The Federal Budget
Grant Distribution Formula and the Solidarity Principle of the Ethiopian
Federal Democratic Republic
Dr. Petra Zimmermann-Steinhart
In May 2009, the House of
Federation endorsed a new Grant Formula to equalize fiscal imbalances between
the federal level of government on one hand and fiscal imbalances on the
regional level of government on the other hand. This article analyses the
relationship between the new grant formula and the solidarity principle
enshrined in the Ethiopian Constitution.
In doing so, the article focuses
on the principles of the formula rather than looking into the details of the
econometric calculation. The objective of this article is to see if and how the
formula responds to the requirements deriving from the solidarity principle set
up by the Ethiopian Constitution. The article sets out the equality and
solidarity principle of the constitution and contrasts it with the principles
of the New Budget Grant Distribution Formula.
Chapter two summarizes the different
aspects of the equality and solidarity principles of the Ethiopian Constitution
in order to set out criteria regarding for the further discussion. Chapter
three outlines basic principles of fiscal equalization and compares the formula
and its different aspects against the criteria found in chapter two. Based on
the previous two chapters, the last section responds to the question whether
the new Federal Budget Grant Formula meets the constitutional requirements of
the solidarity principle.
The organizational principles of
federal states can either base on the competition between the constituent units
(e.g., regions) or on the basis of solidarity among these units and the federal
level of government. In competitive systems, the assumption prevails that the
governments of the constituent units are responsible for the development within
their jurisdiction, which will then result in economically, socially and
politically diversified states. This assumption is often joined by a second
assumption, claiming that (economic and/or political) competition among the
constituent units leads to an overall growth and better living conditions. This
is based on the idea that because people and investors will rationally choose
the best possible environment, all constituent units will strive for the
provision of such environments. The classic positive view towards regional
competition was expressed in 1932 by an US-American Supreme Court Judge, Louis Dembitz Brandeis stating: “It is one of the happy incidents
of the federal system that a single courageous state may, if its citizens
choose, serve as a laboratory, and try novel social and economic experiments
without risk to the rest of the country” (quoted in Tarr
2001: 40).
As opposed to this view, the
solidarity principle is focusing on a stronger co-operation between the federal
and the sub-national governments on one side and between the sub-national
governments on the other side in order to achieve equal or at least comparable
living conditions across the whole country. This implies a responsibility to
support weaker parts of the federation either through the federal government
only or through direct support of the weaker units through the stronger ones.
The constitution of the Federal
Democratic Republic of Ethiopia is based on the voluntary commitment of the
Ethiopian Nations, Nationalities and Peoples to build a political community
which ensures lasting peace, economic and social development through mutual
support and mutual respect (Constitution of the FDRE 1995: Preamble). The
Preamble of the Ethiopian Constitution implies that the goals of lasting peace,
the rule of law, democratic order and a sustainable economic development can
only be achieved through equality, mutual respect and support by rectifying
past injustices. This statement builds the foundation of the equality and solidarity
principles which find further expressions throughout the constitution.
The equality principle is
manifested throughout all chapters of the constitution. It refers to equal
rights and opportunities for individuals regardless of their sex, age,
religious affiliation and to the equal status of all Nations, Nationalities and
Peoples. Instead of listing all occurrences, only those relevant for fiscal
transfer systems shall be listed here: Article 39 (3) grants the right of
self-government to all Nations and Nationalities including the establishment of
the necessary institutions, which has wide implications on administrative
costs. Article 41 (3) grants the right to equal access to public funded social
services, Article 89 (2) obliges the government to provide equal opportunities
to improve their economic conditions to all Ethiopians. Additionally this
sub-article requires the government to promote an equitable distribution of
wealth among Ethiopians. Article 90 (1) refers to the provision of access to
public health services, education, clean water, housing, food and social
security to all Ethiopians.
The above mentioned equality
principle builds the foundation of the solidarity principle. The solidarity
principle itself finds one major direct expression in Article 89 (4) which
reads: “Government shall provide special assistance to Nations, Nationalities,
and Peoples least advantaged in economic and social development.” The
requirements set out here build the basis of affirmative action leading to the
achievement of guaranteeing equal chances throughout the country. The
implementation of Article 89 (4) has implications with regard to policies on
the federal as well as the regional level of government. Providing least
advantaged Nations, Nationalities and Peoples with special assistance in order
to close the gap to others, ultimately leads into additional spending. The
following section will analyze in how far the new Federal Budget Grant Distribution
Formula accommodates these requirements and implications.
