fiscal decentralization and poverty alleviation in a transitional economy: the case of viet nam

FISCAL DECENTRALIZATION AND POVERTY 353[Asian Economic Journal 1998, Vol. 12 No. 3] 353[Asian Economic Journal 1998, Vol. 12 No. 4] 353

Fiscal Decentralization and PovertyAlleviation in a Transitional Economy:The Case of Viet Nam

M. Govinda RaoAustralian National University

Richard M. BirdUniversity of Toronto

Jennie I. LitvackWorld Bank

Intergovernmental fiscal arrangements may play an important role in ameliorat-ing poverty in many countries. Successful poverty alleviation generally requiresboth ‘capacity improving’ and ‘safety net’ policies, and both types of policies may,to some extent, be implemented through, or affected by, intergovernmental trans-fers. From this perspective, we analyse the efficacy of intergovernmental fiscalarrangements in poverty alleviation in a transitional economy, Viet Nam. Weargue that both general and specific transfers are needed for this purpose: theformer to enable all provinces to provide a given basket of public services at agiven tax-price by offsetting their revenue and cost disabilities and the latter toensure that minimum levels of those public services provided by lower levels ofgovernment are targeted to the poor throughout the country.

I. Introduction

A successful poverty alleviation strategy in any country has four distinct elements.First, who are the poor? Where are they located, and what do they do? Second,why are they poor? Only after we know who the poor are, where they live, whatthey do, and have some idea of the causes of poverty, can the third element inthe strategy, the design of a set of specific policies to improve the living stand-ards of the poor, be determined. Third, experience suggests that effective strat-egy to improve the living standards of the poor require both measures aimed ataccelerating economic growth (capacity improving) to provide a lasting solutionto the problem, and more direct (safety net) policies to provide an immediate

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consumption entitlement to the poor. Finally, policies must, of course, be imple-mented effectively to ensure that benefits actually accrue to the targeted groupsat the lowest cost.

Fiscal decentralization may, in principle, enter this picture at several differentlevels. The proximity of policy makers to the people, for example, may reducethe information and transaction costs in identifying the poor and help in design-ing appropriate ‘capacity improving’ and ‘safety net’ policies. Decentralizedprovision of public services enhances welfare when there are significant local-ized differences in preferences although the extent to which this ‘decentraliza-tion theorem’ (or ‘principle of subsidiarity’) actually influences policy in anycountry, of course, depends upon how a nation’s political institutions are organ-ized (Oates, 1972). Further, effective implementation of capacity-improving andsafety-net policies may depend upon the close involvement of local governanceinstitutions. Governments that are ‘closer to the people’ should, in principle, beable to provide services more efficiently and effectively than a remote, central-ized authority provided responsibilities are assigned appropriately and the rightincentives are provided through the system of intergovernmental fiscal arrange-ments (Bird, 1993).

Different regions may have different needs and preferences for poverty alle-viation and different capacities to meet those needs and preferences. If povertyalleviation is a national policy concern, but some key poverty-alleviation pol-icies are for whatever reason delivered by local governments, the capacity ofthe latter to finance such services out of their own resources is likely to differgreatly. In Viet Nam, for example, provinces with a high concentration of pov-erty also have low levels of social and physical infrastructure, low agriculturalproductivity, and low per capita gross domestic product (GDP). Intergovern-mental transfers may thus have to be designed to ensure that the poorer localitieshave sufficient resources to deliver the desired ‘package’ of services (Rao andDas-Gupta, 1995).

This paper considers how fiscal decentralization and central transfers tosub-central governments can help in the task of poverty alleviation policy inViet Nam. In Section II, we describe briefly the poverty situation in Viet Namand introduce the appropriate design and implementation of policies required toaccelerate economic growth and reduce poverty in the light of the experienceof successful East Asian economies. In Section III, we consider the role of cent-ral and local governments in designing and implementing poverty-alleviatingpolicies and the design and mix of different types of intergovernmental transferschemes. In the light of this conceptual discussion, we then analyse in SectionIV current intergovernmental fiscal arrangements and transfer systems in VietNam. Finally, in Section V, we suggest how the intergovernmental fiscal systemmight be reformed to improve poverty-alleviation policies in Viet Nam.

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II. Poverty, Public Policy, and Fiscal Decentralization

II.1 Where do the Poor Live?

The Viet Nam Living Standards Measurement Survey (LSMS) highlights fourimportant features of poverty in Viet Nam (see Table 1) namely: (i) the overallincidence of poverty is extremely high; the consumption level of 51% of popu-lation is below a widely used international poverty line;1 (ii) there are significantregional variations in the incidence of poverty within the country, ranging from33% in the South East to 71% on the North Central Coast; (iii) poverty is abouttwice as common in rural as in urban areas and rural poverty accounts for almost90% of the poor; and (iv) almost 76% of the poor are in the farming population.

As Table 1 shows, in Viet Nam poverty is not only associated with low percapita income, low population density and low agricultural productivity but isalso reflected in low indicators of human development such as infant mortality,maternal mortality and illiteracy. The inverse relationship between the povertyratio and agricultural productivity reflects at least, in part, the importance ofsuch economic services as irrigation, agricultural extension, rural roads and ruralcredit in reducing poverty. Similarly, the high poverty ratio in areas with lowpopulation density reflects in part the lack of social and economic infrastructurefor the population in mountainous and remote regions.

II.2 Poverty and Public Policy: The Asian Experience

Policy interventions to combat poverty may be divided into two broad groups(Bhagwati, 1988). First, longer-term policies attempt to create an environmentfor the efficient use of resources and technological progress and to direct the flowof benefits of ensuing faster growth to the poor: ensuring a conducive incentivestructure through land reforms, generating larger farm and off-farm employmentopportunities through the provision of irrigation, agricultural extension and ruralinfrastructure and investment in human resources through publicly funded broadbased education and primary health care. Second, shorter-term policies to provideimmediate relief through self-employment and wage-employment opportunitiesand social security to the disabled and the destitute.

The experience of such Asian economies as Taiwan (China), South Korea,Indonesia, Malaysia and China underlines the importance of public investmentin rural infrastructure and human capital in generating broad-based growth inrural incomes and reduction in rural poverty irrespective of the political sys-tems. In all these countries, rural transformation was achieved by improving thequality of physical and social infrastructure, improving access to education andhealth facilities, raising agricultural productivity and expanding rural non-farm

1. The poverty line is based on a basket of goods in which food items contain 2100 calories perperson per day and the non-food items reflect the cost of basic goods consumed by the people whojust reach the poverty line.

