The importance of local government units in developing countries

In his book, Local Governance in Developing Countries, Anwar Shah said that globalization and the information revolution are motivating a large and growing number of countries around the globe to reexamine the roles of various levels of government in development, including their partnership with the private sector and civil society. The process typically involves shifting responsibilities to local governments and beyond government providers, with the objective of strengthening local governance. 

Shah maintains that the conceptual literature on the new vision of local governance argues for a strong role of local governments in local development to improve public services and quality of life at the local level. He then went on to present the findings in his study of local governance among a sample of developing countries in the world. Unfortunately, the Philippines was not included in his study.

In his study, Shah shows the relative importance of local governments in developing countries using two indicators: local government expenditures as a percentage of consolidated public sector expenditures and GDP. Shah found out in his study that local governments in China command the largest share—more than 51 percent of consolidated public expenditures and 10.8 percent of GDP—whereas in India, it is the smallest share—3 percent of the expenditures and 0.75 percent of GDP. 

The rank order of some countries, however, is not consistent across both criteria. For example, South Africa does better than Brazil on the first and worse on the second criterion. On average in sample countries, local government expenditures amount to 23 percent of consolidated public sector expenditures and 5.7 percent of national GDP. 

Comparable data for a sample of Organization for Economic Co-operation and Development (OECD) countries presented by Shah revealed that OECD countries performance on the two indicators mentioned above would be 28 percent of consolidated expenditures and 12.75 percent of GDP. Thus, local governments’ role in OECD countries is large in comparison with those in the developing countries, with the exception of China and Poland with respect to their local government expenditures as a percentage of consolidated public sector expenditures (See Figures 1.1 and 1.2 below). 

In terms of their responsibilities, the result of Shah’s study shows that local governments vary across developing countries. In China, local governments have extensive responsibilities. In addition to traditional local and municipal services, local governments in China, for example, are responsible for social security (primarily pensions and unemployment allowances) and have a much larger role in local economic development than local governments in other countries. In India and South Africa, local governments’ role in delivering local services is minimal, which focus mainly on delivery of municipal services. Nearly half of local expenditures in China is for education, municipal administration, justice, and police.

In Shah’s sample developing countries, local governments raise 39.6 percent of revenues from taxes, another 9.5 percent from fees and charges, and the remaining 50.9 percent from higher-level transfers. Comparable figures for OECD countries are 49 percent for taxes, 16.6 percent for fees, and 34.4 percent for transfers. Fiscal transfers is much larger than average in Uganda (85.4 percent), Poland (76 percent), China (67 percent), Brazil (65.4 percent), and Indonesia (62 percent). 

The sample countries also have diverse revenue structures. On average, they raise 32 percent of tax revenues from property taxes, 15 percent of revenues from personal income taxes, 4 percent from corporate income taxes, and the other 49 percent from a large number of small taxes, fees, and charges. 

The figures in OECD countries show that 54 percent of local revenues are from property taxes, 23 percent from personal income taxes, 14 percent from corporate taxes, and 9 percent from other taxes. It can be seen here that local governments place a much greater reliance on property and income taxes in OECD countries than in developing countries. Property taxes raise only 3 percent of local revenues in China.

For all developing sample countries, revenues from property taxes amount to 0.5 percent of GDP compared with about 2 percent of GDP in industrial countries. This means that property taxes represent significant untapped potential for further exploitation in developing countries. User charges are also a significant source of revenues among local government units in developing countries, but often such charges are poorly designed and administered and do not satisfy equity and efficiency principles or provide special safeguards for the poor.