productively and electively efficient.

M c G u i r e ( l99l ) has built an irrformal m o d e l o f IJC, which she labels "destructive competition" that h a s l e s s h a p p y c o n s e q u e n c e s . S h e a s s u m e s t h a t individuals have preferences for redistribution and thus choose revenue systems that rely on ability-to-pay taxes. McGuire fufther assumes that tlre natior.r's population is heterogeneous in terms of income and mobility. An optimal level of public services and taxes c a n b e c o m p u t e d , o n e t h a t c o n c e i v a b l y c o L r l d b e attained in the case of zero rnobility of individuals or businesses.

However, it will never be attained. Any single j u r i s d i c t i o n w i l l h a v e a n i n c e n t i v e t o c u t tax for relatively wealthy and rnobile individLrals or businesses in orderto lure them to relocate. Thejurisdiction would hope to be able to use the revenue gairred from tlie incoming wealthy to cut taxes for current residents or to increase public seruices. The problem is that all jurisdictions will have the same incentive to cut tax for the wealthy and rnobile.

M c G u i r e c o n c l u d e s t l r a t l o c a t i v e efficiency c a n n o t b e a c h i e v e d i n t h e c a s e o f d e s t r u c t i v e competition. She argues that household mobility will ensure that productive efficiency will be attained, h o w e v e r , a s ju r i s d i c t i o n s s e e k to m a x i m i z e t h e i r attractiveness by minimizing the burden of their taxes for given level of public seryices. In McGuire's model, both horizontal and vertical inequities result from IJC. L e s s m o b i l e i n d i v i d u a l s w i l l e n c u m b e r a h i g h e r t a x burdens than their more mobile counterpafis. Vertical inequities will also result, as high-income taxpayers benefit from selective tax relief.

Wolkoff( 1992) asks whether a formal model of economic development programs can explain the existence of some seemingly irrational public policies. In his mind, jurisdictions use economic development subsidies to try to induce potentially mobile firms to stay in the community. Firms are of two types: those that are potentially mobile and tlrose that are not. A c e n t r a l p r o b l e r n in W o l k o f f ' s model is that the j u r i s d i c t i o n c a n n o t e a s i l y d i s t i n g u i s h b e t w e e n t h e s e two fpes of finns. Both the firrns and the jurisdictions engage in strategic behavior. The community decides on the amount of the subsidy and the probability that it will give a sLrbsidy when a finn requesting one.

Bus ines s and Entrepreneurial Review The firm decides on the amount of subsidy requested. Wolkoff assumes that the community chooses the amount of subsidy and probability of granting a subsidy in order to maximize the expected value of its action.

Wolkoff's model explains two types of seeming i r r a t i o n a l i t i e s i n e x i s t i n g economic d e v e l o p m e n t programs. Assuming that all finns request the same subsidy, whether they are potentially rnobile or not. The community then has no way of distinguishing between the two types of firms. It turns out that the most advantageous strategy for tlie community is to offer modest subsidies to all firms. The inevitable result is that some firrns with no relocation potential will also receive the subsidy. It seems like a waste of funds from the perspective ofcommunity with rational maximizing behavior.

An alternative scenario outlined by Wolkoff is based on a cornmunity's effoft to separate potentially mobile from immobile firms. To do this, the community makes subsidy awards become uncertain. Immobile f i r m s t h e n r e d u c e the amount of their subsidy requests. The community ends up avoiding large subsidies to firrns that have no possibilitr, of relocating. However, at the same time, the community rejects the requests of, and thereby loses, some mobile firms. In isolation, the fact of providing insufficient economic development subsidies to certain mobile firms appears irrational. Wolkoff's pointed out that lve cannot look at such phenomena in isolation.

From Besley and Case ( 1995), the exit optirnum is less irnporlant; it did not describe explicitly in their model, but its existence acknowledged. Instead, vote is a key to the accountability of elected officials. Imperfect information is also crucial to the Besley-Case model. Politicians more aware about the cost of providing public services than voters, and voters used the information about tax change in neighboring jr-rrisdictions to evaluate the performance of their i n c u m b e n t s . P o l i t i c i a n s c o r n e in t w o types: good politicians rvho do no rent-seeking and bad politicians w h o d o r e n t - s e e k i n g . P o l i t i c i a n s u s e s t r a t e g i c behavior in their tax-setting in order to influence voters' opinion regarding whether they are good or bad politicians. Voters will not reelect the incumbents whom they j udge by their tax changes, relative to the t a x c h a n g e s o f n e i g h b o r i n g j u r i s d i c t i o n s , a r e c o n s i d e r e d b a d p o l it i c i a r r s .