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Table 1 Regional Profile of Income Levels, Poverty and Social Development in Viet Nam

Region Poverty Ratio Per Capita Density of Illiteracy Rate* Infant Maternal AgriculturalGDP – 1993 Population Mortality Rate Mortality Rate Productivity(1989 Prices) Per sq. km. (Per 1000 births) (Per 1000 births) (Paddy equivalent)1000 Dongs Tons/hectare

Rural Urban Total

1. Northern Mountains 63 34 59 332.5 115 18.9 52.3 2.1 2.072. Red River Delta 55 15 49 448.4 1085 7.2 44.2 1.7 2.743. North Central Coast 74 42 71 277.6 181 10.2 54.2 2.1 2.254. South Central Coast 54 36 49 331.2 157 12.3 50.6 2.2 3.135. Central Highlands 50 – 50 380.8 50 25.6 69.1 2.8 2.366. South East 45 17 33 1117.5 358 10.1 37.4 1.5 2.677. Mekong Delta 52 28 48 472.0 325 15.3 51.7 2.0 3.958. All Regions 57 26 51 478.2 209 13.1 49.5 2.0 3.06

Note: * Percentage of population above 10 years who never attended school has been taken as a proxy for illiteracy rate.Source: Bird, Litvack and Rao (1995).

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activities. This experience suggests that publicly funded investments in ruralinfrastructure (roads, bridges, irrigation and electricity) and broad-based educa-tion and health care in rural areas are critical in the early years of rural transforma-tion. The combination of rural infrastructure and human resource development ledto improvements in productivity, opened up markets, hastened the demographictransition, enhanced the mobility of labour, strengthened urban-rural linkagesand accelerated rural industrialization. Together with changes in the incentivestructure initiated by the land reforms in the early phase of development (as inTaiwan, South Korea and China), investments in rural infrastructure, rural institu-tions and human resource development not only led to strong growth perform-ances, but also created an equitable basis of growth and resulted in a significantdecline in poverty.2 The experience of Viet Nam itself highlights the pressureof demand for rural public services created by the change in the incentive struc-ture with the return to family farming and market opportunities (World Bank,1993b).

As in other Asian economies, analysis of household data in Viet Nam under-lines the importance of physical and social infrastructure in rural areas. As men-tioned earlier, the poor in Viet Nam are concentrated in areas where agriculturalproductivity is low. Those who live near all-weather roads have higher incomes,and education has a significantly favourable effect on agricultural productivityand small household enterprise earnings. Households with more diverse economicactivities enjoy higher living standards. Such findings suggest that significantlevels of investments in irrigation, agricultural extension and research, ruralroads and marketing facilities, access to information and knowledge, marketsand technology and above all basic education and primary health care in VietNam are needed to achieve appreciable reduction in poverty in the medium term(Wiens, 1996; Van de Walle, 1996).

III. Fiscal Decentralization and Poverty Alleviation

III.1 Role of Local Governments in Poverty Alleviation

What is the role of local government expenditure policies in reducing poverty?If poverty alleviation is considered as a purely redistributive task, in principle itsimplementation should be the responsibility of the central government since thepotential mobility of population limits the efficacy of sub-central governmentsin undertaking these redistributive policies (Brown and Oates, 1987; Ladd andDoolittle, 1982). Moreover, if concern for the poor of one locality is not con-fined to the residents of that locality, the volume of resources allocated by the

2. See, World Bank (1993a) for a discussion on the contribution of these factors in impartingdynamism to the agricultural sector in East Asian economies. Ranis (1995) also stresses the impor-tance of well developed rural (roads, drainage, irrigation and power) and institutional infrastructure(agricultural research, experiment stations and farmers’ associations) and effective land reforms inTaiwan and South Korea.

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locality for poverty alleviation would be non optimal.3 However, even from thislimited perspective, local governments may, as noted earlier, have a role to play;governments that are closer to the people should, as a rule, be able to provideservices more efficiently than a remote, centralized authority.

More importantly, as already mentioned, a lasting solution to the problem ofpoverty can be achieved only by accelerating economic growth by promotingefficient allocation of resources. The literature on fiscal federalism has high-lighted the potential efficiency gains from the better matching of the supply withthe demand for public services in different localities and more flexible bundlingof public services (Breton, 1990) when the allocative function is decentralized.Moreover, competition among jurisdictions may lead to greater innovations andproductivity gains (Oates, 1977; Shah, 1994).4

Whether or not fiscal decentralization is a help or a hindrance in designingand implementing poverty alleviation policies, it is an important institutionalreality in a country like Viet Nam with a unitary political system and a signific-antly planned economy. How existing decentralized institutions can be gearedand reoriented to enhance efficiency in the delivery of public services, accelerateeconomic growth and reduce poverty is thus an important question.

III.2 Intergovernmental Transfers: Rationale and Design

Transfers between governments often coexist with transfers between personsexecuted through tax-transfer schemes and public spending policies. Intergovern-mental transfers may be explained in various ways: (i) closing the fiscal gap aris-ing from the assignment of more expenditure responsibility than revenue sourcesor ensuring adequate funds for the sub-central governments to satisfactorilyundertake the functions assigned to them; (ii) offsetting the imbalance betweenrevenue capacity and expenditure need across different sub-central governments(equalization); and (iii) Pigovian-type transfers needed when the benefits ofpublic services spill over jurisdictional boundaries to ensure optimal supply or aprescribed minimum levels of those services considered ‘meritorious’ by thecentral government (Bird, 1993; Shah, 1994). Broadly, general-purpose transfers

3. Brown and Oates (1987) and Ladd and Doolittle (1982) argue for central intervention on thegrounds that poverty anywhere in a country is a concern for people everywhere. In contrast, Pauly(1973) and Tresch (1981) present a local public good view of poverty alleviation and assume limitedmobility of labour to justify local interventions in poverty alleviation.4. Bahl and Linn (1992), however, think that this efficiency case for decentralization in developingcountries is much weaker than industrialized countries. Prud’homme (1995), takes an even strongerposition when he argues that decentralization would result in lower allocative efficiency because thelocal bureaucracy is less efficient (economies of scope) and more corrupt (see also Tanzi, 1995).However, experience shows that capacity or efficiency of local bureaucrats, even when it is seen tobe low in a static situation, may improve dramatically when greater responsibility is assigned andright incentives are given, as in Colombia. (see, World Bank, 1995). As regards corruption, it mayalso be argued that greater transparency in public spending and taxes at the local (rather than central)level may lead to higher accountability (hence less corruption).

