New Study Highlights Challenges in Revenue Redistribution at the Local Level

A new study, Extractive Industries Revenues Distribution at the Sub-National Level, presents a comparative analysis of international legislation regulating distribution of revenues from extractive industries across all levels of government. Prepared by development economics consultant Matteo Morgandi at the request of a working group of the Peruvian National Congress, it encompasses legislative practices in Bolivia, Brazil, Ghana, Indonesia, Mexico, Nigeria and Papua New Guinea.

The assessment stresses the potential and specific challenges associated with the transfer of revenues to lower levels of government through fiscal decentralization. Among these challenges are 'Dutch Disease'—the deindustrialization of an economy due to increased natural resource revenues and a resulting decline in the manufacturing sector; revenue volatility; constraints on local planning and expenditure capacity; the lack of local functional responsibilities proportional to new revenues received; the absence of external controls; and institutional deterioration. Although compensation of resource producing regions with a share of the total revenues is legitimate, empirical evidence from the selected countries shows that the mere transfer of revenue wealth to local governments is not a sufficient remedy to the negative effects of extractive activities on local communities. An explicit strategy to spur economic development and safeguard both institutions and the environment is critical to escaping the resource curse.

The research also finds that countries with high level of resource dependency (e.g., Nigeria, Bolivia, Indonesia and Mexico) are more likely to redistribute extractive revenues to all regions rather than to producers only. Developing a revenue sharing formula that encompasses demographic and economic development parameters is necessary to mitigate inequalities between producing and non-producing regions.

Other mechanisms in the fiscal architecture can also enhance the equity and efficiency of revenue distribution. For instance, the General Grant (DAU) formula in Indonesia automatically allocates more funds to non-producing regions from the general pool of collected taxes.

Nevertheless, even where means of redistribution are in place, the country studies show limited effectiveness in redistributing resources to the poorest regions (such as in Indonesia, Bolivia, and Nigeria), due in some cases to an inadequate formula and in others to the limited amount of funds redistributed. Transparency and consensus building between producers and non-producers are crucial to establishing the legitimacy of any revenue distribution arrangement.

This study was prepared at the request of a congressional working group in Peru in order to review and integrate into a single proposal the numerous partial modifications of the Canon Law presented over the last few years. The Canon Law regulates the way income tax from companies in the extractive sectors (including mining, gas, oil, fisheries, forestry and hydroenergy) is distributed between the central government and the sub-national governments in regions where extractive activity takes place.

The study was presented to both the advisors of the working group and the congressional representatives, as well as to several independent experts.

The working group incorporated the study into its own report to the Congress, along with 12 general recommendations. The report was then approved by Congress, opening the way for debate on concrete proposals for modifying the existing regulations.

Download and read the full report ... (pdf)

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