The Besley-Case model is tikely most applicable to interstate competition because the smaller numbers o f s t a t e s rn a k e the strategic behavior of state politicians are easier to monitor. This rnodel also could apply to suburbs in metropolitan area if only the number of competing suburbs were not too many.

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T h e B e s l e y - C a s e m o d e l d o e s n o t i l l u m i n a t e th e impl ication s of IJC phenomenon for economic develop-ment. Their decision to minimize the impoftance of interstate mobility rnay irnply to an impression that state officials are oversensitive of threats from high-income taxpayers or business to exit.

Breton (1996) formulates a general theory of competitive governments. His model ofpLrblic finance and politics encompasses a wide range of competitive situations: cornpetition for the support of the govemed within governments, competition between govem-ments and othersocial institutions, competition between governments at different levels (for example, between states and local governments), and competition that is the subject of this paper-competition between governments at the same level, or IJC. He assumes that individuals seek to maximize utility and govem-ments seek to maximize expected consent.

In his treatment of IJC, he includes both implicit c o m p e t i t i o n ( T i e b o u t mechanism) a n d y a r d s t i c k competition. Both are generally present iri IJC, but in a pure Tiebout world, Breton corectly notes, yardstick c o m p e t i t i o n c a n n o t e x i s t . I f t h e T i e b o u t r n o d e l operated perfectly, the population would sorl itself by preference for publicly provided goods until each community was homogenous and different from every other community. Tl-ren, individuals could not use the performance of neighboring governments to judge t h e p e r f o r m a n c e o f t h e i r o w n g o v e r n m e n t s ; governments would be too much different from each other in terms of their public service/tax packages.

That a jurisdiction's policy may be influenced by o t h e r j u r i s d i c t i o n ' s p o l i c i e s h a s b e e n r e c o g n i z e d b y several authors (Hettich and Winer, 1984; Salmon, 1987). Still, it has not empirically reached the status of general acceptance. The conventional approach to modeling taxing and spending decisions consist of explaining tlre level of composition of revenues and expenditures by economic, political, and sociological characteristics of the jurisdiction itself(for suryey, see: Inman, 1988). However, a casual look at daily politics suggests that voters and politicians are case sensitive to events outside their geographical boLrndaries.

Three models have been offered in the local public finance literatr.rre to justify the existence of spatial interaction among local govemments. and have been tested intensively on local government data in recent years.

The first one is tlie traditional 'spill-over' or 'externality' model, which expenditure on local public services in ajurisdiction can liave beneficial or harmful effects onto residents in nearby jurisdictions (Gordon,

1 9 8 3 ) . A s a n e x a m p l e i s lo c a l e x p e n d i t u r e o n p o l i c e s e r v i c e s . U s i n g U S c o u n t l , d a t a , K e l e j i a n a n d

Robinson ( 1993) found that police expenditures in a g i v e n county are significantly and positively influenced by neighboring county police expenditures. Since counties inflict a negative externality on their neighbors by spending more on police services due to cross-over between the borders, the need for police services in a given county tends to increase due to increasing of services in neighboring counties.

S e c o n d , s p a t i a l i n t e r a c t i o n a m o n g l o c a l jurisdictions in the form oftax competition arises when public spending was fund through tax on mobile capital by local governments (Wildasin, 1986). Since the level of the tax base in a jurisdiction depends both, on own and otherjurisdiction' tax rates, strategic interaction results. Brueckner ( 1 998) found evidence of policy interdependence in the adoption of growth c o n t r o l m e a s u r e s a m o n g C a l i f o r n i a c i t i e s . B y restricting the amount of developable land, a city government increase land rent both in its own and in nearby cities, thereby generating an externality and strategic interaction in growth control decisions. By using a panel data set of the US states, Figlio et al. (1999) found that decentralized welfare benefit setting deteriorates interstate competition and might i n d u c e s t a t e s t o r e s p o n d a s y m m e t r i c a l l y t o t h e changes in their neighbors' policies.

