Although it has recently been ten years since the promulgation of the federal constitution, it has been eight years since federalism was implemented. During this period, Nepal has made significant progress in some indicators of fiscal federalism.

In the fiscal year (FY) 080/81, the share of provincial and local governments (Prasthas) in the integrated expenditure of all three tiers of government was 37 percent, while 57 percent of the revenue collected by all three tiers of government was spent by Prasthas. And, 52 percent of the total revenue collected by the union has been transferred to Prasthas under various headings. 

These indicators are comparable to some countries known as decentralized. In federal Nepal, improvements can be seen in four basic areas. Physical infrastructure, especially the road network, has been extensively expanded. As many works have been decentralized to the centers and wards of municipalities, citizens' access to public services, especially administrative services, has increased.

Similarly, Prasthas have been found to be more accountable than the federal government, and due to the inclusive system, the participation of women, Dalits, and other disadvantaged groups in the governance system of Prasthas has increased significantly. Fiscal federalism has made a significant contribution to this. However, at what cost are these achievements being achieved? That also needs to be seen.

Federalism is not being implemented in a budget-neutral manner. That is, federalism is not being implemented within the same limits as public spending before federalism. Of course, due to the federalism model we have adopted, its implementation could not have been implemented in a budget-neutral manner. However, the increase in public spending during the implementation of federalism is very high. 

The ratio of public spending to gross domestic product is a means of measuring the size of the government. Accordingly, while this ratio was an average of 21 in the seven years of federalism, it has increased to more than 30 in the seven years after federalism. Since the reconstruction after the earthquake and the implementation of federalism almost coincided, the share of public spending has increased at the same time, but even after the reconstruction work was completed, public spending has not decreased. 

Since the growth in revenue is much lower than the increase in expenditure in the seven years since the beginning of federalism, the deficit of the federal government has increased significantly. While the budget deficit of the Government of Nepal (excluding financial transfers) averaged 14 percent in the seven years of federalism, that percentage has increased to an average of 25 percent in the subsequent seven years. To meet such budget deficits, debt, especially internal debt, has been mobilized, and the burden of debt has been primarily borne by the federal government. By the middle of the fiscal year 2082/83, the total outstanding debt had reached about 44 percent of the gross domestic product. 

As the debt burden has increased in this way, the principal and interest expenses of the debt have been increasing compared to the capital expenditure of the federal government in the past two fiscal years. Such expenses are expected to increase further in the coming years. On the other hand, representatives of the Prasthas and supporters of federalism have demanded a significant increase in the amount being transferred by the federation.

Their main complaint is that the federation keeps a large part of the revenue collected by itself and transfers only a small part to the Prasthas. Some have said that ‘the federation should keep only 40 percent of the revenue and transfer 60 percent to the Prasthas’. Against this background, the article presented will discuss where we have gone wrong in the implementation of fiscal federalism.

Fiscal federalism is a component of overall federalism, and it also has four main sub-components (expenditure, revenue, grants, and debt). Fiscal federalism is also understood through three ‘F’s’ (Functions – Responsibility, Funds – Finance, Functions – Implementation Mechanism). How to take fiscal federalism forward with other components of federalism (political and administrative) and how to coordinate among its sub-components? And what is its long-term goal? How to advance it in the immediate medium term? And ultimately how to transition the unitary state to a federal one? Fiscal federalism was implemented without a policy and strategy. 

As a result, the implementation of federalism became ad hoc and haphazard. In the absence of any written document to guide the federal ministries/bodies, coordination between the ministries/bodies could not be achieved, which was reflected in the laws on the implementation of federalism presented in the parliament.

Dual/triple responsibilities and unclear roles

Except for some areas used by the federal government (such as defense, international relations, monetary policy, etc.), all three levels of government are working in almost all areas and sub-areas. There are many examples of the state and municipality or all three levels of government spending their budgets when building the same school building or road. 

Examples of the state and the union interfering in the work that the municipality should do, and the union and the municipality interfering in the work that the province should do. This is because the first and most important principle of fiscal federalism, which states which level of government should be responsible for what work, has been undermined. The report on the detailed work prepared with great enthusiasm to alleviate this situation is currently stuck in the drawer of the Prime Minister's Office.

