Colombia - Decentralizing revenues and the provision of services : a review of recent experience

Report Nio. 7870JCO Colombia Decentralizing Revenues and the Provision of Services: A Review of Recent Experience Ocdober 23, 1989 Latin Arnerica and Caribbean Region Countiy Operations Division I Country Department III FOR OFFICIAL USE ONLY ~~~~~~~~~. .3 .s C .. , ~ ~~.. . .' , ' Dociuuuu of the WoM Dank This document has a restricted distributlori and may be used by recipients only in the performance of their official duties. Its contents may not otherwise -be disclosed without World Bank authorzation.  CURRENCY EQUIVALENTS Currency Unit - Colomlian Peaos (Col$) (Exchange Rate Effective end-February 1989) US$1.00 = Col$3S0.22 Col$l.00 = US$0.003 WEIGHT AND MEASURES Metric System GOVERJMHNT OF COLOMBIA FISCAL YEAR January 1 - December 31 This report is based on the findings of a World Bank mission consisting of Kazuko Uchimura (LA3C1) and Richard Bird (consultant) which visited Colombia in February 1989. The case studies of local governments undertaken by Jose Fernando Pineda and Alvaro Pach6n in January 1989 also provided input into the discussion of local services in Chapter 5. Eduardo Wallentin (consultant) helped with the design of an alternative IVA distribution formula contained in Annex 3. Laura Santalla typed and proofread the drafts.  ]FOR OFFICLAL USE ONLY PRMICIPAL ACRONYMS AND TERMS USED I THE REPORT ACUA Regional Water Companies (Sociedades de Acueducto) BCH Central Mortgage Bank CORPES Regional Planning Councils DAI4CO Office of Intendencias and Comisarlas of the National Government DNP National Planning Department ECOPETROL Empresa Colombiana de Petr6leos INPO Regional Sanitation Works Companies (Empresas de Obras Sanitarias) ESAP National School of Public Administration PER Regional Education Fund FFDU Fund for Urban Development FNCV National Fund for Local Roads FNH National Hospital Fund FONDO DRI Integrated Rural Development Fund FVN National Road Fund FONADE National Fund for Development Projects ICA Colombian Institute for Agriculture ICCE Colombian Institute for School Construction IDEA Development Institute of Antioquia IGAC Instituto Geografico Agustln Codazzi INCORA Colombian Institute for Agrarian Reform INFIVALLE Financial Institute for Valle del Cauca INS National Institute of Health INSFOPAL National Institute for Municipal Development IVA National .Bales Tax PAS Water and Sanitation Sector Adjustment Program Situado Fiscal Tax Allowance (earmarking of national revenues for departmental spending on health and education) SSS Regional Health Services Thi document hFars auW distiibubnan maybe usedby cipbentsonly in b erforincex of their oficiddutieslts contents may not oterwbe be dicsed wihout Wold Bank autoralnD  Table of Comteuts Page EXECUTIVE SUMMARY ...................................................... . i CHAPTER 1: INTRODUCTION ................................................. 1 Background ................................................... 1 The Reforms Since 1983 ....................................... 5 CHAPTER 2: DECENTRALIZATION AND INSTITUTIONAL CHANGES ................... 7 Political Decentralization and Cownunity Participation ....... 7 The Transfer of Key Public Services to Municipios ............ 7 Institutional Changes Stemming from Decree 77 ............... . 8 Administrative Infrastructure and Regional Differences ....... 10 The Need for Training ........................................ ll The Role of Departments ...................................... 13 Coordinating Planning and Budgeting Processes ................ 14 CHAPTER 3: DECENTRALIZING REVENUES .. 18 A. Law 14 of 1983 .. 18 Measures to Increase Departmental Revenues . . 18 Measures to Increase Local Revenues . . 20 Property Tax ............................................. 21 Constraints Posed by the Valuation Process . . 25 Inadequacy of "Automatic Adjustments" . . 25 Other Local Taxes ........................................ 29 B. Royalties .............................................. 30 C. Law 12 of 1986 ..33 The "Basic' IVA Transfer ..35 The "Additional' IVA Transfer ........................... 37 The "Special" Transfer for Small Mhunicipios . .38 The "Fiscal Effort" Correction ..38 The Effect of Property Revaluation on the Correction Factor . .40 The Relatively Small Impact of the Correction Factor ..41 Broadening the Scope of the 'Fiscal Effort' Correction ...42 The Notch Problem . .42 D. Matching Grants .. ...................................... 43 E. Impact of Law 12 on Local Finances . . 45 F. Impact of Law 12 on National Finances .................... 46  CHAPTER 4: LOCAL GOVERNMENT BORROWING .................................. . 49 The Role of Credit ........................................... 49 FFDU . 49 Borrowing Capacity and Potential Demand for Credit . 52 The Need for Regional Intermediaries . 54 CHAPTER 5: IMPACT OF DECENTRALIZATION ON LOCAL SERVICES . . .55 A. Introduction . 55 B. Water and Sanitation . 58 Current Level of Services and Sectoral Reforms . 58 New Institutional Arrangements . 60 Impact on Rural Water Supply . 60 Assessing Progress in Municipios Previously Served by INSFOPAL . 62 Cost Recovery Efforts . 63 C. Health . 65 Impact of Decentralization on Health Care . 65 Activities at the Local Level . 66 Initiatives by Central Agencies . 67 Remaining Policy Issues . 68 D. Education .. 70 Past Achievements and New Priorities in Education . 70 Disbanding of ICCE and its Impact . 70 Evolving Procedures for Civil Works . .71 E. Feeder Roads . 72 ReallBgment of Responsibilities in the Road Sector . 72 Administrative Arrangements . 74 FNCV Formula for Matching Grants . 74 Investment Selection Criteria . 75 F. Matching Grants for Rural Development . 77 The New Role for the DRI Fund . 77 Eligibility Critert4a . 78 Planning and Budgeting Procedures . 78 he Co-financing Matrix . 79 G. Some Concluding Remarks . 80 CHAPTER 6: CONCLUSIONS AND RECOMMENDATIONS . 82 A. Improving Local Fiscal Performance . 82 Property Taxes . 83 Other Local Own-Source Revenues . 84 B. Improving National Transfers ..85 The IVA Transfer .. 85 Matching Grants ................ .. .. ......... . .87  C. Improving the Institutional Structure .................... as ANNEX Is COMMISSION ON INTERGOVERNMENTAL FINANCE .....................90 ANNEX 2s SELECTED READINGS ON DECENTRALIZATION IN COLOMBIA ............ 92 ANNEX 3: AN ALTERNATIVE FORMULA FOR DISTRIBUTING IVA RESOURCES TO LOCAL GOVERNMENTS ...............t ........97 MAPS Colombia: Population.. 2 Colombias Departments, Intendencias and Comisarias ....... ....... 12 Colombia: Distribution of Oil Royalties .. 31 Colombia: Proven Coal Reserves. 32 Colombiat Municipios of Maicao, Ovejas, Ubat4, and Aipe . . .56 TABLES AND CHNRTS Table 1-l Classification of Municipios by Population Size........ 3 Table 1-2: Colombias Local Budgets, by Size of Municiplo, 1988 .......... 3 Table 3-1: Departmental Revenues, 1979-1987 . ............................ 19 Table 3-2s Local Revenues, 1979-1987 .................. ................ 22 Table 3-3: Principal Local Taxe3, by Size of Municipio, 1979-86 .. 23 Table 3-4s Assessed Values and Property Taxes, 1978-1988 ............... 