Finally, a recent justification for the existence of interaction at the local level is the political agency -that is yardstick competition model. In such model, the imperfectly informed voters in a localjurisdiction use other governrnents' performance as a yardstick to evaluate their orvn government (Salmon, 1987). Politicians are therefore sensitive to their local tax performance relative to similarly situated states. Then they try not to get too far out of line with policies in t h o s e j u r i s d i c t i o n s ( O a t e s , 1 9 8 8 ) . T h e re s u l t i s lo c a l authorities imitating each other's behavior.

R e c e n t l y , t h e e x t e n t t o w h i c h g e o g r a p h i c proximity or either similari|l criteria matteq although is also an empirical question that has attracted some interest by applied economists. Case et al. (1993) estirnated a public expenditure equation using a panel data set of the US states' budget over the period of 1970-85. While they can reject the hypothesis of expenditure spillovers among geographical neighbors, they found a strong ernpirical evidence to support the mimicking hypothesis: state expenditures are similar in terms of demographic composition.

B e s l e y a n d C a s e (1 9 9 5 ) presented a p o l i t i c a l agency model where voters and politicians are case sensitive to events outside their boundaries and tested their yardstick competition hypothesis on US states' income taxes from 1960 to 1988. They found that geographic neighbor'tax changes have a positive and

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5 2 K U N C O R O

significant effect on a given state's tax changed. Heyndels and Vuchelen ( 1998) tested the tax imitation hypothesis at the level of Belgian municipalities and found strong positive spatial correlation in local income tax rates between neighboring authorities.

Bivand and Szymanski ( 1 997; 2000) showed that there was spatial dependence in the cost of domestic

garbage collection in the UK districts due to contracts based on the performance comparison and that spatial interaction were substantially reduced after the i n t r o d u c t i o n o f C C T ( C o m p u l s i v e Competitive Tendering), that imposed standard contracting rules and reduced the scope for local authorities to pursue i d i o s y n c r a t i c p o l i c i e s . M u r i l l o ( 2 0 0 3 ) tested for s t r a t e g i c in t e r a c t i o n a m o n g U S s t a t e s in t h e detemination oftax rates on capital income. He found that states have a positively sloped reaction function to the tax policies of rival states when tax rates are chosen simultaneously.

To sum up, those various studies suggest that geograph ical proxim ity defi n ite ly matters to analy ze fiscal interdependence amongregions. In line with those studies, we will try to apply their approaches to analyze the fiscal competition in Indonesia and try to provide a deeper explanation. Furthermore, it could stimulate other researchers to re-estimate by using more sophis-ticated devices. Final objective is that the figure of local government budget will be more comprehensive for policy makers to address the related issues.

There are many indices to describe how great the inequality is, One of them is Entrophy Index developed by Theil in 1967. The most significant characteristic ofthe Entrophy Index is that the index can distinguish between- and within-region inequality.

In the context of regional (fiscal) disparity in Indonesia, it could be formulated as follows (Kuncoro. 2002:89):

E T I ( y ) : S , = , * , y , ' l o g [ y , , N ] ( l ) where ETI(y) is the overall spatial disparity Entrophy Index for per capita regional income (or fiscal variables), y, is the share of municipality income (fiscal) in province i on the total per capita real income (fiscal) in Indonesia, and N is the number of total municipality in Indonesia.

Furthermore, a standard empirical model of local public finance determination is usually expressed, in a linear specification, as:

Y : X , + p ( 2 )

where y is a vector of public finance variables of N l o c a l g o v e r n m e n t s , X i s a ( N x K ) matrix of explanatory variables, 2 is vector of parameters to be estimate, and p is an error term that is assumed to

Business and Entrepreneurial Review be identically and independently distributed across the observations.

T o f o r m a l l y t e s t t h e p r e s e n c e o f s p a t i a l autocorrelation due to spatial lag or eror dependence, it's necessary to perform several specification tests. The literature on spatialeconometric testing is widely and has suggested several ways for identifoing these effects (see, for example: Anselin, 1988). The first specification test proposed is the Moran (1950) I's test. The Moran's I statistic for testing the null hypothesis that there are no spatial effects.

In general, spatial autocorrelation takes the form as follows:

e , : l W e , * n , , ( 3 ) where e , is mean difference of a given variable, let say X,, from mean value in the corresponding group in the period t. The component of e, could be also the residual generated from the regiession model, T h e f o r m o f I r e p r e s e n t s t h e c o e f f i c i e n t o f autocorrelation, W is aweight given to geographically nearer regions, and n is the new disturbance terms.

