DILG-Resources-2011216-85e96b8954 (1)

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Fiscal Decentralization in the Philippines:

ISSUES, FINDINGS AND NEW DIRECTIONS

Department of the Interior and Local Government with the support of

Asian Development Bank

May 2010

2010 Department of Interior and Local Government and Asian Development Bank All rights reserved. Published 2010. Printed in the Philippines. ISBN # 978-971-93652-2-8 Publication Stock No.

Cataloging-In-Publication Data Niazi, Tariq H., Llanto, Gilbert M., and Fabre, Raymund C. (editors) fiscal decentralization in the Philippines: issues, findings and new directions Quezon City, Philippines: Department of the Interior and Local Government and Asian Development Bank, 2010. 1. fiscal decentralization 2. Local governance I. Department of the Interior and Local Government. This publication was produced with funding from the Asian Development Bank through ADB Technical Assistance Project 7019-PHI: Local Government Financing and Budget Reform. The views expressed in this book are those of the authors and do not necessarily reflect the views and policies of the Asian Development Bank (ADB) or its Board of Governors or the governments they represent. ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. ADB encourages printing or copying information exclusively for personal and noncommercial use with proper acknowledgment of ADB. Users are restricted from reselling, redistributing, or creating derivative works for commercial purposes without the express, written consent of ADB.

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TABLE OF CONTENTS

List of Tables and Figures vii Acronyms xix Message xx Foreword xxi Preface xxiii FISCAL DECENTRALIZATION IN THE PHILIPPINES: ISSUES, FINDINGS AND NEW DIRECTIONS Tariq H. Niazi, Gilbert M. Llanto, and Raymund C. Fabre

1

A. Historical Context 1 B. Expenditure Management 4 Expenditure Allocations and Service Delivery at the Local Level 4 Expenditure on Education 9 C. Key Issues and New Directions in Expenditure Management 11 Personal Services 11 Special Education Fund 13 Fiscal Surplus-Deficit 14 Local Economic Enterprises 16 D. Local Own-Source Revenue Generation 20 E. Key Issues and New Directions in Local Own-Source Revenue Generation

– Exercise of LGU’s Corporate Powers 26

Guiding Principles 27 Building the Promotional Structure 27 Establishing the Policy Support System 28 Capacity Building 28 Advocacy and Technical Assistance 30 Monitoring and Evaluation 30 F. Local Credit Financing 30 G.

Key Issues and New Directions in Local Credit Financing – Improving LGU Access to Official Development Assistance

35

Allow LGUs to use private commercial banks as depository institutions

35

LGUs to access ODA directly from donors: Fast-track the implementation of Executive Order 809

36

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TABLE OF CONTENTS Establish a monitoring system between NEDA, DILG, DBM and DOF for ODA-funded individual LG projects

36

On Processes and Procedures 37 Acquaint LGUs with sources of public investment funds other than

direct ODA grants 38

Develop LGU capacities in local planning and project development 38 Establish a project Feasibility Studies Fund for LGUs 39 Streamline the development and approval processes for small

subprojects 39

Involve LGU representative in the programming exercises with donors 40 Other Recommendations 40

STUDY ON LOCAL PERSONAL SERVICES EXPENDITURE POLICY Rosario G. Manasan and Cynthia G. Castel

41

1. Introduction 41 2. Legal Framework and Institutional Arrangements 47 3. Outstanding Issues and Recommendations 54 3.1 Staffing Concerns 57 3.2 Pay and Compensation Concerns 63 4. Conclusion 77 References 79 Annex – Attachment No. 1 81 THE SPECIAL EDUCATION FUND: PROSPECTS FOR POLICY IMPROVEMENT Rosario G. Manasan and Cynthia G. Castel

83

1. Introduction 83 2. Legal Frame Work 89 3. Current Practice On Allocation of SEF 96 3.1 Allocation for Locally Funded Teachers 96 3.2 Allocation for Capital Outlays 100 3.3 Allocation for Sports Competitions 100 3.4 Allocation for Citizen Development Programs and Co-curricular

Activities 101

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3.5 Use of SEF to Pay for the Cost of Tax Collection 102 3.6 Other Items Charged Against the SEF 102 4. Current Institutional Arrangements 103 4.1 DepEd-driven or LCE-driven LSB Budget Allocation Process 103 4.2 Pattern of Allocation Across Schools 104 4.3 Lessons from Synergeia 104 5. Lessons from International Experience 105 6. Recommendations 106 6.1 Improving Guidelines on the Utilization of the SEF 107 6.2 Improving the Institutional Arrangements 109 6.3 Clarifying Definitions and Usage of Terms in LGC and RA 9155 110 6.4 Clarifying Expenditure Assignment in Basic Education Sector 110 6.5 Increasing Equity in Education Spending 110 7. Conclusion 111 References 112 Annex 1: International Experience on Expenditure Assignments in the Education Sector

113

Annex 2: Joint Circular No. ___ March 31, 2009 Department of Education, Department of Budget and Management and Department of Interior and Local Government

128

STUDY ON LOCAL FISCAL SURPLUS/DEFICIT Rosario G. Manasan and Cynthia G. Castel

131

1. Introduction 131 2. Legal Framework 132 3. Current Practice and Outstanding Issues 135 3.1 Measuring and Monitoring Fiscal Balances of LGUs 135 3.2 Measuring Resources Available for Appropriation 145 3.3 Managing the Fiscal Position 147 4. Conclusion 150 References 153

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TABLE OF CONTENTS IMPROVING THE FINANCIAL MANAGEMENT OF LOCAL ECONOMIC ENTERPRISES Rosario G. Manasan and Cynthia G. Castel

154

1. Introduction 154 2. Local Economic Enterprises Situationer 155 2.1 Increasing Number of LEEs 155 2.2 What Drives the Trend Towards Greater Number of LEEs 157 2.3 Many LEEs Incur Losses Year after Year 158 2.4 Increasing Financial Risks Assumed by LGUs and LEEs 162 3. Outstanding Issues 167 3.1 Need for a Clear Policy Framework for the Creation and Continued

Operation of LEEs 167

3.2 Need to Clarify Treatment of LEE in the LGU Budget 180 3.3 Need to Strengthen LGU Capability Relative LEE Creation and

Operation 188

4. Summary and Conclusion 189 References 192 Annex 1: A Review of Alternative Service Delivery Option 193 Annex 2: Systems of Budget and Financial Management of Local Government Enterprises

208

STUDY ON THE CORPORATE POWERS OF LOCAL GOVERNMENT UNITS

237

I. Introduction 237 II. The Political and Corporate Nature of Local Government 238 Dual Nature of Local Governments 238 Creation of Local Government Units 238 Powers and Functions 239 Economic Activities 240 III. The Corporate Powers of LGUs 241 IV. Current Trends in the Exercise of LGU Corporate Powers 244 Extent of LGU Borrowing 244 Financial Performance of Local Economic Enterprises 245

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TABLE OF CONTENTS

V. Emerging Models of LGUs’ Exercise of Corporate Powers 246 Public-Private Partnership 246 Inter-LGU Cooperation Schemes 246 Corporatizing Service Facility 247 Case Studies of Models 247 1. The La Union Medical Center 247 2. LGU Experience in the Operation of Economic Enterprises: An

Evolving Institutional Arrangement – The Tagum City Model 250

3. A Non-Traditional Approach to Local Economic Enterprises Management

255

4. Corporatization of Economic Enterprise: LGU initiative – Misamis Oriental Telephone Systems, Inc.

256

5. Good Service Delivery and Taking the Lead in Inter-LGU Cooperation: Naga City

259

6. Bond flotation for Tourism Development: The Boracay-Aklan Provincial Bonds

263

7. Privatization of Power and Water Utilities: The Joint Venture Project of the Province of Bohol

266

8. Capitalizing Private-Public Sector Investment Venture: The Bulacan Packaging Service Center

269

VI. Challenges Confronting LGUs’ Exercise of Corporate Powers 271 The Issue of Cost Recovery 273 Cost Recovery Schemes for Existing LEEs 273 Cost Recovery for New LEEs 274 Administratively Feasible Interventions 275 The Organization of Local Economic Enterprises 275 The Beginnings 275 The Evolving Structure 276 A Contemporary Model 278 Professionalization of LEE Management 279 Financial Viability 279 Legal Issues in the Operation of LEEs 280 Exploring a New Mindset in Local Economic Enterprise

Management 280

Legal Impediments in the Exercise of LGU Corporate Powers 281

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TABLE OF CONTENTS Exercise of LGU Corporate Powers through Public-Private Partnership

281

Management contract 282 Lease Contract 283 Concession Agreement 283 BOT Contract 283 Pre-Contract Analysis 283 Typical Responsibility Distribution for Each Model 284 VII. Setting the Stage to Enhance LGUs’ Exercise of Corporate Powers 285 The Local Government as an Economic Unit 286 VIII. Program Strategy 288 Guiding Principles 288 Building the Promotional Structure 288 Establishing the Policy System 289 Capacity Building 289 Sustaining Actions 291 Financing Options 293 General Criteria 294 Description of the LGU Corporate Powers Reform Areas and

Corresponding Grant Component 296

Institutional Framework 297 References 299 Appendix A: Issues on LGU Exercise Corporate Powers 300 Appendix B: Investment of understanding Assets 305 LGU ACCESS TO OFFICIAL DEVELOPMENT ASSISTANCE (ODA): STATUS, ISSUES AND CONCERNS Alex B. Brillantes, Jr., Gilberto M. Llanto and Ruperto P. Alonzo

307

I. Introduction 307 A. Rationale of the Study 307 B. Approach and Methodology 308 C. ODA Policy Framework of the Philippines 308 D. Local Government Unit Access to Official Development Assistance 311

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TABLE OF CONTENTS

II. Background

316

A. National Government Involvement in Developed Functions 316 B. The Policy Framework for Selective National Government

Intervention 317

1. The Rationale for NG Involvement 317 2. The Nature Of National Government Assistance 318 3. Principles for Designing NG Assistance 319 C. The Foreign Borrowing Act of 1966 320 D. The LGU Grant Financing Framework and Cost-Sharing Principles 320 II. Current Situation 324 A. LGU Access to ODA 324 B. LGU Access to ODA Grant Funds 329 C. Other ODA Resources Available to LGU 333 D. Equity in the Distribution of ODA Resources 334 E. Summary 339 III. Certain Issues and Concerns 340 A. Seeking, Managing, and Monitoring ODA at the Local Level 340 1. Positive Stories and Good Practices to Share 340 2. Scaling Up and Avoiding Duplication 341 3. Monitoring ODA Flows to LGUs 343 B. On the Foreign Borrowing Act of 1966 and on Programming Foreign

Assistance 344

C. Challenges in the Implementation of the LGU Financing Framework 345 D. On Access to LGU Financing and the MDFO facility 348 IV. Conclusions and Recommendations 352 A. Recommendations on Policies, Processes and Procedure 352 1. On Policies 352 2. On Processes and Procedures 355 3. Other Recommendations 358

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References

360

Annex 1-A: NG-LGU Cost Sharing Scheme (Financing Mixes), 1990s 362 Annex 1-B: Revised Loan-Grant-Equity Mix for Province/Municipalities, and for Cities, 2009

363

Annex 2: Ranking of Provinces Based on ODA funded projects 364 Annex 3: Ranking of Regions Based on ODA funded projects 366 Annex 4: Distribution of ODA funded projects by Sector, By Province 368 Annex 5: Ranking of Provinces with ODA funded projects in Agriculture/Agrarian Reform

371

Annex 6: Guidelines for Grant Design 373 Annex 7: Experiences of LGUs Surveyed on their ODA Experience 375

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LIST OF TABLES AND FIGURES

FISCAL DECENTRALIZATION IN THE PHILIPPINES: ISSUES, FINDINGS AND NEW DIRECTIONS

Table 1. Local Government Expenditure Relative to GNP and to General Government Expenditure (%)

6

Table 2. Ratio to GNP of Local Government Expenditures (in percent) 7 Table 3. Sub-Sectoral Distribution of Local Government Social

Expenditure 2001-2005 9

Table 4. Selected Education Indicators, 2000/01 and 2005/06 11 Table 5. Tax Assignment in Cities, Provinces, and Municipalities 21 Table 6. Distribution of Local Government Own-source Revenue Across

Levels of Sub-national Government by Type of Revenue (%) 22

Table 7. Distribution of Cost of Devolved Functions Across Levels of Local Governments by Functions, 1992

23

Table 8. Collection Rate of Current Year for Basic RPT, 1989-2000 24 Table 9. Share of National and Local Governments to General

Government Revenue (in percent) 25

Table 10. Local Government Borrowings, 1985-2005 32 Figure 1. Spending on Education by Level of Government, 1991-1998. 11 STUDY ON LOCAL PERSONAL SERVICES EXPENDITURE POLICY

Table 1. LGU expenditures as Percentage of GDP, 1988-2007 44 Table 2. Composition of LGU expenditures, by object of expenditure,

2000-2007 45

Table 3. LGU pay as percentage 0f national schedule as per RA 6758 50 Table 4. Proportion of LGUs Implementing Third Tranche of Revised SS

under Joint Resolution No. 1,1994 a/ 52

Table 5. Size of LGU wage bill, 2007 56 Table 6. Average number of hirees under job order per LGU, 2007 57 Table 7. Average number of personnel, 2007 59 Table 8. Population to LGU personnel ratio, 2007 60 Table 9. Average number of non-regular personnel, 2007 61 Table 10. Percent of Unfilled Regular Positions to Total Number of

Regular Positions, 2007 62

Table 11. Percentage of LGUs complying with PS Cap, 2007 65

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Table 12. Size of LGU wage bill, by compliance with PS cap, 2007 66 Table 13. Number of LGUs Adopting Salary Schedule of Higher Class

LGUs, 2007 67

Table 14. Proportion of LGUs Exceeding PS Cap Before Waivers, by Salary Schedule Adopted, 2007

68

Table 15. Percent of LGUs not complying with restrictions on giving of allowances, 2007

71

Table 16. Percent of LGUs not complying with restrictions on giving of Magna Carta benefits to PHWs, 2007

72

Table 17. Some counterfactuals on number of LGUs exceeding PS cap, 2007

74

THE SPECIAL EDUCATION FUND: PROSPECTS FOR POLICY IMPROVEMENT Table 1. Basic education outcomes, 1990-2007 83 Table 2. TIMSS scale scores, 1990-2003 84 Table 3. Net enrollment rate and completion rate at the elementary and

secondary level by region, SY 2006-2007 a/ 85

Table 4. National achievement test for Grade 6, 2004- 85 Table 5. National achievement test for 2nd Year, 2003-2007 86 Table 6. Educational attainment of HH head and poverty status, 2006 86 Table 7. SEF Income and Expenditures, 2001-2007 (in million pesos) 88 Table 8. SEF expenditure per student vs. Dep-Ed School-Level MOOE

per student, SY 2007-2008 (in pesos) 88

Table 9. Median SEF spending per pupil in municipalities and cities classified according to LGU income class, 2006

89

Table 10. Budget share of PS, MOOE and CO in SEF expenditures, 2005-2008

96

Table 11. Addressing Input Gaps in Basic Education, 2003-2007 97 Table 12. Average number of teaching positions charged to SEF per

LGU, 2006-2008 97

Table 13. Total number locally funded teachers, 2004-2007 98 Table 14. Remaining Numbers of Excess/ Deficit Teachers Given Actual

Number of LGU/ SEF-funded Teachers, SY 2007-2008 a/

99

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LIST OF TABLES AND FIGURES STUDY ON LOCAL FISCAL SURPLUS/DEFICIT

Table 1. Fiscal surplus (deficit) from COA Statement of Cash Flow, 2002-2007

137

Table 2. Percent of LGUs with fiscal deficit based on COA Statement of Cash Flows, 2006-2007

138

Table 3. Overall fiscal surplus (deficit) on cash basis based on BLGF SIE, 2002-2007

139

Table 4. Variation in fiscal surplus (deficit) based on BLGF SIE a/ as % of LGU income, 2002-2006

140

Table 5. Percent of LGUs with overall fiscal deficit based on BLGF SIE, 2002 & 2006

141

Table 6. Cash reserves and amount available for appropriation, 2002-2007

142

Table 7. Gross borrowings and outstanding long-term liabilities of all LGUs, 2002-2007 (in billion pesos)

144

Table 8. Relation between Amount Available for Appropriation and Overall Fiscal Balance, 2007

146

IMPROVING THE FINANCIAL MANAGEMENT OF LOCAL ECONOMIC ENTERPRISES Table 1. Proportion of LGUs (as % of total number who responded to

survey) operating LEE, by type of LEE, 2007 a/ 156

Table 2. LGU Income from Local Economic Enterprises, 2005-2007 157 Table 3. Results of operation of LEEs, 2006-2008 159 Table 4. Percentage of LEEs posting net losses, by type LEE, 2007 160 Table 5. Gross borrowings and outstanding long-term liabilities of all

LGUs, 2002-2007 (in billion pesos) 163

Figure 1. Graphical Presentation of LGU Decision Making Process

Relative to Creation of LEEs 174

Figure 2. Chartered LEEs, LEEs in the General Fund and Regular LGU Unit Delivering “LEE-like” Services

191

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LIST OF TABLES AND FIGURES STUDY ON THE CORPORATE POWERS OF LOCAL GOVERNMENT UNITS Table 1. Criteria for Creating Local Government Units 239 Figure 1. Organizational Structure. 254 LGU ACCESS TO OFFICIAL DEVELOPMENT ASSISTANCE (ODA): STATUS, ISSUES AND CONCERNS

Table 1. LGU Financing Framework 315 Table 2. The Ten Provinces with the Most Number of ODA funded

projects, 1998-2008 325

Table 3. Provinces with the Least Number of ODA funded projects, 1998-2008

326

Table 4. Top Five Regions Based on ODA funded projects, 1998-2008 326 Table 5. Bottom Five Regions Based on ODA funded projects, 1998-

2008 326

Table 6. Number of ODA funded projects by Sector, 1998-2008 327 Table 7. Provinces with the Most Number of ODA-Funded

Agriculture/Agrarian Reform Projects, 1998-2008 328

Table 8. Provinces with the Most Number of Infrastructure Projects, 1998-2008

328

Table 9. Value and Number of ODA Loans and Grants, 1997, 2002, and 2007

329

Table 10. Appropriations and Allocations for Foreign-Assisted Projects (In thousand pesos)

330

Table 11. Obligations for Projects, by Type, 2007-2008 (In thousand pesos)

330

Table 12. ODA Grants, by Implementing Agency, (2007 ODA Portfolio) 331 Table 13. ODA Grants, by Funding Source (2007 ODA Portfolio) 331 Table 14. ODA Facilities for Local Government Units, (as of 31 March

2009) 332

Table 15. ODA Loans with LGU participation, 2000-2008 333 Table 16. Project vs. Program Loans, 2000-2008 334 Table 17. Shares in ODA funded projects Costs*, Population, and GDP

by Region (Based on 2003 ODA Portfolio) 335

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Table 18. Per Capita Cost* of ODA funded projects by Region vs. Poverty Incidence (Based on 2003 ODA Portfolio)

336

Table 19. Average Number of ODA Subprojects per Province, by Area by 2001 Income Class

337

Table 20. ODA Subprojects per Million Residents per Province, by Area by 2001 Income Class

337

Table 21. Subprojects per Province and per Million Residents per Province by Quintile in Poverty Incidence

338

Table 22. Significance Levels of Regression Coefficients 339 Table 23. MDFO Loan-Grant-Equity Mixes, by Project Category, By Type

and Fiscal Class of LGU, 2002, (In percent) 346

Figure 1. ODA Grant Programming Flowchart 310 Figure 2. Local Investment Programming Process 312 Figure 3. ODA funded projects by Sector, 1998-2008 327 Figure 3. LGU Planning Framework 313 Figure 4. Bohol ODA Coordination Framework 343

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ACRONYMS

ADB Asian Development Bank ARMM Autonomous Region of Muslim Mindanao AO Administrative Order ADCOM Additional Compensation Allowance ALS Alternative Learning System AusAID Australian Agency for International Development ARD Associates in Rural Development BEIS Basic Education Information System BCDA Bases Conversion and Development Authority BCCI Bulacan Chamber of Commerce and Industry BESRA Basic Education Sector Reform Agenda BLCI Bohol Light Company, Inc. BLGF Bureau of Local Government Finance BLGD Bureau of Local Government Development BLGF- DOF

Bureau of Local Government Finance of the Department of Finance

BLGS Bureau of Local Government Supervision BPSTC Bulacan Packaging Services and Toll Center BWUI Bohol Water Utilities Inc. BTr Bureau of Treasury BOT build-operate-transfer BSP Bangko Sentral ng Pilipinas CBRM Community-Based Resource Management CESO Career Executive Service Officers CI Congressional Initiatives CCLCP Coordinating Council for LGU Corporate powers CGCP Naga City Computerization Program CIDA Canadian International Development Agency CO Capital Outlays CoAG Council of Australian Governments COA Commission on Audit CPCS Compensation and Position Classification System CPR Country Program Review CSOs Civil Society Organizations CSC Civil Service Commission DA Department of Agriculture

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ACRONYMS

DBCC Development Budget Coordinating Committee DBM Department of Budget and Management DBP Development Bank of the Philippines DECS Department of Education, Culture and Sports DENR Department of Environment and Natural Resources DepEd Department of Education DFA Department of Foreign Affairs DILG Department of the Interior and Local Government DLGCD Department of Local Government and Community Development DOF Department of Finance DOH Department of Health DOTC Department of Transportation and Communication DOST Department of Science and Technology EC European Commission EIB European Investment Bank EIRR Economic Internal Rate of Return EO Executive Order FINEX Financial Executive Institute of the Philippines GAA General Appropriations Act GASB Government Standards Accounting Board GBEs Government Business Enterprises GF General Fund GFI Government Financial Institution GRDP Gross Regional Domestic Product GO-FAR Governance-Facility for Adoption and Replication GOLD Governance in Local Democracy GOCC Government-owned and-controlled corporation GOP Government of the Philippines GDP Gross domestic product GNP Gross National Product GRDP Gross regional domestic product GOJ Government of Japan ICC Investment Coordinating Council IMF International Monetary Fund IASs International Accounting Standards IFAD International Fund for Agriculture

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ACRONYMS

IAEA International Atomic Energy Association IPSAS International Public Sector Accounting Standards IRA Internal Revenue Allotment JBIC Japan Bank for International Cooperation JICA Japan International Cooperation Agency JFPR Japan Fund for Poverty Reduction JC Joint Circular JMEEDO

Jimenez Municipal Economic Enterprise Development office

JICA Joint Commission on Local Government Personnel JV Joint Venture KRA Key Result Areas LBP Land Bank of the Philippines LFF LGU Financing Framework LET Licensure Examination for Teachers LCPCF LGU Corporate Powers Challenge Fund LGSP Local Government Support Program LBC Local Budget Circular LBM Local Budget Memorandum LCE Local Chief Executive LEEU Local Economic Enterprise unit LDIP Local Development Investment Plan LEEs Local Economic Enterprises LGA Local Government Academy LCP League of Cities of the Philippines LGC Local Government Code of 1991 LGPMS Local Governance Performance Management System LGU Local Government Unit LGUs Local Government Units LGUGC LGU Guarantee Corporation LOGTRI Local Government Training and Research Institute LOGOFIND Local Government Unit Finance and Development LLDA Laguna Lake Development Authority LGUGOCC Local Government-owned and Controlled Corporation LSB Local School Board LWUA Local Water Utilities Administration

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ACRONYMS

LUMC La Union Medical Center MC Memorandum Circular MBUSS Mindanao Basic Urban Support Service MDF Municipal Development Fund MDG Millennium Development Goal MDGD Management Development and Governance Division MDFO Municipal Development Fund Office MNDC Metro Naga Development Council MSMEs Micro Small-Medium Enterprises MSBs Municipal School Boards MISORTEL Misamis Oriental Telephone System MOOE Maintenance and Other Operating Expenses MPS Mean Percentage Score MTPDP Medium-Term Philippine Development Plan MTPIP Medium-Term Public Investment Plan NAT National Achievement Test NACIGEA Naga City Government Employees Association NCR National Capital Region NC Needing Clearance NCP National Competition Policy NCC National Competition Council NCPC Naga City People’s Council NEDA National Economic Development Authority NEDA-PMS

National Economic Development Authority Project Monitoring Staff

NEED Naga Early Education Development NG National Government NGA National Government Agency NGAS New Government Accounting System NGO Non-Government Organization NSW New South Wales NGOs NEDA Regional Offices NNC Not Needing Clearance NZAID New Zealand's International Aid & Development Agency O&M Operations and Maintenance OCPC Office of Compensation and Position Classification

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ACRONYMS

ODA Official Development Assistance OPAS Office of the Provincial Agricultural Services OPCCB

Organization, Position Classification and Compensation Bureau

OPDS Office of Project Development Services OPIF Organizational Performance Indicators Framework PCPPs Position Classification and Pay Plans PACAP Philippines-Australian Community Assistance Program PAPs Programs, Activities and Projects PD Presidential Decree PDAF Priority Development Assistance Fund PDF Philippines Development Forum PFI Private Financial Institutions PEGR Philippine-Australian Governance Reform PEP People Empowerment Program PES Provincial Electric System PIB Productivity Incentive Benefits PIP/PSEP

Productivity Improvement Program/Public Service Excellence Program

PHWs Public Health Worker PLC Port and Livelihood Center PNB Philippine National Bank PPEM Provincial Planning and Expenditure Management PPDO Provincial Planning and Development Office PS personnel services PSC Philippine Sports Commission PSOs Private Sector Organizations PWS Provincial Waterworks System RA Republic Act RATA

Commutable Representation and Transportation Allowances

RDIP Regional Development Investment Program RDC regional development council ROOM Rehabilitate-Own-Operate-and-Maintain ROI Return of Investment RORO Roll-On Roll-Off

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ACRONYMS

ROCS Regional Operation Coordination Service RPT Real Property Tax RPS Rationalized Local Planning System SEC Securities Exchange Commission SEF Special Education Fund SEDIP

Secondary Education Development and Improvement Project

SEED School for Early Education and Development SIDA Swedish International Development Cooperation Agency SG Salary grade SPVs Special Purpose Vehicles SPS Small project Scheme SMED Small and Medium Enterprise Development SIP School Improvement Plans SOE State-owned Enterprise SREs Statement of Receipts and Expenses SONA State of the Nation Address SUCs State Universities and Colleges QC-HURA QC-Housing and Urban Renewal Authority SSL Salary standardization Law SSL3 Salary Standardization Law 3 TA Technical Assistance TWG Technical Working Group UBOM Updated Budget Operations Manual UN United Nations UNDP United Nations Development Programme UNDESA

United Nations Department of Economic and Social Affairs

USAID United States Agency for International Development YEB Year-End Benefits WB World Bank

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Republic of the Philippines DEPARTMENT OF THE INTERIOR AND LOCAL GOVERNMENT

A. Francisco Gold Condominium II, EDSA cor. Mapagmahal St. Diliman, Quezon City MESSAGE

This collection of studies titled “Fiscal Decentralization in the Philippines: Issues, Findings and New Directions“ is the Department of the Interior and Local Government’s contribution to the body of knowledge on local revenue generation, local expenditure and budget management, and intergovernmental fiscal relations.

Although much has already been studied and written in the abovementioned areas, this book delves into current and critical but barely investigated issues. Since the passage of the Local Government Code of 1991, much has already been written about the Internal Revenue Allotment (IRA) as a key intergovernmental transfer but little, if any, in-depth studies have been written about the LGU’s access to Official Development Assistance or ODA. Similarly, as much as there have been studies looking into local taxes such as the real property taxes and business taxes, in-depth studies on the exercise of the LGU’s corporate powers have been virtually non-existent. Finally, as much focus have placed on the issues of revenue generation, little has been studied on local expenditure management especially as this relates to the appropriate treatment of personal services and surplus-deficit situations, economic enterprise and the Special Education Fund (SEF). It is the intent of the DILG through this study to provide value-added to the policy reform debate by opening up these little studied issues and recommend possible solutions to the problems identified in these areas. It is also the intent of the DILG to raise these important issues to national and local policy-makers and stakeholders in the hope that the LGU reform agenda can move forward in the coming years.

Let me take this opportunity to thank our partners: the DBM, the DOF, and the Asian Development Bank who worked with us in producing this set of studies and this publication as well as shared our vision of furthering fiscal decentralization reforms in the country. May this partnership continue to strengthen inter-agency and donor cooperation as we continue to address the challenges of reaching excellence in local fiscal governance.

RONALDO V. PUNO Secretary

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Republic of the Philippines DEPARTMENT OF THE INTERIOR AND LOCAL GOVERNMENT

A. Francisco Gold Condominium II, EDSA cor. Mapagmahal St. Diliman, Quezon City

FOREWORD

Asian Development Bank (ADB) has been closely involved in support of decentralization reforms in the country gathered significant pace from the early 2000s. The ADB-supported Local Government Financing and Budget Reform Program (LGFBR) has been running actively since 2006, and provides a range of support to the Government, including program financing, project investment and technical assistance. It has supported the government’s efforts in strengthening decentralization policy framework and building capacity at the national agencies and the local government units (LGUs). The Local Government Code of 1991 provided the legal framework to devolve taxing, borrowing and spending powers to local government units. In the past seventeen years, the country has experienced a positive stimulus to local growth and development brought about by a paradigm shift of entrusting responsibilities and authorities to local government units for local development. In the course of implementation of the new policy framework, several issues have arisen, posing challenges and opportunities to further local development. The current studies analyze some of these outstanding issues by providing a comprehensive review of: (a) utilization of the special education fund; (b) surplus and deficit in local government units; (c) local government personal services expenditure policy; (d) financial management of local economic enterprises; (e) corporate powers of local government units; and (f) procedures on sharing national wealth. The study suggests specific recommendations to assist the government in framing an appropriate response to such issues.

There are varying views regarding the impact of decentralization on the provision of local services but scant actual research. The study on utilization of the Special Education Fund (SEF) gives important leads on how local government units can effectively utilize this fund. The SEF is the share from real property tax collection and has become an important source of income for local government units. The study proposes a set of new guidelines that may provide a better link between SEF allocations and actual needs of local schools.

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The study on local fiscal surplus/ deficit reviews the current practices, guidelines, and procedures on budgeting at the local level as it relates to the treatment of fiscal surplus/ deficit. It appears that while financing is a general constraint to local service delivery, LGUs have paradoxically registered fiscal surpluses. The study analyzes the question in light of fiscal conservatism and inefficiency or under-spending by LGUs that may impact service delivery and suggests measures to improve budgeting policies and procedures to promote more effective and efficient use of government resources.

