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Indonesia’s decentralisation program was designed and implemented along three main policy axes, namely political decentralisation, administration decentralisation and fiscal decentralisation. Under Laws No. 32/2004 and No. 33/2004 concerning regional autonomy and financial balance (dana perimbangan), the governments of autonomous regions are endowed with the right to manage the interests of their own population according to their own aspirations in accordance with the laws.

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Political decentralisation has focused on the handover of political authority from central government to local governments, with the establishment or re-establishment of local government elected through general elections. Political decentralisation has therefore included implementation of regional electoral reform and reform of political parties, as well as granting the right to participate in elections. In Indonesia, the implementation of political decentralisation is characterised by the recognition of areas as separate entities that are entitled to regulate, organise and take care of their areas and government functions. To that end, regional governments are chosen through direct election of both an executive and a legislature—a democratic process that, theoretically, enables the population’s participation in local development.

Administrative decentralisation involves the devolution of part or entire responsibility for the functions of government to the regional and local levels. In a decentralised administration, planning and implementation at regional and local levels is intended to better extend services to the grassroots level, in such areas as public health services, education and road construction.

Fiscal decentralisation implies a transfer of fiscal power from the central to regional governments (regional and local) in specific functional areas, such as adjusting settings for the transfer of resources between regions and giving powers to local government to generate their own sources of income. The transfer of power is also accompanied with an authority to collect taxes and decide on budgeting and expenditure, as well as matters related to the allocation of funds between governments. Fiscal decentralisation in Indonesia, based on Law No. 33/2004, adheres to the principle ‘money follows functions’, in that the fiscal authority delegated to the regions is designed to move delivery of government activity from the centre to the regions. Progressing fiscal decentralisation has become a very important item on the political agenda, which both central and local government must address to create a transparent and efficient agenda for the benefit of society (Brodjonegoro, 2001).

Following more than a decade of operating a decentralised system, the new transfer system has been only partially successful in achieving decentralisation

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benchmarks. Despite making a commitment to increased local budgets given the importance of East Kalimantan’s natural resources to the national economy, intergovernmental transfers from central government to the province are still not well developed. For several years there has been no transparency in budget calculations and there is no local budget consultation with the public at all. This pattern reflects a similar process encountered in China, as confirmed by research conducted by Yongzheng Liu, Jorge Martinez-Vazquez and Baoyun Qiao (2016).

As noted, the policy of fiscal balance between central and regional governments accords with the principle that division of authority or money follows function. In practice this should mean that, in terms of the financial relationship between the central and regional governments, expenditure decisions will be the responsibility of the local area, financed from currently existing revenue sources (Sidik, 2002). Governance activity based on the principle of decentralisation is financed by local budgets, governance implementing the principle of de-concentration is financed by the national budget, and the governance in the context of co-administration is financed jointly by the budgets of the government levels involved (Sidik, 2002).

The authority to levy taxes (tax assignment) includes the provision of revenue sharing and financial assistance (or grants), also known as equalisation funds. In general, the source of regional funds consists of local revenue, fund balance (revenue- sharing fund, general allocation fund, and specific allocation fund) and loan categories, de-concentration and co-administration. The first three sources are directly managed by the local government through the local budget, while de-concentration and co-administration are managed by the central government in collaboration with local government (Sidik, 2002). In accordance with the provisions of Law No. 33/2004, the financial balance is an area of funding from the state budget consisting of revenue-sharing fund, the general allocation fund and the specific allocation fund. The balancing fund is, in addition, intended to boost local authority and reduce the inequality of funding between central and local government while reducing disparities between regions.20

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Despite being the site of large revenue-producing mineral resources, the province of East Kalimantan has been forced to accept low levels of progress compared with elsewhere in the region. However, in 2001 the milestone of regional autonomy was achieved with the implementation of decentralisation in all provinces in Indonesia, including East Kalimantan, and the regions began to be given the new financial resources. Tax assignment (the authority to levy taxes), intergovernmental financial transfers (transfer of funds), and sub-national borrowing have been important elements in fiscal decentralisation on the side of the revenue (Martinez-Vazquez & Boex, 1999).

In accordance with Article 5 of Law No. 33/2004 on financial balance between the central government and local government, financial relations between central and local have been executed through a fund balance mechanism with a revenue-sharing fund (Dana Bagi Hasil/DBH), general allocation fund (DAU) and specific allocation fund (DAK) set every year in the national budget (APBN). DBH is taken from taxes and natural resources and tax revenue consists of: Land and Building Tax (Pajak Bumi dan Bangunan/PBB), Tax on Acquisition of Land and Building (Bea Perolehan Hak atas Tanah dan Bangunan/BPHTB), Articles 21 and 25 of Income Tax, and Article 29 of Taxpayers Domestic Personal. DBH obtained from natural resources cover: forestry, general mining, fisheries, mining of petroleum, natural gas mining and geothermal.

Given the new system of intergovernmental transfer, many Indonesian people expected that Indonesia’s economic growth and associated development would improve. The intergovernmental transfer model is implemented through financial balance, which consists of three types of sub-funds: Revenue Sharing Fund, General Allocation Fund and Specific Allocation Fund.

a. The Revenue Sharing Fund (DBH)

This mechanism for revenue sharing between central government and local government includes: revenue-sharing natural resources (forestry, mining, fishing, oil and gas), property tax (PBB and BPHTB) and personal income tax. The revenue sharing scheme established by the government was in response to

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the aspirations of the region to improve access to and control over local revenues and as a means to address vertical fiscal imbalance. Nonetheless, the East Kalimantan provincial government did not believe that the balance and fairness issues had been addressed by the central government, as evidenced by the collaboration of the provincial elite suing the central government through the Constitutional Court in relation to revenue-sharing from natural resources, and the accusation of the East Kalimantan government that the central government did not behave transparently in the calculation of the province’s natural resources production results.