The statistical test of spatial autocorrelation could be done in the following steps. (see:Anselin,lg99). The first step is to construct a (NxN) matrix linking all regions based on the location. Second, put 0 (null) in the main diagonal ofthe matrix connecting the same region. Third, put 1 (one) in the matrix when the two regions have a border. Forth, each element in the matrix is then normalized so that sum of total is 1 (one). Fifth, the sum of the row is used as weisht (W) in the Moran's I statistics calculation:

'

{[4,6, w,, (e,,) (e,,)] / [e,ei wii]] M I =

{ [ 6 , (e , , ) 2 / n J ]

where W is a row-standardized weights matrix, N is the number of observations, K is the number of i n d e p e n d e n t v a r i a b l e s , a n d M : I - X(X'X)-1X,.

Mathernatically, Moran's I statistics lies between - I and 1 (- I < MI < I ). As indicator, the value of the M o r a n ' s I statistics c l o s e s to + l shows that the stronger the spatial positive autocorrelation, in the sense that the obseruation values tend to close to each other in the corresponding location. On the contrary the value of Moran's I statistics close to *

I indicates negative spatial autocorelation, in the sense that the observation values do not tend to close to each other in the corresponding location. Meanwhile, the val ue of Moran's I statistics close to zero presenting t h a t t h e o b s e r v a t i o n v a l u e s a r e r a n d o m l y distributed (independent) among regions.

In theory, the mean value of the Moran,s I statistics ir E,ru, = - I /(n- I ) and tl.re standard deviation

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is SDlr,rr; : (2lh,h, Wu)"'. The test of significance Moran's I statistics is done by comparing between the Ml-calculated and E,r,.,:

IMI _ E(Mr)] M I . .c a l c u l a t e d

SD,",,

It will be normally distributed (distribution Z-statistics). The significance of Moran's I statistics give a signal that spatial effect plays an important role in the subsequent analysis.

RESULTS AND DISCUSSION

Before presenting the results, a word about datais in order. Data on actual municipal Gross Domestic

Product (GDP) per capita without oil and gas in refere to constant price of 1 993 published by Central Bureau of Statistics were used to test the existence of polarization among Indonesian municipalities. Data of fiscal performance from the same sources are taken from Regional Financial Statistics. All variables were transformed into actual per capita term.

The samples period of 1988-2003 covered 80 percent of total municipalities, were divided into 2 s u b - p e r i o d s , 1 9 8 8 - 2 0 0 1 a n d 2 0 0 l - 2 0 0 3 , i n e f f o r t s t o provide more complete picture about the dynamics of relative income and fiscal distributions before and after fiscal decentralization. Separating this period is also required by Chow test. Table 1 configures the complete definition of all economic variables, which willbe used in this study.

s)

Table l. The Definition of Operational Variables in the Research

Notation Definition Detailed Variables Unit

LOR Local Ou,rr Revenue Revenue sharing Alocation Fund Total Transfbr Total Rer.'enue Operating Expenditures Capital Expenditures Total Expend itr.rres Regional Inconre Regional Plice Deflator'

Local taxes and chalges. local government orvned enterprises protit. and other revenues

Tax and non ta\ reveuues sharing. inclLrding land and build ing taxes. personal income taxes. fbrest. tlsheries. and oil and gas revenues.

Betbre 2001: Autoltolt'lous Regional Subsidies. Re-gional Development grants. Inpres.

AtieL 2001: General Alocation Fund and Special Alocation Fund,

R S + A F L O R + R S + A F

Realization of operating expenditules Realization of capital expend itures O E + C E

Regional GDP lvithout oiland _sas

Ratio betu'een RGDP in current price and RGDP in constant price

Real per capita

(rnillion rupiah)

Real per capita

(rnillion rupiah)

Real per capita (nillion lupiah)

Real per capita

(million rupiah)

Real per capita

(million rLrpiah)

Real per capita

(million rupiah)

Real per capita

(rnillion LLrpiah)

Real per capita

(rrillion rupiah)

