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Revenue Sharing Stalemate between National Government and County Governments

Revenue Sharing Stalemate between National Government and County Governments

Background

The Constitution of Kenya 2010 introduced a two-tier level of government: i.e. The National government and the County governments. The devolved system of government is the cornerstone of the Constitution and its implementation brought a major policy shift on how resources are shared in the country. The Constitution has outlined policies and guidelines on how resources are shared between these levels of government. Despite well formulated guidelines on revenue sharing between the two tiers of government, there has been delays agreeing on the amount to be allocated to the two levels of government, as witnessed in August 2019. There is also concern on delays in disbursement of funds to the devolved units by the National Treasury. Given that the total county revenue basket disbursements by the National Treasury make up a big chunk (over 70%) of the  county financing requirements, delays in disbursement by the National Treasury adversely affects the day to day running of county activities to the extent that there is delayed payment of county staff, suppliers, and implementation of county work plans, programmes and development projects. This therefore affects county services such as health care and other services offered to the counties.

Situational Analysis

In August 2019, a stalemate arose between the National Treasury and the Council of Governors over the share of revenue to be allocated to the devolved units (Vertical share). At the center of this stalemate was the Division of Revenue Bill (DoRB) 2019. The National Assembly proposed that devolved units be allocated Ksh 310 billion (29.8%) as equitable share of total revenue (Ksh 1,038 billion for 2014/15, benchmark) whereas the Senate and the Commission on Revenue Allocation (CRA) proposed Ksh 335 billion (32.3%). This difference was due to use of different formulae in computing the equitable share of revenue. CRA used a base of equitable share of Ksh 314 billion contained in the Division of Revenue Act (DoRA) 2018, whereas the National Treasury used a base of Ksh 304.94 billion as contained in the Budget Review and Outlook Paper (BROP) 2018, which proposed a reduction in equitable share of revenue in 2018/19 by Ksh 9.04 billion due to shortfalls in revenue collected by the National Government since 2015/16. The second reason for the disparity was the use of different revenue adjustment factor by the CRA and the National Treasury. CRA adjusted the equitable share using the three-year average annual inflation of 6.9% of the base (Ksh 314 billion). The DRoB 2019, however, adjusted the equitable share by an absolute figure of Ksh 5.04 billion informed by the provisions of the Budget Policy Statement for 2019/20, which captures the increase in debt service costs, decline of revenue projections, considering shortfalls in revenue in 2018/19. Table 1 analyses the differences in the revenue allocation between CRA and the DoRB 2019.

Table 1: Comparison of recommendations of CRA and the DORB, 2019 on equitable share of revenue (Ksh millions)

Expenditure ItemCRADOBR, 2019
1. Equitable revenue share, 2018/19314,000314,000
2. Less: Adjustment based on fiscal framework (Shortfall in revenue performance in 2018/19)9,038
3. New base of equitable share (1-2)314,000304,962
4. Adjustment for revenue growth in 2019/20(6.9%*314) = 21,7005,038
Total equitable share of revenue (3+4)335,700310,000

Source: National Treasury and Planning

Article 203(2) of the Constitution gives the minimum threshold on the amount of equitable revenue to be allocated to counties as 15% of latest audited revenues. The proposed equitable share of Ksh 310 billion contained in DoRB, 2019 was based on the latest audited revenue of Ksh 1,038 billion for 2014/15. This amount, therefore, represented 29.8% of the total audited revenue way above the minimum threshold of 15% as set out in Article 203 (2) of the Constitution. The stalemate therefore arose as a result of different approaches used in computing the equitable share of revenue by the CRA, and the proposals by the National Treasury to the National Assembly as contained in the Budget Policy Statement for 2019/20.  This stalemate persisted for 5 weeks and was finally resolved when the Senate and the National Assembly reached a consensus that saw counties being allocated Ksh 316.5 billion (30.49% of total revenue) as equitable share, Ksh 2.89 billion as National Government grant and Ksh 39.08 billion as donors grant.

In the next section we discuss the revenue sharing formula and the various sources of counties funds to gain an understanding of the counties’ fiscal environment, requirements and disbursements over the years.