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are intended to meet the objective of equalization and specific-purpose transfers(with matching requirements from local governments) are considered appropri-ate (cost effective) for transfers given for spillover or merit good reasons.5

Arguments for equalization were advanced initially by Buchanan (1950) andlater developed by Boadway and Flatters (1982). Taking comprehensive incomeas an index of wellbeing, it is argued that a central income tax can not ensurehorizontal equity since it does not take account of the redistributive effect oflocal fiscal operations, which can not be distributionally neutral (except in theunlikely case of their financing public services through only benefit taxes). Whenlocal public services are financed by resource rents or source-based (as againstresidence-based) taxes, the net fiscal benefits (NFBs or benefits less locally bornetaxes) will vary systematically with residents of resource-rich (high-income)regions having higher NFBs, inefficient migration into these regions may thusbe induced. For both efficiency and equity reasons then, it may be argued thatthere should be transfers from the rich to poor regions to offset the fiscal dis-advantages arising from lower revenue capacity and higher unit cost of providingpublic services. This can be achieved by a general-purpose transfer equivalent tothe ‘need-revenue’ gap (Bradbury, et al., 1984), which measures the differencebetween what a local government needs to spend to provide a specified level ofpublic services and the revenue it can raise at a given level of tax effort.

Transfers meant to deal with spillover problems or those given for merit,good reasons are required to ensure that local governments provide a prescribednormative (minimum) level of specified public services. Such transfers arecost effective when the purpose for which they are given is specified, and sub-national governments are required to make a matching contribution with thematching ratio varying with the size of the spillovers.6

The objective of intergovernmental transfer, in principle, is thus, not povertyalleviation per se. Rather, such transfers are intended to offset local fiscal dis-abilities and to ensure the provision of prescribed standards of specified publicservices. Of course, one such service might take the form of specific povertyalleviation programmes. By enabling the provision of a reasonable level ofphysical and social infrastructure in low-income areas where the poor are con-centrated, as well as the maintenance of selective schemes to provide short-termself-employment and wage-employment opportunities, the intergovernmentaltransfer system may thus in practice be an important instrument in poverty-alleviation strategy.

An ideal set of intergovernmental fiscal arrangements would include the fol-lowing elements: (i) adequate resources in the hands of local governments asa whole, from a combination of local taxes and central transfers, to enable them

5. Of course, both type of transfers help close the ‘fiscal gap’.6. Since the responsiveness of sub-central governments to a given matching ratio may vary withtheir level of incomes, to elicit equal responsiveness, equalizing matching ratios may be required(Feldstein, 1975).

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to carry out their assigned functions; (ii) a transfer system that ensures each indi-vidual local government has sufficient resources to provide essential functions atan acceptable standard, provided local taxes are imposed at reasonable rates; (iii)sufficient flexibility in setting local taxes and charges so that local governmentscan respond to the preferences, special problems, and resource endowments pre-vailing in different regions; (iv) sufficient incentive to ensure that local fiscal effortis maintained and local budgets are managed efficiently; and (v) where minimumlevels of spending on specific programmes are considered to be of national im-portance, specific-purpose transfers, sometimes with matching requirements.

Such an ideal system, is seldom found in practice, and certainly not in coun-tries such as Viet Nam where, traditionally a unified budget has been employedas a tool to implement central planning. Nonetheless, an essential, but oftenunduly neglected part of the transition towards a more market-oriented economyis precisely a change in the budgetary and intergovernmental system (Bird andWallich, 1993), and such a change is under way in Viet Nam.

IV. Fiscal Decentralization and Delivery of Public Services in Viet Nam

IV.1 Structure of Local Governments

Like most centrally planned economies, Viet Nam has a ‘deconcentrated’ sys-tem, in which the centralized state authority is extended to local administrationsin provinces, districts and communes.7 In this unified structure of government,local governments do not have independent decision-making authority. Nonethe-less, the system provides for local involvement to ensure that the public servicesare delivered in response to the local needs and development is in conformitywith local resources. In this so called ‘double subordination’ system, local gov-ernments are thus accountable in a sense to both the electorate and higher levelgovernments.

Within the unified state, the government is deconcentrated into three locallevels – provinces, districts, and communes. The structure of local governmentconsists of 53 provinces, 560 districts, and 10,032 communes. The unified budgetincludes the revenues and expenditures of the centre, the provinces and thedistricts. Delivery of public services at the commune level is included only tothe extent that it is financed by grants from higher-level governments.8

IV.2 Assignment of Expenditures and Taxes

The assignment of expenditures to different levels of government in Viet Namis based on a resolution of the Council of Ministers passed in November 1989,as subsequently amended. Local governments are responsible for ensuring law

7. For a discussion on typology of decentralization, see, Rondinelli (1996). For a useful descriptionof the ‘double subordination’ system see, World Bank (1996), pp. 42–43.8. Note that as used here, ‘local governments’ refers to all subnational levels.

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and order within their jurisdictions, but, as in many other countries, with a fewexceptions such as defence most responsibilities are shared more on the basis ofthe size of the projects than the type of expenditure. Large investment projects,the benefits of which spill over to a number of provinces, are central respons-ibilities, while small projects benefiting mainly the residents of a province areundertaken by provinces. Thus, all major irrigation, flood control and embank-ment projects and national highways are central responsibilities, but the mainten-ance and repair of minor irrigation works and roads other than national highwaysis a local responsibility. Similarly, primary and secondary education is mainlyassigned to the provinces, but higher education is central, and major hospitalsare managed by the centre, while the provinces run hospitals in provincial townsand districts. Provinces are also responsible for the public health centres run atthe commune level.

Thus, in principle, local governments have a significant role in the deliveryof public services. Expenditure incurred by the provinces constitutes almost athird of the total (Table 2). Their expenditure share is especially high in suchsocial services as education and health. Moreover, although most capital expen-ditures are incurred by the centre, the provinces play a major role in maintainingpublic investments and in activities like agricultural extension and rural roads.Consequently, their share in current expenditures on economic services is alsosignificant.

Nevertheless, the provinces’ leeway in altering expenditure levels is con-strained by the absence of significant revenue-raising powers. The responsibility

Table 2 Government Expenditure in Viet Nam (1992)

Total Expenditure Per Capita Per cent Per cent Share of (Bn Dongs) Expenditure of GDP of Total Provincial

(Dongs) Expenditure (%)

A. Current expenditure1. Gen. adm. services 2,404 34,687 2.4 10.2 43.12. Economic services 1,495 21,571 1.5 6.3 78.93. Social services 6,240 90,035 6.1 26.4 46.0

(i) Education 1,495 21,571 1.5 6.3 88.6(ii) Health 1,136 16,391 1.1 4.8 88.1(iii) Pensions 2,369 34,182 2.3 10.0 –(iv) Others 1,240 17,892 1.2 5.2 15.1

4. Interest 3,218 46,432 3.2 13.6 –5. Others 5,314 76,674 5.2 22.5 18.9Total Current 18,671 269,399 18.3 79.0 35.9expenditure

B. Capital expenditure 4,956 71,509 4.9 21.0 34.4Total expenditure 23,627 390,908 23.2 100.0 35.5

Source: Bird, Litvack and Rao (1995).