A basic policy issue at the local level involves the need to balance the employment and compensation policy with service delivery objectives. LGUs need to attract and retain good technical and managerial staff while at the same time they have to control the wage bill in view of budget constraints. Paradoxically, controlling the wage bill may negatively affect the local service delivery. The study on local personal services expenditure policy recommends giving LGUs flexibility to set their own compensation policy subject to a budget constraint and eliminating most of the waivers in applying the cap on personal services. The study on local economic enterprises finds that though these local entities are intended to be revenue-generating or at least self-sustaining, many of them actually incur financial losses. Less than business-like approach to local enterprise management is cited as a reason for large arrears and low collection efficiency. The study makes important recommendations to strengthen financial management of local enterprises. Another study reviews LGUs’ exercise of corporate powers through the operation of public utilities, economic enterprises and other service facilities. The study proposes a design for a program strategy in harnessing LGU corporate capacities. We see the book as an important input to evidence-based policy making; the studies compiled in this volume will be of great interest to policy makers especially in their review of the Local Government Code that aims to improve the policy framework for decentralization. The study results will be considered carefully by the Government and will be used to help develop better systems and policies. We look forward to ongoing support from ADB through the LGFBR Program and for further analytical policy studies to be jointly developed with the Government.

AUSTERE A. PANADERO Undersecretary

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FISCAL DECENTRALIZATION IN THE PHILIPPINES: ISSUES, FINDINGS AND NEW DIRECTIONS

Tariq H. Niazi, Gilbert M. Llanto, and Raymund C. Fabre

A. Historical Context

The American occupation of the Philippines (1902-1935) saw the promulgation of policies providing limited local autonomy. These include the organization of municipal and provincial councils based on general suffrage. Other pronouncements indicative of the thrust toward local autonomy included the following: the instructions of President McKinley to the Taft Commission; the incorporation of the City of Manila (Act 183 of the Philippine Commission in 1902); the establishment of the Moro Province (Act 787 in 1903); the organization of provincial governments (Act 1396 in 1905); and the extension of popular control, including the elimination of appointed members from provincial boards. Despite the enactment of these policies, purportedly supportive of local autonomy, the Americans maintained a highly centralized politico-administrative structure for security reasons. The Commonwealth period (1935-1946) saw local governments in the Philippines placed under the general supervision of the president, as provided for under Article VII, Section II, of the 1945 Constitution. Additionally, the president, by statute, could alter the jurisdictions of local governments and in effect create or abolish them (Laurel Act of 1926). President Quezon preferred to appoint the chief local officials of cities and would brook no “democratic nonsense.” Philippine political independence was granted by the Americans in 1946. The first local autonomy act (RA 2264) entitled “An Act Amending the Laws Governing Local Governments by Increasing their Autonomy and Reorganizing Provincial Governments” was implemented in 1959. This act vested in city and municipal governments greater fiscal, planning, and regulatory powers. It broadened the taxing powers of the cities and municipalities within the framework of national taxing laws. In 1959 another landmark legislation was passed on local autonomy. The Barrio Charter Act (RA2370) sought to transform the barrios, then the smallest political unit of the local government system, into quasi-municipal corporations by vesting them some taxing powers. Barrios were to be governed by elective barrio councils. Less than a decade later, the Decentralization Act of 1967 (RA 5185) was implemented. It further increased the financial resources of local governments and broadened their decision-making powers over administrative (mostly fiscal

Fiscal Decentralization in the Philippines: Issues, Findings and New Directions

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and personnel) matters. More specifically, the Decentralization Act granted local governments greater freedom and ampler means to respond to the needs of the people and promote prosperity with a more equitable and systematic distribution of governmental power and resources. To this end, local governments were to be entrusted with as much autonomous powers and financial resources as are required in the more effective discharge of their responsibilities. By any measure, the imposition of Martial Law in 1972, which abolished local elections and vested in the dictator Marcos the powers to appoint local officials who were beholden to him, was a great setback for the local autonomy movement in the Philippines. Notwithstanding the highly centralized dictatorial setup, the 1973 Constitution of the Republic of the Philippines rhetorically committed itself to a policy of local autonomy, stating that “The State shall guarantee and promote autonomy of local government units (LGUs), especially the barrio, to ensure their fullest development as self-reliant communities.” The document likewise made constitutional the taxing powers of LGUs when it stated that “Each local government unit shall have the power to create its own sources of revenue and to levy taxes subject to limitations as may be provided by law.” However, the President continued to exercise supervision and control over local governments. The authoritarian government promulgated the Local Government Code of 1983 (also known as Batas Pambansa Bilang 337), which reiterated the policy of the State to “guarantee and promote the autonomy of local government units to ensure their fullest development as self-reliant communities and make them effective partners in the pursuit of national development.” Genuine autonomy, however, could not be realistically implemented under the authoritarian regime. The overthrow of Marcos in 1986 and the installation of President Corazon Aquino saw the creation of the Freedom Constitution. It provided that “the President shall have control and exercise general supervision over all local governments.” It was this provision that enabled President Aquino, through the minister of local government, to remove local officials throughout the country whose loyalties to the government were questionable and to replace them with officers-in-charge. Seen as an isolated act, the appointment of officers-in-charge may be seen as a setback to the cause of local autonomy, but viewed in its proper historical and political context, it may be appreciated as a necessary measure in stabilizing the immediate post-dictatorship transition government. A year later, the 1987 Constitution of the Republic of the Philippines was promulgated. It included specific provisions guaranteeing autonomy to local governments. Among the major state policies articulated was the policy that “The State shall ensure the autonomy of local governments.” Additionally, Article X, Section 3 of the 1987 Constitution of the Republic of the Philippines provided that Congress will enact a local government code to provide for a more responsive and accountable local government structure instituted through a system of


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decentralization giving local government units powers, responsibilities and resources. In 1991, Republic Act 7160 or the Local Government Code of 1991 was enacted in the Philippines. It was by far the most radical and far-reaching policy that addressed the decades-old problem of an over centralized politico-administrative system, which ensured that most significant political and administrative decisions were made in Manila. Most sectors of society welcomed the enactment of the code. It finally transferred the responsibility for the delivery of basic services to LGUs, including appropriate personnel, assets, equipment, programs, and projects. The following are the major features of the code:

(i) It devolves to LGUs responsibility for the delivery of various aspects of basic services that earlier were the responsibility of the National Government. These basic services include the following: health (field health and hospital services and other tertiary services) and social services (social welfare services); environment (community-based forestry projects) and agriculture (agricultural extension and on-site research) projects and public works undertakings (locally funded); education projects (school building program); tourism activities (facilities, promotion, and development); telecommunications services and housing projects (for provinces and cities); and other such services, such as investment support

(ii) It devolves to LGUs the responsibility of enforcing certain regulatory powers, such as reclassifying agricultural lands; enforcing environmental laws; inspecting food products and imposing quarantines; enforcing a national building code; granting franchises and regulating the operation of tricycles; processing and approving subdivision plans; and establishing cockpits and holding cockfights.

(iii) It also provides the legal and institutional infrastructure for

expanded participation of civil society in local governance. More specifically, it allocates to NGOs (Non-Government Organizations) and POs (People’s Organizations) specific seats in local special bodies. These special bodies include local development councils, local health boards, and local school boards. Because of their ability to organize and mobilize people, the door is wide open for NGOs and POs participation in governance in promoting local accountability and answerability, specifically through the recall and people’s initiative provision.

(iv) It increases the financial resources available to LGUs by (i)

broadening their taxing powers; (ii) providing them with a specific


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share in the national wealth exploited in their area (e.g. mining, fishing, and forestry charges); and (iii) increasing their share in the national taxes (i.e. internal revenue allotments [IRAs] from a previous low of 11% to as much as 40%). The 1992 code also enhances the ability of LGUs to generate revenue from local fees and charges.

(v) It laid the foundation for the development and evolution of more

entrepreneurial LGUs. For instance, the code provides the foundation for LGUs to enter into build-operate-transfer (BOT) arrangements with the private sector, float bonds, obtain loans from local private institutions, etc., all within the context of encouraging them to be more business-like and competitive in their operations, which is a change from traditional government norms and operations.

B. Expenditure Management

Expenditure Allocations and Service Delivery at the Local Level

Section 17 of the 1991 Local Government Code (LGC) transferred from National Government agencies to local governments the principal responsibility for the delivery of basic services and the operation of facilities in the following areas: land use planning, agricultural extension and research, community-based forestry, solid waste disposal system, environmental management, pollution control, primary health care, hospital care, social welfare services, provincial/ municipal/city buildings and structures, public parks, municipal services and enterprises (like public markets and slaughterhouses), and local infrastructure facilities (like municipal/city and provincial roads and bridges, health facilities, housing, communal irrigation, water supply, drainage, sewerage, flood control, and intermunicipal telecommunications). In addition, it also devolved the construction of public school buildings to local governments. Under the LGC, provinces are assigned functions that involve the inter-municipal provision of services whose catchment area covers more than one municipality like operation and maintenance of district and provincial hospitals,. Municipalities are made responsible for the delivery of frontline basic services, e.g., primary health care, construction and maintenance of public elementary schools. Philippine cities can be generally classified into three categories: Component, Independent Component, and Highly-Urbanized. The last two are independent of the province and their residents cannot vote for provincial officials. The Code states that a city can be created or abolished through an act of Congress but must be a municipality or a barangay that has at least an average annual income of 20 million pesos for the last 2 years based on 1991 constant prices, a contiguous territory of at least one hundred square kilometers, and a population of no less than one hundred fifty thousand. Highly-urbanized


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cities must have an annual income of at least 50 million pesos and a minimum population of at least 200,000. Generally, the three different categories share the same revenue advantages. They receive their respective shares in the internal revenue allotment (IRA) from the allocation given to all cities, which is 23% of the total IRA. Their share is determined by population, land area and the equal sharing provision under the Code. All cities do not need to share their basic real property tax collections with the province but they have to give 30% of these to their respective barangays. The only advantage of independent component cities and highly-urbanized cities is their political independence from the provincial government. The devolution of expenditure responsibilities to local governments is largely consistent with the decentralization theorem 1. For the most part, devolved functions are those that can be provided at lower levels of governments. Few of them have benefits that spillover outside the territorial jurisdiction of local governments with the exception perhaps of those related to public health and environmental management. One important exception to the application of the decentralization theorem in the Philippines is education. The primary responsibility for the provision of basic education rests with the national government although the construction and maintenance of school buildings is devolved to local governments under the LGC. Moreover, the LGC permits local sub-national governments to group themselves and consolidate/coordinate their efforts, services and resources for purposes that are commonly beneficial to them. There are many documented cases of smaller local governments joining together to carry out specific responsibilities (like coastal resource management, solid waste disposal, water supply development and distribution) when there are economies of scale in doing so. On the surface, Section 17b of the Local Government Code provides an explicit and clear delineation of functions across levels of governments except perhaps in the area of environment and natural resource management.2 However, Section 17c (which allows national government agencies to continue to implement devolved public works and infrastructure projects and other facilities, programs and services provided these are “funded by the National Government under the annual General Appropriations Act (GAA), other special laws, pertinent executive orders, and those wholly or partially funded from foreign sources”) and Section 17f (which allows the national government or the next higher level of local government to “provide or augment the basic services and facilities assigned to a lower level of local government when such services or facilities are not made available or, if made available, are inadequate to meet the requirements of its inhabitants”) obfuscate what initially appears to be a clear cut 1 One important exception to the application of the decentralization theorem in the Philippines is education. The primary

responsibility for the provision of basic education rests with the central government although the construction and maintenance of school buildings is devolved to LGUs under the Local Government Code.

2 The Code gives municipalities responsibility for the implementation of community-based forestry and watershed projects

but allows the Department of Environment and Natural Resources (DENR) to retain supervision and control over such projects.


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assignment of expenditure responsibilities. In a sense, the prevailing arrangements effectively permit the existence of a two-track delivery system where both National Government agencies and local governments can initiate devolved activities. In line with the transfer of functions to local governments mandated under the Code and of more resources at their disposal, total local government expenditure expanded relative to gross national product (GNP) and relative to total general government expenditure. Total local government spending doubled from an average of 1.6% of GNP in 1985-1991 to 3.4% of GNP in 1992-2005. Similarly, the share of local governments in total general government expenditure net of debt service rose from an average of 11.0% in the pre-Code period to an average of 24.2% in the post-Code period (Table 1). Table 1. Local Government Expenditure Relative to GNP and to General Government Expenditure (%)

Year Ratio of local government Expenditure to GNP (%)

Expenditure to General Government Debt Expenditure Net of Debt Service (%)

1985 1.54 12.17

1987 1.44 10.67

1989 1.53 11.20

1991 1.89 12.74

1993 2.72 20.20

1995 3.53 22.38

1997 3.75 22.04

1999 3.67 23.55

2001 3.75 26.33

2003 3.55 26.87

2005 2.88 25.76

Average

1985-1991 1.61

11.40

1992 – 2005 3.36 24.15 Source: Commission on Audit, Bureau of Local Government Finance.


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Source: Bureau of Local Government Finance.

The mandated transfer to local governments of functions previously discharged by National Government agencies caused a major shift in the composition of local government budgets. The share of the social services sector to total local government expenditure expanded while the shares of the economic services sector and the general public services sector contracted (albeit marginally in the case of the latter). While local government spending on all sectors also posted increases when expressed relative to GNP, local government spending on the social services sector almost tripled (from 0.3% of GNP in 1991 to 0.9% of GNP in 2003). In contrast, local government spending on the economic services sector expanded only minimally, from 0.7% of GNP in 1991 to 0.8% in 2003 (Table 2).

The increase in local government spending on social services between

1991 and 2003 went to health, education, housing/community development and social welfare, in order of relative importance. Thus, aggregate local government expenditure on health rose almost five-fold from 0.08% of GNP in 1991 to 0.39% of GNP in 2003 while local government spending on education increased by more than three-fold from 0.07% of GNP to 0.22% of GNP (Table 2). In contrast, total local government expenditure on housing/community development and social welfare services in 2003 were less than twice as large their 1991 levels when expressed relative to GNP. The increases in local government spending on health and social welfare were largely due to the fact that the local governments had very little choice but to absorb the cost of devolved health and social welfare personnel which accounted for more than half of the total cost of all devolved personnel. Higher local government expenditures on education and housing/community in the post-Code period, on the other hand, largely reflect the higher priority that local officials assign to these sectors in the more decentralized regime. However, local governments were not locked into pre-devolution national government expenditure levels in these sectors because local governments were

Table 2. Ratio to GNP of Local Government Expenditures (in percent)

NG-LG Benchmark 1991 1993 1995 1997 1999 2001 2003 2005

GRAND TOTAL 2.35 1.9 2.7 3.5 3.8 3.7 3.8 3.5 2.9 Total Economic Services 0.77 0.7 0.7 1.0 1.0 0.9 0.9 0.8 0.6 of which: Agriculture 0.11 0.0 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Transportation and Communication 0.53 0.5 0.4 0.6 0.5 0.5 0.5 0.4 0.3 Total Social Services 0.65 0.3 0.8 0.9 1.0 1.0 1.0 0.9 0.7 of which: Education 0.07 0.1 0.2 0.3 0.3 0.3 0.3 0.2 0.2 Health 0.38 0.1 0.3 0.4 0.5 0.4 0.4 0.4 0.3 General Public Service 0.85 0.8 1.1 1.4 1.5 1.5 1.5 1.5 1.2 Others 0.07 0.1 0.1 0.2 0.2 0.2 0.2 0.3 0.3 Debt Service 0.01 0.0 0.0 0.1 0.1 0.1 0.1 0.1 0.1


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not obligated to absorb devolved personnel. On the other hand, the increase in local government spending on the education sector may be attributed to the fact that the local governments’ Special Education Fund (SEF) grew by substantial amounts in the post-Code period.

Although aggregate local government spending on the social services

sector registered a general upward trend in 1991-1997 (when measured relative to GNP and in real per capita terms), it manifested some stagnation in 1997-2005. In fact, there are indications that aggregate local government spending on health and social welfare in 2004-2005 is even lower than combined National Government/Local Government spending in 1991. These developments are true for provinces and municipalities in particular, but not for cities and appear to be related to the fiscal difficulties faced by local governments during this period. This trend is worrisome considering that municipalities are primarily responsible for the delivery of basic health services.

Local government spending on the economic services sector expanded only minimally, from 0.7% of GNP in 1991 to 0.8% in 2003. With the devolution of agricultural extension and environment/natural resource management, the expenditure share of these sub-sectors rose somewhat between 1991 and 2003. In contrast, despite the devolution of the responsibility for local infrastructure, including the construction and maintenance of local roads to local governments, local government spending on the transportation and communication sub-sector in the post-Code period did not increase relative to the 1991 level when expressed as a proportion of GNP. Spending of provinces and municipalities on the transportation and communication sub-sector was lower than the 1991 level for most of the post-Code period. This is unexpected as investment in infrastructure (classified as building roads, bridges and canals) ranks high in citizens’ preferences. These developments are a cause of concern considering the robust and strong association between economic growth and infrastructure spending.

Given the trends above, by 2005 the education and health sectors combined comprised more than 78% of local government social expenditure (Table 3). Housing and social welfare commanded slightly higher than one-fifth of the local expenditure pie with labor and employment less than one half of a percent. Health and education’s share of local expenditures rose steadily since 2000. In contrast, social expenditures for housing and social welfare have been declining or stagnant over the same period.


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Table 3: Sub-Sectoral Distribution of Local Government Social Expenditure 2001-2005 (at current prices)

Period

Education

Health, Nutrition and Population Control

Labor and Employment

Housing and Community Development

Social Welfare

Total Social Expenditure

2001 27.1 44.0 0.6 16.8 11.6 100.0

2002 25.5 45.7 0.6 17.2 11.0 100.0

2003 30.1 47.6 0.5 10.5 11.3 100.0

2004 29.9 49.7 0.3 9.3 10.8 100.0

2005 31.9 46.8 0.3 10.0 11.0 100.0

Source: Department of Finance: Bureau of Local Government Finance-Statement of Receipts and Expenditures

The problem of low growth and welfare in local communities can be traced

to poor delivery of local public goods and services. This can be broadly attributed to: (a) lack of resources, (b) poor fiscal and expenditure management, and (c) unclear expenditure assignments, The lack of resources is mainly due to unfunded mandates (e.g., mandated increases in salaries and benefits of local government employees without the corresponding revenue measure), uncertainty in national transfers such as the IRA and special shares such as shares in the income from the taxation of natural wealth, absence of equalizing transfers, insufficient generation of local own-source revenues, and poor access of local governments to development credit from public sources for social projects and private capital markets for income-generating projects,. Weak fiscal and expenditure management can be broadly attributed to a lack of clear guidance and support from national government (NG) oversight agencies and inadequate local capacity in fiscal and expenditure management. Unclear expenditure assignments result from the continued provision of devolved services by the national government agencies and from a poor matching of expenditure assignments or functions and resources both at the inter-governmental level (i.e. NG and local governments) and intra-governmental levels (i.e. between provinces and cities).

In this regard, it will be important to install an effective performance measurement motivate local governments to adequately address the needs of their communities. The current lack of an effective performance measurement system in local governments may be attributed to the insufficiency of local resources to create or improve existing measurement systems and the lack of incentives to utilize performance measurement systems.

Expenditure on Education

Basic public education is still largely the responsibility of the national government, delivered through the Department of Education (DepEd), notwithstanding the devolution of many basic services to LGUs. However, LGUs


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are able to provide supplementary funding support to public basic education because they have access to a sustainable source of funding, which has been earmarked by law for the basic education subsector, the Special Education Fund (SEF).

The monies in the SEF comes from an additional 1% tax on real property that LGUs are mandated by the Local Government Code to impose and collect. Aggregate local government spending on basic education went up from an average of 0.1% of GDP in the pre-Code period to 0.2% of GDP in the post-Code period. While local government spending on basic education does not seem large when compared to either general government education spending (5% in 1992-2007) or total DepEd spending (7% in 1992-2007, it is substantial when reckoned relative to DepEd non-personal services spending (40%-85%) and DepEd maintenance and operating expense or MOOE (70%-140%) in 2001-2007 and has the potential to have some impact on basic education outputs and outcomes.

Aggregate local government spending on basic education registered a

general upward trend in 1992-1997 (when measured relative to GDP) but manifested a well- defined downward trend in 1998-2007. This movement is common across all levels of local government and is similar to the movement in national government spending on basic education during this period (Figure 1). It appears that the trend in spending on basic education is correlated with the fiscal position of the government during a given period of time.

To some extent, the largely poor performance of education indicators

between 2001 and 2006 can be partially attributed to the fiscal difficulties faced by government. Primary education enrollment has declined from almost 97% in 2001 to 73% in 2005 while secondary education enrollment has declined from 66% in 2001 to 44.5% in 2005 (Table 4). Completing education in both primary and secondary schools have suffered as well. Students completing a primary education declined from 67% in 2001 to 62% in 2002 while students completing a secondary education declined from 73% in 2001 to 55% in 2005.

The importance of local spending for education is strongly supported by the available data. Although national government spending has been increasing, in the previous years, spending at the local level is needed to supplement this expenditure. In addition, local spending can be better targeted to address local education issues while national government spending can address homogenous or generic educational needs.


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Figure _1 - Spending on Education by Level of Government, 1991-1998.

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

1991 1992 1993 1994 1995 1996 1997 1998

CG/GDPLG/GDP

Source: National Statistics Coordinating Board. 2007. Philippine Statistical Yearbook 2007. Table 4_: Selected Education Indicators, 2000/01 and 2005/06 2000/01 2005/06 Net enrollment ratio – primary (%) 96.80 73.51 Net enrollment ratio – secondary (%) 66.10 44.50 Cohort survival rate – elementary (%) 67.18 62.58 Cohort survival rate – secondary (%) 73.05 54.99 Adult Literacy Rate (%) 92.30 93.40* *2003 Source: Department of Education

C. Key Issues and New Directions in Expenditure Management

Personal Services

The basic policy problem with respect to public sector employment and compensation policy at the local level revolves around the question of how to effectively control the LGU wage bill while simultaneously trying to ensure that LGUs have an adequate number of personnel with the appropriate qualification, which will enable them to deliver efficient services to their constituency. Thus, the twin challenge is how to control wage costs but at the same time, improve remuneration to attract and/ or retain good technical, professional and managerial staff. The guidance from the international literature suggests that the first step in a pay reform strategy is to determine the medium-term resource envelope. In other words, fiscal sustainability should be primordial in the LGUs’ hierarchy of objectives.


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Since the wage bill is simply the product of the number of employees and the wage rate, personal services (PS) expenditure policy has to contend with issues related to both staffing and pay policy. Moreover, position classification and compensation concerns cannot be completely divorced from staffing concerns. Relative to this, is the need for a body similar to the Joint Commission on Local Government Personnel Administration to be constituted to act as oversight body on local personnel matters and to ensure better coordination of (i) staffing and employment policies, (ii) position classification and compensation policies, and (iii) sectoral policies.

There is also a need to review and define model organizational structures for LGUs with corresponding staffing pattern (by level and by income class). The amended model organization structures should be indicative rather than prescriptive. Corollary to this, criteria and/ or benchmarks that LGUs can refer to in deciding on the staffing pattern that is appropriate for their particular situation should be established.

The revised model organizational structure and staffing pattern could possibly lead to a more compact list of plantilla positions that include only positions that are needed for the delivery of the core mandates of LGUs. Fixed-term employment contracts may then be considered for personnel who are focused on the delivery of the priorities of the current administration, which are not part of the core mandates of the LGU.

It is recommended that the cap on LGU spending on personal services be retained. This is important so as to reinforce the imperative for LGUs to live within hard budget constraints. Related to this, it is recommended that LGUs be given the flexibility to set their own compensation and pay policy (choosing one from the eight alternative salary schedules described in RA 6758) as long as they work within the fiscal constraint embodied in the PS cap. It is further recommended that most if not all of the waivers to the application of the PS cap be eliminated as the presence of these waivers seriously undermines fiscal discipline.

There is also a need to revisit the criteria for assigning different salary grades for higher level positions in LGUs of different income class and different levels. Meanwhile, the practice of granting additional/ extra year-end benefits subject to the availability of funds at the level of the operating unit as the budget year is about to come to a close should be discontinued in order to improve public expenditure management at the local level.

Furthermore, the pertinent provision of the LGC allowing the grant of additional allowances and benefits to national government officials should be amended as this puts undue pressure on LGUs to provide such allowances at the expense of local service delivery. In addition, it is necessary to coordinate implementation of benefits under various Magna Carta legislations with


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implementation of the overall compensation structure of government, especially under Salary Standardization Law 3 (SSL3).

Finally, a toolkit, which LGUs can use in making hard choices between number of employees and the corresponding wage bill would be helpful if developed. Such a toolkit will be particularly useful for LGUs when they consider the sustainability of the proposed round of salary increases and their alternative responses. While the implementation of SSL3 will present difficulties as it further exerts greater pressure to increase the LGU wage bill, likewise it also presents an opportunity for staffing and pay reforms to be made.

Special Education Fund

Education reform initiatives in the county seek to address issues primarily

on access to basic education and the quality of education programs. Among such issues are adequate number of teachers, classrooms and other facilities, and instructional materials, which remain as major concerns towards improving the access to and the quality of basic education in the country.

While the annual budget of the national government has always given highest priority to the education sector, particularly elementary and secondary education, the basic education sector continues to be hounded by lack of financial resources.

The country’s population increases at an alarming rate. The 2005 census has placed the population of the country at 88 million, from the 75 million of the 2000 census. The concomitant funding requirement to implement the elementary and secondary education program to respond to the increased demands arising from population growth prompts a strategic review of the present financing framework for the basic education program.

With the devolution policy under the Local Government Code of 1991 and the decentralized governance of the sector under Republic Act 9155, the burden of providing basic education is now shared with Local Government Units (LGUs) and the private sector. A strong alliance among these three sectors is needed for sustained funding of the education programs. At the local level, the commitment of the LGUs is anchored primarily on its support of the education programs through the Special Education Fund or SEF.

The SEF represents the share of the LGUs from the annual collection from real property taxes. SEF income has been growing through the years, with increasing real property tax assessments and a more aggressive tax collection by LGU. In 2007, SEF stood at PhP 14.2 Billion. Yet, there is no official monitoring report on how the SEF is used and how it actively supports or complements the national program on basic education.


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Circulars or issuances jointly issued by the Department of Education, the Department of Local Government, and the Department of Budget and Management provide the general guidelines for SEF utilization. Nevertheless, Local School Board (LSB) budgets provide evidence that the prioritization in the allocation has in a number of instances, been a parochial, if not a political, decision in the absence of clearer identification as what can and what cannot be supported by SEF.

The management of the SEF is done through the Local School Boards

(LSBs) in each of the provinces, cities, and municipalities. Co-chaired by the LGU and the DepEd, the LSB allocates the local government’s SEF to the various education programs that they consider as priority. While the membership is provided for in the LGC, there are some indications that additional membership or representation by other stakeholders in the different Boards has been adopted by some LGUs.

The SEF budget is not processed like a regular local budget as no local appropriation is required. It is approved by the Board through a LSB Resolution. However, the implementation is in accordance with budgeting and accounting rules and processes, including the use of allotments as disbursement authority, and involves the participation of local budget and accounting staff who are not necessarily members of the Board.

There is a need for greater alignment of the SEF budget with the programs and priorities at the national level. Information on the allocation from the national budget for the local schools would need to be communicated to the LSBs concerned to help ensure that the SEF is used in the most effective and efficient manner to advance the programs for the basic education subsector.

There should be clear statements as to the expenditures chargeable to the SEF. A Joint Circular of the DepEd, DILG and DBM should contain in unequivocal terms the type and purpose of the utilization. Although previous versions of the guidelines have done this, there is a need for clear guidelines for a better link between SEF allocations and what the schools actually need.

Fiscal Surplus-Deficit

Local governments in the Philippines are subject to some form of balanced

budget constraint, just like local governments in other parts of the world. While it is generally agreed that financing is a constraint to local service delivery in the Philippines, LGUs in the aggregate have paradoxically registered fiscal surpluses year after year. On the other hand, such surpluses are to a large extent illusory because once LGUs actually realize a fiscal surplus at the end of the fiscal year, they immediately appropriate the full amount by enacting a supplemental budget.


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It is noted that the stock of outstanding LGU long-term debt has almost doubled in the five-year period between 2002 and 2007. At the same time, there is anecdotal evidence that some LGUs have resorted to frequent restructuring of their outstanding debt, indicative perhaps of some kind of fiscal stress. The policy problem thus boils down to the extent one can further stretch the fiscal space given existing resources without compromising fiscal discipline.

Significant differences in the BLGF and COA data on LGU fiscal aggregates measured on a cash basis have been observed in 2002-2007. There is a need to better understand the sources of the disparity and for the oversight agencies to adopt common measures and definitions. In the light of the balanced budget provision in the LGC, the fiscal performance indicators in the Local Government Performance Monitoring System should include the current fiscal balance as a measure of LGU savings and its contribution to the pool of resources that is available for investment. Still another measure of fiscal performance, which may be included in the list of indicators of fiscal performance that should be tracked, is the overall fiscal balance as a summary measure of LGU’s borrowing requirement. The overall fiscal balance allows government to focus on the financing constraint, which has traditionally been viewed as government’s most binding constraint. In addition, some debt management indicators may also be considered, e.g., a measure that assesses the size of debt service relative to LGU income and one that compares the amount of cash outflows to amortize/ redeem past debt relative to amount of cash inflows from the incurrence of new debt.

At the same time, the amount available for appropriation is another important indicator of fiscal performance that should be monitored on a regular basis. It is also important for LGUs to be able to arrive at good estimates of this measure in order for them to be able to delimit how much they can legitimately subject to further appropriation.

The guidelines, processes and procedures governing the preparation, review and execution of the budget are well laid out in the Updated Budget Operations Manual (DBM 2005). It outlines the specific steps LGUs have to take and the specific forms LGUs have to use as they go through the budget cycle in a manner that will ensure that they comply with the process and documentation requirements of law on local budgeting.

There is a need for a handbook to complement the UBOM. The handbook should aim (i) to communicate a policy framework for LGU budgeting that is anchored on the basic principles of public expenditure management, and (ii) to provide LGUs with tools and techniques that will help them incorporate these tenets in their budget processes. The articulation of the policy framework is important because there is a need to provide the proper motivation for the various processes that are part and parcel of the local budgeting. On the other


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hand, there is also a need to equip LGUs with the tools that will assist them on the more technical aspects of budgeting.

In particular, there is a need to upgrade the technical capacity of LGUs in formulating honest and realistic estimates of income and sources of budget finance including the amount available for appropriation at the end of each fiscal year. The Local Governance and Fiscal Management Project of ADB (TA 4778) has developed a training module for this purpose.

There is also a need to build the technical capacity of LGUs to do cash flow forecasting and analysis. These are essential inputs to a better functioning allotment system that will assist LGUs strike the right balance between fiscal conservatism and the need to provide the services that local communities are in dire need of.

