Sharing of Natural Resource Revenues/ Petroleum Revenue Decentralization International Experience and Iraq

1. Sharing of Natural Resource Revenues/Petroleum Revenue DecentralizationInternational Experience and Iraq Presented to: Extractive Industries: Legal and Fiscal Regimes, Revenue Management, and Good Governance May 16-17, 2007, I 2-220 Wednesday 2:30-3:15 pm Presented by: Monali Chowdhurie-Aziz, Senior Public Sector Specialist, MNSED Kai Kaiser, Senior Economist Public Sector Group

2. Fiscal Decentralization and Natural Resources • Prevailing Issues in Range of Countries • Nigeria, Russia, Indonesia, Iraq, Bolivia, Sudan, DRC, Malaysia, PNG, etc. • Challenges in applying developed country models for our clients • Weak Institutions and poor governance contribute to “resource curse” at various levels of government • Recent price increases and new discoveries in range of countries with pressures for decentralization • Claims to oil revenues highly contested with diverse states…

3. Welcome to Southern Sudan

4. Overview of Presentation • Revenue Assignments in Decentralized/Inter-Governmental Settings • Political and Economic Arguments around Sub-National Natural Resource-Revenue Allocation • Some International Experience • How do we define Success? • Illustrative Challenges from Iraq

5. Natural Resource Revenues Must Be Seen Within the Context of Good Intergovernmental Design Decentralization spans • Political/Legal • Including Constitutional Assignments (e.g., DRC 2005) • Fiscal • Shaped by country’s economic/revenue structure • Administrative Natural-resources can add to the complexity…

6. Five Fundamental Questions Facing Any Decentralizing System • Expenditure Assignments/Responsibilities • Finance Follows Function Principle • Revenues • Own Source Revenues (autonomy of bases/rate setting) • Role of Sub-Nationals in Negotiating Exploitation/Revenue Streams • User Fees • Intergovernmental transfers • Derivation Based Revenue Sharing • Transfers • Fiscal Equalization • Specific Purpose/Conditional Grants • Subnational borrowing/debt • Capacity Development: Organizational, Institutional and Human

7. Expenditure Assignment Considerations • Macroeconomic stability • Takes on special importance with natural resource revenue dependence • Public Service Delivery • Effectiveness/Efficiency • Public Management Innovation • Poverty Reduction • Responsiveness • Equalization Expenditure assignments often span multiple tiers of government

8. Rationales for Intergovernmental Transfers • Vertical imbalances • Horizontal imbalances • Inter-jurisdictional spillovers (externalities) • Enhancing national objectives at the subnational level • Paying for national programs implemented by subnational governments

9. (Sub-National) Natural-resource revenue assignments tend to make inter-regional disparities prominent • Assignment of Petro-Revenues to Sub-Nationals • Shared versus Own Source (i.e., incorporates effort) • How much is assigned to sub-nationals on derivation basis? • Assignment of Other Revenues • Property Tax? • Income Tax? Other? • Expenditure Needs • Ideally funds follow function • Transfer Design • Vertical Shares/Pools? • Horizontal Allocation Criteria

10. Revenue Structures Vary Significantly

11. Arguments Around Natural Revenues Sharing • Arguments for Greater Degree of Centralization • Stability: Natural Revenues Subject to high Degree of Volatility • Disparities: Known and potential endowments highly unequal • National Treasure: Belongs to all the people! • Local Capacity: National governments better placed to manage • Coherence in Natural-Resource Policy: Avoid distortion across regions • Revenue Transparency: Easier if revenues accrue to one “account” • Arguments for Decentralization/Derivation Based • Cost-Reimbursement: Including Environmental Costs • Heritage Argument: Non-renewable resource • Political/Conflict Resolution Arguments: • Often very important where legitimacy between central and sub-national governments have been contested

12. A “Good” Transfer System • Transfers should be transparent and predictable • Preference for formula-based • Natural-resource revenue rich settings need to place special emphasis on transparency • Equalization transfers should include • A realistic measure of “need” • Population, Area, Cost, “Backwardness” • A realistic measure of “fiscal capacity” • Adequate sub-national revenue autonomy • Stable but flexible financing • No Single Transfer May Meet All Objectives • But, avoid proliferation of different grants

13. Managing Transfers Across Levels • Hierarchical Models • 2nds tier has full autonomy over LG allocations • Indonesian districts receive direct allocations • Pakistan (with some modification) • Nigeria: transfer allocations earmarked to locals, but concerns about state interception • National Models • Direct allocations to second & third tiers • E.g., Indonesia’s provinces & districts • Guidelines for 3rd tier allocations • Mixed/Asymmetric Models • Special autonomy in Indonesia (Aceh/Papua) • North/South Sudan • Iraq’s Regions/KRG

14. Intergovernmental Revenue Management • Addressing Petroleum Revenue Volatility • Transfers Based on Realizations or Actuals • Sub-National Revenue Predictability • Ex Ante Rules • Stabilization Accounts • Addressing Petroleum Revenue Non-Renewability • Heritage Funds • Who benefits and when? • Transfer Transparency • Commissions for Dispute Clarification/Resolution • Reporting to Higher Levels • Revenue Transparency and Accountability

15. The Challenge of Sub-National Accountability • Natural-Resources Revenues May be Especially Prone to Weak Accountability • Weak Bottom-Up Accountabilities • No Representation Through Local Taxation • Beneficiary Regions Subject to Windfalls • Weak Top-Down Accountability • Sub-National Allocation of Natural-Resources May Be Subject of Political Bargains • Petroleum Revenues May Be Inherently “Centralized” • Allocation to Sub-National Governments May (Also) Fail to Trickle Down • Revenue-led Fiscal Decentralization Associated with Weak Accountability for Outcomes • Explore Linkages to Sectoral/Frontline Outcomes?

