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Towards a more responsive

and accountable IRA sharing scheme


BY JESSE M. ROBREDO
Mayor, Naga City

PHILIPPINE cities, through their national league, are once again faced with another
proposed measure pending in the House of Representatives that seeks to relax cityhood
requirements favoring 32 capital towns of provinces without a city.

As a former League of Cities president, I support the LCP position unequivocally, which is to
oppose House Bill 5737 on the grounds of its (1) doubtful legality, (2) violation of the equal
protection clause of the Constitution, and (3) trifling with the imperative requisite on locally
generated income. The LCP position paper, which incorporates my earlier stand* on a similar
measure in the Senate that would benefit 23 municipalities, has fully elaborated the legal
and financial bases of our continuing opposition.

In this brief, let me amplify the big picture framing this debate, and propose a possible way
out.

The need for a comprehensive solution


The controversy attending the proposed large-scale conversion of between 23-32
municipalities will be resisted strongly by the LCP, especially because it requires a lowering
of the bar for cityhood on the one hand, rendering inutile a policy it actively campaigned for
and secured from Congress; and because of its sheer impact on their IRA share, on the
other.

If given due course, it will be a financial windfall for the beneficiary municipalities but a
disaster for the 117 member cities of the LCP. The worst-case scenario prepared by the
Senate shows a reduction of P55.7 million this year, rising to P61.55 million in 2007. For
sure, these will be carried over into the succeeding years; with floodgates opened, these
costs will be aggravated by further conversion measures that will surely be filed in its wake.
Unless resolved under mutually acceptable terms, it will continue to fuel recrimination and ill
feelings among the disadvantage parties.

Clearly, a more comprehensive solution to this problem is required. If the Senate is open to
the idea of deferring IRA increase by one year from a municipality’s acquisition of city status,
then it should be equally open to the idea of deferring any IRA increase until such time that
a comprehensive solution—a more responsive and accountable IRA sharing scheme among
Philippine LGUs—is crafted. In short, the LCP and its member cities will not oppose
any proposed conversion provided the accompanying IRA increase will only be
effected when a more relevant IRA formula is put in place.

*
“The imperatives of protecting the IRA share of Philippine cities: A position paper on the proposed conversion
of 23 municipalities to cities” dated May 2, 2005.
The missing framework:
A more relevant IRA sharing formula
On October 10, the country will be celebrating the 15th anniversary of the Local Government
Code of 1991. Among others, the Code provides the following:

SEC. 521. Mandatory Review Every Five Years. - Congress shall


undertake a mandatory review of this Code at least once every
five (5) years and as often as it may deem necessary, with the
primary objective of providing a more responsive and
accountable local government structure.

Fifteen years later, no such review has been successfully concluded and effected, especially
in regard to the current IRA sharing formula which has already outlived its usefulness. It is
high time that any further conversion of a municipality into a city be tied to this mandated
review for two reasons arising from that very provision:

1. The need for a more responsive local


government structure

Evidence shows that the current IRA allocation formula no longer responds to current
realities. Let me to summarize the basic arguments of my previous position paper:

ƒ Philippine cities have been losing heavily under the current conversion scheme.
Provinces and municipalities have cornered the windfall gains arising from the current
IRA sharing. While the total IRA grew by 200% over the last decade, the cities’ IRA share
grew by less than 50% compared to provinces and municipalities whose shares increased
by at least 160%.

ƒ Ironically, this has been taking place at a time when cities increased their share in the
country’s total population. A decade back, only 25% of Filipinos are residing and/or
working in cities; now, the number has grown to 34% (during night time) and 43%
(daytime) of the Philippine population. Let me put it differently: Ten years ago, only 1
out of every 4 Filipinos is found in the cities; now, it is close to 1 of every 2. Yet their
IRA share remains pegged at 23%.

2. The need for a more accountable local


government structure

From policy perspective, the current system is hampered by the following limitations:

ƒ The IRA system is not tied to measurable development and governance outcomes among
local governments. By limiting the allocation criteria to population, land area and
equalization, the IRA remains as a performance-neutral system of national transfers. This
is a significant disincentive towards achieving the avowed goal of “providing a more
responsive and accountable local government structure.”
Fifteen years after the Code, we continue to hear divergent voices: on the one hand,
national government agencies, including Congress, bewail that LGUs are getting an
inordinately huge amount of money; on the other, LGUs keep on complaining that what
they are getting is not enough, given their expanded responsibilities. Yet the Holy
Scriptures admonish us: To whom that much is given, much is required. It is high time
we address this gap by bundling in performance-based criteria into the IRA system.

ƒ Moreover, the current IRA sharing formula, as well as House Bill 5737 itself, perpetuates
a regime of soft budget constraint (SBC), which breeds inefficiency and is therefore
inimical to national development interest. Let me elaborate further.