Since simple spreadsheet models for cash flow forecasting and analysis have been developed under the AusAID’s Philippine-Australian Governance Reform (PEGR) project, the DBM may also wish to establish benchmarks against which LGUs can compare the results of their cash flow forecasts and cash flow analysis to aid in decision making for the timing of the release of reserves, revisiting revenue generation strategies, and revising the methodology for revenue forecasting.

Local Economic Enterprises

Although local economic enterprises (LEEs) are meant to be self-sustaining, if not revenue-generating units, many of them actually incur losses on a continuing basis. Current practice in many LGUs does not engender a clear appreciation of the true cost of the local economic enterprise. COA has documented many cases wherein the operation of LGU economic enterprises was not treated as special accounts in the General Fund contrary to the provisions of the Local Government Code (LGC) of 1991. The less than transparent reporting of the actual financial condition and profitability of these enterprises may have some adverse effect on decisions taken by LGU officials. On the one hand, economic enterprises are oftentimes used as vehicle for charging casual employees who are utilized elsewhere in the LGU system so as to circumvent the prescribed 45%-55% limitations on personal services (PS) expenditures of LGUs. On the other hand, part of the cost of LEE operation and management is sometimes charged under other offices in the LGU. Overall, the less than business-like approach to local enterprise management has resulted in large arrearages and low collection efficiency. Given this perspective, the need to establish a clearer and more comprehensive policy framework to govern the creation of new LEEs and continued operation of existing ones is critical. Many of the elements of the existing framework will still be part of the new framework but a number of new


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features will have to be put in place. First, the new policy framework should be anchored on the basic principle that LGUs need to focus on their core functions. It should also be premised on the superiority of private-sector led development unless a strong case can be made for government intervention. The framework should thus establish guidelines when government provision of outputs that could be provided by the market is justified.3 These guidelines should take into account the possibility of market failures and government failures as well. The new policy framework should also recognize that some goods/ services are better delivered by the national government4 while at the same time recognizing that the LEE modality is but one of a number of alternative service delivery modes. It may be the case that the private sector is the efficient provider of certain goods and services.

Thus, when an LGU is confronted with the need to decide whether to provide a given good/ service, the LGU should be advised to first check the alignment of said good/ service with its goals and core functions. Once the LGU deems it appropriate to provide a given service, it should then assess the suitability of the alternative service delivery modalities in the context of its own particular situation. Such an evaluation should take into account the financial risks, managerial problems and political realities that come into play against the inherent strengths and weaknesses of each of the various alternative service delivery modes.

Service delivery can be done either (i) through organizations external to the LGU like private sector enterprises and non-governmental organizations (NGOs) via various types of public-private partnerships arrangements like service contracts, management contracts, leases, concessions, and licenses or (ii) directly by the LGU either through an LEE or through a regular unit or office in the LGU. In other countries, public service delivery through external organizations is commonly used for public utilities and social services like education.

Second, the new policy framework should also provide LGUs guidance on

the criteria that they may use in analyzing the advantages/ disadvantages of using external organizations to deliver public services as opposed to direct service delivery by the LGU itself. In this respect, two factors have to be taken into account: (i) market orientation, and (ii) alignment with the public interest. On the one hand, the fixing of tariffs or prices in the LEE is normally done by fiat or through an administrative process and is thus more subject to political interference. Political pressure also tends to be strong on the LGU service provider in the area of staffing and personnel administration. In contrast, external service providers tend to operate in a more competitive environment and are

3 These guidelines may simply provide criteria that will assist LGUs decide whether it should be engaged in the direct

provision of marketable goods/ service and may include either a positive list of what marketable goods/ services are appropriate or not appropriate for LGU provision.

4 The assignment of expenditure responsibilities across levels of government is largely defined by the Local Government Code.


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thus subject to the discipline of the market place when they determine the appropriate number of their personnel complement as well as the level of tariffs that they should charge. Consequently, the LGU service provider and external providers tend to be substantially different in terms not only of the incentives for efficiency and economy but also in terms of their cost structures5.

On other hand, it is usually assumed that direct delivery of service by the LGU can be more easily aligned with the public interest in terms of access and coverage (e.g., servicing of areas with low traffic volume), tariffs/ service charges (e.g., lifeline pricing and subsidization of poorer segment of the population), quality of service (e.g., LGU service providers directly accountable to clients but compliance to service standards is typically part of contractual agreements between LGU and external service provider), and innovations in service delivery (e.g. external provider might be more willing and capable of introducing service improvements especially if contractual arrangements provide the incentives to do so6.

If the LGU deems it best to provide the service directly by itself, it then has

to choose whether to do so via an LEE or through a regular unit or office in the LGU. These two approaches differ in terms of (i) staffing, (ii) tariff setting, (iii) investments in capital assets and maintenance of the same and (iv) overall performance orientation in the delivery of services. LEEs are less subject to restrictions on staffing and have some flexibility in terms personnel remuneration allowing them to better attract professional and technical personnel. However, this approach opens up the possibility for abuses in hiring of staff and paying of the staff. On the other hand, LEE tariffs are set by Sanggunian legislation and are determined, in principle, with some degree of cost recovery in mind because by their very definition LEEs raise the bulk of their revenues from the sale of their outputs. Given these considerations, LEEs tend to have greater inclination and wherewithal to make the necessary investments to maintain the equipment and facilities needed to deliver the service. Also, LEEs may have greater drive for results and performance especially when the performance measures are clearly defined and monitoring/ evaluation systems are established and enforced.

The new policy framework should provide explicit guidance on the creation of LEEs. The guidance should specify that LEEs should be established by enacting an ordinance that specifies in unequivocal terms: (i) LGU policy on degree of cost-recovery of LEE up front in terms of what percent of cost will be recovered from user charges, (ii) tariff rates or user charges that will be charged for goods/ services provided by LEE, and (iii) who will be subsidized and by how much;7 including schedule of rates by income bracket of clients where applicable. 5 Wright, Glendal. 2008. “A Review of Alternative Service Delivery Options.” Report submitted to the Asian Development

Bank (ADB) under the Technical Assistance 4778 Project. 6 Ibid. 7 This means that subsidy given to LEEs is an ex-ante conscious decision on the part of the LGU rather than an ex-post item that finances whatever the resulting gap between revenue and expenditure is. The La Union Medical Center provides a good example of how a well articulated policy on providing subsidy to the poor contributes to the efficient operation of the LEE.


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Third, the new policy framework should reiterate and re-emphasize the importance of the maintenance of special accounts for LEEs as prescribed by the COA under the NGAS. The maintenance of special accounts for LEEs is essential in tracking the results of LEE operations and how closely LGUs follow their intent for creating LEEs.

In addition, the framework should also institutionalize the periodic review of the operation of existing LEEs to help LGUs decide whether these LEEs deserve to continue their operation especially in the light of changing market environment. For instance, some LEEs may have been created at a time when no private sector providers were present in the LGU jurisdiction but in the interim the private sector has entered the marketplace. If the review shows that the continued operation of some LEEs is no longer justifiable, the new policy framework should then provide guidance on what the alternative options available to the LGUs in LEE divestment.

A number of LGC provisions related to budgeting create some confusion.

At the same time, we argue that the budget format sends signals on how budget execution should proceed and thus affects LGU spending behavior, particularly as it relates to LEE operations. In practice, different LGUs exhibit different ways of treating their LEEs not only when they prepare their budgets but also when they execute their budgets. On the one hand, there are LGUs (e.g., Tagum City) that treat their LEEs just like any other unit/ office when they prepare their budget such that the income of the LEEs are shown as part of the income estimate for the General Fund and all expenditure proposals related to LEE operation are shown as part of the expense items in the proposed budget. As a corollary, the same budget format is carried over in the appropriation ordinance.

On the other hand, key informant interviews and discussions during consultation workshops reveal that some LGUs essentially treat their LEEs off-budget. LEE income does not form part of the total income estimate that is used as basis for budget preparation. In like manner, proposed expenditures of LEEs do not form part of the spending proposals in the proposed budget of the local chief executive. However, proposed subsidies to LEEs (if any) are shown as an expenditure item in the proposed budget.

During budget execution, revenues earned from an LEE’s operation are credited to an intra-agency receivable account known as “due from operating units account” while the operating expenditures of the LEE are debited from the same account by the LGUs. In this way, income derived from the operation of LEEs is utilized in the payment of operating expenses without passing the usual budget procedures. However, this is in direct violation of the basic principle of local fiscal administration that no money shall be paid out of the local treasury except in pursuance of an appropriations ordinance.


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In this regard, it is recommended that the LGU budget be divided into three parts. Part 1 shows the income estimates and spending proposals (including subsidy to LEE) for the General Fund Proper. Part 2 shows the income estimate and spending proposal for the LEE. This implies that Sanggunian authorization for LEE spending is required. Part 3 shows the consolidation of Parts 1 and 2. This budget format is not only more transparent than current practice, it also provides incentives for LEE managers to improve their collections since they are better able to isolate their earnings from the rest of the General Fund Proper.

During budget execution, this presentation tends to build a firewall between the General Fund Proper and the LEE. For instance, if actual collections of the LGU’s General Fund were to fall short of the estimate in the course of the budget year, then it is likely that only expenditure items in GF proper will be affected. In like manner, if actual collections of local economic enterprise were to fall short of the estimate in the course of the budget year, then it is likely that only expenditures items for the LEE will be affected. However, if actual collections of were to exceed the estimate, the LEE can automatically increase their spending beyond what has already been appropriated without first enacting a supplemental budget.

This presentation also defines an unambiguous demarcation line that separate the LEE from the GF proper. Thus, it is not only more transparent than current practice, it also provides incentives for LEE managers to improve their collections since they are better able to isolate their earnings from the rest of the General Fund Proper. D. Local Own-Source Revenue Generation The LGC authorizes local governments to levy local taxes on a good number of tax bases, including some which were not allowed during the pre-LGC period like banks and other financial institutions, and printing/publication. It is worth noting that the assignment of revenues under the LGC has effectively shifted the distribution of own-source revenue from municipalities and provinces to cities. The Code not only allows cities to impose all the taxes that provinces and municipalities are authorized to levy, it also gives them a greater discretion in setting the tax rates. Also, under the LGC the share of provinces in the proceeds of the Real Property Tax (35%) is smaller than that of cities (70%) and municipalities (40%).


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Table 5. Tax Assignment in Cities, Provinces, and Municipalities Subject Cities Prov. Muni’s Brgy. On Real Property Transfers On Business of Printing and Publication On Franchise On Sand, Gravel and other Quarry Resources a/ a/ On Amusement Places a/ On Professionals On Delivery Vans and Trucks On Real Property a/ a/ On Idle Lands On Business On Community Tax a/ a/ Shares in proceeds of levy of province.

Source: Philippines – Local Government Code of 1991.

In 2006, tax revenue accounted for 25% of total regular income8. Studies have shown that local governments have created revenue codes with a huge array of taxes, fees and charges.9 Many of these are under-collected and some not collected at all. In addition, there are many low yielding taxes which impose substantial collection and administrative costs on local governments and contribute to a lack of transparency on the side of the taxpayer. For example taxes on peddlers, fishing vessels, and radio fees, each bring in, on average, no more than 0.02% of the local governments total own-source revenue. In Bacolod City there are over 200 different rates for the mayor’s business permit fee, all of which depend on the type of establishment. There is a need to focus on taxes, fees, and charges that have high yield potentials, and to improve their administration and collection. The LGC seriously limits the power of local governments to set local tax rates. First, the Code fixes the tax rate of some of the taxes that are assigned to local governments (like the SEF real property tax and the community tax). Second, while local governments do have some discretion in setting tax rates in the case of other local taxes, the Code sets ceilings (or floors) on the tax rates that local governments may impose which in some cases appears to be low (or high) given current realities. For instance, the LGC set ceilings for the real property tax assessment levels for different classes of property whereas the assessment levels themselves were fixed in the pre-LGC period. Moreover, the maximum assessment levels set under the LGC are no higher and often significantly lower than the fixed assessment rates in the pre-LGC period10, thereby resulting in the reduction in the effective assessment levels of residential

8 Bureau of Local Government Finance. 9 This can be partly attributed to the Code itself. Section 143 – Tax on Business has a very detailed schedule of fees

which can be simplified. 10 The LGC also provided for the exemption of residential buildings with market value below P175,000 from real property

taxation.


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land, all types of buildings and all types of machinery, potentially leading to an erosion of RPT revenues. Third, the Code mandates that tax rates can only be adjusted once in 5 years and by no more than 10%. This provision is particularly restrictive in the case of taxes (like the professional tax and the tax on delivery vans and trucks) whose rates are specified in nominal peso terms. Clearly, the resulting adjustments will not allow local governments to maintain the real value of their revenues. Thus, future Code reviews should look at giving local governments greater discretion in setting tax rates by raising the maximum allowable tax rates. There is a need to move away from tax rates that are not indexed to inflation as such practice necessitate frequent revisions of local tax ordinances if local governments want to keep their own-source revenues buoyant. In addition, the tax structure prescribed by the Code for the local business tax is too complicated such that different categories of firms are subject to different rate schedules. This situation tends to increase administrative and compliance costs which is further exacerbated by a weak local tax administration. That local tax administration is severely inadequate in many local governments is highlighted by the declining trend in Real Property Transfer collection efficiency of both provinces and cities in the post-Code period. Table 6. Distribution of Local Government Own-Source Revenue Across Levels of Sub-national Government by Type of Revenue (%)

*Sums equal 100%. Source: Bureau of Local Government Finance.

In addition, the current assignment of taxing powers across levels of government scores low in terms of the fiscal autonomy criterion. The broader powers given cities relative to provinces and municipalities is justified by the fact that cities are expected to carry out all the functions that are assigned to both provinces and municipalities.11 However, the cost of devolved functions (specifically those that are accompanied with actual transfer of personnel) is heavily skewed in favor of provinces and municipalities (Table 7). A comparison of Table 5 with Table 6, thus, highlights the inconsistency between tax 11 This is true in both the pre-Code and post-Code period.

Total Own-Source Revenues* Total Tax Revenues* Total Non-Tax Revenues* Province Municipal. Cities Province Municipal. Cities Province Municipal. Cities 1999 12.8 25.6 61.6 11.7 21.9 66.3 61.1 37.1 46.7 2001 11.9 23.4 64.7 10.1 20.3 69.6 17.5 33.0 49.5 2003 10.1 22.7 67.2 8.4 19.1 72.6 16.1 35.8 48.2 2005 10.9 22.4 66.7 9.0 18.7 72.3 16.7 33.6 49.7 Average 1985-91 19.9 37.1 43.0 15.2 38.0 46.8 29.1 35.3 35.6 1992-05 12.1 26.1 61.8 10.2 23.0 66.8 17.8 35.9 46.3 1985-05 13.3 28.4 58.3 11.2 25.8 63.1 19.8 36.3 44.0


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assignment and expenditure assignment across levels of local governments. The share of provinces and municipalities in total local government own-source revenue contracted from an average of 19.9% and 37.1%, respectively, in 1985-1991 to 12.1% and 26.1%, respectively, in 1992-2005 (Table 5). In contrast, the share of cities in total local government own-source revenue expanded from 43.0% in the pre-LGC period to 61.8% in the post-LGC period. This kind of movement is evident for tax as well as non-tax sources of own-source revenues. In short, the share of provinces and municipalities in total local government own-source revenue declined in the post-Code period despite their larger share in the cost of devolved functions.

Table 7. Distribution of Cost of Devolved Functions Across Levels of Local Governments by Function, 1992

Percent distribution Provinces Munis Cities All LGs across levels of local governments General Public Services 7.1 87.7 5.2 100.0 Economic Services 37.9 57.4 4.8 100.0 Agriculture 33.4 61.6 5.0 100.0 Environment and Natural Resources 97.6 0.8 1.6 100.0 Social Services 51.7 44.2 4.2 100.0 Health 60.2 37.2 2.6 100.0 Social Welfare and Employment 4.8 82.3 12.9 100.0 TOTAL 47.5 48.1 4.3 100.0 Percent distribution across functions General Public Services 0.5 5.6 3.7 3.1 Economic Services 15.9 23.8 22.0 19.9 Agriculture 13.0 23.7 21.5 18.5 Environment and Natural Resources 2.9 0.0 0.5 1.4 Social Services 83.7 70.6 74.3 77.0 Health 82.5 50.4 38.9 65.1 Social Welfare and Employment 1.2 20.3 35.4 11.9 TOTAL 100.0 100.0 100.0 100.0 Source: Commission on Audit.

The size of the local tax base outside of the real property tax and the local

business tax is not significant and the bulk of the productive tax bases still rest


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with the national government. Limiting the number of local taxes to those which are buoyant may be an effective way to increase transparency and reduce transaction costs.

Weaknesses in the supporting mechanisms for local government tax administration at the national government level likewise hamper local tax performance. The enforcement of local business taxes is held back by the lack of coordination between the BIR and local treasurers. The local government Leagues have actively pursued the implementation of Section 171 of the LGC which requires the BIR revenue district offices to share their tax information with the local treasurer. However, these efforts have been stalled by the non-issuance of the implementing guidelines for this provision because of concerns regarding the provision of the National Internal Revenue Code on non-disclosure of tax information. In this regard, the President recently has passed an executive order to provide guidelines on sharing of tax information between the BIR and the local governments. Some implementing regulations on local taxation are not favorable to all local governments. Key among this is the guideline for taxation of bank branches in favor of the head office, and hence the local government hosting the head office12. The current interpretation of the relevant LGC provision has caused the bulk of the bank’s revenues to be posted to the head office causing the bank branches, usually in less wealthy local governments, to face a lower basis for imposition of their business tax. Also, there are no implementing guidelines for imposition of business taxes on mining sites.13 That local tax administration is severely inadequate in many local governments is highlighted by the declining trend in Real Property Tax (RPT) collection efficiency of both provinces and cities in the post-Code period (Table 8). Table 8. Collection Rate of Current Year for Basic RPT, 1989-2000

All LGs Provinces Cities 1989 58.0 55.6 61.0 1991 58.9 54.1 65.1 1994 60.7 54.0 66.3 1997 57.4 50.0 62.0 1999 54.1 52.4 54.9 2000 54.6 44.7 57.1 Average 1989-1991 58.2 54.4 63.1 1992-2000 55.4 49.0 59.7

Source: Bureau of Local Government Finance

12 Department of Finance Local Finance Circular 1-93. 13 See footnote 13.


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Given this perspective, it comes as no surprise that the contribution of local governments to total revenues of the general government (national government and local governments combined) remains low – an average of 7.1% in 1992-2005 compared to an average of 4.9% in 1985-1991 (Table 9) Table 9. Share of National and Local Governments to General Government Revenue (in percent)

Total Revenues Tax Non tax

Year GG NG LG GG NG LG GG NG LG

2001 100.0 92.8 7.2 100.0 93.6 6.4 100.0 87.6 12.4 2003 100.0 91.9 8.1 100.0 92.6 7.4 100.0 88.1 11.9 2005 100.0 92.3 7.7 100.0 93.2 6.8 100.0 87.3 12.7

Average

1985-1991 100.0 95.1 4.9 100.0 96.1 3.9 100.0 90.9 9.1 1992-2005 100.0 92.9 7.1 100.0 93.8 6.2 100.0 87.4 12.6 1985-2003 100.0 93.4 6.6 100.0 94.2 5.8 100.0 88.1 11.9 Source: Commission on Audit.

One important outstanding concern in efforts to increase RPT tax

collections relates to the failure of many local governments to conduct regular general revision of the schedule of market values of real property as mandated under the LGC and their tendency to have adopt property values that do not adequately reflect the true market value of real properties in their jurisdiction when they do implement a general revision of assessments. As a result, real property assessments have not kept up with changes in market values. Some analysts have proposed the transfer of the assessment function to the National Government as a means of de-politicizing the updating of real property assessments. Under this proposal, local governments will retain the power over the determination of the tax rate and the collection of the RPT.

Undeniably, however, poor local revenue performance may also be attributed to the fact that many local government officials tend not to fully utilize the tax powers assigned to them. For instance, many provinces and cities have done a general revision of the schedule of market values only once since 1991, resulting in declining collections in real terms.14 Also, few governments have revised their local tax codes since 1992 despite the fact that rate of some of the taxes are not indexed to inflation. This development is reportedly due to the resistance on the part of either the local chief executive or the local Sanggunian (Council),or both, to increase the tax rates in general for fear of a backlash from their constituents during election. Ultimately, the decision whether to impose and collect local taxes is a choice that local elected officials make. However, it is important to understand the incentive structure that drives this choice. In this 14 The Code mandates that LGUs to conduct a general revision of market values once every three years with the first one

taking effect in 1994.


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regard, the poor incentives resulting from the mismatch between the assignment of taxes and the assignment of expenditure responsibilities to the different levels of local government and the inadequate tax autonomy given to local governments cannot be ignored. On the one hand, many local governments (especially those which have a limited tax base) tend not to maximize the use of their taxing powers because they would have to levy taxes at fairly high rates before they are able to raise sufficient revenues to fund services at levels that are palpable enough to make any difference in the overall welfare of their constituents. Thus, these LGUs can always point to the national government as the culprit for not allowing finance to follow function. On the other hand, some local governments have no incentive to utilize their revenue raising authorities fully precisely because more resources have been transferred to them relative to their needs. At the same time, local communities tend not to complain about the inadequacy of local services because they do not pay much in terms of local taxes anyway. Local government tax administration capacity is constrained due to (i) low professional qualification of the staff, and (ii) inadequate automation of core tasks. These problems affect all aspects of tax administration: poor taxpayer registration systems and low-quality record keeping results in widespread tax delinquencies, tax audits and enforcement are inadequate which erode the credibility of the system and results in low compliance, and limited availability of taxpayer services which increases taxpayer compliance costs. For instance, many of the personnel assigned to the tax division are not well-equipped technically for their tasks. Very few of these units have certified public accountants in their rolls, thereby impairing their audit capability. Also, while a number of local governments are investing in information technology to improve their tax registers, assessment and collection of the real property tax and local business tax, local governments have not fully explored the adoption of a common IT platform for local tax administration. E. Key Issues and New Directions in Local Own-Source Revenue

Generation – Exercise of LGU’s Corporate Powers

By tradition, the National Government has been tasked with the responsibility of promoting economic development in a community. However, in more recent years, such responsibility has been shifted to local governments as they are now cognizant of their bigger and proactive role in securing the economic wellbeing of their constituents. Thus, the traditional role of local governments as service provider has been expanded to include economic promotion as a necessary function of local governance. On a broader perspective, local economies are the building blocks of the national economy. While national economic development is principally the task of the National Government, local governments have to assume a significant role in the national economic strategy, as regional and global competition for markets and resources accelerate. The emerging reality is for local governments to steer their local


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economies to be able to confront the twin challenges of globalization and local autonomy.

The envisioned role for LGUs in economic development is that of an

enabler and creator of an environment conducive to sustainable development. The basic goal of an enabler is to create a social, physical and economic environment favorable to the development and growth of the locality, and to structure this environment through appropriate policies, regulations and enforcement to ensure the dynamic and efficient interplay of market forces and private initiatives.

Harnessing and enhancing LGUs’ corporate capacities must be anchored

on a strategy, inspired by some guiding principles to serve as guideposts. It requires the dynamic interplay of policy support, capacity building sustaining actions through advocacy, technical assistance and funding support, monitoring and evaluation, and an institutional framework to galvanize stakeholders’ support.

Guiding Principles

LGUs must act primarily as planner, broker and promoter of inward

investments and play the role of an investor in basic enterprises where private sector is absent. LGUs’ operation of local economic enterprises could be viewed as two-pronged:

o As stand-alone investment by improving returns realized directly

from the use/operation of such enterprises. o As a catalyst for economic growth by utilizing the enterprise as a

strategic and deliberate tool for local economic development.

Building the Promotional Structure

As the lead oversight government agency for the local government sector, the DILG can advocate improvement in technical and financial capacities of LGUs for preparing and managing local development investments in a corporate manner. The different bureaus and offices of the Department can provide the policy and promotional support for the program. The Office of Project Development Services (OPDS), as DILG’s conduit with multilateral and bilateral institutions, can take the lead in the promotional and advocacy initiatives in LGUs exercise of corporate powers. Further, the OPDS can assist LGUs in packaging programs and projects and in channeling funding support along these initiatives. The Bureau of Local Government Development (BLGD) can be the focal office in terms of policy review, policy consultation and policy formulation, with respect to LGUs’ corporate powers. The Local Government Academy (LGA), in collaboration with other institutions, on the other hand, can take the lead in LGU


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institutional capacity building initiatives to enhance LGUs’ exercise of corporate powers. The Bureau of Local Government Supervision (BLGS) can provide the framework for effective monitoring and evaluation of LGUs’ initiatives in the exercise of corporate powers.

Establishing the Policy Support System

There are numerous factors that impact on LGUs’ ability to exercise

corporate powers- some are internal, while others are external. The internal factors include organizational and managerial culture, financial and other organizational systems and the overall notion of LGU capacity, among others. Visionary and committed Local Chief Executives (LCEs) with entrepreneurial mindset are needed to trigger a paradigm shift in LGUs operation and culture.

On the other hand, there are external factors that impact on LGUs’

exercise of corporate powers, and these pertain to policy and oversight support and to market forces as well. There are a number of laws and policies that govern LGUs’ exercise of corporate powers. Some of them are vague as to LGUs’ mandate to establish LEEs, and policies on organizational and financial systems for LEEs are not in tune with private enterprise standards. The policy environment needs to be reviewed against the backdrop of the above-mentioned guiding principles and of the rapid changes in the public and private domain. Indeed, the policies on LGUs’ exercise of corporate powers must be responsive and more enabling to LGUs’ initiatives. Further, major gaps are encountered not necessarily in the policies themselves, but often in their interpretation and implementation at the operational/local level. Developing a framework for policy reform therefore has to take into consideration the institutional, organizational and competency implications of policy implementation. Likewise, proper consultation with stakeholders (e.g., the LGUs by the DILG Regional Offices) by oversight agencies as they issue policy directives and guidelines would ensure healthy national-local dynamics and goal congruence. It is envisioned that the BLGD will take the lead in this aspect of policy support.

Capacity Building

Equally important is the need for a capacity building framework, a crucial ingredient in harnessing and enhancing LGUs’ corporate powers. Capacity building should be viewed in three inter-related dimensions: a) institutional interrelations; b) organizational capacities; and c) individual competencies. Addressing one (e.g., personal training) without the others will not be completely effective. However, attempts at rationalizing or strengthening institutional interrelations and organizational capacities are often viewed as threatening and thus resisted. In contrast, training in individual competencies is generally viewed as non-threatening and is thus often supported. This prevailing organizational culture (absence of entrepreneurial culture, rigid policy framework based on tradition and past precedence and top-down approach to management, among


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others) needs to be reformed if capacity building is to become truly effective. In any case, training in identifying investment and economic potentials and potential economic niches, in entrepreneurship and enterprise management, business planning, management skills, financial management and risk management, among others, can be used as an “entry point” for pursuing the other dimensions of capacity building. Further, provision of broad-based information on LGUs’ exercise of corporate powers through documented good practices and improved approaches is also an integral part of capacity building. This is the area of intervention where the LGA can provide the necessary support with the active participation of the DILG Regional Offices. The capacity building interventions in the inter-related dimensions of: (a) institutional interrelations; (b) organizational capacities; and (c) individual competences are appropriately the concern of the LGA. Linking with academic institutions can be considered in the following highly technical areas:

Identifying investment potentials for LGUs

a. Identification of economic potentials, needs and demands b. Identifying potential economic niches c. Determination of modes of investments

Managing local economic enterprises

Various modes of LGUs’ exercise of corporate powers

Institutionalization of Local Economic Enterprise Offices In the non-traditional exercise of LGU corporate powers, e.g., public-private partnerships, joint venture and bond flotation, coaching and mentoring by or engaging the services of practitioners and experts will probably be necessary to help LGU in the following areas, among others:

Identification and valuation of assets Risk allocation and risk mitigation Contract design Analysis and identification of appropriate regulatory regime Timing and form of private sector involvement

The experience of some LGUs in finding use for their under-utilized assets is worth replicating. The use of LGU assets in public-private partnerships, especially in joint ventures, offers opportunities for expanding service delivery, employment generation and economic promotion.


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Sustaining Actions

Advocacy and Technical Assistance The successful exercise of LGU corporate powers would require not only the necessary policy support but sustained advocacy and adequate technical and funding assistance as well. LGUs would need some assistance in identifying investment potentials of their respective communities. The OPDS can take the lead in collaboration with the DILG’s Regional Offices, DTI, and Small and Medium Enterprise Development (SMED)15 Council in promoting LGUs’ exercise of corporate powers and in providing them the necessary technical assistance in identifying its economic potentials, potential economic niches, needs and demands, provide assistance in managing LEEs as well as act as broker for LGUs in sourcing financing for its projects and initiatives in line with LGUs’ exercise of corporate powers.

Monitoring and Evaluation

In collaboration with the DILG Regional Directors and Local Government Officers, the BLGS shall have overall responsibility for collecting data and monitoring results. The baseline data shall be established by BLGS in collaboration with the concerned DILG and local officials; this could be part of DILG’s LGPMS. The results of monitoring system will be incorporated as part of DILG’s overall management information system, and shall be used to implement the performance-based grant on LGUs’ exercise of corporate powers. Community monitoring tools could also be developed by DILG to be actively used by accredited civil society organizations and private sector organizations to promote better governance and transparency in project activities.

F. Local Credit Financing Credit financing is used by local governments to support development of infrastructure, capital investment, and partly to cover operating expenses. Sources include domestic banks, GFIs, and loans through the NG from foreign sources. The long term vision of the NG is for the capital market, rather than national agencies, to play a dominant role in financing local governments. However, several key issues need to be addressed to facilitate local government access to private capital markets. There is a need for transparent local government financial information, credible local sub-national government loan repayment capacity, availability of a collateral and other loan security, and a framework for local governments to make deposits and set up special accounts for bond repayments. It is believed that addressing these issues will mitigate the more general fears of creditors over the short political tenure (3 years but with re-election) of local chief executives, lack of local government familiarity with

15 Includes micro-enterprises


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financing instruments, their weak project identification and preparation capacities, low credit worthiness, and the danger of loan default. Prior to 1991, local governments were restricted from contracting loans to finance their capital requirements. The passage of the Local Government Code allowed local governments greater flexibility in tapping various sources of credit financing – bank credit, bonds and build-operate-transfer arrangements. So far, many local governments (especially provinces and municipalities) remain dependent on their 20% Development Fund16, also known as the Local Development Fund to finance major development expenditures. Local government access to credit at commercial rates will not only increase the amount of resources available for infrastructure spending, but also instill the discipline of the market on local governments and increase their propensity to increase their tax collection efficiency, to recover cost from local services, and to improve their financial management systems.