Real per capita

(rnillion rupiah) 1 9 9 3 = 100 RS A T TT TR O E C E T E

Table 2 shows Theil's Entrophy index of the selected fiscal variables and income per capita during last l6 years. In general, all of indices cousistently increase. Looking merely at the magnitude, the Theil Entrophy index of percapita regional income (Y) was

the greatest. In contrast, the Theil Entrophy indices for revenue sharing (RS) and LOR were the lowest. It indicates that RS andLORwererelatively distributed equally; in comparison with the disparity of percapita regional income which was distributed unequally. Table 2. Theil Entrophy Index of Local Government Budget and Regional Income, 1988-2003

TE C E O E TT A F RS LOR Year r 9 8 8 1 9 8 9 I 990 1 . 8 1 2 ' l r . 8 9 2 0 2.0220 2.1720 2. 52 55 2 . 6 1 3 8 2.5253 2 . 5 8 l 8 2 . 6 7 7 9 t.79',70 1 . 8 4 0 7 t . 8 7 7 6 t t l l t t . + ) t ) 2.4s84 2 . 1 3 0 0 2 . l l 9 l 2.3005 2.5652 2 . 5 9 3 0 z . o o J / 6.0'102 6.0621 6.0122

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5 4 K U N C O R O Bus i ne s s and Entre pre neur ia I Reyiew 1 9 9 I 1992 I 993 1994 I 995 1996 1997 1 9 9 8 1999 2000 200 I 2002 2003 2.0542 2 . 1 1 9 3 2.2288 2.2836 2 . 3 0 5 6 2.3306 2 . 3 8 3 5 2.21t6 2.2861 2.5460 3 . 1 4 3 r 3 . 1 5 4 8 3 . 2 t 9 2 2.6609 z . t + ) L 2.7980 2.8102 2.823'7 2 . 8 5 0 0 2 . 9 3 3 8 2 . 8 4 0 r 2.9343 3 . t 2 4 0 3 . 3 5 0 5 i.,l I 05 3.7.105 2.72'73 2 . 8 r 4 8 2 . 8 7 5 2 2.9006 2.9201 2.9484 3 . 0 2 5 8 2.9240 3 . 0 0 8 2 3.2 r r0 3 . 4 7 9 3 3.52 r r 3 . 8 0 6 8 l . 9 l 0 8 1 . 9 4 3 6 r . 9 9 1 5 2.0643 2 . 1 3 7 6 2 . 1 7 6 8 2 . 1 ' / 4 l 2.2092 2 . 2 7 3 2 2 . 3 7 t l 2 . 4 1 6 9 2.3406 2 . 3 1 1 1 2.47 44 2.5495 2 . 6 3 5 5 2.6829 2 . ' i l 2 2 2.71,+9 2.8274 2.7420 2.8213 3 . 0 i l 0 3.2196 3.3 r 55 3.4291 2.4603 2.5894 2.5926 2.5969 2.6086 2 . 6 3 2 7 2.6862 t < t t < 2.6000 3 . 0 r 6 6 3 . I 6 2 5 3.2849 3.3299 2.7't83 2 . 8 5 0 1 2 . 8 9 8 5 2.92'74 2 . 9 5 1 9 2.9826 3 . 0 5 4 2 2.91'73 3 . 0 r 5 5 3.2942 3 . 4 5 3 0 3.5644 3 . 6 4 l 0 6 . 0 9 1 9 6 . 1 1 4 6 6 . t 4 7 2 6.18'/2 6.2236 6.2539 6.3606 6 . 3 1 3 7 6 . 3 2 8 5 6 . 3 3 5 9 6 . 3 8 0 5 6 . 3 7 3 6 6 . 3 9 8 3 Source: CBS (recalculated)

Table 3 delivers the result of spatial correlation test for selected variables. The Moran's I statistic v a l u e s o f a l l t h e v a r i a b l e s w e r e p o s i t i v e . T h e s e positive values of Moran's I statistics imply that the spatial autocorrelation is getting stronger to the same direction and the observation values tend to become similar among regions in a particular area. Compared to LOR, the value of Moran's I statistics was the lowest among the four variables tested.