24 Table 3-5: Adjustment of Assessed Values, 1984-89 . ...................... 26 Table 3-6: Relation Between Increase in Assessed Values and Year of Prior Assessment, 1988 ........... ......... 28 Table 3-7: The Distribution of Sales Tax Revenues, 1985-1992 ............34 Table 3-8: IVA Transfers to Municipios Aggregated by Department, 1988 .....36 Table 3-9: Components of IVA Transfers . .. 37 Table 3-10: Impact of Fiscal Effort on Special Transfer to Small Municipios, 1988 .................... ........ 39 Table 4-ls FFDU Disbursements by Sectors . ...................... 51 Table 4-2s FFDU Loan Approvals by Departments . ...... ..................... Sl Table 4-3s Borrowing Capacity of Municipios by Size, 1988-1992 ................................. ..... 53 Table 5-lt Socio-Economic Data on Selected Jurisdictions ................ 57 Table 5-2: Fiscal Data for Selected Jurisdictions . . 59 Table 5-3: Entities Providing Water and Sewerage Services ............... 61 Table 5-4: Calculation of Co-financing Percentages ... ................ 75 Table S-5s DRI Fund Co-financing Matrix .......................... .19 Table A-ls Illustration of Revised IVA Transfer (Annex 3) .............. 100 Chart 2-1: Administrative Decentralization Under Decree 77 .............. 9 Chart 2-2: Institutions Invelved in Development Planning ................ 15  Executive Summnar Background 1. The struggle between the proponents of greater centralization and those advocating greater decentralization has long been waged in Colombia. Until recently, centralization seemed to have won the day. The Government in Colombia for much of its history has been a three-tier system comprising the national, regional (departmental) and local levels. The national government and its agencies not only controlled almost all public revenues but over time had supplanted the departmental and local governments in the provision of virtually all public services. However, by the mid-seventies, the increasing strain on the national budget and a concern over the decline of local and regional functions and institutions had resulted in a public debate over the respective role of the three levels of Government. A series of reforms instituted by the Betancur administration (1982-1986) and continued by the present Government represent a truly historic turning point in Colombia's fiscal and institutional development. The Reforms Since 1983 2. The objectives of the decentralization refosms were clearly ambitioust the national government was to be relieved of some of the burden of financing local services; local government finances were to be strengthened through additional national transfers as well as improved local revenue mobilization; and local public services were to be provided more efficiently and more in keeping with the wishes and needs of local people. The reforms are explicitly designed to allow the country's 1,009 local government units, called the mmnicipios, greater decision-making powers on matters directly affecting their welfare, e.g., provision of basic services and levels and types of productive and infrastructure investments. 3. The process was set in motion in 1983 with a series of legislative measures. First came the fiscal packages. Law 14, promulgated in 1983, sought to strengthen local government finances by granting municipios greater revenue raising powers. Unfortunately, the fiscal decentralization measures have not resulted in sustained increases in local revenue collection. Hany municipios took no advantage of the new flexibility provided to them by Law 14 to set their own property tax rates (within a given range). Moreover, the slow pace of property revaluations by the national valuation agency (IGAC) and the inadequate adjustments of property values for inflation also made it difficult for local governments to maintain their property tax base. The lack of administrative capacity in many of the smaller municipios has hampered tax collection, especially of the industry and commerce tax and the motor vehicle tax.  - il - 4. Next, Law 12 of 1986 provided for a transfer of increasing shares of national sales (IVA) tax to local governments. The distribution formula for this transfer program, which is intended to reward local fiscal effort, also favors small municipios and provides additional IVA resources to those with fewer than 100,000 inhabitants. The law also stipulates fixed percentages of IVA transfers that must be directed to investments. The transfers under Law 12 started promptly in the mid-1986 and initially there were some concerns that the national government might be channeling substantial additionel resources into some small municipios with very limited absorptive capacity. 5. Then, Decree 77, announced in January 1987, mandated that certain public services be transferred to local governments and ordered that two central agencies be diamantled (see para. 8 below) and functions and responsibilities realigned among the three levels of Government and among different national agencies. This was all to be accomplished before January 1993, according to a staggered timetable. The services transferred include provision of water, sewerage and solid waste disposal: conatruction, operation and maintenance of slaughter houses and markets, and of health posts, health centers and local hospitals: construction and maintenance of schools, athletic facilities and parks; construction and maintenance of urban local roads and maintenance of bridges and river portst management of urban transport system; provision of low-income housing; extension of electricity network; and provision of agricultural extension as well as co-financing with national agencies of rural development projects. 6. In the meantime, Legislative Act No. 1 of 1986, in a dramatic departure from Colombia's political tradition, took away the center's authority to appoint local mayors and instead introduced a system of national mayoral elections every two years. The measure was intended to strengthen the democratic process and to bring Government closer to local communities. The first national election of mayors took place in March 1988 and the newly elected mayors assumed office in June 1988. The Impact on Local Services 7. The transfer of responsibilities for providing basic social services to local authorities is still in its initial phase of implementation. The process is continuously evolving and it is likely to take years before the full Impact of the reforms can be evaluated. The present report attempts to review the country's experience with decentra- lization as the Bank mission observed it in February 1989. The mission noted that there was a significant effort made at all three levels of Government to implement the provisions of Decree 77, adapt to the resultant institutional changes, and to devise new mechanisms for providing the services effectively at the local level. O. To date, Implementation effort has understandably been focussed on those sectors with more pressing deadlines for the transfer of services. In the water and sewerage sectors where the transfer of responsibilities was to take place before December 31, 1989, the liquidation