The principle or paradigm
according to which a particular political system is organized usually has
implications for the way fiscal equalization is achieved. Generally speaking,
there are two types of fiscal equalization: Fiscal equalization becomes
necessary, when the revenue of a level of government or administration does not
fit the spending needs of this level. In federal states world-wide, it is
usually the federal government which is creating/raising a higher revenue than
it needs to carry out its mandates while the sub-national level of government
(regions) raise a far lower level of income than they would need to cover their
needs. This situation is called vertical fiscal imbalance and is addressed
through vertical fiscal equalization mechanisms. Vertical fiscal imbalances are
equalized in both, federations based on competition and on federations based on
solidarity.
Besides the vertical imbalance,
we also find horizontal imbalances. This is the case if regional states vary
significantly in their revenue raising capacity and/or their spending needs.
Whether these imbalances are balanced or not, is very much a question of the
type of federalism in place. If the federation is based on a competitive
relationship between the regions, horizontal equalization is not likely to be
applied. The underlying assumption here is that the regions are responsible for
their income and spending, so only the vertical gaps will be addressed.
In cases of federations building
upon solidarity, equalization of horizontal imbalances is far more likely than
in those applying competitive models. Principally, horizontal imbalances can be
reduced through two different ways:
1) By equalizing regional revenues through
transfers from financially strong regions to financially weak regions: A share
of the revenue of those regional states having raised a revenue which is
significantly above the average of the revenue raised by all regional states is
transferred to those regional states having raised a revenue significantly
below the average. In order to achieve this, the margins need to be defined and
calculated and a formula for the distribution needs to be set up. This process
tends to be a sensitive and controversial issue within federations. An example
where this method is applied – and contested (in combination with measures to
reduce vertical and horizontal imbalances through funds of the federal government)
is Germany (Jochimsen 2008).
In the German case, the goal is to achieve comparable living conditions across
the German Laender.
2) By transfers provided by the federal
government going beyond simply addressing vertical imbalances. In this case,
the actual revenue raised by regional governments is not taken into account and
the balancing is based on the capacity to raise revenue. The goal is not to equalize
the budgets of the regional states, but to equalize uneven capacities to
provide services (see also Rangarajan
2004; Zimmermann-Steinhart 2008).
The following section will
demonstrate the mechanisms applied by the new Federal Budget Grant Distribution
Formula.
One of the requirements of the
new Federal Budget Grant Distribution Formula was to be effort neutral, i.e.,
it should not be affected by regional government policies and it should not
affect the behavior of regional governments. This is designed to avoid negative
impacts of the formula. One negative impact could arise if regional states are
punished for raising revenue above their capacity deducting this additional
revenue from the share the region gets. Deducting this higher revenue would
mean that the region will remain with the same level of revenue, whether it is
active in improving its income base or not. This again means that the region
would not have any incentive to increase its own revenue.
The formula has been designed in
a highly participative process between representatives of the regional
executives and legislatives, including experts as well as political
representatives. Additionally to joint meetings with experts of and contracted
by the House of Federation, field trips have been undertaken to analyze the
situation in each regional state to complement data derived from the Central
Statistics Agency (House of Federation 2009).
The new Federal Budget Grant
Distribution Formula adopted by the House of Federation on May 15, 2009
combines mechanisms of balancing vertical and horizontal imbalances. It builds
on three main pillars:
1) Balancing differences in revenue raising
capacities;
2) Balancing differences regarding expenditure
needs;
3) Reserving one percent of the distribution
pool for Benishangul-Gumuz, Afar, Gambela
and Somali Regional States, the four so-called emerging regions requiring
special attention.
Revenue Raising Capacities
For the estimation of the revenue
capacities (revenue potentials), those sources (taxes) building the main
regional revenue have been included. These taxes/fees are:
·
Personal
income tax
·
Business
profit tax
·
VAT
·
Agricultural
income tax
·
Rural and
land use fee
·
Sales tax
(TOT)
·
Fees for
medical supply and treatment
The accumulation of these taxes
accounts for 80 percent or more of the regional revenues on average. In order
to calculate the potentials for these taxes, different approaches depending on
the nature of the tax and data availability have been used. While data on
Personal Income Tax is easily accessible, other data proved more difficult to
be computed (for details see House of Federation 2009:
13-22). After the potential revenues from the individual taxes were computed
for each region, the revenues have been aggregated. As a next step, the
aggregated potential revenue was compared to the actual revenue collected by
the regions. For this calculation the average revenue of three years has been
used. The comparison leads to a ratio between actual and potential revenue for
each regional state. This ratio has been averaged across all regional states.
