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THE FINANCIAL SELF-SUFFICIENCY OF
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THE FINANCIAL SELF -SUFFICIENCY OF
LOCAL GOVERNMENTS IN KOREA

By

Yong Hwan Lee

A DISSERTATION
Submitted to
Michigan State University

in partial fulﬁllment of the requirements
for the degree of

DOCTOR OF PHILOSOPHY

Urban and Regional Planning Program
College of Social Science

1997

Copyright by
Yong Hwan Lee
1997

ABSTRACT

THE FINANCIAL SELF-SUFFICIENCY OF
LOCAL GOVERNMENTS IN KOREA

By

Yong Hwan Lee

An important activity of local governments in developing countries is to increase the
degree of local ﬁnancial self-sufﬁciency, which refers to the ability of a local government
to raise own-source revenues for public services. The structural mix of local revenue,
which means a composition of local revenue raised from various types of revenue
sources, is a key factor explaining the ability of local governments to raise public
revenue. The characteristics of each local revenue source may also affect the degree of
local ﬁnancial self-sufﬁciency in a city. Some local governments are in ﬁscal trouble.
Some reasons include 1) insufﬁcient tax base; 2) too great a share of wealth-based
revenues; 3) too small a share of non-tax revenues; 4) income inelasticity of revenues; or
5) limited intergovernmental transfers from higher levels of government. The variety and
nature of local revenue sources bring different implications about the extent of local
ﬁnancial self-sufﬁciency in developing countries.

This study examines the relationship between the characteristics and structural mix of
local revenue sources and the variations in local ﬁnancial self-sufﬁciency across localities
in Korea. It also analyzes the relationship between environmental factors such as

demographic, socioeconomic, and geographical characteristics and local ﬁnancial self-

sufﬁciency. Using the Cobb-Douglas production function in public economics, this study
derives a multiple regression model to determine how much the differences in the
structural mix of local revenue sources relate to the variations in local ﬁnancial self-
sufﬁciency across Korean cities. The data pertaining to 68 cities in Korea come from the
Financial Yearbook of Local Government, 1994 and the Statistical Yearbook of City
Governments in Korea, 1994.

In the model, dependent variables are the variations in local ﬁnancial self-sufﬁciency,
which are measured by the four types of local ﬁscal indices. These indices are as follows:
the composite share index, composite per capita index, revenue decentralization index,
and expenditure decentralization index. Independent variables include the standard
deviation among the per capita local revenue types, local revenue variables, and other
environmental variables surrounding local governments. The magnitude of various types
of local revenue sources is also used. Demographic, socio-economic, and geographical
variables such as population, poverty, city size, and history are also employed as
independent variables. The results of the empirical analysis show that the differences in
standard deviation among the per capita local revenue sources, the per capita Synthesis
Land Tax, and the per capita Automobile Tax relate most closely to the variations in local

ﬁnancial self-sufficiency across Korean cities.

To my father

ACKNOWLEDGMENTS

A number of scholars have made this work possible. I wish to express my sincere
appreciation to Dr. Roger B. Hamlin for his unfailing support and encouragement
throughout the preparation of this dissertation. He provided the idea on the current
ﬁnancial problems of local governments that was incorporated into the introduction of
this study. Dr. Roger B. Hamlin read the entire manuscript and supplied extremely
helpful comments. He provided enough soothing words to allow me to enjoy meeting his
vigorous challenge to sharpen this study’s arguments.

I am deeply indebted to MSU endowed Professor Gill-Chin Lim who freely gave
of his time to guide me through every step of the research process, ﬁ'om the early
conceptualization of ideas to the ﬁnal analysis. Among other things, Gill read more
drafts of the chapters than he cares to recount, I am sure. Most importantly, he constantly
reminded me that social science research must always take its impetus and direction from
theory.

The published work of Dr. Richard Hula played an important role in helping me
formulate the initial ideas and questions that prompted this research. I want to especially
thank Dr. Hula for his comments on early drafts of this work, and particularly for his
suggestions on the role of local governments in the global trend of decentralization. His
comments led me, at several points, to consider federalism and its implications for

intergovernmental relations.

vi

The important contribution Dr. Leslie Papke made to this work by way of
comments, advice, dialogues and criticisms is greatly appreciated and humbly
acknowledged. She shared with me her knowledge on local taxation for revenue
generation. Dr. Papke’s spirited energy spilled over to refuel my own dwindling energy
supplies.

Sincere appreciation is also extended to Mr.Tae Gun Lee for moral and economic
support. He has always encouraged me to improve on and ﬁnish this study. Several
graduate colleagues took time to discuss ideas with me. I especially want to thank
Hyunsung Lee, Chung-Won Seo, and Il-Tae Kim for their thoughtful suggestions
concerning this study. Finally, I thank my wife, Young-Sook, for her unconditional

support for the my long student life.

vii

TABLE OF CONTENTS

viii

LIST OF TABLES .............................................................................................. xi

LIST OF FIGURES ...................................................................................................... xii
CHAPTER ONE

INTRODUCTION 1

I. Background ............................................................... 1

[1. Statement of the Problem ............................................ 2

III. Organization of the Study ............................................ 4
CHAPTER TWO

LITERATURE REVIEW . 7

I. Overview ....................................................................... 7

11. Fiscal Stress Measurements . 8

III. Fiscal Decentralization ...................................................................... 11

IV. Local Finance in Developing Countries .......................... 15

1. Local Revenue Sources ............................................ 15

2. Financing Local Government in Developing Countries . 18

V. Local Finance in Korea ............................................................................. 20

1. Administrative Structure of Local Governments and

Decentralization ................................................................. 20

2. Local Revenue System ................................................................. 23

3. Financial Autonomy of Local Governments ............................. 26

4. Local Financial Capacity and the Revenue Base ................. 27

CHAPTER THREE
THEORETICAL FRAMEWORK OF LOCAL FINANCIALSELF-SUFFICIENCY
IN DEVELOPING COUNTRIES ............................................................. 31
I. Overview ............................................................................ 31
11. Local Financial Self-sufﬁciency ................................................. 32
1. Deﬁnition ................................................................... 32
2. Fiscal Accounts of Local Government ............................... 34
III. Development of Local Financial Self-sufﬁciency Indices ............. 39
1. Existing Indices .......................................................... 4O
2. Indices for Local Fiscal Decentralization ...................... 45
IV. Theoretical Framework of Local Financial Self-sufﬁciency ............. 48
1. Production Function ................................................. 48
2. Production of Local Financial Self-sufficiency ...................... 51

3. Limited Production of Local Financial Self-sufficiency

in Developing Countries ........................................ 56
CHAPTER FOUR

I. Overview ............................................................................ 66

II. Hypotheses ................................................................... 66

III. Analytical Model .......................................................... 72

1. Closed Model .......................................................... 73

2. Open Model .......................................................... 76

3. Extended Model .......................................................... 77

ix

4. Data and Variables ................................................. 79

CHAPTER FIVE
I. Overview ............................................................................ 83
II. Empirical Analysis ............................................................. 84
1. Variations in Local Financial Self-Sufﬁciency ...................... 84
2. Regression Results ................................................. 88
III. Summary of Findings .......................................................... 110
CHAPTER SIX
POLICY IMPLICATIONS AND CONCLUSION ........................................... 113
1. Summary ........................................................................... 113
11. Policy Implications ......................................................... 115
1. Local Policy Implications ................................................................ 116
2. Provincial Policy Implications .................................................... 119
3. National Policy Implications .................................................... 120
III. Limitations and Recommendations ....................................... 121
BIBLIOGRAPHY ........................................................................... 124

Table 4.1 :

Table 5.1 :

Table 5.2 :

Table 5.3 :

Table 5.4 :

Table 5.5 :

LIST OF TABLES

Variables and Deﬁnitions .......................................................... 81
Mean Levels of Selective Variables by City Size .............................. 85
Determinants of Local Financial Self-Sufﬁciency (DCENXl) ............. 91
Determinants of Local Financial Self-Sufﬁciency (DCENXZ) ............. 97
Determinants of Local Financial Self-Sufﬁciency (CPX) ............. 101
Determinants of Local Financial Self-Sufﬁciency (CCPX) 106

xi

LIST OF FIGURES

Figure 2.1: Local Government System in Korea ..................................................... 21
Figure 2.2: Local Tax Systems ............................................................................. 24

Figure 5.1: Differences in Local Financial Self-Sufﬁciency
by Revenue Diversiﬁcation 87

xii

CHAPTER ONE

INTRODUCTION

I. Background

With the recent trend of decentralization, local governments in developing
countries face pressure to increase the level of local service delivery. Since local
governments in developing countries have suffered from limited local ﬁnancial capability
(Smoke, 1994; Linn & Bahl, 1992; Linn, 1981), a major issue in urban and regional
planning is to promote greater ﬁnancial self-sufﬁciency so local governments can provide
local services with minimal external funding assistance. In particular, maintaining a
proper mix of local ﬁnancial resources is a key task of local governments in developing
countries.

Local ofﬁcials and planners alike have become aware of the necessity for
analyzing the revenue-raising capacity of their localities, no matter how large or small
their population, in order to expand local service delivery. Limited governmental
capacities of developing countries indicate that local governments need to focus their
scarce administrative efforts on those revenue-generating areas where the greatest returns
lie, instead of devoting the same effort to all revenue sources. Furthermore, they need to
identify the revenue sources that they will have a comparative advantage in raising local

revenues ﬁ'om their own sources.

2
Unfortunately, both theoretical and empirical analyses of local revenue raising

capacity in developing countries are lacking. The reasons are the weakness of local
autonomy and insufﬁcient practical data for local ﬁnance. Local authorities in
developing countries are often politically ineffective and technically weak. Thus, they do
not have the ability to implement ﬁscal analyses. Developing countries also do not place
an emphasis on organizing data related to local ﬁnancial resources. This factor makes
studies of local ﬁscal revenue raising capacity nearly impossible. Furthermore, it is
difﬁcult to apply the existing experience and knowledge of local ﬁnance in developed
countries to local ﬁscal management. The ﬁscal planning of local governments for
promoting local ﬁnancial self-sufﬁciency needs to consider the nature of local revenue

systems in a speciﬁc country.

11. Statement of the Problem

The purpose of this dissertation is to explore the relationship between the
magnitude and structural mix of local revenue sources and variations in local ﬁnancial
self-sufﬁciency. Variation in local ﬁnancial self-sufﬁciency is deﬁned as the relative
capability of local governments to deliver local public services. A high degree of local
ﬁnancial self-sufﬁciency occurs when local govemments raise adequate revenues from
local sources. Thus, it is crucial to know which local revenue source is best for
increasing local ﬁnancial self-sufﬁciency. Even though various forms of local revenues
have ﬂourished, theoretical and empirical analysis about what types or mix of local

revenues are most closely associated with the degree of local ﬁnancial self-sufﬁciency is

3

lacking. No consensus exists concerning the optimal choice among local revenue
sources.

Many studies of local revenue generation in developing countries have focused on
the expansion of scarce local revenue sources. Few studies have examined the effect of
the mix of these local sources on the revenue-raising capabilities of a local government in
developing countries. In fact, little is known about various local revenue sources other
than the property tax in developing countries.

Previous studies examining the ﬁscal conditions of local governments have
mainly focused on socioeconomic variables, such as income, wealth, and population.
Many studies on socioeconomic variables relied on a belief that local socioeconomic
conditions limit the ability of local governments to raise local revenues. However, each
local government has a different structural mix of revenue sources according to its
socioeconomic, cultural, historic or political conditions. This revenue mix may be related
to the variation of local ﬁnancial self-sufﬁciency.

Furthermore, each revenue source has different output elasticity in generating
total revenue. The output elasticity is the percentage increase in total revenue resulting
from a one-percent increase in a revenue source, holding the quantities of the other
revenue sources constant. This output elasticity may detennine the degree of local
ﬁnancial self-sufﬁciency. Thus, local governments that retain adequate local revenue
sources with strong output elasticity may have a high degree of local ﬁnancial self-
sufﬁciency.

Many empirical studies, however, have not paid attention to the relative output

elasticity and structural mix of local revenue sources in determining the degree of local

4

ﬁnancial self-sufﬁciency. To overcome the lack of studies explaining the effects of local
revenues on the local ﬁnancial self-sufﬁciency in Korea, this study focuses on the relative
output elasticity of local ﬁnancial sources and structural mix of revenues for increasing

the degree of local ﬁnancial self-sufﬁciency.

III. Organization of the Study

A critical factor in local ﬁnance in developing countries is to build an appropriate
theoretical framework to help local decision-making. This dissertation ﬁrst sets forth a
theoretical framework to analyze local revenues based on a neoclassic economic
approach. This approach makes it possible to identify key relationships in local revenue
sources and the degree of local ﬁnancial self-sufﬁciency. To create an applicable local
ﬁscal framework, each of the following chapters concentrates on a particular research
topic.

Chapter Two discusses the current literature relating to local revenue raising
capacity in the context of developing countries. Chapter Two also demonstrates the
measurements of local ﬁscal conditions, the ﬁscal responsibility among the levels of
government, and the characteristics of local ﬁnancial structure in developing countries.

Chapter Three describes types of local revenue sources and their likely effects on
local public goods production. The chapter looks at the ﬁscal indices of local
governments and the appropriate index type for local ﬁnancial self-sufﬁciency. Chapter
Three develops a theoretical framework to investigate the relationship between the

characteristics of local revenue resources and the variations in local ﬁnancial self-

5

sufﬁciency in developing countries. Also, the framework explains the relationship
between the structural mix of local revenue resources and the degree of local ﬁnancial
self-sufﬁciency. This theoretical framework is based on the concept of the Cobb-Douglas
production function in public economics. The Cobb-Douglas production function is
employed to analyze what types of revenue mix produce the optimal level of local
ﬁnancial self-sufficiency.

Chapter F our provides a methodology for an empirical analysis of the degree of
local ﬁnancial self-sufﬁciency. This chapter presents hypotheses concerning the impact
of local ﬁscal variables on the indices of local ﬁnancial self-sufficiency in Korea. The
analytical method of this study is a statistical analysis using multiple regression models
that identify the relationship between the structural mix of local revenue resources and
the degree of local ﬁnancial self-sufﬁciency. The multiple regression models use
empirical data from 68 cities in Korea. Dependent variables are the variations in local
ﬁnancial self-sufﬁciency, which are measured by the four types of local ﬁscal indices.
These indices are as follows: the composite share index (CPX), composite per capita
index (CCPX), revenue decentralization index (DCENXl), and expenditure
decentralization index (DCENXZ). Independent variables include the standard deviation
among the per capita local revenue types, local revenue variables, and other
environmental variables surrounding local governments. Standard deviation is
considered to explain the structural mix of local revenue sources. The magnitude of
various types of local revenue sources is also used. Demographic, socioeconomic, and
geographical variables such as population, poverty, city size, and history are also applied

as independent variables.

6

Chapter Five focuses on empirical analyses of local revenue sources. This chapter
explains the relationship between the structural mix of local revenue resources and the
degree of local ﬁnancial self-sufﬁciency. This chapter also identiﬁes the determinants of
the variations in local ﬁnancial self-sufficiency. Interlocal differences in the degree of
local ﬁnancial self-sufﬁciency and structural mix of local revenue sources are examined
to see whether the pattern of differences is related to each other. As a result, the chapter

examines what sorts of ﬁscal policies might be most appropriate.

CHAPTER TWO

LITERATURE REVIEW

1. Overview

The purpose of this chapter is to provide a review of current literature concerning
local ﬁnancial self-sufﬁciency in developing countries. The studies in this ﬁeld,
compared to similar studies in advanced countries, lack both theoretical rigor and
empirical richness. Among a number of potential topics, three subjects for research
related to local ﬁnancial self-sufﬁciency in developing countries are key.

First, studies on local ﬁscal stress measurements provide general implications
about the degree of local ﬁnancial self-sufﬁciency. One element to study in local ﬁnance
is the measurement of local public ﬁnancial performance. The local ﬁscal stress
measurements show whether local governments have enough local revenue resources to
satisfy local service needs or not. These measurement-related studies have focused on the
veriﬁcation of the relationship between socioeconomic conditions and local ﬁscal
performances. These types of studies include analyses of the measure of the degree of
local ﬁscal crisis, capacity, and stability.

Second, the degree of local ﬁscal responsibility in multilevel governmental
systems is a crucial factor affecting the degree of local ﬁnancial self-sufﬁciency. The

ﬁscal responsibility among the levels of government in a country is closely related to the
7

8
political and administrative systems of that country. The ﬁscal role by which a

government raises revenue and spends public money is dependent on the assignment of
the governmental functions among the levels of government. In particular, the degree of
ﬁscal decentralization is a crucial element in understanding the local revenue
responsibility in the context of multilevel governmental systems.

Third, the speciﬁc ﬁscal structure of developing countries is related to the degree
of local ﬁnancial self-sufficiency. The nature of local ﬁnance in developing countries is
different from the nature of local ﬁnance in developed countries. For example, political
and economic systems are crucial factors in shaping the local ﬁnancial behavior.
Compared to developed countries, developing countries show undeveloped local
economies, administrative systems, and speciﬁc cultural characteristics. Moreover, the
national public service delivery system and intergovernmental ﬁscal relations may affect

the degree of local ﬁnancial self-sufﬁciency of developing countries.

11. Fiscal Stress Measurements

Improving the quality of local government service production is ultimately
affected by the relative scarcity of available resources. The allocation of scarce resources
has always been a primary concern for every government. A principle issue of much of
the research on local public ﬁnance is a matter of low ﬁscal capacity in various
governmental jurisdictions. A locality’s inability to generate its own revenues will

adversely affect the provision of such services as the urban infrastructure. Thus, it is

9
unlikely that ﬁscally stressed local governments will be able to perform their

developmental functions adequately, given such circumstances.

Measuring local ﬁscal stress is crucial to understanding the factors related to the
local ﬁnancial self-sufﬁciency in developing countries. Existing measurement studies
(Muller 1975; Nathan and Adams 1976; and Burchell et a1. 1984) of local ﬁscal stress
show that various socioeconomic factors inﬂuence revenue raising capacity and
expenditure decisions of local governments. These studies indicate that local
socioeconomic change affects local ﬁnancial conditions. Local ﬁnancial stress comes in
part from the long-term decline in a local economy. Some measurements have been
incorporated by the Congressional Budget Ofﬁce as allocation formulas for speciﬁc
federal government urban aid programs; others have been independently developed as
ﬁscal indicators, which are related to assessing the relative merits of these different
measurements of the changing local ﬁnancial environment. Various approaches to
measuring local ﬁscal conditions have been developed along with speciﬁc research
interests, such as local ﬁscal crisis, stabilization, and capacity.

Many measurements of local ﬁscal performance are found in the local ﬁscal stress
or crisis-related studies. Previous research on local ﬁscal crises developed measurements
of the local ﬁscal performance of major US. cities since the 19705. These studies explain
the role of external determinants, such as socioeconomic and demographic changes which
impact the local revenue bases. Many studies focused on identifying the relationship
between local revenue or expenditure patterns and changing socioeconomic
circumstances, such as the change of population size, the magnitude of income, the

incidence of poverty, the change of employment rate, housing starts, the age of housing,

10
and so on. These studies include Muller (1975), Clark et al. (1976), Grarnlich (1976),

Nathan and Adams (1976), Barro (1978), Municipal Finance Ofﬁcers Association (1978),
Howell and Stamm (1979), Morgan (1980), Burchell et a1. (1981), Clark (1981), Fossett
and Nathan (1981), Weinstein and Clark (1981), Bradbury et a1. (1982), Martin (1982),
Clark and Ferguson (1983), Burchell et a1. (1984), and Inman (1992, 1995).

According to these studies, local ﬁscal stress is related to the outmigration of
people and industry. In particular, Lirn (1982) provides a theoretical explanation of
‘disequilibrium adjustment processes’ by migrations in local ﬁnance. Muller’s analysis
(1975), which offers an interregional migration model, states that the decline of jobs and
industry in older cities causes the local tax base to shrink and increases the cost of
providing public services. Fiscal stress, basically, refers to the inability of a government
to balance its budget. Inman (1995) argues that ﬁscal crisis exists when local
govemment’s revenue capacity is insufﬁcient to cover the locality’s service needs. Inman
points out that an unfavorable economy and demographics, reduced external funds, and
local policy inﬂuence the rate at which the local tax base shrinks.

Fiscal stress may be a result of local budgetary processes. Its extent can be
measured by examining ﬁscal factors surrounding local budgetary processes. Therefore,
“ﬁscal stress is a structural phenomenon, reﬂecting shifts in the social and economic
conditions of the city” (Pagano and Moore 1985:23). Measurements of budgetary
distress may include such variables as surplus (or deﬁcits) in an operating budget
(Gramlich 1978) and the availability of liquid assets relative to existing claims on those
assets (Howell and Stamm 1979). External factors usually inﬂuence local ﬁscal

performance. Local budget constraints are dependent on national economic conditions

11

and are not subject to local control. In this sense, some researchers have identiﬁed that
ﬁscal stress is the result of excessive debt requirements (Peterson 1976; Clark and Fuchs
1977; Bahl, Jump, and Schroeder 1978; Aronson and King 1978); poor administrative
qualities and mismanagement by public officials (Gerard 1976; Clark and Ferguson
1983); and urban age (Perry and Watkins 1977; Mollenkopf 1983).

Other approaches offer different sets of analytic measures. Nathan and F ossett
(1979) presented a widely-cited urban conditions index which was based on the
weighting of a community’s per capita income, percentage of housing stock built before
1940, and the rate of population change. Fainstein and F ainstein (1976) argue that ﬁscal
stress is affected by the amount of intergovernmental aid that a jurisdiction receives.
Matching programs induce local governments to spend more than they otherwise would
have.

