The Fiscal Equalization Scheme for Woredas

Mohammed Dejen, Centre for Federalism and Governance Studies, Addis Ababa University

Relevance of the Practice

The most common rationales for intergovernmental fiscal transfers cited by scholars[1] are addressing vertical and horizontal fiscal imbalances and mitigating inter-jurisdictional externalities (spillover) effects. Equity and fairness issues among constituent units of a federation, local tax efforts and expenditures control, revenue adequacy, and transparency and stability are also used as basic criteria for implementing effective fiscal transfer. In the words of Anwar Shah, equalization fiscal transfers are often seen as ‘the glue that holds a federation together’.[2] The fiscal transfer could take one of these forms: conditional or unconditional grants.

The success of any political devolution of power is very much dependent on the availability of financial resources at the hands of local officials to fulfil their powers and responsibilities. To state differently, political decentralization will not be meaningful unless financial powers are equally dispersed at the lowest levels of governments. Financial autonomy is essential element of political decentralization. And yet, the availability of financial resources at the disposal of local governments by itself is not enough. There must be financial autonomy for these governments to expend according to their priorities and needs.

Ethiopia uses the block grant approach for financial transfer to regional states and the same applies to local level equalization transfers. Block grants account for about 70 per cent of the total share of the woreda budget.[3] Woredas, in principle, are free to spend the block grant on the basis of their priority areas. In theory, the unconditional grant for local governments help maintain their autonomy and to be free from the undue influence of the zonal and regional administrations.  

Description of the Practice

In Ethiopia, local governments are not entitled to clearly defined tax sources. Of course, woredas have the power to set tax rates and collect thereof. Their main sources are from levying on agricultural income tax, sales tax and user fees. They have also the power to collect rural land tax use.[4] However, the tax rate is to be determined by the regional governments.[5] Overall, adequate taxing power is not transferred to local governments that matches their functions and responsibilities. Although local governments are entitled to block grants transferred from the regional government and are free to spend based on their priorities in principle, in practice they are not free. For example, regional states will set guidelines how and on which areas to spend. Practically, almost more than 70 per cent of the source of income for local governments comes from unconditional block grants from the regional state.[6]

One of the principles of fiscal equalization is to provide financial means for local governments to provide equal or comparable public services such as health, education, clean water etc. for their population with other relatively rich local governments. Taking this into account, Ethiopia applied a horizontal fiscal equalization scheme for all states. Vertical fiscal imbalances are very wide in Ethiopia as the federal government controls the very lucrative sources of income. The federal government controls more than 80 per cent of the total income where regional states are left with meagre resources which account for less than 20 per cent on average. The horizontal imbalances are also very much visible arising from resource endowment disparities and the differential costs of public service provisions. For the regional states to provide at least the minimum standards of public service provision for their residents, the equalization fiscal transfer from the federal government is necessary. The fiscal transfer from the federal government indeed is one of their major sources of revenue. It takes either the conditional or unconditional grants, in most cases focusing on the second option. 

In line with this general principle, all regional states also introduced a mechanism of fiscal equalization among all local governments.

Assessment of the Practice

However, an assessment done by Ghebrehiwet[7] for the 2007 and 2009 fiscal year on fiscal equalization indicates that the scheme has created disincentives for those better performing local governments in their efforts of generating more revenues. Those local governments which are high contributors to the equalization pool have less incentives to better perform in collecting more revenues in the future. Ethiopia is also ethnically the most diverse state and applying horizontal equalization among the ethnically different local governments became politically sensitive as those well-off woredas think that they are subsidizing poor woredas which are ethnically different. Political entrepreneurs also mobilize their ethnic groups as their resources are being taken by other ethnic groups. The practice is also not encouraging as many of the woreda and other local governments are not in a position to cover their own expenditure let alone to contribute for fiscal equalization.

References to Scientific and Non-Scientific Publications

Legal Documents:

Constitution of the Federal Democratic Republic of Ethiopia (1995)

Scientific and Non-Scientific Publications:

Baraki GT,‘The Practice of Fiscal Federalism in Ethiopia: A Critical Assessment 1991-2012. An Institutional Approach’ (doctoral thesis, University of Fribourg 2015)

Chukwuemeka EO and Amobi DS, ‘The Politics of Fiscal Federalism in Nigeria: Diagnosing the Elephantine Problem’ (2011) 6 International Journal of Business and Management 126

Ma J, ‘Intergovernmental Fiscal Transfers in Nine Countries: Lessons for Developing Countries’ (WPS1822, World Bank 1997)

Shah A, ‘Horizontal Fiscal Equalization in Australia: Peering Inside the Black Box’ (WPS3785, World Bank 2017)

Negussie S, Fiscal Federalism in the Ethiopian Ethnic-based Federal System (Wolf Legal Publishers 2006)

[1] Jun Ma, ‘Intergovernmental Fiscal Transfers in Nine Countries: Lessons for Developing Countries’ (WPS1822, World Bank 1997) (Cases of the United States, Canada, the United Kingdom, Australia, Germany, Japan, Korea, India and Indonesia).

[2] Anwar Shah, ‘Horizontal Fiscal Equalization in Australia: Peering Inside the Black Box’ (WPS 3785, World Bank2017).

[3] Tilahun Meshesha Fenta, ‘Local Government in Ethiopia: Practices and Challenges’ (2014) 2 Journal of Management Science and Practice 71.

[4] ibid.

[5] ibid.

[6] Zemelak Ayele, ‘Local Government in Ethiopia: Still an Apparatus of Control?’ (2011) 15 Law, Democracy and Development 133.

[7] Ghebrehiwet Tesfai Baraki, ‘The Practice of Fiscal Federalism in Ethiopia: A Critical Assessment 1991-2012. An Institutional Approach’ (doctoral thesis, University of Fribourg 2015).