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

8. Thrust I: Economic Democratisation – Fiscal Decentralisation

8.2 Fiscal decentralisation policies

Other countries, such as Canada, Spain, and the UK have been moving in the opposite direction recently compared to Malaysia, by increasing decentralisation. Nearer to home, China and Indonesia have also successfully decentralised much of their financial and economic decision-making process. Even smaller countries such as Switzerland and Belgium have developed forms of fiscal federalism. To ensure that Malaysia is able to tap into the sizeable latent potential benefits arising from the political accountability, economic efficiency and economic growth, DAP proposes that states are granted greater control over their finances.

8.2.1 Tax revenue sharing agreements
It is proposed that the federal government enter into tax revenue sharing agreements with states so that there is a stronger link between a state’s performance and its revenue share. 20% of individual and corporate income taxes collected in a state, as determined by the residence of the taxpayer and location of the establishment, will become the state’s entitlement. Income taxes will continue to be collected by the federal government using the existing infrastructure, but the states’ portion will be distributed back to the states for each financial year. This is the system which has been adopted by Germany.

For Selangor state, which contributes approximately RM 16 billion a year in income taxes, this revenue sharing agreement would return RM 3.2 billion to state coffers, which is twice the size of their current budget. For Penang on the other hand, 20% of what an approximate RM 2.5 billion in income taxes would give them RM 500 million, which is larger than their current budget.

8.2.2 Equalisation and development grants
For the poorer states with smaller tax bases, equalisation grants will be given to meet their fiscal needs and make sure people benefit from similar levels of public services at a similar tax burden throughout the country. The formula for equalisation grants will be linked to the relative tax base in state compared to average tax base in country.

Development grants will also be given to less developed states to promote economic development and help them catch up. These grants will be formula-based to ensure that states and the rakyat get what they are entitled to, and that grants are not used for rewarding political support or obedience. The formula will likely be based on some measure of poverty rates and average income. These formulae will also be reviewed every 5 years to ensure their relevance. We will also review the amounts guaranteed in the apitation grant.

In Indonesia for example, the “Expenditure Needs” of each of its 434 districts and 32 provinces is a function of population, poverty, area development, cost, human development and gross revenue per capita indices. A formula-based equalisation and development grant will ensure greater predictability of grants and state finances, ensuring better long term planning by the respective state agencies.

8.2.3 Rights to borrow
Furthermore, it is proposed that states be given power to borrow from sources other than the federal government. States lost their right to borrow when they joined the Federation of Malaysia because the Constitution only allows borrowing from the federal government. But this need not be the case. Many other federations in the world, e.g. the US, Canada, Germany and Switzerland, allow states or provinces to have autonomous borrowing rights. This enables states to invest in infrastructure and development projects without needing to wait for federal approval and funds. Additionally, state governments would also be accountable to their creditors and thus have further pressure to invest wisely.

To ensure that the states utilise this new found right in a responsible and effective manner, restrictions will be put in place initially to ensure a managed transition. States can only borrow up to a maximum of 50% of their annual own-source revenue, which is revenue raised directly by the state governments and does not include federal grants or shared federal income tax revenue. The funds raised must be used for development expenditure and not operating expenditure. In the initial 3 years of introducing this measure, the federal government will guarantee only 30% of state debt to help states enter the borrowing market. The burden of scrutiny must however, be on the private sector lenders.

8.2.4 Increased state expenditure responsibilities
At the same time, we propose increase more spending power to states. States will be granted the responsbility to take charge of expenditure on areas such as public transport, amenities, utilities and social welfare, where the state government and local councils are better positioned to tailor responses to local needs. There will also be new responsibilities created such as the setting up of community police which will be given to the state for implementation.

States will have access to federal expertise at the Economic Planning Unit which will act as a co-ordinating agency, and various federal ministries to make sure they are able to use their new allocations most efficiently, and to prevent unnecessary and ineffective duplication of functions or investments.