SBC and intergovernmental fiscal relations


There is a growing body of literature on SBC and its impact on intergovernmental relations,
especially in the light of decentralization movement in many countries worldwide. Vigneault
(2005) said: “The soft budget constraint problem in intergovernmental fiscal relations arises
when subnational governments’ spending and borrowing decisions are influenced by the
expectation of receiving additional resources from the central government.”

The problem of soft budget constraints was first recognized by Kornai (1979, 1986) in
relation to state-owned enterprises in former communist countries like Hungary. According to
Kornai, a soft budget constraint arises when a state-owned enterprise expects an additional
subsidy if it experiences financial difficulty. The expectation of additional resources in turn
results in opportunistic behavior that may precipitate a financial crisis in the firm.

How the SBC applies to the IRA system


On first glance, the SBC problem, strictly speaking, does not seem to apply to Philippine
LGUs; we have yet to hear or see a local government so mired in a financial crisis that the
national government had to bail it out. This is because of stringent local budgeting
regulations that largely prevent LGUs from operating on a deficit.

But come to think of it: is not the current performance-neutral IRA system one gigantic
bailout facility that props up most Philippine LGUs today?

In a presentation during a recent training event sponsored by the Friedrich Neumann


Foundation, former Finance Undersecretary Milwida Guevara bewailed the failure of most
Philippine LGUs to develop their local revenue sources, particularly among provinces and
municipalities. In 1990, before LGC 91 became law, locally generated monies accounted for
68% of total LGU expenditures. Starting in 1993 onwards, it dropped to 43% and it was
downhill even since, with the lowest at 32% in 2001. In 2004, it eased up a bit to 38%.

And why is this so? Because of the endemic dependency on the IRA of course, which is a
manifestation of the SBC syndrome. The continued expectation that the IRA will increase
annually in absolute amounts has bred complacency among most LGUs, to the detriment of
fiscal discipline and efficient governance. This is particularly pronounced among provinces
(83% of whose income are derived from national transfers) and municipalities (78%). Cities,
by comparison, depend on such transfers up to 45% of their income.

How the SBC applies to House Bill 5737


In a perverse way, we are also seeing a political incarnation of the SBC problem arise in
what proponents of HB 5737 want to accomplish.

In trying to address the situation of city-less provinces, the “expectation of additional


resources” arising from increased IRA share upon conversion has resulted in a clear
“opportunistic behavior”: the legislative effort to lower the bar for cityhood in favor of the 32
capital towns that will benefit from the proposed measure at the expense of sound
policymaking. The main difference is that only the 117 Philippine cities at present, among all
local governments we have today, will suffer.

A way out: Shooting three birds with one stone


One way to resolve this problem is to focus the mandatory Code review solely on Section
285 of the LGC 91 which defines the current IRA allocation formula among LGUs. A more
responsive and accountable IRA formula will have the following features:

1. More realistic sharing based on current demographics. As pointed out above,


cities today are supporting between 34-43% of the population. Obviously, a 23% share is
no longer tenable. The most logical source would be the share of provinces, which have
emerged as clear winners under the current scheme.

2. Portability of municipal IRA. Allowing municipalities up for cityhood to bring along


their municipal IRA allocation will mitigate the huge cost of conversion. (The additional
57 cities converted since 1991, for example, represents an opportunity cost of P238
million for each of the 60 original cities.) One possible approach is to assign a fixed
municipal IRA share that will be automatically transferred to the cities’ total IRA for every
approved conversion. Another is treating the municipal and city IRA shares as one pool
so any further conversion will not affect the total.

For instance, each of the 1,505 municipalities will, on the average, receive an IRA share
of P34.2 million in 2006. A policy effecting municipal IRA portability will cushion the
negative impact of the Senate’s worst-case scenario by more than half (56%).

3. Inclusion of performance-based criterion. At least five percent (5%) of the annual


IRA should be set aside as a performance-based facility which will be shared among
provinces, cities and municipalities based on their efficiency and effectiveness in
mobilizing local revenues. This will encourage them to pay attention to fiscal discipline
and more efficient governance.
References
Discussion Notes on House Joint Resolution No. 1. Senate of the Philippines.

Guevara, Milwida, “Local Finance: Where does the Money Come From; Where Does it End
up?” FNF Philippines Liberal Leadership Training, AIM, Makati City.
http://www.box.net/public/vekslqyq0f

Kornai, Janos (1979), "Resource-Constrained Versus Demand-Constrained Systems,"


Econometrica 47, 801-819.

Kornai, Janos (1986), "The Soft Budget Constraint", Kyklos 39, 3-30.

Vigneault, Marianne (2005), “Intergovernmental Fiscal Relations and the Soft Budget
Constraint Problem,” IIGR Working Papers, Queen’s University.
www.iigr.ca/pdf/publications/353_Intergovernmental_Fiscal.pdf

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