This existing literature provides no clear criteria for identifying local ﬁscal stress,
because many studies have analyzed the speciﬁc socioeconomic conditions of individual
cities. Furthermore, these studies have focused on only describing the current crisis.
Thus, it is very difficult to apply these measurements to evaluate the degree of local

ﬁnancial self-sufﬁciency in developing countries.

III. Fiscal Decentralization

In the public ﬁnance ﬁeld, one of the key issues is the veriﬁcation of the

appropriate division of responsibilities among speciﬁc levels of government. A country

usually has several levels of government such as the federal, state, and local government

12

in the USA. Each of these levels of government levies taxes and provide services. In
addition, higher levels of government sometimes transfer some money to lower levels
through intergovernmental systems. There are questions regarding which levels of
government provide which services. Do taxes levied by a certain government support
enough of the public services that are required by that government? Therefore, the degree
of decentralization is a crucial element in understanding the local revenue responsibility
in the context of a multilevel governmental system.

Richard Musgrave (1959) has classiﬁed three economic functions as the
appropriate role for a government. They are 1) stabilization of the economy, 2) the
distribution of resources, and 3) the allocation of resources. The stabilization function
means a governmental role as an instrument of macroeconomic policy that maintains
market price stability, appropriate employment, and economic growth within a country.
To achieve the goal of stabilization, a government implements ﬁscal and monetary
policies. Thus, this stabilization function is more appropriate to the federal or central
government whose policies can inﬂuence the entire territory. The distribution function,
which refers to the redistribution of income or other resources between the rich and the
poor, is more appropriate to the higher levels of government. Higher levels of
government can implement redistribution policies across jurisdictions. State and local
governments inherently have limited ability to implement stabilization and distribution
functions, because of mobility and diversity among the lower levels of government.

For the allocation function, Tiebout (1956), Oats (1972), and King (1984) argue
that decentralized subnational governments are more efﬁcient than national or central

government. According to the ﬁscal federalism theory (Oats 1972), a perfect

l3

correspondence, internalizing beneﬁts in public goods provisions, refers to Pareto
efﬁciency. The decentralized levels of government in the allocation function may
enhance economic efﬁciency because demand is not uniform across communities for
public goods and services. Decentralized governments may provide appropriate levels of
public services to the individuals with similar demands. Thus, there would be a
misallocation of resources if uniform levels of services were provided across large
geographical areas. Economic efﬁciency may be enhanced through decentralized public
goods provision because people in small communities may conform with their true
preferences.

Politically, decentralization is a normative concept for political governing forms,
emphasizing popular participation. Decentralization can be used to strengthen
accountability, political skills and national integration. Decentralization brings the
government closer to the pe0ple. It provides better services to client groups (Wilson
1948; Ylvisaker 1959; Maddick 1963; Smith 1985). Decentralization provides a training
ground for citizen participation and political leadership at both local and national levels.

Economically, decentralization improves the efﬁciency of local public good
provisions according to some authors (Tiebout 1956; Ostrom, Tiebout and Warren 1961;
Shepard 1975; Magnusson 1981). Market models of local decision-making regard
decentralization as a means of expanding the scope of consumer choices for public goods
and services. According to the public choice theory, decentralization is essential for
increasing social and individual welfare. Like free market competition, competition
among local governments provides people with better choices in terms of taxes and

public services. People ‘vote with their feet’ by comparing packages of taxes and services

14
in different municipalities (Tiebout 1956). Therefore, fragmented localities and

decentralization are important elements for increasing the general welfare, according to
some points of view.

Previous empirical studies pointed out that population, urbanization, land area,
and income factors were signiﬁcantly associated with ﬁscal decentralization (Litvack and
Oates 1970; Giertz 1976; and Wallis and Oates 1987). Population growth and
urbanization lessen the extent of ﬁscal decentralization. In a cross-sectional study using
data from the 1962 ﬁscal year, Litvack and Oates (1970) found urbanization and
population size were negatively related to ﬁscal decentralization. Wallis and Oates
(1987) also argued that the extent of ﬁscal centralization was negatively related to
population size and urbanization.‘ In addition, the geographical size of a government was
identiﬁed as a factor in the decision for the degree of ﬁscal decentralization. Also, Giertz
(1976) found a negative relationship between ﬁscal decentralization and land area.

The extent and variation in ﬁscal decentralization in state and local sectors in the
United States were deeply related to general welfare. The magnitude of personal income
and income distribution are crucial factors in shaping the variation in ﬁscal
decentralization. Wallis and Oates (1987) explained that ﬁscal decentralization was
positively related to the level of per capita income. In a cross-sectional study of ﬁscal
decentralization using data from the 1969-70 ﬁscal year, Giertz (1976) found a positive
relationship between the Gini coefﬁcient and the extent of ﬁscal centralization. This

result suggested that a higher degree of inequality in the distribution of income was more

15

related to greater centralization. Therefore, income redistribution may be necessary for
ﬁscal decentralization.

And yet, these studies do not describe which local sources are most closely related
to local ﬁnancial self-sufﬁciency. Decentralization may generally be associated with a
wide range of economic, social, and political objectives. In dividing governmental
responsibilities, decentralization as a policy may force local governments to mobilize
locally owned resources for national economic development. The policy of
decentralization in developing countries has strategic aspects relating to economic growth
and development. In practice, these decentralization policies show some contradictions
among governmental goals such as efﬁciency, democracy, and equity in individual socio-

political settings.

IV. Local Finance in Developing Countries

1. Local Revenue Sources

The study of local ﬁnance in developing countries has been a crucial topic for

Third World development related scholars as well as international development

organization like the World Bank. Fundamentally, local ﬁnances in developing countries

have a common theme, weak local revenue resources (Bahl and Linn 1992). The reasons

 

‘ They performed econometric studies using a measure of ﬁscal centralization as the dependent variable
and land area, population, urbanization, race, region, per capita income, homogeneity of farm and race as
independent variables.

16

are intrinsic poverty and low-income, the weak discretion of local authority, and an
unskilled administration (Beier et a1. 1976; Renaud 1979; Linn 1979).

Local revenue systems in developing countries oﬁen differ substantially from
developed nations. A local government in developing countries usually has a weak local
economy that comes from intrinsic cultural, and institutional and political characteristics.
With this weak local economy, local authorities in developing countries fail to raise
enough revenue from their own sources (Bahl and Linn 1983; Davey 1983; Bahl, Miner
and Schroeder 1984; Bahl and Linn 1992). The substantial underdevelopment of the
local economy is a key factor that causes the weak local revenue base in developing
countries.

Unlike industrialized countries, local economies in developing countries usually
show weak private savings, informal economic sectors, and undeveloped industries.
Generally, industrialization is a key factor indicating a stable local revenue base.
However, local revenue bases in developing countries mainly rely on the agricultural
sectors that may be much less important or inapplicable to local revenue increases in
developing countries. In particular, the lack of home-ownership in developing countries
limits the revenue base.

Consequently, the local revenue base in many developing countries is unstable
(Bahl and Linn 1983; Davey 1983; Bahl, Miner and Schroeder 1984; Bahl and Linn
1992). With a weak local economy, local authorities cannot effectively mobilize local
revenue within their jurisdiction. Local residents who do not have enough local income
or savings from the local economy may not be able to pay enough local taxes to even

sustain their local governments. Furthermore, this weak local economy tends to cause

l7

insufficient land taxes, income taxes, sales taxes and user charges, which are used to
provide stable yields in industrialized countries. In particular, some local economies in
developing countries may be dominated by the informal market system such as barter
transactions. These informal market systems may make local revenue increases
impossible or inefﬁcient (Smoke 1994).

Cultural inﬂuences may be constraints in raising local revenue in developing
countries and affect local revenue strategies. These are irrelevant or less severe in
developed countries (Bahl, Miner and Schroeder 1984; Mawhood 1987). Some religious
groups or ethnic groups may posses most or part of the local resources. Attempts by local
governments to tax this base may be ultimately impossible.

Institutional underdevelopment can result from the weak ﬁnancial capacity of the
local authority. The policy of central governments in many developing countries has
failed to establish appropriate intergovernmental ﬁscal relations to help raise local
revenue. In a study of local government systems in developing countries, Bahl and Linn
(1983) found that few countries exhibit an efﬁcient assignment of local authority. Even
in areas where sensible and adequate local revenue bases are established, central
governments may control local government revenue systems in many ways, including
setting tax rates, stipulating tax exemptions, and directly inﬂuencing the size of tax bases
(Bahl and Linn 1983; Davey 1983; Bahl, Miner and Schroeder 1984; Bahl and Linn
1992)

As noted above, arbitrarily or otherwise improperly administered central control,
apparently common in developing countries, can undermine equity and local revenue

raising capacity. Furthermore, local authorities in developing countries are typically

18

more reliant on central government institutions for revenue collection assistance,
transfers, and loans than they are in the developed world (Davey 1983; Bahl and Linn
1983; Bahl, Miner and Schroeder 1984; Davey 1988, 1989; Bahl and Linn 1992). It is
important to understand whether such reliance is consistent with public ﬁnance objectives
and how it affects the performance of local authorities and their accountability to their
constituents. Central government oriented policies or ﬁscal control may also obstruct the
operation of local revenue systems (Bahl, Miner and Schroeder 1984; Rondinelli, Nellis
and Cheema 1984; Rondinelli, McCullough and Johnson 1989; Bahl and Linn 1992).
Central government may reserve the most productive revenue sources for its own use.

Military use of local land, for example, may limit the raising of local revenues.

2. Financing Local Government in Developing Countries

Revenue diversity and ﬁnancially weak resources are the characteristics of local
ﬁnancing in developing countries. Linn (1981) indicated that urban ﬁnancial systems of
developing countries had great diversity of revenue and expenditures, and the common
feature of a weak ﬁnancial system.2

Local revenue sources in developing countries generally consist of various types
of revenues such as local taxes, user charges, fees, local borrowings, and

intergovernmental transfers. Out of these revenue sources, local taxes, user charges, and

 

2 Linn (1981) analyzed the experiences in large cities on the revenue trends of local governments in
selected cities of developing countries. The data of the analysis is based on the previous case studies,
carried out by the authors in the World Bank is study of urban ﬁnances in developing countries.

l9

fees are locally owned sources; local borrowings and intergovernmental transfers are
external sources.

Financing local governments in developing countries tended to be dependent on
the extent of locally raised revenues rather than external revenues. Linn (1981) found
that the share of locally-raised revenue in ﬁnancing total expenditures was typically 60%
- 90% with a median of 79% in 17 selected cities. According to Linn’s study, local taxes
are the main source to locally-raised revenues, contributing over 50%. User and beneﬁt
charges share 25% of locally-raised revenues. Therefore, local taxes have played a
crucial role in local ﬁnancing. The magnitude of local tax bases is positively related to
the degree of local ﬁnancial self-sufﬁciency.

Meanwhile, external sources, especially intergovernmental transfers, have not
played an important role in ﬁnancing local government in developing countries.
According to Linn's study (1981), the degree of grant and shared tax ﬁnancing is about
14% of the total local revenue. It is a very small contribution to the ﬁnancing of cities in
developing countries. In addition, it is lower than the percent found in developed
countries.’ It shows that the degree of local self-ﬁnancing in developing countries has
been higher than in developed countries.

Therefore, the changes in the magnitude of local revenue sources will determine
the ability of the local government to provide local services to its residents. Where local
governments have weak local revenue bases, local governments will suffer from

insufﬁcient revenue to sustain their budget balance. In addition, when intergovernmental

 

3 In the USA, total intergovernmental transfers share 20-30% between the years 1979 - 1991. In Japan,
grants and shared taxes share 30-40% between the years 1963-1987.

20

transfers and borrowing play only minor roles, it is very difﬁcult for local authorities to

operate local governments themselves.

V. Local Finance in Korea

1. Administrative Structure of Local Governments and Decentralization

Korea has a unitary governmental system. Traditionally, the top—down
governmental policies of Korea have shaped a centralized administrative system. As a
result, the central government has raised and spent most of the govemment’s revenues.
Korea’s local governments have possessed only a small revenue base. Consequently,
local entities have been hard-pressed to generate enough local revenue to run their
governmental organizations.

Local governments in Korea are backed by the Constitution. At present, the Local
Autonomy Law provides for a two-level system of local governmental structure" Figure
2.1 illustrates the system of local governments in Korea. The upper levels of local
governments consist of a special city (Seoul), ﬁve direct jurisdiction cities (Busan,
Daegue, Daejeon, Gwangju, and Incheon), and nine provinces. The lower levels of local
governments consist of 68 cities, 136 counties, and 56 autonomous districts in 1993. The

cities and counties are within the provinces. The autonomous districts are within the

 

‘ For a review of Korean local governmental and ﬁnancial system, see An-Je Kim (1994) and Kazuhisa lto
(1992).

21

Figure 2.1: Local Government System in Korea

 

Central Government
(Ministry of Home Affairs

 

 

 

  
 

    

   
 
 

  
  

  
  

I Provinism 5
(D0) l

l

I Direct Jurisdiction
1 Cities:

~ Special City: ‘-
Seoul 1

   

Busan

Taegue
Daejeon
Gwangju
Incheon

 

 

 

 

Autonomous Autonomous City County
District District (Si) (Gun)
(GU)

 

 

 

 

 

 

 

District I l
Eup Myun

® ® @
®®

Upper Level of Local Government

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

ii: Lower Level of Local Government

22

special city and direct jurisdiction cities. The chief executives of all levels of local
government are elected directly by their residents. The local councils of all levels of local
governments are also established by local general elections. The lower administrative
units under the local governments are Gu (district), Dong (urban village), Eup (town),
Myun (township), and Li (village).

In reality, Korea has had a highly centralized form of governmental system. Thus,
Korean local governments have been limited in their autonomous administration because
the traditional top-down governmental policies have regarded local governments as
agents of the central government. The Ministry of Home Affairs has the power to
supervise every level of local governments. Also, the provincial governments supervise
the lower level of local governments such as cities and counties. A special city and direct
jurisdiction cities supervise autonomous districts within their jurisdictional boundaries.’

The recent trends of decentralization and localization are bringing about strong
demands for both greater investments in local economic development and strict
implementation of local autonomy. This trend has surely brought about changes in
Korea’s centralized governmental structure. Since Korea revised the Local Autonomy
Law in 1988, there have been some signs of decentralization. Some of the centralized
governmental ﬁmctions have devolved on to the local governments. With the
decentralization, the rearrangements of governmental functions and ﬁscal resources

between central and local governments have become imminent issues.

 

5 The Korean Local Autonomy Law also suggests such special organizations as the intergovernmental
associations for the upper level of local govemments and the intergovernmental associations for the lower
level of local governments. The purpose of the intergovernmental associations is to handle or coordinate
governmental functions, with spillovers and public functions related to more than two local governments.

23

The decentralization has changed the central-local governmental relations.
Traditionally, the Korean local governments had worked as the agents of the central
government. Nowadays, however, local governments try to work as independent
governmental bodies, and thus they compete with other governmental bodies for the
public service provisions. Thus, with the advent of decentralization, local governments
have experienced greater responsibilities to provide more public services, as well as

exercising discretionary power in local policy-making.

2. Local Revenue System

Local governments in Korea have two types of budgetary accounts: the general
account and special accounts. The general account covers local functions as well as
national ﬁrnctions that are assigned to the local governments by the central government.
Financial sources for the general account consist of local taxes, local non-tax revenues,
intergovernmental transfers, and local borrowing. The special accounts cover those
ﬁmctions associated with the management of speciﬁc projects or funds, which are
classiﬁed for convenience sake into the categories of local public hospitals, local public
enterprises, education, and other special accounts.

Local taxes are the main source of local revenue. Local taxes are classiﬁed into
the same category as general taxes and objective (earmarked) taxes. General taxes
include acquisition taxes, registration taxes, license taxes, horse-race taxes, residence

taxes, property taxes, automobile taxes, synthesis land taxes, farmland taxes, butchery

 

Provincial
Taxes

 

 

 

City Taxes

 

 

:] General Tax

24
Figure 2.2: Local Tax Systems

«— ——»
~— —»
«—

~—

_ ' ta
_ Wtit l
-e

developmn ax

a—-— [— ———»

 

   

 

Special City
Taxes;
Direct
Jurisdiction
City Taxes

 

 

 

Autonomou
5 District
Taxes

 

-Earmarked Tax

 

25
taxes, and tobacco taxes. Objective (earmarked) taxes include city planning taxes,

facilities taxes, regional development taxes, and business ﬁrm taxes.

Each level of local government has its own taxes in order to ﬁnance its own
service provisions, as illustrated in Figure 2.2. The special city and direct jurisdiction
cities collect acquisition taxes, registration taxes, residence taxes, automobile taxes,
famrland taxes, butchery taxes, horse-race taxes, tobacco taxes, city plamring taxes,
facilities taxes, and regional development taxes. The autonomous districts have license
taxes, property taxes, synthesis land taxes, and business ﬁrm taxes. The provincial
governments have acquisition taxes, registration taxes, license taxes, horse-race taxes,
facilities taxes, and regional development taxes. Cities and counties collect residence
taxes, property taxes, synthesis land taxes, automobile taxes, farmland taxes, butchery
taxes, tobacco taxes, city planning taxes, and business ﬁrm taxes.

Every local government has such non-tax revenues as property rent revenues,
rents, fees, business ﬁrm revenues, collection grants, interest, property disposal revenues,
contributions, loan collections, transfers from other accounts, allotments, and
miscellaneous revenues. Other revenue sources for local governments include local
borrowing and intergovernmental transfers. The intergovernmental transfers are broken
down into local shared taxes which the central government shares with the national
revenues for local governments (13.27 percent of the amount of national taxes), and
national subsidies, from which the central government also gives subsidies to local

governments for projects.

26

3. Financial Autonomy of Local Governments

The ﬁnancial autonomy of local governments is related to the ﬂexibility of
revenue sources. It is very important to know whether a local government can raise more
revenues to pay for higher levels of local services. The main sources for ﬁnancial
autonomy are local taxes. Regardless of the type of tax, the amount of tax revenue is
directly dependent upon both the tax base and the tax rate. The tax base is the price of the
unit on which the tax is predicated. The tax rate is the amount of tax paid on each unit.
Increasing either the tax base or the tax rate can enhance the amount of the tax revenues
collected. Of course, the tax base and the tax rate can be increased simultaneously.

In Korea, however, the regulation of local taxes by the central government limits
the local governments’ ﬁnancial autonomy. The national law of local tax controls the
type and rate of local taxes. In reality, the national law of local taxes sets a standard and a
maximum tax rate, along with the valuation of the tax base. Local governments may be
free to raise the rates up to the maximum, with the approval of the Ministry of Home
Affairs. In practice, the standard rates are employed.

For the non-tax revenues such as charges, fees and allotments, local governments
may impose the appropriate amounts, which are set by the local council. These types of
revenues provide local governments with important avenues of raising revenues.
However, local governments may face political unpopularity for raising taxes.

According to the Korean Local Autonomy Law, local governments may increase their
revenues through local borrowings. Local borrowing, however, also limits local ﬁnancial

autonomy, since this borrowing is subject to the approval of the central government.

27

Fiscal relations between the central and local governments are very hierarchical,
because the central government provides national funds for lower levels of local
governments via upper levels of local governments such as the special city, direct
jurisdiction cities, and provincial governments. The central government controls the
subordinate units of government. The upper level of local governments also supervises
the lower level of such local governments as cities, counties and autonomous districts.

In Korea, local shared taxes refer to those taxes allocated to local governments at
a ﬁxed rate from among such taxes collected by the national government as the income
taxes, corporation taxes, etc. Depending upon the ﬁnancial strength of the local
government, more shared tax is granted to those local governments that have less tax
revenues. Theoretically, this is done in order to equalize, to some extent, ﬁnancial
resources between local public bodies. However, this allocation process is sometimes
political, as does not close the gap between ﬁscally strong and ﬁscally weak cities.

The local transferred tax refers to all or part of the taxes which are transferred to
local governments, such as the local road tax, special tonnage tax, etc., that are collected
by the central government as national taxes. On the contrary, national subsidies are given

for purposes deﬁned by the central government.

4. Local Financial Capacity and the Revenue Base

In reality, the best method for increasing revenues levied by local governments is

to increase the local tax base. Recent studies of local ﬁnances in Korea point out vertical

28
and horizontal ﬁscal disparity.6 The vertical inequality of the tax base causes the

different tax amounts among the governmental levels. The amount of national taxes for
the central government is larger than the amount of local taxes for local governments.
This disparity is related to the centralized government system found in Korea. The
horizontal inequality of tax bases across the local governments means that each local
government has a different size and composition in their tax bases. These differences
cause variations in revenue capacity among local governments in Korea.

Lee (1993) focused on the tax base assignment among various levels of
government. Lee assumed that the central government has a larger and better tax base,
with higher income elasticity. In addition, the central government of Korea has a well-
developed consumption tax system which is called the value added tax. Therefore, Lee
argues that a rational tax base assignment is very important to improve local ﬁnancing
abilities.

Unequal local revenue capacity among local governments is a crucial issue in
Korea’s local ﬁnances. The variation in the tax bases across local governments results
from the geographic or economic characteristics of local governmental jurisdictions.
Whether a local government is in a growing or declining region may cause differences in
the size and composition of tax bases. The variation in the level of local economic
development may affect the differences in the size and composition of tax bases across
local governments. Furthermore, the variation in the tax bases of local governments may

be related to the shape of local land use. The specialized use of residential, commercial,

 

6 In Korea, most of the research is related to revenue, especially tax sources of local governments, because
local revenue capacity directly affects local autonomy itself.

29

industrial, or recreational land in local governments may affect the tax bases disparity
across the local governments

Ahn (1988) pointed out that local revenue capacity is a function of regional
economic development. He argues for a positive relationship between local revenue
capacity and the gross regional product (GRP). He hypothesizes that “a low level of
gross regional product results in a low level of savings, and that in turn results in a low
level of ﬁscal capability, a low level of public investment, and, ﬁnancially, a low level of
gross regional product” (Ahn 1988: 202).

