An analysis of Indonesia’s transfer system: Recent performance and future prospects

Bambang Brodjonegoro and Jorge MartinezVazquez INTRODUCTION Since the mid-1970s, fiscal decentralization in Indonesia had been a slowburning affair. However, with the ‘Big Bang’ of the 1999 reforms, in the space of one year Indonesia changed from one of the most centralized to one of the most decentralized countries in the world. It was with significant trepidation that observers saw the share of sub-national government spending in total government spending almost double from 2000 to 2001, to over 30 percent, and at the same time over two million civil servants and thousands of facilities were re-assigned to local level. However, the widespread concerns about chaos and disarray did not materialize. The transition to the new decentralized system had some bumps, but overall was fairly smooth. In hindsight, there are many reasons for this largely successful transition. There is little doubt that, despite some defects, the institutional framework for fiscal decentralization, laid out in Laws No. 22/1999 and No. 25/1999, deserves much credit for the success. The centerpiece for the new fiscal decentralization institutions in Indonesia is the new system of transfers comprising revenue sharing of natural resources, personal income tax, and property taxes, the DAU (Dana Alokasi Umum) a large unconditional grant intended to fund sub-national governments in an equalizing manner, and the DAK (Dana Alokasi Khusus), a set of yet to-be-developed conditional grants. In this chapter we examine the performance of this transfer system. We first discuss the history of transfers in Indonesia. We next review the structure and….