Stimulus or Enforcement? How Intergovernmental Transfers Crowd-in Local Taxes in Indonesia

Abstract

This study quantifies intergovernmental transfers’ contemporaneous and lagged effects on local tax revenues of districts/municipalities in Indonesia. This study found that transfer as aggregate and unconditional transfers/Dana Alokasi Umum have crowding-in effects on local tax revenues. Meanwhile, revenue sharing/Dana Bagi Hasil and conditional transfers/Dana Alokasi Khusus do not significantly affect the tax revenues of districts/municipalities. In addition, system-Generalized Method of Moments estimation results show that the contemporaneous effects of transfers are more prominent in magnitude than their lagged effects. It indicates that local tax enforcement due to transfers provides a larger portion than the local spending stimulus in determining local revenue increases. Our findings refute the negative stigma that emerged after implementing fiscal decentralization, particularly related to the disincentive effect of transfers on local government efforts to generate their revenues. Therefore, equitably endowing local governments with intergovernmental transfers will improve their accountability and build public trust.