Indonesia’s New Fiscal Decentralization Law: A Critical Assessment

In a recent publication by Blane D. Lewis from The Australian National University, the intricacies of Indonesia’s fiscal decentralization law come under scrutiny. This paper, titled “Indonesia’s New Fiscal Decentralization Law: A Critical Assessment,” offers a comprehensive analysis of a crucial aspect of Indonesia’s governance. Lewis’s assessment delves deep into the implications of the fiscal decentralization law, dissecting its potential impact on the nation’s economic landscape, governance, and society at large.

Indonesia’s recent enactment of Law 1/2022 regarding fiscal decentralization marks a significant development scheduled for implementation this year. This legislation introduces a series of noteworthy technical adjustments to the existing intergovernmental fiscal framework. Beyond its technicalities, the law is underpinned by a more implicit strategic objective: to enhance central government influence over regional entities. This augmented central control is executed through conventional tools of public finance, with a distinct focus on mechanisms such as “performance incentives, revenue earmarking, and expenditure directives.”

The Policy Question

The ongoing policy discussion in Indonesia revolves around the effectiveness of the country’s unique fiscal federalism system in enhancing the quantity and quality of local public services. The paper considers the debate on whether this system has brought about sufficient improvements in public services, both on average and across the diverse regions of Indonesia. The author examines and evaluates the major elements of the new decentralization law, with a particular focus on its objectives related to improving ‘district own-source revenue generation, the design and distribution of intergovernmental fiscal transfers, district borrowing and savings, and district spending’. This is done through a review of the recent macroeconomic developments in Indonesia and then the Law 1/2022.

Key Findings

  • The result of an in-depth analysis reveals inherent flaws in the design of many of the law’s proposed reforms. The paper highlights that this legislation, by its very nature, cannot address the fundamental challenges associated with decentralization, including issues such as corruption and clientelism.
  • Consequently, the interventions outlined in the law are unlikely to successfully achieve their intended goals, which encompass improving the equitable distribution of financial transfers among regions and enhancing subnational government capabilities in terms of tax collection, fiscal efficiency, and the delivery of public services.
  • As a result, the measures delineated in the legislation are improbable to effectively attain their desired objectives, which encompass enhancing the fair allocation of financial transfers across regions and strengthening the capacity of subnational governments in areas such as tax collection, fiscal efficiency, and the provision of public services.

Lewis highlights that as a result, the law’s interventions are unlikely to satisfactorily realize their intended objectives of improving the distributional equity of transfers across regions and enhancing subnational government tax mobilization, spending efficiency and service delivery outcomes.

According to Blane D. Lewis’s assessment, the potential implications of this new law for Indonesia’s economy and political landscape are mixed. Overall, the success of the new law will depend on how well it is implemented and whether its flaws can be addressed.

Blane D. Lewis (2023) Indonesia’s New Fiscal Decentralisation Law: A Critical Assessment, Bulletin of Indonesian Economic Studies, 59:1, 1-28, DOI: 10.1080/00074918.2023.2180838

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