In term of significance, the calculated Moran's I

statistics values, except forLOR, were biggerthan the Z-table normal distribution at 95 percent confidence level, It indicated that spatial corelation was mattered especially in total expenditures, intergovernmental transfers, and percapitaregional income. Implicitly, it could be interpretedthat local government expenditures in a. particular region positively affects fiscal behavior in the geographical ly nearby areas. Thi s was in line with theprevious studies conducted byLadd ,1992; Heyndels a n d V u c h e l e n , 1 9 9 8 ; R e v e l l i . 2 0 0 0 : S o l e . 2 0 0 1 . Table 3. The Results of Spatial Correlation Test of the Selected Variables

Year LOR Z-test TT TE Z-test l' Ltest

1 9 8 8 l 989 I 990 1 9 9 I t992 I 9 9 3 1994 I 995 t996 t997 l 998 1999 2000 200 I 2002 2003 Chorv F-Test 0.0572 0.0434 0.0404 0 . 0 5 3 0 0 . 0 4 8 8 0.045 7 0 . 0 5 8 9 0.0628 0 . 0 5 8 1 0.0677 0 . 0 5 8 6 0 , 0 5 9 2 0.0732 0.0900 0 . t4 5 I 0.2066 1 . 2 6 7 2 0.9396 0.8696 t . t 6 7 1 t.0692 0 . 9 9 5 0 r . 3 0 6 0 r . 3 9 8 r t.2882 r . 5 t 3 8 1.2992 1 . 3 1 3 9 t . 6 4 1 4 2.0422 J , J + I I 4.7917 0 . 3 7 0 5 0.395 5 0.4659 0 . 5 3 1 7 0.5273 0.5646 0.6044 0 . 5 8 0 3 0.5924 0.4956 0.389.1 0 , 3 3 4 0 0.2994 0.3312 0. I 994 0 . 0 3 5 r 8.6669 9.2579 1 0 . 9 2 l 0 12.4761 I 2 . 3 7 0 5 t3.2526 1 4 . I 9 3 6 13.6235 r 3 . 9 0 9 1 1 . 6 2 t 3 9 . 1 t 2 9 7.806 I 6 . 9 8 7 4 7.809 I ,1.6251) 0.7 437 9 . 2 8 5 0 1 0 . 3 1 8 0 l 1 . 4 0 6 5 t 0 . 9 9 4 8 9 . 6 0 8 3 I 1 . 9 8 8 2 13.6177 1 3 . 0 0 9 7 t 2 . 7 5 5 6 | 1 . 0 1 2 7 9.4999 7 . 9 1 8 5 6.9467 7 . 6 0 0 1 6.7444 6 . 5 5 I 4 0 . 2 3 5 9 0 . 2 0 9 1 0.2127 0.2000 0 . | 8 8 0 0. I 795 0 . 1 4 2 5 0 . 1 4 9 9 0 , I 3 4 5 0.0913 0 . 1 0 5 7 0.t026 0.0896 0 . r 8 6 1 0 . 1 9 0 r 0. I 964 5.488 8 4 . 8 5 5 7 4.9389 1.6395 1 . 3 5 6 8 4. r 560 3.2812 3 . 4 5 7 2 3 . 0 9 1 6 2 . 1 4 3 5 2 . 4 1 1 1 2 . 3 3 8 7 2 . 0 3 0 8 + , J r l / -4.4068 ,1.5543 t 5 8 . 9 7 1 0 0.3961 0.4404 0.4865 0.1690 0 . 4 r 0 3 0 . 5 1 I I 0 . 5 8 r 3 0 . 5 5 4 3 0 . 5 4 3 6 0.4698 0.4057 0 . 3 3 8 8 0 . 2 9 7 7 0 . 3 2 5 3 0 . 2 8 9 r 0 . 2 8 0 9 l . | 7 0 8 r 0 8 . 3 4 1 8 5 . 1 9 2 1

Note: critical value of Z-table for a: 5 percent is 1.645 critical value of F-table lbr a : 5 percent is 4.54 The absence of spatial effect on LOR collection would be a materialization of fiscal centralization

policy which had been implemented previously. The Z-value in the corresponding periods was less than

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Z-table value in 95 percent level of confidence. In those periods, objects, items, and tariffs in LOR had been decided by central government and equally implemented for all local governments.

In accordance with fiscal decentralization era s i n c e 2 0 0 1 , th e s p a t i a l e f f e c t s w o u l d h a v e b e e n significant. It was confirmed by Cliow test using 2001 as breaking year.

Those phenomena indicate that the surrounding areas influen ce realization of the LOR collection. It seems that realization of the LOR collection in a p a r t i c u l a r lo c a l g o v e r n m e n t w o u l d b e c a m e a reference for others to determine realization of the LOR collection in the next period. In tlre long run, it would induce local tax competition among local governments altd in turn stimulate the high cost economy (Saad, 2003).

