Federalism in jeopardy

Nepal is now challenged with how to operationalise the federal structure, with the latest fault line emerging around the way in which revenue will be shared.

Aug 1, 2017The Brief

From the archive blog: The Brief

Iain Payne and Binayak Basnyat

A decade ago, Nepal’s political parties agreed to change the country’s unitary system of government to a federal system. Two years after Nepal’s 2015 Constitution established federalism, the country is now challenged with how to operationalise the federal structure—with the latest fault line emerging around the way in which revenue will be shared among local, provincial, and central governments.

In Nepal’s federal structure, power is assigned to three governments — local, provincial and central-- each of which has autonomy to raise and spend revenue. However, the legislative framework for the assignment of revenue was not put in place prior to local government elections, which has resulted in a confusing mixture of claims and counter claims emanating from old and emergent power centers. Consequently, continued progress in successful implementation of the federal provisions of the 2015 Constitution is in jeopardy.

New Legislation

Despite the many months since the promulgation of a new constitution, it was only on July 7, 2017, that two bills—the Natural Resources and Fiscal Commission Bill and the Inter-Governmental Fiscal Transfer Bill—were tabled ind Parliament. These bills are crucial for the management of public finance in the federal structure, overseeing revenue distribution among the three governments. However, the bills tabled further demonstrate a worrying trend—the deliberate stalling of the power-sharing process called for in Nepal’s new constitution., the bills give the central government an increased share of the proceeds of national revenue collection, at the expense of local governments.

After strong public criticism lawmakers are now trying to amend the Inter-Governmental Financial Management Bill, which will regulate the distribution of resources between local, provincial, and central governments.

When viewed in the context of the nation’s total income, reducing local government’s share of the revenue generated from sources such as hydropower and natural resources may seem insignificant. In the 2016-2017 fiscal year, royalties from mining, hydropower, and forestry accounted for only approximately Rs 2.5 billion —or less than 0.5 percent—of central revenue collections. In the grand scheme of things, whether local bodies take 5 percent or 50 percent of these royalties may not prove to be significant for local budgets, which can be subsidised by central grants. What is significant is the way in which these latest developments demonstrate yet another barrier put up by centrist forces to maintain status quo and derail attempts to share power beyond Kathmandu.

Meaningful Decision-Making Power

The 2015 Constitution envisages local (and provincial) governments as meaningful contributors to and drivers of the local planning process. With successful local elections after two decades in six of the country’s seven provinces, hopes are high that local governments will deliver on their mandates.

However, to do this, local governments must not only be politically empowered but also be sufficiently resourced.. Newly instituted subnational governments have a meaningful degree of decision-making power to execute their constitutionally-mandated responsibilities. This autonomy only comes when local governments are able to raise their own revenue and set their own budgets. However, far from providing increased fiscal authority, these new bills are moving in the opposite direction.

Charting a Way Forward

Nepal’s Constitution provides for a relatively centralised system of revenue collection. The central government retains all major revenue sources—such as income taxes, and VAT; provincial and local governments are assigned a limited number of comparatively low-yielding revenue sources, such as property and vehicle taxes. In a context where subnational governance systems are required to be built from the ground up, and in which revenue-raising potential will vary greatly from province to province, this design is appropriate. Local governments should not be expected to raise the lion’s share of their own revenue; gaps will need to be filled by intergovernmental fiscal transfers.

The fact that a considerable share of the financing for provincial and local government budgets will come via fiscal transfers is not in and of itself cause for alarm; it does not mean that these subnational governments will lose their independence, per se. In fact, this provides a safety net for these governments while they begin to raise the bulk of necessary revenues through other means. However, what should concern us is that given the opportunity , political forces in Kathmandu once again are manipulating legislation to prevent the sharing of power.

(Iain Payne is a Colombo Plan Nepal Fellow and Binayak Basnyat is a program associate at the Asia Foundation in Kathmandu. A longer version of this piece is In Asia blog)