Fiscal decentralization for a functional Ethiopian federation

Fiscal decentralization for a functional Ethiopian federation

A clearer legal framework on the division of powers between federal and regional governments is a starting point for achieving political stability.

(ethiopia-insight)-Ethiopia’s multinational federal system was adopted in 1995 by the Ethiopian People’s Revolutionary Democratic Front (EPRDF) government primarily to try and end conflict among Ethiopia’s ethnic groups.

Implemented to institutionalize Ethiopia’s ethnic diversity and protect the integrity of the state, the constitution divided the country into administrative tiers: the federal government, regional states (kilils), zones, districts (weredas), and also the village areas (kebeles) inherited from the Derg.

This provided for top-down decentralization with the expectation that lower tiers of government would gradually acquire political and fiscal decision-making autonomy.

The implementation of a power-sharing arrangement involving the formation of nine ethnically self-administered states from a highly heterogeneous and dynamic society, a move to protect the rights and freedoms of the “nations, nationalities and peoples” of Ethiopia, subsequently dominated public debate.

This was partly because the states’ territorial and administrative boundaries in places fell short of reflecting Ethiopia’s ethnic diversity, and rather exacerbated exclusionist politics. It is a complex and heated debate, but solutions to Ethiopia’s social and economic problems are dependent on this power-sharing conundrum and its resolution.

When Abiy Ahmed was appointed as the Prime Minister in 2018, his government promised democratic reforms and the ending of poverty by unlocking Ethiopia’s economic potential. Indeed, the current transition and Abiy’s rise to power were driven in part by economic grievances arising from the unresolved problems of the federal system.

It seems clear that despite having shown a strong track record of economic growth, Ethiopia still needs to address structural economic defects and improve the federation’s functioning in order to move towards political stability. From this perspective Ethiopia’s Homegrown Economic Reform is good news—but only if it can successfully address uneven regional development patterns and wealth distribution.

Fiscal federalism theory

Federalism combines self-rule and shared rule, with the territorial, political, and fiscal power-sharing structures divided, but linked. Fiscal federalism or fiscal decentralization is a branch of public economic theory that analyses which fiscal functions (concerning expenditure) and instruments (concerning revenue collection) should be centralized and which are best decentralized and to what extent. The aim is to achieve optimal utilization of resources to produce sustainable growth.

The fiscal relationship between a federal government and the lower levels of administration, defined by the division of these functions and instruments, is institutionalized by an agreed tax system. In theory, expenditure for macroeconomic stabilization and redistribution functions is normally assigned to the federal government and revenue allocation for public services (e.g. allocation of income to different sectors such as health, education, or agriculture) to lower levels.

However, unless there is a mutually agreed arrangement to allow local governments to determine their revenue sources, a central government tends to take a more centralized fiscal approach. This appears as a decentralization of expenditure, but not revenue collection. It means that lower tiers of government can decide how they allocate federal transfers to different economic sectors but lack the autonomy to decide upon the tax sources or the share of revenue going to the federal government.

Citizens prefer policies that maximize local revenue generation and promote sustainable use of funds. But this requires a principle of subsidiarity to be respected and enforced within a federation, as the multilevel governance system allows for local government to be closer to the people, and arguably be more efficient and responsive to citizens’ needs.

Fiscal federalism practice 

The process of decentralization—the devolution of political and fiscal decision-making powers from the central government to regional states—began in 1991 and was institutionalized by the 1995 constitution. The District Level Decentralization Program to promote local self-governance and improve service delivery, for example, was launched in 2001 in Tigray to deepen decentralization, transferring fiscal and political powers, instruments, and resources from the regional state to zones and district administrations.

This was followed by a pilot project in Amhara, Oromia, Southern Nations Nationalities and Peoples (Southern Nations), and Somali regional states allowing districts to implement economic plans based on locally determined priorities.