The ratio is 48.53 percent and has been used as deflator to calculate the
effective aggregate potential revenue used for the formula. The result of this
operation is shown in Table
1:
Table 1: Effective
Potential Revenues
|
Region |
Effective potential revenue in Mio Birr |
percentage of effective potential revenue of the national
potential revenue |
|
Tigray |
110.64 |
9.95 |
|
Afar |
14.29 |
1.29 |
|
Amhara |
245.29 |
22.07 |
|
Oromiya |
455.33 |
40.96 |
|
Somali RS |
27.84 |
2.50 |
|
Benishangul-Gumuz |
17.24 |
1.55 |
|
SNNPR |
201.62 |
18.14 |
|
Gambella |
9.99 |
0.90 |
|
Harari |
12.71 |
1.14 |
|
Dire Dawa |
16.58 |
1.49 |
|
National Total |
1,111.53 |
100.00 |
|
Source: (House of Federation 2009: 23) |
||
Expenditure Needs
Similarly to the calculation of
the revenue potential, the expenditure needs have been calculated based on
indicators accumulating to more than 90 percent of regional expenditures based
on constitutional mandates and implementation of national policies. These
indicators are:
·
General
administration costs
·
Education
·
Public
health
·
Agriculture
and natural resources
·
Clean water
supply
·
Rural road
construction and maintenance
·
Micro and
small scale enterprise development
·
Work and
urban development
The results of the calculations
are shown in Table
2.
Table 2:
Expenditure Needs
|
Region |
Total expenditure need, partially adjusted for spatial price
variations in Mio Birr |
|
Tigray |
2,313.82 |
|
Afar |
999.70 |
|
Amhara |
7,546.74 |
|
Oromiya |
10,635.70 |
|
Somali RS |
2,535.10 |
|
Benishangul-Gumuz |
538.85 |
|
SNNPR |
6,428.82 |
|
Gambella |
464.86 |
|
Harari |
291.46 |
|
Dire Dawa |
332.98 |
|
National Total |
32,088.04 |
|
Source: (House of Federation 2009: 42) |
|
Special Attention to Emerging Regions
Four out of the nine Ethiopian
regional states, Afar, Benishangul-Gumuz, Gambella and Somali Regional State, have significantly
lower revenue raising capacities and higher expenditure needs than the rest of
the regions. This is a function of policies of former Ethiopian regimes.
Similar to equalization mechanisms in other solidarity-based federations or
systems, like Germany or the European Union (Jacoby 2008; Jochimsen
2008), it is also assumed here, that the four emerging regions would not be
able to catch up with the rest of the region. In order to address this
inequality, one percent out of the total grant is reserved for the four
emerging regions.
The share out of this reserved
part of the total budget grant is again computed on the basis of weighted
indicators relating to the particular situation of these four regional states.
The indicators used are shown in Table
3.
Table 3: Indicators
and distribution of special funds to the emerging regions
|
Indicator |
Weight |
Afar |
Somali |
B.-G. |
Gambela |
|
Area of cultivated land (in hectares) |
0.2 |
|
|
|
|
|
Population |
0.1 |
|
|
|
|
|
Tropical livestock unit |
0.15 |
|
|
|
|
|
Urban unemployment |
0.1 |
|
|
|
|
|
Spatial price index |
0.15 |
|
|
|
|
|
Tax raising effort |
0.2 |
|
|
|
|
|
Number of poor people |
0.1 |
|
|
|
|
|
Share
among regions |
1 |
18.61 |
42.48 |
28.87 |
10.3 |
|
Source: (House of Federation 2009: 45) |
|
|
|
|
|
Table 3 also shows the
distribution of the one percent share across the four emerging regions based on
their distinct development situation.