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for determining the tax base and the rate structure of all taxes lies with thecentral government. Except for taxes on foreign trade (administered by the cus-toms department), tax administration and enforcement is done by the GeneralDepartment of Taxation (GDT) of the Ministry of Finance (MOF) and by pro-vincial and district tax offices under its direction. The centre determines virtuallyall aspects of tax policy, but the provinces effectively control tax collection,ensuring that the targets set are achieved through proper enforcement in part byproviding cash incentives to provincial and district tax departments. Provinceshave an incentive to overreach centrally determined targets because the excessamount can be used by the province for any social or economic service (not gen-eral administration). In addition, provinces can collect some minor charges andfees, although in total these account for less than 5% of their revenues.

IV.3 Balancing Provincial Budgets

The budget law, which assigns expenditure functions to the central and local gov-ernments, also provides financing for them either through tax revenue assign-ment or grants. The determination of expenditures and assignment of revenuesto the different levels of government is carried out through the budgetary processinvolving a number of steps. First, the MOF issues a budget circular in Junecontaining detailed guidelines for preparing the budget to be submitted to the MOFby July or August. The guidelines are prepared on the basis of macroeconomicforecasts, the strategic framework and the projected availability of resources.The guidelines also prescribe the norms for projecting expenditures under eachof the heads.

Based on these guidelines, the provinces project current expenditures and alsoconsolidate similar estimates they receive from the districts. In a parallel process,they also prioritize their own investment projects and those submitted by thedistricts and communes and submit them to the Ministry of Planning and Invest-ment (MPI). Similarly the central line ministries submit forecasts of currentexpenditures to the MOF based on the guidelines, and investment projects to theMPI. These ministries also prepare the estimates with respect to the NationalProgrammes (see below) – the specific purpose transfers to local governments.The MPI then finalizes the investment outlay of the central government and eachof the provinces. The GDT and the customs department prepare forecasts ofrevenues and the State Bank of Viet Nam (the Central Bank) provides an estimateof borrowing. Finally, the MOF puts together the estimates of revenue fromdomestic and foreign sources and establishes budgeted recurrent and investmentexpenditures to balance the revenues. As a rule, the central expenditure forecastsmade by the provinces and line ministries are far in excess of the availableresources, two or three rounds of negotiations are required between the budgetdepartment of MOF and the provinces and other spending agencies.

Once the expenditures of each of the provinces are finalized, revenues areassigned to meet these expenditures through a combination of methods. Certain

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revenue sources are assigned directly to the provinces. Collections from cer-tain other taxes are shared with them. The residual gap is filled by sharing theproceeds from the turnover tax.9 Finally, if turnover tax is not adequate to fillthe gap, cash grants are allotted. The effect of policy and price changes, madebetween the budget cycles, on revenues and expenditures are calculated by theMOF, and additional grants are given, if necessary.

Thus, although the provinces account for almost one-third of total spending,their actual role in determining expenditure decisions is limited. The selectionof investment projects is done by the MPI. Provincial preferences are taken intoaccount only indirectly, and the final selection is both complicated and non-transparent. Similarly, though the provinces project current expenditures basedon an elaborate set of norms, the norms themselves are developed with respectto revenue constraints and hence do not really represent cost/need factors ad-equately. Moreover, in the end expenditure levels are decided by negotiations tomatch revenues, and the norms lose much of their relevance anyway. Provincesalso have very limited flexibility with regard to the composition of expenditure.Even though in principle, they can vary allocations between different functionswithin the overall ceiling, in practice they have hardly any leeway since thecentre determines both the number of employees and their salary levels in eachdepartment. Provinces can spend more than the budgeted amounts only when theyare able to collect more than the targeted amount of revenues assigned to them.

Two features of revenue assignments are notable. First, as may be seen fromTable 3, there is no fixity or stability in the assignments; the type of tax and theproportion to be assigned to each province is determined afresh every year. Thead hoc nature of assignments makes it difficult for local governments to planexpenditures. This problem should be obliterated by a new Budget Law imple-mented in 1996 under which the arrangements will remain stable for five years.Second, the system provides incentives to the provinces to distort the estimatesbecause they can retain revenues in excess of the targets and either spend theexcess or economic and social services or build the financial reserves.

IV.4 Evaluating Fiscal Arrangements

The preceding discussion shows that the system of transfers in Viet Nam fallsfar short of the ideal discussed in Section III. Indeed, the concept of transferitself is unclear. At one extreme, all revenue collections made by a province maybe considered as its own; in this case, the difference between expenditures andrevenue collections may be construed as transfers. Another concept of transferswould be to consider the transfers as the balancing component – the share ofturnover taxes and the cash grants received by provinces. Perhaps, the most

9. A province’s share of turnover tax is given by (Ei – Ri)/Ti if (Ei – Ri) > 0, where Ei, Ri , and Ti

respectively represent expenditures, assigned revenues from other tax and non tax sources (exclud-ing cash grants), and revenue from turnover tax in the ith province.

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Table 3 Revenue Assignment to Provinces in Viet Nam 1993–94

Central Revenues Assigned Revenues Shared Revenues

1993

1. External trade taxes2. Special

consumption tax3. Profits and

depreciation ofcentral enterprises

4. Revenue frommajor minerals (oil)

5. Personal income tax

1994

1. External trade taxes2. Special

consumption tax3. Profits and

depreciation ofcentral enterprises

4. Revenue frommajor minerals (oil)

1993

1. Land and housingtax

2. Slaughter tax3. Licence fee/taxes4. Registration fee5. Depreciation and

tax on capital useand profits ofcommercialenterprises

6. Profits tax7. Taxes on lottery8. Import/export tax

at the land border9. Transportation fees

10. Revenue fromforestry

1994

1. Agricultural tax2. Land and housing

tax3. Slaughter tax4. Licence fee/taxes5. Registration fee6. Depreciation and

tax on capital useand profits ofcommercialenterprises

7. Personal incometax (Except in BaRia-Vung Tau)

8. Taxes on lottery9. Transportation fees

10. Revenue fromforestry

11. Other minor feesand taxes

1993

1. Six provinces of theMekong River deltareceived shares ofagricultural taxesranging from 8 to60%. The remainingprovinces receivedthe entirecollections

2. Turnover tax

1995

1. Turnover tax (39Provinces receiveda 100% share andthe remainingreceived varyingshares depending onthe differencebetween projectedexpenditures and allassigned revenues)

2. 45 provincesreceived the entirecollections fromprofit tax. Theremaining 8 mostprosperousprovinces received50% of the taxcollected in theprovince

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realistic solution is to consider the entire expenditure of the provinces (exclud-ing the small amount of fees and charges they levy) as a transfer since provincesdo not have independent power to raise taxes. The critical factor in determiningtransfers is thus the preparation of the expenditure budget at the provincial level,and the relevant test in evaluating them is the distribution of expenditures acrossthe provinces – whether they enable the poorer provinces to provide a givenlevel of public services at reasonable tax rates.