While fiscal decentralization may have begun over 25 years ago, Ethiopia hasn’t yet achieved its intended core objectives. Despite being one of the fastest-growing countries in sub-Saharan Africa in recent years, the poorest sectors of society have been unable to benefit evenly from poverty-reduction mechanisms, such as better infrastructure, job availability, or agriculture assistance.

The goal of promoting local self-governance has not been fully met either.

Decentralization was implemented by EPRDF as a mechanism to rule Ethiopia through its respective disciplined party administrations. In the attempt to reconcile the previous government’s authoritarian nature with a multinational federation, fiscal decentralization was a tool to deflate secessionist demands; a short-term solution to Ethiopia’s existential questions.

There is, however, an overarching problem that has prevented the benefits of decentralization manifesting in Ethiopia, and, if not addressed, could very well hinder the positive impact of the economic reform. This is the lack of a clear and comprehensive legal framework to define the fiscal responsibilities and powers of the federal government vis-a-vis other administrative tiers.

One of the legacies of all previous regimes in the country is the highly bureaucratic administration, which still today made transparency and accountability of government expenditure and economic processes very opaque. In fact, public access to key fiscal information remains very low.

This could explain why EPRDF’s imposed top-down devolution of political and fiscal powers, meant to improve the government’s ability to deliver public services, failed to ripple down to lower tiers of government, and, arguably, contributed to chronic poverty remaining a big issue.

Even when administrative devolution takes place, it is not always followed by a devolution of decision-making powers. This further prevents local governments from controlling their economic aspirations and resource use.

The federal constitution has surprisingly little to say about fiscal matters.

Articles 94 and 95 stipulate that “the federal government and the states shall respectively bear all financial expenditures necessary to carry out all responsibilities and functions assigned to them by law” and “share revenue taking the federal arrangement into account.”

Since there is no clear division between the responsibilities of zones and district administrations, zones, often without fiscal autonomy, interfere by assigning unelected officials or civil servants to woreda administrations and sectors. It is true that district administration divisions no longer operate along ethnolinguistic lines, but they face challenges to redress zero-sum games played by locally elected officials.

Articles 96 and 97 determine the division of taxation powers. Article 98 states that the federal government and the regional states can jointly collect taxes of shared tax sources, but the federal government’s revenue generating power is higher than the states because it holds on to the bigger sources of revenue.

Article 100 attempts to define rules to prevent taxation negatively affecting the regional states, demanding, for instance, that taxes, should be “determined following proper considerations”; a statement that falls far short of understanding historical marginalization of the periphery. Nor, in practice, is the divide between federal and regional governments’ tax powers sufficiently clear.

Given the EPRDF’s controlling modus operandi, it is probable that the government coalition never planned to grant fiscal autonomy to regional states or districts, instead seeing them as vehicles to implement centrally determined development plans. However, as regional states developed their own national identities as well as political interests and the federal government continued its covert centralizing tendencies, resource distribution increasingly became a contested area.

Ultimately, decentralization becomes meaningless if the tools to implement it are not respected. Albeit inconsistently, zonal and district level administrations do now have the authority to implement centrally crafted development plans and can coordinate diverse development strategies, but they remain dependent on the resources transferred from the centre because their revenue-collection capacity has not significantly improved.

Certainly, as supporters of federalism frequently argue, Ethiopia’s solutions need to go beyond detangling the dichotomy of decentralized versus centralized economic and political structures.

It is rather that Ethiopia needs to overcome the legacies of the partisan realities that have so far prevented any genuine devolution of political and fiscal powers to the regional states. To improve people’s standard of living, local officials need to prioritize effective and equitable service delivery to all citizens under their jurisdiction.

Resulting tensions

For instance, in Dire Dawa, a city disputed by Oromo and Somali and their regions, competition for resources has taken on an identity dimension as identities have been reshaped to alter the demographic composition of the city to match the 2006 power-sharing formula 40:40:20 (political leadership is divided among Somalis, Oromos, and other ethnic groups, respectively).