of the National Institute for Municipal Development (INSFOPAL) is virtually complete and the Basic Rural Sanitation Division of the National Institute of Health (INS) has been abolished. In the education sector, where the liquidation of the Colombian Institute for School Construction (ICCE) has been completed ahead of its January 1990 deadline, the local governments are starting to assume responsibilities for school maintenance and  - iii - construction. On the other hand, work is just starting in the health sector where some critical policy decisions will need to be made before the January l99S deadline for the transfer of responsibilities. These include decisions on policies and mechanisms to share the cost of constructing, equipping and operating local hospitals; on ensuring recurrent funding for all primary health care facilities; on formulating a pragmatic and manageable user charge policy for primary health care facilities; on the respective roles of the National Hospital Fund (FNH) and the Regional Health Service (SSS) offices; and on an appropriate schemes for co- financing between FNH and local governments. Similarly, in the road sector, where implementation is somewhat behind schedule (the deadline set by Decree 77 was January 1, 1989), preparatory work now underway includes an inventory of the condition of all secondary roads, a functional- jurisdictional road classification and corresponding regulations and establishing a program of institution building to allow an orderly transfer of maintenance responsibilities to local governments. Policies for co- financing road projects between the National Fund for Local Roads (FNCV) and local governments have also been established. 9. Progress has been slower in the agriculture sector, but here, the concerned agencies (e.g. Caja Agraria, Colombian Institute for Agriculture and Colombian Institute for Agrarian Reform) have until 1992 to work out a reasonable division of responsibilities among themselves and with the three levels of Government. On the other hand, intensive work is underway to draw up policies and formulae for co-financing rural development projects, the responsibility for which the Rural Integrated Development Fund (Fondo DRI) must assume before December 31, 1989. 10. Given that Colombia is a regionally diverse country, it is not surprising that the impact of the decentralization refomss on the provision of services has differed considerably from municipio to municipio. For example, the country's four largest cities (viz., Bogota, Medellin, Cali and Baranquilla) and many of the medium-sized cities have managed their own local services for years prior to the recent decentralization reforms. 'With continued efforts on the part of local public service entities to improve management practices and cost recovery, most large and intermediate cities should be able to expand the coverage of their services, improve service qu&lity and fund fully their investment and operations. On the other hand, small municipios, defined as those jurisdictions with fewer than 100,000 inhabitants (see para. 11 below), are a cause for concern because most tend to lack the necessary managerial and technical skills and experience. The present report, accordingly, focuses on how the reforms are implemented in small, relatively underdeveloped municipios. As part of the preparatory field work for the report, a Bank mission in January/Februarv 1989 carried out case studies of four such municipios --Aipe (Huila), Maicao (Guajira), Ovejas (Sucre) and Ubate (Cundinamarca)-- to assess how the local officials are coping with the new responsibilities and how the institutional changes are affecting the provision of local services. The findings of the case studies are summarized in Chapter 5 of the report.  - iv Improving the Institutional Structure and Capacity 11. Colombia's municipios constitute a very heterogeneous group, and one of the difficulties with the implementation of decentralization reforms is that this heterogeneity has not been recognized adequately. The decentralization laws have tried to address this issue by classifying the municipios into two categories --those %ith fewer than 100,000 inhabitants and those with more. However, even among those municipios with population of under 100,000, the fiscal base and the administrative infrastructure vary enormously. The Bank mission believes that it would require many years of technical assistance and training before local authorities in some of the smallest municipios are able to exercie their new responsibilities fully. The institutional weaknesses at the local level mean that the departmental authorities and other regional entities will need to assume a much greater role than befcre in guiding and coordinating the activities of local governments. The regional entities have familiarity with local circumstances that national agencies do not, and it would be wasteful not to tap their experience and expertise. 12. A key requirement for the success of the decentralization reform in Colombia will be the creation (or strengthening, as the case may be) of intermediary agencies at the department, sub-department (provincial) and national levels capable of providing local officials with technical assistance and even training. For example, the presence of strong intermediary entities is critically important for ensuring the most effective use of the new credit facilities accessible to many municipios for the first time as a result of the expanded IVA transfers. Strong and experienced regional intermediaries are clearly needed to help inexperienced local officials with the technical aspects of investment credit financing--project identification and design, evaluation, execution and monitoring. At the same time, the central credit agency will have to meet the challenge of combining a coherent and sound credit policy with pragmatic administrative arrangements that take adequately into account the enormous differences that are certain to persist, not only among municipios but also among regional intermediaries. 13. Indeed, the same can be said about the many other spheres of national-regional-local interactions brought to the fore by decentral- ization. They include panning (sectoral and spatial), budgeting and financial management, training and, of course, the provision of a wide variety of important public services. In every case, the challenge for the national governwent is (a) to develop appropriate policy guidelines, (b) to foster the development of the institutional structure needed to carry them out, (c) to design and implement an adequate system of intergovernmental financial relations for this purpose (see para.14 below), and (d) to monitor the ongoing process with care, making such adjustments as the evolution of local capacities or the emergence of general and local problems may require. In all this, the main guiding principle should be pragmatic flexibility: if something works, use it.  