In his 1988 study, Ahn analyzed how Korean intergovernmental ﬁscal relations
affected the country’s capacity for local governments to generate tax revenues from
locally owned resources. He pointed out that the imbalances in regional growth caused
the variation in local revenue capacity in Korea. He discussed the unbalanced patterns of
regional grth and the ﬁscal resources that ﬂow among the governmental levels. He
analyzed the relationship between the local revenue capacity and the gross regional
product, applying a linear regression model. His analysis focused on those provincial
governments with weak ﬁnancial positions.

In general, local governments in Korea depend on the central government to
ﬁnance their developmental programs. During the rapidly industrializing period, they
also became dependent on the central government for their recurrent expenditures, since
most regional development projects were leaded by the central government.
Intergovernmental ﬁscal transfers, therefore, were important sources of ﬁnancing local

governments in Korea.

30

The unequal revenue resources among local governments are also other factors of
unequal ﬁnancial capacity of local governments in Korea. Local governments that are
wealthy in revenue sources have raised sufﬁcient revenues, but others have not. Thus,
this unequal capacity to ﬁnance development programs and projects has contributed
signiﬁcantly to the existing disparity of the regional per capita gross regional product. A

local government with a lower level of development produces a lower revenue capacity.

CHAPTER THREE
THEORETICAL FRAMEWORK OF LOCAL FINANCIAL SELF-SUFFICIENCY

IN DEVELOPING COUNTRIES

I. Overview

The review of existing literature in Chapter Two indicates that the following three
areas are important for research into local ﬁnancial self-sufﬁciency in developing
countries. First, local ﬁscal studies need to develop an accounting framework that will
explain the composition of local revenues and expenditures in developing countries.
Accounting might be an important instrument for ﬁnding the ﬁscal resources of local
governments. An accounting framework provides a mechanism for the mobilization and
control of local revenue sources. Thus, a basic understanding of local ﬁscal accounts is
important to the analysis of local ﬁnancial self-sufﬁciency in developing countries.

Second, for advanced research, developing countries need to develop new
measures of local ﬁnancial self-sufﬁciency. Existing theories of local ﬁscal performance
for advanced countries cannot be applied to developing countries’ situations because
local ﬁscal structure and characteristics differ from those of advanced countries. This
chapter suggests the four types of local ﬁscal indices that are employed in the

measurement of local ﬁnancial self-sufﬁciency. These indices are as follows: the

31

32
composite share index (CPX), composite per capita index (CCPX), revenue

decentralization index (DCENXl), and expenditure decentralization index (DCENX2).

Third, existing theories point out the need for an explanation model of the
relationship between the magnitude and mix of local revenue sources and the extent of
local ﬁscal ﬁnancial self-sufﬁciency in developing countries. Without this kind of
explanation model, existing theories will fail to estimate the relationship between various
types of local revenue sources and the degree of local ﬁnancial self-sufﬁciency in
developing countries. Thus, local governments in developing countries may make
appropriate ﬁscal policies to elevate the degree of local ﬁnancial self-sufficiency in the
delivery local public services.

In this context, this chapter presents the development of an appropriate ﬁscal
framework for the analysis of local ﬁnancial self-sufﬁciency, the measures of local
ﬁnancial self-sufﬁciency, and an estimation model of the relationship between local

revenues and the degree of local ﬁnancial self-sufﬁciency in developing countries.

11. Local Financial Self-sufﬁciency

1. Deﬁnition

Local ﬁnancial self-sufﬁciency is the local ﬁnancial capacity necessary to support

local programs or policies without the assistance of external funds such as subsidies from

higher levels of government. Promoting local ﬁnancial self-sufﬁciency is an objective of

local governments in developing countries in order to sustain local autonomy and

33
increase local planning capability. In analyzing local ﬁnancial self-sufﬁciency, the status

of the local government must be scrutinized. Local governments are subunits of an entire
multilevel governmental system; the national constitution, statutes, and regulations deﬁne
the nature of the local ﬁnancial self-sufﬁciency.

Among local jurisdictions, the extent of ﬁnancial self-sufﬁciency is relative:
different communities will require different amounts. Local ﬁnancial self-sufﬁciency
should be analyzed in the context of a jurisdiction’s functional role and the extent of its
ﬁscal or service needs. One key point to consider is the type of services local
governments provide. In general, a local government provides both pure local public
goods that beneﬁt only local residents and broader public goods that beneﬁt people
beyond the local jurisdiction. A local government providing services with extemalities
will typically need more intergovernmental transfer payments than one that has a more
limited role.

In reality, perfect local ﬁnancial self-sufﬁciency is not possible. Promoting local
ﬁnancial self-sufficiency really means increasing the amount of locally raised revenues or
decreasing the portion of external ﬁmds from other levels of government. Local ﬁnancial
self-sufﬁciency can, however, have a range of more speciﬁc deﬁnitions in other contexts.
The deﬁnition of local ﬁnancial self-sufﬁciency will be tailored to the needs of the users,
the perspective of the analysts, and the nature of the data available.

The purpose of studying local ﬁnancial self-sufﬁciency is to evaluate and
understand local ﬁscal resources so that a local government may provide the local
services that its residents desire. The focus is on the individual local government and its

ability to mobilize local resources to support its service programs. Thus, local ﬁnancial

34
self-sufficiency can generally be deﬁned as the ability of a local jurisdiction to raise

revenues from locally owned sources. The deﬁnition of a “good” level of local ﬁnancial
self-sufﬁciency will vary with the nature of the jurisdiction and is only valid for a very

limited time and space.

2. Fiscal Accounts of Local Government

1) Identig of Local Revenue Sources

 

In order to understand local ﬁnancial self-sufﬁciency, the ﬁrst task is to scrutinize
the governmental ﬁscal structure in which revenue sources and expenditures are arranged
or organized. Identifying revenues and expenditures is basic to understanding the ﬁscal
conditions of each local government, divisions of governmental function and revenue
sources. Generally speaking, a country’s ﬁscal structures are composed of national, state
(or provincial) and local ﬁscal accounts. Each ﬁscal account has its own revenue and
expenditure system. Revenues usually represent the resource mobilization of government
and administrative capability for public service delivery. Expenditures offer insight into
governmental functions and responsibility, relating to the supply of governmental
services.

This study presents a national (federal) ﬁscal accounts and local ﬁscal accounts. It
helps to analyze the national—local ﬁscal relationship because considering only a national
(federal) ﬁscal account and local accounts reveal clearly the national-local fund ﬂows. In
reality, various types of state (or provincial) governments play different roles along with

the different governmental systems in developing countries. This study, however,

35

doesn’t include state (or provincial) ﬁscal accounts in the national-local ﬁscal
frameworks because the national-state (or provincial) ﬁscal relations and the state (or
provincial)-local relations may cover the national-local ﬁnancial relations. In addition,
national government’s inﬂuence on the local governments tends to be stronger than state
or provincial governments’ one in developing countries. Therefore, analysis of national
ﬁscal account is very important to understand the degree of local ﬁscal self-sufﬁciency.
At the national level, total national revenue (R1,) is the sum of various national
revenue sources. This consists of intergovernmental transfers, national taxes, custom

duties, fees, charges, and other miscellaneous revenues.

(3.1) R, = TD, + TE, + T1, + Tc, + D0, + or, + CH, + MR, + 15,

where,
RN . total national revenue
TDN : custom duties
TEN : selective sales taxes
T1N : individual income taxes
TC, : corporation income taxes
DGN : death and gift revenue
OTN : other taxes
CHN : current charges
MRN : miscellaneous revenue
ISN : insurance trust revenue
BF, : national borrowing from the outside of national territory

National expenditures depict a national government’s public service or objectives.
Total national expenditures (EN) are equal to the total cost of governmental services. The

total is shown as follows in (3.2):

(3.2) E, = IT, + FP, + ED, + sw, + TR, + SF, + EH, + AD, + 1N, + GN, +113,

where,

GNN :

IE,:

36

total national expenditure
intergovernmental expenditures (transfers)
expenditures for federal programs

: education services expenditures
: social services and income maintenance expenditures
: transportation expenditures

public safety expenditures

: environment and housing expenditures
: government administration expenditures

interest on general debt
general expenditures, n.e.c.
insurance trust expenditures

To identify the local ﬁscal accounts, the national budget structure is applied to the

local level to generalize the accounting structures of local governments. Thus, in the i th

local government, total local revenue (Ru) is the sum of all local revenue sources such as

local taxes, non-tax revenues, intergovernmental transfers, and local borrowing. In

accounting formulas,

(3.3) R1,- = GFL, + GLLi + TPLi + TSLi + TELi + TILi + TCLi + DGLi + LFLi
+ OTLi + CHLi + MRLi + ULLi + ISLi

where,
RLi :

GFLi :
GLLi :
TPLi :

TSLi :
TELi :

TILi :

TCLi :
DGLi :
LFLi :
OTLi :

total local revenue in the i th local government
intergovernmental revenue from national (federal) government in
the i th local government

intergovernmental revenue from local government in the i th local
government

property taxes in the i th local government

general sales taxes in the i th local government

selective sales taxes in the i th local government

individual income taxes in the i th local government

corporation income taxes in the i th local government

death and gift revenue in the i th local government

license fees in the i th local government

other taxes in the i th local government

CHLi :

ULLi :
ISLi :
LBLi

37

current charges in the i th local government

- : miscellaneous revenue in the i th local government

utility and liquor revenue in the i th local government
insurance trust revenue in the i th local government

: local borrowing in the i th local government

Total local expenditures (EU) in the i th local government represent the cost of

local services to its residents.

(3-4) Eu = ”II + EDLi + SWLi + TRLi + SFLi + EHLi + ADLi + INLi + GNU + UELi
+ LEU+ IE“

where,
Eu :
ITLi :
EDLi :
SWLi

TRLi :
SFLi :
EH“ :
ADLi :

INLi :
GNu :
UELi :
LELi :
IELi :

total local expenditures in the i th local government
intergovernmental expenditures in the i th local government
education services expenditures in the i th local government

: social services & income maintenance expenditures in the i th local

government
transportation expenditures in the i th local govermnent
public safety expenditures in the i th local government
environment and housing expenditures in the i th local government
government administration expenditures in the i th local
government
interest on general debt in the i th local government
general expenditures, n.e.c. in the i th local government
utility expenditures in the i th local government
liquor store expenditures in the i th local government
insurance trust expenditures in the i th local government

Total local revenues and expenditures in the entire nation are the sum of each

local government’s revenues and expenditures. They are given as follows.

(3.5) Total Local Revenue (RL):

M:
W
C

38

(3.6) Total Local Expenditure (EL): 2 ELi

k=1

2) Substitution: National-LocaIRelationsﬂp

In general, the ﬁscal relationship between the national government and local
governments is represented by the relationship between national ﬁscal accounts and local
ﬁscal accounts. Intergovernmental transfers can be expressed as a ﬁscal relationship
between national and local governments. Intergovernmental expenditures (IT,) in
national ﬁscal accounts can be substituted for intergovernmental revenue (GFL) in the
sum of local ﬁscal accounts and vice-versa. Thus, the amount of intergovernmental
transfers may represent the relative ﬁscal responsibility between national and local
governments.

Assuming the national budget is balanced, intergovernmental expenditures (IT,),
as one of the national expenditures, can be expressed by subtracting national costs for
national public services from total national revenues. Thus, intergovernmental

expenditures (IT,) is given by

(3.7) IT, = (TD, + TE, + T1, + TC, + DC, + 0T, + CH, + MR, + 15, + BFN)
- (FP,+ ED, + sw,+TR,+ SF,+ EH,+ AD, + 1N, +GN, +1E,)

This means that the national (federal) government provides some money out of the
national revenues to local governments.

In the i th local government, total local revenues include intergovernmental
revenue (GFU) that comes from the national (federal) government. This

intergovernmental revenue (GFU) can be expressed by subtracting locally raised revenue

39
and other local governments’ subsidies (GLU) from total local expenditures. It is given

by

(3.8) GFLi = ( ITLi + EDLi + SWLi + TRLi + SFLi + EHLi + ADLi + INLi + GNLi + UELi +
CHu + MRu + ULu + ISLi ) - GLu

where,
ITLi : intergovernmental expenditures in the i th local government
GLLi : local subsidies from other local governments in the i th local
government

In the local accounting framework, total intergovernmental revenue (GE) is the
sum of intergovernmental revenues of each local government. Total intergovernmental

revenues (GFL) from the national government can be expressed by subtracting the sum of

local revenue from the sum of local expenditures. This is denoted by

W

or, = Z [( 11‘, + ED, + sw, + TR, + SF, + EH, + AD, + IN, +
i=1 i=1

GN, + UE, + LE,+ IE, ) - ( TP, + T3, + TE, + T1, + TC, +
DGU + LFU + OTU + CH“ + MR” + UL” + ISL; ) ' GLLI]

(3.9)

This means local expenditures exceed locally raised revenue. Local governments usually

depend on the national government for ﬁnancial assistance.

111. Development of Local Financial Self-Sufﬁciency Indices

A major issue in urban and regional planning is the promotion of ﬁnancial self-

sufﬁciency, which will permit local governments to provide local services without

40
external funding assistance. The degree of ﬁnancial self—sufﬁciency varies widely across

local governments in developing countries. The variations in local ﬁnancial self-
sufﬁciency may exhibit the relative capability of local governments for local public
service delivery. Measuring local ﬁnancial self-sufﬁciency is crucial to understanding
the interlocal differences in local governments’ capacity for public service delivery.
Developing operational measures is necessary to determine the degree of local
ﬁnancial self-sufﬁciency. The operational measures should be designed to represent a
conceptual deﬁnition and the extent of ﬁnancial self-sufﬁciency of local governments
within a country. This study constructs four types of measures that describe the degree of
local ﬁnancial self-sufﬁciency, using ﬁscal accounts that were examined in a previous

section.

1. Existing Indices

Reviewing existing indices is the ﬁrst step in developing the operational measures
of local ﬁnancial self-sufﬁciency. Generally, the following seven types of indices have
been considered as measures of local ﬁnancial conditions. These indices include the local
taxes index (LTX; CLTX), local self-reliance index (LSX; CLSX), local general revenue
index (LGX; CLGX), per capita expenditure index (CEX), per capita local and state tax
efforts index (TFX), and national share index of per capita local and state tax efforts
(STFX). These indices have been used for understanding the extent of ﬁscal

responsibility or autonomy of local governments.

41
The ﬁscal responsibility of local governments depends on the ﬁscal relationship

between the levels of government. According to the local accounting framework in a
previous section, local revenues come from local and intergovernmental sources.
Therefore, the relative portion or extent of intergovernmental funds in local ﬁnance may

represent a local government’s degree of ﬁscal dependency.

1) Local Taxes Index (LTX; CLTX)

Local taxes are important local resources that effect the extent of local ﬁscal
autonomy and ﬂexibility. The index of local taxes is designed to measure the extent of
local ﬁscal autonomy and ﬂexibility. Local taxes used to construct this index are
property taxes (TPU), general sales taxes (TSU), selective sales taxes (TEU), individual
income taxes (TIU), corporation income taxes (TCU), death and gift revenues (DGU),
license fees (LFU), and other taxes (OTU). The local taxes index can be expressed as both
share and per capita index. Share index (LTX) considers the local proportion of total

local revenue. The indices may show the ﬁscal stability of local governments.

(3.10) LTx = [(TP, + T3, + TE, + T1, + TC, + D0, + LF, + 0T, ) / R, ] * 100

Per capita index standardizes the degree of local resources, considering population.

Per capita index (CLTX) is given by

(3.11) CLTX = (TPL, + TSLi + TELi + TILi + TCLi + DGLi + LFLi + OTLi ) / PopLi

where,
PopLi : the number of residents in the i th local government

42

2) Local Self-reliance Index (LSX; CLSX)

 

The index of local self-reliance is a good indicator of the local government’s
ﬁscal autonomy and ﬂexibility. It is related to the extent of locally raised revenues.
Locally raised revenues are the sum of local taxes and non-tax revenues that include
current charges (CHU), rrriscellaneous revenue (MRU), utility and liquor revenue (U LU),
and insurance trust revenue (18,). Share index (LSX) is the portion of locally raised

revenue in total local revenue.

(3.12) LSX = [(TPU + ISL, + TEL, + TIL, + TC“ + DGU + LFU + OTL,
+ CHU + MR” + ULL, + IS“) / Ru ] * 100
=[{RLi'(GFLi+GLLi)}/Ru]*100

Per capita local self-reliance index (CLSX) is given by

(3.13) CLSX = (TPL, + TS” + TEL, + TIL, + TCU + DGU + LFU + OT”
+ CHLi + MRLi + ULLi + ISLi) / POPLi
=[Ru'(GFu+GLu)]/P0Pu

3) Local General Revenue In_dex (LGX; CLGX)

Local general revenues are local revenues without any conditions on the use of the
funds. The local general index attempts to capture the local government’s capability to
establish its own projects to deliver local public services. Thus, this index measures the

degree of local autonomy. Subtracting conditional revenues and special purpose revenues

43

from total local revenues identiﬁes these local general revenues. The share index of local

general revenues is denoted by

(3.14) LGX = [( RLi - CRLi ) / RU] * 100
where,

CRLi : Conditional Local Revenues
= Conditional Grants and Special Purposed Revenues

Per capita local general revenue index (CLGX) is given by

(3.15) CLGX = ( R, - CR, ) / Pop,

4) Per Capita Expenditure Index (CEX)

Local expenditures represent the distribution of the local government’s services.
The per capita expenditures index is a good measure to express the local government’s
extent of public services. The variables used to construct this index are total local
expenditures and the number of local residents. This per capita expenditures index
(CEX) is given by

(3.16) CEX = ELi / PopLi

5) Per Capita Local and State Tax Efforts Index (TFX)

The index of per capita local and state tax efforts is designed to capture the extent
of local residents’ tax burden. The tax burden is a good measure of local ﬁscal
performance for each local government. Local residents pay their taxes to various levels

of government. The variables used to construct this index (TFX) are local residents’ tax

44

payments to local and state (provincial) governments and the number of local residents.

This index (TFX) is given by

(3.17) TFX = (TPLi + TSLi + TELi + TILi + TCLi + DGLi + LFLi + OTLi+ TSPSi )/ PopLi

where,
TSPSi : State or Provincial Government Taxes

6) National Share Index of Per Capita Local and State Tax Efforts (STFX)

 

Local residents also pay national taxes to the national government. The ratio of
per capita local and state (provincial) tax efforts to national tax efforts is one measure of
the relationship between local governments and the national government. The magnitude
of tax efforts depends on the magnitude of tax bases. Therefore, the national share index
of per capita local and state tax efforts (STFX) may capture the extent of the tax base
arrangement between governmental levels. Moreover, this index may show the
mismatches between tax efforts and public service responsibilities. The index (STFX)
comes from the ratio of per capita local and state (provincial) tax efforts to per capita

national tax efforts.

(3.18) SFTX = [TFX / (TTN, / Pop,)] * 100

where,
TTNN : Total National Taxes

45

2. Indices of Local Fiscal Decentralization

The above indices have their own speciﬁc characteristics. Therefore, each index
can measure only a speciﬁc ﬁscal characteristic in local governments. To provide
comprehensive measures, this section presents composite and decentralization indices for

local ﬁnance.

1) Composite Indices

The composite indices for local governments are designed to combine
characteristics of each index. Share indices and per capita indices have different
characteristics from each other. Therefore, both types of indices should be calculated and
standardized separately by index type. In this section, the composite share index is the
simple average of share indices. The composite per capita index is the simple average of
per capita indices. These indices will provide combined measures to evaluate local
governments’ ﬁscal responsibility, ﬂexibility, and autonomy.

The variables used to design the composite share index (CPX) are the local taxes
index (LTX), local self-reliance index (LSX), local general revenue index (LGX), and
national share index of per capita local and state tax efforts (STFX). Thus, the composite

share index (CPX) is given by

(3.19) CPX = (LTx + LSX + LGX + STFX) / 4

46
The variables used to design the composite per capita index (CCPX) are the per

capita local taxes index (CLTX), per capita local self-reliance index (CLSX), per capita
local general revenue index (CLGX), per capita local expenditures index (CEX), and per
capita local and state tax efforts (TFX). Thus, the composite per capita index (CCPX) is

given by

(3.20) CCPX = (CLTX + CLSX + CLGX + CEX + TFX) / 5

2) Decentralization Indices

The degree of local ﬁnancial self-sufﬁciency should be analyzed in the context of
the national ﬁnancial system and the degree of decentralization. Decentralization means
subnational governments have more governmental functions. However, legal or political
devolution is not always accompanied by economic or ﬁnancial decentralization. Thus, it
is very important to measure the degree of ﬁscal decentralization. This helps to identify
local ﬁscal responsibility. To measure the degree of ﬁscal decentralization, the
magnitude of local revenues from own-sources and local expenditures, including
intergovernmental assistance, should be considered. In this section, two types of ﬁscal
decentralization indices are formulated to describe the relationship between national and
local governments.

The extent of responsibility allowed by the national government for local
revenues or expenditures varies widely. Depending on the national-local ﬁscal
relationship, the degree of local revenues or expenditures responsibility also varies.

Fiscal assignments of revenues and expenditures between national and local governments

47

may determine the degree of ﬁscal decentralization in a local government. One way to
consider an intergovernmental ﬁscal assignment is to examine which level raises the
revenue and which provides the services. The indices of ﬁscal decentralization may be an
appropriate measure to determine the extent of local ﬁscal capacity in developing

countries.

a. Revenue Decentralization Index (DCENXI )

This index focuses on total locally raised revenues and total national revenues in a
comparative concept. The index of revenue decentralization (DCENXI) is given by the
portion of per capita total locally raised revenues in the sum of per capita total locally
raised revenues and per capita total national revenues. This index indicates the revenue
raising responsibility of each local government compared to the national revenue raising

responsibility.

