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Local Government Form in Indonesia: Tax, Expenditure, and Efficiency Effects

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Abstract

This paper examines the impact of local government form on fiscal outcomes in Indonesia. The form of local government, that is, whether it is headed by a popularly (directly) elected or parliament appointed (indirectly elected) executive, is exogenously determined and therefore tax, expenditure, and efficiency effects of interest are well identified. The paper finds that the direct election of local government executives has no influence on the generation of own-source taxes but that local governments with directly elected heads spend less, especially on infrastructure, and save more compared to their counterparts with indirectly elected executives. Local governments with directly elected heads also spend more efficiently in pursuit of service outcomes than local governments with indirectly elected officials. Efficiency effects are found to be robust across education, health, and infrastructure sectors. A plausible underlying argument is that districts led by directly elected executives are relatively less corrupt than are local governments with indirectly elected heads and that this reduced corruption leads to declining spending on rent-seeking intensive infrastructure projects and more efficient use of fiscal resources in general. The investigation provides general support for the continuation of direct local elections in Indonesia, which have lately come under attack by some national politicians.

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Notes

  1. This study broadly equates local governments that are led by directly (or popularly) elected heads with presidential forms of government; they are referred to as mayor-council local governments in city management research. The article associates local governments with indirectly elected (or appointed) executives with parliamentary forms of government; they are denoted as council-manager local governments in the city management literature. The relevant terms are used interchangeably in this study.

  2. There are currently 34 provinces and 529 districts (not including Jakarta), comprising 430 (mostly) rural districts (kabupaten) and 99 municipalities (kota).

  3. The 20% education expenditure requirement includes spending on teacher salaries, and this makes the mandate rather easily met.

  4. Note that district-specific time trends are not included in the SFA specification. This was attempted but convergence proved difficult to achieve. A standard (i.e., non-district specific) time trend is included instead.

  5. Both σu and σv are also allowed to vary as a function of exogenous variables in the SFA model as well but this study does not employ these possible specifications.

  6. See Greene (2004) for another example of an SFA that uses service (health, in this case) outcomes as the output in the production function and government spending as one of the inputs.

  7. The impact of moving from indirect to direct elections on log per-capita spending can be approximated by e(β1) − 1 where β 1 is the estimated coefficient of the direct elections dummy. In the present case, the relevant calculation becomes e(−0.040) −1 = −0.039. That is, direct elections result in a decrease in total spending of 3.9%.

  8. TFE estimation sometimes suffers from the well-known “incidental parameters” problem, which may lead to biased and inconsistent parameter estimates (Greene 2005). In order to test the robustness of the TFE results, the models here have also been estimated by true random effects (TREs). Derived conclusions presented in the analysis, especially as regards the impact of direct elections on service delivery efficiency, are robust with respect to estimation method but space does not permit the presentation of the full set of results.

  9. Given that production in the current case is not defined in terms of physical outputs as would be typical in a production function model, the meaning of estimated coefficients (of both production inputs and determinants of inefficiency) is somewhat ambiguous. As such, the analysis and interpretation focus on the sign of the coefficients and not the magnitude. See the discussion in Greene (2004) regarding a similar set of circumstances.

  10. Along similar lines, other recent research on Indonesia (Martinez-Bravo et al. 2016) suggests that the longer that (Soeharto-era) appointed district executives held office, the worse governance and service outcomes tended to be.

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Authors and Affiliations

  1. Arndt-Corden Department of Economics, Crawford School of Public Policy, The Australian National University, HC Coombs Building, Room 7132, Canberra, ACT, 2601, Australia

    Blane D. Lewis

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Lewis, B.D. Local Government Form in Indonesia: Tax, Expenditure, and Efficiency Effects. St Comp Int Dev 53, 25–46 (2018). https://doi.org/10.1007/s12116-017-9236-z

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