(Extracts from DAP Alternative Budget 2010 launched on 7th October 2009)

8. Thrust I: Economic Democratisation – Fiscal Decentralisation

8.1 Greater economic efficiency and political accountability

Many countries have pursued fiscal federalism and have devolved or are devolving more power to state and local governments. China and Indonesia’s recent economic success has also been linked with the decentralisation of economic decision-making. In the UK, the Calman Commission has recommended that Scotland be given greater tax-varying powers in order to further improve their devolution process. This is largely because of the economic efficiency and accountability arguments.

Certain areas of expenditure responsibilities should be decentralised because states and local governments are better placed to tailor their programmes to local needs. For example, state governments are more likely than the central government to know their region’s comparative advantage and hence promote investment initiatives accordingly. In order to decentralise expenditure, revenue must also be shared with states. Instead of being dependent on the federal government spending directly in the states, states would be able to implement their own programmes encouraging tourism, SMEs and industry. In this case, when the 13 states are unshackled in their courting of investment projects with their tailored policies, it is very likely that more and better investments will be attracted and made.

The stronger link between a state’s work efforts and its revenue would also increase economic growth incentives for both public and private sectors. The public sector has greater motivation to increase their tax base and hence to promote and develop industry within their borders. There will also be healthy competition between states that will encourage greater efficiency in public service delivery and innovation in promoting development. More importantly, the greater control states have over their revenue and expenditure and the states’ development would allow voters to hold the state governments more accountable, instead of letting state governments blame their shortcomings on the federal government.

Existing imbalances between federal and state powers

Malaysia was created as a federation that guaranteed the rights of the member states. But in the past 50 years, political and financial power has been increasingly centralised at the federal level. Federal government revenue grew from 4.4 times the consolidated State government revenues in 1990 to 7.2 times in 1999 to 10.4 times in 2007. Federal government expenditure increased from 4 times the consolidated State government expenditure in 1990 to 7.8 times in 1999 to 12 times in 2007.

Considering how consolidated State government revenue and expenditure is made up of 13 states, it is clear that public spending is highly dependent on the federal government. The federal government had a budget of more than RM 200 billion in 2009 whereas state budgets ranged from less than RM200 million (Perlis) to just under RM3 billion (Sabah).

In addition, federal allocations to State governments have slowly shifted from grants to loans. Federal Government grants to the States decreased from 9.0% of its operating budget in 1975 to 3.2% in 1999 to 2.9% in 2008.15 Between 1975 and 1999, outstanding loans from the Federal government to the State governments also increased from RM1,107 million to over RM9,000 million.

This imbalance in revenue flow and the federal government’s shift from giving grants to loans has tightened federal control over states. Due to a lack of fiscal resources, State governments have gradually surrendered various functions to the federal government, thus allowing further centralisation.

Direct federal grants to the states make up a small proportion of federal allocations to states. For example, Penang was allocated RM 1.2 billion in federal development expenditure in 2007 and only received RM 127 million in grants. This in turn means that the federal government has great influence over what goes on in each state and there is a lack of accountability by state governments to their voters for public spending in states.

Political abuse of discretionary federal power

Currently, the Constitution only guarantees capitation grants and grants to maintain state roads. However, despite amendments over the last half century to the sums guaranteed, the figures have not kept up with inflation. E.g. in 2007, Johor got RM41,049,159 or RM11.80 per capita under capitation grants, Selangor got RM67,661,987 or RM12.80 per capita, and Perlis got RM8,389,573 or RM34.10 per capita. The rest of the federal allocations to states, whether in the form of grants, project-specific or direct spending, are discretionary and entirely up to intra-BN negotiations or the whims of the federal government. Unfortunately, this distorts the state governments’ incentives. Instead of working for the benefit of the people who elected them into power, state governments are beholden to whoever is in power at the federal government.

The politicizing of federal-state fiscal relations is clear when analysing allocations to Kelantan and Terengganu. These two states have been among the poorest and least developed in Malaysia. But during periods in which their state governments were controlled by opposition political parties, the rakyat were punished by smaller and delayed grants to the State governments. Furthermore, when PAS formed the Terengganu State government in 1999, the federal government withheld the petroleum royalties due to the state and instead issued
payments directly to villagers through ad hoc programmes. Thus, federalism in Malaysia can be characterized as “retractable”: The rights of the states have been at the mercy of the federal government.

The centralisation of financial power and decision-making at the federal level may also have contributed to the biased focus on developing the Klang Valley. As a result, the development of secondary cities within Malaysia is depriortized and this has resulted in excessive migration to the Klang Valley which further decelerate economic activities and progress of these cities. On the one hand, it has created immense stress on the infrastructure and it development in the Klang Valley, while on the other hand, for state capitals such as Ipoh and Kuala Terengganu which are designated as official “cities”, economic activities there remains focused on less sophisticated industries and a clear absence of high-end professional and financial services.