Improving Local Fiscal Performance 14. A critical element in achieving greater public sector efficiency through decentralization is improved local fiscal performance. Local governments should not only be encouraged but required to call first on their own resources before turning to the national government for assistance in financing local services. The reality in Colombia now, as before the recent wave of decentralization measures came into being, is that most local governments, and particularly the smaller and poorer municipios, remain overwhelmingly dependent on national transfers. During 1980-1985, for example, the current revenues of local governments on the average accounted for only about 82 of total Government revenues. Moreover, the fiscal performance at the local level cannot be expected to change dramatically over the short to medium term. Nonetheless, whatever additional measures are possible to strengthen the local resource base and to improve collection ought to be taken. 15. The most important local tax in small municipios is the property tax. There are three ways to improve the revenue performance of any tax: to increase the base, to raise the rates and to improve the efficiency of the collectiou process. Action is needed on all three fronts. First, the revaluation process should be speeded up and improved to meet the five-year cycle mandated in Law 14. Moreover, it will be essential to ensure that annual "automatic" adjustments keep pace with inflation. Second, to increase tax revenues, it would be necessary to raise property tax rates--revaluation and annual adjustments will, at best, only help maintain the real level of local property taxes. By any objective economic measure, there should be ample room for such tax rate increases in most municipios. Third, it is important that local governments receive assistance not only in the form of updated cadastral values but also in terms of improving their collection and (now virtually nonexistent) enforcement capabilities. Improving National Transfers 16. The principal national transfer program for local governments in Colombia is the national sales tax (IVA) transfer. The Bank mission believes that the design of this transfer program merits a close re- examination and modification. The main rationale for the IVA transfer is equalization--putting local governments having different economic bases on a more equal footing in terms of their ability to provide basic public services. Presently, the IVA transfer program does not perform this task effectively because (a) population size is the only criterion it uses to differentiate among municipios; and-(b) its correction factor, when not giving perverse results, is too small and inappropriately focussed on fiscal effort and not fiscal capacity. The result is that the IVA transfer currently functions essentially as a flat per capita grant for the small municipios. It does nothing to correct the wide disparities in fiscal resources available to these municipios. 17. The mission proposes a revision of the IVA transfer formula to remtdy these deficiencies. Two alternative approaches are suggested. The  - vi - first approach is to keep the "fiscal effort" correction factor in the formula of the IVA transfer but to aprly the correction to all municipios (and not only to those with fewer th,a 100,000 inhabitants), and to base it on a much broader definition of revenue base than just assessed property values. In particular, the importance of royalty incomes on coal and oil and gas its selected municipios should be taken into account. The alternative approach is to give up the fiscal effort correction factor in the IVA transfer formula and replace it by a grant as followst Gi - f (P, tBi) where G is the amount of the grant, P is population, B is a measure of the tax base, t is the average rate on the ta: base for the country as a whole and the subscript i refers to a particular municipio. Such a grant would take population as a measure of need, as in the present system, but the amount of the transfer after the adjustment would also vary inversely with on how 'ricnh a municiplo was in terms of the tax base. A grant in this form would also avoid such perverse discouragement to fiscal effort as results from the present correction factor (i.e. revaluation in property resulting in reduced IVA transfers). It is possible to develop many alternative formulae from this concept; one example is provided in Annex 3. 18. The system of matclxing grants is yet another form of national transfer, a system uader which national agencies negotiate with individual local governments to co-finance specific investment projects. There are some aspects of the nascent matching grant schemes that cause concern. First different national agencies appear to be using different equity criteria. Second, different cost-sharing formulae are being used by different agencies for financing very similar types of investments. Consequently, it is not clear what the net effect of these different schemes is likely to be on the levels and composition of investment in individual municipios. The Government might consider three types of improvements to the current practice. First, it would make sense to vary the matching rate with some measure of wealth, such as the taxable assessed value per capita, rather than with population. Second, considerably more effort should be directed to developing an agreed categorization of municipios rather than letting every national agency come up with its own classification. Third, to help determine the appropriate levels of matching grants by type of services financed, the National Planning Department (DNP) will need to play a much more active role in establishing clear national priorities and minimum standards in the provision of different local services. 19. The decentralization task facing Colombia is enormous. Nonetheless, substantial progress has already been made. 'What is most needed to facilitate the progress of decentralization is the development of adequate institutional infrastructure at all levels, especially at the regional level. This is going to take a number of years. In the meantime, the Government is urged to take another look at the design of the national transfer programs and to continue to take all the necessary steps to support the strengthening of the local fiscal system. Over the next few years, the impact of the decentralization process on the national budget is likely to be negative. In the long-run, however, the cost and the effort involved may well be considered worthwhile if the efficiency and effectiveness of a substantial proportion of public sector activity can be improved as a result.  - I - CHAPTER 1 Introduction Background 1.01 The decentralization process now underway in Colombia represents a major departure from the centralist tradition that has shaped the country's political, social and economic development for more than a century. The struggle between the proponents of centralizatlon and those advocating greater decentralization has long been waged in Colombia. Until recently, centralization seemed to have won the day. The national government and its central agencies not only controlled almost all public revenues, but had also, outside of the largest cities, supplanted the departmental and local governments in the provision of services that were pre-eminently local in nature, such as primary education, primary health care, housing, water and sewerage. 