The LGU Financing Framework (developed by the Department of Finance in 1996) envisions the greater participation of the private capital market in local government financing. It calls for the segmentation of the local government financing with lower-income local governments accessing the Municipal Development Fund (MDF), middle-income local governments accessing the GFIs and upper-income local governments accessing PFIs. To bring this into effect, the framework promotes the establishment of a “graduation program” that will induce creditworthy local governments to shift from GFIs to the private capital market. It also recommended the strengthening of local capacity to generate own-source revenue, restructuring of the MDFO, the re-orientation of the role of GFIs in local financing, the improvement of local government access to private banks, the promotion of PSP mechanisms (including BOT schemes), and development of the local government bond market.

Local government borrowings rose steadily from P448 million in 1991 to a peak of P6.9 billion in 2004 and an average of P5.8 billion in 2001-2005. Thus, local government borrowing became a more important source of local financing, accounting for 3.5% of total local government receipts net of borrowing in 2005 from less than 2% in 1991 (Table 20). Cities had greater access to local credit markets than provinces and municipalities. Borrowings contributed to 5.4% of the total receipts net of borrowings of cities compared to 3.7% in the case of provinces and 2.1% in the case of municipalities in the post-Code period.

16 The Local Government Code of 1991 requires LGUs to set aside 20% of their regular income for development projects.

This is one of the budgeting provisions under the Code in which non-compliance can be grounds for rendering the local budget inoperative.


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Source: Bureau of Local Government Finance, Commission on Audit.

However, not many local governments are able to borrow from banks because not all are creditworthy. Overall, cities are better positioned to access credit financing. Thus, cities account for the bulk (54%) of total outstanding local government loans as of 30 June 2004 while the provinces account for 18.8% and municipalities 25.8%. Part of the problem is the non-availability of reliable information on local government creditworthiness in which cities can likely provide better information than provinces and municipalities.

As a result, little progress has been made to end local government reliance on the GFIs, despite the adoption of the LGU Financing Framework (LFF) in 1996. The intention of the framework was to lead to a reduction in the role of GFIs and MDFO in lending to local governments, and an increased participation of private financial institutions (PFIs) by graduating more creditworthy local governments to private capital markets. However private lending is still not substantial. To date, GFIs and the MDFO continues to be the dominant source of local government financing, accounting for 76% and 7%, respectively, of total local government borrowing in 2006. Local governments have been unable to access private bank lending to date.

GFIs possess an advantage in the local government credit market due to their role as local government depository banks17 while the MDFO has access to an IRA intercept mechanism in the event of a loan default. However, the inability of private banks to become depository banks for local governments appears to be an important structural impediment to the PFIs’ entry into the local

17 GFIs do not have an IRA intercept mechanism to protect them. However, they protect themselves through what is

commonly referred to as a “back-to-back” agreement. LGUs are required to sign along with the loan document another agreement which authorizes the GFI lender in the event of a default in the payment of interest and amortization of principal to debit the LGUs IRA depository account in the GFI.

Table 10. Local Government Borrowings, 1985-2005 (In Million Average

Pesos) 1985-1991

1992-2005 1991 1995 1999 2001 2002 2003 2004 2005

ALL LGs 110 4,111 448 2,493 5,949 5,574 4,219 5,635 6,879 6,651 Provinces 57 961 325 593 771 1,639 1,482 1,794 1,735 1,360 Municipalities 12 840 37 579 561 892 915 1,853 1,103 1,610 Cities 41 2,310 87 1,321 4,618 3,043 1,822 1,988 4,041 3,680 Ratio to LG Average

Income (%) 1985-1991

1992-2005 1991 1995 1999 2001 2002 2003 2004 2005

ALL LGs 0.79 3.76 1.91 3.81 5.20 4.21 2.65 3.26 3.95 3.46 Provinces 1.50 3.69 5.51 3.59 2.78 5.21 3.87 4.48 4.36 3.09 Municipalities 0.23 2.08 0.37 2.30 1.32 1.87 1.58 2.95 1.78 2.33 Cities 0.88 5.37 1.13 5.59 10.48 5.70 2.88 2.83 5.60 4.65


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government credit market. Together with GFIs’ access to ODA funds, the depository bank privilege has also allowed them to maintain a competitive advantage over PFIs18. Moreover, the graduation policy enunciated under the LGU financing framework described above has not been realized. The LBP and the DBP appear reluctant to relinquish their monopoly over the more creditworthy local governments as this segment of the market has emerged to be a profitable part of their portfolios.19 Part of the problem is that there has been no official issuance on the part of the NG on the Local Financing Framework as a national policy. Because of this, there is no clear demarcation of the markets to be served by the MDFO, GFIs, and PFIs or for that matter which entity should be providing developmental credit vis-à-vis commercial loans.

At the same time, the lower effective rate of interest charged by the MDFO (because of the bundling of the grant with the loan component of on-lent funds from ODA sources) acts as a disincentive for even the more creditworthy local governments to access funds from the private capital market. Thus, a revisit of policies on matching grants, development of policy-based loans/ grants, the evolution of the MDFO into a second-tier funding entity for local governments and a bond-pooling agency is in order to make the MDFO a more effective institution for local financing. Local government access to non-traditional capital markets is rising but still sluggish. As of March 2002, a total of 9 local governments Built-Operate-Transfer projects have been documented20. Also, there have been 21 LGU bond issuances to date worth about P3.7 billion .

A number of factors provided the impetus for the modest growth of the local government bond market. First was the creation of the LGU Guarantee Corporation (LGUGC). Second was the presence of enhancements on the purchase of local government bonds. Local government bonds are now 50% risk-weighted if backed by the LGUGC guarantee, eligible for compliance of banks to the law requiring them to set aside a fixed portion of their loan portfolios as loans to the agriculture and agrarian sector, and no longer subject to the documentary stamp tax for secondary transactions. To further develop the local bond market, the LGUGC and the Financial Executive Institute of the Philippines (FINEX) are actively advocating to have local government bonds tax exempt in the same manner as treasury bills.

However, important constraints continue to hamper the development of the local government bond market, namely: higher costs associated with bond flotation compared with direct bank borrowing, lack of reliable information about local governments, uncertainty about management capacity at the local level, lack of a market for secondary trading, and lack of access to IRA as a security for local government obligations21. One of the more serious concerns affecting the growth of the local government bond industry is the uncertainty in the approval 18 ADB/World Bank. 2003. Public Expenditure, Procurement and Financial Management Review. Manila. 19 In 2003, LBP’s outstanding loans to LGUs amount to some P12 billion while that of the DBP is P1.8 billion. 20 ADB/World Bank. 2005. Decentralization in the Philippines. Manila. 21 Ibid.


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process at the national level. The Bangko Sentral ng Pilipinas (BSP), which has regulatory power over the issuance of local government debt to the private sector22, requires local governments to first obtain a Certificate of Debt Service Capacity from the BLGF. Although this is not difficult to obtain, the BSP has occasionally vacillated on its policies and have held off issuing a no-objection opinion until the prospective local government issuer has provided more information. The BSP has expressed concern over the impact of an increasing local government debt base on monetary aggregates. The lack of a consistent policy stance from the BSP has delayed a number of bond floatations, increased transactions costs, and created more uncertainty in the market.

Under the Local Government Unit Finance and Development (LOGOFIND) project and the Community-Based Resource Management (CBRM) project of the Municipal Development Fund Office, many 3rd to 6th income class local governments were able to access financing for urban infrastructure, health and environmental projects that were aimed at improving local service delivery in these areas. As of 2007, the LOGOFIND has provided credit to 217 3rd to 6th income class local governments with total loans amounting to 2.7 billion pesos. The MDFO, by project end in 2009, has extended credit to 131 local governments, regardless of income class, for improved service delivery in environment and health. Similarly, the MDFO will provide credit financing to the Mindanao Basic Urban Support Services (MBUSS) project also through its second generation fund. The program-policy lending facility or PROLEND of the MDFO was launched in 2007. This launching came as a result of the completion of the PROLEND policy and operations guidelines which were completed in December 2006. The 2 billion pesos PROLEND facility provides provinces with a program loan for the pursuit of policy reforms not only at the provincial level but also in more than 50% of their component cities and municipalities. Also in 2007, the MDFO will be launching its 500 million peso Millennium Development Goal (MDG) fund for 4th to 6th income class local governments to pursue development project aimed at achieving MDG objectives. All these facilities will be financed through the second-generation fund or reflows of the MDFO. . In addition to credit financing for local government development projects, the MDFO also provides grants as a part of its financing package. The MDFO is currently reviewing its loan-grant mix to take into consideration not only the income class of the local government but also the difficulties inherent in different types of social projects. The MDFO is also looking into performance-based grants and is commissioning a study to develop a framework for policy-based grants which can be implemented next year. Notably, the MDFO has incorporated a performance based grant system into the second phase of Mindanao Rural Development Project Phase 2; an $84 million project that will provide grant amounting to 20% of the total project cost of the local government. 22 Section 299 of the Local Government Code


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The grant will be subject to the achievement of performance objectives in local tax revenue collections. G. Key Issues and New Directions in Local Credit Financing – Improving

LGU Access to Official Development Assistance A general concern of LGUs given devolution, local autonomy and the

imperative of raising substantial resources is how to complement local resources, which have been dependent on traditional LGU sources such as the Internal Revenue Allotment (IRA) with other financing sources. Various modalities have been identified – ranging from the exercise of their corporate powers through public-private partnerships, build-operate-transfer, privatization, etc., to availing of loans and grants from both local and international sources. A promising policy area which has not been well studied is access by local governments to Official Development Assistance (ODA) resources.

Statistics on the distribution of ODA loans show that the local government sector is the smallest recipient of this funding source. As of 2006, national government agencies held the biggest share of the ODA pie at 65%; government-owned and controlled corporations - 22%; government financing institutions -13% while the LGUs held less than one percent (1%)23. While it has been observed that the amount of ODA grants and the number of ODA grant projects have been declining over the years, a number of other factors could explain the poor performance of LGUs in availing themselves of ODA funds. One major factor is the fact that LGUs (with very few exceptions) have inadequate capacity to access and manage ODA funds. On the other hand, there is also a perception among LGUs that the process of accessing ODA is complex and cumbersome.

At the policy level, the government needs to look into: i) allowing LGUs to use private commercial banks as depository institutions; ii) fast-tracking the implementation of Executive Order 809; and, iii) establishing a monitoring system between NEDA, DILG and DOF for ODA funded local government projects.

Allow LGUs to use private commercial banks as depository

institutions. Allowing LGUs to use private commercial banks as depository institutions

will enable them develop a closer working relationship with those banks, which will compete for LGU business by way of offering higher interest on deposits, lower interest on loans, and better banking services in general. For many areas in the countryside, the LGU is the single biggest potential banking client. With access to LGU accounts, more private banks will also be enticed to establish branches outside traditional areas in the regions.

23 NEDA. 2006. 15th Annual ODA Portfolio Review. Manila


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LGUs to access ODA directly from donors: Fast-track the implementation of Executive Order 809.

A proposal from the League of Provinces of the Philippines to allow LGUs

direct access to ODA without any sovereign guarantee by the national government is worth considering. This used to be a moot issue before, when practically all donor partners, multilateral and bilateral, refused to lend without sovereign guarantee. Lately, however, ADB is open to relaxing this condition. The fear of most national governments in allowing direct local foreign borrowing is that, even without sovereign guarantee, a default by the LGU may affect the country’s sovereign risk rating negatively. Studies of other country experiences would help towards a better appreciation of the merits and demerits of the proposal.

Executive Order 809 issued by President Arroyo on June 9, 2009

(“Implementing the Financing Policy Framework for Local Government Units by Identifying New Sources of Funding for First Tier LGUs under Republic Act No. 7160”) directs the DILG and the DOF to implement the LGU Financing Framework, whereby first-tier LGUs (provinces, cities, and municipalities whose average regular and locally-source funds for the past three years comprise 60% of their total income) may borrow directly from multilateral agencies to ensure that they have sufficient funding sources for their vital projects.

The EO stresses that “any such loan obtained shall be on a stand-alone

basis, without any direct or indirect National Government guarantee.” Although this may add on some 1.5 percentage points to the cost of funds to the LGU (this is the current charge of the LGU Guarantee Corporation), the LGUs are nevertheless expected to enjoy a lower cost of funds if they are able to borrow directly from ODA sources.

To jumpstart this initiative, the first ODA-funded project should be an

“easy,” well-prepared one that would serve as a showcase for emulation by other LGUs. Among the Philippines’ ODA partners, the ADB is probably the one most ready (and willing) to lend directly to LGUs.

Establish a monitoring system between NEDA, DILG, DBM and DOF for ODA-funded individual LG projects. The concerned government agencies need to agree that there is a need to

establish such a system and develop an institutional arrangement that would monitor not only the disbursement of ODA funds, but also confirm their utilization and evaluate development results. For ODA projects still in the pipeline, information on which LGUs are covered by a particular project is at best indicative, as such projects are often demand-driven, and the list of participating LGUs included in the project proposal may change upon implementation. For ongoing foreign-assisted projects, however, coordination among the oversight


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agencies will help towards greater transparency and accountability for both the government and the donor community.

Under the ODA Act of 1996, NEDA is the agency mandated to monitor

foreign-assisted projects (through its Projects Monitoring Staff, or NEDA/PMS). NEDA’s monitoring, however, is at the agency and project levels. NEDA/PMS does not have the personnel and other resources to monitor subprojects. It is at the LGU subproject level that DILG can help in the monitoring process. DBM, meanwhile, would have the financial flows, while DOF (through BLGF and MDFO) would have the broader fiscal picture for the LGU (such as borrowing capacity and projected amortization of LGU loans).

Probably the best venue for installing a tracking and monitoring

mechanism for ODA funds going to LGUs is DILG, as chair of the PDF Working Group on Decentralization and Local Government. The subprojects that trickle down to the LGUs (especially at the municipal level and below) are so many and so widely dispersed across the country. DILG has offices that go all the way down to the local level.

The tracking and monitoring system should gather information not just

from the LGUs but from the donor agencies as well. Especially on financial matters, grant aid recipients in many instances are not informed by donors on the magnitude of technical assistance involved. In the interest of transparency and accountability, a common reporting system should be devised and installed that would allow the Philippine government (and the donor governments themselves) to say with a reasonable degree of confidence how much aid flowed in and where it went.

A byproduct of such an ODA monitoring system that goes down to the

LGU level is transparency in the award of subprojects. It sometimes happens that an LGU may already have expressed interest in getting a subloan from, say MDFO or LBP, to finance its domestic water supply project. However, local officials hearing that the neighboring town is getting a grant from a donor agency for a similar project may decide to cancel the subloan application, hoping that they would get a grant as well. The ODA monitoring system, aside from simply providing a database, may be tapped to apprise the LGU if the expectation of getting a grant is realistic or not.

On Processes and Procedures At the organizational level, efforts should be exerted to address the

following: i) acquaint LGUs of sources of local public investment funds other than direct ODA grants; ii) develop LGU capacities in local planning and project development; iii) streamline the development and approval processes for small subprojects; iv) involve LGU representatives in the programming exercises with donors; and v) improve the monitoring system on ODA flows, particularly grants.


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Acquaint LGUs with sources of public investment funds other than direct ODA grants. LGUs should be reminded that they have access to external resources

other than the ones in the management of which they formally participate. By far the bigger resources are in the programs, activities, and projects (PAPs), whether foreign-assisted or locally funded, that are undertaken by the line agencies of the national government in their respective localities and jurisdictions. The national government, for strategic reasons, often reserves ODA for those large projects that, if funded from the President’s budget, may stir much debate and have a rough sailing in Congress.

Another source is the Priority Development Assistance Fund (PDAF) or

congressional initiatives (CIs) which are allocated by congressional district and run into billions of pesos.24 The PDAF is a significant extra-budgetary source for many small and poor LGUs. The national government, particularly DBM, has been trying to “rationalize” the uses of the PDAF by defining the set of local infrastructure projects that may be funded by the facility. Lobbying by the local chief executive (usually the mayor, as the governor is often a rival of the congressman) helps assure that the small local project is consistent with the local development plan.

For the bigger projects, locally funded or foreign-assisted, the immediate

venue for the LGUs’ influence on design and implementation is the regional development council (RDC), where the regional directors of the national line agencies sit as members. But not all LGUs are members of the RDC. The smaller LGUs (the municipalities) have to course their requests through the governors or lobby with the regional directors. If the regional directors are not close to their national office superiors, LGU representation or lobbying may have to be with the national office superiors themselves. These are political realities with which LGUs have to contend.

Develop LGU capacities in local planning and project development. As mentioned earlier, the limited technical capacity of LGUs is a perennial

problem that cannot just be solved simply through more training and capability building. The donor agencies themselves contribute to the problem as they compete for the services of local planning and project development officers who perform well.

The compensation package for local government personnel should have a

performance-based component, but this is more easily said than done. The third phase of the Salary Standardization Law (SSL III) substantially raises the salaries of government employees, both national and local, but fears have been expressed that the poorer LGUs may not be able to afford the higher pay scales. 24 Historically, the PDAF or CIs reached their highest levels in 2003 (P19.5 billion) and 2004 (P19.7 billion)


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A possible way of stemming the outflow of good, trained LGU technical personnel is a temporary, periodic cross-posting or special secondment scheme with the major donor agencies. At present, this may be observed at the more senior level among NGAs (oversight and line), where a bureau director or division chief goes on leave to join a foreign-assisted project for, say, six months or one year. A similar arrangement may be developed for LGU technical personnel. These aspects deserve a closer look by the PDF Working Group on Decentralization and Local Government.

Meanwhile, the DILG’s Local Government Academy (LGA) may enter into partnership with other training institutions especially in the regions so that the supply of training services could be sustained and made more easily accessible.25

Establish a Project Feasibility Studies Fund for LGUs. Side-by-side with the capacity building initiatives, especially in the short

run, is the need to set aside a Project Feasibility Studies Fund, especially for the smaller LGUs. It may be unrealistic for these small LGUs to build up their own internal capability to conduct full-blown project studies, as the typical municipal development office may have only one or two technical persons. The ODA Act actually says that “NEDA shall endeavor to obtain ODA funds from donor countries, which shall approximately be five percent (5%) of the total ODA loan from the immediately preceding year. Said funds shall be administered by the NEDA for project identification, feasibility studies, master planning at local and regional levels, and monitoring and evaluation.” Unfortunately, this has not been implemented. Nevertheless, the NEDA Regional Offices (NROs) have a facility to assist LGUs in project preparation, but these resources are limited. The establishment of a Project Feasibility Studies Fund, lodged within NEDA or DILG, would go a long way towards helping LGUs gain better access to ODA funds.

Streamline the development and approval processes for small

subprojects. For the on-lending facilities of the GFIs and MDFO, templates can

probably be developed for small subloans, e.g., P3 million and below), such that full-blown feasibility studies may be dispensed with. For example, school-building projects are fairly standard and a checklist-type template on the market, technical, financial, and economic aspects may be easily developed. This would substantially reduce the project development costs and make the ODA on-lending facilities more accessible for the lower-tier LGUs.

25 In fact, LGA has been working with local training institutes, the Philnet which is based on the Local Government

Training and Research Institutes (LOGTRI) network in the Asia region. The network of the Association of Schools of Public Administration in the Philippines (ASPAP) may also be tapped.


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Involve LGU representatives in the programming exercises with donors.

A common question asked by a local chief executive is why a neighboring

town received a grant from a particular donor while his own town was apparently bypassed. While DILG participates in most (if not all) of the bilateral and multilateral consultations on country programming, it may be good to invite representatives of local government leagues to attend, even as observers.

Other Recommendations 1) Set-up an MDFO website for greater transparency and wider reach of

the facility with an appropriate easy-to- follow steps and procedures; 2) make available a ready pool of consultants to assist LGUs in preparing for the necessary financing application requirements through MDFO; 3) use ODA for better access to performance-based LGU financing; and 4) build-up SREs database within BLGF and harmonize them with other concerned agencies.

Study on Local Personal Services Expenditure Policy

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STUDY ON LOCAL PERSONAL SERVICES EXPENDITURE POLICY

Rosario G. Manasan and Cynthia G. Castel

1. INTRODUCTION The Local Government Code (LGC or Code) of 1991 is a landmark piece of legislation that gives local government units (LGUs) greater local autonomy overall. It gave LGUs responsibility for a wide range of functions including some that were previously assigned to national government agencies. The LGC also broadened the taxing powers of LGUs and provided for increased intergovernmental transfers from the central government to local governments. Concomitant with the devolution of functions from national government agencies, significant number of personnel from these agencies were transferred to the rolls of the LGUs. Furthermore, LGUs created new offices and hired additional staff for newly assigned functions even in cases where no personnel were devolved from national government agencies. The expansion of existing functions and absorption of new ones by LGUs pursuant to the expenditure assignments mandated under the LGC have thus resulted in the growth of their organization and the increase in the number of LGU staff. While the LGC provides LGUs some degree of autonomy in designing their own organization structure and in determining the compensation of local officials and employees, it also imposes certain restrictions on LGU staffing and compensation. One, the LGC mandates that LGUs’ organizational structure and staffing patterns should not only take into account their service requirements and financial capability but should also comply with the guidelines prescribed by the Civil Service Commission (Section 76).Two, while the LGC gives Local Sanggunians the discretion to determine the positions, salaries and wages, allowances and other benefits of local officials and employees, the Code also limits the spending of LGUs on personal services (PS) to less than 45% of their total annual income from regular sources in the next preceding fiscal year in the case of LGUs belonging to LGU income classes 1-3 and 55% in the case of LGUs belonging to LGU income classes 4-6 (Section 81). Three, LGC also provides that the rates of pay in LGUs should be set at fixed percentages1 of the prescribed national salary schedule as provided under RA 6758 (The Salary Standardization Law of 1989).

1 The fixed percentages are based on the LGU income class and are increasing as the LGU income class increases.


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Soon after the implementation of the devolution program in 1993/ 1994, another round of government salary increases was mandated for all levels of government, including local governments, with the enactment of the second Salary Standardization Law (SSL2) in 1994. Subsequently, the three basic provisions of the LGC with respect to LGU staffing and compensation were modified in response to changing policies and conditions. First, SSL2, in its desire to minimize the disparity in pay between the organic personnel of LGUs and the devolved personnel of national government agencies that have been absorbed by local government units, allowed LGUs to adopt the salary schedule of higher class LGUs provided that said are financially capable of doing so.2 Second, because many LGUs were not able to implement the salary increases envisioned under SSL2 without breaching the budgetary limitations on their PS spending, the Department of Budget and Management (DBM) introduced so-called “waivers” to the PS cap, i.e., items that are not included as part of PS spending in determining LGU compliance with the PS spending limitation. These items include: implementation of SSL, absorption of devolved personnel, creation of mandatory positions, payment of benefits provided under the Magna Carta for Public Health Workers and absorption of the cost of devolved hospital services transferred from provinces to cities. The introduction of waivers in computing compliance with the PS cap and the discretion given to LGUs to adopt the salary schedule of higher income class LGUs have rendered the budgetary limitation on personal services expenditures inutile to a large extent. This is exacerbated by the lack of uniformity in the review of LGUs budgets. At the same time, these developments have necessarily resulted in increased spending on personal services relative to the pre-Code period. Thus, PS spending of all LGUs combined more than doubled from an average of 0.8% of GDP in 1989-1991 to 1.7% of GDP in 1994-1998 (Table 1). On the other hand, the budget share of personal services in all LGUs as a group went up from 46% to 47% during the same period. This figures mask the huge increases in the budget share of personal services in municipalities (from 46% to 55%) and in provinces (from 43% to 49%) which were somewhat dampened by the decline in the budget share of personal services in cities (from 48% to 38%) during the same period (Table 2). Moreover, the PS spending of LGUs as a proportion of their regular income two years back was well over the PS cap on the average in 1994-998, at 75% for all LGUs combined, 80% for all provinces and all municipalities, and 65% for all cities.

2 Note that devolved personnel retained their pay scales and th devolved personnel retained their pay scales and thus were getting first class rates, regardless of the income class of the LGU that absorbed them.us were getting first class rates, regardless of the income class of the LGU that absorbed them. This situation created some discord at the local level.


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From November 1, 1997 (the last tranche of SSL2) to June 30, 2007, government salaries have not been adjusted. Consequently, total LGU spending on personal services went down from 2.0% of GDP in 1998 to 1.4% of GDP in 2007 for all LGUs combined, reflecting the erosion of real wages in the entire public sector, not just the LGU sector during this period (Table 1). While the share of PS in total LGU expenditures contracted for all LGUs as a group and for all levels of local governments in 1998-2007, the budget share of personal services in provinces and cities remained high in municipalities (54%) and in provinces (47%) during the period (Table 2). Moreover, LGUs’ PS spending as a proportion

The Special Education Fund: Prospects for Policy Improvement

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Table 1. LGU expenditures as Percentage of GDP, 1988-2007A. ALL LGU's 1989=1991 1994-1998 1999-2007 1989 1991 1992 1993 1994 1996 1998 1999 2001 2003 2005 2007

GRAND TOTAL 1.69 3.64 3.57 1.50 1.90 1.94 2.77 3.33 3.47 3.84 3.86 4.01 3.73 3.15 3.16 PS 0.77 1.72 1.61 0.66 0.85 0.97 1.29 1.47 1.67 1.95 1.86 1.82 1.56 1.47 1.36

MOOE 0.59 1.21 1.32 0.58 0.62 0.62 0.95 1.14 1.16 1.27 1.33 1.42 1.53 1.19 1.21CO 0.32 0.71 0.64 0.26 0.43 0.35 0.52 0.72 0.65 0.62 0.68 0.76 0.63 0.49 0.59

B. ALL PROVINCES 1989=1991 1994-1998 1999-2007 1989 1991 1992 1993 1994 1996 1998 1999 2001 2003 2005 2007

GRAND TOTAL 0.50 0.88 0.84 0.47 0.55 0.46 0.70 0.82 0.82 0.92 0.89 0.97 0.87 0.72 0.72 PS 0.21 0.43 0.39 0.19 0.23 0.23 0.35 0.39 0.41 0.47 0.45 0.44 0.36 0.36 0.33

MOOE 0.17 0.30 0.30 0.16 0.19 0.16 0.26 0.31 0.26 0.30 0.30 0.34 0.37 0.25 0.26CO 0.11 0.15 0.14 0.13 0.13 0.07 0.09 0.13 0.15 0.15 0.14 0.19 0.13 0.11 0.13

C. ALL MUNICIPALITIES 1989=1991 1994-1998 1999-2007 1989 1991 1992 1993 1994 1996 1998 1999 2001 2003 2005 2007

GRAND TOTAL 0.67 1.34 1.28 0.58 0.76 0.82 1.19 1.28 1.28 1.35 1.39 1.38 1.33 1.15 1.13 PS 0.31 0.74 0.69 0.25 0.35 0.44 0.61 0.66 0.71 0.82 0.80 0.76 0.67 0.61 0.56

MOOE 0.25 0.41 0.43 0.25 0.25 0.26 0.38 0.41 0.39 0.39 0.43 0.43 0.49 0.40 0.40CO 0.11 0.19 0.16 0.08 0.16 0.12 0.19 0.21 0.18 0.14 0.15 0.19 0.16 0.14 0.17

D. ALL CITIES 1989=1991 1994-1998 1999-2007 1989 1991 1992 1993 1994 1996 1998 1999 2001 2003 2005 2007

GRAND TOTAL 0.52 1.42 1.45 0.45 0.59 0.66 0.88 1.23 1.37 1.57 1.58 1.65 1.54 1.28 1.32 PS 0.25 0.54 0.54 0.22 0.27 0.30 0.33 0.43 0.55 0.66 0.60 0.62 0.52 0.50 0.48

MOOE 0.18 0.50 0.59 0.17 0.18 0.21 0.31 0.42 0.50 0.58 0.59 0.65 0.67 0.54 0.54CO 0.10 0.37 0.33 0.05 0.14 0.16 0.24 0.39 0.32 0.33 0.38 0.38 0.34 0.24 0.30

Source of basic data: COA Annual Financial Report for LGUs, various years


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Table 2. Composition of LGU expenditures, by object of expenditure, 2000-2007A. ALL LGU's 1989=1991 1994-1998 1999-2007 1989 1991 1992 1993 1994 1996 1998 1999 2001 2003 2005 2007

GRAND TOTAL 100.00 100.00 100.00 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 PS 45.81 47.11 45.15 44.2 44.7 49.9 46.6 44.2 47.9 50.8 48.1 45.5 41.9 46.7 43.1

MOOE 35.19 33.37 36.99 38.8 32.8 32.0 34.5 34.1 33.4 33.0 34.3 35.5 41.1 37.6 38.2CO 19.00 19.53 17.86 17.0 22.4 18.1 18.9 21.7 18.7 16.1 17.5 19.1 17.0 15.7 18.8

% of PS to reg. inc. 2 years back 84.03 74.78 52.83 74.6 87.5 81.6 96.2 95.4 64.0 72.5 62.4 58.1 51.4 46.5 47.3B. ALL PROVINCES 1989=1991 1994-1998 1999-2007 1989 1991 1992 1993 1994 1996 1998 1999 2001 2003 2005 2007

GRAND TOTAL 100.00 100.00 100.00 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 PS 43.29 49.30 46.78 39.9 41.6 50.4 49.9 47.5 50.2 51.5 50.8 45.1 42.1 50.1 45.5

MOOE 34.00 34.23 36.10 33.5 35.2 34.0 37.3 37.3 31.9 32.3 33.9 35.4 42.8 34.3 36.8CO 22.71 16.47 17.12 26.6 23.3 15.6 12.8 15.3 17.9 16.2 15.3 19.6 15.1 15.6 17.7

% of PS to reg. inc. 2 years back 101.68 79.90 54.26 90.2 98.3 83.7 113.1 112.4 63.2 75.6 63.9 57.8 50.7 49.2 49.2C. ALL MUNICIPALITIES 1989=1991 1994-1998 1999-2007 1989 1991 1992 1993 1994 1996 1998 1999 2001 2003 2005 2007

GRAND TOTAL 100.00 100.00 100.00 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 PS 46.08 55.13 53.52 43.5 46.1 53.6 51.5 51.2 55.0 61.0 57.9 55.3 50.8 52.9 49.6

MOOE 37.11 30.76 33.66 43.3 33.3 31.5 32.4 32.3 30.8 28.7 31.0 31.1 36.9 34.7 35.6CO 16.82 14.11 12.82 13.2 20.5 14.9 16.1 16.5 14.2 10.3 11.2 13.6 12.3 12.3 14.8

% of PS to reg. inc. 2 years back 86.56 80.39 61.56 74.6 94.0 92.0 110.0 99.2 70.0 81.5 71.2 65.6 61.5 53.0 54.2 D. ALL CITIES 1989=1991 1994-1998 1999-2007 1989 1991 1992 1993 1994 1996 1998 1999 2001 2003 2005 2007

GRAND TOTAL 100.00 100.00 100.00 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 PS 47.98 38.13 36.87 49.6 45.8 45.1 37.4 34.7 40.0 41.7 38.1 37.5 34.2 39.3 36.2

MOOE 34.05 35.21 40.40 38.5 30.0 31.2 35.1 33.9 36.7 37.1 37.6 39.2 43.7 42.0 41.0CO 17.97 26.67 22.72 11.9 24.2 23.8 27.4 31.4 23.4 21.2 24.3 23.4 22.1 18.7 22.7

% of PS to reg. inc. 2 years back 71.04 65.41 44.04 65.1 73.9 68.8 69.1 79.7 58.0 62.0 52.7 51.0 42.7 39.1 40.1Source of basic data: COA Annual Financial Report for LGUs, various years


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of their regular income two years back continued to exceed the budgetary limitation on PS spending on the average in 1999-2007 for all municipalities combined (62%) and for all provinces as a group (54%). On the other hand, although there has been some increase in the budget share of maintenance and other operating expenditures (MOOE) and capital outlays (CO) in 1999-2007 relative to their levels in 1994-1997, the contraction in total LGU income relative to GDP in recent years3 resulted in the concomitant decline in total LGU spending on MOOE and CO as a proportion of GDP. To wit, total LGU spending on MOOE went down from 1.3% of GDP in 1999 to 1.2% of GDP in 2007 while total LGU spending on CO dipped from 0.7% of GDP to 0.6% of GDP. Given pending proposals to implement another round of salary adjustments as part of the third wave of the salary standardization initiative, the need to secure an effective control over the public sector wage bill becomes even more imperative. Otherwise, LGUs risk further diminution of the quantity and quality of local services precisely because an increase in the wage bill will likely put the squeeze on non-wage items (i.e., MOOE and CO) which are just as essential as wages and salaries in local service delivery. In like manner, it is likely that local economic development will be severely compromised if LGU spending on personal services eats up an even larger part of their budgets as LGUs become less and less able to improve local infrastructure. Yet, if government sector pay is not adjusted as is now being proposed in order to address the overall erosion of public sector wages and to decompress public sector compensation, government will find it difficult to recruit and retain quality staff, to encourage productivity and to avoid corruption. On the other hand, a host of other staffing and compensation issues have emerged after devolution and created certain dysfunctions in the local bureaucracy. First, some of the positions devolved resulted in some redundancy in the LGU staffing pattern, as similar positions were already existing in the LGU plantilla even prior to devolution. Second, there is some anecdotal evidence that the large number of casual employees in the rolls of some LGUs have a significant impact on their wage bill. Third, devolved personnel retained their pay scales and thus were getting first class rates, regardless of the income class of the LGU that absorbed them. Moreover, devolved health personnel also receive Magna Carta benefits. The higher rates given to devolved personnel and the benefits from the Magna Carta for Health Workers created some conflict in the LGUs. Given this perspective, there is thus need to review existing policies on the organization, position structure and compensation levels of LGUs as these have significant impact on local budget allocation and prioritization as well as the effectiveness of local service delivery. 3 This is largely because of the relative decline of the IRA which in turn was due to the persistent deterioration in BIR tax effort in 1998-2005.