(3.21) DCENXI :[CLSX/ {CLSX+ (TRN,/Pop,))]

where,
TRNN : total national revenue

b. Exmnditure Decentralization Index (DCENXZ)

The index of expenditure decentralization (Decenx2) is given by the portion of per

capita local expenditures in the sum of per capita local expenditures and per capita

48
national expenditures. This index indicates the expenditures responsibility of each local

government compared to the national expenditure responsibility.
(3.22) DCENX2 : [CEX/ {CEX + (EN/ Pop,)}]
where,

EN : Total National Expenditure

IV. Theoretical Framework of Local Financial Self-Sufficiency

1. Production Function

For a given technology a neoclassical production function as a single equation
explains the maximum output obtainable from speciﬁed inputs and emphasizes their

substitutability.l A neoclassical production function can be expressed by

(323) X = X061. X)
where, X = output per annum

xj = absorption of j th input per annum, j = 1, 2

This production function is a form ﬁrst written by Wicksell.2 Cobb and Douglas3 tested it

empirically. Let the equation (3.23) be rewritten as a Cobb-Douglas production function

 

' Hans Brems, Quantitative Economic Theory: A Synthetic Approach, New York: Wiley, 1968
2 K. Wicksell, Lectures on Political Economy 1, London, 1934: 128.

49

(3.24) X: Mx,“x,ﬂ

where,
a, ,6 = parameters of a Cobb-Douglas production function

M = multiplicative factor in the production function
In the function, 0 < a < 1, 0 < ,6 < 1, and M > 0. The production function (3.24) is
considered with these restrictions: x1 2 0, x2 2 0, and X 2 0. The two inputs are substitutes
but not perfect ones. The parameter M may measure the scale of production, how much
output we would get if we used one unit of any input. The parameters a and ,6 measure
how the amount of output responds to changes in the inputs.

If a + ,B = 1, the function (3.24) exhibits constant returns-to-scale. If a + ,6 > 1,

the ﬁmction exhibits increasing returns-to-scale. If a + ,6 < 1, the function exhibits
decreasing returns-to-scale. A Cobb-Douglas production function always has the
elasticity of substitution one. Therefore, if we may replace xl with 1x, x2 with 1x2, then

output becomes AX. We then take the derivatives

 

(3.25) g = a_)_(_

al &1

W X
3.26 — = —
( ) 0&2 .3012

32X X
3.27 = a a —1 —
( ) 0112 ( )0}12

 

3 C. W. Cobb and P. H. Douglas, “A Theory of Production,” Am. Econ. Rev., 18, :139-165, Supplement
1928.

50

 

 

 

 

 

52X X
3.28 = _
( ) dc; .393 1) a2;
(3.29) 32X = 52X
@3012 é‘zdﬁ
(3.30) = aﬂ X
xrxz

For positive M, x, and x2 the equation (3.25) and (3.26) will be positive if and
only if a and ,B are positive; for positive a and )6 equations (3.27) and (3.28) will be
negative if and only if a and ,6 are both less than one. Thus the marginal productivity of
any input has been shown to be positive and diminishing with that input if and only if
both a and ,6 lie between zero and one. All this was assumed to be the case. Then,
equations (3.29) and (3.3 0) are seen to be positive. Thus, the marginal productivity of
any input has been shown to be increasing with the other input.

This Cobb—Douglas production function is useful in many applications because it

is linear in logarithms:

(3.31) lnX=lnM+orlnx,+,Blnx2

The parameter a is then the elasticity of output with respect to input xI and ,6 is the

elasticity of output with respect to input x2. These parameters can be estimated from

actual data; the estimates may be used to measure returns to scale and for other purposes.

51
2. Production of Local Financial Self-Sufficiency

As a local production function,

(332) X= M(x,)"" a)“: . . . . a)“:

In production functions, x,- are capital (K), labor (L), production technology (T),
and other endowments. For a practical model of local ﬁnancial self-sufﬁciency, x,- are
replaced with real local inputs. The extent of local ﬁnancial self-sufﬁciency (X) as a
product of a local government is a function of these local inputs.

In this study, the local ﬁnancial self-sufﬁciency is deﬁned as the ability of a local
government to raise revenues from locally owned sources. This local ﬁnancial self-
sufﬁciency is a local output that a local government produces, using local revenue
sources. Thus, production theory can provide the explanation of how local governments
transform inputs into outputs. Production function provides the relationship between
local ﬁnancial self-sufﬁciency (output) and local revenue sources (inputs). Production
function also shows how each revenue source contributes to the degree of local ﬁnancial
self-sufﬁciency.

Of course, production function does not show the extent of local demand of self-
sufﬁciency, which may be an important factor to decide the degree of local ﬁnancial self-
sufﬁciency. In developing countries, however, the degree of local ﬁnancial self-

sufﬁciency is decided by the characteristics and magnitude of local revenue sources

52

rather than by the local demand as local residents’ preferences. Thus, production function
will provide an appropriate explanation of how the degree of local ﬁnancial self-
sufficiency is related to the each local revenue sources.

Suppose a local government uses local revenue for any product. The inputs of

local ﬁnancial self-sufﬁciency are local revenue sources. Therefore, local production

ﬁrnction is given by
(3.33) X = M(TA)“' (T RE)“’ (LF)“’ (T PD“ (T P)“’ (T 579““ (T L00” (LGPUa'
(0T)“" (T OB)“'° (RENT)““ (FEE)“" (CG)“” (NC0T)“" (PD)“"
(LBOR) 0.. (FLOAN) “'7 (LCOL)“" (T RF) “'9 (ALL0)“2° (NT 07")“2'
(ST)“” (GN)“” ( 019“"
where,
X : local ﬁnancial self-sufﬁciency
M : multiplicative factor in the production functions
a, : parameters of a Cobb-Douglas production function, i = 1, 2, .. , 2
TA : acquisition taxes
T RE : registration taxes
LF : license fees
TH : residence taxes
T P : property taxes
TET : tobacco taxes
TLC : synthesis land taxes
LGPY : carry-over from previous year of general taxes
0T : other taxes
T OB : objective taxes
RENT : rent revenues
FEE : fees
CG : collection grants
NCOT : other current non-tax revenues
PD : property disposal
LBOR : local borrowings
FLOAN : loan from funds
LCOL : loan collection
TRF : transferred from

ALLO : allotments

53

NT 0T : other temporary non-tax revenues
ST : local share taxes

GN : national subsidies

GP : provincial subsidies

As a cost (local budget constraints) function,

(3.34) C = P'xl + sz2 + . . . + Pix,-

F or a practical model,

(3.35) C = P‘(TA) + P2(TRE) + P3(LF) + P‘(T}D + P’(TP) + P"(TE7) +
P7(T LC) + PVLGPI? + P’(0T) + P'°(T OB) + P”(RENT) +
P‘2(FEE) + P'3(CG) + P”(NC07) + P"(PD) + P'°(LBOR) +
P”(FLOAN) + P'8(LC0L) + P"(TRF) + P2°(ALL0) + P2‘(NT0T)
+ P22(ST) + P23(GN) + P2‘(GP)
where,
C : total costs (total local revenue)
Ps :the price oftlreithinput, andP‘>0,s= 1,2, .., 24

For maximizing the production function (3.33) subject to a constraint (local

revenue), the Lagrangian expression is set up:

(3.36) L = M(x,)“n(x,)“2....(x)“r+1.[C-P‘x,-P2x,-...-Pix,]

(3.37)

54

For a practical model,

L = M014)“ (TRE)“’ (U905 (7‘10“) (TP}a’ (TEDG‘ (T LC)‘ (LGPUa'
(079% (T OB)“'° (KEN 77““ (FEE)"” ( CG)“" (NC0T)a“ (PD/1"
(LBOR) a... (FLOAN)“" (LCOL)“" (TRF) “19 (ALL0)“2° (NTODan
(swan (GA/)“n (019% + 1.[ C - P' (TA) - P2(TRE) - P3(LF) — P‘(TH)
- P’(TP) - P"(TET) - P7(TLC) - P8(LGP19 - P9(07) - P'°(TOB) -
P"(RENT) - P‘2(FEE) - P‘3(CG) - Pl‘ovcor) - P"(PD) -
P‘6(LBOR) - P”(FLOAN) - P‘8(LC0L) - P"(TRF) - P2°(ALL0) -
P2'(NT0T) - P22(ST) - P23(GN) - P2‘(GP)]

A ﬁrst order condition for a maximized local service production is as follows.

Setting the partial derivatives of L (with respect to every input and 1.) equal to 0 yields

several equations representing the necessary conditions for a maximum:

(3.38)
(3.39)

(3.40)

(3.62)

(3.63)

 

 

11— : Ma, —X— - AP' = o
OTTA) 5(TA)

01 = Mar2 X —/1P2 = 0
a(TRE) a(TRE)
i- : Ma3 i - AP’ = 0
6(LF) dLF)

5L X

——= Ma25——/1P25 =0
aGP) éIGP)
% = c - pm) - P’(TRE) - mo - P‘(TH) - P’m’) - 10°an —

P7(TLC) - P“(LGP}7 - 109707) - P'°(TOB) - P“(RENT) - P‘2(FEE) -
P'3(CG) - P"(NCOT) - P'5(PD) - P‘6(LBOR) - P"(FLOAN) - P'8(LC0L) -
P"(TRP) - P2°(ALL0) - P2‘(NT07) - P”(ST) - P’3(GN) - P"(GP) = 0.

55

The second order conditions state that the Hessian matrix of second order partial
derivatives of the Lagrangian with respect to the instruments must be negative deﬁnite or

negative semidefrnite when evaluated at the local maximum.

 

 

 

 

 

 

 

 

— 32L ﬂzL coo 62L _
5(TA)’ 5(TA)&(TRE) a(TA)o‘(GP)
32L an 521 521.
(3.64) 03,}? = aTRE:)§(TA) 5(TRE)2 O’ITRE)§(GP)
32L _iL__
_ (51013474) now

These equations can usually be solved for the optimal x1, x2, . . . xj and for A. The
ﬁrst-order conditions represented by equations (3.38), . . . (3.63) can be rewritten in a

variety of interesting ways. For example, for any two inputs TA and TRE, we have

 

 

a X
1 1
OTTA) _P_
(3.65) X — P2
“2
5(TRE)

Theoretically, the ratio of the marginal productivity of two inputs is in fact
identical to the marginal rate of technical substitution between them. Therefore, the
conditions for an optimal allocation of production become:

Pl

(3.66) RTS (TA for TRE) = .5.

2

56
Another result can be derived by solving equations (3.3 8), . . . (3.63) for 1.:

Ma, — X Ma, Ji—
a(TA) _ 0”(TRE) _ _ amp)

P1 P2 P24

 

Ma2

 

 

 

(3.67) 2 =

This equation says that at the production maximizing point, each input should yield the
same marginal productivity per dollar input on any input factors.

The value of the Lagrangian is the optimal value of the objective function. The
Lagrange multiplier method, therefore, in addition to solving the classical maximization
problem, also provides a sensitivity analysis, showing in the values of the Lagrange
multipliers, how sensitive the optimal value of the objective ﬁrnction is to changes in the
constraint constants. For example, if any Lagrange multiplier were equal to zero at the
solution, then small changes in the corresponding constraint constant would not affect the

optimal value of the objective function.

3. Limited Production of Local Financial Self-Sufficiency in Developing Countries

In the previous section, the ﬁrst-order and the second-order conditions are the
necessary conditions for the efﬁcient production of local ﬁnancial self-sufﬁciency. The
ratio of marginal productivity of an input to its cost is equal for all inputs for an efﬁcient
production of local ﬁnancial self-sufﬁciency. The efﬁcient production condition shows

that if the fraction differs from one local government to another, an efﬁcient production

57
condition and the optimal productivity with respect to local inputs will vary among the

different local governments.

The efﬁcient production conditions are based on the constrained maximization
model of an industrialized country. This model, however, assumes a ﬂexibility and
discretion in ﬁscal response that local governments in developing countries do not often
have. Local governments in developing countries have limitations caused by a weak
revenue structure and local ﬁscal administration (Smoke 1994; Bahl and Linn 1992).

Suppose that a local government uses a number of inputs that can be varied in
quantity, with input x being only one of them. A change in the price of input x will result
in changes in the quantities used of other variable inputs, which will affect the quantity
used of input x. However, local governments in developing countries may not respond
appropriately to a change in the price of input x because they have limitations to revenue
generation. Therefore, local governments in developing countries may not change the
quantities of other variable inputs.

Bahl and Linn (1992) describe local tax or revenue administration in developing
countries as being so weak that local governments cannot raise sufﬁcient dollar amounts
to provide local services. Local tax administration simply cannot respond to changes in
other socioeconomic conditions and local needs. Thus, revenue mobilization and
efﬁciency are not realized. Furthermore, "tax bases given to the local governments are
not income-elastic and local government is legally prohibited from increasing rates on the
taxes to which they do have access" (Bahl and Linn 1992:423). Local ﬁscal choice of

inputs to produce local ﬁnancial self-sufﬁciency will vary, limited to their intrinsic input

58

characteristics. Therefore, the degree of local ﬁnancial self-sufﬁciency of a given local

government is related to input composition and magnitude.

lLMix of Revenue Sources

The recent trend of ﬁscal decentralization in developing countries has led to
increased efforts to raise local government revenues from local resources. Local
governments have tried to diversify revenue sources to improve the stability, equity, and
efﬁciency of local revenue systems. The proper mix of local revenue sources is a crucial
ﬁscal choice for local governments to achieve the most optimal revenue mobilization.

A variety of factors might explain the differences in revenue mix across local
governments in developing countries. Some local governments in developing countries
have undeveloped local economies causing difﬁculty in raising revenue from their
economic activities. Some local governments do not have enough revenues raised by
non-property taxes (such as income and sales taxes) and user charges because their
residents suffer from relatively low incomes. Some local governments lack the staff and
leadership required for adopting and administering new revenue sources. In addition,
local governments in developing countries tend to provide fewer services than do local
governments in industrialized countries. Fewer local services may cause the loss of local
opportunities to apply user charges.

The differences in the type of local revenue mix may bring interlocal ﬁscal
differences in developing countries. For example, revenue generation is likely to be more

productive in local areas with higher incomes or in local areas which serve as regional

 

I'Lﬁﬁrg

59

marketing or tourist centers than in local areas without these characteristics. This may
increase ﬁscal disparities among communities. For example, if the national government
requires that all local governments cut property tax rates and shift to sales taxes, this

might actually increase the ﬁscal disparities between rich and poor communities.

a. Own Sources

Property taxes traditionally have been the most crucial revenue source for local
governments. Property taxes may be the only major direct revenue source which local
governments can hope to retain and develop. They are usually assigned to local
governments. In particular, they provide substantial resources in urban areas in
developing countries. Property taxes are politically and economically desirable to local
governments because their base is visible, allowing local tax administration to be easy.
"Revenues from property taxes are frequently substantial, stable, and predictable. The tax
base does not ﬂuctuate in face of short-tenn changes in the economy and revenues are
immune from immediate cyclical phenomena” (Davey 1983:49-50). The stability of
property taxes is a crucial element for local ﬁnances in developing countries.

Property taxes, however, have serious weaknesses. Property taxes in developing
countries show income inelasticity, problems of equity, problems of base valuation, and
political sensitivity (Davey 1983; Bahl and Linn 1992). Thus, property taxes do not tend
to respond to the local demands and challenges of inﬂation and growth. Nowadays,
reliance on property taxes in local governments in developing countries has declined.

In the case of rural land taxation, even though it is a stable and historically

important source of revenue, its signiﬁcance has also declined considerably in almost all

60

countries. It is questionable whether land taxation is an effective instrument in extracting
surplus from the agricultural sector. According to Bird’s 1973 survey, effective tax rates
were almost universally too low to achieve theoretically allocated purposes.4 Therefore,
this type of local taxation does not work as an efﬁcient revenue source.

Income taxation has been known as a most desirable source of revenue,
characterized by a high degree of income elasticity and equity. Every country has derived
the highest proportion of its public revenue from income taxation (Davey 1983; Goode
1980’). Even though it is most advantageous for local governments to gain some share in
the utilization of this revenue source, the local income tax base in developing countries is
very small compared to the national income tax base. The attractiveness of income
taxation creates obvious problems of competition with the central government. Any form
of local income taxation beyond a limited percentage assignment of the national tax
yields presents strong administrative and political conﬂicts. Increase or utilization of
income taxation in local governments is mainly based on a political compromise among
various levels of the government.

Consumption taxation or "the taxation of goods and services is a lucrative and
elastic form of revenue upon which reliance is particularly strong in countries where more
direct taxation faces critical problems of assessment and collection" (Davey 1983: 85).
Davey argues that it is, therefore, a valuable revenue source for local government
wherever the local government has any substantial access to its taxation. Today, many

local governments in developing countries tend to raise their revenue from this form of

 

" Richard M. Bird, Taxing Agricultural Land in Developing Countries (Harvard University Press, 1974).
5 R. Goode, “Limits to Taxation,” Finance and Development, 1980, 11-13.

61
taxation through “assigned shares or surcharging” (Davey 1983; Bahl and Linn 1992).

However, sales and excise taxes often tend to be revenue sources of a national or
subnational government with a larger jurisdiction, rather than the smaller local
governments. Therefore, a key issue concerns the local portion or assignment of this
taxation. In addition, local tax administration of consumption taxes creates problems
including how to collect the taxes for interlocal sales and how to handle the effects of
levy variations upon price levels.

Many local governments in developing countries levy an automobile tax on motor
vehicle ownership and use. Automobile taxation is very useful for local governments
because the number of automobiles often grows faster than the local population
governments in developing countries. Automobile ownership and use are easily taxable
and the burden of automobile taxes is likely to fall on persons with higher incomes.
Local governments may take advantage of a rapidly growing tax base and recapture the
costs of public expenditures required because of automobile use. In developing countries,
automobile taxation is the most desirable source of local revenue because automobile
taxation shows good revenue performance, administrative ease, political acceptability,
economic efﬁciency, and distributive equity.

Fees and charges may be good local revenue sources. Their acceptability comes
from the ease of collection and the appeal of charging service costs directly to the
consumer. Fees and charges as “local revenue may well fall below the levels needed to
operate a service effectively, particularly in times of inﬂation, because of political
reluctance to increase tariffs or enforce sanctions” (Davey 1983: 99). Local governments

in developing countries do not have enough revenue from fees and charges because their

62

residents, who have low incomes, cannot pay enough to cover the costs of local services.
Furthermore, local governments in developing countries tend to provide fewer services
than do local governments in industrialized countries. Fewer local services may cause the
loss of local opportunities to apply user charges. Therefore, the raising of revenue ﬁ'om

fees and charges has some problems of adequacy and elasticity.

b. External Sources

The justiﬁcation of borrowing is investment in developmental projects beyond the
limits of current local ﬁscal capacity. Local governments with only taxes and charging
revenue will often severely curtail or eliminate long-term development. The additional
investment enabled by borrowing may well generate extra current revenue, directly or
indirectly. Although borrowing normally incurs interest charges as well as capital
repayment, the burdens of these are eroded by inﬂation; indeed, if the rate of inﬂation
exceeds that of interest, it is cheaper in real terms to borrow money. Long-term loans
pass on part of the costs of capital assets to the future generations of taxpayers that will
enjoy their beneﬁts.

Extensive borrowing by public authorities is criticized on a number of counts.
Taxpayers are not faced immediately with the full cost of loan-fmanced projects; this can
weaken ﬁnancial discipline and accountability. Excessive borrowing, particularly at high
interest rates, can build up an intolerable burden of debt service for the future;
irresponsible leaders may win cheap popularity or beneﬁts for their supporters by

indulging in investments that exceed any reasonable expectation of increases in revenue.

 

63

Intergovernmental transfers result from the ﬁscal imbalance of responsibility
among governments, namely vertical and horizontal imbalance. Vertical imbalances stem
from ﬁnancial resource imbalances among various levels of government. Horizontal
ﬁscal imbalances are derived from ﬁscal disparities among governments at the local
level. The magnitude of intergovernmental transfers is signiﬁcant to total local revenues.
This magnitude reﬂects primarily the ﬂow of shared revenue, grants, and other aid from
the higher levels of government to the local level.

As a local revenue source, intergovernmental transfer payments are very
dependent on political decisions at higher levels of government. The allocation of
resources is an essential attribute of power and one must expect political values to
predominate. Bird points out that explicit, objective criteria for intergovernmental
transfer payments are needed in developing countries. The allocation of
intergovernmental transfer payments in developing countries tends to depend on political

inﬂuence, vague national objectives, and loose statistical analysis.6

2) Environmental Factors in the Production of Local Financial Self-Sufﬁciency

The differences in environmental conditions surrounding local governments cause
the extent of local ﬁnancial self-sufﬁciency to vary across local governments. The
environmental factors of local production are 1) population size, 2) area, 3) economic

development, 4) poverty, 5) city age, 6) regional setting, and 7) local political setting.

 

6 Richard M. Bird, Intergovernmental Fiscal Relations in Developing Countries (World Bank Staff
Working Paper No. 304, 1978).

64

Local governments produce local public goods and services with a given quantity
of inputs as well as the various environmental factors. Even though individual local
government has enough revenue sources as inputs of production, each local government
may produce local public goods and services in different production environments and
use different production technology.

Differences in each local government’s production function, particularly
differences in the environmental conditions for providing local public services, cause
differences in the production of local services. For example, one of the direct results
from differences in the population size is a difference in the local revenue base.
Differences in the local revenue base, in turn, bring about differences in the total local
revenue across local governments, thus creating a difference in local ﬁnancial self-
sufficiency.