1.02 The state sector in Colombia is a three-tier system consisting of the national, departmental and local governments. The country is divided into 23 departments each of which is run by a centrally appointed governor and an elected assembly. The Special District of Bogota also has departmental status. There are, in addition, four lintendencias" and five "comisarias" (known collectively as the national territories) covering the less developed parts of the country and administered directly by the national government. The departments are further divided into 1,009 local government units, known as "municipios". Ranging from large metropolitan centers like Medellin and Cali to tiny, rural jurisdictions with fewer than 1,000 inhabitants like Busbanza, these municipios represent an enormous range in terms of population, natural resources, economic activity and fiscal capacity. This diversity can be seen clearly in Table 1-1 (Classification of Municipios by Population Size) and the population map on page 2. Table 1-2 shows the great disparities in expenditure and financing patterns among municipios of different sizes. 1.03 Over the years, the departmental governments had become particularly weak with just a few functions on which to devote the scarce resources at their disposal. The situation at the local level was almost universally as weak except in large cities (e.g. Bogota, Cali and Medellin) whose size and resource base gave them a degree of independence though their mayors, too, were appointed. For the most part, little scope, and almost no reward, existed for local initiative. The most successful local officials --all of whom, in any case, were appointed from the center --were those who could best find their way through the labyrinthine national government system to serve local needs. 1.04 Given that Colombia is a regionally diverse country, however, there has always been considerable variation in practice with respect to the relative roles of national, departmental and local authorities. Stronger (and generally richer) departments such as Valle and Antioquia and the larger cities such as Bogota, Medellin and Cali were dominant rather than subordinate partners in some respects. Moreover, at various times, political movements urging increased 'decentralization' -- often in the form of providing increased access to national taxes for departmental  -2- UM 21W COLOMBIA . .. -r POPULATIO \ /ve,:. < ! ~~~~~~~VENEZUELA t~~~~~~ ~~~~ _- r-- PANAMA A. )~~~~~~ANUC Pacific ,ocean \..OYACAs, ) C . t 1 _ f ) I ,,> w~~~~~f T UAINCAD f > . - / \ N.\ GUA VIADE N. CAG\.UETA VAVR,S 41 . K BRAZIL MUICIPAIJTIS WIth 1a 8 ThN O, 100,000 INImTNS -5 0D.000 ', 2000000 m ' 1_000,000 C00.000 AMAZONIAS 10 100 200 TOTAL POPLATION OF ) gAET DEPARtTMENT. INIENDENCIA. OR COMISARIA* 2.000,000 - 4.000.000 (Highest vahu: Bo0ot6 - jJ1.000,000.- <2,000,000 3.98,941) E3 500.000 - <1,000,000 100.000 - <5W,000 tJ - < 100,000 (Lot valwlue. Guadiio -9.214) PERU - * Nokxd Cqpd/ - -- _ Departn1* bntndmnci,a and Comswic Boundaries ' - bhternol,ncd Boundaries ' . * 1985C.nws 74. > _ X,~~~~~~~AY)Iil  -3- Table 1.1: Classification of Municipios by Population Size Population Number of Mnunicipios 800,000 and above 4 100.000 - 799,999 22 30,000 - 99,999 41 12,000 - 29,999 84 Smaller than 12,000 858 1,009 Sources DANE: 1985 Population Census, DNP. Table 1.2: Colombia: Local Budgets, by Size of Municipio, 1988 (as percent of total) Less than 6 to 12 to 20 to 30 to S0 to 100 to Over 6,000 12,000 20,000 30,000 50,000 100,000 500,000 500,000 Revenues Property tax 10.2 8.6 8.3 7.0 6.5 10.0 12.1 4.5 Industry and comerce tax 2.0 2.3 3.1 3.9 4.6 7.2 18.3 25.4 Vehicle taxes 0.2 0.2 0.4 0.4 1.2 1.1 1.9 1.2 Valorization 0.2 0.2 0.3 0.7 1.4 0.7 0.5 1.1 Royalties 2.0 1.8 1.2 2.3 1.9 0.9 3.3 0.0 Total own source 14.6 13.1 13.3 14.3 15.6 19.9 36.1 32.2 Departmental transfers 2.7 1.7 2.5 1.2 0.9 1.2 2.6 0.5 National sales tax (IVA) transfer 71.1 73.0 71.0 68.0 65.9 57.4 31.8 17.0 Domestic credit 0.4 1.0 1.6 1.9 2.5 2.5 10.2 27.8 Other 11.2 11.2 11.6 14.6 15.1 19.0 19.3 22.5 Total Revenues 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Expenditures Current 54.8 51.7 52.8 55.7 55.8 53.4 58.4 39.3 Debt service 2.3 2.4 2.5 1.8 4.1 4.6 10.4 10.6 Investment 42.9 45.9 44.7 42.5 40.1 42.0 31.2 50.1 (of which funded by IVA) (14.4) (16.9) (17.5) (17.0) (16.1) (15.7) (3.1) (2.7) Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: Data from a survey of some 730 municipios by DNP.  -4- and local governments -- have shown considerable strength. This political pressure was perhaps most evident in 1968 when a constitutional amendment provided for the tax allowance ('situado fiscal"), under which a significant portion of national revenues was earmarked to finance departmental spending on health and education. At the same time, the departments and municipios were given access to a growing share of revenues from the then new sales tax. 1.05 As the budgetary deficits of the national government continued to widen in the 1970s, however, the very success of the 1968 initiatives in directing an increasing share of national fiscal resources to subnational governments created a new, and quite different, interest in decentra- lization. This time the pressure came from the national government, which was becoming increasingly concerned with the extent to which its strained fiscal resources were being directed toward financing services that were essentially local in nature. It was these fiscal concerns, coupled with the persistent pressures from regional and local interests for more 'balanced' regional development and greater local "autonomy', that led to the appointment of the Commission on Intergovernmental Finance in 1980.1 Nonetheless, the 1981 report of this Commission urged that the two major national transfer programs--tax allowance and national sales tax--be continued (though in modified versions). It also concluded that given the disparities in the "initial" conditions, Colombia's small municipios were likely to remain dependent on national transfers to finance local services, and that the only way the national government could achieve any form of budgetary 'savings' was by having the richer cities and departments assume greater fiscal responsibility in the expansion and operation of their own services.2 1.06 In the meantime, there was a growing sense of misgiving in the country over the steady decay of the departmental and local institutions, prompting policy-makers to re-examine seriously the respective functions and responsibilities of the three levels of government. The Lopez government (1974-1978) proposed a broad restructuring of local government In a planned Constituent Assembly which, due to legal and problems never met. Nonetheless, interest in administrative reforms remained strong in the country. The series of reforms instituted by the Betancur government (1982-1986) and continued by the present Barco administration represent a truly historic turning point in Colombia's fiscal and institutional development. 