As already noted, expenditure determination is beset with a number of prob-lems. The process of selecting investment projects is both complicated and non-transparent, and is certainly not based solely on consideration of the relative needsof the provinces. The fact that provinces can use ‘excess’ revenue collections asthey wish advantages the more prosperous provinces. The norms specified as thebasis for projecting current expenditures do not adequately represent needs norare expenditures finally allocated according to the specified norms. Some attemptis made to take account of cost differences by specifying different norms for cities,plains, midland and coastal areas, low mountainous and remote areas and high-lands, but it is not clear that the central government has adequate cost informationfor this purpose. In addition, the constraint on resources causes the norms to beset too low to provide reasonable levels of services.10 Inter-Provincial distributionof social and economic infrastructures is thus less a matter of objective analysisthan of negotiation and bargaining. In the final analysis, the allocation of expend-itures basically responds to bureaucratic and political judgements at the centrallevel, although the relationship between political leaders at the central and pro-vincial levels also appears to play an important role in expenditure allocation.

Uncertainty in revenues renders planning for the medium term difficult. More-over, larger revenue collections in a province in one year result in higher targetsfor the next year and appear, in at least some cases, to result in a lower provin-cial share of turnover taxes. In Ha Noi, for example, revenue collections in 1993were more than 50% higher than in the previous year and exceeded the budgetestimates by 15%. Much the same happened in 1992. Consequently, the share ofturnover tax accruing to the city was reduced from 70% in 1992 to 36% in 1993and was further reduced to just 6.3% in 1994.

Another source of possible inequity is in the system of revenue projectionitself. The tax department consistently tends to underestimate revenues so that itcan easily fulfil the targets set. This is in the interest of provinces as well, sincecollections in excess of the targets can be spent by them. Unsurprisingly, actual

10. In the case of education, for example, on an average, per capita expenditure in 1991–92 wasjust about US$1 and as over 80% was spent on teachers’ salaries alone, little was left for books,furniture and educational aids. In fact, in Soc Trang, one of the poorer provinces, per studentexpenditure was less than US$2. The situation is equally bad in the case of economic services. InThanh Hoa, for example, the sanctioned budget for strengthening embankments is less than 10% ofwhat is requested, with the result that the province must mobilize a lot of voluntary labour from thecommunity even to strengthen the weakest segment of the embankments. The situation is similar inthe case of other services.

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Table 4 Revenues and Expenditures – Targets and Estimates

Provinces Per Capita Revenues – 1993 Per Capita Expenditures – 1993

Targets Latest Estimate Increase in Percentage Targets Latest Estimate Increase in Percentage(Dongs ’000) (Dongs ’000) Estimates over increase (Dongs ’000) (Dongs ’000) Estimates over increase

Targets (Dongs ’000) Targets (Dongs ’000)

High-Income 656.43 758.10 10.67 15.5 178.83 230.2 51.67 28.9Middle-Income 95.43 111.19 15.76 16.5 95.65 122.45 26.8 28.0Low-Income 54.53 69.92 15.39 28.20 104.73 135.76 31.03 29.6All Provinces 278.60 323.89 45.29 16.30 126.54 162.99 36.45 28.8

Source: Bird, Litvack and Rao (1995).

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revenue collections have exceeded the targets in every single province since1990 (Table 4). Although a larger share of some of the taxes collected in higher-income provinces goes to the centre in per capita terms, the richer provinces stillretained higher excess collections and therefore had higher per capita expendit-ures. Actual per capita expenditures exceeded the budgeted amounts by D 51,670in high-income provinces, by D 26,800 in middle-income provinces, and by D31,030 in low-income provinces. Thus, the system has worked to the relativeadvantage of the richer provinces.

To summarize, the system of fiscal arrangements and the design of intergov-ernmental transfers in Viet Nam can clearly be improved in a number of respects.First, local authorities have very little autonomy and flexibility in deciding thelevel and composition of expenditures. Second, the norms used to make projectionare neither scientific nor relevant in the final analysis. Third, the ad hoc nature offiscal arrangements creates both uncertainties and disincentives for provincialgovernments. Finally, the provision that revenues in excess of targeted amountsmay be retained has disproportionately helped the richer provinces.

IV.5 Equalizing Effect of Transfers

Although the provinces accounted for almost 35% of total public expendituresin Viet Nam the amount they spent in absolute terms seems unlikely to be largeenough to make a significant dent on the poverty problem. In 1992, per capitaexpenditure of the provinces was just about 126,000 dongs or about US $12(Table 5) which does not amount to much even considering the relatively lowunit cost of providing public services. As capital expenditures constituted about20% of the total, on average, local governments had little more than $2 (US) perhead to invest. The absolute level of resources available to local governments inViet Nam is so low as to make it difficult for those governments to provide eventhe most minimal level of services.

The basic inadequacy of local fiscal resources has been exacerbated by stabil-ization policies since 1989, which have severely compressed investment expend-itures. In 1991, capital expenditure in constant prices was actually lower than thecorresponding figure for 1985 by 12.3%.11 The compression appears to have beenespecially marked with respect to expenditures on agriculture and irrigation, andto some extent, roads. Although the share of government expenditure in GDPincreased from less than 20% in 1985 to 23% in 1992, expenditures on agricul-ture, irrigation and roads – the three most identifiable and important items fromthe viewpoint of poverty alleviation – actually declined.

Unfortunately, the distribution of central government expenditure by provinceis not available. Although it is possible that such expenditure may be allocatedto some extent to offset the disequalizing effects of provincial expenditure, only

11. Government investment expenditure at constant (1982) prices in 1991 was 21,762 dongs ascompared to 24,839 dongs in 1985. See, Bird, Litvack and Rao (1995, p. 11).

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Table 6 Per Capita Provincial Expenditures (1993)(’000 dongs)

High-Income Middle-Income Low-Income All ProvincesProvinces Provinces Provinces

1992 (Actual)1. Capital expenditure 34.6 14.9 20.8 25.02. Current expenditure: of which: 126.3 73.6 79.7 98.1

Education 22.0 17.3 17.4 19.4Health 13.7 7.8 7.8 10.4

3. Total expenditure 160.9 88.5 100.5 123.1

1993 (Budget Estimates)1. Capital expenditure 27.0 14.0 19.9 19.92. Working capital for SOEs 12.4 2.8 2.4 5.63. Current expenditure, of which: 139.2 78.9 82.5 100.6

Economic services 40.4 11.1 13.7 21.9Education 26.5 21.8 23.3 23.0Health 14.7 9.3 4.4 11.3

4. Total expenditure 178.6 95.7 104.7 126.6

Note: High-income provinces are those with per capita income more than 450,000 dongs; middle-income provinces are those with 300,000–450,000 dongs and low-income provinces are thoseless than 300,000 dongs.

