Federal-local government fiscal relations

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114 Dr. S. C. Ugwu. Erne Okechukwu & Okeke Martin Ifeanyi



1999 2007 . :~."'-



Enugu State University Of Science And Technology


Erne Okechukwu & Okeke Martin Ifeanyi
Department of Public Administration &
Local Government Studies
University of Nigeria, Nsukka
E-mail: okechukwunncnt(a)yahoo.com
E-mail: martinokckcifcanyieuyahoo.com


It is axiomatic to posit that the severity of Nigeria's socio-economic
and political crisis dictates that all available human and material resources
be effectively mobilized to reverse the trend in the afore-mentioned sectors.
In recent times, local governments in Nigeria have been assigned specific
responsibilities by constitution (see the 1979 constitution). But this should
not be taken to suggest that in the past local governments did not contribute
to socio-economic development of Nigeria. For example, between 1955
and 1965, local governments were responsible for an average of 12 percent
of total public expenditure in the polity.

In a federal polity like Nigeria, local government has been
recognized as one significant instrument for rural transformation and for the

del ivery of social services. This is because; they are closer to the people and
hence could effectively alter socio-economic and political conditions
within their jurisdiction. Apart from providing and maintaining basic
infrastructures, local governments can complement the economic activities ~
of other tiers of government (Federal and state governments). In the sphere

of the economy, the establishment of governmental organs such as the then
Directorate offor Food and Rural Infrastructure (DFFRI), Peoples Bank of
Nigeria (PBN) and Community Banks (CB), Better Life Programmes and
Women Commission and the coordinating of their activities of the
consultation with local government has helped in opening up rural areas for


dcvclopmcnr. Local governments then had departments for Better life
which mobilized rural women in matters pertaining to politics and economy
with a view to making them well informed, productive and self-reliant. The
peoples Banks of Nigeria and the Community Banks become very much
handy in helping and promoting rural economic activities and grassroots
developments. These agencies, therefore, became significant platforms of
socio-economic and political transformation, thus strengthening the
objectives of which local government was meant to attain.

Fiscal operations at the local government level become significant if
macroeconomic stability is necessary in the wider economy. If fiscal
imbalance appears rampant at the local level, it could pose problems for
macroeconomics management of the economy. The scenario is even
more complex when local governments depend on transfers from the
center. In this era of economic crisis, local government in Nigeria face
more challenges in terms pf struggling to be less dependent on the
higher tiers of government (federal and state) for financial resources.
Though the revenue allocation system mandates that a certain amount
of the federation account be ~lIocated to local governments, these funds
are never enough to meet expenditure requirements. This is because the
size of the account is related to revenue from oil, which is subject to
fluctuation, litigations and deductions, and expectations of local
councils far exceed the available resources. In a system characterized
by ethnic jingoism, federal pnd state governments have attempted for
political reasons to frustrate the existence of effectiveness of local
government by defaulting on their statutory allocations to local
governments, rendering Iqcal councils financially and politically

Guidelines for local Government Reform (1976: 1) notes:

Local governments have over the years suffered from the
continued whittling down of Ihfir powers, and state government
I/(Id continued to encroach upoh what would normally have been
the exclusive preserve oflocal governments and consequently there
has been a divorce between the people and governments at their
most basic levels.

Unfortunately, the picture is now not different in spite offunctions
of local governments; sources Qf revenues and other responsibilities now
have constitutional backing. Ekpo and Ndebbio, (1991), Eme (1998) and
Eme and Edeh (2006) not onlYi traced the evolution of fiscal federalism
within the Nigerian economy b~t also concentrated on fiscal relationships
·etween the federal and state ~overnments. There also exist economic
relationships between state and Ircal governments. An examination oflocal
government fiscal operations l\ecomes very significant for a complete

116 Dr. S. C. Ugwu, .Erne Okechukwu & Okeke Martin IfeanJ,i

understanding of intergovernmental fiscal relations.

The objective of this paper i's to descri e and analyze fiscal
relations and operations between the federal and local governments in ••
Nigeria using the Obasanjo administration (1999-2007) as a case study. The
extent of self-financing, the fiscal gap and its volatility at the level will be,
examined. It is anticipated that a study of this nature will contribute the.
ex isting literature on fiscal federalism in deve~~ping nations. '

. .