More finance than rights and responsibilities

According to another principle of fiscal federalism, responsibility should be followed by finance. In our country, finance came before rights and responsibilities. In the first year of local government elections (2074/75), the highest ever (Rs. 1 trillion 48 billion) equalization grant was sent, while there was neither any institutional infrastructure for government operation nor the minimum information on what to spend it on. How was the amount, which was estimated to be around Rs. 200 million, spent? Ironically, in the current year, the equalization amount per municipality was Rs. Even Rs 120 million is not enough.

It seems that the mentality of ‘responsibility comes later, but let’s send the money first’ is at work in this. Of the three ‘Fs’ of fiscal decentralization, finance is the easiest to decentralize. Many responsibilities (such as peace and security, land management, etc.) and implementation mechanisms (including the police) have not yet been transferred, and they have been placed in unnecessary structures and employee unions in the name of employee adjustment. 

The practice of sending large amounts of grants without clarifying or transferring the responsibilities that must be fulfilled has led to the development of the habit of spending equalization grants in a haphazard manner, which is not so easy to correct.

Ambiguity in the objectives of grants

The constitution has taken the revenue and equalization grants raised from its own sources as the main sources of meeting the expenses of the institution. The constitution intends to use the other three grants (conditional, complementary and special) for specific purposes rather than as sources of meeting expenses. For example, conditional grants should be provided based on national policies and programs, standards, and infrastructure conditions, while complementary grants and special grants should be provided to address the impact of the activities of a municipality or province on other municipalities. 

In practice, conditional grants have become a source of financing for the state and even local government. And, from 2074/75 to the current fiscal year, the share of conditional grants in the total grant has almost doubled. Although the objective of equalization grants is to maintain minimum equality in certain government services regardless of which province or municipality one resides in, it is not clear which services/facilities are being sought to be equalized, let alone in this direction. Since basic services (such as health, education, etc.) are covered through conditional grants (as mentioned above), equalization grants have become a means of spending the state wherever it wants. In the long run, the sustainability of the model of sending conditional grants for basic services and sending equalization grants for other expenses can be questioned.

Weak accountability of Prasthas

It is believed that the closer the government is to the people, the more responsible and accountable it becomes. In this sense, the provinces are more responsible and accountable than the union, and the local governments are more responsible and accountable than the provinces, for which, in addition to periodic elections, the overall environment needs to be conducive. To what extent does this system exist? That is a separate topic of discussion, but the accountability of Prasthas has been weakened due to two main reasons for the functioning of the union government. 

Due to the existing grant system (conditional, complementary and special), the union has direct control over almost half of the expenses incurred by Prasthas and the status of Prasthas is limited only to the implementation unit of the union's plans. And, since the Chief Administrative Officer of the municipality and the Chief Secretary of the province are appointed by the union government and they are primarily accountable to the union government, Prasthas have no control over their own employees. Remember, the accountability to the extent that the union government controls them should be taken by the union government.

Weak revenue mobilization of local governments

Although the revenue base of municipalities is broader than that of provinces, their revenue mobilization is extremely weak. In the last 6 years, municipalities have received only eight percent (on average) of their revenue from internal revenue, while this has remained stable in recent years.

There are three basic reasons behind this. The existing grant system has not been able to motivate municipalities to raise internal revenue sufficiently. The ‘narrative’ has been established that the revenue collected by municipalities can be spent on administrative work of the municipality rather than on local service delivery. And since large amounts of money were transferred without developing the minimum institutional infrastructure to spend, there was no sufficient pressure on the people's representatives to mobilize local revenue.

Weak role of the National Natural Resources and Finance Commission 

Constitutionally, the amount of financial transfer received by the municipality should be as recommended by the commission. However, the role of the commission is limited to revenue sharing, royalties received from natural resources, and equalization grants. Most of the revenue received by the Prasthas is based on the decisions of the federal government, which has become very inconsistent.