Table 5 Distribution of Per Capita Provincial Expenditures by Region (1993)(’000 dongs)

Per capita GDP Poverty Ratio Capital Total(1989 prices) Expenditure Expenditure

1. Northern Mountains 332.5 59 22.3 119.12. Red River Delta 448.4 49 20.5 126.33. Central Coast-Northland 277.6 71 13.5 83.04. Central Coast-Southland 331.2 49 20.4 122.05. Central Highlands 380.8 50 25.4 134.56. Northeast of Southland 1117.0 33 31.8 235.17. Mekong River Delta 472.0 48 13.7 99.18. Average 478.2 51 19.9 126.1

the latter can be analysed here. In general, as Table 5 shows, per capita provin-cial expenditures are clearly higher in more prosperous regions. The highestbudgeted per capita expenditure was in the North-East of Southland (Ho ChiMinh City) where per capita income was the highest and the poverty ratio wasthe lowest. Similarly, the lowest per capita expenditure was in the North-Centralcoastal region where per capita income was the lowest and the poverty ratio wasthe highest. A similar pattern emerges for expenditures on different items for thetwo years shown in Table 6. In aggregate, per capita expenditure in the high

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Table 7 Correlation Coefficients of Per Capita Expenditures with Capacity andNeed Variables

Current Expenditure Capital Expenditure Total Expenditure

A. Variables Representing ‘Capacity’1. Per capita GDP 0.574* 0.338* 0.366* 0.282* 0.543* 0.327*2. Per capita agricultural −0.424* −0.354* −0.351* −0.388* −0.426* −0.368*

production3. Per capita industrial 0.479* 0.243* 0.279* 0.207 0.445* 0.236*

production4. Per capita production 0.493* 0.179 0.216 0.136 0.368* 0.170

(Agriculture + Industry)

B. Variables Representing ‘Need’1. Population density 0.324* 0.349* 0.132 0.239* 0.283* 0.323*2. Road length/sq. km. area 0.050 0.122 −0.008 0.100 0.035 0.0923. Agricultural productivity −0.228* −0.282* −0.277* −0.350* −0.257* −0.3054. Infant mortality rate 0.093 0.144 0.053 0.244* 0.086 0.1745. Illiteracy rate 0.160 0.214 0.140 0.365* 0.163 0.259*

Notes: 1992 – Actual. 1993 – Budget Estimates. * denotes significance at least at 5% level.

income provinces was 31% above average in 1992 and 41% above in 1993,though in some services like education the inequality was much less pronounced.The positive and significant correlation of per capita expenditures with per capitaincomes in different provinces both in 1992 and 1993, confirms that the relat-ively more affluent provinces have higher per capita expenditures.

Two important inferences emerge from this discussion. First, the resourcesavailable at the provincial level are so low in absolute terms that they are unlikelyto have more than a very limited impact on poverty. Second, the distributionof resources among the provinces appears to favour the relatively better-offprovinces who spend more in per capita terms. Although unit costs of providingsome public services may be higher than the national average in more urbanizedareas, others will be lower. Cost differentials alone seem unlikely to account forthese results. Indeed, in the north mountainous region, where low populationdensity means that the unit costs of providing public services are also likely tobe well above average, per capita expenditures were actually below average.

The correlation coefficients reported in Table 7 confirm that provinces withhigher per capita GDP had higher per capita expenditures. The results show thatboth current and capital expenditures are higher in more developed provinces.Per capita capital and current expenditures are significantly related to per capitaindustrial output, but have a significant negative correlation with per capita agri-cultural output and productivity. Per capita expenditures were also higher in moredensely populated provinces, which implies that higher unit costs in mountainousand remote areas are not adequately reflected in the determination of aggregateexpenditures. Actual per capita expenditure in 1992 had no significant association

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Table 8 Inter-Provincial Variations in Per Capita Expenditures: Regression Results(Log-linear equations)

Independent variables Total Expenditure Total Expenditure Current Exp. Capital Exp.(1992) (1993) (1992) (1993)

Constant 0.771 1.316 0.347 0.244(0.726) (1.202) (0.308) (0.217)

Per capita GDP 0.651* 0.499* 0.650* 0.578*(6.639) (5.259) (6.974) (6.497)

Population density −0.076 −0.021 −0.117 −0.108(−1.208) (−0.318) (−2.465) (−2.296)

Agricultural productivity −0.355* −0.485* – –(−2.129) (−2.700)

Illiteracy rate 0.245* 6.305* – –(2.268) (2.693)

Infant mortality rate 0.075 0.090 – –(0.424) (0.487)

Length of roads per sq. 0.041 0.061 −0.015 0.058km. area (0.771) (1.097) (−0.325) (−1.186)

Enrolment ratio – – −0.187 0.020(−1.599) (0.171)

Teacher-student ratio – – 0.1611 0.230(0.718) (0.992)

Hospital beds per 1000 – – 0.294* 0.246*persons (2.617) (2.131)

K2 0.494 0.412 0.541 0.509F 9.444 7.078 11.206 8.699

* Significant at least at 5% level.

with other ‘need’ variables such as infant-mortality rate or the literacy rate thoughthe latter showed significant correlation with budgeted expenditure in 1993.

The regression results for inter-provincial differences in per capita current,capital and total expenditures are presented in Table 8, generally confirm theseobservations. In all the equations, the regression coefficient of per capita GDP ispositive and significant for both 1992 and 1993. Similarly, population densityshows significant diseconomies of scale though the rate of increase in expend-itures was lower as the rate of population density increases (log-linear equation).These regressions do suggest, however, that there is some attempt to spend morein provinces with lower agricultural productivity and higher illiteracy rate. Butper capita expenditures were not significantly related to other need variablessuch as infant mortality and road length per sq. km of area.

