The fall in national government revenue is a matter of serious concern for the country as it indicates a shrinking base for revenue and suggests that the pace of economy activity is slowing or even contracting. Nominal government revenue has shrunk over the last two years. Our provinces should be even more concerned as this could lower the amount of grants they receive from the national government.
In Figure 1 the numbers that matter most for provinces are shown. Tax revenue has been declining and even after removing corporate income taxes from mining and petroleum companies this downward trend in net national revenue is still visible.
Currently all provinces excluding N.C.D. and now Morobe rely on conditional block grants from the national government for fiscal equalization. Fiscal equalization is a fancy term that refers to the budget funding that the national government provides to provinces so they have the financial means to meet the operational cost of a specified minimum benchmark of key services in education, health, transport infrastructure, agriculture services and village courts.
NEFC (National Economic and Fiscal Commission) have done some tremendously good work to shape the regime for revenue sharing between national governments and provincial and local-level governments. Such a system is necessary as government revenue systems work better, that is more efficiently and with less administrative costs if many, but not all, taxes are centralized under the national government. One example is a consumption tax like GST (goods and services tax). If provincial governments were to impose and collect GST themselves this could lead to various complications, including cascading taxes and economic distortions.
Given these constraints it is clear that the national government will need to share the revenue it collects with provinces, especially those revenue receipts that are generated from activity within provinces otherwise the pool of funding for provinces will be too small.
Nearly every province, has a fiscal gap, for example NEFC reports that for Madang, its funding capacity is just above 10% of the total cost required for the benchmark services. This is greatly concerning. Whilst the fiscal equalization system will ensure Madang gets incremental funding from the National Government it does impart some perverse incentive effects. There is a need to embed within the regime incentives for provinces to increase their fiscal capacity.
Figure 2 depicts the process NEFC follows to determine the level of funding and the apportionment of resources for fiscal equalization. NEFC recommends the allocations for provincial operational grants to the Treasurer, who then makes a final determination. This is a recommendation for a minimum amount and does not stop the National Government from allocating more funding.
From Figure 2, national net revenue is computed using the Government’s fiscal reports. Provincial governments and local-level governments (LLGs) combined get a fixed ratio, 6.57%, of the net national revenue. LLGs then get 10.05% of that combined amount. This is then separated between rural LLGs and urban LLGs in the ratio of 79% to 21%.
Figure 2 shows within the text boxes the final share of national net revenue that each level of government receives. Urban LLGs as a group receive only 0.14%, rural LLGs get 0.52%, provincial governments combined get 5.91% whilst 93.43% remains with national government. For sub-national governments these are comparatively small amounts. This allocation does not include the Services Improvement Program allocations of K10 million for each district or the K10 million for each province or the funding for each LLG or staffing costs borne by the National Government.
For the provincial allocation, each province receives an amount that is equivalent to its share of the fiscal gap. Similarly, each LLG receives an amount that is equivalent to its share of the total LLG fiscal gap.
Now therein lies the problem. This gives no assurances that the funding levels will be sufficient to bridge the gap.
So whilst the distribution of funding is then determined by the relative cost of funding, the total amount granted for sub-national government administrations is not. There is a disconnect between revenue streams and the funding gaps. The cost analysis by NEFC only serves to guide how to divide up the pie without actually ensuring that the level of required funding is achieved.
Additionally, there is a performance disincentive in that provinces that fail to bridge the fiscal gap can continue to rely on the National Government. There are many provinces that will never the bridge the gap for the foreseeable future but you do want them increasing their efforts at improved self-reliance. The service improvement programs for districts and provinces have tended to add to the costs of provincial government operational expenses as most are physical capital outlays that will require maintenance funding over the coming years.
The fiscal grant amounts computed by NEFC have a data lag of two years so the 2017 allocation are determined by 2015 data. The provincial and district cost of services estimates are updated at 5-year intervals with the last completed last year by NEFC. So we can project the 2018 total pool using the 2016 budget outturn statistics from National Government.
The driver of demand for many services funded by the grants is population. For example, as population grows so too does the demand for health services. We know too that costs of equipment, drugs, transportation and so forth will increase. All of this needs to be taken into account when determining the cost of delivering essential basic services. We can make the necessary adjustments to the funding envelope to see how cost increases and population growth impact the level of funding.
As shown in Figure 3, we know the allocations for 2017 and 2018. The levels of grants decline after accounting for inflation and for population growth. So we see that the challenges of delivery basic services for the majority of our people will only get more difficult.
If you return to Figure 3, for 2018, without additional grant funding from the National Government, provinces and LLGs can expect to receive conditional grants that are nearly 6 percent below the equivalent funding they received in 2013. This is a sharp decline and will most likely lead to a decline in the quality of services received by the majority of our rural based people.
Compounding this is the persistent problem of delayed funding by the National Governments. NEFC report that provincial and local-level governments continue to receive the bulk of their funding in the second-half of the year. This is completely unacceptable and unthinkable that service providers are expected to deliver in 6 months.
So what are potential solutions to the incentives problem and the falling resource envelope. An obvious solution is to rely on the service improvements program funding as a gap filler when economic conditions are difficult and a consequential decline in conditional grants is anticipated. Whilst this will be unpalatable to Parliamentarians this has the benefit of encouraging them to seriously consider improving the fiscal capacity of their provinces so as to ensure they receive their district services improvement program (DSIP) and provincial services improvement program (PSIP) funds and to improve the efficiency of the resources they have available. The district and provincial SIPs are often prioritized for funding allocation so this too can address the cash-flow problems sub-national government face.
Unfortunately, there is a sting in the tail of the PNG LNG induced boom as the economic cycle leads to a decline in public revenue that will imperil the delivery of essential services for our vulnerable rural communities. The new Government will need to move decisively to address this, amongst a host of other emerging budgetary and development problems, to protect our people from further hardship.