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Objective of the study. This study aims to review current practice in budgeting for personal services expenditures at the local level and to develop improved and updated personal services expenditure policies for LGUs in order to promote more effective and transparent LGU budget processes and public expenditure management. The study hopes to assist LGUs in formulating budgets with a more rational distribution of their financial resources across the different spending categories, by class of expenditure. Methodology. In the conduct of this study, a survey questionnaire was sent out to all LGUs by the study team in collaboration with the Organization, Position Classification and Compensation Bureau (OPCCB), Regional Operations Coordination Service (ROCS) and all the Regional Offices of the Department of Budget and Management (DBM) in the second quarter of 2008 to gather information on the number of LGU personnel (distinguishing between permanent and non-regular employees), the details of LGU spending on personal services and the salary schedule adopted by the LGU, among others. The response rate was 38% for provinces (31 out of 81), 33% for cities (45 out 120) and 34% for municipalities (510 out of 1495). The analysis of the data gathered from this survey informs the discussions and recommendations of the outstanding issues in Section 3. The analysis provides useful information on As part of this study, field visits to 26 LGUs were also undertaken during which LGU officials were interviewed. These LGUs include the following: the provinces of La Union, Leyte, Iloilo, Guimaras, Davao del Norte, and Agusan del Sur; the cities of Quezon, Marikina, San Jose del Monte, Tagaytay, Tacloban, Iloilo, Butuan, Surigao, Bayugan, Tagum and San Fernando (La Union); and the municipalities of Bauang and Caba in La Union, Asuncion and Sto. Tomas in Davao del Norte, Basey in Samar, Palo in Leyte, Sta. Barbara in Iloilo, Tubay in Agusan del Norte and Trento in Agusan del Sur. Many other LGUs also attended the consultation workshop held in Manila in December 2008 and in Cebu in January 2009. The consultation workshops and key informant interviews provided important insights and contributed to the formulation of some of the recommendations in this study. In addition, a desk review of relevant legislation, manuals and regulations governing personal service expenditures and civil service concerns and COA Annual Audit Reports for various cities and provinces for the years 2005-2007 was also undertaken. 2. LEGAL FRAMEWORK AND INSTITUTIONAL ARRANGEMENTS Prior to the issuance of Presidential Decree (PD) 1136 in 1977, the local legislative bodies of local governments units (i.e., provinces, cities, municipalities and barangays) were vested with specific powers (as defined in the Revised Administrative Code and individual LGU charters) including the power to


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determine the number of employees that each office should have and to fix their salary rates. DBM (2007) noted, however, that in exercising such power, there were no specific guidelines nor definite standards used in the creation of positions and the fixing of salaries. Also, some position titles were not descriptive or reflective of the duties and responsibilities of the positions and salaries were fixed in an arbitrary manner. Moreover, a wide gap was created between the salaries of rank-and-file employees and local elective officials because certain laws (e.g., Republic Act (RA) No. 268 as amended and RA No. 4477) fixed the salaries of municipal, provincial and city elective officials, Presidential Decree No. 1136. Entitled “The Local Government Personnel Administration and Compensation Plans Decree of 1977,” PD 1136 called on LGUs “to adopt rational personnel policy and position classification and compensation plans, based on the principle of equal pay for substantially equal work, and on the need to recognize differences in pay arising from substantive differences in duties, responsibilities and qualification requirements” with the end in view of promoting “the efficiency, effectiveness and integrity of the local government personnel service.” It also created the Joint Commission on Local Government Personnel Administration (JCLGPA) (i) to serve as the principal coordinating body for agencies with direct responsibilities for local government supervision, budgeting, personnel administration, position classification and salary administration, (ii) to formulate policies affecting personnel administration, position classification and salary and compensation plans for local governments, (iii) to evaluate and approve LGU position classification and compensation plans, and (iv) to provide general supervision of personnel administration in local governments (DBM 2007). PD 1136 also set the maximum salary rates for provincial, city and municipal officials by equating them to Career Executive Service Officers (CESO) ranks. The Joint Commission was chaired by the then Secretary of the Department of Local Government and Community Development (now the Department of Interior and Local Government or DILG) and included the Secretary of the Budget Commission (now the Department of Budget and Management or DBM), the Secretary of the Department of Finance (DOF), the Chairman of the Civil Service Commission (CSC) and a Provincial Governor (represent local governments) as members. The DLGCD was responsible for prescribing model organization and staffing patterns for LGUs, and provided secretariat services to the commission. The Budget Commission, through the then Office of Compensation and Position Classification (OCPC), now the Organization, Position Classification and Compensation Bureau (OPCCB), (i) prepared guidelines for the preparation, installation, administration and maintenance of the position classification and pay plans (PCPPs) and (ii) reviewed and recommended PCPPs for LGUs to ensure that all positions are allocated to proper position titles and salary grades. The DOF determined the fiscal capacity of local governments to carry out the proposed PCPPs and reviewed local government budgets to ensure that the expenditures for personal services are in conformity with approved PCPPs. The


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CSC was responsible for matters dealing with certification of eligibility, examination, appointments, promotions, performance evaluation, disciplinary action and such other personnel activities as defined in pertinent laws, rules and regulations. Republic Act No. 6758 or “Compensation and Position Classification Act of 1989.” While PD 1136 allowed LGUs to formulate their own position classification and salary and compensation plans, RA 6758, more popularly known as the Salary Standardization Law, directed the DBM to establish and administer a unified Compensation and Position Classification System for the entire government, including LGUs, as mandated in the 1987 Constitution. The Joint Commission was also tasked under RA 6758 to oversee the proper implementation of salary standardization in accordance with the policies and guidelines issued by the DBM. Meanwhile, Section 10 of RA 6758 provides that the rates of pay in LGUs are to be determined on the basis of their income class and financial capability and are to be set at fixed percentages of the prescribed national salary schedule as indicated in Table 3. Thus, while first income class cities and provinces and special cities pay their employees salaries equal to the rates set in the national government salary schedule, second income class cities and provinces pay their employees at rates equivalent to 95% of those set in the national government pay schedule. On the other hand, first income municipalities pay their employees at rates equal to 90% of the national government salary schedule. That is, the discount factor applied to the national government pay scale rises as the income class of the LGU goes down. Republic Act No. 7160 or Local Government Code (LGC) of 1991. The LGC authorizes LGUs to design and implement their own organizational structure and staffing pattern taking into consideration its service requirements and financial capability subject to the minimum standards and guidelines prescribed by the Civil Service Commission (Section 76). It also provides that every local government unit shall be responsible for human resources and development in the LGU and shall take all personnel actions in accordance with the Constitutional provisions on civil service, pertinent laws, and rules and regulations thereon, including such policies, guidelines and standards as the Civil Service Commission may establish (Section 77). Furthermore, it provides for the Local Sanggunians to determine the positions, salaries and wages, allowances and other emoluments and benefits of local officials and employees provided such compensation shall not exceed the limitations on the budgetary allocations for personal services and are based on the pertinent provisions of RA 6758 (Section 81).


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Table 3. LGU pay as percentage of national schedule as per RA 6758

LGU Income For ForClass Province/Cities Municipalities

Special Cities 100%1st Class 100% 90%2nd Class 95% 85%3rd Class 90% 80%4th Class 85% 75%5th Class 80% 70%6th Class 75% 65%

At the same time, the LGC subjects total annual appropriations for personal services to a cap equal to 45% of their total annual income from regular sources realized in the next preceding fiscal year in the case of 1st to 3rd income class LGUs and 55% in the case of 4th to 6th class LGUs (Section 325). Under the LGC, local sanggunians may provide additional allowances and benefits to judges, prosecutors, public school teachers and other national government officials stationed in or assigned in localities when LGU finances allow [Section 447 a (1) (ix), Section 458 a (1) (ix), Section 468 a (1) (ix)]. The LGC also abolished the Joint Commission on Local Government Personnel Administration and transferred its personnel, records and assets to the CSC (Section 78). However, the Code was silent as to which agencies the functions of the member agencies of the Joint Commission are to be transferred. The lack of a clearly identified authority over position classification and compensation gave rise to the issue as to the real powers of the Local Sanggunian on staffing and compensation. Administrative Order (AO) No. 42. The issuance of AO No. 42 in 1993 reiterated DBM’s continuing responsibility regarding position classification and compensation and the applicability of rules and regulation under RA 6758 with respect to LGUs. As part of its mandate to administer RA 6758, AO 42 specified that the DBM shall (i) provide guidelines on the classification of local government positions and on the specific rates of pay therefore; (ii) provide criteria and guidelines for the grant of all allowances and additional forms of compensation to LGU employees; (iii) advise and assist LGUs on matters of position classification and compensation of LGU personnel; and (iv) provide technical expertise in the training of LGU personnel to enable them to administer and maintain the compensation and position classification system (DBM 2007). Senate and House of Representatives Joint Resolution No. 1 of 1994 (otherwise known as SSL 2). This Joint Resolution revised the compensation and position classification system originally prescribed under RA 6758. In order to minimize the disparity in pay between devolved personnel of national government


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agencies and organic personnel of LGUs, the Joint Resolution also allowed LGUs other than special and 1st class cities and provinces to adopt the salary schedule of higher class LGUs, provided that (i) the LGU must first implement fully the prescribed salary schedule for its income class and assure sustainability before it can exercise the option to adopt a higher salary schedule; (ii) the LGU is financially capable; (iii) the salary schedule adopted shall be uniformly applied to all positions in the said LGUs; (iv) the difference arising from the adoption of the higher salary schedule shall be subject to the budgetary and general limitations on personal expenditures mandated under Section 324 and Section 325 of the LGC (DBM 2007). Subsequently, AO 282 was issued in 1996 reiterating DBM’s role in administering RA 6758 and calling on LGUs to strictly adhere to the provisions of RA No. 6758, as amended by Senate and House Resolution No. 01, s. 1994. However, despite the issuance of AO 42 and AO 282, issues on the perceived authority of the local sanggunian over position classification and compensation persist to this day. There is, thus, a need to revisit the pertinent provisions of RA No. 7160. The salary schedule prescribed under the Senate and House of Representatives Joint Resolution No. 01, s. 1994, was implemented in 4 tranches starting January 1, 1994 through November 1, 1997. A study conducted by DBM in 19964 shows that 36% of provinces, 24% of cities and 66% of municipalities were not able to fully implement the third tranche of the new salary schedule under said Joint Resolution. Moreover, 88% of the municipalities which were unable to fully implement the third tranche belong to the 4th-6th income classes (Table 4). Director Myrna Chua concluded that this situation paved the way for the waiver of the 45%/55% personal services cap on budgets of LGUs adopting the salary schedules for their income classes. Institutional arrangements. As provided under the Local Government Code, LGUs have the power to design, approve and implement their organizational structures and staffing patterns and modify the same, provided their actions conform to the guidelines provided by the Civil Service Commission and the Department of Budget and Management. In particular, the position titles in their plantilla have to conform to the position titles established under RA 6758 as administered by the DBM. LGUs also submit their approved plantilla of personnel to the CSC for the latter’s information and guidance in processing appointments and other personnel action. At the same time, LGUs pay salaries and step increments pursuant to the provisions of RA 6758 and its implementing rules and regulations as issued by the DBM. They also grant allowances and benefits based on existing laws and guidelines, rules and regulations issued by the DBM. In addition, Sangguniang Panlalawigan reviews ordinances of lower level LGUs authorizing their annual or supplemental appropriations (including personal services appropriations). 4 This is based on the presentation of Director Myrna Chua of OPCCB in ADB TA 4778 workshop on PS expenditure policy in December 2008.


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Table 4. Proportion of LGUs Implementing Third Tranche of Revised SS under Joint Resolution No. 1, 1994 a/

% of LGU which % of LGUs which did notLGU Category implemented implement

third Trance fully third tranche fully

Province 64.1 35.9Cities 76.5 23.5Municipalities 34.0 66.0a/ 1996 unpublished DBM study as cited in presentation of Director Myrna Chua in December 2008 workshop for PS expenditure policy study.

In other words, LGU actions related to staffing (i.e., determining the number and kinds of positions) are guided by the standards, rules and regulations set by the Civil Service Commission. On the other hand, LGU actions on position classification and compensation (i.e., providing the correct position titles and salary grades) are guided by standards, rules and regulations set by the Department of Budget and Management. In particular, CSC Memorandum Circular (MC) No. 19, s. 1992 provides the guidelines and standards for the establishment of organizational structures and staffing patterns of LGUs. MC 19 also lists offices each level of LGU may create (e.g., Office of Local Chief Executive, Office of Secretary of Sanggunian, Office of Local Treasurer); echoes mandatory and optional positions per LGU category as provided in the LGC; provides for the creation of other offices not in the list provided mandatory positions are already created and PS cap is met; and cites section, division and department as the structural units of an office. Related to this, the CSC provides technical assistance in the design and implementation of organizational structure and staffing pattern and provides guidance that these should be in accordance with the basic services and facilities assigned to LGUs as per Section 17 of the LGC, the financial capability of LGUs and the qualification requirement for specific positions as provided in the LGC. In addition, it processes appointments to LGU positions and other personnel actions. It also conducts periodic inspection and audits of the implementation of LGU organization structures, staffing patterns and personnel actions. While the LGC provides that Local Sanggunians shall determine the positions, salaries and wages, allowances and other emoluments and benefits of local officials and employees, it also provides that these shall be based on the provisions of RA 6758 and standards, rules and regulation to guide its implementation as issued by the DBM. In this regard, the Organization, Position Classification and Compensation Bureau (OPCCB) of the DBM continues to establish and maintain the guidelines, rules and regulations pertaining to LGU position classification and compensation, including (i) the creation of new classes of positions with corresponding salary grades as the need arises; and (ii)


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inclusion of certain existing classes of positions in the Index of Occupational Services, Occupational Groups, Classes and Salary Grades concerning positions in national government agencies in the Index for LGUs, as need arises. The OPCCB also sets standards for classes of positions and provide advice on correct classification of LGU positions (Chua 2008). Through various Local Budget Circulars, the OPCCB continues to establish and maintain the guidelines, rules and regulations pertaining to LGU position classification and compensation. In more specific terms, the OPCCB issues Local Budget Circular (LBCs) providing guidelines, or rules and regulations on (i) salary adjustments, the latest of which is LBC No. 88, on the 10% across-the-board salary increase effective July 1, 2008; (ii) adjustments in rates of allowances such as representation and transportation allowances and clothing allowance; and (iii) grant of new allowances and benefits. It also provides advice and clarification on compensation issues and conducts studies on compensation concerns to recommend policies and refine existing guidelines, rules and regulations (Chua 2008). At present, there are proposals pending in Congress to revise government salary schedule upwards as part of the third wave of salary standardization. The objective of this proposal is twofold. First, it aims to correct the erosion of public sector wages and salaries that came about because of the very infrequent and minimal adjustments in the last 10 years because of the fiscal constraints. Second, it aims to rectify the relatively compressed wage structure in the public sector (as evidenced by the ratio of the salary of the highest position to that of the lowest position) which make it difficult for government to recruit and retain staff particularly those at occupying managerial, technical and professional positions. Recommendation. Although the original objective of this study is more focused on PS expenditure policy (i.e., position classification and compensation concerns), it is recognized that position classification and compensation concerns cannot be completely divorced from staffing concerns. For instance, position classification also considers the number and kind of positions supervised and level of organizational units supervised Chua (2008). In this regard, there appears to be a need for a body similar to the Joint Commission on Local Government Personnel Administration to act as oversight body on local personnel matters and to ensure better coordination of (i) staffing and employment policies, (ii) position classification and compensation policies, and (iii) sectoral policies. The combined efforts of the agencies responsible for related policies on staffing, allowances and other benefits, salary schedules to be followed, and other concerns, as the Civil Service Commission, DBM, the Department of Finance and the Department of Interior and Local Government, need to be harnessed and coordinated to rationalize staffing needs of the LGUs and control the growth


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of the wage bill which has been observed to be growing primarily after the devolution. The proposed creation of a Joint Committee on Local Government Personnel Administration, much like the previous such entity, will provide the coordinated policy formulation and implementation guidance on local personal services. Its creation appears to be supported by both DBM and CSC, and no objection is expected from the DILG. Logistical support for the initial year of implementation would need to be clarified in the enabling Administrative Order to avoid its becoming an issue among agencies concerned or to become an impediment to smooth operations. This new entity, if instituted immediately, could already be tasked to formulate the policies and guidelines on the issues and problems presented in the study. Collegial action would facilitate the speedy responses to policy needs as well as provide the forum for concerted action or decision on problems and issues especially those prevailing, but which are not the concern of only one particular agency, as the indicative staffing model and position mix by level of LGU, creation of new operating units, retention or not of the PS cap and under what circumstances, grant of allowances to selected national government personnel assigned in the LGU. 3. OUTSTANDING ISSUES AND RECOMMENDATIONS The basic policy problem with respect to public sector employment and compensation policy at the local level revolves around the question of how to effectively control the LGU wage bill while simultaneously trying to ensure that LGUs have an adequate number of personnel with the appropriate qualifications that will enable them to deliver the services needed by their constituency and to improve remuneration to attract and/ or retain technical, professional and managerial staff. There is no definitive way of determining whether the wage bill is excessive or not but the most common measure is the degree to which non-wage expenditure is being crowded out in relation to the PS spending (Nunberg 1988). As indicated earlier, service delivery requires a mix of both wage and non-wage spending. If spending is too skewed in favor of personal services, service delivery suffers because there is little room in the budget to pay for supplies (e.g., books, medicine), travel and other resources that are needed to complement personnel resources. At the same time, if PS spending is too high LGUs are not able to improve local public infrastructure which is the main driver of local economic development. While recognizing that policy recommendations cannot be "read off" the employment and wage statistics, the World Bank (World Bank website on administrative and civil service reform) notes that as a rule of thumb, when the public sector wage bill as a percentage of total public sector spending rises over 25%, governments risk reducing their effectiveness by squeezing non-wage expenditure such as goods and services, maintenance, and capital expenditure. Another writer set the benchmark at 40% (UNDP/ MDGD 2001). In a sense, the LGC provision mandating LGUs to keep their PS spending below 45% or 55% of


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their regular income two years back (depending on LGU income class) is consistent with this thinking. Table 2 shows that personal services accounted for 45% of aggregate LGU spending on the average in 1999-2007 while 37% was accounted for by MOOE and 18% was accounted for by capital outlays. On average, the budget share of personal services was highest for municipalities (54%), followed by provinces (47%) and cities (37%). These figures are higher than both the World Bank benchmark of 25% and the UNDP benchmark of 40%. Given this situation and the current proposals to implement another round of salary adjustments as part of the third wave of the salary standardization initiative, the need to secure an effective control over the public sector wage bill becomes even more imperative. Otherwise, there is a risk that there will a further reduction in the quantity and quality of local services precisely because an increase in the wage bill will necessarily reduce the non-wage items (i.e., MOOE and CO) which are just as critical as wages and salaries in local service delivery. Thus, this study argues for the retention of the cap on LGU spending on personal services. The national averages mask wide disparities in the composition of the LGU budget across different income classes (Table 5). The budget share of personal services appears to be directly related with the income class of municipalities such that lower income class municipalities tend to have higher relative PS spending. For instance, the budget share of PS was 40% in first income class municipalities compared with 63% in fifth income class municipalities in 2007. However, the relationship between the PS spending and LGU income class is not as clear cut in the case of provinces and cities.


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Table 5. Size of LGU wage bill, 2007

Provinces Total No. of LGUs

% of PS Expd to Total Income

% of PS Expd to Current

Regular Income

% of PS Expd to Total Expd

% of MOOE to Total Expd

% of Capital Outlay to

Total Expd

ProvincesFirst Income Class 15 35.9 37.9 38.6 45.6 15.7Second Income Class 4 42.8 43.1 50.4 46.1 3.5Third Income Class 8 42.0 46.6 42.2 35.8 22.0Fourth Income Class 3 43.9 47.8 63.8 29.9 6.4Fifth Income Class 1 48.8 48.8 48.2 37.5 14.3Sixth Income Class 0 NA NA NA NA NA

Total 31 38.5 40.8 41.7 42.9 15.4Cities

First Income Class 20 24.8 25.3 27.4 54.4 18.2Second Income Class 6 34.2 34.8 44.4 48.2 7.4Third Income Class 10 36.2 40.5 39.3 43.9 16.8Fourth Income Class 9 36.3 37.1 36.0 49.4 14.6Fifth Income Class 0 NA NA NA NA NASixth Income Class 0 NA NA NA NA NA

Total 45 27.2 28.0 30.2 52.7 17.2Municipalities

First Income Class 57 35.9 40.7 40.2 45.1 14.7Second Income Class 50 42.3 44.4 47.3 39.1 13.6Third Income Class 95 47.3 49.1 52.0 40.3 7.7Fourth Income Class 166 50.9 52.9 55.7 35.2 9.1Fifth Income Class 120 56.5 58.8 63.1 28.1 8.8Sixth Income Class 22 46.6 47.3 48.1 41.1 10.7

Total 510 45.5 48.4 50.4 38.7 10.9Source of basic data: PS expenditure policy survey, 2008 It should also be pointed out that the budget shares for MOOE that are reported in Table 5 may be higher than what the real situation in the field would indicate. Interviews with LGU officials reveal that some LGUs use job order hirees (who are charged against MOOE) to work on tasks that would normally be assigned to regular employees in order to avoid exceeding the PS cap. Table 6 shows that the number of job order hirees of provinces, cities and municipalities in 2007 is not insignificant.


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Table 6. Average number of hirees under job order per LGU, 2007Provinces Cities Munis

First Income Class 290 767 85Second Income Class 591 1795 47Third Income Class 276 229 54Fourth Income Class 0 370 30Fifth Income Class 0 NA 23Sixth Income Class NA NA 8

All LGUs 288 705 40Source of basic data: PS expenditure policy survey, 2008

Because the arithmetic is such that wage bill is very simply the product of the number of employees and the wage rate, the discussion that follows is divided into three parts: policies and standards relating to employment/ staffing, (ii) policies and standards relating to pay/ compensation, and (iii) how these policies and standards impact on the ability of LGUs to keep within the PS cap. 3.1. Staffing concerns Issues on LGU staffing include (i) overall size of the LGU personnel complement, (ii) too many casuals and contractuals, and (iii) too many unfilled regular positions. The rise in personal services expenditures of LGUs may partly be attributed to the expansion of the LGU organizational structure and increases in the total number of positions in LGU plantilla following the passage of the LGC. Additional operating units have also been created for the now popular operations of local economic enterprises, or state-owned enterprises. The number of personnel in LGUs have increased considerably from 189,878 in 1984 to 316,023 in 1994 and 377,227 in 2004 (Brillantes and Fernandez 2008). This implies that the population-to-personnel ratio went down from 286 in 1984 to 211 in 1994 and 220 in 2004. Clearly, LGUs have been adding to their staffing pattern, but there is no information as to whether these conform with the model under MC 19, in terms of both the organization structure and the allowable level and number of positions. There is thus a need to revisit the level and nature of positions in the existing model to respond to the changing needs of the LGUs in the delivery of public services at the local level. A number of considerations impinge on the size of the LGU personnel complement. On the one hand, LGUs need to ensure that they have staff in sufficient numbers and with the appropriate qualifications to enable them to deliver services needed by their constituency at a level that they can afford. On the other hand, interviews with local chief executives during the field visits conducted for this study confirm that local officials are sometimes tempted to act as an "employer of last resort,” hiring large numbers of employees/ casuals in the lowest salary grades as response to lack of employment opportunities in their jurisdictions.


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3.1.1. Overall Size of LGU Personnel Complement Overstaffing is a relative concept. In this regard, it is very tempting to benchmark the country vis-à-vis other countries. However, such an exercise is often futile because of the vast differences in country specific characteristics, ranging from differences in the role of the state in the economy, differences in political structure (federal states versus unitary states; parliamentary versus presidential governments), differences in the functional assignments across different levels of governments, differences in the design of intergovernmental transfers and differences in the level of overall development. Clearly, the issue is motivation and affordability rather than staff numbers (World Bank website on administrative and civil service reform http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/ EXTPUBLICSECTORANDGOVERNANCE/administrative&civilservicereform). In this regard, a comparison of different LGUs classified according to the level of government and according to LGU income class is perhaps more informative. The variation in the average number of personnel across the different LGU income classes for the different levels of LGUs suggests that indeed affordability is a major factor that influences LGUs’ staffing decisions. Higher income class LGUs are generally shown to have larger staff complement than their “poorer” counterparts regardless of the level of local government (Table 7). The data also show that the number of filled regular positions in the average city (705) and that in the average province (749) are quite similar. The same can be said of the average number of filled regular and non-regular positions in provinces and cities. This finding is quite surprising considering that provinces operate hospitals which have fairly large personnel requirements while only a few cities do, largely because of the way health facilities were actually assigned to different levels of LGUs under the devolution program. On the other hand, the size of the LGU population clearly has some impact on decisions regarding the appropriate size of the LGU staff complement. The variation in the size of the LGU staff complement becomes even larger when one corrects for population size. However, the variation in the population-to-LGU-personnel ratio across different LGU income class does not support the affordability hypothesis that higher income class LGUs would tend to exhibit lower ratios (Table 8). It appears that the larger populations of higher income class LGUs are not quite compensated by their higher income levels to allow them to maintain ratios that are at par with their “poorer” counterparts. When the size of the personnel complement is standardized by population size, it becomes evident that cities and municipalities have fairly close population-to-personnel ratios. This is consistent with the fact that these levels of local governments have very similar service responsibilities as per their mandates under the LGC.


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In either case, the wide disparity in both the average number of personnel per LGU as well as the population-to-personnel ratio (as measured by the interquartile ratio) is indicative of the scope for rationalizing the size of the LGU personnel complement. This problem should be studied further. Nonetheless, some of the LGU officials interviewed for this study report their interest in re-organizing and, perhaps, even rationalizing their personnel complement. They are seeking guidance on organizational structure, staffing pattern and appropriate size of personnel complement – not so much on the process but more on the design of structure and determination of size of personnel complement that responds to their needs. Some of them have engaged the services of private organizations which have demonstrated their expertise in this area. However, they suggest that it would be helpful if the CSC technical advisory services in this area were to be more accessible. At the same time, it is also important to recognize that while there are indeed indications of overstaffing overall in some LGUs, skills shortage in specific sectors, particularly the health sector, in many LGUs cannot be denied. Table 7. Average number of personnel, 2007

Income Class

Average number of

filled regular positions

Average number of

filled regular and non-regular

positions

Average number of

filled regular positions

Average number of


positions

Average number of

filled regular

positions

Average number of


positionsFirst Income Class 843 1030 1059 1489 146 256Second Income Class 842 874 515 690 102 133Third Income Class 667 833 447 740 92 108Fourth Income Class 507 828 334 458 72 90Fifth Income Class 337 337 NA NA 51 62Sixth Income Class NA NA NA NA 45 55

All income classes 749 917 705 1010 81 108

Minimum 295 337 96 124 21 21Maximum 1653 2567 4,754 8260 306 3306Quartile 1 533 664 300 397 56 65Quartile 2 or Median 721 885 452 605 74 88Quartile 3 907 1024 624 1040 97 119Interquartile ratio (Q3/Q1) 1.7 1.5 2.1 2.6 1.7 1.8Source of basic data: PS expenditure policy survey, 2008

Provinces Cities Municipalities


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Table 8. Population to LGU personnel ratio, 2007

Income Class

Ratio of Population to No. of Filled

Regular Positions

Ratio of Population to No. of Filled Regular and Non-regular

Positions


Regular Positions


Positions


Regular Positions


PositionsFirst Income Class 1082 886 416 296 647 371Second Income Class 632 609 318 237 514 395Third Income Class 520 416 235 142 443 377Fourth Income Class 499 789 303 221 356 284Fifth Income Class 47 47 NA NA 258 211Sixth Income Class NA NA NA NA 380 308

All income classes 834 681 370 259 439 328

Minimum 47 47 121 49 36 23Maximum 2410 1646 1569 767 2718 1586Quartile 1 433 346 223 151 265 216Quartile 2 or Median 713 679 315 247 370 307Quartile 3 1116 855 560 364 498 419Interquartile ratio (Q3/Q1) 2.6 2.5 2.5 2.4 1.9 1.9Source of basic data: PS expenditure policy survey, 2008


3.1.2. Too Many Casuals The conventional wisdom is that there are too many casual personnel in the employment rolls of LGUs. The average number of casuals per LGU rose from 157 in 2006 to 182 to 2008 for provinces, from 207 to 215 for cities and from 18 to 23 for municipalities. The growth in the number of casuals in terms of absolute numbers appears be minimal and may even be just about consistent with the growth in population. However, it is telling that non-regular employees (consisting mostly of casual employees) do account for a significant percentage of the total number of LGU personnel regardless of employment status. To wit, provinces had 168 non-regular employees on the average, representing 18% of total number of LGU personnel while cities had 304 non-regular employees on the average, representing 30% of total number of LGU personnel in 2007 (Table 9). On the other hand, municipalities had 27 non-regular employees on the average, accounting for 25% of total number of LGU personnel. The data shows that non-regular employees of cities and provinces are generally paid more that their counterparts in municipalities. However, the compensation of non-regular employees in provinces, cities and municipalities remains very close to the minimum wage rate on the average.