In early 2019, protests were held to demand the end of this quota system claiming that it does not reflect the city’s evolving ethnic diversity. The problem of this power-sharing arrangement is that it does not take into account the city’s fast population growth that could alter the ethnic composition, nor the importance of regular elections that grant legitimacy to the arrangement.

Council elections for Dire Dawa have been postponed twice. In 2019, the National Electoral Board of Ethiopia (NEBE) could not hold them as the election preparation was behind schedule. In 2020, elections were postponed due to the COVID-19 pandemic. In June 2020, the government will try to organize both the Dire Dawa and the national elections amid general political instability.

Across the Oromia-Somali border violence has been intermittently showing the effect of not fully demarcated boundaries. In an attempt to re-define internal borders, some groups have been forced to renounce their identities and assimilated into larger identity groups. This issue, not exclusive to this area, has manifested in forms of inter-communal violence over land ownership and access to resources and contributed to high numbers of internal displacement.

The Sidama referendum, which marked a turning point for Ethiopia’s federalism as Article 47 on self-determination was put in practice for the first time since the constitution was enacted in 1995, falls short of being the solution to Ethiopia’s federal problems.

The campaign for autonomy in Southern Nations regions, a long struggle for identity recognition, access to resources, and political representation, was given momentum by Abiy’s arrival amid the EPRDF’s weakening. Other ethnic groups in Southern Nations such as Wolayta, now trying to follow the Sidama example, framed claims to autonomy partly as means to acquire taxation powers and administrative rights over land and natural resources.

However, although the Sidama group’s political aspirations are motivated as means to redress the problems of the Ethiopian federal system—inadequate devolution of economic and political powers and administrative deficits—they do not guarantee the enforcement nor the protection of economic and political interests of minority groups residing within the Sidama state. It is thus a Russian doll-like effect.

Equally, when Sidama pursues its bid to make Hawassa the capital of the new state, already opposed by the Wolayta and others, it would be detrimental to the remaining Southern Nations minorities. The region would already lose the revenue sources and a great share of the federal grants allocated to Sidama, the biggest constituency of the regional state. In October 2020, the Sidama council approved Birr 10.7 billion for the 2019/20 annual budget, which is 38.5 percent of the total government subsidies to the whole Southern Nations for the fiscal year.

What do the numbers tell us?

On 6 June, the  Council of Ministers approved a 476 billion birr budget for the 2020/21 fiscal year. The federal budget increased from 386.9 billion birr allocated in the 2019/20 fiscal year, as a result of federal finance policies to control inflation and increase economic productivity.

In addition to expanding and diversifying exports to generate revenue, the lifting of legal constraints on private investment will contribute to creating a good investment climate in the country and increase productivity.

The grant allocation formula, approved in 2017 and unchanged since then, considers population size, the revenue-generating capacity of the regional states, and expenditure responsibilities. The total amount is divided and transferred as follows: Oromia, 34.5 percent, Amhara 21.6 percent, Southern Nations 20.1 percent (though this will now presumably be shared with the new Sidama regional state), Somali 9.98 percent, Tigray 6 percent, Afar 3 percent, Benishangul-Gumuz 1.8 percent, Gambella 1.3 percent, Dire Dawa 0.9 percent and Harari 0.8 percent.

The same formula identifies the regions with the highest revenue potential as Oromia, SNNP, and Amhara, raising 36.3 percent, 18.8 percent, and 21.9 percent, respectively, of the total percentage of revenue generated or shared with the federal government.

Structural fiscal deficits remain a problem for Ethiopia’s sustainable economic growth as they constrain productivity.

For the regional states, the federal government’s general-purpose grants are the main source of annual budgets, and their respective parliaments retain full autonomy over how the grants are used. Oromia is the region with the largest fiscal gap (high expenditure and low revenue) forcing it to rely on the federal government to meet its spending. Harar, surprisingly, has the smallest shortfall and thus the greatest fiscal autonomy.