It is easy to see that differences in the political environment and bureaucratic
setting can produce different amounts of local ﬁnancial self-sufﬁciency. For example,
increasing inefﬁciency in political and bureaucratic decision making is likely to increase
the political and bureaucratic input cost. The result of the increased input cost is the shift
to a lower level of production isoquant.

It is also well recognized that differences in local economic factors can cause
interlocal production differences. Differences in the degree of local economic
development also result in a shift of the production isoquant. A growth in the local
economy, given input prices, expands the level of the local revenue base. This indicates
that an increase in local revenue from local sources can alter the level of local ﬁnancial

self-sufﬁciency.

65

It has already been shown that differences in the price of environmental factors
cause interlocal differences in local ﬁnancial self-sufﬁciency. Differences in the prices of
other inputs also differentiate the level of local production. In general, any conditions
that do not generate the same production ftmction among local governments cause

differences in the production of local services.

CHAPTER FOUR

METHOD OF ANALYSIS

1. Overview

This chapter provides a methodology for an empirical analysis of the degree of
local ﬁnancial self-sufﬁciency in Korea. The analytical method of this study is a
statistical analysis using multiple regressions model that identify the relationship between
local ﬁnancial self-sufﬁciency and various types of local revenue and environmental
factors, such as the demographic, socioeconomic, and geographic factors surrounding
local governments in Korea. Based on the relevant literature in Chapter Two and
theoretical analyses in Chapter Three, this chapter speciﬁes three types of analytical
models: a closed model, which focuses on locally raised revenues; an open model, which
considers external revenues including intergovernmental transfers and local borrowings;

and an extended model, which considers environmental factors.

11. Hypotheses

This study will analyze the relationship between the degree of local ﬁnancial self-
sufﬁciency, which refers to the ability of cities to raise own-source revenue and the level

of the structural mix of local revenue sources. Nationally, when local own-source
66

67

revenues increase, the ﬁscal function of the government overall is decentralized, which
means stronger roles for local ﬁscal functions. The local government that has enough
local resources may be ﬁnancially independent from higher levels of government.
Promoting the degree of local ﬁnancial self-sufﬁciency is an objective of local
governments in developing countries in order to sustain local autonomy and increase
local planning capabilities. An increase in the per capita amounts of local own-source
revenues may relate to an increase in the degree of local ﬁnancial self-sufﬁciency,
because an increase in the amounts of locally raised revenues means the local government
has the ability to support local programs or policies.

Local revenue diversiﬁcation may be a crucial strategy for promoting the degree
of local ﬁnancial self-sufﬁciency. Revenue diversiﬁcation has been suggested as a way
to improve the stability, equity, and efﬁciency of local revenue systems, weakening the
ﬁnancial reliance on property taxes. As a result, local government revenue sources have
become more diversiﬁed and much local revenue has come from sources other than
property tax. Therefore, the hypothesis of this study may be established as follows: in a
given city, the level of local revenue diversiﬁcation relates positively to the degree of
local ﬁnancial self-sufﬁciency. In addition, the level of revenue diversiﬁcation is related
to the reliance on each of the local revenue sources. Thus, this study establishes three
kinds of subsets of hypotheses pertaining to local revenue sources.

The ﬁrst subset of hypotheses pertains to local tax revenues. In Korean cities,
major local taxes are: (1) residence tax, which is levied on all heads of households and
corporations with domiciles or ofﬁces in each city; (2) building and machinery tax, which

is a type of property tax on buildings, ships, airplanes, and machinery; (3) automobile tax,

68
which is on motor vehicle ownership and use; (4) farmland tax, which is on the harvests

from the farm land; (5) tobacco tax, which is an excise tax on tobacco sales; (6) synthesis
land tax, which is levied on land and land ownership, and (7) city planning tax‘, which is
an earmarked tax on buildings and land in a city.

The buildings and machinery tax, synthesis land tax, and city planning tax are,
generally, kinds of property and wealth taxes. In realty, the property and wealth tax is
known as a primary local revenue source. However, city governments in Korea have a
very inﬂexible property and wealth tax. The rate and base of property and wealth tax
seem to remain unchanged. Differences among local governments in per capita property
and wealth taxes are very small. Thus, it is likely that differences in other local taxes
rather than the property and wealth tax are most strongly related to the degree of local
ﬁnancial self-sufﬁciency.

Income and consumption-based rather than wealth—based taxes are generally more
elastic to the changes in environmental factors. The residence tax and the farmland tax
are considered to be income-based taxes in Korea. To the tax on heads of households and
on corporations Korean cities have been altered some power to add a certain percentage
of surtax on all tax liabilities of national personal income tax, the corporate income tax,
and farmland tax. While this gives them some discretion to maximize wealth-based tax
revenues, the surcharge is small and variations in the surcharge are generally used to
differentiate between wealthy and less wealthy taxpayers.

Therefore, cities in Korea seem to hold great revenue potential in the residence

tax. The tobacco tax is a consumption tax in Korean cities. However, as an excise tax,

 

' Its use is formally designated for city planning activities.

69

the burden of this tobacco tax is likely to fall on persons with lower income. Thus, the
tobacco tax provides limited revenue potentials in Korean cities. The automobile tax may
show great revenue performance. A city’s number of automobiles oﬁen grows faster than
its population. A city in developing countries should take advantage of this rapidly

growing tax base. Thus,

H1: In a given city, the per capita amount of total local tax revenues relates
positively to the degree of local ﬁnancial self-sufﬁciency.

Hla: In a given city, the per capita amount of residence tax revenue relates
positively to the degree of local ﬁnancial self-sufﬁciency.

H1 b: In a given city, the per capita amount of automobile tax revenue relates

positively to the degree of local ﬁnancial self-sufﬁciency.

The second subset of hypotheses concerns the relationship between the degree of
local ﬁnancial self-sufﬁciency and the level of non-tax revenues. Non-tax revenues in
Korean city governments are composed of rents, fees, property disposal revenues, public
property rents, collection grants, loan collection, transfers from other accounts,
allotments, contributions, business ﬁrm revenues, interests, and other miscellaneous
revenues. Rents are beneﬁt charges on speciﬁc activities or purchases that are generally
related to the use of public facilities. Fees are payments normally based on an
individual’s voluntary consumption of publicly provided goods and services. Property
disposal revenues are revenues from the sale of government property. Public property

rents are the rent revenues raised from govemment-created property rights. Collection

70

grants are intergovernmental payments for local expenditures to collect national or
provincial taxes or charges. Loan collections are revenues from the redemption of loans
provided by local government. Transfers from other accounts are to bring in some money
from accounting changes. Allotment is a kind of special assessment which means it is a
compulsory payment imposed on real property for speciﬁc beneﬁts generated by public
investment or services. Contributions are voluntarily given from individuals or
corporations. Business ﬁrm revenues are receipts of local public ﬁrms. Interests
revenues are earnings on deposits in the bank. Miscellaneous revenues come from ﬁnes,
forfeiture, and sale of unused public property.

Out of local non-tax revenues, the level of the revenues from public property
rents, disposal of public property, and allotment show the largest differences among local
governments. The revenue ﬁ'om the public property rents and public property disposal
comes from the management of public property. The magnitude of a city’s public
property may be different from other cities. These intercity differences in the magnitude
of public property may cause differences in the amount of non-tax revenues. The level of
public investment in a city may also be different from other cities. This would result in

intercity differences in the level of allotment revenue. Therefore,

H2: In a given city, the per capita amount of local non-tax revenues relates
positively to the degree of local ﬁnancial self-sufﬁciency.
H2a: In a given city, the per capita amount of public property rent revenue

relates positively to the degree of local ﬁnancial self-sufficiency.

71

H2b: In a given city, the per capita amount of local revenues from the
disposals of public property relates positively to the degree of local ﬁnancial self-
sufﬁciency.

H2c: In a given city, the per capita amount of allotment revenue relates

positively to the degree of local ﬁnancial self-sufficiency.

The third subset of hypotheses relates to intergovernmental ﬁscal relations in the
Korean governmental system. In Korean cities, the types of intergovernmental transfer
payments are: 1) local shared taxes which represent a kind of general revenue sharing, 2)
national subsidies which are conditional grants from the national government, and 3)
provincial subsidies which are conditional grants from the provincial government.

Local planning is usually interwoven with adjacent localities. The
interdependence of local planning produces intergovernmental spillovers. Public goods
with spillovers require intergovernmental transfer revenues to ensure that an efﬁcient
level of service is provided. There is a belief that intergovernmental transfer revenues are
positively related to local government developmental expenditures. Intergovernmental
transfer payments, it is thought, stimulate local expenditures. Intergovernmental
payments from higher levels of government may give a city government income effects,
which means a city government feels the increase in city income. Therefore, the city
government increases its expenditures.

On the other hand, assuming that local budgets are balanced, total local
expenditures are equal to total local revenues. Thus, an increase in intergovernmental

transfer payments may cause a decrease in locally raised revenues. According to this

72

logic, intergovernmental transfer payments may be negatively related to the degree of
local ﬁnancial self-sufﬁciency. In this context, a hypothesis is established to test the
relationship between the level of intergovernmental transfers and the degree of local

ﬁnancial self-sufﬁciency in Korea.

H3: In a given city, the per capita amount of intergovernmental transfer
payments relates negatively to the degree of local ﬁnancial self-sufﬁciency.

H3a: In a given city, the per capita amount of local shared taxes relates
negatively to the degree of local ﬁnancial self-sufﬁciency.

H3b: In a given city, the per capita amount of national subsidies relates
negatively to the degree of local ﬁnancial self-sufﬁciency.

H3c: In a given city, the amount of provincial subsidies relates negatively to

the degree of local ﬁnancial self-sufficiency.

III. Analytical Model

I propose a statistical method to ﬁnd the relationship between the degree of local
ﬁnancial self-sufﬁciency as a local ﬁscal condition and various local revenue sources.
The following equation expresses the degree of local ﬁnancial self-sufﬁciency (LFSSLi)
as a local ﬁscal condition index that is affected by various independent variables (X,).
For a local government, the degree of local ﬁnancial self-sufﬁciency (LFSSU) is

presented by a production ﬁrnction using the neoclassical economic theory.

73
(4.1) LFSSLi #13sz.. ----- X.)

Where local ﬁnancial self-sufﬁciency is the calculated degree of local ﬁnancial self-
sufﬁciency as a local ﬁscal condition index in the i th local government, X ,, X2, ----- Xn
are factors that are related to the degree of local ﬁnancial self-sufficiency.

As a dependent variable, the degree of local ﬁnancial self-sufﬁciency (LFSSU) is a
local ﬁscal condition measure. It is calculated with Korean local ﬁscal data. Four types
of measures, which were presented in Chapter 3, can then be applied to the above
equation. These measures are as follows: the composite share index (CPX), composite
per capita index (CCPX), revenue decentralization index (DCENXl), and expenditure

decentralization index (DCENX2).2

1. Closed Model

Local ﬁscal attributes possess local public revenues (RU), such as local taxes, non-
tax revenues, intergovernmental revenues, and local borrowings. The local public

revenues (R1,) are denoted by (4.2).

(4.2) R1,,- = f(TH, TBM, TA UTO, TFAR, TBUT. TET. TSL, PRENT, GRENT, FEE, FR,
CG, INTR, PD, LTPY, CONT, LCOL, TRF, ALLO, MR, LTDPY, ST, GN,
GP, LBOR)

where,
TH : residence tax
TBM : building and machinery tax

 

2 Detailed explanations of these indices are in Ch. 3.

74

TA UT 0: automobile tax

T FAR : farmland tax

TB UT : butchery tax

TET : tobacco-spending tax

TSL : synthesis land tax

PRENT: public property rent revenue

GRENT: beneﬁt charges for use of public facilities

FEE : payments for voluntary consumption of public services
FR : receipts of local public ﬁrms

CG : grants for collection of national or provincial taxes or charges
INT R : earnings of deposits belonging to the bank
PD : revenues from the sale of government property

LTPY : carry-over of annual surplus

CONT : voluntary contributions

LCOL : loan collection

TRF : transferred from other accounts

ALLO : allotment

MR : revenues from ﬁne, forfeiture, sale of unused public property, etc.

LTDPY: non-tax revenues raised in previous year

ST : local shared tax

GN : national subsidies

GP : provincial subsidies

LBOR : local borrowings

In general, locally raised revenues are positively related to the degree of local

ﬁnancial self-sufﬁciency by deﬁnition. Locally raised revenues consist of local taxes and
non-tax revenues; these are also classiﬁed as wealth-based revenues, income-based
revenues, and consumption-based revenues, even though some revenues have both
characteristics. Assuming local property and wealth-based taxes are the basic own-source
revenues for local governments, other types of revenue are complementary or substitute.
The complementary revenues will be positively related to the degree of local ﬁnancial
self-sufficiency, and, contrarily, the substitute revenues will be negatively associated.

Assuming that a local ﬁnancial system is closed within a jurisdiction, the degree of local

ﬁnancial self-sufﬁciency is only a function of locally raised revenues. The differences in

75

local revenue patterns showing how local governments raise revenue from their own-
sources makes a difference in local ﬁnancial self-sufﬁciency among localities. The local
revenue pattern includes local reliance on revenue sources and the extent of revenue mix

expressed as a standard deviation3 of the amounts of local revenues. Thus,

(4.3) LESS, = lfss(SD,, LT, (TH, TBM, TA UTo, TFAR, TB UT, TET, TSL,,),
Non-tax, (PRENT, GRENT, FEE, FR, CG, INTR, PD, LTP Y,
CONT, LCOL, TRF, ALLo, MR, LTDP Y,))

where,
SDLi : standard deviation in the amount of various local
revenues in the i th local government
LT 1.1 : local taxes in the i th local government
Non-taxLi : local non-tax revenues in the i th local government

Transforming this equation to a Cobb-Douglas type function to identify the role or
intensity of each variable relating to local ﬁnancial self-sufﬁciency provides us with the

following:

(4.4) LFSS, = M(SD,) "1 (TH,)“= (TBM,)“3 (TA UTO,) “A ﬂ‘FARL-J “5 (TB UT,) “6 (TET,)"7
(TSL,)“‘ (PRENT,)“° (GRENTL) “w (FEEL) “n (FR,) «2.. (C0,) “n
(INTRL-J “"(PDU) “w (L TPY,) “w (C0NT,) “n (LCOLU) “n (TRE,) “w
(ALL0,) “20 (Mayan (LTDPY,)“22

 

3 The standard deviation is a measure of spread or variability, calculating the differences from the mean in
a given sample. In formula,

 

N _
Standard Deviation (s) = \iS2 = 2(X, —X)2
i=1
where, Xi : the amount of ith local revenue
X : the average amount of local revenues

Large value of standard deviation means that the amounts of local revenues are quite spread out. Small
value of standard deviation indicates that the amounts of local revenues are pretty similar.

76

In this equation, a, a, and or,2 mean production elasticity, which explains the extent
that the factors contribute to the production process of local ﬁnancial self-sufﬁciency.
To examine the relationship between local ﬁnancial self-sufﬁciency and local
public ﬁnancing, additional assumptions are required. It is assumed that local ﬁnancial
self-sufﬁciency (LFSSU) has approximately a log linear relationship with a local

government’s input revenue sources:

(4.5) logLFSSLi = logM + a,Iog(SDL-,) + azlog(THL-,) + a3log(TBMb-) +
a4log(TA UT 0,) + a5log(TFAR,_-,) + a610g(T BUT 1.1) + a,log(TET,)+
aglog(TSL,) + a9log(PRENTU) + amlog(GRENTU) + aulog(FEE,-) +
a1210g(FRL-,) + a13log(CGL-,) + a14log(INTRu) '1' a15log(PDb-) ‘1'
a1610g(LTPY,) + a) 710g(C0NT u) + alglog(LCOL._,) + alglog(TRFL-,) +
a2010g(ALL0U) + (22110g(MRU) + a2210g(LTDPYu)

2. Open Model

Local governments in Korea also raise their revenue from external sources such as
intergovernmental transfers and local borrowings. The intergovernmental transfers are
composed of national subsidies, provincial subsidies, and local shared taxes. Many
studies have argued that the external sources have had an impact on local govemments’
expenditures so that the amount of these external sources may be related to local ﬁnancial
self-sufﬁciency. Therefore, an alternative model considering external funds may explain
the relationship between local ﬁnancial self-sufﬁciency and local revenue sources
including intergovernmental transfers and local borrowings. The model that incorporates

the external funds provides the following:

77

(4.6) LESS, = Ifss(SD,, LT, (TH, TBM, TA UTO, TEAR, TB UT, TET, TSL,),
Non-tax, (PRENT, GRENT, FEE, ER, CG, INTR, PD, LTPY,
CONT, LCOL, TRE,, ALLO, MR, LTDPY,, LBOR, ST, ON,
GP,

Transforming this equation to a Cobb-Douglas production function type equation:

(4.7) LESS, = M(SD, “1 (TH,“2 (TBM,)“-‘ (TA UTO, “4 (TEAR, “4 (TB UT, “6 (TET,)“’
(TSL,“= (PRENT,“» (GRENT, “w (FEE, «2.. (ER, «2.. (CO, “v
(INTR, a~(P1),"‘v (L TPY, a... (CONT, “n (LCOL, an (TRE, “-9
(ALLO, “20 (MR,“n (L TDP Y, “22 (LBOR, “4 (ST, “24 (GN, “=5 (GP, «2..

For the log linear relationship with a local government’s input endowments:

(4.8) logLFSSLi = logM + allog(SD,) + azlogﬂ’Hu) + a3log(TBM,) +
a4log(TA UT 0,) + a5log(TFAR,) + a610g(T BUT Li) + aJogﬂ’ETu) +
aglog(TSL,) + aglog(PRENTL-,) + alolog(GRENTL-,) + anlog(FEE,) +
alzlog(FR,_,) + a13log(CGU) + a14log(INTRL,) + a15log(PD,) +
a16log(LTPYL-,) + a17log(C0NTu) + alglog(LC0LL-,) + a19log(TRFb-) +
azalog(ALLO,) + a2110g(MR,) + a2210g(LTDPY,) + a23log(LBOR,) +
a24log(ST,) + a25log(GN,) + a26log(GP,)

3. Extended Model

Local ﬁnancial self-sufﬁciency may be a product of various surrounding factors

including economic, social, cultural, historical, and geographical elements. The factors

consist of political and administrative attributes (Pol), local ﬁscal attributes (F is”), local

78
economic attributes (Ecou), local social attributes (Socu), cultural attributes (CulU),

historical attributes (His,), and geographical attributes (Geou). Thus, the above equation

(4.1) is rewritten as:

(4.9) LFSSL,‘ = lfss( Pol, Fish, Econ, Soc”, Culu, His”, Geo“)

Transforming this equation to a Cobb-Douglas production function type equation:

(4.10) LFSSLi = M(POI) 0" (F is,,)"‘2 (Econ) “3 ($0ch a: (C ulU) “5 (Hist) 0. ( Geo,)“’

Assuming that Korea has a unitary governmental system, each local government
has the same political or administrative structure. We may say political conditions are the
same in any speciﬁc year.‘ Therefore, political attributes may be regarded as ﬁxed -- one
for every local government in any speciﬁc year.

The local ﬁscal elements were presented in the previous section in explaining a
closed and open model. The local economic conditions are related to the local ﬁnancial
self-sufﬁciency (LFSSU). A growing local economy may be an element to support local
ﬁscal autonomy. An independent variable explaining local economic conditions is the
number of registered cars in each locality. Today, the car (CAR) in Korea is a symbol of
economic development. Social strata are also deeply related to local ﬁscal autonomy.

Severe poverty levels negatively affect ﬁscal decentralization. The total number of low-

 

‘ Each local government reveals political homogeneity geographically. In the 1996 general election, local
residents voted with geographical preferences.

79

income people (POV) will be used as an explaining variable. Older cities tend to have a
deteriorating economic and ﬁscal base; therefore, older cities may be negatively related to
the degree of local ﬁnancial self-sufﬁciency. As an historical variable, a city’s legal
establishment year (HIS) will be used for the above equation. Population is the most
important factor to consider in local ﬁscal revenue and expenditure studies. Thus, this
study employs per capita concepts in all ﬁscal variables. A city’s geographical size is
also an important explanatory variable for the degree of ﬁscal decentralization. Area
(AREA) will be used as an explanatory variable in this study. Regional aspects (REG)
are also considered as dummy variables.

A log linear ﬁrnction for local ﬁnancial self-sufficiency (LFSSU) is as follows:

(4.5) logLFSSLi = logM + a;log(POl) + azlog(Fis,) + a3log(EcoL,) + a4log(SocL,) +
a5log(CulL-,) + a610g(His,) + aJog(GeOL-,)

IV. Data and Variables

The Republic of Korea is a developing country from which one can gather data to
estimate the above equations. Korea can be representative of any developing country
with customs. As a newly industrialized country, it has experienced some of the most
rapid industrialization and urbanization of any developing country. Korean cities include
communities with diverse mixtures of manufacturing, commercial, and residential
housing property bases.

A major reason for using Korea is its brief history of political and administrative
decentralization; it has passed legislation that allows local autonomy. The act of

‘Korean local autonomy,’ enacted in 1988, was the backbone of this legislation. In effect,

80

local autonomy is granted at local govemments’ discretion for future local economic
development. For new local public goods production and service delivery, this trend of
decentralization is a crucial factor, which emphasizes the role of local government in
raising revenues.

A data set was gathered from a cross-section of Korean City governments’. The
city government is deﬁned as a legal authority for general administration in an urbanized
area. In 1993, Korea has a two-level system of local governmental structure. Figure 2.1
in Chapter Two illustrates the system of local governments in Korea. The upper levels of
local governments consist of a special city (Seoul), ﬁve direct jurisdiction cities (Busan,
Daegue, Daejeon, Gwangju, and Incheon), and nine provinces. On the contrary, the
lower levels of local governments consist of 68 cities, 136 counties, and 56 autonomous
districts. The cities and counties are within the provinces. The autonomous districts are
within the special city and direct jurisdiction cities.