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Table 9. Average number of non-regular personnel, 2007

Income Class

Average number of

non-regular personnel

% of Non-regular

Positions to Total No. of

Filled Regular and Non-regular

Positions

Average number of non-

regular personnel

% of Non-regular



Positions

Average number of

non-regular personnel

% of Non-regular



PositionsFirst Income Class 187 18.1 430 28.9 117 42.8Second Income Class 32 3.7 176 25.4 32 23.1Third Income Class 166 19.9 293 39.6 16 14.9Fourth Income Class 321 38.7 124 27.1 19 20.3Fifth Income Class 0 0.0 NA NA 12 18.5Sixth Income Class NA NA NA NA 11 19.1

All income classes 168 18.3 304 30.1 27 25.3

Minimum 0 0 0Maximum 914 4,035 3004Quartile 1 6 4 0Quartile 2 or Median 108 127 7Quartile 3 213 303 27Interquartile ratio (Q3/Q1) 35.5 75.8Source of basic data: PS expenditure policy survey, 2008


A good number of local appointive officials interviewed during the field visits readily admitted that some casuals in the employment rolls of some LGUs are hired to pay political debts. In many instances, LGU officials find themselves having to “make work” for some of those thus hired. Consequently, some casuals are assigned to do regular technical work sometimes with sub-optimal competency. They also report that there are many “permanent” casuals. That is, although casual employees are officially hired on a short-term basis, many of them become “regular” casuals, with their contracts being renewed continuously and actually staying on the employment roll for extended periods, ranging from 2 years to 15 years. In cases like this, it is reported that the employment status of casual employees are not made permanent for a variety of reasons. For instance, many of the casuals do not meet the qualification standards of plantilla positions. However, some LGU officials averred that they choose to retain the casual status of some of their employees even if these employees are able to meet the qualification standards because casual employees tend to be more productive and efficient than their counterparts who are hired on a permanent basis because of the casual’s fear of being fired anytime.

Key informant interviews also reveal that in many LGUs casual employees substitute for permanent employees. That is, some of the regular positions in these LGUs are not filled intentionally to accommodate the hiring of non-regular


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employees. Thus, 14% of regular/ plantilla positions in provinces are unfilled in 2007. The corresponding figure is 24% in cities and 8% in municipalities (Table 10).

Income Class Provinces Cities Municipalities

First Income Class 13.2 27.7 13.3Second Income Class 21.1 12.3 8.2Third Income Class 7.7 9.0 5.4Fourth Income Class 20.2 25.8 6.1Fifth Income Class 19.4 NA 7.1Sixth Income Class NA NA 10.0

All income classes 13.9 24.0 8.0Source of basic data: PS expenditure policy survey, 2008

Table 10. Percent of Unfilled Regular Positions to Total Number of Regular Positions, 2007

The discussion above highlights the tension between the imperative to professionalize the local bureaucracy and to provide security of tenure, on the one hand, and the need for flexibility to respond to changing needs and to work for greater efficiency in government operation. The greater protection from dismissal that is generally granted to civil servants in many countries is anchored on: (i) the need to promote continuity in the delivery of public services and to serve the longer-term concerns of government; (ii) the need to secure the neutrality of bureaucracy and protect it from inappropriate personnel changes due to political pressures; and (iii) the perceived efficacy of long-term career paths in encouraging discipline in the workplace because the risk of losing tenured employment is viewed by many as a serious threat (World Bank website on administrative and civil service reform). On the other hand, there is a need to balance these concerns with the reality that the civil service has to also be sensitive to the priorities of the current administration. Shepherd (2003) emphasizes two factors that are important in thinking about the issue of tenure in the civil service: (i) the kind of labor market that is applicable to civil servants occupying certain positions and (ii) the functional role that certain positions are meant to perform, differentiating between core and non-core functions and between high-level policy making functions, on the one hand, and policy execution functions, on the other hand. He says:

“The tenure argument applies most clearly to senior civil servants at the core of government: it is the more important decisions and actions made by these people that can be subject to political manipulation; and it is these civil servants who tend to be committed to a career in an internal labor market with few career alternatives. Other senior civil servants working in non-core functions, notably service delivery, arguably function within external labor markets, and can thus shift with more ease into private-sector jobs. In these cases, private-sector labor-contract arrangements (or at least fixed contracts under public-employment statutes) seem more appropriate. The tendency in


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advanced countries to separate policy-making from policy-executing agencies (and to create executive agencies for the latter) goes in this direction. Arguments against tenure in the lowest levels – drivers, cleaners, guardians, for instance – are these jobs are part of external labor markets. Some countries, sensibly, exclude these jobs from the civil service.”

The World Bank (World Bank website on administrative and civil service reform) notes that fixed term employment contracts are increasingly being used to define terms of employment, pay arrangements and to specify performance requirements in developed and even some developing countries. In these countries, fixed term employment contracts are common for senior positions as this type of employment arrangement were originally introduced to endow the senior civil service with more flexibility. 3.1.3. Recommendations There is a need to review and define model organizational structures for LGUs with corresponding staffing pattern (by level and by income class). Needless to say, the amended model organization structures should be indicative rather than prescriptive. Related to this, the model staffing patterns may indicate minimum and maximum number and level of positions for each LGU level and income class. As a corollary, there is a need to establish criteria and/ or benchmarks that LGUs can refer to in deciding on the staffing pattern that is appropriate for their particular situation. Revisions to the model organizational structure and staffing pattern could possibly lead to a more compact list of plantilla positions that include only positions that are needed for the delivery of the core mandates of LGUs. Fixed-term employment contracts may then be considered for personnel who are focused on the delivery of the priorities of the current administration but which are not part of the core mandates of the LGU. The tenure of department heads and heads of the various offices may also have to be revisited, weighing the trade-off between the need for personnel who have the full trust and confidence of the LCE, on the one hand, and the need to promote continuity in public administration at the local level, on the other hand. 3.2. Pay and Compensation Concerns The international literature suggests that the framework in thinking about public sector pay and compensation policy is arriving at “a level of pay that is consistent with the operation of a motivated and professional public service at a scale the government can afford on a sustained financing basis” (World Bank website on administrative and civil service reform). In this regard, the World Bank further notes that the first step in a pay reform strategy is to determine the medium-term resource envelope. UNDESA (2005) echoes the same guidance saying that “a pay policy does not determine affordability; rather, affordability is a constraint


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imposed by the budget.” In other words, fiscal sustainability should be primordial in the LGUs’ hierarchy of objectives. UNDESA (2005) further argues that pay policy involves the following:

Bringing pay in line with government’s overall policy objectives; Determining the basis for pay which consists of the appropriate mix of

primary factors (e.g., affordability, job content) and secondary factors (e.g., cost of living, market-based pay, qualifications and individual performance);

Establishing an appropriate “compression ratio” between the pay of the highest and lowest positions; and

Striking a balance between pay, other benefits (including pensions) and allowances.

Given this framework, this subsection reviews the following outstanding issues related to LGU pay and compensation policy: (i) PS cap issue, (ii) differentiated salary schedule (iii) too many allowances, (iv) Magna Carta benefits for public health workers and public social workers, (v) grant of unanticipated extra year-end benefits, and (vi) grant of allowances/ honoraria to NG personnel. 3.2.1. Compliance with the PS Cap Prior to Waivers Section 325 of the Local Government Code provides that the total annual appropriations for personal services of LGUs should not exceed 45% of their total annual income from regular sources realized in the next preceding fiscal year in the case of 1st to 3rd income class LGUs and 55% in the case of 4th to 6th class LGUs. Many LGUs fail to comply with the PS cap prior to the application of the waivers. Fifty-eight percent of provinces, 40% of cities and 75% of municipalities exceed the PS cap prior to the application of the waivers in 2007 (Table 11). Moreover, compliance with the PS cap appears to be correlated with the fiscal capacity of the LGU as proxied by its income class. That is, regardless of level of local government, the percentage of LGUs that are not able to meet the PS cap requirement tends to be higher for LGUs belonging to the lower income categories than for those belonging to the higher income categories. The impact of the non-compliance with the PS cap on the distribution of the total LGU spending on different objects of expenditures is shown in Table 12. It underscores the perverse impact of non-compliance with the PS cap on both MOOE spending and capital outlays of LGUs at all levels of local government. For instance, provinces which successfully adhered with the PS cap allocated 34%, 45% and 21% to PS, MOOE and CO, respectively, compared to the 50%, 41% and 10% that their non-compliant counterparts provide in 2007. In like manner, municipalities which comply with the PS cap (abstracting from the waivers) allocated 42%, 46% and 12% to PS, MOOE and CO, respectively, compared to the 54%, 35% and 10% that non-compliant municipalities provide.


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These figures provide a strong argument for sustaining the budgetary limitations on PS spending that are now found in the LGC.

Table 11. Percentage of LGUs complying with PS Cap, 2007

Income ClassNumber of

LGUs in Sample

No. of LGUs exceeding PS

cap before waivers

% exceeding the PS cap

before waivers

Number of LGUs in Sample


cap before waivers


before waivers

Number of LGUs in Sample


cap before waivers


before waivers

First Income Class 15 7 46.7 20 5 25.0 57 32 56.1Second Income Class 4 2 50.0 6 3 50.0 50 33 66.0Third Income Class 8 6 75.0 10 5 50.0 95 77 81.1Fourth Income Class 3 2 66.7 9 5 55.6 166 124 74.7Fifth Income Class 1 1 100.0 0 0 NA 120 108 90.0Sixth Income Class 0 0 NA 0 0 NA 22 10 45.5

All income classes 31 18 58.1 45 18 40.0 510 384 75.3Source of basic data: PS expenditure policy survey, 2008

MunicipalitiesProvinces Cities

3.2.2. Adoption of Salary Schedule of Higher Class LGUs As indicated earlier, the Senate and House of Representatives Joint Resolution No. 1 of 1994 allowed LGUs other than special cities and first income class provinces and cities to adopt the salary schedules of higher class LGUs subject to the following conditions and limitations:

That the LGU must first implement fully the prescribed salary schedule for its income class and assure sustainability before it can exercise the option to adopt a higher salary schedule;

That the LGU is financially capable; That the salary schedule to be adopted shall be uniformly applied to all

positions in the LGU concerned; That the difference arising from the adoption of the higher salary schedule

shall be subject to the budgetary and general limitations on personal services expenditures mandated under Sections 324 and 325 of RA No. 7160 as implemented by Local Budget Circular (LBC) No. 75 dated July 12, 2002; and

That in the case of component cities and municipalities, the salary schedule to be adopted shall not be higher than that of the province where they belong.


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The Manual on Position Classification and Compensation System (DBM 2007) provides that when an LGU which has adopted a higher salary schedule as authorized finds that it can no longer afford to sustain such schedule, may revert to the prescribed or lower salary. However, to maintain the integrity and consistency of the Pay Plan the following rules shall apply in reverting to the prescribed/ lower salary schedule:

No personnel whose salaries have been adjusted based on the higher salary schedule shall suffer diminution in pay as a result thereof.

For new hirees/ appointees, their salaries shall be at the hiring rates of their positions based on the prescribed/ lower salary schedule.

Table 12. Size of LGU wage bill, by compliance with PS cap, 2007

Provinces Total No. of LGUs

% of PS Expd to

Total Income

% of PS Expd to Current Regular Income

% of PS Expd to

Total Expd

% of MOOE to

Total Expd

% of Capital

Outlay to Total Expd

ProvincesComplying with PS cap 13 32.9 35.4 34.2 44.8 21.0Not complying with PS cap 18 43.9 45.9 49.7 40.9 9.5

Total 31 38.5 40.8 41.7 42.9 15.4Cities

Complying with PS cap 27 25.0 25.5 28.1 55.1 16.7Not complying with PS cap 27 37.7 40.4 38.8 42.2 19.0

Total 54 27.2 28.0 30.2 52.7 17.2Municipalities

First Income Class 126 36.7 38.2 41.6 46.0 12.4Second Income Class 384 49.6 53.3 54.3 35.4 10.2

Total 510 45.5 48.4 50.4 38.7 10.9Source of basic data: PS expenditure policy survey, 2008 The DBM (2007) notes that the intent of this provision of the Joint Resolution No. 1 of 1994 was to minimize the disparity in pay between personnel of national government agencies who were devolved to LGUs and the organic personnel of the LGUs. This problem arose because devolved personnel retained their salaries which were set on the basis of the national government pay scale and thus were getting first class rates, regardless of the class of the LGU to which they were devolved. It should be noted that despite the LGC provision authorizing Local Sanggunians to determine the positions, salaries and wages, and allowances of local officials and employees, LGUs actually have little flexibility in terms of actually setting pay and compensation at the local level prior to the passage of the Joint Resolution No. 1 of 1994 because whatever pay and compensation scheme they adopt has


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to be consistent with the provisions of RA 6758 which are fairly specific. However, the provision on Joint Resolution with respect to the adoption of salary schedules of higher class LGUs changed this. With this provision, LGUs are now basically able to choose from any one of the eight salary schedules that are available to them subject only to the budget constraint. Although the guidelines governing the implementation of the Joint Resolution allows for reversion to the prescribed or lower salary schedule should LGUs find the current PS spending fiscally unsustainable, the provision regarding “no diminution of salaries” of incumbents in cases of reversion effectively ensures that such reversion would have little impact on PS spending in the near to medium term. Also, the provisions of the Joint Resolution with respect to the adoption of higher salary schedules together with the many waivers that were later allowed in computing compliance to the PS cap weakens the imperative for LGUs to work within hard budget constraints. In a sense, the Joint resolution and the waivers tended to nullify the fiscal discipline imposed by the PS cap. In 2007, 29% of provinces, 36% of cities and 40% of municipalities adopted salary schedules of higher class LGUs (Table 13). Moreover, more than half of these LGUs adopted salary schedules that are more than one notch higher than that of their own income class.

Higher Class LGUs, 2007Salary schedule adopted No. of LGUs %

All Provinces 31 100.0

for own income class 22 71.0 for immediately succeeding income class 4 12.9 for next succeeding income class or higher 5 16.1All Cities 45 100.0

for own income class 29 64.4 for immediately succeeding income class 5 11.1 for next succeeding income class or higher 11 24.4All Municipalities 510 100.0

for own income class 307 60.2 for immediately succeeding income class 101 19.8 for next succeeding income class or higher 102 20.0Source of basic data: PS expenditure policy survey, 2008

Table 13. Number of LGUs Adopting Salary Schedule of Higher

Predictably, adherence with the PS cap requirement is compromised by the adoption of the higher salary schedules. Thus, 78% of provinces which adopted salary schedules higher than their own exceeded the PS cap (abstracting from the waivers to the application of the cap) while only 50% of those which implemented the schedule of their own income class did in 2007 (Table 14). In


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like manner, the percentage of cities which fail to observe the PS cap is higher for cities which implemented salary schedules other than that of their own income class (44%) compared to those which adopted the salary schedule of their own income class (38%). Similarly, 79% of municipalities which implemented higher salary schedules had PS expenditures in excess of the PS cap compared to 73% of those which adopted the prescribed schedule that were not able to meet the PS cap requirement.

Salary schedule adopted

No. of LGUs in Sample

No. Exceeding

PS Cap%

All Provinces 31 18 58.1 for own income class 22 11 50.0 for immediately succeeding income class 4 2 50.0 for next succeeding income class or higher 5 5 100.0

All Cities 45 18 40.0 for own income class 29 11 37.9 for immediately succeeding income class 5 2 40.0 for next succeeding income class or higher 11 5 45.5

All Municipalities 510 384 75.3 for own income class 307 223 72.6 for immediately succeeding income class 101 81 80.2 for next succeeding income class or higher 102 80 78.4Source of basic data: PS expenditure policy survey, 2008

Table 14. Proportion of LGUs Exceeding PS Cap Before Waivers, by Salary by Salary Schedule Adopted, 2007

3.2.3. Differentiated Salary Schedule for LGUs There are two levels of differentiation in rates of pay that are applicable to same positions in LGUs of different levels and different income classes. The first level of differentiation is due to the provision under Section 10 of RA 6758 (as shown in Table 3) which is presumably based on the financial capacity of LGUs as indicated by their income class. The second level of differentiation arises from the fact that in the implementation of RA 6758 different salary grades are assigned to higher level positions in the LGU depending on the kind of city (i.e., highly urbanized cities/ independent component cities vis-a-vis component cities), on the income class of the municipality and on whether the said position is in the province, city or municipality. For instance, the applicable salary grade for department heads is from salary grade (SG) 27 in special cities, SG 26 in provinces and HUCs, SG 25 in component cities and municipalities in NCR and SG 24 in other municipalities. Similar differentiation is also applied to assistant department head positions in different LGUs.


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One could argue that the first level of differentiation is based on the principle that the LGU staffing and compensation should be set at levels that are fiscally sustainable for the LGU. The premise of the second level of salary differentiation is not as obvious. Conceivably, the higher salary grades prescribed for provinces and highly urbanized cities may be related to the relatively wider span of control that department heads and LGU officials occupying relatively higher positions exercise relative to their counterparts in component cities and municipalities. Also, it is not clear why there should be a difference in the salary grades assigned to higher level positions in component cities, on the one hand, and their counterparts in municipalities, on the other hand, given that the component cities and municipalities have very similar expenditure assignments. If the reason for the differentiation between these two groups is anchored on the fact that the fiscal capacity of cities are generally higher than that of municipalities, then one can argue that this concern is already being addressed by the first level differentiation. Given this perspective, there is a need to revisit the parameters of the second level of salary differentiation at the local level. 3.2.4. Waivers to Application of the PS Cap As discussed in Section 2 above, the failure of a significant proportion of LGUs to implement SSL2 while observing the PS cap paved the way for certain PS expense items to be waived in computing compliance with the budgetary limitation on PS spending. In line with these, the salaries, allowances and other compensation associated with the creation of mandatory positions, continued implementation of SSL, absorption of devolved personnel, payment of MC benefits of public health workers (PHWs), and absorption of devolved hospital services cost transferred to cities from provinces are considered waived in evaluating compliance with the PS cap. Without the waivers on the PS cap, many LGUs find it difficult to formulate their budget without violating some of the budgeting rules or the limitations on Ps spending. However, the lack of consistency in the review of local budgets given the fact that different entities are tasked with this budget review function resulted in the uneven application/ enforcement of Local Budget Circular (LBC) 75 of 2002 which governs the application of the waivers. Thus, some of the observers interviewed for this study opined that compliance with LBC 75 is a farce. 3.2.5. Allowances and Other Benefits Too many allowances. The list of authorized allowances and benefits for LGU personnel under LBC No. 75 (2002) included the following: Additional Compensation Allowance (ADCOM), Personnel Economic Relief Allowance (PERA), uniform/ clothing allowance, Productivity Incentive Benefits (PIB), commutable representation and transportation allowances (RATA), year-end benefits (YEB), step increments for length of service, Magna Carta Benefits for


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Public Health Workers, per diem of the local officials/ employees, specialists’ fees and allowances (in case employer-employee relationship exists). Very specific guidelines are provided by DBM as to the application of each of these allowances: (i) who benefits and (ii) how each is computed. Surprisingly, Table 15 shows that many LGUs do not comply with the said rules and guidelines. It would streamline not only the financial reports but more importantly the work of the payroll unit if some of the allowances can be embedded in the base pay if so warranted (e.g., PERA and ADCOM). Also, there is a need to evaluate the other allowances, differentiating position-based allowances and task-based allowances with the end in view of integrating or consolidating those that are similar to each other.5 Grant of “unanticipated” extra benefits at year-end. In recent years, there has been a tendency for the national government to announce the grant of additional/ extra year-end benefits subject to the availability of funds at the level of the operating unit as the budget year is about to come to a close. This practice has created perverse incentives on the part of the LGUs. So as to be able to give such extra benefits, LGUs deliberately generate “savings” from its regular activities sometimes at the expense of service delivery. Thus, this practice should be discontinued in order to improve public expenditure management at the local level. PHW Magna Carta benefits. Under the Magna Carta of Public Health Workers (Republic Act 7305), said workers are granted subsistence allowance, laundry allowance, night-shift differential, hazard pay, and longevity pay. The subsistence allowance is equal to PhP 1,500 per month, while the laundry allowance is equal to PhP 150 per month. On the other hand, the hazard pay is equivalent to at least 25% of basic pay for PHWs receiving salary grade 19 and below and 5% of basic pay for PHWs receiving salary grade 20 and above. The longevity pay is equal to 5% of basic pay for every 5 years of continuous service.

5 Position-based allowances are those which are usually attached to jobs with more than usual risk or skills requirement such as dealing with law and order, or attached to "hardship" locations such as mountainous or inaccessible areas, and which are often a percentage of the base salary. On the other hand, tasked-based allowances are those which are paid on the assumption that a civil servants is doing more than what one person can reasonably be expected to do and which are given to persuade an employee to take on the additional responsibility as a temporary measure.


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Table 15. Percent of LGUs not complying with restrictions on giving of allowances, 2007

Provinces

First Income Class 15 100.0 73.3 86.7 46.7 33.3 80.0 100.0 80.0 86.7 93.3 13.3Second Income Class 4 100.0 50.0 75.0 75.0 50.0 100.0 100.0 75.0 75.0 100.0 0.0Third Income Class 8 100.0 62.5 62.5 37.5 37.5 62.5 100.0 87.5 87.5 100.0 0.0Fourth Income Class 3 66.7 0.0 33.3 33.3 33.3 66.7 100.0 66.7 100.0 100.0 0.0Fifth Income Class 1 100.0 100.0 0.0 0.0 0.0 0.0 100.0 100.0 0.0 100.0 0.0Sixth Income Class 0 NA NA NA NA NA NA NA NA NA NA NA

Total 31 96.8 61.3 71.0 45.2 35.5 74.2 100.0 80.6 83.9 96.8 6.5

Cities

First Income Class 20 65.0 50.0 50.0 45.0 5.0 60.0 85.0 65.0 60.0 75.0 10.0Second Income Class 6 100.0 16.7 83.3 0.0 0.0 83.3 100.0 83.3 83.3 100.0 16.7Third Income Class 10 100.0 30.0 60.0 50.0 30.0 70.0 100.0 70.0 80.0 100.0 20.0Fourth Income Class 9 100.0 0.0 77.8 22.2 11.1 77.8 100.0 88.9 88.9 100.0 22.2Fifth Income Class 0 NA NA NA NA NA NA NA NA NA NA NASixth Income Class 0 NA NA NA NA NA NA NA NA NA NA NA

Total 45 84.4 31.1 62.2 35.6 11.1 68.9 93.3 73.3 73.3 88.9 15.6

Municipalities

First Income Class 57 82.5 63.2 77.2 36.8 12.3 54.4 100.0 84.2 70.2 94.7 8.8Second Income Class 50 96.0 66.0 68.0 48.0 24.0 52.0 100.0 84.0 66.0 86.0 4.0Third Income Class 95 88.4 62.1 67.4 47.4 29.5 55.8 100.0 77.9 74.7 93.7 6.3Fourth Income Class 166 95.8 59.0 60.8 48.2 29.5 44.6 98.8 88.0 68.7 90.4 4.8Fifth Income Class 120 90.0 52.5 59.2 55.8 37.5 29.2 99.2 85.8 70.8 95.0 1.7Sixth Income Class 22 63.6 50.0 22.7 13.6 9.1 9.1 81.8 68.2 77.3 86.4 0.0

Total 510 90.2 58.8 62.5 47.1 28.0 43.3 98.6 83.9 70.6 92.0 4.5Source of basic data: PS expenditure policy survey, 2008

% of LGUs w/ Cash Gift

>PhP 5000

% of LGUs w/

RLIP/ salary <.12

% of LGUs w/ PAG-

IBIG/salary <.02

% of LGUs w/ Ave.

Anniversary Bonus

>PhP3000

% of LGUs w/ ave.

subsistence allowance of PHWs <

PHP 1500*12

% of LGUs w/ ave. laundry allowance of PHWs < PHP

150*12

% of LGUs w/ total

overtime pay >.05 *

annual salary

% of LGUs w/ Year-end Bonus/ annual salary>

1/12

Total No. of LGUs

% of LGUs w/ ave. PERA >

adj. PHP 500*12

% of LGUs w/ ave. addl

comp> PHP 1500*12

% of LGUs w/ ave.

clothing allowance

> PHP 4000


>PhP 5000

% of LGUs w/

RLIP/ salary <.12

% of LGUs w/ PAG-

IBIG/salary <.02

% of LGUs w/ Ave.

Anniversary Bonus

>PhP3000

% of LGUs w/ ave.


PHP 1500*12


150*12

% of LGUs w/ total

overtime pay >.05 *

annual salary


1/12

Total No. of LGUs


adj. PHP 500*12


comp> PHP 1500*12

% of LGUs w/ ave.

clothing allowance

> PHP 4000


>PhP 5000

% of LGUs w/

RLIP/ salary <.12

% of LGUs w/ PAG-

IBIG/salary <.02

% of LGUs w/ Ave.

Anniversary Bonus

>PhP3000

% of LGUs w/ ave.


PHP 1500*12


150*12

% of LGUs w/ total

overtime pay >.05 *

annual salary


1/12

Total No. of LGUs


adj. PHP 500*12


comp> PHP 1500*12

% of LGUs w/ ave.

clothing allowance

> PHP 4000


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To date, many LGUs are not giving all the allowances due PHWs under RA 7305 in full. Less than 50% of provinces, cities and municipalities are providing the subsistence and the laundry allowance at the prescribed rates in 2007 (Table 16). Key informant interviews suggest that the percentage of LGUs which are providing the hazard pay at the prescribed rates is even smaller.6 Data from the PS expenditure survey indicates that the subsistence allowance and the laundry allowance actually granted by LGUs account for about 3% of total PS expenditures of provinces and less than 2% of total PS expenditures of both cities and municipalities.

Provinces

First Income Class 15 46.7 33.3Second Income Class 4 75.0 50.0Third Income Class 8 37.5 37.5Fourth Income Class 3 33.3 33.3Fifth Income Class 1 0.0 0.0Sixth Income Class 0 NA NA

Total 31 45.2 35.5

Cities

First Income Class 20 45.0 5.0Second Income Class 6 0.0 0.0Third Income Class 10 50.0 30.0Fourth Income Class 9 22.2 11.1Fifth Income Class 0 NA NASixth Income Class 0 NA NA

Total 45 35.6 11.1

Municipalities

First Income Class 57 36.8 12.3Second Income Class 50 48.0 24.0Third Income Class 95 47.4 29.5Fourth Income Class 166 48.2 29.5Fifth Income Class 120 55.8 37.5Sixth Income Class 22 13.6 9.1

Total 510 47.1 28.0Source of basic data: PS expenditure policy survey, 2008

Magna Carta benefits to PHWs, 2007Table 16. Percent of LGUs not complying with restrictions on giving of

No. of LGUs w/ ave. laundry allowance of PHWs < PHP 150*12

No. of LGUs w/ ave. subsistence allowance of PHWs < PHP 1500*12




Total No. of LGUs

Total No. of LGUs

Total No. of LGUs


6 The PS survey was not able to get firm numbers on the proportion of LGUs which are providing the hazard pay at prescribed rates.


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However, the Magna Carta of PHW is a especially sensitive matter at the local level. It creates conflict between the LCE and other officials, on the one hand, and the PHWs, on the other, where the Magna Carta allowances are not granted in full or where said allowances are not granted at all. There are many reports of cases filed in the courts or Ombudsman against LCEs and sometimes other local officials like the local Budget Officer by PHWs due to non-implementation of the Magna Carta benefits. This study recommends that Congress should revisit the desirability of grant of Magna Carta-type MC benefits to all government employees instead of special groups only. The desire to provide higher pay to public health workers, particularly doctors and nurses, who are deemed to be underpaid relative to the demand for their services in the local as well as foreign labor markets is understandable. But, perhaps this concern might be addressed better by adjusting the salary grades that currently assigned to these positions instead of providing blanket salary top-ups to all PHWs. Moreover, the experience with the implementation Magna Carta of PHWs shows that legislation of this type can be counterproductive. Grant of allowances to national government personnel. The LGC allows LGUs to grant additional allowances and benefits to judges, prosecutors, public school teachers and other national government officials stationed in or assigned in localities when LGU finances allow. Although the grant of these allowances is not a must, LGUs are put under extreme pressure to actually grant them. Moreover, the list of national government personnel being given additional allowances is long and includes, in addition to those already mentioned, personnel from the PNP, the Bureau of Fire Protection, Comelec, the BIR among others. The grant of these allowances imposes a heavy drain on LGU resources, especially that of poorer LGUs. It also raises the possibility that said national government personnel may actually be getting allowances from multiple sources (from different LGUs as well as from their own mother unit). It is recommended that the pertinent section of the LGC be amended to disallow the grant of additional allowances and benefits to national government officials. 3.2.6. Decomposing Non-Compliance with the PS Cap Counterfactual simulations were made as part of this study to better understand the reasons for non-compliance with the PS cap. In particular, the impact of (i) the hiring of non-regular employees, (ii) the adoption of higher salary schedule and (iii) the payment of Magna Carta benefits of public health workers were examined. The analysis reveals that if all three of these elements were excluded from the computation of compliance with the PS cap, the proportion of provinces which are not able to observe the PS cap will go down from 58% to 42%. The corresponding proportion for cities is estimated to decrease from 40% to 20% while that for municipalities is estimated to be decline from 75% to 56% (Table 17).


