Fiscal Decentralisation in Developing Nations: Key Strategies and Outcomes

When we think about effective government, we often focus on national policies and central planning. But in many countries, the real transformation happens much closer to home-at the provincial, state, or municipal level. Fiscal decentralization, the practice of transferring financial responsibilities and revenue-raising powers from central to local governments, has become a powerful tool for improving public services and empowering communities. Yet how this plays out varies dramatically across different nations. Let’s explore how three developing countries-China, Brazil, and South Africa-have approached fiscal decentralization, each with unique strategies that reflect their political systems, economic realities, and social priorities.

China’s approach: balancing central control with local initiative 🔗

China’s journey with fiscal decentralization offers a fascinating case of trying to achieve two seemingly contradictory goals: giving local governments more autonomy while maintaining strong central oversight. Starting in 1980, China moved away from its highly centralized fiscal system toward what they called the “contract responsibility system,” where central and provincial governments began to “eat in separate kitchens,” sharing revenues rather than pooling everything centrally.

The most significant reform came in 1994 with the tax-sharing system, which fundamentally reorganized how revenues flow between different levels of government. Under this arrangement, taxes are divided into three categories: those belonging exclusively to the central government (like customs duties), those belonging to local governments (like business taxes), and shared taxes that are split between levels. The most important shared tax is the value-added tax, or VAT, where the central government receives 75 percent and local governments keep 25 percent.

Think of it like a household budget where parents and children agree on who pays for what. The parents (central government) handle the big-ticket items like national defense and major infrastructure, while the children (local governments) manage their own expenses like local schools and hospitals. They agree to split certain income sources, ensuring both have resources to meet their responsibilities.

The challenges of implementation 🔗

China’s system hasn’t been without challenges. After the 1994 reform, the central government’s share of total revenue jumped from 22 percent in 1993 to 56 percent in 1994-a dramatic recentralization. However, this share gradually declined in subsequent years as local tax bases grew faster than central ones.

Local governments, responsible for most public service delivery, often find their revenue inadequate to meet expenditure needs. This creates what economists call a “vertical fiscal imbalance,” where spending responsibilities don’t match revenue capacity. To manage this, China relies heavily on fiscal transfers from the central government to provinces, though these have historically been based more on negotiated contracts than on objective formulas addressing regional disparities.

Brazil’s autonomous municipalities: a federal success story 🔗

Brazil took a very different path, one that reflects its democratic transformation. Following the end of military dictatorship, the 1988 Constitution-often called the “Citizen’s Constitution”-elevated municipalities to full members of the federation with unprecedented autonomy. Unlike most federal systems where local governments are subordinate to states, Brazilian municipalities enjoy constitutional status as autonomous federal entities.

Revenue sources: the IPTU and ICMS 🔗

Brazilian municipalities have robust revenue-raising powers centered on two key taxes. The first is the IPTU (Imposto Predial e Territorial Urbano), or urban property tax, levied on real estate within city limits. Large cities generate substantial revenue from IPTU, though many smaller municipalities struggle with outdated property registries and undervalued assessments.

The second major revenue source comes from the state-level ICMS (Imposto sobre Circulação de Mercadorias e Serviços), a value-added tax on goods and services. While collected by states, municipalities receive 25 percent of the ICMS collected in their territory. This creates a direct link between local economic activity and municipal budgets, incentivizing economic development.

In 2019, ICMS transfers represented about 17 percent of total municipal revenue nationally, making it the main revenue source for many municipalities. The FPM (Municipal Participation Fund), a constitutionally mandated federal transfer based on population, followed at 14 percent. Among own-source revenues, the service tax and property tax contributed 10 percent and 7 percent respectively.

The autonomy-capacity paradox 🔗

Brazil’s system showcases both the promise and challenge of strong local autonomy. Large cities like São Paulo generate over half their revenue from their own tax bases, giving them substantial independence. In contrast, small municipalities with fewer than 10,000 inhabitants obtain only 8 percent of their revenue from own taxes and fees, making them heavily dependent on transfers from other government levels.

This disparity means that while Brazil’s system technically grants all municipalities equal autonomy, their actual fiscal independence varies enormously. It’s like giving everyone the same toolkit but only some have the materials to build with.

South Africa’s equitable share formula: addressing historical inequalities 🔗

South Africa’s approach to fiscal decentralization is distinguished by its deliberate focus on equity and addressing the legacy of apartheid. Rather than simply dividing revenue by population or economic activity, South Africa uses sophisticated formulas that explicitly account for need.

The provincial equitable share formula 🔗

South Africa’s Provincial Equitable Share (PES) uses a weighted formula with six components, each designed to capture different aspects of provincial needs. The two largest components are education (48 percent of the formula) and health (27 percent), reflecting these sectors’ importance and their labor-intensive nature. These aren’t just based on population but on specific indicators like school enrollment numbers and risk-adjusted health profiles.

The education component considers both school-age population and actual enrollment data, ensuring funds follow children into classrooms. The health component is even more sophisticated, using a risk-adjusted index that accounts for the proportion of people without private medical insurance and adjusts for each province’s health risk profile based on factors like disease prevalence and demographic characteristics.

Building in redistributive elements 🔗

Beyond these service-specific components, the formula includes a poverty component (3 percent) based on the share of people in the poorest 40 percent of households, explicitly redistributing resources toward disadvantaged provinces. There’s also a basic population component (16 percent), an institutional component (5 percent) divided equally among provinces to ensure even the smallest can maintain basic administrative capacity, and an economic activity component (1 percent) based on regional GDP.

The result is a formula that produces dramatically different per capita allocations. In 2024-25, per capita equitable share transfers ranged from approximately 8,000 rand in wealthy Gauteng to over 12,000 rand in poorer provinces like the Eastern Cape and Northern Cape, reflecting their greater needs and lower fiscal capacity.

Phasing in changes gradually 🔗

To maintain stability, South Africa doesn’t implement formula changes all at once. Instead, data updates are phased in over three years, with one-third of the impact implemented each year. This prevents sudden budget shocks while still allowing allocations to respond to changing demographics and service demands.

Lessons from three different paths 🔗

These three countries illustrate that there’s no single “right” way to implement fiscal decentralization. China demonstrates how decentralization can coexist with centralized political control, using revenue-sharing to incentivize local economic development while keeping ultimate authority at the center. Brazil shows the potential of granting genuine autonomy to local governments, though it also reveals the capacity challenges facing smaller, poorer municipalities. South Africa exemplifies how formulas can be designed not just to distribute funds, but to actively address historical inequalities and ensure equity in service delivery.

What emerges from these cases is a fundamental truth: fiscal decentralization isn’t just a technical exercise in moving money around different levels of government. It’s about deciding who makes decisions closest to citizens’ lives, how to balance local autonomy with national coordination, and whether the system actively works to reduce or potentially exacerbate existing inequalities.

What do you think? Should developing countries prioritize local autonomy even when it means some areas will have fewer resources than others? How can governments balance the need for equity with respect for local decision-making?

References

1. https://www.imf.org/external/pubs/ft/seminar/2000/idn/china.pdf
2. https://banotes.org/brics-administrative-system/brazil-local-governance-structure-objectives-impact/
3. https://link.springer.com/chapter/10.1007/978-3-031-41283-7_5
4. https://www.treasury.gov.za/documents/national%20budget/2024/review/Annexure%20W1.pdf