Generally, the category of city governments may include the special city and
direct jurisdiction cities, the cities within the provinces, and the autonomous districts.
However, each type of city governments has different ﬁscal structure from each other.
The special city and direct jurisdiction cities, which are legally upper levels of local
governments, have more sufﬁcient ﬁscal resources and autonomy than the cities within
the provinces. Even though the autonomous districts are the lower levels of local
governments like the cities within the provinces, their legal and ﬁscal status are very
limited, comparing to the ones of the cities within the provinces. These city governments
cannot be considered as research target for this study together. Therefore, the special

city, direct jurisdiction cities, and the autonomous districts are excluded.

 

5 The basic unit of local authorities in urban settings.

81
Table 4.1: Variables and Deﬁnitions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable Deﬁnition
Dependent CCPX Composite index of per capita ﬁscal Indexes of a city
CPX Composite index of ﬁscal indexes of a city
DCENXI Decentralization indexes(revenue decentralization) of a
city; Proportion of per capita local revenue in the sum of
per capita local revenue and per capita national revenue
DCENX2 Decentralization indexes(expenditure decentralization)
of a city; Proportion of per capita local expenditures in
the sum of per capita local expenditures and per capita
national expenditures
Independent AREA Per capita geographical size a city Km2
CAR Per capita cars registered in a city Vehicle
DENSITY The number of local residents per Km2 Person
13va Per capita total employees in a city Person
HIS Established Year of a city Year
POV Per capita total low-income peoples in a city Person
REG] Dummy Variable of Region GyeongGi
REG Dummy Variable of Region GangWon
REG3 Dummy Variable of Region ChungCheong
REG4 Dummy Variable of Region JeonRa '-
RFGS Dummy Variable of Region GyeongSang
ALDO Per capita revenue of allotment in a city Million Won
(1‘: Per capita grants for collection of national or provincial Million Won
taxes or charges in a city
CDNF Per capita voluntary contributions in a city Million Won
FEE Per capita revenue from payments for voluntary Million Won
consumption of public services in a city
FR Per capita receipts of local public ﬁrms in a city Million Won
GN Per capita national subsidies in a city Million Won
GP Per capita city & provincial subsidies in a city Million Won
GRENT Per capita beneﬁt charges for use of public facilities in a Million Won
city
INTR Per capita earnings on deposits belonging to the bank in Million Won
a city
LBOR Per capita local borrowings in a city Million Won
[LDLL Per capita loan collection in a city Million Won
LTDPY Per capita temporary non-tax revenues in previous year Million Won
in a city
LTPY Per capita carry-over of annual surplus in a city Million Won
MR Per capita revenue from ﬁne, forfeiture, sale of unused Million Won
public property, etc. in a city
PD Per capita revenues from the sale of government Million Won
property in a city
PRENI‘ Per capita public property rent revenue in a city Million Won
SD Standard Deviation of the amounts of local revenue
sources
81‘ Per capita local shared tax in a city Million Won
TAUTO Per capita automobile tax in a city Million Won
TBM Per capita buildings and machinery tax in a city Million Won

 

 

82

 

 

 

 

 

 

 

 

 

 

 

TBU Per capita business ﬁrm tax in a city Million Won
TBUT Per capita butchery tax in a city Million Won
1131‘ Per capita tobacco spending tax in a city Million Won
TFAR Per capita farmland tax in a city Million Won
111 Per capita residence Tax (Inhabitant Tax) in a city Million Won
TRF Transfers from other accounts in a city Million Won
TSL Per capita synthesis land tax in a city Million Won

 

The availability of data was limited by the administrative jurisdictional boundary
of 1993. The result is a sample of 68 cities for a cross section. The set consists of city
govemments’ ﬁscal data from the ‘settled account’ of 1993. I believe this account is
substantial enough for this study. The data concerns 68 cities in Korea and comes from
the Financial Yearbook of Local Government, 1994 and the Statistical Yearbook of City
Governments in Korea, 1994.

It is sufﬁcient to generally deﬁne the variable as a unit or Won (W)" of local
revenue and expenditure. Socio-economic variables are available from the Statistical
Yearbook of City Government in Korea. All nominal monetary terms are in 1993 real
Korean Won. Table 4.1 contains deﬁnitions for all variables used in the regression

estimation.

 

‘5 Won is a unit of Korean money. $1 is worth about 790 Won at this time.

 

CHAPTER FIVE

EMPIRICAL ANALYSIS

1. Overview "*

This chapter presents the results of the empirical analysis, which attempts to

investigate the relationship between the degree of local ﬁnancial self-sufﬁciency and the

 

1r
I

mix of local revenue sources. To induce appropriate results, this study uses three types of
analytical models: a closed model, which focuses on locally raised revenues; an open
model, which considers external revenues including intergovernmental transfers and local
borrowings; and an extended model, which considers environmental factors.

Dependant variables for the empirical models include four types of indices such as
the revenue decentralization index (DCENXl), the expenditure decentralization index
(DCENX2), the composite share index (CPX), and the composite per capita index
(CCPX), which show the degree of local ﬁnancial self-sufﬁciency. The results of the
empirical analysis illustrate that the interlocal differences in the mixes of local revenue
sources exist across Korean cities. These differences are structurally related to
differences in the degree of local ﬁnancial self-sufﬁciency. In addition, the regression
analyses in this chapter present which revenue sources are most closely related to the

degree of local ﬁnancial self-sufﬁciency in a given Korean city.

83

84
II. Empirical Analysis

1. Variations in Local Financial Self-Sufficiency

This study contains a sample of local Korean governments from 1993, some of
which are large-sized cities (Type I) which have a population over 300,000, some of
which are mid-sized cities (Type II) which have a population between 100,000 ~ 299,999,
and the remainder being small-sized cities (Type III) which have a population of less than
100,000. In 1993 there were 13 large-sized cities, 22 mid-sized cities, and 33 small-sized
cities.

This study uses four types of ﬁscal indices in order to measure the degree of local
ﬁnancial self-sufﬁciency. The indices are the revenue decentralization index (DCENXl),
the expenditure decentralization index (DCENX2), the composite share index (CPX), and
the composite per capita index (CCPX). Table 5.1 presents the mean levels of these
indices in Korean cities in 1993 broken out by city size. The mean level of the composite
share index (CPX) in Type I (large-sized cities) is higher than the corresponding mean
levels in Type II (mid-sized cities) and Type III (small-sized cities). The mean levels of
the composite per capita index (CCPX), the revenue decentralization index (DCENXl),
and the expenditure decentralization index (DCENX2) in Type III (small-sized cities) are
higher than the corresponding mean levels in Type I (large-sized cities) and Type II (mid-

sized cities).

85
Table 5.1: Mean Levels of Selected Variables by City Size

 

 

All Large Cities Medium Small Cities
Cities

Composite Share Index (CPX) 76.150 98.756 63.554 75.643

Composite Per Capita Index 220282.294 201341.832 193956.261 245294.378
(CCPX)

Revenue Decentralization Index 0.233 0.225 0.213 0.250
(DCENXI)

Expenditure Decentralization 0.263 0.189 0.226 0.317
Index (DCENX2)

Area (kmz) 95.3 82 1 18.991 92.445 88.040

Density (Persons/ km2) 2524.291 5685.401 2600.168 1228.421

Per Capita Employment (Persons) 0.126 0.147 0.131 0.1 14

Poverty Rate (Low Income 0.038 0.015 0.034 0.050
People/Population, %)

Per Capita Cars Registered 0.088 0.069 0.088 0.095
(Vehicle)

Per Capita Building Floor (m2) 2.846 2.787 3.167 2.656

Per Capita Total Expenditures“ 0.393 0.242 0.315 0.504

Per Capita Total Revenues“ 0.481 0.337 0.400 0.592

Per Capita Total Local Taxes“ 0.126 0.135 0.119 0.128

Per Capita Local Residence 0.018 0.022 0.015 0.019
Taxes“

Per Capita Buildings and 0.008 0.010 0.009 0.008
Machinery Taxes"

Per Capita Automobile Taxes” 0.022 0.025 0.022 0.021

Per Capita Tobacco Spending 0.041 0.038 0.040 0.043
Taxes"I

Per Capita Synthesis Land taxes" 0.018 0.017 0.016 0.019

Per Capita Local Objective 0.016 0.020 0.015 0.016
Taxes“

Per Capita Non-tax Revenues“ 0.176 0.156 0.149 0.201

Per Capita Temporary Non-tax 0.1 18 0.088 0.103 0.139
Revenues‘

Per capita Local Shared Taxes“ 0.104 0.012 0.076 0.159

Per capita National Grants“ 0.026 0.012 0.023 0.033

Per Capita Provincial and Local 0.038 0.010 0.028 0.055
Subsidies“

Local Borrowings“ 0.012 0.012 0.005 0.016

Standard Deviation of Revenue 0.023 0.019 0.019 0.027

Sources

 

* : Million Won ( Won is a unit of Korean money )

86

Table 5.1 also shows the mean levels of selected local ﬁscal variables. The mean
levels of per capita local residence taxes and per capita local objective taxes (earmarked
taxes) in Type I (large-sized cities) are higher than the corresponding mean levels in Type
II (mid-sized cities) and Type III (small-sized cities). The mean levels of per capita local
borrowings in Type II (mid-sized cities) is lower than the corresponding mean levels in
Type I (large-sized cities) and Type III (small-sized cities). The mean levels of per capita
non-tax revenues, per capita intergovernmental transfers (local shared tax, national grants,
provincial or local subsidy), and standard deviation of per capita local revenues in Type
III (small-sized cities) are higher than the corresponding mean levels in Type I (large-
sized cities) and Type II (mid-sized cities). The mean levels of per capita property tax,
per capita automobile tax, per capita tobacco tax, and per capita comprehensive land tax
are poorly differentiated from each other.

The mean level of per capita local expenditures in Type III (small-sized cities) is
higher than the corresponding mean levels in Type I (large-sized cities) and Type II (mid-
sized cities), for 1993. The mean levels of area, density and per employment in Type I
(large-sized cities) are higher than the corresponding mean levels in Type II (mid-sized
cities) and Type III (small-sized cities). On the other hand, the mean levels of poverty
rate and per capita registered cars in Type III (small-sized cities) are higher than the
corresponding mean levels in Type I (large-sized cities) and Type II (mid-sized cities).
The mean level of per building ﬂoor in Type II (mid-sized cities) is higher than the
corresponding mean levels in Type I (large-sized cities) and Type III (small-sized cities).

This result shows that the ﬁscal structures of Korean cities differ from one another

by city size. The heterogeneous ﬁscal structures of Korean cities may cause the interlocal

DCENX 1

CPX

* DCENXl: Revenue Decentralization Index

"CSD: Standard Deviation of Per Capita Amounts in Local Revenue Sources

0.4 7 7 I I
03 ° , —
o . . ° .
'° ‘2. :13:
’. s 8.’ °
’0‘ o
0.2 .n-f:
0.1 1 l l l
0.01 0.02 0,03 0.04 0,05 0.08
080
c. Composite Share Index

1 1O I I I I
100 - ° _

90 - . ~

80 — ,° . -

70 F . ,v' I ° ° 7

0 ‘ : ° . . .
60 i- 0. 3 9 O 0.. d
o O ’0 o'
50 - ° ’ . ..° . -
O . . .
40 L I I L
0.01 0.02 0.03 0.04 0.05 0.06
080

a. Revenue Decentralization Index

87

Figure 5.1: Diﬁ’erences in Local Financial Self-Suﬁciency
by Revenue Diversiﬁcation

 

 

 

 

 

 

 

 

CPX: Composite Share Index

CCPX

b. Expenditure Decentralization Index

 

 

 

 

 

 

 

 

0.5 . . r .
0.4 ~ ° -
or 3 °
X . Q
515 0.3 - . °; . ° -
o O c O
O , 0° . o ,
.. .0 . .
0.2 - I" . ° —
O1 1 l J 1
0.01 0.02 0.03 0.04 0.05 0.06
CSD
d. Composite Per Capita Index
400000 I I r I
300000 ~ ° ° -
O . .
O O Q
0. o ”o. .
.. o. ..I
200000 - , u '. ... _
5.50: .
100000 4 1 . i
0.01 0.02 0.03 0.04 0.05 0.05
030

DCENX2: Expenditure Decentralization Index
CCPX: Composite Per Capita Index

88

differences in the mixes of local revenue sources. In addition, some variations in the
degree of local ﬁnancial self-sufﬁciency also exist in 1993, as Table 5.1 indicates.
Therefore, these interlocal differences in the mixes of local revenue sources may be
structurally related to differences in the degree of local ﬁnancial self-sufﬁciency.

Figure 5.1 illustrates the differences in the degree of local ﬁnancial self-
sufﬁciency in Korea by plotting the differences in ﬁscal indices against the extent of
revenue diversiﬁcation, which is expressed by standard deviation of per capita amounts in
local revenue sources. The graphs show a positive relationship between indices of local
ﬁnancial self-sufﬁciency and the extent of standard deviation of per capita amounts in

local revenue sources.

2. Regression Results

This study can test the null hypothesis that each city’s ﬁnancial status is the same
for the year of 1993. Based on preliminary regressions run for the purpose of testing this
hypothesis, this study performed F tests. These tests indicated that the null hypothesis of
homogeneous structures could not be accepted for the 1993 sample. This study
determined where ﬁscal differences accrued, additional socioeconomic variables were
included in the regression equation.

The results of the 1993 data refute the hypothesis that per capita ﬁscal outcomes
are the same regardless of city type. On the basis of the test performed, however, this
study cannot ascertain whether the non-homogeneity in Korean cities’ ﬁscal structure is

primarily a consequence of the fact that most cities are faced with different

89

socioeconomic and demographic conditions or, rather, are due to the different constraints
for revenue mobilization. This study observed some differences in per capita outcomes
of local ﬁscal revenue sources; revenue mix differences may lead to different behavioral
parameters and city preferred revenue levels. The conclusion is that these ﬁscal
differences are not due to the socioeconomic proﬁle of the community but, rather, are due
to differences in the resource constraints for revenue mobilization.

The data of each city were analyzed so as to determine whether the ﬁscal
structural coefficients were different across local governments (cities). Following the
multiple regression procedure used for determining a local government’s ﬁscal structural
difference, this study concluded that differences in the magnitude of some local revenue
bases caused the differences in the degree of local ﬁnancial self-sufﬁciency across cities
in Korea. In particular, the differences in the per capita amounts of automobile tax
(TAUTO), the per capita amounts of synthesis land tax (TSL), the per capita amounts of
miscellaneous revenue (MR), and the degree of revenue diversiﬁcation (SD) correlated to
the differences in the degree of local ﬁnancial self-sufﬁciency in Korea during 1993.

Model I only considers local ﬁscal variables to identify the relationship between
local ﬁscal factors and the degree of local ﬁnancial self-sufﬁciency. In Model 11, this
study expands the independent variables, which explain the external funding sources
including intergovernmental transfers and local borrowings. In Model 111, socioeconomic
variables, which may affect the degree of local ﬁnancial self-sufﬁciency, are included.
The socioeconomic variables are per capita employment levels (EMP), per capita low-
income people (POV), per capita cars registered (CAR), per capita permitted building

ﬂoor area (BLD), city age (HIS), and density (DENSITY). In addition, the Model 111

9O
tries to identify the differences in the degree of local ﬁnancial self-sufﬁciency by

constructing a new variable of “REG,” (Region or Province). The “REGi” is a dummy
variable which stands for each of the regions in Korea, such as, Gyeonggi, Gangwon,
Chungchung, Jeonra, Gyeongsang. These regression models yielded the coefﬁcient
estimates presented in Tables 5.2, 5.3, 5.4, and 5.5. Listed for each of the three models

are the coefﬁcient’s estimates and their t-values, squared multiple R, and F values.

1) Determinants of the Revenue Decentraflization(DCENX1)

Table 5.2 presents the relationship between the revenue decentralization measures
and the per capita amounts of local revenue sources. This includes regression coefﬁcients
for three kinds of ﬁscal models such as the closed model (Model I), the open model
(Model 11), and the extended model (Model 111). These models have strong explanatory
power. The R2 statistics of the models I, II, and III are 0.922, 0.945, and 0.965
respectively.I The F statistics of these models are 24.198, 27.220, and 22.100
respectively.2 The results for the three models are virtually identical. The per capita
external local revenue such as per capita local shared tax (ST), per capita national grants
(GN), per capita provincial and local subsidies (GP), and per capita local borrowings
(LBOR), and socioeconomic variables have no systematic effect on coefﬁcient estimates

for the remaining variables.

 

' The R2 statistics give the proportion explained by the regression linear model.
2 The F statistics indicate that the data are appropriately ﬁtted to the regression model.

91

Table 5.2: Determinants of Local Financial Self-Sufﬁciency (DCENXl)

 

 

VARIABLE MODEL 1 MODEL 11 MODEL 111
CONSTANT 2.084 2.401 2.536
(4.432) (5.703) (4.308)
TH 0.026 -0.01 1 -0.046
(0.729) (0294) (4.021)
TBM 0.084 ** 0.072 r 0.072
(1.736) (1.552) (1.284)
TAUTO 0.047 0.130 1.. 0.186 H
(0.680) (1.965) (2.361)
TFAR -0002 -0002 -0.002
(-I.061) (-1292) (4.113)
TBUT 0.003 0.004 r 0.002
(1.137) (1.364) (0.597)
TET 0.070 0.052 0.104
(1.016) (0.854) (0.920)
TSL 0.052 ** 0.066 m 0.078 m
(2.046) (2.679) (2.833)
PRENT 0.017 0.015 0.017
(1.181) (1.125) (1.039)
GRENT 0.003 0.008 0.020 r
(0.291) (0.776) (1.555)
FEE 0.063 r 0.071 r 0.082 r
(1.328) (1.483) (1.335)
FR 0.001 0.002 -0.001
(0.291) (0.565) (-0.382)
CG 0.002 -0.002 0.009
(0.084) (-0.079) (0.262)
INTR -0014 -0009 0.009
(-0.661) (-0477) (0.423)
CPD 0.002 0.001 0.004
(0.280) (0.150) (0.590)
LTPY -0.063 -0.103 * -0.141 ..
(-0.821) (4.477) (-I.886)
CONT 0.004 0.003 0.003
(1.161) (1.038) (0.562)
LCOLL 0.005 r 0.006 n 0001
(1.623) (1.796) (-0.213)
TRF -0.008 " -0.005 r -0.006 r
(-2077) (-l.516) (-l.567)
ALLO 0.003 0.001 0.002
(0.871) (0.290) (0.434)
MR 0.042 H 0.035 H 0.044 **
(2.382) (2.168) (1.788)
LTDPY 0.018 " 0.020 " 0.013 r
(2.140) (2.403) (1.350)
SDI (SD) 0.452 PM
(4.621)
ST -0009 -0004
(-0.823) (0271)
ON 0.032 H 0.012
(1.740) (0.523)

 

92

 

 

GP -0.01 1 0.004
(-0.683) (0.147)
LBOR -0.003 -0.004
(-0.701) (-0.926)
SD 0.514 "" 0.538 "*
(5.830) (4.787)
EMP 0.032 "
(1.342)
CAR -0.008
(-0.322)
POV -0.001
(-0.047)
BLD -0.021
(-0.908)
REGI -0.080
(-0.757)
REG2 0.014
(0.147)
REG3 0.069
(0.746)
REG4 0.074
(0.878)
REGS 0.030
(0.383)
HIS 0.085
(1.213)
DENSITY 0.015
(0.601)
R2 0.922 0.945 0.965
F 24.198 27.220 22.100
Note: t values are in parentheses.

‘, ", and "‘ indicate signiﬁcance at 10%, 5%, and 1% level respectively.

It is interesting to note that the coefﬁcient estimates for standard deviations of per
capita amounts in local revenue sources (SD) are signiﬁcantly different from zero. This
means that some specialized local revenue sources are highly related to the degree of
local ﬁnancial self-sufﬁciency. This analysis rejects the ‘external fund shifting
hypothesis’ and ‘socioeconomic inﬂuence hypothesis’ in favor of a perceived ‘local ﬁscal
beneﬁt hypothesis.’ Since the three models produce such similar results, the following

discussion will focus on the linear model, Model I.

93
The results have interesting implications regarding the relationship between the

degree of local ﬁnancial self-sufficiency and the mix of local own-source revenues. In
the closed model (Model I), the most meaningful revenue in 1993, when considering
coefﬁcients of local own-source revenues, is per capita building and machinery tax
(TBM), whose coefﬁcient is 0.084 and t-value is 1.736. This value is statistically
signiﬁcant at the ﬁve percent level. This building and machinery tax (TBM) has the
biggest elasticity (coefﬁcient) to the degree of local ﬁnancial self-sufﬁciency, expressed
by the revenue decentralization index (DCENXI ). This result suggests the amount of
change in the per capita building and machinery tax (TBM) will most signiﬁcantly relate
to the change of local ﬁnancial self-sufﬁciency.

The elasticity of per capita synthesis land tax (TSL) in 1993 is estimated to be
0.052 and is signiﬁcantly different from zero (F2046). This means that per capita
synthesis land tax (TSL) is an important variable explaining the degree of local ﬁnancial
self-sufﬁciency. The revenues from per capita user fees (FEE), per capita local loan
collection (LCOLL), per capita miscellaneous (MR), and per capita temporary non-tax
revenues in the previous year (LTDPY) have positive and statistically signiﬁcant
coefﬁcients. Therefore, these variables also relate positively to the degree of local
ﬁnancial self-sufﬁciency, expressed by revenue decentralization index (DCENXI ).
Although per capita tobacco spending tax (TET) shows relatively high coefﬁcient
(0.070), it is not statistically signiﬁcant. On the whole, per capita revenue that is
transferred from other accounts (TRF), is negatively related to the degree of local
ﬁnancial self-sufﬁciency. Its coefﬁcient is -0.008 and t-value is -2.077, which is

statistically signiﬁcant at the ﬁve percent level.