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Table 17. Some counterfactuals on number of LGUs exceeding PS cap, 2007

No. of LGUs in Sample

No. of LGUs with PS Expd in Excess of

PS Cap Before

Waivers

% of LGUs with PS Expd in Excess of

PS Cap Before

Waivers

No. of LGUs with PS net

Non-Regular Positions in

Excess of PS Cap

% of LGUs with PS net


Excess of PS Cap

No. of LGUs with PS Expd Net of Magna

Carta Ben. For PHWs in Excess of PS

Cap

% of LGUs with PS Expd Net of Magna

Carta Ben. For PHWs in Excess of PS

Cap

No. of LGUS w/ PS Expd

Net of Cost of Adoption of Higher SS in excess of PS

Cap

% of LGUS w/ PS Expd Net

of Cost of Adoption of Higher SS in excess of PS

Cap

No. of LGUs with PS net of

non-reg personnel and

MC benefits

% of LGUs with PS net


Excess of PS Cap and MC

Benefits

No. of LGUs with PS net of

non-reg personnel, MC benefits & cost

of higher SS

% of LGUs with PS net of non-reg personnel, MC benefits & cost of higher

SS

ProvincesFirst Income Class 15 7 46.7 5 33.3 6 40.0 7 46.7 5 33.3 5 33.3Second Income Class 4 2 50.0 2 50.0 2 50.0 2 50.0 2 50.0 2 50.0Third Income Class 8 6 75.0 6 75.0 6 75.0 6 75.0 6 75.0 5 62.5Fourth Income Class 3 2 66.7 2 66.7 2 66.7 1 33.3 1 33.3 1 33.3Fifth Income Class 1 1 100.0 1 100.0 1 100.0 0 0.0 1 100.0 0 0.0Sixth Income Class 0 NA NA NA NA NA NA NA NA NA NA NA NA

All income classes 31 18 58.1 16 51.6 17 54.8 16 51.6 15 48.4 13 41.9

CitiesFirst Income Class 20 5 25.0 1 5.0 8 40.0 8 40.0 4 20.0 4 20.0Second Income Class 6 3 50.0 1 16.7 1 16.7 1 16.7 1 16.7 1 16.7Third Income Class 10 5 50.0 5 50.0 6 60.0 5 50.0 5 50.0 4 40.0Fourth Income Class 9 5 55.6 0 0.0 0 0.0 0 0.0 0 0.0 0 0.0Fifth Income Class 0 NA NA NA NA NA NA NA NA NA NA NA NASixth Income Class 0 NA NA NA NA NA NA NA NA NA NA NA NA

All income classes 45 18 40.0 7 15.6 15 33.3 14 31.1 10 22.2 9 20.0

MunicipalitiesFirst Income Class 57 32 56.1 22 38.6 31 54.4 32 56.1 20 35.1 20 35.1Second Income Class 50 33 66.0 26 52.0 30 60.0 32 64.0 22 44.0 20 40.0Third Income Class 95 77 81.1 72 75.8 76 80.0 73 76.8 71 74.7 66 69.5Fourth Income Class 166 124 74.7 105 63.3 116 69.9 99 59.6 98 59.0 77 46.4Fifth Income Class 120 108 90.0 102 85.0 106 88.3 101 84.2 100 83.3 90 75.0Sixth Income Class 22 10 45.5 10 45.5 10 45.5 10 45.5 10 45.5 10 45.5

All income classes 510 384 75.3 337 66.1 369 72.4 347 68.0 321 62.9 283 55.5Source of basic data: PS expenditure policy survey, 2008


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The analysis also shows that the payment of Magna Carta benefits of PHWs appears to have the smallest impact on the ability of LGUs regardless of level to conform with the PS cap requirements. In contrast, the number of non-regular employees in the employment rolls of LGUs appears to have the biggest impact on compliance with the PS cap, especially in the case of cities and municipalities. For instance, the proportion of cities which are not able to comply with the PS cap is estimated to go down from 40% to 16% if the PS cost of non-regular employees were excluded from LGUs’ actual PS expenditures. The corresponding proportion for municipalities is estimated to be reduced from 75% to 66%. The impact of the adoption of higher salary schedules is found to be significant as well. To wit, the proportion of cities which are not able to comply with the PS cap is estimated to go down from 40% to 31% if all LGUs had adopted the salary schedules that are prescribed for their own income class. The corresponding proportion for municipalities is estimated to be reduced from 75% to 68% while that for provinces was reduced from 58% to 52%. Given this findings, this study recommends that LGUs be given the flexibility to set their own compensation and pay policy provided they comply strictly with the PS cap. In line with this, the study also recommends that most if not all of the waivers to the application of the PS cap be eliminated in as much as the presence of these waivers seriously undermines fiscal discipline. 3.2.7. Simulation of Impact of SSL3 A proposal to revise the government salary schedule upwards as part of the third wave of salary standardization is pending in Congress at present. This proposal (which has come to be known as SSL3) aims to correct the erosion of real public sector wages and salaries in recent years and to decompress the wage structure in the public sector. This study simulated what will happen to the LGU wage bill using the staffing pattern of 3 municipalities, 2 cities and 1 province if SSL3 were to be implemented starting 2010 over a 4 year period. The results of the simulation indicate that the full implementation of SSL3 will jack up the wage bill of municipalities by 82%-102%, that of cities by 78%-94% and that of provinces by some 69%. As expected, SSL3 will increasingly make it difficult for LGUs to keep their PS spending below the PS cap. It is estimated that the ratio of PS spending to the PS cap will go up by some 5-11 percentage points in the case of municipalities, by 4-8 percentage points in the case of cities and 1 percentage point in the case of provinces. These estimates are based on the assumption that LGU income will increase by 19% in 2009 and 10% every year thereafter until 2013.7 Admittedly,

7 The projected 10% growth rate for LGU income in 2010-2013 is based on historical performance in the last 5 years.


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these results are based on a fairly small sample. Prospectively, this issue needs to be studied further. It would also be helpful if a toolkit which LGUs can use in making hard choices between number of employees and the corresponding wage bill is developed. Such a toolkit will help LGUs evaluate different “what if” scenarios. This will be particularly useful for LGUs when they consider the sustainability of the proposed round of salary increases and alternative responses. 3.2.8. Recommendations First, there is a strong argument for retaining the cap on LGU spending on personal services. Doing so reinforces the imperative for LGUs to live within hard budget constraints. Thus, it is recommended that the PS cap be retained. This recommendation is anchored on the premise that service delivery requires a mix of both wage and non-wage spending. If spending is too skewed in favor of personal services, service delivery suffers because of the squeeze on supplies, travel and other resources that are needed to complement personnel resources as well as local public infrastructure needed for local economic development. Second, it is recommended that LGUs be given the discretion to choose any which one of the eight alternative salary schedules (which is provided in Section 10 of RA 6758 and which is shown as Table 3 in this paper) that they think is best suited to their particular situation guided by their fiscal capacity and subject to their complying strictly with the PS cap. In other words, we recommend that LGUs be given the flexibility to set their own compensation and pay policy as long as they work within the constraints imposed by the fiscal headroom that is actually available to them. In line with this, we also recommend that most if not all of the waivers to the application of the PS cap be eliminated. The presence of these waivers seriously undermines fiscal discipline. Third, there is a need to revisit the parameters that form the basis for assigning different salary grades for higher level positions in LGUs of different income class and different levels. Fourth, the practice of granting additional/ extra year-end benefits subject to the availability of funds at the level of the operating unit as the budget year is about to come to a close should be discontinued in order to improve public expenditure management at the local level. Fifth, it is recommended that the pertinent section of the LGC be amended to disallow the grant of additional allowances and benefits to national government officials. This provision puts undue pressure on LGUs to provide such allowances at the expense of local service delivery.


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Sixth, there is a need to coordinate implementation of benefits under various Magna Carta legislations with implementation of the overall compensation structure of government, especially under SSL3. Congress should revisit the desirability of grant of Magna Carta-type MC benefits to all government employees instead of special groups only. The experience with the implementation Magna Carta of PHWs shows that legislation of this type can be counterproductive. On the other hand, the desire to provide higher pay to public health workers, particularly doctors and nurses, might be addressed better by adjusting the salary grades that currently assigned to these positions instead of providing blanket salary top-ups to all PHWs. Moreover, 4. CONCLUSION The basic policy problem with respect to public sector employment and compensation policy at the local level revolves around the question of how to effectively control the LGU wage bill while simultaneously trying to ensure that LGUs have an adequate number of personnel with the appropriate qualifications that will enable them to deliver the services needed by their constituency and to improve remuneration to attract and/ or retain technical, professional and managerial staff. The guidance from the international literature suggests that the first step in a pay reform strategy is to determine the medium-term resource envelope. In other words, fiscal sustainability should be primordial in the LGUs’ hierarchy of objectives. Because the arithmetic is such that wage bill is very simply the product of the number of employees and the wage rate, PS expenditure policy has to consider issues related to both staffing and pay policy. Moreover, position classification and compensation concerns cannot be completely divorced from staffing concerns. Related to this, there is need for a body similar to the Joint Commission on Local Government Personnel Administration to be constituted to act as oversight body on local personnel matters and to ensure better coordination of (i) staffing and employment policies, (ii) position classification and compensation policies, and (iii) sectoral policies. There is also a need to review and define model organizational structures for LGUs with corresponding staffing pattern (by level and by income class). The amended model organization structures should be indicative rather than prescriptive. As a corollary, there is a need to establish criteria and/ or benchmarks that LGUs can refer to in deciding on the staffing pattern that is appropriate for their particular situation. The revised model organizational structure and staffing pattern could possibly lead to a more compact list of plantilla positions that include only positions that are needed for the delivery of the core mandates of LGUs. Fixed-term employment contracts may then be considered for personnel who are focused on


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the delivery of the priorities of the current administration but which are not part of the core mandates of the LGU. It is recommended that the cap on LGU spending on personal services be retained. This is important so as to reinforce the imperative for LGUs to live within hard budget constraints. Related to this, we recommend that LGUs be given the flexibility to set their own compensation and pay policy (choosing one from the eight alternative salary schedules described RA 6758) as long as they work within the fiscal constraint embodied in the PS cap. We further recommend that most if not all of the waivers to the application of the PS cap be eliminated. The presence of these waivers seriously undermines fiscal discipline. There is also a need to revisit the parameters that form the basis for assigning different salary grades for higher level positions in LGUs of different income class and different levels. Meanwhile, the practice of granting additional/ extra year-end benefits subject to the availability of funds at the level of the operating unit as the budget year is about to come to a close should be discontinued in order to improve public expenditure management at the local level. Admittedly, the success of the new PS expenditure guidelines recommended above depends on the effective enforcement of said guidelines. Monitoring of LGU compliance is primarily done by way of the budget review process, where budgets of LGUs are reviewed by the DBM (for provinces, highly urbanized and independent cities and LGUs in the NCR) and the appropriate Sanggunian or legislative body (Sangguniang Panlalawigan for component cities and municipalities, Sangguniang Panlungsod for city barangays, and Sangguniang Bayan for municipal barangays). In this regard, there is a need to strengthen the capacity of provincial/ city/ municipal governments, specifically those of the provincial/ city/ municipal budget officers who support the Sanggunians in discharge of their budget review function (including compliance with the budgetary limitations on personal services expenditures). Furthermore, the pertinent provision of the LGC allowing the grant of additional allowances and benefits to national government officials should be amended as this puts undue pressure on LGUs to provide such allowances at the expense of local service delivery. In addition, there is a need to coordinate implementation of benefits under various Magna Carta legislations with implementation of the overall compensation structure of government, especially under SSL3. Finally, it would be helpful if a toolkit which LGUs can use in making hard choices between number of employees and the corresponding wage bill is developed. Such a toolkit will be particularly useful for LGUs when they consider the sustainability of the proposed round of salary increases and their alternative responses. While the implementation of SSL3 will surely present difficulties as it further exerts greater pressure to increase the LGU wage bill, but it also presents an opportunity for staffing and pay reforms to be made.


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REFERENCES Administrative Order No. 42, 1993. Clarifying the Role of the Department of

Budget and Management in the Compensation and Classification of Local Government Positions Under R.A. No. 7160

Administrative Order No. 282 (1996) Brillantes, Alex Jr. and Maricel Fernandez. 2008. “Is There a Philippine Public

Administration?” A paper presented in the public colloquium on: “Is there a Philippine Public Administration: A Timeless Issue,” held at the UP National College of Public Administration and Governance (UP NCPAG) on June 26-27, 2008.

Civil Service Commission (CSC) Memorandum Circular No. 19, s. 1992

Guidelines and Standards in the Establishment of Organizational Structures and Staffing Pattern for Local Government Units

CSC-DBM Joint Circular No. 2, s. 2003. Supplemental Rules and Regulations on

the Appropriation for Personnel Benefits Chargeable Against the Annual or Supplemental Budget of the Local Government Units

DBM Local Budget Circular No. 63, 1996. Position Classification and

Compensation of Barangay Officials and Personnel Department of Budget and Management (DBM) Local Budget Circular No. 71,

2000. Adoption of Higher Salary Schedule by Local Government Units Department of Budget and Management (DBM) Local Budget Circular No. 75,

2002. Guidelines on Personal Services Limitation Department of Budget and Management (DBM) Local Budget Circular No. 88,

2008. Rules and Regulations on the Grant of Compensation Adjustments to Local Government Personnel Pursuant to Executive Order No. 719

Department of Budget and Management (DBM). 2007. Manual on Position

Classification and Compensation System. Manila Nunberg, Barbara. 1988. “Public Sector Pay and Employment Reform.” Policy,

Planning, and Research Working Paper No. 113. Washington, D.C.: The World Bank.

Nunberg, Barbara and John Nellis. 1995. “Civil Servlce Reform and the World

Bank.” World Bank Discussion Papers No. 161. Washington, D.C.: The World Bank.


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Presidential Decree (PD) No. 1136. 1977. The Local Government Personnel Administration and Compensation Plans Decree of 1977.

Republic Act (RA) No. 7160. 1991. Local Government Code of 1991 Republic Act (RA) No. 6758. 1989. Compensation and Position Classification

Plan of 1989. Senate and House of Representatives Joint Resolution No. 01, s. 1994. Urging

the President to Revise the Existing Compensation and Position Classification System in Government and to Implement the Same Initially Effective January 1994.

Schiavo-Campo, Salvatore. 1996. “Reforming the Civil Service.” Finance and

Development. Washington, D.C.: International Monetary Fund. Shepherd, Geoffrey. 2003. “Civil Service Reform in Developing Countries: Why Is

It Going Badly?” Paper presented in the 11th International Anti-Corruption Conference held in Seoul, Republic of Korea on 25-28 May 2003.

United Nations Department of Economic and Social Affairs (UNDESA). 2005.

Unlocking the Human Potential for Public Sector Performance: World Public Sector Report 2005. New York: United Nations

United Nations Development Programme/ Management Development and

Governance Division (UNDP/ MDGD). 2001. Civil Service Reform Paper, (http://unpan1.un.org/intradoc/groups/public/documents/UN/UNPAN001183.pdf)

World Bank. 1999. “Rethinking Civil Service Reform.” PREM Notes No. 31.

Washington, D.C.: The World Bank. World Bank website on administrative and civil service reform.

http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTPUBLICSECTORANDGOVERNANCE/0,,contentMDK:20133435~menuPK:286310~pagePK:148956~piPK:216618~theSitePK:286305~isCURL:Y,00.html

http://unpan1.un.org/intradoc/groups/public/docum





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Annex

Attachment No. 1

MALACANANG

Manila

BY THE PRESIDENT OF THE PHILIPPINES

ADMINISTRATIVE ORDER NO. CREATIING A JOINT COMMITTEE ON LOCAL GOVERNMENT PERSONNEL ADMINISTRATION WHEREAS, there is a need for coordinated efforts among the oversight agencies to facilitate and integrate their efforts to promote and develop the efficiency and effectiveness of local government units and to encourage them to adopt and implement rational personnel policies and position classification and compensation system as prescribed under existing legislation’; WHEREAS, the formulation of more responsive local government personnel policies and the development of more appropriate organizational structure and staffing of the local government units, taking into account the existence of the unified position classification and compensation system; WHEREAS, the Joint Commission on Local Government Personnel Administration was abolished by RA 7160, the Local Government Code of 1991; Now, therefore, I, Gloria Macapagal-Arroyo, President of the Philippines, by virtue of the powers vested in me by law and the Constitution, do hereby order the following: Section 1. There is hereby created a Joint Committee on Local Government Personnel Administration (JCLGPA). Section 2, The JCLGPA shall be composed of the Secretary of the Department of Interior and Local Government as Chairman, the Secretary of the Department of Budget and Management (DBM), the Secretary of the Department of Finance (DOF), and the Chairman of the Civil Service Commission as Members, and hereafter to be know as the Joint Committee. The President may


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appoint as member of this Joint Committee the sitting Head of the League of Governors. Section 3. The Joint Committee will have the responsibilities of formulating policies, rules and regulations to further develop the capacity of LGUs in the development, implementation and monitoring of more meaningful personnel programs. It shall rationalize the compensation and pay plans of local government units, including the levels of pay and the allowances authorized at present; Section 5. Secretariat services shall be provided by the Organization, Position Classification and Compensation Bureau of the Department of Budget and Management. Section 6. Expenses in the conduct of this program shall initially be shared by the Department of Budget and Management and the Department of Interior and Local Government. Section 7. The Joint Committee will issue the policy paper on this matter within 45 days after the issuance of the AO. Section 8. This Order shall take effect immediately. By the President Eduardo R. Ermita

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THE SPECIAL EDUCATION FUND: PROSPECTS FOR POLICY IMPROVEMENT


1. INTRODUCTION Background. The lackluster performance overall of the Philippine basic education subsector in the last 20 years has been underscored in a number of studies (PESS, EDCOM, etc.). In fact, many analysts agree that the basic education subsector is in crisis today. To wit, the net enrollment rate from declined from 92.7% in 2000 to 84.8% in 2007 at the elementary level and from 62.3% in to 2000 to 61.9% to 2007 at the secondary level (Table 1). Also, although some improvement in the completion rate is evident at both the elementary and secondary level in 1990-2007, the basic education completion rate continues to be low. Thus, only 73 out of every 100 grade 1 entrants finish grade 6 and only 75 out of every 100 first year entrants finish high school. At the same time, the outcomes of basic education achievement tests have been erratic during the period. Moreover, student achievement scores remain at a fairly low level. For instance, the average mean percentage score (MPS) was, respectively, 64% and 49% at the elementary level and secondary level National Achievement Test (NAT) in 2007 Moreover, only 20% of grade 6 pupils attain 75% or better mastery level in the NAT for the elementary level while less than 1% of 4th year students achieve 75% or better master level in the NAT for the secondary level in 2005 (Abad FEF presentation). Table 1. Basic education outcomes, 1990-2007

1990 2000 2002 2003 2004 2005 2006 2007

Elementary level participation rate 84.6 92.7 90.3 88.7 87.1 84.4 83.2 84.8Secondary level participation rate 54.7 62.3 59.0 60.2 60.0 58.5 58.6 61.9Elementary level cohort survival rate 69.7 69.3 72.4 71.8 71.3 70.0 73.4 75.3Secondary level cohort survival rate 76.4 71.0 76.8 71.7 72.4 61.0 72.1 79.9Elementary level completion rate 67.6 66.1 66.9 70.2 69.1 68.1 71.7 73.1Secondary level completion rate 71.5 70.6 59.9 71.7 72.4 61.0 72.1 75.4Elementary level achievement score a/ 40.1 b/ 51.7 54.0 58.7 54.7 59.9 64.8Secondary level achievement score a/ 35.6 b/ 53.4 44.4 46.8 44.3 46.6 49.3

a/ based on NEAT and NSAT for 1994-2000 and o NAT for 2003-2006b/ refers to 1994 The sad state of the quality of basic education in the country is further underscored by the results of the Trends in International Mathematics and Science Study (TIMMS). In 1999, the Philippines ranked 36th in both the Math


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and Science tests given to eighth graders in 38 countries. Although the Philippines posted some gains in the 2003 TIMMS (relative to the 1999 TIMSS), the Philippines’ ranking remains low: 34th of 38 countries taking the Grade 8 Mathematics test and 43rd of 46 countries taking the Grade 8 Science test. Moreover, the Philippines continues to under perform all the countries in the region (Table 2). As a result, the country’s competitive edge in the global economy that has been attributed to its well educated labor force is continuously being eroded.

Table 2. TIMSS scale scores, 1999-2003Country

1999 2003 1999 2003Singapore 604 605 568 578South Korea 587 589 569 571HongKong 582 586 549 558Taiwan 585 585 530 556Malaysia 519 508 492 510Thailand 467 441 a/ 482 471 a/Indonesia 403 411 435 420Philippines 345 378 345 377a/ refers to result of 2007 test

Grade 8 Math Grade 8 Science

Moreover, national averages mask wide disparities across regions, indicating pockets of under-served areas. For instance, net enrollment rates vary from a low of 71% (Davao region) to a high of 81% (Bicol region) while completion rates ranged from a low of 31% (ARMM) to a high of 76% (NCR) at the elementary level (Table 3). In like manner, net enrollment rates vary from a low of 19% (ARMM) to a high of 56% (NCR) while completion rates ranged from a low of 39% (ARMM) to a high of 65% (Ilocos region). Also, the functional literacy rate ranged from a low of 63% in ARMM to a high of 95% in NCR compared to a national average of 84% in 20031. Meanwhile, the Philippines has the highest spread in test scores of grade 4 pupils among all 25 participating countries in the 2003 TIMMS. Moreover, disparities in the results of the national achievement tests at both the elementary and secondary level persist and appear to be rising (Table 4 and Table 5).

1 2003 Report on Functional Literacy, Education and Mass Media Survey (FLEMMS)


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Net Enrollment Ratio (NER)

Completion Rate

Net Enrollment Ratio (NER)

Completion Rate

Region I - Ilocos Region 76.5 76.0 52.8 64.9Region II - Cagayan Valley 74.0 70.1 46.2 62.2Region III - Central Luzon 78.8 74.1 49.9 58.7Region IV-A (CALABARZON) 79.1 67.4 51.7 55.0Region IV-B (MIMAROPA) 80.8 62.4 47.4 51.2Region V - Bicol Region 81.2 64.5 45.9 52.0Region VI - Western Visayas 71.7 59.8 45.2 55.5Region VII - Central Visayas 73.4 66.8 39.7 52.6Region VIII - Eastern Visayas 76.4 58.8 42.6 60.1Region IX - Zamboanga Peninsula 75.7 59.4 40.9 52.2Region X - Northern Mindanao 74.5 58.0 37.3 49.3Region XI - Davao Region 70.7 55.8 38.3 44.5Region XII - SOCCSKSARGEN 72.2 47.3 39.6 48.9CARAGA Region 75.8 60.5 40.6 61.5ARMM 74.3 31.1 19.3 38.8CAR 72.7 61.4 39.5 57.8NCR 73.2 76.2 55.7 62.1PHILIPPINES 75.6 62.8 45.0 55.5 Male (M) 74.8 58.8 41.0 48.7 Female (F) 76.4 67.4 49.1 62.3

Table 3. Net enrollment rate and completion rate at the elementary and secondary level by region, SY 2006-2007 a/

Elementary level Secondary level

Region

Table 4. National achievement test for Grade 6, 2004- 2004-

2005-

2006-

2007-

ILOCOS REGION 63.9 56.7 61.7 68.8 CAGAYAN VALLEY 53.5 53.2 58.0 58.7 CENTRAL LUZON 57.57.6 53.3 63.4 67.7 CALABARZON 63.4 57.0 63.3 68.4 MIMAROPA 61.1 62.4 67.1 70.2 BICOL REGION 55.0 50.4 54.6 57.2 WESTERN VISAYAS 55.8 49.3 53.7 60.4 CENTRAL VISAYAS 60.6 55.5 58.9 65.7 EASTERN VISAYAS 69.1 67.7 74.1 74.7 ZAMBOANGA PENINSULA 57.9 57.1 61.8 67.6 NORTHERN MINDANAO 54.6 54.0 56.1 62.9 DAVAO REGION 55.3 52.7 58.8 61.3 SOCCSKSARGEN 53.4 49.7 51.3 63.9 NATIONAL CAPITAL REGION 57.9 49.0 60.2 62.3 CAR 54.5 56.1 57.9 60.9 ARMM 47.0 45.3 45.1 47.0 CARAGA 68.9 70.8 71.9 75.5 TOTAL 58.7 54.7 59.9 64.8

Minimum 47.0 45.3 45.1 47.0 Maximum 69.1 70.8 74.1 75.5

Max/ Min 1.47 1.56 1.64 1.61


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Table 5. National achievement test for 2nd Year, 2003-20072003-2004 2005-2006 2006-2007 2007-2008

ILOCOS REGION 38.3 52.3 51.5 56.8CAGAYAN VALLEY 37.9 48.0 43.6 44.4CENTRAL LUZON 36.0 47.6 47.2 52.2CALABARZON 37.9 45.1 46.1 47.7MIMAROPA 36.5 49.8 47.2 50.4BICOL REGION 35.2 41.3 41.5 40.2WESTERN VISAYAS 36.7 44.8 44.8 45.2CENTRAL VISAYAS 37.2 50.8 46.9 52.6EASTERN VISAYAS 43.8 65.3 64.3 65.5ZAMBOANGA PENINSULA 40.2 49.5 47.2 55.6NORTHERN MINDANAO 37.6 45.5 43.4 47.5DAVAO REGION 37.1 42.8 43.5 44.3SOCCSKSARGEN 35.8 42.0 41.2 46.7NATIONAL CAPITAL REGION 38.2 40.5 43.1 43.9CAR 40.1 44.9 45.8 49.2ARMM 32.5 44.7 42.6 46.5CARAGA 45.8 61.0 62.9 62.9TOTAL 37.7 47.0 46.6 49.3

Minimum 32.5 40.5 41.2 40.2Maximum 45.8 65.3 64.3 65.5

Max/ Min 1.41 1.61 1.56 1.63 The disappointing performance of the basic education subsector and the large disparities across regions is a cause of concern given the close link between educational attainment of household heads and poverty status of households. Poverty incidence is found to be higher among households which are headed by individuals with lower educational attainment. In 2006, poverty incidence among households which are headed by individuals who have had no education at all is 54%. In contrast, only 2% of households headed by college graduates are poor (Table 6).

Table 6. Educational attainment of HH head and poverty status, 2006Educational attainment of HH head Poverty incidence % distn of poor HHs

No education 53.9 5.7Some elementary education 43.3 36.3Elementary graduate 35.3 25.3Some high school 29.5 13.9High school graduate 17.2 14.4Some college 8.1 3.7College graduate 1.6 0.6All HHs 26.9 100.0


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Objective of the study. It is against this backdrop that the present study is undertaken. This paper focuses on the need to ensure that all sources of financing for the basic education subsector are used in the most effective and efficient manner. In particular, this study aims to review and assess LGUs’ current practice in the allocation and utilization of the Special Education Fund (SEF) and to recommend improvements in the utilization of the SEF, if need be. The analysis below suggests that the current allocation of the SEF is going to less efficient uses. For instance, data from the Basic Education Information System (BEIS) on the actual deployment of locally funded teachers across schools show that many of these teachers are assigned in a sub-optimal manner such that in SY 2007-2008 many LGU/ SEF-funded teachers were assigned in public elementary and secondary schools with excess teachers even while the actual number of LGU/ SEF-funded teachers who were assigned in teacher-deficit public elementary and secondary schools fell short of the required number (net of the number of teachers actually deployed by the DepEd). At the same time, the analysis also suggests that the budget for capital outlays in the SEF of all LGUs as a group has declined between 2006-2008 despite the large shortage in classroom that persists during the period in many areas around the country, particularly at the secondary level. Also, some LGU officials as well as some DepEd officials point out that some Local School Boards allocate significant portions of their SEF on sports activities and competitions at the expense of instructional/ academic activities of schools. Basic public education is still largely the responsibility of the central government, delivered through the Department of Education (DepEd), notwithstanding the devolution of many basic services to LGUs. However, LGUs do provide supplementary funding support to public basic education because of they have access to a sustainable source of financial resources that are earmarked for the basic education subsector, the Special Education Fund (SEF). The monies in the SEF comes from an additional 1% tax on real property that LGUs are mandated by the Local Government Code to impose and collect. Aggregate SEF spending is fairly stable when reckoned relative to GDP, at 0.2% of GDP yearly in 2001-2007. The SEF income of all LGUs in the aggregate grew from PhP 8.5 billion in 2001 to PhP 14.2 billion in 2007. On the other hand, SEF expenditures increased from PhP 7.8 billion in 2001 to PhP 12.1 billion in 2007. While SEF spending does not seem large when compared to either general government education spending (7%-9%) or total DepEd spending (7%-10%), it is substantial when reckoned relative to DepEd non-personal services spending (41%-86%) or DepEd maintenance and operating expense or MOOE (71%-142%) (Table 7).


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In the aggregate, SEF expenditures per student in 2007 is significantly higher than the DepEd allocation for school level MOOE.In particular, if one assumes that all of the SEF expenditures of all LGUs are spent on school level MOOE and if the SEF were distributed across LGUs in direct proportion to enrollment, then per student SEF spending would equal to PhP 692. This figure is estimated to be about 3.4 times the DepEd allocation for school level MOOE of elementary schools and 1.4 times the DepEd allocation for school level MOOE of secondary schools following the regular curriculum (Table 8).

Table 7. SEF Income and Expenditures, 2001-2007 (in million pesos)2001 2002 2003 2004 2005 2006 2007

SEF Income 8,451 9,537 11,002 10,693 12,352 13,167 14,153 Province 1,440 1,658 1,707 1,702 2,038 2,100 2,287 Cities 5,516 5,875 7,104 6,824 7,887 8,691 9,620 Municipalities 1,495 2,005 2,191 2,167 2,427 2,376 2,246

SEF Expenditures 7,774 7,395 8,826 8,854 10,265 12,249 12,063 Province 1,456 1,377 1,510 1,554 2,010 1,646 1,669 Cities 4,953 4,411 5,397 5,384 6,155 8,424 8,511 Municipalities 1,365 1,607 1,920 1,916 2,100 2,179 1,883

Total LGU Educ Expd 11,022 7,838 10,068 10,311 11,067 13,226 13,816 Province 1,990 1,515 2,062 1,956 2,047 2,180 2,175 Cities 7,016 4,744 5,807 6,219 6,679 8,722 9,182 Municipalities 2,016 1,580 2,198 2,136 2,340 2,324 2,459

DepEd Expd incl. SBP 100,393 105,923 108,074 107,941 109,182 122,718 145,860

SEF expd as % of Gen Gov Educ Expd 7.0 6.5 7.5 7.5 8.5 9.0 7.6

SEF expd as % of total DepEd spending 7.7 7.0 8.2 8.2 9.4 10.0 8.3

SEF expend as % ofDepEd non-PS spending 61.0 86.4 83.9 73.9 85.5 80.6 41.0

SEF expend as % ofDepED MOOE 85.7 135.0 142.3 120.1 121.7 139.7 70.7

Source of basic data: BLGF SIE

DepEd School Level MOOE per student elementary level 207 secondary level regular curriculum 500 tech-voc curriculum 700

Aggregate SEF expenditure per student 692

Table 8. SEF expenditure per student vs. DepEd School-Level MOOE per student, SY 2007-2008 (in pesos)


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Just as there are wide disparities in basic education outcomes, there are also substantial disparities in per pupil SEF spending across LGUs of different income classes. To wit, per student SEF spending of NCR cities is almost 3 times as large as that of first income class non-NCR cities and almost 8 times as large as 5th income class cities. On the other hand, per student SEF spending of cities is greater than that of municipalities regardless of the income class of LGUs. Moreover, per student SEF spending of 1st income class municipalities is more than three times as large as fifth income class municipalities (Table 9). This occurs primarily because the more urbanized LGUs tend to have larger real property tax base as a result of the higher property values in these LGUs compared to less urbanized LGUs, other things being equal.