In all cases, however, the fiscal gaps allow the federal government to use the grant formula as a political tool to threaten regions that do not follow its economic or political demands. This means that by controlling budgets, the federal government still infringes the limits of shared- or self-rule.

Note: Except for negligible external assistance, the rest of the resources are transferred from the federal administration in the form of grants. Addis Ababa administration reports to self-generate 99 percent of its yearly revenues. Source: PEFA reports for Ethiopian Fiscal Year 2017/2018.

Although this affects all the regions, Tigray offers a good example of the way government transfers have been used to force political elites in regional states to follow centrally determined policy lines with detrimental consequences. On 6 October, the upper house of the Ethiopian parliament, the House of Federation, voted to sever ties with the TPLF-run regional government executive, after the Tigray People’s Liberation Front’s (TPLF) landslide win in the 9 September unilateral regional elections.

As part of its punitive response, the federal government planned to divert federal subsidies (10.4 billion Ethiopian Birr for the 2019/2020 fiscal year) to local administrations in an attempt to bypass the regional executive. This move, which put in question the structural power divides established by the federal system, was, according to TPLF, “tantamount to a declaration of war”.

Months before the run-up to conflict between TPLF and the federal government, political elites in Tigray had already claimed, on a number of occasions, that the federal government has threatened to withdraw fiscal transfers unless the TPLF supported the federal government political agenda and de-escalate secessionist trends.

The postponement of the national census is a sensitive issue that has not been given enough importance.

Ethiopia’s population has grown rapidly in recent years, yet since 2017 the federal government has postponed the census three times, using COVID-19 or internal displacement problems as the pretext for delay. Since population is one of the pillars of the grant-allocation formula, any changes can exacerbate the mismatch between expenditure necessities and economic productivity.

Whatever the census figures eventually reveal, they not only will they alter the current share of federal transfers, but will also raise important political questions that could jeopardize the upcoming electoral process. In this context, revising the federal grant formula to take account of Ethiopia’s population growth rate could contribute to helping reverse the mismatch between the expenditure responsibilities of regional states and their revenue-generating capacities.

Towards a functioning federation

The COVID-19 pandemic has exacerbated latent constitutional crises as well as drastically affected economies across the globe. One lesson to be learned is that mature federal systems do not re-centralize decision-making powers to address crises.

International examples prove the point.

Germany’s federal government notably cooperated with the sixteen landers (states) to plan an efficient response to the pandemic. Spain, where the constitutional legal framework does not protect the devolution of political, fiscal, and territorial decision-making powers, was however quick to re-centralize decision-making powers.

In Ethiopia, inconsistencies in the rule of law and economic strains have been clear.

From March until April 2020, before it imposed a State of Emergency, the federal government implemented measures without grounding them in existing laws. In June, the government was also able to extend its own tenure indefinitely without provisions to limit its political power.

While the process of constitutional interpretation to fill a gap in the country’s electoral law was a somewhat commendable exercise, the result showed that Ethiopia’s socio-economic and political realities are far more complex than the solutions offered in the constitution.

A comprehensive legal framework should be developed to consolidate the benefits of fiscal decentralization, to determine and regulate economic operations in all tiers of government and prevent the central and regional governments from altering or undoing aspects of regional and sub-regional autonomy.

Allowing regional states, zones, and districts to pass legislation to adjust their own tax rates would have a direct impact on their fiscal independence, giving subnational governments bargaining leverage and a degree of political independence.

In 2014, deadly protests erupted in Oromia after the federal government produced ‘the master plan’ to integrate Addis Ababa’s development with surrounding Oromia. In 2020, similar protests erupted in Oromia after the killing of Hachalu Hundessa, resulting in the authorities arresting Oromo opposition leaders.

Among other things, these protests in the same region five years apart reveal an increasing public perception that the government is accumulating political and fiscal powers in Addis Ababa at the expense of the political and development wishes of the largest ethnic group in Ethiopia.

