A recent conversation between Prime Minister KP Sharma Oli and the chief minister of Province 2 provides an example of the financial challenges facing the state. The chief minister is telling the prime minister how they are short of money to conduct their daily business. Other provinces in Nepal are seeing similar problems of a resource mismatch, thus it is pertinent to explore the fiscal aspects to assess the issue. One of the popular methods of making such an assessment is analysing the degree of decentralisation in terms of expenditure and revenue assignments.

Division of control

The constitution of Nepal has divide power among all three levels of government: federal, state and local. The federal government is in charge of 35 items of national importance like defence and military, war, peace, central police, planning, finance, monetary, banking, foreign grants and loans, international relations and telecommunication. The responsibilities of the states include 21 items touching the life and welfare of the people such as maintenance of peace and order, healthcare, electricity, irrigation, water supply, higher education, protection and use of languages and cultural issues. Similarly, there are 25 subjects over which both the federal and provincial governments have jurisdiction.

The local level has been given control over 22 matters of local concern like town police, local level development plans, projects, basic and secondary education, local roads, agro roads, irrigation, water supply, protection of wildlife, mines, minerals and development of languages and cultures. There is a separate list consisting of 15 concurrent items upon which all three levels of government can exercise jurisdiction. They include cooperatives, education, health, agriculture and services like electricity, water supply and irrigation. Residual powers not included in any of the above lists have been assigned to the federal government.

The above lists imply that the state and local level governments have been entrusted with a vast range of public goods to be delivered. In such instances, the states and local level units would require substantive resources for the disposal of the listed deliverables. Therefore, it is essential to assess the revenue side of the federal fiscal design so as to comprehend the fiscal viability of provinces and local units.

Collection of revenue

With regard to collecting revenue, the power to tax has been distributed among the three levels of government. Major sources of revenue, accounting for almost 80 percent of the total tax revenue, have been put under federal jurisdiction. With the single exception of agro income tax, provincial governments have no exclusive area of taxing power. Provincial governments have been given the power to collect entertainment and advertisement tax and registration charges for land and house which are to be collected concurrently with local governments.

Meanwhile, all three levels of government have concurrent jurisdiction over service charges, penalties, fines and tourism charges. Local units, like the federal government, have also been entrusted with some exclusive powers to tax although the tax base is narrow. Local units have the power to collect land tax, property tax, business tax, vehicle tax and tax on house rent. This existing modality implies that around 90 percent of the total tax revenue will be under the jurisdiction of the central government through its exclusive and concurrent powers.

In most federal systems of government, taxes on international trade (customs duties) are levied at the federal level. Taxes on the consumption of goods and services are levied at both the federal and sub-national levels. In Canada, the federal government levies value added tax (VAT) and provinces levy retail sales taxes. Brazil levies VAT at both the central and state levels. In Switzerland, cantons have wide taxing powers. Cantons collect nearly 80 percent of the total tax revenue of the country.

On the basis of above analysis following inferences can be drawn. 1. It is desirable that significant legislative authority is provided to the lower levels of government because of their proximity, accessibility and quicker response to the public need. This is a progressive aspect of a federal constitution. 2. But looking at the revenue side, almost 90 percent of the revenue is under federal control. This inevitably will result in incidences of vertical fiscal imbalance (VFI) and horizontal fiscal imbalance (HFI). 3. Consequently, redistributive and equalisation mechanisms will be required to correct VFI and HFI. Though the constitution provides for a National Natural Resource and Finance Commission, it is silent about equalisation mechanisms and intergovernmental transfers.

Mishra is a freelance consultant