1/ Originally published as Finanzas Intergubernamentales en Colombia: (Bogota, Departamento Nacional de Planeaci6n, 1981), the report of the Commission is also available in English as R.M. Bird, Intergovernmental Finance in Colombia (Cambridge, Mass.: Harvard Law School International Tax Program, 1984). 2/ The main recommendations of the Commission on Intergovernmental Finance are summarized in Annex 1 to the present report.  -5- The Reforms Since 1983 1.07 The ongoing decentralization process was set in motion in 1983 with a series of legislative measures. First came the fiscal package. Law 14, promulgated in 1983, sought to strengthen local finances by allowing local governments greater revenue raising powers. Next came Law 12 of 1986 which provided for the transfer of increasing shares of national sales tax (IVA) to local governments. Then, Decree 77, announced in January 1987, mandated that some public services be transferred to local governments, that certain central agencies be abolished and that responsibilities among different levels of Government and among central agencies be realigned, all before 1992. Finally, Law 78 of 1986 took away the departmental governor's authority to appoint local mayors and, instead, introduced a system of national mayoral elections every two years. This measure was intended to strengthen the democratic process and to bring Government closer to local communities. The first national election of mayors took place in March 1988 and the newly elected mayors assumed office in June 1988. 1.08 The original objectives of the decentralization reforms were indeed ambitious: the national government was to be relieved of some of the burden of financing local services; local government finances were to be strengthened both by the provision of additional transfers and, in particular, by enabling municipios to increase their own resources; local public services were to be provided more efficiently and in accordance with the real needs and desires of local people. Given that these and other apparent objectives represent such a radical departure from the country's centralist tradition, it is not surprising that the implementation of decentralization reforms has encountered some difficulties over the last few years, as the discussion of the subsequent chapters will indicate. Nonetheless, what appears certain amid the seeming uncertainties of this initial period is that the ongoing decentralization process is well in motion. There appears to be sufficient consensus among different segments of society on the merits of the reforms to ensure their continuation as well as a strong bi-partisan political commitment to its successful implementation. The all important question, therefore, is how the country can best attain the intended benefits of decentralization while ndnimizing its transitional costs. 1.09 The decentralization reforms and their attendant changes in institutions and intergovernmental functions present a number of important issues for the Bank's economic dialogue with the Government as well as its lending operations in the country. For example, there is the question of the impact of the reforms on the national budget. A critical element in achieving greater public sector efficiency through decentralization is improved local fiscal performance. However, the reality in Colombia is that most local governments, and particularly the smaller and poorer municipios remain heavily dependent on national transfers, and it does not appear likely that this intergovernmental fiscal relationship will change significantly in the foreseeable future. Hence, it is important to take a close look at the IVA transfer and the matching grants to ensure that they are performing their intended functions, i.e., (a) achieving greater fiscal equalization and (b) influencing investment patterns and levels at the locai level in accordance with national policies, respectively. There is  - 6 - also the issue of the impact of the decentralization measures on the quality of services provided at the local level. The transfer of responsibilities for service provision to inexperienced and untested local entities could lead to inefficiencies and waste, at least in the initial period. This may have negative implications for the quality and coverage of basic services and the access to these services by the poor. In this context, institution building is crucial, and a key requirement for the success of the decentralization reform would appear to be the creation (or strengthening, as the case may be) of intermediary agencies at the regional level to help provide local officials with technical assistance and training. 1.10 The aim of the present study is to review these issues and to make suggestions on new approaches for providing local services as well as the policies and mechanisms for financing these services. Particular attention is paid to the needs and conditions of small municipios (i.e., those with fewer than 100,000 inhabitants). As part of the review, a Bank team in January/February 1989 carried out case studies of four such municipios, viz., Ubate (Cundinamarca), Ovejas (Sucre), Haicao (Guajira) and Aipe (Huila), to ascertain the responses of local authorities to the decentralization measures and the progress made in the transfer of services. The findings of these case studies constitute a key input into the present report. 1.11 Decentralization in Colombia is a continuously evolving process, and it is likely to take years before its full impact can be evaluated. The present study reviews the country's experience and the progress made as of February 1989 when the Bank decentralization study mission was in the field for the last time. The fiscal decentralization measures are reviewed in detail in Chapter 3. The corresponding organizational and institutional measures taken on the expenditure side are reviewed in Chapter 2, and the impact of these changes on the provision of services in four selected municipios is discussed in Chapter 5. Chapter 4 reviews the potential role of credit in financing local investment. Finally, Chapter 6 contains a brief sumary of the main recommendations emerging from this review of decentralization measures in Colombia.  -7- CHAPTER 2 Decentralization and Institutional Chanses Political Decentralization and Community Participation 2.01 In a conspicuous departure from Colombia's centralist political tradition. Law 78 of 1986 took away the national government's authority to appoint mayors, and in its place introduced a system of national mayoral elections every two years. The first election of mayors took place in 1988, and the newly elected mayors took office in June 1988. This important measure was intended to strengthen the country's democratic process and to make local governments more responsive to the needs of the communities. To further promote community participation, Decree 1333 of 19861 created "comunasn, subdivisions within murAcipios; each comuna has a representative organ called the 'Junta administradoraw to serve as a vehicle for communicating initiatives and viewpoints from grassroot organizations (i.e., 'Junta de acci6n comunal" and various civic and professional groups) to the mayor's office. Furthermore, through a process called the 'consulta popular"2 local communities can now raise questions on specific actions or decisions of the local government. 