Addis Ababa collects 20 percent of the government’s targeted annual budget from tax revenue, despite having only around five percent of the population. According to Article 100 of the constitution on taxation powers, the federal government and regional governments cannot levy taxes in their jurisdictions. However, they have concurrent taxation powers, which means that they share revenue from personal taxes on enterprises they jointly establish, among other revenue sources.

In the dispute between Oromo nationalist parties and the federal government over the political status and ownership of Addis Ababa, the fast expansion of the city and its role as the capital of Ethiopia without established legal frameworks to regulate land grabbing in contested areas has been resisted by Oromia.

Adanech Abiebie, the newly appointed Mayor of Addis Ababa has said she will prioritize the issue of land ownership, but this will need to be consistently addressed through elections and consultative initiatives that can restore trust between the Addis Ababa administration and its citizens.

With the recent security crackdown against prominent opposition leaders, including Eskinder Nega from Balderas for True Democracy, which has a significant constituency in Addis Ababa, the leadership of the Prime Minister’s Prosperity Party in the capital has been questioned. Contrary to the needs which emerged from the episodes mentioned above, the Prosperity Party’s development strategy has been seen as an extension of centralist policies pursued by former Ethiopian leaders.

Decision-making over infrastructure and development remains a top-down process. A realistic solution would be to further decentralize tax sources to infrastructurally limited regional states as this would help generate more revenue in the periphery to transform the extractive economy into a productive one.

Additionally, the imposed silence of opposition and weak institutional channels to challenge the government’s policies illustrate the failure of the federal government to understand that Ethiopia’s democratic political transition is only possible if opposition forces are recognized and accepted as important players.

Finally, all the examples discussed have been about competition over access to resources exacerbated by exclusionist politics. To allow full implementation of decentralized and democratic governance, greater oversight and accountability mechanisms are needed to encourage prudent fiscal management and assessment of concerns regarding the disparity between the quality of public services and the efficiency of local administrations.

This means shifting from upwards accountability to downward fiscal accountability mechanisms. This will make sub-federal politicians focus on satisfying their constituents, rather than competing among each other for a slice of the federal pie.

As Ethiopia works to break away from ethnic politics, public scrutiny should be expanded to create an atmosphere conducive for healthy political and fiscal competition.

A federal solution

Fiscal decentralization was originally implemented to promote local self-governance and to improve the quality and quantity of government service delivery to its citizens, but for nearly three decades Ethiopia has been struggling to define its political identity and maintain its sovereign integrity after losing access to the Red Sea following Eritrea’s independence in 1991, and it is now facing emerging self-determination movements, with Tigray secession from Ethiopia now a looming and destabilizing possibility.

Trying to combine de facto centralization with decentralizing tendencies has been seriously detrimental to political stability. Equally, many Ethiopians are still waiting for the government to meet its promise and lift the country out of poverty. That remains unlikely to happen in a country where vicious cycles of ethnic violence prevail.

Ethiopia needs to regulate the self-governance of the regional states and the relationship between the federal and state administrations more effectively, including decentralization of tax to help regions increase fiscal accumulation and encourage more participatory politics and accountable politicians.

Investing in policies that promote better mobilization of internal resources will allow the government to meet its goals of sustainable economic development and poverty reduction. For instance, the closure of export destinations due to COVID-19 has highlighted the need to increase local demand to meet the needs of its growing population. Meanwhile, the agriculture sector, which still accounts for around 80 percent of revenue from exports and remains the principal source of employment in the country, needs to be industrialized at a faster pace.

Today, almost three years after Abiy took office on a reformist ticket, Ethiopia remains polarized between ethno-nationalist and centralist forces. Federalism must remain the solution for Ethiopia’s structural problems—but it needs to have a legal framework to prevent the federal government from trespassing across the divide between central government and regional administrations.