16. Gauging “Performance” of Natural Resource Revenue Sharing in an Intergovernmental Context • Glue or Solvent for National Cohesion? • Revenue Flows Translate Into Development Outcomes • Finance Follows Function • Accountabilities Promote Service Delivery • Revenue Assignments/Collection Consistent with Coherent Revenue Policy • Effective in attracting investment to best placed locations • Consistent with Good PFM at all Levels • E.g., as benchmarked by PEFA • Intergovernmental Arrangements Consistent with Fiscal/Macro-Economic Stability • “Overgrazing” undermines stabilization/heritage arrangements • Natural-Resource Rents Don’t Subvert Country’s Institutional Development/Integrity • Corruption Further Corrodes Representative/Legitimate Institutions

17. Fiscal Decentralization in Iraq • Legacy of centralization • With some history asymmetric arrangements, notably Kurdistan • High Dependence on Petroleum Revenues • >95 percent of domestic revenues in 2006/2007 • Oil concentrated mainly in south • Debates around “old” and “new” oil • 2005 Constitution with Federal Vision • Distinction between provinces and regions • Tendency to overlap regions with ethnic identify

18. Baghdad MinFin/Central Bank/Line Agencies Sub-National Government in Iraq’s 15 Governorates MinFin Gov Treasuries * Basra CB Regional Government Central Line Agencies Provincial Councils Governor’s Offices KRG Erbil/Dohuk, Sulaimania Municipal/Other Local Government Municipal/Other Local Government Prevailing Asymmetric Arrangements in Iraq

19. Petroleum is Concentrated in the South

20. (Illustrative) Fiscal Gaps in Iraq? Sources: PC Oil Revenues are drawn from April workshop Module 3, Estimates for Baghdad Own Source and Shared Revenues are proxied by Jakarta, Indonesia

21. Political Economy of Management, Regulation and Development of Hydro-Carbon Revenues • In a Low Trust Environment • Kurds view the development of their oil fields as having been historically under-resourced. • Historically Denied their share of revenues from the center • Currently revenues are not transparent and are poorly managed at the centre • Suggested solutions • Distinction between “old Fields’ and ‘new field” in the Constitution • Contracting for “new field” in Kurdistan by KRG • Allocate share of “actual” revenues to region based on population • Variant of this has already been in place by allocating 17% of national budget, minus a series of “sovereign” expenditures

22. Political Economy of Management, Regulation and Development of Hydro-Carbon Revenues • Problems with Suggested Solutions • Contradictory rules for oil exploration • Optimal resource development requires policies for that development of old and current are coordinated (and distinction itself may be difficult in practice) • Coordination is important if stabilization is left to the subnational • Incentive for the one with the smaller budget to run a pro-cyclical fiscal policy while the one with the larger budget absorbs the costs of the counter-cyclical policy

23. Petroleum Revenues and The Future of Iraq • On-Going Constitutional and Legal Debates • Revisions to 2005 Constitution • Parallel to debates on Hydrocarbon Law, Revenue Sharing Law, Law on Local Governments, and Revenues Sharing Law • Concerns about lack of transparency • Future of Development Fund for Iraq (DFI) • Significant Pressures to Increase Revenue Flows to Provinces/Regions • Allure of concentrated oil wealth may increase incentives to create regions around ethnic lines (Shiastan, Sunnistan) • But also uncertainty about location of actual oil reserves behind “veil of ignorance” and various myths of manna • Need to come to some arrangements that accommodate all main actors

24. Areas of On-Going Engagement in IraqAround Natural-Resource Sharing • Clarify options of intergovernmental sharing and transfers to executive and legislative counterparts • Emphasize that revenues should need to follow functions, not vice versa, as well as principles of (rule-based) equalization • Identify options for revenue management and revenue assignment, as well as institutional arrangements to mediate these in practice across interests of various regions • Promote sub-national PFM capacity • …in advance of new roles, responsibilities, and financing • Promote bottom-up and top-down accountabilities • Promote Revenues Arriving at Frontline Service Delivery • Schools, Clinics, Communities around “outcomes” • Limited Incentives for Revenue Diversification

25. New institutional arrangements will have to mediate respective concerns…given prevailing realities Prospectivebut underappreciated institutions • Public Commissions for Revenue Management • 2005 Constitution Art. 106), including audit functions, to be regulated by Law (pending) • Public commission for “interest of regions” • (Art. 105) (pending) • Asymmetric arrangements may be the most practical solution • Overcentralization may itself be recipe for secession, less transparency • Question is whether decentralization dynamics work for or against resource curse? • E.g., contestation for revenue transparency, or overgrazing to maximize own returns

26. Q&A Selected References ESMAP (2005). Comparative Study on the Distribution of Oil Rents in Bolivia, Colombia, Ecuador, and Peru. Washington, DC, ESMAP (Joint UNDP/World Bank Energy Sector Management Assistance Programme: 142. ODI, 2006. Sub-National Implementation of the Extractive Industries Transparency Initiative (EITI). London, Prepared for the EITI Secretariat and DfID, London, Issues Paper, April. Fiscal Decentralization and Sub-National Public Financial Management in Iraq, Washington, DC: MNSED (mimeo)

27. Annex: Alternatives Forms of Structuring Intergovernmental Grant Programs Vertical Shares: Method of determining the total divisible pool Source: Adapted from Roy Bahl (2006)