What Is Intergovernmental Fiscal Relations?

An intergovernmental relation refers to the vertical and Iiorizontal
interactions between and among different levels of govern~ent in a polity.
There are various ways to describe the relationship between a larger
comprehensive unit J of government and its constituent parts. A
confederation, for example is a system in which the constituent units grant
powers to the national government, but do not ~llow it! to act independently.
A unitary system is one in which all powers reside with the central
government, and various units derive their powers from the unit, France and
Sweden, for instance are characterized by unitary systems, as is the
relationship between States and localities in the United States; localities

. ,

hold those powers specified by the state.

The 'relationship between Nigerian central government and the
States and local governments, however is federal in that it involves a
decentralization (or division of power) between and among the various
levels of government. Some powers are granted specifically to the national
government to conduct foreign relations, to regulate inter State commerce
and banking, some are reserved by the states to conduct' el~ctions, to
establish local government among others and some are shared 'or held by

, , )

both levels, such as to tax, to borrow money ana to make laws among thers.

This system of governance is also referred to as "federalism": .

The term "intergovernmental relations" is often used to encompass
or capture all the complex and interdependent relationships among those
various levels of government as they seek to develop and implement public
programmes. Indeed, it is tHrough this mechanism of intergovernmental
rc lat ions that the federation functions and jobs get done. Intergovernmental

fiscal relations had to do with fiscal federalism. I

Fiscal federalism or intergovernmental fiscal transfer or relations ••
describes the division of fiscal resources and responsibilities among ~
various tiers of government. It deals with problems arising from the
situation of divided political-juridical jurisdictions within an economically .•.
integrated polity. It equally covers efforts to define the appropriate
functions and finances of the various tiers of government as efficiently and
complimentarily as possible to maximize welfare of the political

AJPAS VOL[4] No. 1 SEPT~BER, 2008


community. Intergovernmental fiscal relations cover such issues as models.
for the assignment of responsibilities and tax powers, discussions of"
intergovernmental spill over and intergovernmental grants, fiscal mobility
and migration, vertical fiscal imbalance and dependence, macroeconomic
inanagement and fiscal decentralization. According to Egwaikhade

- (2004: 1) ?everal pertinent issues are discernable from the literature. These

-. .


First, is the problem of how to allocate revenue ,\
among the three tiers of government, such that each tier can
carry out its constitutional assigned functions. There is


vertical revenue imbalance with the federal government

appropriating more than its fair share from the federation
accounts. The. revenue expenditure divergence is
reinforced through increased jiscal centralization.
Intergovernmental fiscal conjlict is the resultant direct
effect of the concen tration process in Nigeria.

Second there is horizontal imbalance unequal
fiscal capacity among states. Derivation principle, which
dominated the horizontal revenue allocation scheme·
between the late I940s and mid I 960s, exacerbated the
horizontal imbalance (E. Mbanefoh and Egwaikhide,
1988). It was advocated that this criteria should be de-
emphasized or discarded since it promoted uneven
development. Since I970s when oil revenue started to
'account for a sizeable proportion of Nigeria's total
revenue, the use of derivation diminished to a negligible


I •

The thiri i~sue has to do with the oil p;oquction
externalities in the oil-producing states, which has
climaxed to the demand for resource control by the
southern governors and leaders.

Put differently, fiscal federalism in Nigeria has its legal basis laid in
the constitution. For example, the 1999 constitution, contains various
clauses in the second and fourth schedules on the tax powers of the federal,
state and local governments and also on the system of revenue sharing and
management of public funds, Details of these are contained in sections (i)
162-168, items 59 (part 1 ), Item A la, band 2 part (II) D 7-10 in the second
schedule, item 32 a-c in the third schedule and item: 1 b, section 7 of the
Forth schedulerespectively.

Fiscal federalism according to Anyanwu (1997: 159) " ... implies
the co-existence of both national and sub national governments which
perform the economic functions required by the society or an association of

J' \ )

118 Dr. S. C. Ugwu, Erne Okechukwu & Okeke Martin lfeanvi

two or more levels tiers of government within a country". He goes on t!)
argue "the method oftaking collective decisions is predetermined and that it
is relatively efficient".