2.02 It is too early to tell if these measures will succeed in bringing about the desired results. What is clear, however, is that having a popularly elected mayor answerable to local communities will intensify the pressure at the local level not only to provide social services efficiently at the existing capacity but also to increase significantly the coverage of these social investments. This development may well have adverse fiscal implications for the national government unless measures (such as those proposed in Chapter 6 below) are taken to strengthen local resource mobilization. The Transfer of Key Public Services to Municipios 2.03 The decentralization reforms attempt not only to provide for a democratic opening in local governments, but also to increase significantly its control over resources and functions. An important aim of this decentralization process is to allow the elected mayors of the 1,009 municipios greater decision-making powers and expenditure authority on matters directly affecting the welfare of the local people such as (a) provision of basic public services and (b) planning and budgeting for productive and infrastructure investments in response to perceived local priorities and within a national policy framework. By doing so, it is intended to improve the efficiency of service provision and to restrain pressures for more funds from the national budget to support essentially local purposes. 1/ C6digo de R4gimen Municipal, Art. 311-316. 2/ Legislative Act No. 1 of 1986.  -8- 2.04 Decree 77 of 1987 specifies the public services that the local governments must take over before January 1993 and the staggered timetable for transferring responsibilities from central agencies to municipios. These services include provision of water, sewerage and solid waste disposal; construction, operation and maintenance of slaughter houses and markets; operation and maintenance of health posts, health centers and local hospitals; construction and maintenance of schools, athletic facilities and parks; construction and maintenance of urban local roads and maintenance of rural feeder roads; construction and maintenance of transport terminals, bridges and river ports; management of urban transport system; provision of low-income housing; extension of electricity network; provision of agricultural extension; and co-financing with national agencies for rural development projects. (See Chart 2-1). 2.05 The local governments are expected to finance these wide-ranging services with additional IVA transfers provided by Law 12 of 1986, their own revenues, credit, and, in specific sectors (e.g., rural roads, rural development), matching grants from Ministries and central agencies. This delegation of greater spending powers to the local level requires that local governments assume responsibilities for planning and budgeting for these services as well as for other purposes. This in turn will entail in most municipiou institution building and training since the necessary administrative infrastructure for this purpose does not currently exist. Institutional Chanses Stemming from Decree 77 2.06 Law 12 of 1986 and Decree 77 of 1987 envisage an "orderly transfer, of functions to local governments to be implemented sequentially during the 1989-1992 period with as little disruption to the services as possible. The decree contains broad guidelines with respect to the realignment in responsibilities among different levels of Goeernment and among central agencies according to specific timetables. 2.07 While implementation is still at an early phase, the sum total of institutional changes caused by decentralization is expected to be significant. As shown in Chart 2-1, the decree mandates the liquidation of two central agencies, namely, the National Institute for Municipal Development (INSFOPAL) and the Colombian Institute for School Construction (ICCE). Similarly, central agencies that have hitherto provided the new local services are required by law to relinquish those functions. The affected agencies include the National Monument Fund (FIN), National Institute of Health (INS), National Road Fund (FVN), Colombian Institute for Agrarian Reform (INCORA) and Colombian Institute for Agriculture (ICA). Moreover, the Integrated Rural Development Fund (Fondo DRI), National Fund for Local Roads (FNVC) and National Hospital Fund (FNH) are to be transformed into co-financing agencies.3 2.08 To date, implementation effort has understandably been focussed on those sectors with more pressing deadlines. In the water and sewerage subsectors where the transfer of responsibilities must take place before 3/ These central agencies will receive, as now, national budget allocations for their programs on condition that they negotiate matching grant arrangements with local governments for financing specific programs or projects.  Chart 2-1 _IN IENT- U/ Sector Serv icg Irenaferred to Locol ov,rnmsnts Int Itutionl Chen WVter Supply and Water supply. sewerage, garbage disposal, National Intitute for Municipal Development Sanitation laugter houa. markets. (INSFUPAL) and iheic Rural Sanlittion. Dlvilion of the Notional Institute of Health (DIO) to be abolished. wealy creutad Dlrectorate in Public Works and Truneport Minlitry to assume roa,ionihltive for policy formulstion, setting of technical *t4adarde and provitnon of technical tecil*tenc. iealth Construction and maintenance of health National Hospital Fund sill no longar psrfore posts, health cenrs, local hoapitt. sl-ervvice tranaterred to local juriediction. Its reesponibiltite In the ares of primary health will consiet of technical and financial *a letance to local governente. Education Construction and mintenance of primary, Liquidation of Colombian Intitu f*or School -sonWary and vocatIonal achool-. Construction (ICCE). Newly created directorate Appolntment, transfer nd personnel in ittnietry of Education to assum re-pontibilities management of teachers, for planning of Infrastructure, setting standards and providing technical asesltance. Agriculture Provislon of agricultural extension to smal ICA to b- reorganized to corcentrate on rearch, frrsar either directly or through sub- technology transfor and training of local govrnment contracting agreementt with Colob ian staff In the use of technical packages. DI8RA to Institute for Agrarian Reform (PICURA). Cajs juriedictione undortaking colonization nd land AgarrIa or private research institute. parcelization. ORtI und authoriaed to co-finance Prepration of necessry Information for rural developmet project with local jurisdictions. farmrs participating In colopiztion and land parcellastion Projects. Titlino of land on the baeIs of norma estabilshed by INCORA. Urban Dsvelopmnte Construction and maintenance of urban rods. Urbcn Develtepsnt Enterprises (ElI) will become management of urban tranaporte and provision local entities. Superintandencic a Sncaris of los-income houing construction and Inspection of bulldina destined for shelter. Land Credit Institute (ICr) wll1 reduce Its direct participation In urban tvtil works end reinforce its technical assistance and financing services. rtth primary responsibility for co-financing low incow houing with Iocal governments. Public Works Construction, adinistration and mIntenance National Road Fund (PVt4) to comse contruction of local roads and parkia ad onusants, and maintennc of all urban roads. Ntional and local river ports and hbrbors. Monuments Fund (FIN) to relinquish maintaining atd adminietering loctl p"s end onusante. Notional Fund for Noighworhood Reeds (FiVC) ill1 co-finance road projects aIth local governsnte. J/ Provided tner Decree 77 of 1987. B Slltt .pprovwe by 198 Congress.  - 10 _ December 31, 1989, the liquidation of INSFOPAL is virtually complete and the Basic Rural Sanitation Division of INS has been abolished. Under the umbrella of the Bank-financed Water and Sanitation Sector Adjustment Program (PAS), each local jurisdiction is working out its own mechanisms for providing water and sewerage services in close coordination with a central credit agency, the Fund for Urban Development (FFDU). In the education sector, where the liquidation of ICCE has been completed ahead of its January 1990 deadline, the local governments are starting to assume responsibilities for school maintenance and construction. On the other hand, work is Just starting in the health sector where the mechanisms for decentralizing primary health care services must also be worked out before January 1, 1990. Similarly, in the road sector, where implementation is somewhat behind schedule (the deadline set by Decree 77 was January 1, 1989), preparatory work now underway includes an inventory of the condition of all secondary roads, a functional-jurisdictional road classification and corresponding regulations and establishing a program of institution building to allow an orderly transfer of maintenance responsibilities to local governments. As discussed in Chapter 5, a co-financing formula between FNCV and local governments has also been established. However, it will be necessary to review and, if necessary, revise this co-financing approach as this formula was developed, in view of the deadlines, with only limited consultation with other agencies and local authorities. 2.09 Progress has been slower in the agricultural sector. However, ICA has until 1992 to finalize arrangements for the transfer of its agricultural extension services and INCORA's deadline for relinquishing the agricultural service functions is January 1, 1993. There is thus ample time to work out a reasonable division of responsibilities among agencies and among the three levels of governments for these services. On the other hand, intensive work is underway to draw up policies and formulae for co- financing rural development projects, the responsibility which Fondo DRI must assume before December 31, 1989. Administrative Infrastructure and Regional Differences 2.10 There is a broad consensus within the Government on the merit of handing over public services to municipios. Nonetheiess, the lack of administrative capacity at the local level has been a cause for serious concern, and institution building is correctly considered critical to the successful implementation of decentralization reforms. In practice, perhaps the most daunting obstacle to implementation has been the great diversity in initial conditions from region to region, which precludes the Government adopting standardized training and technical assistance policies across the country. The challenge consists in formulating a flexible approach to technical assistance, training and other forms of management support that takes account of the huge differences among regions (departments) and municipios. 2.11 By transferring the responsibilities for the provision of key public services to all 1,009 municipios equally and without discrimination, the decentralization laws and decrees implicitly treat these administrative units as a homogeneous group. In reality, however, the municipios run the  - 11 - gamut from large modern cities like Medellin (population 1.5 million) to tiny, predominantly rural jurisdictions like Busbanza in the department of Boyaca (population 787).4 They represent an enormous range in terms of population, natural resource base, economic activity and fiscal capacity, degrees of urbanization and public service coverage. The administrative infrastructure also differs significantly from municipio to municipio, giving rise to a wide range of training and technical assistance needs. 2.12 At the same time, each sector or branch of public service that is being transferred to local governments has its own unique sets of characteristics with respect to how the service is financed and managed. The combination of Colombia's regional diversity and the differing sectoral characteristics of those services affected has given rise to a complex matrix of requirements across the country that call for flexibility and innovativeness in implementation approaches. The Need for Training 2.13 Clearl: , training is central to the institution building effort at the local level. However, the National School of Public Administration (ESAP), a lead training agencj,5 has so far concentrated its efforts on explaining the decentralization laws, decrees and regulations to the newly elected mayors and local officials through publications and seminars. There has been a fair amount of information disseminated on the fiscal reform provisions, especially those associated with IVA transfers, the industry and commerc' tax and the vehicle registration tax. Much less attention has been given to training in basic practical skills needed for planning, budgeting and financial management, in particular the formulation of expenditure priorities, and the evaluation and ranking of investment projects. Nor has there been any attempt to provide hands-on instruction on how public services need to be managed. With respect to sector-specific expertise, training and technical assistance programs are dispersed among a large number of sectoral agencies such as ICA, INCORA, Caja Agraria and FNCV as well as the National Vocational Training Institute (SENA) with no attempt to ceordinate their activities. 2.14 It is critical that the Government quickly design a coherent training policy that takes into account the differences in regional and sectoral requirements at the same time. An essential ingredient of such a policy would appear to be an immediate external evaluation of ESAP's central role and of the role presently and potentially played by other entities in training. It would be unrealistic to expect ESAP (or any other national agency, for that matter) to serve all local governments single- handedly. Wherever possible (and once again, it is necessary to emphasize the enormous regional disparities in administrative capacity), ESAP might 4/ The Special District of BogotA is classified among the departments even though its administration is organized along lines similar to other large cities, and has an elected mayor. 5/ Designated to take the lead in the training of local officials, ESAP receives allocations of IVA revenues under Law 12. (See Table 3-7).  - 12 - iER 2X15 |w " * >