Municipal Grant System
An Overview

By Rup Khadka

THERE is a need to transfer resources from the central government to local governments, including municipalities because of the mismatch between the responsibilities of the local governments and the resources available to them. This is because since most of the broad based taxes including value added tax, customs duties, and income tax can be collected more efficiently and equitably at the central level, these taxes are generally levied by the central government in various countries. This means that local governments are authorised to levy only such taxes, which are based on property, vehicles or some limited services such as entertainment. On the other hand, since local government can respond more quickly to the local conditions and wishes, many public functions can be carried out more efficiently and timely at the local level, local governments are assigned many responsibilities.

Need

There is a need to bridge the gap between the responsibilities and resources of the local governments by means of grants from the central level. Central grants are also required to compensate for spill over effects, which are created when municipalities carry out projects that also, benefit people outside their jurisdiction. Further, since not all municipalities are equally developed and do not have equal level of resources base; they are also given grants to develop particular areas and maintain similar level of services in different areas. Sometimes, grants are also given to meet the budget deficits of a municipality.

Thus, municipalities receive money in the form of grants to carry out their functions. Grants can be received in different forms which may be general or specific. General grants are given in the form of formula grants, generally based on population and resource need. Municipalities have full discretion in visiting the general grants.

Sometimes grants are provided in the form of multipurpose development grants; such grants may be given to top-up direct local incomes of all municipalities or of only those municipalities with below average or below standard fiscal capacity. On the other hand, specific grants are provided for financing programme specified by the central government, except the grants provided for redistributive purposes, which are given in the form of a lump sum or block grants.

Grants may also be conditional or unconditional. Under the conditional grants, municipalities are required to meet certain conditions such as tax effort or expenditure requirements. It is not necessary to meet any requirements under the unconditional grants. Municipalities can use this money freely. It enhances autonomy in the expenditure side.

Grant may also be closed or open-ended. Close-ended grants are fixed amount while open-ended grants are not fixed. The latter depends upon the level of expenditure of the municipalities. In case of local public services with large slipover effects, open-ended, matching grants would be desirable.

Grants also might be provided in the form of matching or non-matching grants. Matching means that both the donor and the recipient governments will finance specified percentage of the expenditures on that service, while non-matching grants are given as a fixed or lump sum amount rather than a fixed percentage of its total expenditures or revenue generation. Matching grants depend upon expenditure or tax level. They rise with increase in local expenditure or local tax revenue. This works as a subsidy that might encourage over spending. It also encourages municipalities to put more efforts to raise tax revenue locally. Additional grants may be given to match local exploitation of particular revenue locally. Additional grants may be given to match local exploitation of particular revenue sources e.g. extra grants for local revenue exceeding a target.

In Nepal, municipalities receive money in the form of grants to carry out their functions. Government grants are given in the form of an administrative grants and development grants. Administrative grants are given to support government employees posted at the municipal offices, while development grants are provided to carry out development activities at the local level. All municipalities receive government administrative grant. Government development grant is provided to the less developed municipality, which are in fact the most important grants. This type of grant is provided only to those municipalities whose internal revenue is less than one crore rupees. They also receive grants for the operation of fire fighter. Municipalities get grants from DDCs also. Depending on their eligibility, they may also receive grants from the TDF for specific infrastructure projects.

In 1998/99, municipalities received total grants of Rs. 247 million. Out of this Government Administrative Grant was Rs. 22 million Development Grant was Rs. 120 million, DDC and Other Grants was Rs. 65 million and TDF Grant was Rs. 40 million.

On average, grants constitute less than 20 per cent of total income of municipalities. This is, however, not the case in all the municipalities. In general, since grants are not a very important source of income of municipalities, there is not much pressure from the government on expenditure decision making of the municipalities.

Grants will remain as sources of income of municipalities, perhaps forever. Grants are given for various reasons, including for redistribution purposes. Grants might be used in the case of public services provided by the municipality. They may also benefit the residents of other areas or municipalities, in the sectors such as education, health and transportation.

Considering substantial disparities among the municipalities, it would be necessary to distribute government grants on the basis of various factors. For example, grants could be given on the basis of population, resource need, level of development and revenue base. It is also necessary to base the grant system on the performance of municipalities, particularly in terms of the collection of property taxes. Municipalities have not made any serious efforts to generate tax revenue.

Design

In this context, grant system should be designed in such a way that it encourages municipalities to raise taxes. This means that those with higher tax efforts should be rewarded more than those with lower tax efforts. Such a grant system will encourage putting more effort to raise tax revenue. Grants also could be tied up with the maintenance and submission of proper accounts of their revenue and expenditure.

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