94

Here lies the most fundamental difference across city governments’ ﬁnancial self-
sufﬁciencies. The elasticity (coefﬁcient) of standard deviation of per capita amounts in
local revenue sources (SD) for 1993 is 0.452 and signiﬁcantly different from zero at a
0.01 signiﬁcance level. This means that standard deviation of per capita amounts in local
revenue sources (SD) is the most important variable, which is related to the degree of
local ﬁnancial self-sufﬁciency.

Considering external ﬁnancing variables, such as local shared tax (ST), national
grants (GN), provincial and local subsidy (GP), and local borrowings (LBOR), Model II
explains the relationships between these local ﬁscal variables and the degree Of local
ﬁnancial self-sufﬁciency (DCENXI). The open model (Model 11) reveals that per capita
automobile tax (TAUTO) and per capita synthesis land tax (TSL) relate positively to the
local ﬁnancial self-sufﬁciency expressed by revenue decentralization index (DCENXI).
The coefﬁcients of per capita automobile tax (TAUTO) and per capita synthesis land tax
(TSL) for the open model (Model 11) are 0.130 and 0.066 respectively. Both coefﬁcients
are statistically signiﬁcant at the one percent level.

Generally, local shared tax (ST) as a kind of revenue sharing was negatively
correlated with local wealth. In Korea, a main purpose of local shared tax is to sustain
local ﬁscal balance of the poor localities, which cannot raise enough revenue to operate
general governmental functions. During 1993, in Korea, the degree of local ﬁnancial
self—sufﬁciency was positively correlated with wealth. This correlation may make it
difﬁcult to identify the effect of changes in local shared tax on the degree of local

ﬁnancial self-sufﬁciency. Therefore, cities in Korea may have resisted increasing

95

spending in response to such aid revenues as local shared tax so to avoid large future tax
increases should the aid formula change signiﬁcantly.

Most national grants in Korea are matching grants, which require some amount of
revenue ﬁom the city government. The coefﬁcient for per capita national grants (GN),
which is a kind Of conditional grant, is positive and signiﬁcantly different from zero. Its
elasticity estimate is 0.032 and t-value is 1.740. Out of external sources, the differences
in the per capita amount of this source are only related to the differences in local ﬁnancial
self-sufﬁciency (DCENXI) over cities. This result veriﬁes, indirectly, the ﬂypaper effect
of the national grant in Korea.

Model 111 explains that the differences in socioeconomic variables are not related
to the differences in the local ﬁnancial self-sufﬁciency over cities. Similar to Model I
and Model 11, the differences in standard deviation of per capita amounts in local revenue
sources (SD), per capita automobile tax (TAUTO), per capita synthesis land tax (TSL),
and per capita miscellaneous revenue (MR) are positively related to the local ﬁnancial

self-sufﬁciency.

2) Determinants of the Expenditure Decentralization (DCENX2)

Table 5.3 shows that the results of three regression equations explain the
relationship between the per capita amounts of local revenue sources and the extent of
expenditure decentralization (DCENX2) as a measure of the local ﬁnancial self-
sufﬁciency. The three models bring different results. As Table 5.3 shows,

socioeconomic variables such as per capita employment levels (EMP), per capita low-

96
income people (POV), per capita cars registered (CAR), per capita permitted building

ﬂoor area (BLD), city age (HIS), density (DENSITY), and regions (REGi) have
systematic effects on coefficient estimates for the remaining ﬁscal variables. It is
important to note that the coefﬁcient estimates for per capita cars registered (CAR),
density (DENSITY), and regions of Gyeonggi (REG 1), Gangwon (REG 2), and
Chungchung (REG 3) are signiﬁcantly different from zero. This analysis may accept the
‘socioeconomic inﬂuence hypothesis’ rather than a perceived ‘local ﬁscal beneﬁt
hypothesis’ and ‘external ftmd shifting hypothesis.’

The extended model (Model 111) shows unique results, which explain how
socioeconomic factors relate to the degree of expenditure decentralization (DCENX2).
Compared to ﬁscal variables, socioeconomic variables are more closely related to the
degree of expenditure decentralization in Korea. First of all, dummy variables (REGi) of
regions have high estimated coefﬁcients. The estimated coefﬁcients for Gyeonggi
(REG 1), Gangwon (REG 2), and Chungchung (REG 3) are also statistically signiﬁcant. On
the other hand, the estimated coefﬁcients for Jeonra (REG4) and Gyeongsang (REG 5) are
not statistically signiﬁcant, even though their values are relatively high. The results for
the extended model (Model 111) argue that the regional factor in Korea is closely related
to the degree of local expenditure decentralization (DCENX2).

Per capita cars registered (CAR) is an important factor for the expenditure
decentralization (DCENX2) and statistically signiﬁcant at the one percent level. It means
that there is a positive relationship between the increase in cars registered and the
increases in local expenditure. Per capita low-income people (POV) also Show a positive

coefﬁcient but this is not statistically signiﬁcant. It is interesting that per capita

 

97

Table 5.3: Determinants of Local Financial Self-Sufﬁciency (DCENX2)

 

 

VARIABLE MODEL 1 MODEL 11 MODEL [11
CONSTANT 1.164 1.714 2.065
(1.083) (1.737) (2.000)
TH -0.084 -0.022 0.087
(1.033) (-O.265) (1.108)
TBM -0.228 H -0092 0.106
(2.054) (0.850) (1.081)
TAUTO 0.040 0.154 0040
(0.249) (0.994) (0.289)
TFAR 0.003 0.002 0.001
(0.764) (0.515) (0.283)
TBUT 0.024 *H 0.019 *H 0.005
(3.459) (2.782) (0.780)
TET 0.342 H 0.311 H 0.048
(2.168) (2.160) (0.245)
TSL 0.050 0.010 -0.051
(0.853) (0.171) (-l.056)
PRENT 0.021 0.027 0.040 *
(0.626) (0.867) (1.391)
ORENT -0013 -0005 -0.021
(0.509) (0.220) (-0.946)
FEE 0.246 H 0.070 -0.005
(2.253) (0.628) (0.047)
FR 0.009 * 0.007 -0.000
(1.349) (1.043) (0.061)
CG 0010 -0.042 -0.013
(0.149) (0.619) (0.212)
INTR -0.077 r -0.048 -0001
(1.582) (1.031) (0.028)
PD -0009 -0.013 0.004
(0.639) (1.012) (0.356)
LTPY -0.048 -0211 * -0.165
(0.271) (1.296) (1.256)
CONT 0.008 0.005 0.001
(0.873) (0.626) (0.092)
LCOLL 0.024 H* 0.011 r 0.001
(3.401) (1.350) (0.187)
TRF -0.002 0.000 -0.002
(0.255) (0.022) (0.270)
ALLO -0.013 r -0.006 0.003
(1.567) (0.768) (0.488)
MR 0.010 -0003 0.001
(0.247) (0.088) (0.032)
LTDPY -0.018 -0.008 -0012
(0.936) (0.427) (0.709)
SDI (SD) 0.444 H
(1.985)
ST 0.043 H 0.008
(1.741) (0.340)
GN 0.045 0.005
(1.061) (0.130)

_ _._—. —1—- w—

 

 

98

 

 

GP 0.050 0.122 *"”"
(1.278) (2.756)
LBOR -0.000 0.004
(-0.030) (0.536)
SD 0.504 *** 0.348 **
(2.43 8) (1.765)
EMP -0.055 *
(-l.329)
CAR 0.143 ***
(3.137)
POV 0.063
(1.268)
BLD -0.01 I
(-0.262)
REGI 0.510 "‘"
(2.744)
REGZ 0.388 **
(2.320)
REG3 0.473 *"
(2.905)
REG4 0.168
(1.137)
REGS 0.152
(1.104)
HIS -0.046
(-0.374)
DENSITY -0.1 13 "*
(-2.535)
R2 0.765 0.826 0.937
F 6.652 7.495 12.097
Note: t values are in parentheses.

*, ", and ‘" indicate signiﬁcance at 10%, 5%, and 1% level respectively.

employment levels (EMP) and density (DENSITY) are negatively related to the degree of
expenditure decentralization (DCENX2) and statistically signiﬁcant. Per capita permitted
building floor area (BLD) and city age (HIS) show negative coefﬁcients but are not
statistically signiﬁcant. These results may explain, indirectly, that the local ﬁscal
decisions are related to the geographical differences, rather than the economic

differences.

99

For ﬁscal variables, some detailed discussion will follow. The estimated
coefﬁcients of standard deviation of per capita amounts in local revenue sources (SD) are
0.444, 0.504, and 0.348 for Model 1, Model 11, and Model 111 respectively. These
coefﬁcient values are high and statistically signiﬁcant. The high degree of standard
deviation (SD) means that local revenue sources are not diversiﬁed. Thus, these results
show that there is some specialized local revenue sources strikingly contributing to the
degree of local ﬁnancial self-sufﬁciency throughout Korean cities.

In general, the roles of local ﬁscal variables for expenditure decentralization
(DCENX2) are not clear in these three estimation equations. The estimated coefficients
of tobacco spending tax (TET) as consumption tax are 0.342 and 0.311 for Model I and
Model 11 respectively. They are highly positive and statistically signiﬁcant. Models I
and 11 show that per capita butchery tax (TBUT), per capita revenues from service fees
(FEE), and per capita local loan collections (LCOLL) are positively and signiﬁcantly
related to the degree of expenditure decentralization (DCENX2). However, per capita
residence tax (TH), per capita buildings and machinery tax (TBM) and per capita interest
revenues (IN TR) are negatively related to the degree of expenditure decentralization
(DCENX2). In addition, per capita synthesis land tax (TSL) as an example of wealth-
based tax seems not to be clearly related to expenditure decentralization.

For external local revenue variables such as local shared tax (ST), national grants
(GN), provincial and local subsidies (GP), and local borrowings (LBOR), the results of
the open model (Model 11) are not in accordance with the results of the extended model
(Model 111). In Model 11, intergovernmental transfer payments (ST, GN, and GP) are

positively related to the degree of expenditure decentralization (DCENX2). Out of

100
external ﬁnancing variables, only the coefﬁcient of per capita local shared tax (ST) is

statistically signiﬁcant at the ten percent level. On the while, Model 111 shows that only
the coefﬁcient Of per capita provincial and local subsidies (GP) is 0.132 and statistically

signiﬁcant at the one percent level.

3) Determinants of the Comp_osite Share Index (CPX)

 

Composite share index (CPX) equation results are presented in Table 5.4, with
separate models for local ﬁscal variables and socioeconomic variables. These results
argue that some local ﬁscal variables have remarkable effects on the degree of local
ﬁnancial self-sufﬁciency, when measured by the composite share index (CPX). On the
other hand, socioeconomic variables have no important effects on coefﬁcient estimates
for the remaining ﬁscal variables. Therefore, this analysis for the composite share index
(CPX) rejects the ‘socioeconomic inﬂuence hypothesis’ in favor of a perceived ‘local
ﬁscal beneﬁt hypothesis.’

The estimated coefﬁcients of standard deviation of per capita amounts in local
revenue sources (SD) are 0.801, 1.096, and 1.035 for Model 1, Model 11, and Model III
respectively. The coefﬁcients are very high and statistically signiﬁcant at the one percent
level. The high degree of standard deviation (SD) means that there is a low degree of
revenue diversiﬁcation. Therefore, according to the results in Table 5.4, some specialized
local revenue sources are highly associated with the degree Of local ﬁnancial self-

sufficiency, when measured by the composite share index (CPX).

101

Table 5.4: Determinants Of Local Financial Self-Sufﬁciency (CPX)

 

 

VARIABLE MODEL 1 MODEL 11 MODEL 111
CONSTANT 10.404 10.687 1 1.499
(4.162) (4.190) (2.911)
TH -0. 169 -0.1 16 -0.123
(0.893) (0.533) (0.408)
TBM 0.292 0.233 0.399
(1.130) (0.830) (1.062)
TAUTO 1.052 *H 1.108 *H 1.534 *H
(2.838) (2.773) (2.909)
TFAR 0.002 -0.003 0.007
(0.189) (0.290) (0.557)
TBUT -0.003 0.003 -0.003
(0.188) (0.160) (0.1 19)
TET -0242 -0204 0.759
(0.659) (0.547) (1.003)
TSL 0.042 0.003 -0091
(0.308) (0.022) (0.490)
PRENT 0.059 0.065 -0.015
(0.758) (0.821) (0.134)
GRENT 0131 H .0131 H -0.148 H
(2.159) (2.060) (1.720)
FEE 0.218 0.385 r -0.078
(0.857) (1.328) (0.190)
FR 0001 -0.006 -0.002
(0.053) (0.335) (0.075)
CG -0335 H 0447 *H -0.468 H
(2.154) (2.543) (2.054)
INTR 0.202 H 0.208 H 0.304 H
(1.780) (1.729) (2.181)
PD -0.055 H 0071 H -0.050
(1.765) (2.093) (1.089)
LTPY -1.039H* -1.ll6*" -1.132H
(2.530) (2.650) (2.257)
CONT 0.008 0.004 0.022
(0.407) (0.198) (0.720)
LCOLL 0.014 0.008 0.014
(0.842) (0.392) (0.479)
TRF -0.001 -0.005 0.017
(0.059) (0.222) (0.675)
ALLO 0.005 0.004 -0.005
(0.270) (0.183) (0.21 1)
MR 0.138 r 0.114 -0.025
(1.456) (1.175) (0.151)
LTDPY 0.038 0.005 0.049
(0.836) (0.107) (0.735)
SDI (SD) 0.801 r
(1.539)
ST 0.039 -0.042
(0.602) (0.470)
ON 0104 -0.092

 

102

 

(0.944) (0.617)
GP 0137 r 0.044
(1.352) (0.261)
LBOR -0.027 0009
(1.245) (0.332)
SD 1.096 H 1.035 *
(2.052) (1.373)
EMP -0245 r
(1.536)
CAR 0.1 10
(0.630)
POV 0.063
(0.331)
BLD -0.016
(0.100)
REG] 0.104
(0.146)
REoz 0.068
(0.106)
REG3 -0141
(0.227)
REG4 0.502
(0.889)
REGS -0.038
(0.071)
HIS 0.232
(0.493)
DENSITY 0.061
(0.360)
R2 0.489 0.533 0.630
F 1.956 1.803 1.383

 

Note: t values are in parentheses.
’, ", and "* indicate signiﬁcance at 10%, 5%, and 1% level respectively.

It is crucial to note that the coefﬁcient estimates for per capita automobile tax
(TAUTO), per capita beneﬁt charges for using public facilities (GRENT), per capita
intergovernmental grants for collection of national or provincial taxes or charges (CG),
per capita revenues from interest eamings on deposits belonging to the bank (INTR), per
capita revenues from the sale of government property (PD), and per capita carry-over of

annual surplus (LTPY) are signiﬁcantly different from zero. Out Of these variables, per

103

capita automobile tax (TAUTO) and per capita revenues from interest earnings on
deposits belonging to the bank (INTR) relate positively to the degree of local ﬁnancial
self-sufﬁciency. On the other hand, per capita beneﬁt charges for using public facilities
(GRENT), per capita intergovernmental grants for collection of national or provincial
.taxes or charges (CG), per capita revenues from the sale of government property (PD),
and per capita carry-over of annual surplus (LTPY) relate negatively to the degree of
local ﬁnancial self-sufﬁciency.

Per capita automobile tax (TAUTO) coefﬁcients are 1.052, 1.108, and 1.534 for
the closed model (Model I), the open model (Model 11), and the extended model (Model
111) respectively. The coefﬁcients are very high and statistically signiﬁcant at the one
percent level. These values verify that per capita automobile tax (TAUTO) is the most
closely related to the degree of local ﬁnancial self-sufﬁciency (CPX). Per capita tax on
building and machinery (TBM) for the three models shows relatively high coefﬁcients
(0.292, 0.233, and 0.399 respectively), but are not statistically signiﬁcant. The
coefficients for per capita residence tax (TH) are relatively high with a negative sign.
However, the values are not statistically signiﬁcant. Per capita tobacco spending tax
(TET) coefﬁcients for the closed model (Model I) and the open model (Model II) also are
relatively high, both being negative - about -0.242 and -0.204. The values, however, are
statistically insigniﬁcant. In the case of per capita synthesis land tax (TSL), the
coefficients do not show remarkable results.

The coefﬁcients for per capita revenues from interest earnings on deposits
belonging to the bank (INTR) are 0.202, 0.208, and 0.304 for Model 1, Model II, and

Model 111 respectively. The coefﬁcients are relatively high and statistically signiﬁcant at

104
the ﬁve percent level. The per capita revenues from user fees (FEE) and per capita

miscellaneous revenues (MR) have signiﬁcant coefﬁcients for Model 11 and Model I
respectively. Per capita beneﬁt charges for using public facilities (GRENT), per capita
intergovernmental grants for collection of national or provincial taxes or charges (CG),
and per capita carry-over of annual surplus (LTPY) Show negative relationships to the
levels of composite share index (CPX). Their coefﬁcients are statistically signiﬁcant at
the ﬁve percent level. The coefﬁcients of per capita revenues from the sale of
government property (PD) are negative and statistically signiﬁcant for Model I and
Model 11.

The open model (Model 11), considering external ﬁnancing variables, such as per
capita local shared tax (ST), per capita national grants GN), per capita provincial and
local subsidy GP), and per capita local borrowings (LBOR), shows that there are no
signiﬁcant relationships at the levels of composite share index (CPX), except per capita
provincial and local subsidy (GP), which has a negative coefﬁcient of —0.l37. In Korean
cities, per capita local shared taxes (ST) are positively related to the levels of composite
share index (CPX), but are not statistically signiﬁcant. Per capita national grants (GN)
and per capita local borrowings (LBOR) have also negative coefﬁcients, but are
statistically insigniﬁcant.

Model 111 indicates that the differences in socioeconomic variables are not closely
related to the differences in the levels of composite share index (CPX) throughout Korean
cities. Only employment level (EMP) has a statistically signiﬁcant coefﬁcient of -0.245.
Per capita cars registered (CAR), per capita low-income people (POV), city age (HIS),

Gyeonggi region (REG 1), Gangwon region (REG 2), and Jeonra region (REG4) Show

105

positive coefﬁcients, but are statistically insigniﬁcant. On the other hand, the coefﬁcients
of per capita building ﬂoor (BLD), Chungchung region (REG 3), and Gyeongsang

(REG 5) are negative but are not statistically signiﬁcant.
4) Determinants of the Conyosite Per Capita Index (CCPX)

Table 5.5 presents the results of three equations for composite per capita index
(CCPX) as a measure of the degree of local ﬁnancial self-sufﬁciency. These results point
out that some of the local ﬁscal variables play important roles in the level of composite
per capita index (CCPX) in Korean cities. External variables and socioeconomic
variables have no important effects on coefﬁcient estimates for the local ﬁscal variables.
Thus, this analysis for composite per capita index (CCPX) rejects the ‘external fund
shifting hypothesis’ and the ‘socioeconomic inﬂuence hypothesis’ in favor of a perceived
‘local ﬁscal beneﬁt hypothesis.’

The differences in the per capita amounts of local revenue sources are closely
related to the differences in the levels of composite share index (CCPX). The estimated
coefﬁcients of standard deviation of per capita amounts in local revenue sources (SD) are
0.656, 0.608, and 0.609 for Model 1, Model 11, and Model 111 respectively. The
coefﬁcients are remarkably high and statistically signiﬁcant at the one percent level. The
high degree Of standard deviation (SD) in a given city means that there is some
specialized revenue sources that raise local total revenues. Therefore, the high

coefficients of standard deviation of per capita amounts in local revenue sources (SD)

106
Table 5.5: Determinants of Local Financial Self-Sufficiency (CCPX)

 

 

VARIABLE MODEL 1 MODEL 11 MODEL 111
CONSTANT 16.633 16.837 16.712
(35.105) (40.855) (33.862)
TH 0.037 0.037 0.056 *
(1.032) (1.060) (1.497)
TBM -0.035 -0.003 0.009
(0.719) (0.063) (0.197)
TAUTO 0.118 H 0.221 H 0.224 *H
(1.679) (3.422) (3.404)
TFAR 0.000 0.001 0.002 r
(0.223) (0.644) (1.335)
TBUT 0.007 H 0.004 * 0.004
(2.268) (1.476) (1.279)
TET 0.144 H 0.113 H 0.273 *H
(2.064) (1.872) (2.885)
TSL 0.082 Hr 0.090 Hr 0.063 Hr
(3.178) (3.721) (2.710)
PRENT 0.002 -0000 -0017
(0.129) (0.036) (1.207)
ORENT -0.002 0.005 0.002
(0.177) (0.488) (0.140)
FEE 0.093 H -0002 -0.047
(1.922) (0.047) (0.909)
FR 0.003 0.003 0.002
(0.944) (1.113) (0.598)
CO 0.063 H 0.076 *H 0.088 *H
(2.146) (2.685) (3.091)
INTR -0009 0.009 0.018
(0.438) (0.487) (1.021)
PD -0005 -0.004 0.003
(0.766) (0.791) (0.438)
LTPY -0.208 *H -0242 *H 0230 Hi
(2.668) (3.551) (3.679)
CONT 0.005 * 0.002 0.004
(1.376) (0.535) (0.959)
LCOLL 0.011 *H 0.006 H 0.003
(3.481) (1.810) (0.753)
TRF -0005 0.001 -0.001
(1.190) (0.210) (0.185)
ALLO 0007 H -0.006 H -0.003
(2.034) (1.724) (1.157)
MR 0.078 *H 0.064 *H 0.029 r
(4.336) (4.099) (1.425)
LTDPY 0.006 0.013 r 0.003
(0.693) (1.624) (0.364)
SDI (SD) 0.656 Hr
(6.648)
ST 0.010 -0.003
(1.008) (0.292)
GN 0.058 *H 0.034 H

 

107

 

(3.293) (1.854)
GP 0.019 0.016
(1.182) (0.751)
LBOR 0.003 0.005 *
(0.873) (1.473)
SD 0.608 *H 0.609 *H
(7.048) (6.467)
EMP ~0.018
(0.888)
CAR -0.025
(1.128)
POV 0.029
(1.232)
BLD 0.001
(0.037)
REGI -0.050
(0.559)
RE02 -0030
(0.375)
REO3 -0051
(0.661)
REO4 0.096 *-
(1.367)
REGS 0.015
(0.221)
HIS 0.080 *
(1.354)
DENSITY 0040 H
(1.859)
R2 0.951 0.967 0.984
F 39.347 46.524 51.406

 

Note: t values are in parentheses.
‘, ”, and “" indicate signiﬁcance at 10%, 5%, and 1% level respectively.

argue that the levels of the composite per capita index (CCPX) are highly related to the
differences in the amounts of some specialized revenue sources. Out of local revenue
sources, automobile tax (TAUTO), tobacco spending tax (TET), synthesis land tax (TSL),
and intergovernmental grants for collection Of national or provincial taxes or charges
(CG) show positive relations, while carry-over Of annual surplus (LTPY) shows negative

relations, to the levels of the composite per capita index (CCPX).