Vertical revenue sharing

Chapter 12 of the Kenyan Constitution 2010 outlines the provisions on public finance issues and gives two core values under which resources are to be shared out: Equity in resource sharing between two levels of government and public participation in the budgeting process and exploring financing options by the county governments. Revenue raised nationally shall be shared equitably between the national and county governments (vertical share) and among the county governments (horizontal share) to enable them provide services and perform their functions.

Article 215 of the Kenyan Constitution 2010 established the Commission on Revenue Allocation (CRA) with a mandate to recommend the basis through which revenue is shared equitably between the two levels of government – National and County governments (vertical share), and among the devolved units (horizontal share). For the vertical share, it was agreed that the National Government would receive 84.5% of the national cake, not less than 15% would go to the County Governments and 0.5% would be the Equalization Fund (Article 203 (2) of the Kenyan Constitution).

Horizontal revenue sharing

This refers to revenue sharing by the devolved units. CRA has a mandate to determine how the 15% of the national cake is shared among the devolved units and ensure fairness and equity, given the varied nature of the devolved units economically and socially. To ensure fairness in horizontal share, CRA developed a revenue sharing formula that incorporated the following parameters: Population, Poverty Index, Land area, Basic equal share, and Fiscal Responsibility. The second revenue formula introduced a new parameter, Development index, which considered access to water, electricity and roads, to capture infrastructure needs of counties.  The first formula was developed in 2012 before the advent of the devolved units and the second formula was developed in June 2016. Table 2 gives the first and the second formula developed by CRA and gives the specific parameter weights.

Table 2: First and second revenue sharing formula

First Revenue Sharing FormulaSecond Revenue Sharing Formula
ParameterWeight (%)Weight (%)
Population4545
Basic Equal Share2526
Poverty2018
Land Area88
Fiscal Responsibility22
Development Index1
Total100100

Source: Commission on Revenue Allocation (CRA)

Looking at the formula, and based on the population parameter, a more populous county will receive more revenue allocation than their counterparts with lower population. The basic equal share component is the same for all counties to cater for the fixed costs incurred for running the counties. Counties therefore share 26% of total revenue equally. Fiscal responsibility component is an incentive for counties that manage their resources better and mobilize their OSR more effectively. This component therefore acts as a reward to counties that have high fiscal discipline. Currently, this proportion is shared equally among the counties. However, given resource disparities across the counties, the Kenyan Constitution 2010 provides for the equalization fund to smoothen out the income flows and enhance equality in development in less marginalized areas.  In the next section, we discuss some of the sources of revenue, performance, and allocations in various financial years to gain an understanding on county fiscal space and dynamics.

Sources of Funds to Counties

Funding for counties comes from various sources, which include transfers from the national government as equitable share of total revenue raised, loans and grants, equalization fund for selected counties, conditional grants from the National Government and development partners, and from own source revenue (OSR) which is made up of property rates, licenses and fees, entertainment taxes, among others. Since the establishment of counties, a total of Ksh 1.58 trillion has been disbursed to counties as equitable share of revenue raised nationally as shown in the Table 3.

Table 3: Revenue allocation to counties (Ksh billions)

Financial Year2013/142014/152015/162016/172017/182018/19Total
Total Funds Available to Counties224.2304.78343.18369.45387.09445.362,074.06
Total Disbursements by OCOB174.4262.3303.47369.45324.12405.171,838.91
Equitable Share of Revenue193.4226.66259.77280.33023141,576.13
Conditional Grants202.621.921.926.8535.98129.23
Total Expenditure169.4258295.3319.06303.83376.431,722.02
Recurrent132.8167.56191.85215.71236.942691,213.86
Development36.690.44103.45103.3466.89107.44508.16