Summary
Vertical imbalances are defined
as the gap between the revenue raising capacity of a government and the
expenditures this government has to make in order to fulfill its constitutional
mandates and duties and / or to implement policies of the federal level of
government. These imbalances result from a usually lower capacity to raise
revenue of the sub-national level. In order to reduce these imbalances,
equalization mechanisms, i.e., fiscal transfers from the federal to regional
level are applied. Whether this is done by addressing either expenditure needs
or revenue needs only or by a combination of both factors, depends on the
political choice and the socio-economic context of a given country.
In order to reduce the vertical
balance, the new Ethiopian Budget Grant Distribution Formula considers both sides:
the expenditure needs and the revenue raising capacities because of the
heterogeneous composition of the regional states and their development needs.
This approach enables the regional states to discharge their constitutional
mandates and to meet the constitutional requirement of access to equal services
across the country.
These two steps, however, do not
touch the relatively worse situation of the four emerging regions. Using the
general distribution through the first two pillars of the formula would make it
extremely difficult for these regions to provide the necessary services and to
undertake the prescribed investments. Therefore, the formula applies a third
step. Dividing the overall amount of the Budget Distribution Grant into a 99
percent share, which is divided according to the principles of vertical fiscal
equalization, and a one percent share, which is reserved for the four emerging
regional states, includes an element of horizontal equalization into the
formula.
The question underlying this
article is whether the new Federal Budget Grant Distribution Formula meets the
requirements of the equality and solidarity principle of the Ethiopian
Constitution. These two principles basically state the right of equitable
development, equal access to services and a special assistance to those
Nations, Nationalities and Peoples who have been least advantaged throughout history.
As has been shown above, the new
Federal Budget Grant Distribution Formula enables the regional states to carry
out their constitutional mandates. The vertical imbalance emanating from the
lower capacity of raising revenue of regional states in comparison to the
federal government is addressed through the first two pillars of the formula:
the equalization of the revenue raising capacities and the expenditure needs.
In order to equalize these two elements, 99 percent of the overall Budget
Distribution Grant is used. The horizontal imbalance between the four emerging
regions, Benishangul-Gumuz, Afar, Gambela
and Somali regional states and the rest of the regional states is equalized
through a share of one percent of the overall Budget Grant which is divided
among those four regions in addition to their share out of the 99 percent
allocation.
The combination of the two
equalization steps, vertical and horizontal equalization addresses both, the
equality and the solidarity principles. The equality principle is met because
all regional states are enabled to provide the constitutionally granted
services and access to resources on an equal base: the regions in higher need
for more investments gain a higher share of the funds because they have higher
expenditure needs.
Table 4: Shares vertical / vertical and horizontal
equalization
|
Region |
Share of regions vertical equalization only in percent |
Share of regions after vertical and horizontal equalization in percent |
|
Tigray |
7.11 |
7.04 |
|
Afar |
3.18 |
3.34 |
|
Amhara |
23.57 |
23.33 |
|
Oromiya |
32.86 |
32.53 |
|
Somali RS |
8.09 |
8.43 |
|
Benishangul-Gumuz |
1.68 |
1.96 |
|
SNNPR |
20.1 |
19.9 |
|
Gambella |
1.47 |
1.57 |
|
Harari |
0.9 |
0.89 |
|
Dire Dawa |
1.02 |
1.01 |
|
National Total |
100 |
100 |
|
Source: (House of Federation 2009: 47) |
||
Table 4 highlights the
differences in the shares of the regional states with and without the
application of the horizontal equalization. Reserving a one percent share for
the emerging regions leads to a reduced share of all other regions and a higher
share of the emerging regions in comparison to a purely vertical equalization.
In federations, where the federal transfers are decided by federal institutions
without involvement of the beneficiaries, the application of this formula would
have come with only little surprise although it is common knowledge that any
equalization formula is usually contested within the country it is applied. The
situation in Ethiopian bears an additional feature. The formula has been prepared
and decided by representatives of the beneficiaries. The decision to apply a
model including both, horizontal and vertical equalization was taken
unanimously after a series of consultation processes with representatives of
all regions. This unanimous decision is quite remarkable and not self-evident,
especially not in a situation, where even the relatively better-off regional
states have nothing to spare. And still, these relatively stronger regions did
agree to reduce the amount of funds distributed among them by one percent. This
is a strong expression of solidarity!
Therefore it can be concluded
that the New Budget Grant Distribution Formula not only addresses the equality
principle, but also the solidarity principle stated in the Ethiopian Constitution.
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