F u r t h e r , l v e d i s c o v e r e d t h a t t h e r e w a s a c l o s e relationship between unequal econotnic variables

C O N C L U S I O N

B y u s i n g p a n e l d a t a o n t h e I n d o n e s i a n l o c a l government, this paper has explored the source of spatialauto-correlation in local pLrblic finance. The results ofthe analysis found that the fiscal competition among municipalities were greater compared to the

distribution and their spatial correlations, as described in figure 1. It is notable that in general the increase in LOR unequal distribution associates with the increase in LOR interdependence among regions. Second, the increase of local government expenditures in total were un-equally supported by transfers associate with the decrease in their interdependences among regions. This condition was strengthening especially after 1 998" Third, the increase in regional income disparity corre-lates to its interdependence in the opposite direction. Howeveq after regional autonomy era, this correlation changed to parallel direction. Those indicate that fiscal equalization in regional autonomy and fiscal ciecen-tral ization era requires a decl ining of the degree of fi scal interdependence amon gmun icipal ities. On the contrary the regional income equalization using localgovem-ment expend itures i nstrument, induced by intergovern-mental transfers, requires an increasing ofthe degree of fi scal interdependence among municipalities.

pre-fi scal decentralization period.

I t s e e m s t h a t t h e l o c a l tax setting and local government expenditures decisions in a particular municipality were mimicking on the behavior of neighbor regions. Fufihermore, the spatial interaction is negatively correlated to the fiscaldisparity. Those imply tliat in the regional autonomy era, the local Figure l. Relationships between Entrophy Theil Index and Moran's I Statistics

Local Own Revenue, Total Transfer, Total Expenditure, and Regional Income, t988-2003 2 6 2 4 2 . 2 2 . O 1 . 8 ' 1 . 6 0 2 5 0 2 0 0 . 1 5 0 1 0 0 . 0 5 0 . 0 0 88 90 92 94 96 98 00 A2

Tahun i trrPlo l\,llPAD

LOR 4 . 0 3 . 8 3 . 6 3 2 3 0 2 A 2 6 2 . 4 o . 7 0 . 6 0 . 5 0.4 0 . 3 o . 2 0 . 1 0 . 0 88 90 92 94 96 98 00 02 I a h u n I E T D P M I D P TT 3 8 3 . 4 3 . 0 2 . 8 2 6 2 4 8 8 9 0 9 2 S 4 9 6 9 8 0 0 0 2 tahun ierre MlrB TE 6 . 4 6 3 6 . 2 6 1 6 . 0 90 T a h u n 9 4 96 98 00 02 t\4YC Y

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5 6 K U N C O R O

governments tend to increase both their local own revenue intensively and intergovernmental grants, in order to finance their expenditures. In the long run, this could lead to the high cost economy, worsening f i s c a l d e p e n d e n c y a n d i n e f f i c i e n c y i n l o c a l government expenditures.

Above findings suggested thatthe distribution of intergovernmental transfers among regions should consider as local tax effort and minimum standard of services have to play an irnportant role in spending the local government expenditures efficiently.

R E F E R E N C E S

Anselin, L.,1999. "Spatial Econometrics ", Working Paper, Bruton Center, School of Social Sciences, University of Texas, Dal las, http://www.csiss.org/ learn ing_ resources/content/ papers/baltchap.pdf. Anwar Shah, 2006. Fiscal decentralization and

macro e c onom ic m anage men t. lnternational Tax a n d P u b l i c F i n a n c e . B o s t o n . V o l . 1 3 , I s s . 4 ; p . 4 3 7 . Bardacke, Ted, 2000. Indonesia leaves nothing to

c h a n c e w i t h a g e n d a : A n e w three-year agreement with the IMF and budget for fiscal year 2000 is a triumph in goal-setting, writes Ted Bardacke:; [London editionJ. Financial T i m e s . L o n d o n ( U K ) . p.08.

Bivand, R. and S. Szymanski, 2000. "Modeling the Spatial Impact of the Introduction of Compulsive Competitive Tendering", Regional Science and Urban Economics, 30:203-19. B l a n e D . L e w i s , 2 0 0 5 . I n d o n e s i a n L o c a l

Government Spending, Taxing and Saving: A n E x p l a n a t i o n o - f P r e - and Post-decentralization Fiscal Outcomes+. Asian Economic Journal. Oxford. Vol. I 9, Iss. 3;p.291 . B r u e c k n e r , J . , 1 9 9 8 . " T e s t i n g for Strategic

Interaction among Local Governments: The Case of Growth Controls ", Journal of Urban Economics, 44:438-67.

