Rwanda: Lessons from Applied Intergovernmental Fiscal Equalization Formula

Abstract

It is a well-known fact that budgetary allocations need to be based on a just formula for balanced service delivery in the modern world. This paper describes the intergovernmental formula designed for Rwanda in 2003 to allocate grants from the central to local governments (LGs). First, the previous criterion, the Local Authority Budget Support Fund, was reviewed. This was followed by a literature review and field visits. Finally, the specifications of the mathematical model are described, followed by the proxy selection, data analysis, econometric evaluation, and estimations used in the study. In 2003, data analysis revealed that LGs had low fiscal capacities and ubiquitous fiscal needs. These were proxied by mean own source revenues and expenditure needs, respectively, in the proposed formula. The difference between the two was taken as the mean fiscal gap. This formula corrected the inherent weaknesses in the previous transfer system. It proposed weighting parameters to determine subnational transfer entitlements. Additionally, it constructed and applied welfare poverty and fiscal gap indices that captured the behavior of LGs in terms of wellbeing, fiscal needs, and revenue capacity for the first time in Rwanda. The study recommendations were entirely adopted by the government. The formula was used to allocate unconditional grants from the central government to LGs to improve service delivery and reduce poverty. The study also highlights that any successful transfer formula design depends on how the following are determined—the transfer pool, weights, proposed variables, and proxy indices—and how they enter the model.