What is Intergovernmental Fiscal Relations'!

Intergovernmental relations refer to the interactions between levels
of government in a state system. Intergovernmental relations are
particularly important in a federation because its condition reflects the
health of a eountry's federal structure. Indeed. it is through the mechanisms
of intergovernmental relations that the federation functions and jobs get
done. Intergovernmental fiscal relations have to do with Fiscal federalism.

Fiscal federalism describes the division of fiscal resources and
responsibilities among levels of government. It deals with problems arising
from the situation of divided political jurisdictions within an economically
integrated state-system. It covers efforts to define the appropriate functions
and finances of the various tiers of government as efficiently and
complimentarily as possible to maximize welfare of the political
community. Intergovernmental fiscal relations cover such issues as models
for the assignment of responsibilities and .. tax powers. discussions of
intergovernmental spillovers and intergovernmental grants. fiscal mobility
and migration. vertical fiscal imbalance and dependence. macroeconomic

management and fiscal deeentralization. ~

Theoretical and Scientific Debates on I nteruovernmental fiscal

There is an age long debate about the benefits offederalism and the
attendant challenges it throws up on intergovernmental relations. Kincaid
(200 I). for instance

believes that modern federalism emerged at about the
same time as the concept ofthe market economy and that
one vet:.v important reason/or thefonnation ofthefederal
union was the need to create a common market that would
facilitate the movement of goods. Among the advantages of
democratic federations identified hy Kincaid (200/ :88)
are (I) more efficient provision oj" public services: (2)
better alignment ofthe costs and benefits ofgovernment of
a diverse citizenry and, thereby. more equity in so far as
citizens get what they payfor and payfor what they get (3)
beuer fix between public goods and their spatial
characteristics, especially the variable economies ofscale
of different kinds of public goods, (4) increases
competition, experimentation, and innovation in


government sector. (5) greater responsiveness to
community and capacity to respond to their preferences,
(0) more transparent and close to the citizen accountability
in policy/making. (7) more sensitivity to sub/national
regional concerns, including the power of constituent
governments to provide for their own needs. These
advantages have largely been teased outfrom the works of
Hayek (/945) and Tiebot (/956). Hayeks point is that local
governments enjoy the advantages of better access to
information about local conditions, and are therefore in a
better position to make decision than national governments
in providing local public goods. Tiebouts idea of
laboratory federalism emphasizes the experimentation
front which other regions may learn and imitate that which
is successful. Such local experimentation reduces the costs
of failure under centralization, where such
experimentation would have to be done on a larger scale.
Thus, federalism ensures macroeconomic stability,
promotes experimentations and innovativeness while
securing a huge market so necessaryfor the achievement of
economyof scale. (Aiyede 2008: I)

Aiyede, (2008) goes on to posit that the political business cycle
literature looks at the advantage offederalism in terms ofthe way federalism
creates checks and balances among the levels of government. Such checks
and balances commit central policy-makers policy to spending restraints,
'thus preventing them from reneging on their macroeconomic commitments.
Absent such checks and balances, politicians at the central level have a
tendency to expand the economy during election campaigns in an attempt to
woo myopic voters, although the long term results are sub-optimal. Such
action might provoke inflation when it is financed by deficit budgeting.
With federalism state governments can police the inflationary and deficit
bias of these central officials Lohmann (1998), Qian and Roland (1999).
Similarly, Lohmann (1997: 17) argues that federations are more likely than
unitary countries to develop politically independent, inflation-averse
central banks that refuse to provide accommodating monetary policy.
Besides, competition among sub-national units for tax revenue and
investment constrains the size of the public sector and ensures efficient
delivery of public services consistent with the diverse demands of disparate,
decentralized constituencies.