The Revenue Sharing Fund, decreed by Law No. 25/1999 and revised Law No. 33/2004, states that the division of income between the central and provincial and local governments will be as follows:

Table 5.1 Revenue Sharing Fund Distribution Revenue Sharing

Instrument Central Share

Provincial Share

District/Municipality Share Property Tax 10%. Distributed to

district/municipality: 6.5% in equal amounts across all localities and 3.5% to places based on previous years’ achievements

16.2%. By derivation

64.8%. By derivation (except oil and gas sectors) a

Property Title Transfer Tax

20%. Distributed to all districts & municipalities in equal amounts

16%. By

derivation.

64%. By derivation Forestry Right to Operate

Levy 20% 16%. By derivation. 64%. By derivation Forestry Resources Commission 20% 16%. By derivation. 32% by derivation; 32% by commission in equal amounts across all localities within province

Mining Sector Land Rent 20% 16%. By

derivation.

64%. By derivation

Mining Sector Royalties 20% 16%. By

derivation.

32% by derivation; 32% in equal amounts (for all places within province) Tax Revenue on

Fisheries Operations

20% 0% 80%. Equal amounts for

all districts & municipalities in the country

Tax Revenue on Fisheries Output

20% 0% 80%. Equal amounts for

121 Revenue Sharing

Instrument Central Share

Provincial Share District/Municipality Share municipalities in country Oil Revenues 84.5% 3%. By derivation. 6% by derivation; 6 % in equal amounts within province

Natural Gas Revenues 69.5% 6%. By

derivation.

12% by derivation; 12 % in equal amounts within province

Personal Income Tax 80% 8%. By

taxpayer locationb

12%. Distribution by provincial choice

Notes:

a. Remaining 9% of property tax revenues reserved for support of tax collections carried out by central and local governments.

b. Taxpayer location, according to the legislation, may be employee residence, place of business activity, or employer home/office location. In practice, it appears to most often be the latter.

c. 0.5% of revenue generated from oil and gas respectively are specifically allocated for basic education. These funds are shared between the province, the producing district and other districts within the province.

Source: Central government Law No. 33/2004 on Fiscal Balance between central government and regional government

All levels have their own taxing powers, although the national government enjoys an average 20% of revenue sharing from income derived from activities such as Property Tax, Property Title Transfer Tax, Forestry Right to Operate Levy, Forestry Resources Commission, Mining Sector Land Rent, Mining Sector Royalties, Tax Revenue on Fisheries Operations and Tax Revenue on Fisheries Output. However, in the case of oil and gas, the central government received 84.5% and 69.5% respectively, while regional and local governments received just 15.5% and 30.5%, despite being the sources of the country’s oil and gas production.

b. The General Allocation Fund (DAU)

The general allocation fund states that at least 26% of revenue raised by each region will be reallocated back to the province. According to Government Regulation No. 110/2007, a further Allocation may be made for fiscal needs determined by population size, land mass, construction cost index, the human development index and the future fiscal capacity of the province (dependent on future potential income such as industry potential, natural resources potential, human resources potential, and Gross Domestic Product).

122 c. The Specific Allocation Fund (DAK)

In principle, the Specific Allocation Fund (DAK) is primarily intended to help fund critical needs that cannot be predicted in advance, in particular to assist local expenditures related to national priority events, such as disasters. The Specific Allocation Fund is also used to finance investments in physical capital, although the financing for a limited period of operational and maintenance requirements is permitted under special circumstances. For Specific Allocation Funds, allocation is based only on income from reforestation programs; currently 40% of revenue is returned to the county of origin, to be used for local reforestation efforts. It is a priority of the central government to further accelerate the design and implementation of various activities covered by the DAK (Alm et al., 2005).

Figure 5.1 Intergovernmental Fiscal Transfers in Indonesia

Source: Law No. 33/2004

The system of intergovernmental financial transfer has two main channels: grants and a Revenue Sharing Fund (DBH). Grants encompass two types of transfers: General Allocation Fund (DAU) and Specific Allocation Fund (DAK). General Allocation Fund cover salary expenses for public employees, the so-called basic allocation, but the bulk of DAU is allocated on the basis of a jurisdiction’s fiscal

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capacity and fiscal need—i.e. a fiscal gap approach. The formula-based fiscal need of a jurisdiction is defined by a number of socio-economic indicators, including population, area, Human Development Index, Gross Regional Product (GRP) as a proxy for economic potential, and a cost index. Fiscal capacity is defined by ‘own source revenues’ (PAD) and shared revenues. The Revenue Sharing Fund (DBH) comprises transfers from taxes and natural resources. General Allocation Funds (DAU) constituted the most important source of finance in the structure of local government revenue prior to decentralisation and continue to do so now (Lewis, 2005). Specific Allocation Fund (DAK) is allocated on the basis of specified criteria and finance targeted activities linked to central government priorities, ranging from education and health to rural facilities and the environment

The East Kalimantan government claims that there has been an imbalance between central government and the provinces—the source of the abundant natural resources—in revenue sharing, especially oil and gas. Although decentralisation is underway and the expectation is that resource-rich regions will benefit, the central government does not seem to have the intention to hand over its control of all revenues and management of natural resources to the regions. The wealth of natural resources may be owned by the local community, but it is not enjoyed by them. The claim by the elite in East Kalimantan that most of the province’s natural resources wealth, especially oil and gas, is not shared equitably has won popular support from all sections of the East Kalimantan community, who (as described in Chapter 7) united with the regional government and regional parliament to sue the central government through the Constitutional Court for the injustices of Law No. 33/2004 article 14 paragraphs e and f.