Christoph Beier, Gabriele Ferrazzi, 1998. Fiscal decentralization in Indonesier: A comment on Smoke and Lewis. World Development. Oxford. Yo|. 26, lss. 12;p.220 1 .

Era Dabla-Norris, 2006. The Challenge of Fiscal Decentralisation in Transition Countries. Comparative Economic Studies. New Brunswick. V o l . 4 8 , Is s . 1 ; p . 1 0 0 .

Figlio, D., V. Koplin, and W. Reid, 1999. "Do States Play ll/elfare Games? ", Journal of Urban

Business and Entrepreneurial Rev iew Economics, 46: 437 -454.

G. Gulsun Arikan, 2004. Fiscal Decentralization; A Remedy for Coruuption?. International Tax and P u b l i c F i n a n c e . B o s t o n . V o l . I 1 , Is s . 2 ; p . 1 7 5 . H e y n d e l s , B . a n d J . V u c h e l e n , 1 9 9 8 . " T a x

Mimicking among Belgian Municipalities", N a t i o n a l T a x J o u r n a l , 5 l( 1 ) , M a r c h : 8 9 - 1 0 1 . I n d o n e s i a Forum, 2000. Kajian tentang Aspek

Finansial Otonomi Daerah, Executive Summary Y a y a s a n I n d o n e s i a F o r u m a n d USAID/OTI, M a y , 2 0 0 0 .

John Thornton, 2007. Fiscal decentralization and economic growth reconsidered Journal of Urban Economics. NewYork. Vol. 61, Iss. l;p.64. Kuncoro, M.,2002. Analisis Spasial dan Regional, Studi Aglomerasi dan Kluster Industri Indonesia, UPP AMP YKPN, Yogyakarta. Larry Schroeder, 2003. Fiscal decentralization in

Southeast Asia. Journal of Public Budgeting, A c c o u n t i n g & F i n a n c i a l Management. B o c a R a t o n : F a l l . V o l . 1 5 , Is s . 3 ; p . 3 8 5 .

Murillo, R H., 2003. "Strategic Interaction in Tax Policies among States ", Review, the Federal Reserve Bank of St. Louis, May/June: 47-56. O a t e s , W E . , 1 9 9 9 . " A n E s s a y o n F i s c a l

Federalism ", Journal of Economic Literature, 37(3), September: 1 120-49.

R e v e l l i , F . , 2 0 0 0 . " S p a t i a l Patterns in Public Spending and Taxation: A Test of Horizontal I n t e r a c t i o n among Local Governments", W o r k i n g P a p e r , Department of Economics, University of Torino, Septernber, 2000, l^fttp:ll www. unipv. itl websiep/ wp/04 I .pdf.

Saad, I., 2003. "lmplikasi Otonomi Daerah Sudah Mengarah pada Penciptaan Distorsi dan High Cost Econo my", http: I lwww.dec.orgipdldocs/ PNACU424.pdf

Sidik, M.,2001. "Studi Empiris Desentralisasi Fiskal: Kebijakan Perimbangan Keuangan Pusat dan D a e r a h d i E r a O t o n o m i D a e r a h , ' , p a p e r presented in the 9th ISEI Panel Discussion, April,

l 3 - 1 4 , 2 0 0 1 i n B a t a m .

S o l e , A . , 2 0 0 1 . " B u d g e t S p i l l o v e r s i n a Metropolitan Area: Typology and Empiriccrl Ev idenc e ", Working Paper No. 200 | I 5,lnstitute d ' E , c o n o m i a de Barcelona, May, http:ll www.pcb. ub.es/ieb/serie/doc200 I -5.pdf. Wif son, J D., I 999. "Theories of Thx Competition",

Figure

Table 2 shows Theil's Entrophy index of the selected  fiscal variables  and income per capita during last l6 years
Table 3. The Results of Spatial Correlation Test of the Selected Variables
Figure l.  Relationships  between Entrophy Theil Index and Moran's I  Statistics Local Own  Revenue,  Total Transfer,  Total Expenditure, and Regional Income,

References

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