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Reforming Intergovernmental Fiscal Relations and the Rebuilding of Indonesia

Reforming Intergovernmental Fiscal Relations and the Rebuilding of Indonesia

The ‘Big Bang’ Program and its Economic Consequences

Studies in Fiscal Federalism and State–local Finance series

Edited by James Alm, Jorge Martinez-Vazquez and Sri Mulyani Indrawati

Indonesia is currently facing some severe challenges, both in political affairs and in economic management. One of these challenges is the recently enacted decentralization program, now well underway, which promises to have some wide-ranging consequences. This edited volume presents original papers, written by a select group of widely recognized and distinguished scholars, that take a hard, objective look at the many effects of decentralization on economic and political issues in Indonesia.

Chapter 8: An Analysis of Indonesia’s Transfer System: Recent Performance and Future Prospects

Bambang Brodjonegoro and Jorge Martinez-Vazquez

Subjects: asian studies, asian development, asian economics, development studies, asian development, economics and finance, asian economics, public finance


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...

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