Unfortunately, data on provincial expenditures are available at the requiredlevel of disaggregation only for the education and health sectors. Similar cor-relation and regression analysis was carried out for per capita education andhealth expenditures with various ‘capacity’ and ‘need’ variables (Bird, Litvackand Rao, 1995) with broadly similar results. Expenditure on education was, forexample, higher in provinces with a higher illiteracy rate. In the case of health

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Revenue-93

Exp-93

Exp-94

9

8

7

6

5

4

35 5.5 6 6.5 7 7.5 8 8.5

Ln Per Capita GDP

Ln P

er C

apita

Rev

enue

/Exp

endi

ture

Table 9 Regression Equations

Dependent Variable Constant Reg Coeff Per K2 FCapita GDP

Per capita revenues – 1993 –3.5445 1.4044 0.6152 82.5262(–3.7741)* (9.0841)*

Per capita expenditure – 1993 2.6991 0.4067 0.2489 17.8988(4.6220)* (4.2307)*

Per capita expenditure – 1994 4.1612 0.1975 0.0632 4.4414*(7.2891)* (2.1075)*

Notes: Both dependent and independent variables are in logarithmic form.* Significant at least at 5% level.

expenditures, significant positive correlation with population density perhapssuggests inadequate recognition of cost disabilities. Although per capita healthexpenditure has no correlation with such ‘need’ variables as infant mortality rates,it is significantly influenced by the number of health workers and hospital beds.Interestingly, although budgeted expenditures on education and health in 1993in different provinces were not significantly related to per capita GDP, actualexpenditures in 1992 were higher in provinces with higher per capita GDP. Thedifference between planned and actual expenditures appears to result from theability of more prosperous provinces to collect larger than targeted revenues.

In spite of the positive relationship between per capita expenditure of the pro-vinces and per capita GDP, there has been a significant degree of equalizationacross provinces. This can be inferred from the difference in the income elasticit-ies of revenue collections and expenditures estimated by employing a log-linearregression model for the cross-section of the provinces in 1993. The estimatespresented in Table 9 show that income elasticity of expenditures (0.407) wasappreciably lower than that of revenues (1.404). Thus, expenditures are distributedmore equally than revenues and, as may be seen from Figure 1, the overall effect

Figure 1 Equalization in Viet Nam

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of the transfer system is clearly redistributive. Further, the degree of equaliza-tion increased between 1994 and 1993. While the income elasticity of provincialexpenditure in 1993 was 0.4, it was just about 0.2 in 1994. Even if a part of thedifference in the elasticities may be accounted for by tax spillovers (richerprovinces collecting revenues from the residents of poorer provinces), it wouldappear that with all its imperfections, the general purpose transfers do have asignificant redistributive effect.

IV.6 Specific Purpose Transfers in Viet Nam

Even in a system in which the general-purpose transfers fully offset local fiscaldisabilities, specific-purpose transfers are necessary to ensure that the public ser-vices with inter-jurisdictional spillovers are provided in optimal quantities. Inaddition, with respect to certain priority or meritorious public services like pov-erty alleviation, the centre may have to ensure that minimum levels are providedthroughout the country. Additional specific-purpose transfers are then necessaryto alleviate the effects of differential provincial capacities to provide servicesrelated to poverty alleviation.

In Viet Nam the central government has introduced 32 different special pro-grammes in the education, health and social welfare sectors to cope with theperceived inadequacy of provincial spending on specific items. These programmesare funded by the central government, but implemented by the local governments.Not all of them are specifically directed at poverty alleviation, either directly orindirectly. There are nine programmes on health care, 12 on education and train-ing, and the balance relate to social, cultural and other areas. Total expenditureon these programmes in 1993 amounted to only 1615 bn dongs, or just about 4%of total expenditures or 12% of provincial expenditures. By and large, the dis-tribution of expenditures on these National Programmes across provinces seemsequitable as may be seen from Table 10. Though the programmes are for spe-cific purposes, the amount of money is distributed so thinly across different pro-grammes and provinces that it is doubtful whether they can make an appreciabledifference to the level of services.

One important central programme that is specifically targeted to alleviatepoverty is a subsidized loan programme introduced by the Treasury and imple-mented through the Ministry of Labor for self employment for the unemployed.The programme was introduced in mid-1992, and budgeted expenditure was aboutD 300 bn in 1993. The loans are given to individuals (D 50 bn) and to smallenterprises and workshops (D 200 bn). The scheme covers Ha Noi and Ho ChiMinh cities and mountainous low density provinces. Loans for self-employmentat subsidized interest rates are given after scrutinizing applications submitted tothe Provincial Peoples’ Committees. The process is similar for small enterpriseloans, which are not directly targeted to the poor, but are given to generateemployment. Loans carry a monthly interest rate of 0.5% for loans up to oneyear, 0.4% for loans up to 2 years, and 0.3% for loans up to 3 years.

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Table 10 National Programmes on Education and Health

Programmes High-Income Middle-Income Low-Income All ProvincesProvinces Provinces Provinces

Health programmesCentral Programmes 2.81 3.48 4.85 3.65Provincial and District 21.92 17.90 19.64 19.78

ProgrammesCommune Programmes 0.18 0.36 0.60 0.37

Total 24.91 21.74 25.09 23.80

Education programmesPre-primary 2.76 1.31 1.38 1.83Primary 18.37 16.12 14.44 16.40Jr. secondary 8.72 7.94 10.00 8.80Sr. secondary 4.19 2.98 3.10 3.43Others 1.96 1.20 1.81 1.64

Total 35.96 29.48 30.78 32.07

This employment programme could be useful but at present it suffers from anumber of shortcomings. First, it is only a small pilot programme in two citiesand a few provinces – and, as mentioned earlier, the incidence of poverty in thetwo cities is relatively low. In terms of the amount of money, D 300 bn is lessthan 0.5% of the total budget. Second, although the loans to enterprises areostensibly given to generate employment, the recipients may be quite affluent,and there is no mechanism in place to ensure that these enterprises in factgenerate the number of jobs proposed, once the loan is received. Third, themaximum individual loan is D 500,000 or about $45 (in Ho Chi Minh city, it isD 600,000). Even at a 25% rate of return, the additional income generated willonly be 125,000 or about $12 per year: any impact on the living conditions ofthe poor is going to be marginal. Moreover, the fact that the loan is given for amaximum of three years makes it more difficult for poor persons to benefit fromthe scheme. Finally, while obviously repayment capacity should be taken intoaccount to some extent in any loan programme, there is no explicit attempt toallow for the intensity of poverty in determining who benefits from this pro-gramme. The available information on the distribution of expenditures on theprogramme across provinces shows that per capita expenditures were signific-antly higher in richer provinces, as may be seen from Figure 2.

V. Reorganizing Intergovernmental Fiscal Arrangements forPoverty Alleviation

As Viet Nam makes a transition from central planning to market-determinedresource allocation, intergovernmental fiscal arrangements need to be reorientedto ensure responsive provision of public services corresponding to the diversifieddemands and varied resources and potential of different regions. The growth

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Figure 2 Distribution of Expenditure on National Programme on Hunger Eradication

Ln P

er C

apita

Exp

endi

ture

5

6

789

10

10 11 12 13 14 15 16

11

Ln Per capita GDP

Notes: The fitted regression equation is: LnE = −8.7538 + 0.7844 Ln Y * K2 = 0.126*(−2.246) (2.625)

where E refers to per capita expenditure on the programme and Y, per capita GDP. Figures inthe parentheses are ‘t’ values of the regression coefficients. * denotes significant at 5% level.

potential of the economy may be best realized and the faster improvement in theconsumption standards of the poor achieved when public services respond to thediversified preferences of different regions. The effectiveness of decentralizedgovernments in efficient provision of public services can be enhanced by reori-enting intergovernmental fiscal arrangements to provide incentives and promoteaccountability, replacing the negotiated system with one which is rule-based,transparent, and properly designed to achieve the objectives of offsetting the fiscaldisabilities of poor provinces and ensuring minimum standards of ‘merit goods’(such as poverty alleviation) throughout the economy.