Source: County Governments Budget Implementation Review Report, OCOB

Conditional grants

Conditional grants are allocations to counties meant to ensure provision of certain specific services, achieve international commitments such as the Sustainable Development Goals (SDGs), and fund under-resourced services or infrastructure. Conditional grants are therefore meant to bridge development gaps in the counties to ensure equitable and sustainable development in the devolved units. They are restrictions on spending, and the grants cannot be diverted to fund other budget items. Conditional grants in Kenya come in form of loans and grants from International Development Agencies (IDAs) such as the World Bank and from the National Government, disbursed by the National Treasury or specific government ministries. The Equalization Fund is a constitutionally provided conditional grant and only benefits counties specified as marginalized by the CRA. Some of the conditional grants by the World Bank include: Transforming health systems for universal health care project, and Kenya Devolution Support Programme (KDSP). Conditional grants by the National government include: Level Five Hospitals, Road Maintenance Levy, and Development of Youth Polytechnics.  One unique feature is that not all counties benefit from these conditional grants, it is subject to a county meeting some specific requirements. An example is that a county will only receive Level Five Hospital grant if it has a Level 5 Hospital in its jurisdiction. Counties are also supposed to meet certain conditions failure to which it is withdrawn. An example is submission of financial reports to the funding agency. Table 4 gives a schedule of some conditional grant allocations in billions.

Table 4: Conditional grants to counties

Conditional GrantFinancial Year
2015/162016/172017/182018/19
Level Five Hospitals3.644.24.33
DANIDA0.840.408
Compensation for User Fee Forgone0.90.90.90.9
Road Maintenance Levy Fund3.34.3110.267.42

Source: County Governments Budget Implementation Review Report, OCOB

Own Source Revenue

Counties collectively have not achieved the targeted own source revenue (OSR) over the years, thus hampering service delivery. Some counties have, however, met their individual OSR targets. In 2018/19, counties collected a total of Ksh 40.3 billion against a target of Ksh 53.86 billion. Since 2013, OSR have contributed an average 11.96% of total county expenditures. In the financial year 2018/19, OSR accounted for 10.71% of total county expenditures. OSR’s contribution to total expenditures is significant but low, implying that counties cannot fully rely on OSR to fund county expenditures should transfers from the National government be withdrawn.

Counties have a great potential in meeting their own source revenue. However, the legal and institutional frameworks to guide the OSR collection and accountability are weak. Poor setting of annual revenue targets, and ambitious projections often lead to deficits. The accounting framework for OSR also needs to be strengthened to ensure that all revenue collected is channeled to the County Revenue Fund to avoid leakages in the accounting system. For counties to meet their OSR targets, they should: build capacities for their staff (both the technical and the management staff), strengthen revenue collection systems and examine possible new sources of revenue through imposition of new taxes, charges and fees as per the OSR policy. Finally, they should enhance governance, accountability and oversight in OSR management.

In 2018/19, thirteen (13) counties achieved their OSR targets, an improvement from three counties who met their targets in 2017/18. This can be attributed to improved legal and institutional environment, proper accountability, and automation of OSR collection. The National Treasury has made proposals that to enhance revenue collection, counties should partner with private companies and the Kenya Revenue Authority. Some counties have embraced this proposal, an example being Kiambu County whose property rates, land rates and single business permits fees are collected by KRA.  This is in a bid to match the global perspective whereby property rates account for 40% to 80% of OSR for Local governments. An example is South Africa where property taxes contributed to 0.4% of GDP. A brief analysis of OSR is given in Table 5.

Table 5: Total expenditure against own source revenue

Financial Year2013/142014/152015/162016/172017/182018/19
Own Source Revenue (OSR)26.333.8535.0232.5232.4940.3
Target OSR50.3850.5157.6649.2253.86
Total Expenditure169.4258295.3319.06303.83376.43
OSR as a Percentage of Total Expenditure (%)15.5313.1211.8610.1910.6910.71

Source: County Governments Budget Implementation Review Report, OCOB

Conclusion and Recommendations

Failure to agree on the method and parameters to be used in computing the equitable share of revenue by the CRA, National Treasury, and the National Assembly led to the stalemate experienced in August 2019. In light of this:  

  • There is need for harmonization and consensus by the relevant parties (CRA, The National Assembly, The National Treasury, and the Council of Governors) on the method and parameters to use when making proposals on the division of revenue.
  • Counties should endeavor to strengthen the legal and institutional frameworks for own source revenue collection to meet their budget estimates and ensure that the estimates they make are more realistic. This will reduce over-reliance on national government disbursements.
  • Counties should liaise/comply with the National Treasury to ensure that the equitable share of revenue allocated to them are disbursed timely to ensure smooth service delivery in the counties.

By Josphat Kipsaat and Carolyne Mbatia

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