These claims have however not been consistently proven by
decentral ization experience everywhere. Indeed, some scholars have argued
that federalism often aggravate problems associated with collective action

120 Dr. S. C. Ugwu, Erne Okechukwu & Okeke Martin Ifeanyi

in the formulation and implementation of economic policy, especially
macroeconomic management and market reforms (Prud'hornme 1995,
Triesman 1999). In a sample of developing countries, Wibbels (2000) finds
higher and more volatile deficits and inflation rates among federations than
among unitary systems. Using a higher sample, Treisman (2000) finds that
federations do not demonstrate higher inflation rates than unitary systems,
but if inflation problems develop federations are less likely to resolve them.
According to the Wallis Hypothesis, decentralisation increases sub-national
government size. Also, the collusion hypothesis is that sub-national
governments try to circumvent the competition brought about by
decentralization. There are a series of collective action problems that are
peculiar to federal systems that account for this state of things. For instance,
Gandhi (1995) opines that the establishment of an efficient and modem tax
system could be difficult if important taxes essentially belong to lower lcvc I
governments. When borrowing is not strictly controlled by the national
government, free spending sub-national governments may build 1I1)
unsustainable deficits and then call upon the central government to prm Ilic-
special bailout transfers or otherwise assume their liabilities. Indeed. muli \
tier governments face the possibilities that sub-national govemmcnt- \\ .'
try to over fish the common pool by shifting their costs onto others. I hi'
opportunistic behaviour on the part of sub-national governments described
as the soft budget constraint, may undermine macroeconomic stability.
Thus, it will be difficult to achieve optimal and macro economically sound
public debt policy, if lower sub-national governments have complete
authority to borrow from whatever sources they may wish. There are severn I
empirical studies to demonstrate that this possibility of over fishing the POl) I
may make decentralisation dangerous if it allows subnational governments
to expand their expenditures while externalising the cost to others (Rodden

2002, Vigneault 2005). '

Ahmad, Hewittt and Ruggiero (1997) have observed .that the
reliance on transfers and grants from central government to finance sub-
national government expenditure' 'creates an incentive for sub-national
governments to inflate expenditure and-engage in perennial negotiations
with the central government to attract more grants and transfers.

Such competition among sub-national governments to secure larger
portions of distributable central funds may lead to free riding, because
sub-national governments have an incentive to inflate their budgets for
fear oflosing sharable revenues to competing jurisdictions (de Mello
1999, Fukasaku and de Mello 1998). This type of behaviour may

entrench free riding in a context wherecentral funds are derived from the.
exploitation of natural resources or foreign aid. The situation is worse
where such centralized funds are derived from natural resources that are


located in sub-national territories of minority groups, as we shall see in
the Njgerian case. Free riding may completely overtake competition for
inve tment, replacing it with opportunistic competition for federation

funds. J

To deal with these problems a wide range of options have been
adopted worldwide. Ter-Minasian and Craig (1997) identify numerical debt
ceiling, restrictions on the use of debt, outright prohibitions of borrowing,
limits on foreign debt, and . balanced budget requirements are strategies

However, beyond the effort to remedy the difficulties of federal
fiscal relations, others have argued in favour of more centralised systems. In
some situations where decentralisation has thrown up issues of
coordination and control, there has been a reverse wave of recentralisation,
like in Latin America where recentralisation drives have come to dominate
the broader policy and political agenda in several countries (Eaton and
Dickovick 2004). It has been argued that the central government needs to
control the main taxes and borrowing instruments to ensure effective
macroeconomic management. Besides, central government needs to
control investment capital in order to maximize returns and to ensure that a
coherent growth policy is put in place for the purposes of privati sat ion and
building public and industrial infrastructure. As a corollary, centralisation
enables the central government to "allocate fiscal resources to goods and
services with national benefits. If local autonomy is too broadly defined, it
will create a situation where aggregate expenditure will be greater on these
services that have more local benefits. Fiscal centralisation is also
considered essential to achieve even development. That is, to reduce
disparities in income and wealth between rural and urban areas and across
geographical regions and ethnic groups. This is the case because
centralisation allows the central government more discretion in shaping
regional differences in levels of public services and taxation. The central
government can use the tax policy and subsidies to shape spatial economic
development. This indeed may be an important strategy of keeping a
divided country together but it might also be a source oftension when the
consequence of equalisation includes central government deficits. Russia
has faced the difficult decision of choosing among equalisation, central
government solvency and appeasing the potential break away provinces
(Bahl 1994:3-4, 1995). This is really the dilemma for countries in the
developing world with divided societies like Nigeria, Aiyede (2008)


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