An important way to ensure appropriate incentives and accountability in theprovision of public services is through linking the revenue raising and expendituredecisions of sub-central governments at the margin. One way to do this would befor provinces to have greater power to raise revenues. At present, the provincescannot vary the levels of public services even if their residents would be willingto pay higher taxes because they do not have the right to determine the rates ofany taxes. Provinces can increase spending only when the actual collection ofrevenues assigned to them exceeds the budgeted targets or by levying some minorcharges and fees. Of course, the power to levy taxes whose bases are mobileacross different provinces should remain with the centre, and provincial govern-ments should be restrained from imposing taxes that will basically be exportedto other areas. The basic principles of local revenue assignment are: (i) localown-source revenues should ideally be sufficient to enable at least the richestlocal governments to finance from their own resources all local services primarilybenefiting local residents (as opposed to those with significant externalities suchas education); and (ii) as far as possible, local revenues should be collected fromlocal residents only, preferably in relation to the perceived benefits they receivefrom local services (Bird, 1993).

When transfers are needed to finance provincial expenditures, ideally theyshould both provide incentives for provincial revenue mobilization and, as a

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rule, allow for some degree of equalization. The critical point is that provincialgovernments must, if they are to be held accountable for their actions, havesome responsibility for determining tax rates. This would both allow them tovary rates to collect larger revenues to finance higher levels of public servicesif they so choose and at the same time allow the central government to designits transfers in such a way as to ensure that provincial fiscal efforts were notdiscouraged by the receipt of such funds. Assigning at least some independentrevenue-raising authority to the provinces is essential to establishing a linkagebetween revenue raising and expenditure decisions at the margin.

Of course, if the power to levy important taxes is assigned to provincial gov-ernments, inevitably richer Provinces will collect larger revenues. To offset thisdisequalizing effect, as just noted, transfers have to be designed to provide suf-ficient revenues to provincial governments to carry out a ‘standard’ (minimum)set of provincial expenditure, as set for example by a revised (and more accurate)set of norms, provided they levy taxes at average national rates. In the evolutionof an objective system (as opposed to the current negotiated system) of deter-mining provincial expenditure requirements, the development of appropriate normsfor current and capital expenditure is important. In principle, it is not difficult towork out the precise design and implementation of such a transfer system, ifadequate information on the cost and need variables are collected.12 In practice,in a developing country like Viet Nam it is probably better to keep the systemsimple by using unit costs (e.g. per student) adjusted only for easily ascertain-able factors such as population density.

Sensible local government decisions require more stability and certainty infinancial arrangements than now prevails. Although Viet Nam’s new budget lawshould improve matters in this respect, a more scientific method of forecastingrevenues and expenditures would also be an improvement. As in the case of cur-rent transfers, simpler and more transparent arrangements in determining invest-ment allocations are also needed.

Another area where reform seems needed is in regard to the National Pro-grammes initiated by the centre. Most of these programmes are so small they seemunlikely to have any significant impact on anything. It would seem more sensibleto focus on a few programmes that might have an impact on poverty reduc-tion. Providing drinking water, family planning, and adult literacy, for instance,are programmes that would appear useful from this perspective. Programmes tocombat widely prevalent diseases (like malaria and goitre) may also of course beessential. Given the nation-wide externalities from spending on human capitalformation, provincial initiative in these areas may be encouraged by specific-purpose matching grants. There may also be a place for such grants, at higherrates of subsidization, in mountainous regions and for ethnic minorities. If theprovinces are given the right to levy and collect some taxes as suggested above,the introduction of specific-purpose transfers with matching resource requirements

12. For examples of an analysis along these lines, see Ahmad (1996).

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should result in greater provincial participation and hence augment the resourcesfor such special programmes. Equally important is the need to maintain localinitiative and flexibility in implementing the National Programmes. It wouldseem appropriate to have a set of nationally important schemes eligible for assist-ance. Each province should be able to choose from among these schemes subjectto a provincial ceiling of central assistance. This procedure would enhance localinitiative, and ensure that the provision of public services conformed to localpriorities. The matching rate could also be made to vary with the income levelsof the provinces as it is unlikely that the general purpose transfers would be ableto offset the fiscal disabilities of poorer provinces entirely.13

In mountainous regions and drought-prone areas and in areas in which thereis large scale unemployment of unskilled labour, a rural works programme ofcreating wage employment might be introduced to provide infrastructure suchas rural roads, creating and deepening of ponds, lakes and canals, repairing andstrengthening of embankments and building school and health centres. Such aprogramme might, for example, generate a fixed number of person-days of em-ployment during the lean season. One advantage of such a programme is its self-selection process: targeting the programme to benefit the poor is easy as only thepoor will seek such employment. This approach might supplement the presentself-employment loan programme, which, as noted earlier, needs to be betterdesigned and targeted.

In evolving improved intergovernmental fiscal arrangements, it is obviouslyuseful to build on the existing system as much as possible by minimizing itsundesirable effects and imparting the necessary, autonomy, incentives and ac-countability to various levels of government. The key elements in this processwould seem to include the following:

(i) devolution of some independent revenue-raising authority to provincial gov-ernments, in particular, the right to set the rates of some provincial taxes;

(ii) creation of a more adequate method of resolving vertical and horizontalimbalance through a stable, simple and transparent revenue-sharing arrange-ment and general-purpose grants;

(iii) identification of activities for which specific-purpose transfers should bemade and determination of the matching requirements that should be estab-lished for different provinces;

(iv) provision of adequate stability in intergovernmental fiscal arrangements;

A system along these lines should prove much more responsive to the chang-ing needs of an emerging market economy while providing social and economicinfrastructure in an efficient manner. On paper, Viet Nam currently has a highlycentralized public sector. In practice, however, the way the system works pro-duces unplanned decentralization and basically places the poorer provinces in arelatively weaker position. A more formal system of fiscal decentralization in a

13. Higher subsidy rates may be needed in poorer areas to induce similar responses (Feldstein, 1975).

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coordinated and coherent framework along the lines sketched above could provehelpful in implementing more effective policies for poverty alleviation.

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fiscal decentralization and poverty alleviation in a transitional economy: the case of viet nam

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