108
Per capita automobile tax (TAUTO) coefﬁcients are 0.118, 0.221, and 0.224 for

the closed model (Model I), the Open model (Model 11), and the extended model (Model
III) respectively. The coefﬁcients are relatively high and statistically signiﬁcant at the
ﬁve percent level for Models I and II, and the one percent level for Model III. These
results suggest that the automobile tax (TAUTO) may be the most important source to
raise local revenue in a given Korean city. Per capita tobacco spending tax (TET)
coefﬁcients are 0.114, 0.113, and 0.273 for the closed model (Model I), the Open model
(Model II), and the extended model (Model 111) respectively. The values of coefﬁcients
are relatively high and statistically signiﬁcant at the ﬁve percent level for Models I and II,
and the one percent level for Model 111. Per capita synthesis land tax (TSL) is positively
- related to the levels Of composite per capita index (CCPX). Its coefﬁcients are 0.082,
0.090, and 0.063 for Models I, II, and 111 respectively, and are statistically signiﬁcant at
the one percent level for all models.

Per capita butchery tax (TBUT) shows statistically signiﬁcant relations with
positive coefﬁcients for Models I and II. The coefﬁcients of residence tax (TH) are
relatively high with a positive sign. However, the values are not statistically signiﬁcant,
except for Model 111. Taxes on building and machinery (TBM) for Models I and 11 show
negative coefﬁcients (-0.035 and -0.003 respectively) but are not statistically signiﬁcant.

The coefﬁcients of per capita intergovernmental grants for collection of national
or provincial taxes or charges (CG) are 0.063, 0.076, and 0.088 for Models I, II, and III
respectively. The values of coefﬁcients are positive and statistically signiﬁcant at the ﬁve
percent level for Model I, and the one percent level for Models 11 and 111. Per capita

miscellaneous revenues (MR) are positively related to the levels of the composite per

109
capita index (CCPX). Its coefﬁcients are relatively high with 0.078, 0.064, and 0.029 for

Models 1, II, and 111 respectively. The coefﬁcient of per capita user fees (FEE) for Model
I is statistically signiﬁcant with 0.093, but its coefﬁcients are negative for Models 11 and
III. The coefﬁcients of per capita revenues from loan collections (LCOLL) are positive
for Models 1 and II, and are statistically signiﬁcant. The revenues from per capita
voluntary contribution (CONT) have signiﬁcant and positive coefﬁcients for Model I.

On the other hand, per capita carry-over of annual surplus (LTPY) shows a
negative relationship with respect to composite per capita index (CCPX) with high
coefﬁcients of -0.208, -0.242, and -0.230 for Models 1, II, and 111 respectively. Also, the
coefﬁcients of per capita revenue of allotment (ALLO) are negative and statistically
signiﬁcant at the ﬁve percent level for Models I and II.

For external ﬁnancing variables, per capita national grants (GN) show positive
and signiﬁcant results. Its coefﬁcients are 0.058 (signiﬁcance at the one percent level)
and 0.034 (signiﬁcance at the ﬁve percent level) for Models 11 and 111 respectively. Per
capita local borrowings (LBOR) have a positive and statistically signiﬁcant coefﬁcient
(0.005) for only Model 111. These results may say the national grants (GN) and local
borrowings (LBOR) are positively related to the levels of the composite per capita index
(CCPX).

The extended model (Model III), considering socioeconomic variables, points out
that the differences in socioeconomic variables may not be closely related to the
differences in the levels of composite per capita index (CCPX) across Korean cities.
Only city age (HIS) and Jeonra region (REG4) have statistically signiﬁcant and positive

coefﬁcients of 0.080 and 0.096 at the ten percent signiﬁcance level. On the other hand,

110
population density (DENSITY) is negatively related to the levels of the composite per

capita index (CCPX) at the ﬁve percent signiﬁcance level. In addition, the coefﬁcients of
per capita lower income people (POV), per capita building ﬂoor (BLD), and Gyeongsang

(REG 5) are positive but not statistically signiﬁcant. Per capita cars registered (CAR), per
capita employment level (EMP), Gyeonggi region (REG 1), Gangwon region (REG 2), and

Chungchung region (REG 3) show negative coefficients, but are statistically insigniﬁcant.

111. Summary of Findings

The estimated coefﬁcients presented in the previous section argue that there are
strong relationships between the degree of local ﬁnancial self-sufﬁciency and the mix of
local revenue sources in Korea. In general, the results of the empirical analysis support
the initial hypothesis that, in a given city, the level of local revenue diversiﬁcation relates
positively to the degree of local ﬁnancial self-sufﬁciency. This analysis also tests the
subsets of hypotheses that the interlocal differences in the reliance on each local revenue
source explains the differences in the level of local ﬁnancial self-sufﬁciency.

This analysis, however, provides some difﬁculties for the interpretation Of the
estimated coefﬁcients for each local ﬁscal variable related to the multiplicity Of measures
for the degree of local ﬁnancial self-sufﬁciency. It is hard to generalize the role of each
of the four dependent variables such as the revenue decentralization index (DCENXl),
the expenditure decentralization index (DCENX2), the composite share index (CPX), and

the composite per capita index (CCPX). Despite these difﬁculties, many ﬁscal variables

111

Show consistent results when estimating their relationship to the degree of local ﬁnancial
self-sufﬁciency.

This analysis suggests some useful observations on the role of local ﬁscal
variables and socioeconomic variables. First of all, Korean cities have the high degree of
coefﬁcient estimates for standard deviation (SD) of per capita amounts in local revenue
sources. This means that some of the specialized local revenue sources are highly related
to the degree of local ﬁnancial self-sufﬁciency. This result of empirical analysis argues
that the differences in the mixes of local revenue sources across Korean cities are related
to the differences in the degree of local ﬁnancial self-sufﬁciency.

The analyses for the revenue decentralization index (DCENXl), the composite
share index (CPX), and the composite per capita index (CCPX) reject the ‘external fund
shifting hypothesis’ and ‘socioeconomic inﬂuence hypothesis’ in favor of a perceived
‘local ﬁscal beneﬁt hypothesis’. On the while, the analysis for the expenditure
decentralization index (DCENX2) accepts the ‘socioeconomic inﬂuence hypothesis’
rather than a perceived ‘local ﬁscal beneﬁt hypothesis’ and ‘external fund shiﬁing
hypothesis’.

Out of local taxes, automobile tax (TAUTO), tobacco spending tax (TET), and
synthesis land tax (TSL) show positive relationships to the degree of local ﬁnancial ’self-
sufﬁciency. Also, as non-tax revenues, miscellaneous revenues (MR), service fee (FEE)
revenues, and local loan collections (LCOLL) are positively and signiﬁcantly related the
degree of local ﬁnancial self-sufﬁciency. On the while, carry-over of annual surplus

(LTPY) shows a negative relationship to the degree of local ﬁnancial self-sufﬁciency.

112

In particular, socioeconomic variables show important roles for only the
expenditure decentralization index (DCENX2). In this case, the variables of cars
registered (CAR), Gyeonggi region (REG 1), Gangwon region (REG 2), and Chungchung
region (REG 3) show positive and signiﬁcant coefﬁcients. On the other hand,
employment level (EMP) and population density (DENSITY) tend to show the negative

relationship to the degree of local ﬁnancial self-sufﬁciency.

CHAPTER SIX

POLICY IMPLICATIONS AND CONCLUSION

1. Summary

This concluding chapter discusses the overall results, policy implications and
limitations of this study, while providing recommendations for further studies. This
study analyzed the relationship between the magnitude and mix of local revenue sources
and the degree of local ﬁnancial self-sufﬁciency in Korea. The results of this study
presented the types or mixes of local revenues that were most closely associated with a
high degree of local ﬁnancial self-sufﬁciency. These results suggest the optimal mix of
local revenue sources, which are associated with an increase in the degree of local
ﬁnancial self-sufﬁciency in Korean local governments.

This study consisted of establishing a theoretical framework for local ﬁnancial
self-sufﬁciency and analyzing empirical data. This study proposed three types of
analytical models: the closed model that considered only locally raised revenue sources,
the Open model that considered locally raised revenue sources and external funding
sources, and the extended model that considered locally raised revenue sources, external
funding sources, and socioeconomic variables.

This study developed four types of measurements for the degree of local ﬁnancial

self-sufﬁciency. The measures are: l) revenue decentralization index (DCENXI); 2)
113

114
expenditure decentralization index (DCENX2); 3) composite share index (CPX); and 4)

composite per capita index (CCPX). In particular, the revenue decentralization index
(DCENXI) and expenditure decentralization index (DCENX2) explain the degree of
local ﬁnancial self-sufﬁciency in the context of national-local ﬁscal relations.

In the multiple regression models, twenty-ﬁve local revenue variables were
identiﬁed as independent variables. Population density, employment levels, poverty
levels, registered cars, the total building ﬂoor area, and city age were used as
socioeconomic variables. Five dummy variables representing regions in which cities are
located were employed in the multiple regression models.

The results presented in the preceding chapters reveal some important aspects of
local ﬁnance in Korea. The estimated coefﬁcients presented in the chapter on empirical
analysis argue that there are strong relationships between the degree of local ﬁnancial
self-sufﬁciency and the mix of local revenue sources in Korea. The degree of local
ﬁnancial self-sufﬁciency was strongly associated with a limited number of specialized
revenue sources. This empirical analysis result argues that the differences in the mixes of
local revenue sources across Korean cities are related to differences in the degree of local
ﬁnancial self-sufﬁciency. However, the results of the empirical analyses did not support
the initial hypothesis that, in a given city, the diversiﬁed local revenue sources relate
positively to the degree of local ﬁnancial self-sufﬁciency.

The analyses for the revenue decentralization index (DCENXl), the composite
share index (CPX), and the composite per capita index (CCPX) show that there are no
close relationships between external funding variables or socioeconomic variables and the

degree of local ﬁnancial self-sufﬁciency. On the whole, the analysis for the expenditure

115
decentralization index (DCENX2) demonstrates that there is a relationship between

socioeconomic variables and the degree of local ﬁnancial self-sufﬁciency.

Out of local taxes, automobile taxes (TAUTO), tobacco spending taxes (TET),
and synthesis land taxes (TSL) show positive relationships to the degree of local ﬁnancial
self-sufﬁciency. Also, such non-tax revenues as miscellaneous revenues (MR), service
fees (F EE), and local loan collections (LCOLL) are positively and signiﬁcantly related to
the degree of local ﬁnancial self-sufﬁciency. On the other hand, the carry-over of annual
surplus (LTPY) shows a negative relationship to the degree of local ﬁnancial self-
sufﬁciency.

Socioeconomic variables show an important role only for the expenditure
decentralization index (DCENX2). In this case, the variables of cars registered (CAR),
Gyeonggi region (REG 1), Gangwon region (REG 2), and Chungchung region (REG 3)
show positive and signiﬁcant coefficients. On the other hand, employment level (EMP)
and population density (DENSITY) tend to show negative relationships to the degree of

local ﬁnancial self-sufﬁciency.

11. Policy Implications

The coefﬁcient estimates presented in this study have important policy
implications. High coefﬁcient estimates of standard deviation (SD) demonstrate that a
few specialized local revenue sources are positively related to the degree of local
ﬁnancial self-sufﬁciency. The results, however, are inconclusive regarding the impact of

the few specialized local revenue sources on the increase in total local revenues. If the

116

magnitude of the few specialized sources is not related to income or population change,
the special revenue sources will not contribute to an increase in the degree Of local
ﬁnancial self-sufﬁciency. In reality, the nature Of income inelasticity in local revenue
sources may have caused the limited ﬁnancial capacity of local governments in Korea.

The result indicating that the degree of local ﬁnancial self-sufﬁciency is related to
a few specialized revenue sources explains why some local governments suffer from a
low degree of local ﬁnancial self-sufﬁciency. If a local government does not have
adequate revenue bases for the specialized sources, this local government is ﬁnancially in
a trap to generate revenues.

In order to achieve the current goal of a high degree of ﬁnancial self-sufﬁciency,
there may be a need for local, provincial, or national policy reform in Korea. The results
of this study can be used to suggest the implications for increasing the degree of local
ﬁnancial self-sufﬁciency in local governments that posses insufﬁcient revenue source.
Good ﬁscal planning also requires some strategies for mobilizing revenue resources that

will shape the ﬁscal ﬁrture of a local government.

1. Local Policy Implications

Local governments in Korea need to preserve their revenue options in order to
retain individual identity and autonomy. Local governments need to design their own
revenue portfolios to extract revenue from the entire local economic base. The designing

revenue portfolios will make the Optimal mix Of local revenue sources possible, thus

117
increasing local self-sufﬁciency. The results of this study can help them design an

appropriate revenue portfolio.

This study suggests that while local governments are afforded limited ﬂexibility
in the setting of tax rates, they can have a signiﬁcant impact on their tax base. This study
further suggests that they should focus on an increase in the wealth-based revenue
sources, especially the synthesis land tax bases, which are closely related to the degree of
local ﬁnancial self-sufﬁciency. For example, appropriate land use planning may be a
good strategy for increasing the tax base of local governments. Land use planning is a
means of achieving the long-term maximization of land values. By creating zoning and
density controls land use planning enables land to move more readily to its highest and
best use. Within limits, localities may also choose to promote ‘high rateable land uses.’
These are land uses that have higher values and therefore contribute more to the tax base.
Local governments may need inducements to induce a change to high rateable land uses
such as retail and industrial rather than residential.

Inﬁ’astructure maintenance and development are also necessary to local ﬁscal
planning because the public capital stock is related to increases in the value Of wealth-
based revenue sources. Local governments need to cooperate with the national
government so that national money can be invested in the local capital stock.

Local governments should improve the administrative skills Of wealth-based tax
assessment and collection--even though national government has typically had the
responsibility for tax rate decisions. These skills include the listing and valuation of
property. In reality, the administrative skills vary widely among local governments. The

quality of these skills is in general poor. The wealth-based taxation is inherently difﬁcult

118
and time-consuming. Furthermore, administrators are often inadequately trained. The

result of these poor skills at the local level is that some property is not assessed to its full
value and assessments are not kept up to date. Furthermore, the degrees to which tax
payments are current vary widely among cities. Therefore, the improvement of
administrative skills will help increase in the amount of wealth-based tax revenues and
improve local self-sufﬁciency. 1F-
Local governments must create strategies to utilize public property, including
public land and buildings, in order to Obtain long-term ﬁnancial help for their residents.

In managing its prOperty, local governments should continually monitor the potential of

 

1:

all public property to generate rental revenue. This may include the lease and
development of public properties. Local governments may sell and lease public
properties as incentive programs for industrial and commercial developments.

Local governments should preserve the automobile tax and tobacco tax within
their jurisdiction. The automobile tax will be the most desirable source Of revenue for
local governments because the number of automobiles is rapidly growing, the tax is
easily administered, and the burden of taxation is likely to fall on persons with high
incomes. A strategy for enhancing the automobile tax base is to sustain a good road
system and automobile facilities. The better road systems and automobile facilities will
help increase automobile ownership and use within the local jurisdiction.

The tobacco tax will also be useful for local governments to increase their own
local revenues. Local governments, however, should pay greater attention to devices that
adjust prices for low-income customers in the expanding tobacco tax system, because

tobacco taxation tends to be regressive.

119

For revenue diversiﬁcation, increasing non-tax revenues is a good choice. With
the popularity of telecommunications, including cable systems, local governments may
want to consider purchasing and operating a cable system or charging a fee for an

exclusive franchise. It may help increase the local revenues.

2. Provincial Policy Implications

Increasing the degree of ﬁnancial self-sufﬁciency is a worthy goal, but some
localities have such inadequate revenue bases that they will be unable to generate
sufﬁcient revenues. Therefore, augmenting local revenue bases is crucial. The expansion
of local revenue bases is mainly related to the extent of economic development. Local
economic growth requires various types of development projects. In reality, most
economic development projects in Korea are large in scale. The effects also spread
across local boundaries.

Therefore, it is very difﬁcult for a local government to carry out economic
development projects alone. However, economic development may be an appropriate
function for provincial governments. Provincial governments can efﬁciently carry out
large-scale economic development projects. These economic development projects,
guided by provincial governments, will help increase local revenue bases.

Provincial governments may wish to consider coordinating local land use. In a
decentralized governmental system, local governments must be very competitive to
obtain and increase local tax bases. For example, local governments may expand

excessively commercial land and recreational facilities to increase local revenues. This

120

inter-local competition will cause inefﬁcient land use in the province or nation.
Therefore, provincial governments should focus their attention on coordinating local land
use or development.

Furthermore, provincial governments may introduce a tax base sharing system
where a certain percentage of provincial or local taxes are shared with local governments
according to some reasonable distribution criteria. This system may be employed for
taxes on commercial land and property that is developed by provincial governments, or

large-scale economic development projects.

3. National Policy Implications

According to the results of this study, intergovernmental transfer payments, such
as local shared taxes, national grants and provincial subsidies, did not show signiﬁcant
relations to the degree of local ﬁnancial self-sufﬁciency. The national government,
however, must induce desirable local ﬁscal health and provide for local autonomy, in
harmony with the policies of other governmental levels. For example, such incentives as
grants from the national government will lead to changes in the level of local resource
mobilization.

One Objective of national grants may be to positively encourage local authorities
to raise their own revenue. An increase in national grants will decrease the tax price of
local expenditures and allow local Ofﬁcials to increase their own local taxes. Matching
grants may have this effect to the extent that the local contribution is not diverted from

other expenditures.

121

General-purpose grants may well have an inherent incentive element that weights
in favor of authorities raising higher levels of per capita revenue. Local shared taxes, as
general-purpose grants, have the goal of equalizing expenditures across local
governments in Korea. The national government should consider the interlocal
differences in the magnitude Of growing revenue sources, such as the automobile tax
base.

Currently, the transfer of national tax bases to local governments is a hot issue
within the decentralizing governmental system in Korea. This tax base reassignment will
rely on political decisions to formulate what the new sources of revenues will look like.
In addition, the transfer of income and consumption tax bases to local governments is
also very difﬁcult in practice. Alternatively, the central government may consider
indirect subsidies to local governments. For example, if local residents invest in local
property in declining areas, the central government may reduce the income tax of the
local residents. This kind of indirect subsidy will bring about increases in the local

property values.

111. Limitations and Recommendations

This study was designed to analyze the degree of local ﬁnancial self-sufﬁciency
by taking a cross-sectional analysis. The results of this cross-sectional analysis may only
be relevant for 1993. This study provided the coefficient estimates of local revenue
sources with which Korean cities can be compared to each other. Cross-sectional studies

have an inherent problem. The results of a cross-sectional analysis are based on

122

Observations made at only one time. Cross-sectional analyses do not provide causal
processes that occur over time. Therefore, this analysis may not provide an accurate
prediction of the future relationship between the mix of local revenue sources and the
degree of local ﬁnancial self-sufﬁciency. To elevate the prediction accuracy of this kind
of study, time series data and analysis will be needed. Time series data for individual
regions could indicate the effect of incentives, correlating changes in the incentive
elements with ﬁscal performance.

For an appropriate revenue choice, a government should consider such policy
objectives as economic efﬁciency, fairness, revenue performance, and low administrative
costs. This study focused only on the revenue performance of local revenue sources, and
related these to the degree Of local ﬁnancial self-sufﬁciency. Further study will need to
consider these policy objectives in order to anive at comprehensive solutions.

In comparing revenues across local governments, the need for public services may
be important. The need for services may vary from location to location, according to the
levels of service provision in previous years. Different local governments may need
different levels of new service provisions. Therefore, the analysis of service needs may
be necessary for an accurate analysis Of ﬁnancial self-sufﬁciency in any given local
government. Also, many of the local services are intergovernmental. Positive or
negative extemality exists in providing public services. Thus, the existence Of adjacent
local governments affects the decision regarding the levels of public services to be
provided. The analysis of local ﬁnancial self-sufﬁciency might require an economic

boundary that considers adjacent communities.

123

This empirical analysis used data regarding revenues and expenditures, which are
products of the local budgeting process. The local budgeting process might be political
rather than technical. The political process in local budgeting is very complicated. This
study did not extensively consider local political processes in budgeting. Thus, in future
studies, the budget process from each local government could be analyzed individually as

a case study before it is compared with that of other communities.

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