LGU income class Municipalities LGU income class Cities

First 143 NCR cities 1,938Second 87 First class non-NCR 669Third 68 Second/ Third 453Fourth 59 Fourth 371Fifth 45 Fifth 249

Table 9. Median SEF spending per pupil in muncipalities and cities classified according to LGU income class, 2006

2. LEGAL FRAMEWORK The Local Government Code does not explicitly devolve the provision of basic education. The Department of Education (then called the Department of Education, Culture and Sports or DECS) is not one of the national government agencies affected by the devolution program pursued following the enactment of the LGC which involved the transfer of personnel and facilities from national government agencies to LGUs and which subsequently reduced the budgetary allocations of said agencies. However, the LGC gives LGUs access to a financing source, the Special Education Fund (SEF), which is earmarked for the operation and maintenance of public schools. Because of this, the provision of basic education arguably became the shared responsibility of the central government and local government units. On the other hand, the Basic Education Governance Act of 2001 (Republic Act 9155) envisions a different kind of decentralization in the basic education sub-sector. It calls for the empowerment of schools in making decisions that improve quality of learning and for the establishment of school and community networks, emphasizing the need for the greater participation of parents, teachers and the community itself in the governance of the schools. In other words, RA 9155 envisages decentralization in the tradition of what has come to be known in the education literature as school-based management. Nonetheless, given the important role LGUs play in the financing of the school, the LGU is naturally one of the major stakeholders in school-level governance.


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As will be evident below, while the provisions of the LGC are not entirely inconsistent with that of RA 9155, there are certain mismatches that cause confusion, if not discord. Perhaps key to improving the utilization of the SEF is finding a better alignment of the provisions for the LGC on the membership in the Local School Board and the allocation of the SEF with the provisions of RA 9155 on the roles, tasks and responsibilities of the different units in the education bureaucracy and the empowerment of schools. Republic Act 5447. The Special Education Fund was originally created under Republic Act (RA) No. 5447, entitled “An Act Creating a Special Education Fund to be Constituted from the Proceeds of an Additional Real Property Tax and a Certain Portion of the Taxes on Virginia-Type Cigarettes and Duties on Imported Leaf Tobacco Defining the Activities to be Financed, Creating School Boards for the Purpose, and Appropriating Funds There from,” which took effect in 1969. In the case of provinces, 50% of the collections from the additional 1% real property tax imposed under RA 5447 went to the SEF of municipality where the property subject to tax is situated, 20% to the SEF of the province and 30% to the Bureau of Treasury (BTr). In the case of cities, 60% of the collections from the additional 1% tax on real property went to the SEF of the city while 40% went to the BTr. The amounts remitted to the BTr were meant to be expended exclusively for stabilizing the SEF in municipalities, cities and provinces. Under RA 5447, the allocation and utilization of the SEF was largely under the control of the then Department of Education. To wit, the SEF was meant to be expended exclusively for the following activities of the Department of Education: (a) the organization and operation of extension classes that may be needed to accommodate all children of school age desiring to enter Grade I; (ii) the construction and repair of elementary school buildings, and the acquisition of sites, (iii) the payment and adjustment of salaries of public school teachers; (iv) the preparation, printing and/or purchase of textbooks, teachers' guides, forms and pamphlets, approved in accordance with existing laws to be used in all public schools; (v) the purchase and/or improvement, repair and refurbishing of machinery, laboratory, technical and similar equipment and apparatus, including spare parts needed by the Bureau of Vocational Education and secondary schools offering vocational courses; (vi) the purchase of teaching materials such as workbooks, atlases, flip charts, science and mathematics teaching aids, and simple laboratory devices for elementary and secondary classes; (vii) the implementation of the existing program for citizenship development in barrio high schools, folk schools and adult education classes; (viii) the undertaking of education research, including that of the Board of National Education; (ix) the granting of government scholarships to poor but deserving high school graduates who intend to enroll in priority courses in higher education institutions; and (x) the promotion of physical education, such as athletic meets. RA 5447 called for the creation of Local School Boards (LSBs) at the provincial, city and municipal levels which were composed of the provincial/ city division


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superintendent/ district supervisors as chairman and the representative of the governor/ city mayor/ municipal mayor, the local treasurer, the representative of the local council and the representative of the League of Parents-Teachers Associations as members. Under RA 5447, the LSBs were mandated to determine the allocation of the SEF for the operation and maintenance of public schools within the province, city or municipality in accordance with the criteria set by the Bureau of Public Schools or by the Bureau of Vocational Education, as the case may be, and approved by the Secretary of Education. Local Government Code (LGC) of 1991 (Republic Act 7160). The Local Government Code (LGC) of 1991 amended RA 5447 and provides that a province or city, or a municipality within the Metropolitan Manila Area, may levy and collect an annual tax of one percent (1%) on the assessed value of real property which shall be in addition to the basic real property tax and that the proceeds thereof shall exclusively accrue to the Special Education Fund (Section 235). Furthermore, the LGC provides that the proceeds from the additional one percent (1%) tax on real property shall be automatically released to the local school boards (Section 272). In the case of provinces, the proceeds are divided equally between the provincial and municipal school boards. At the same time, the LGC calls for the creation of the Local School Board (LSB) in provinces, cities and municipalities. The LSB is composed of the local chief executive and the division superintendent/ district supervisor of schools as co-chairmen and with the following as members: (i) chairman of the education committee of the Sanggunian, (ii) local treasurer, (iii) representative of “pederasyon ng mga sanggunian kabataan,” (iv) duly elected president of the federation of parents-teachers associations, (v) duly elected representative of the teachers’ organizations, and (vi) duly elected representative of the non-academic personnel of public schools in the LGU (Section 98). In turn, the LSB is mandated (i) to determine the allocation of the school board budget, (ii) to authorize the local treasurer to disburse funds from the SEF and (iii) to act as an advisory committee to the Sanggunian on educational matters (Section 99). The Local Government Code contains two provisions that pertain to how the SEF is to be allocated. First, Section 100 provides that the annual school board budget shall give priority to the following: (i) construction, repair, and maintenance of school buildings and other facilities of public elementary and secondary schools; (ii) establishment and maintenance of extension classes where necessary; and (iii) sports activities at the division, district, municipal, and barangay levels. Second, Section 272 provides that “the proceeds [of the SEF] shall be allocated for the operation and maintenance of public schools, construction and repair of school buildings, facilities and equipment, educational research, purchase of books and periodicals, and sports development as determined and approved by the Local School Board.”


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On the other hand, Section 17 of the LGC enumerates the basic services and facilities that LGUs are mandated to provide. In particular, Section 17 (b) (2) (viii) lists “infrastructure facilities intended primarily to service the needs of the residents of the municipality and which are funded out of municipal funds including but not limited to, municipal roads and bridges; school buildings and other facilities for public elementary and secondary schools,…” as one of the basic services and facilities that municipalities are tasked to provide. On the other hand, Section 17 (b) (4) calls on cities to provide “all the services and facilities of the municipality and province, and in addition thereto, the following: ….(ii) support for education, police and fire services and facilities.” It is curious, however, that the Section 17 does not specifically list education or school buildings as one of the basic services and facilities that provinces should provide, notwithstanding, the fact that “in case of provinces, the proceeds [of the additional 1% SEF tax] shall be divided equally between the provincial and municipal school boards” (Section 272). Joint Circulars issued by the Department of Education or DepEd (formerly the Department of Education, Culture and Sports or DECS), the Department of Budget and Management (DBM) and Department of Interior and Local Government (DILG) provided the implementing guidelines on the utilization of the fund. Apparently taking off from Section 100 of the LGC, the expanded list of priorities included the following: (a) operation and maintenance of public schools, including organization of extension, non-formal, remedial and summer classes and payment of salaries and other authorized allowances of public school teachers; (b) construction, repair and maintenance of school buildings, and facilities; (c) other needed capital outlays such as the purchase, titling and improvement of school sites; (d) educational research; (e) acquisition/ procurement of books, instructional materials, and periodicals; (f) acquisition of equipment, including information technology resources; (g) expenses for school sports activities at the national, regional, division, district, municipal and barangay levels; and (h) other DECS/DepEd related activities, including co-curricular activities. It was also clarified that the payment of salaries and authorized allowances of teachers hired to handle new extension classes of public elementary and secondary schools is included under operation and maintenance of public schools. The payment of salaries and authorized allowances of the non-teaching personnel was a late addition to the list, with the justification that this expense is apparently part of the cost of operating and maintaining schools. Basic Education Governance Act of 2001 (RA 9155). RA 9155 calls for greater decentralization in delivery of basic education services in the tradition of school-based management. That is, it calls for the empowerment of schools and learning centers “to make decisions on what is best for the learners they serve” (Section 2 – Declaration of policy). Section 2 also asserts that the state will encourage local initiatives towards the improvement of the quality of basic education.


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RA 9155 establishes the application of the principle of shared governance in the delivery of basic education. This principle “recognizes that every unit in the education bureaucracy has a particular role, task and responsibility inherent in the office and for which it is principally accountable for outcomes.” In line with this principle, the office of the Secretary of education shall have the authority, accountability and responsibility for the formulation of national basic education policies, plans and standards and for the monitoring and assessment of national learning outcomes. On the other hand, the regional offices shall have the authority, accountability and responsibility for the development of regional basic education policy framework, plans and standards and for the monitoring and assessment of regional learning outcomes. The regional office is also tasked to approve the proposed staffing pattern of schools divisions and schools districts; evaluate the performance of division superintendents and assistant division superintendents and to approve the establishment of public and private elementary and secondary schools and learning centers. Meanwhile, RA 9155 gives schools division offices the authority, accountability and responsibility for the formulation and implementation of division basic education plans, recruitment, deployment and evaluation of division supervisors and district supervisors, monitoring the utilization of funds provided by the national government and LGUs to schools and learning centers, supervising the operations of all public and private elementary and secondary schools and learning centers and ensuring compliance of the quality standards of basic education programs. On the other hand, the schools district supervisor is responsible for curricula supervision and providing professional and instructional advice and support to the school heads and teachers/ facilitators of schools and learning centers in the district. Finally, the schools (headed by the school head) are given the authority, accountability and responsibility for setting the vision, mission, goals and objectives of the school, creating in the school an environment that is conducive to teaching and learning, implementing the curriculum and being accountable for learning outcomes, developing and implementing the school education and school improvement plan, administering and managing all personnel, physical and fiscal resources of the school, recommending the staffing complement of the school based on its needs, establishing school and community networks, and encouraging the active participation of teachers organizations, nonacademic personnel of public schools, and parents-teachers-community associations in school level decision making. To better implement RA 9155, the DepEd formulated the Basic Education Reform Agenda (BESRA). The BESRA aims to achieve:

universal completion of full cycle of basic education schooling with satisfactory achievement levels by all at every grade/ year,

universal school participation and elimination of drop-outs and repetition in first 3 grades, and


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Universal coverage of out-of-school youths and adults in provision of basic learning needs.

The BESRA has five key result areas (KRTs), namely:

KRT 1: Get all schools to continuously improve KRT 2: Enable teachers to further enhance learning outcomes KRT 3: Increase social support to attainment of desired outcomes KRT 4: Improve impact on outcomes from complementary early childhood

education, alternative learning systems and private sector participation

KRT 5: Change institutional culture of DepEd to better support KRTs

As part of attaining KRT 1, the BESRA emphasized the need for (i) presence/ assignment of a head for every school, and (ii) the institutionalization of a process for the school and community to continuously improve the school and learning outcomes thereof, including the formulation of school improvement plan and the establishment of school governing councils, (iii) school-level reporting of learning outcomes to parents and the community, and (iv) school-driven representation in the Local School Board. In other words, central to the achievement of KRT 1 is the adoption of the school-based management framework. Assessment of legal framework. A closer reading of both the LGC and RA 9155 reveals some gaps within each one as well as mis-alignments between the provisions of the LGC and RA 9155. The provisions of the LGC and RA 9155, while not entirely inconsistent, are not congruent with one another either. Consequently, these mismatches cause confusion, if not discord, and in a general lack of clarity in the implementation of both laws especially with respect to the utilization of the SEF. One, the LGC provides that schools district supervisor shall seat as co-chair of the Municipal School Board, perhaps because there is almost a one-to-one correspondence between the municipality and the schools district.2 In this context, schools district supervisors are expected to collate and evaluate the personnel, physical and fiscal requirements of the schools vis-à-vis the total amount of resources that are available to the school from various sources. However, the mandate of schools district supervisors under RA 9155 is largely limited to curriculum and instructional supervision. Under RA 9155, it is the school heads who are responsible and accountable for administering and managing the fiscal resources of the school while the division superintendents are tasked with the utilization of funds provided to schools including those provided by the LGUs. At the same time, it is the school heads who prepare and implement the school improvement plans while the schools division superintendents are tasked to prepare and implement the division education development plan. 2 However, there are some municipalities which are divided into two schools districts.


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The existing arrangement regarding representation of the DepEd in the Local School Boards is also not quite consistent with the BESRA advocacy for a school-driven representation in the LSBs. Note that schools district supervisors in some sense do not play a central role in the flow of budgetary information as well as actual budgetary resources into schools with the greater decentralization of resources to the schools within the DepEd system in more recent years. Key informant interviews done during the course of this study suggest that some schools district supervisors are not fully informed about how much resources schools actually receive from the DepEd budget and how these resources are actually used. As such, this situation raises some issues on the quality of representation that district supervisors provide in the LSBs in terms of providing a school-based perspective. These findings notwithstanding, district supervisors may still be able to adequately represent the schools in the Local School Boards if they have access to good quality information on school level learning outcomes and the flow of resources (personnel, budgetary and physical) to schools. Two, the DepEd has put in place a number of instruments and protocols (mostly based on the Basic Education Information System) like the teacher deployment analysis and the classroom shortage analysis that will provide good support for evidenced-based resource allocation at the school level. However, the key informant interviews and the survey instrument sent out to LGUs for the purpose of this study suggest that the connection between these instruments/ protocols are largely not being made even at the schools division level where LSB representation is not an issue. Three, the LGC provides that the annual school board budget shall give priority to, among other activities, sports activities at the division, district, municipal, and barangay levels. However, RA 9155 transferred all functions, programs and activities of the DepEd related to sports competition to the Philippine Sports Commission (PSC) even while school sports and physical fitness remains part and parcel of the basic education curriculum. At the moment, there appears to be some confusion on where one exactly draws the line between school sports and physical fitness and sports development/ sports competition. To further complicate matters, an Executive Order that was issued more recently has re-instituted the administrative attachment of the PSC to the DepEd. As a result, many division superintendents and district supervisors interpret the provisions of the LGC to mean that participation in the barangay, district, division, regional and national level of the Palarong Pambansa should be one of the priorities of the SEF. Four, the use of the term “operation and maintenance of public schools” in Section 272 of the LGC is the subject of varying interpretations. On the one hand, the ambiguity in the use of the term “operation and maintenance” gives LSBs greater flexibility to respond to actual needs at the level of the schools in the LGU. On the other hand, one of the guiding principles of good expenditure assignment in fiscal decentralization is the need for greater clarity in the


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assignment of functions across levels of government. This stems from the fact that if all levels are made responsible for the same functions, it becomes extremely difficult to exact accountability from any one level of government. 3. CURRENT PRACTICE ON ALLOCATION OF SEF In the aggregate, the bulk of the SEF (44%-49% in 2006-2008) is spent on maintenance and other operating expenditures (MOOE). On the other hand, 27%-29% of the SEF of all LGUs combined was allocated to personal services while 23%-30% went to capital outlays in 2006-2007 (Table 10).

Provinces Munis Cities All LGUsPS

2006 18.8 31.2 27.4 26.62007 20.5 34.8 29.5 29.12008 19.5 34.5 29.2 28.7

MOOE2006 46.6 47.6 41.9 43.82007 54.6 50.6 46.8 48.42008 55.7 47.0 47.9 48.8CO

2006 34.6 21.3 30.7 29.62007 24.9 14.7 23.8 22.52008 24.8 18.5 22.9 22.5

Table 10. Budget share of PS, MOOE and CO in SEF expenditures, 2005-2008

Source of basic data:SEF survey conducted under ADB TA 4778 All levels of local governments allot about half of their SEF on MOOE. However, in the aggregate, municipalities and cities tended to spend a bigger portion of their SEF on personal services (31%-35% and 27%-30%, respectively) than provinces (19%-21%) in 2006-2008. On the other hand, provinces and cities tended to allocate a larger proportion of their SEF on capital outlays (25%-35% and 23%-30%, respectively) than municipalities (15%-21%). 3.1. Allocation for Locally Funded Teachers Recognizing the urgent need to address the huge shortfall in the required number of teachers in public elementary and secondary schools, 37,676 new teacher items were created in the DepEd budget in 2005-2007 thereby reducing the teacher deficit from 37,986 in SY 2003-2004 to 9,333 as of the end of SY 2007-2008 (Table 11). Despite this development, however, an analysis of the current allocation of the SEF reveals that the share of personal services in total SEF expenditures of LGUs went up from 27% in 2006 to 29% in 2008 for all


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LGUs in the aggregate (Table 10).3 The same trend is evident for cities and municipalities. However, SEF expenditures of provinces showed some contraction in the budget share of personal services between 2007 and 2008. In like manner, the average number of SEF funded teachers based on the DBM survey hardly changed in 2006-2008 with the exception of those charged to the SEF of provinces (Table 12).

Table 11. Addressing Input Gaps in Basic Education, 2003-2007Teacher Requirements Classroom Requirements

Teacher deficit as of SY 2003-2004 37,986 Classroom deficit as of SY 2003-2004 a/ 31,952

Additional teachers required for 2004-2007 Additional classrooms required for 2004-2007 due to enrollment growth 9,023 due to enrollment growth 7,536

Total teachers required 47,009 Total classrooms required 39,488

Number of teacher positions created in 2004-2007 37,676Net increase in number of classrooms between SY2003-2004 and SY 2007-2008 b/ 19,250

Gap as of end of SY 2007-2008 9,333 Gap as of end of SY 2007-2008 20,238

a/ without double shiftingb/ A total of 41,546 new classrooms were built from various funding sources in 2004-2007 but many of these were actually used to replace dilapidated or sub-standard classrooms.

2006 2007 2008Provinces 68 69 61Munis 12 12 13Cities 65 64 65Source: SEF Survey under TA 4778

Table 12. Average number of teaching positions charged to SEF per LGU, 2006-2008

Data from the Basic Education Information System (BEIS) of the DepEd corroborates these findings. The BEIS shows that the number of SEF funded teachers who are assigned at public elementary schools rose 24% from 7,353 in 2004 to 9,087 in 2007 while the number of locally funded teachers charged against the General Fund (GF) of LGUs increased by 33% from 3,275 in 2004 to 3 The figures cited in Table 11 are obtained from a survey conducted by the Department of Budget and Management (DBM) under ADB TA 4778 in the second quarter of 2008 on the utilization of the SEF in 2006-2008. The response rate was 67% provinces (54 out of 81), 65% for cities (88 out 136) and 59% for municipalities (888 out of 1495).


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4,354 in 2007 (Table 13). While the numbers are not as dramatic in the case of public secondary schools, the number of locally funded teachers charged against the SEF and the GF continued to rise between 2004 and 2007.

2004 2007Elem Level 10,628 23,756 of which:

SEF 7,353 9,087LGU 3,275 4,354PTCA 4,800 6,609

Sec Level 18,948 19,098 of which:

SEF 11,116 11,302LGU 3,407 3,911PTCA 2,139 1,891

Both Levels 29,576 42,854 of which:

SEF 18,469 20,389LGU 6,682 8,265PTCA 6,939 8,500

S ource of basic data: DepE d B E IS

Table 13. Total number of locally funded teachers, 2004-2007

On the other hand, BEIS data on the actual deployment of locally funded teachers across schools show that many of these teachers are assigned in a sub-optimal manner at the level of the school and the LGU. For instance, the some 12,017 LGU/ SEF-funded teachers were assigned in public elementary schools with excess teachers in SY 2007-2008. At the same time, the actual number of LGU/ SEF-funded teachers who were assigned in teacher-deficit public elementary schools fell short of the required number (net of the number of teachers actually deployed by the DepEd) by 6,369 in SY 2007-2008 (Table 14). Thus, the actual number of LGU-funded teachers hired in SY 2007-2008 was 5,648 more than the actual teacher deficit nationwide even if the excess LGU/ SEF-funded teachers were re-deployed to fill in the gap in teacher-deficit schools. Meanwhile, the actual number of teachers funded out of LGUs’ GFs and SEFs was 8,915 less than the required number in all teacher-deficit public secondary schools in SY 2007-2008. In contrast, the actual number of LGU/ SEF-funded teachers in all teacher-rich public secondary schools exceeded the required number by 8,006. These results are quite surprising given the fact that the teacher deployment analysis using the color coding scheme has been in place


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for quite some time now and appears to be widely known within the DepEd community.

Region I (12) 852 (69) 437 Region II (29) 1,066 (176) 543 Region III (297) 2,842 (753) 733 Region IV-A (1,405) 597 (1,627) 638 Region IV-B (136) 550 (176) 421 Region V (162) 555 (353) 611 Region VI (72) 1,000 (253) 887 Region VII (351) 759 (1,479) 826 Region VIII (107) 619 (256) 250 Region IX (305) 307 (345) 327 Region X (108) 83 (493) 94 Region XI (88) 473 (329) 301 Region XII (498) 752 (429) 220 CARAGA (15) 286 (338) 271 NCR (769) 712 (739) 1,146 CAR (24) 413 (166) 204 ARMM (1,992) 152 (934) 98 Total Philippines (6,369) 12,017 (8,915) 8,006 a/ Required number of teachers computed assuming that a teacher-pupil ratio of 1:45 for both elementary and secondary level

Table 14. Remaing Numbers of Excess/ Deficit Teachers Given Actual Number of LGU/ SEF-funded Teachers, SY 2007-2008 a/

Regions

Elementary Level Secondary LevelRemaining

teacher deficit inclusive of LGU/ SEF

funded teachers

Excess teachers after assignment of

LGU/ SEF funded

teachers

Remaining teacher deficit

inclusive of LGU/ SEF

funded teachers

Excess teachers

after assignment

of LGU/ SEF funded

Key informant interviews during the field visits also reveal that locally funded teachers are paid salaries/ honoraria that are much lower than the compensation of nationally funded teachers. In some areas, locally funded teachers are paid an honorarium of PhP 2,500 per month. Nonetheless, there are also many LGUs which pay locally funded teachers the DepEd rate. It is not clear, however, if such disparities in the compensation of teachers have any impact on learning outcomes at the school level. On another note, however, it is commendable that all the LSBs visited in the conduct of this study report that all locally funded teachers passed the licensure examination for teachers (LET). Furthermore, these LSBs also report that all locally funded teachers are ranked in accordance to DepEd guidelines.


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3.2. Allocation for Capital Outlays Table 11 above indicates that the lack of classroom continues to be a serious problem, especially if double shifting is considered to be a stop-gap measure rather than as a long-term policy. Despite this, however, the budget share of capital outlays in the SEF of all LGUs as a group declined from 30% in 2006 to 23% in 2008 (Table 10). A similar movement is registered by the budget share of capital outlays of provinces and cities. On the other hand, the budget share of capital outlays in municipalities was stagnant. This result is quite unexpected in the case of municipalities and cities in the light of Section 17 of the LGC which explicitly included school buildings as one of the facilities that municipalities and cities are mandated to provide. However, the lackluster support for school building construction by provincial governments in the aggregate may be linked to the fact that education and school building construction is not specifically mentioned in the list of mandated services and facilities for provinces under Section 17 of the LGC. Furthermore, the overall disappointing trend in LGU spending on school building construction may have also been influenced by the disincentive effect of the Roxas Law which is biased towards giving a uniform share per legislative district. 3.3. Allocation for Sports Competitions The allocation for sports competitions in the LSB budget vary widely across LGUs. However, the limited sample from the field visits undertaken as part of this study4 suggests that the amount is not inconsequential, ranging from 10%-30% of the LSB budget. The allocation for this item includes support for barangay sports, uniforms and travel allowances for representation in district, division, regional and national sports competition (Palarong Pambansa), awards and incentives for outstanding performance in sports competitions, and travel allowances and registration fees for training of coaches. The emphasis on sports competition in the LSB budget is surprising considering that RA 9155 transfers all functions, programs and activities of the DepEd related to sports competition to the Philippine Sports Commission. However, there are two contrasting views from the DepEd. On the one hand, some DepEd central office officials appear to view the current LSB allocation as one which overly emphasizes sports competitions at the expense of instructional/ academic activities of schools. On the other hand, many of the schools division and schools district officials interviewed for this study assert that the Palaro 4 As part of this study, field visits to 25 LGUs were undertaken during which LGU officials and DepEd schools division and schools district officials were interviewed. These LGUs include the following: the provinces of La Union, Leyte, Iloilo, Guimaras, Davao del Norte, and Agusan del Sur; the cities of Quezon, San Jose del Monte, Tagaytay, Tacloban, Iloilo, Butuan, Surigao, Bayugan, Tagum and San Fernando (La Union); and the municipalities of Bauang and Caba in La Union, Asuncion and Sto. Tomas in Davao del Norte, Basey in Samar, Palo in Leyte, Sta. Barbara in Iloilo, Tubay in Agusan del Norte and Trento in Agusan del Sur. In addition, many other LGUs officials who attended the consultation workshop last December 4, 2008 at the Linden Suites, Pasig City).


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Pambansa is an activity that DepEd expects the field offices to participate in but for which there is little, if any, budgetary support coming from the central/ regional office. Because of this, they report that field offices are left with very little choice but to get the requisite financing for the holding of the various levels of the Palarong Pambansa from the SEF. Moreover, they argue that the LGC provision on the use of the SEF is quite specific in saying that the LSB budget shall give priority to sports activities at the division, district, municipal, and barangay levels (among other things). Furthermore, they note that the Philippine Sports Commission has been “re-attached” to the DepEd more recently. The field visits also found an emerging third perspective on LSB spending on sports competitions from both LGU officials and DepEd field officials. One of the city mayors interviewed for this study said that he has cut the allocation for sports competitions in the LSB budget thinking that monies previously allotted to it will be put to better use if allocated to support the instructional needs of the schools in order to improve learning outcomes. On the other hand, one DepEd regional director suggested that the DepEd central office should clarify and rationalize the current policy on school’s participation in the Palaro. These officials were quick to add, however, that they do recognize the importance of physical development and sports in the well-rounded development of the child but stressed that there is a difference between physical education and school athletics, on the one hand, and the development of athletes (which is the objective of the Palaro), on the other. 3.4. Allocation for Citizen Development Programs and Co-curricular

Activities Again, as with the allocation for sports competitions, there is considerable variation across LGUs with respect to the allocation for citizen development programs and co-curricular activities in their LSB budgets. While the budget share for citizens development/ co-curricular activities is not as large as that allocated for sports competitions, the limited sample from the field visits showed numbers that range from 5%-25% of the LSB budget. The activities supported under citizen development and co-curricular programs include academic competitions at various levels including quiz bee, math contests, science fairs, cultural contests, music festivals, and press conferences. One DepEd regional director pointed out that there is a need to rationalize the holding of these activities because they are not only costly to support but also because they take the time of teachers and students away from the classroom. One of the specific recommendations is to limit the number of national level competitions and to have some of the competitions go up to the level of the division or region only.


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3.5. Use of SEF to Pay for the Cost of Tax Collection Key informant interviews during the field visits indicate that a number of LGUs (e.g., in Region 1 and CARAGA) charge expenses related to the cost of SEF collections like cost of accountable forms (e.g., receipts) and personnel doing work related to either RPT assessment and/ or collection against the SEF. In some of these LGUs, these charges against the SEF amounted to 10%-20% of SEF income. While LSB members knew that this is not in consonance with the provision of the LGC on the earmarking of the proceeds of the additional 1% tax on real property for education, concerned LSB members opined that it is difficult to go against the local treasurer who has the authority to disburse funds from the SEF. 3.6. Other Items Charged Against the SEF In addition to the items specifically mentioned above, the list of expenses that are charged against the SEF varies across LGUs and schools but typical includes the following: honorarium of education supervisors and district supervisors, additional allowances for DepEd teachers, electricity and water utility expense of schools and district offices, repair and maintenance of school buildings, interest expense for loans incurred to construct schoolbuildings, and travel allowance/ registration fees of teachers attending training. Some LSBs also provide allocations for reproduction machine and materials for student testing, textbooks, workbooks and worktexts, instructional materials, acquisition of motor vehicles for schools and district offices, school bags and supplies for distribution to students and stipend for scholars. Many LSBs also provide allocations for activities related to alternative learning system (ALS) including honorarium of ALS teachers and materials. It is notable that this list is quite comprehensive and includes almost all of the inputs that are necessary for the operation of the schools. The allocation for the acquisition of textbooks is particularly problematic because of the current policy on centralized procurement of textbooks. Under this arrangement, textbooks procured by the central office are not available in the market. Thus, LSBs trying to supplement the supply of textbooks from the center will most likely be procuring textbooks with titles that are different from those distributed by the DepEd central office. Such response though well meaning will not be of much help in addressing gaps in the availability of textbooks. On the other hand, the acquisition of motor vehicle using the SEF is not allowed under existing DBM guidelines. Key informant interviews suggest that this rule may have to be revisited because of the recognition that the availability of a motor vehicle aids school supervision. But what is perhaps more important than the list of items that are actually charged against the SEF is the manner of how the SEF is allocated and spent, i.e., the manner by which the LSB arrives at its spending priorities.


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4. CURRENT INSTITUTIONAL ARRANGEMENTS 4.1. DepEd-driven or LCE-driven LSB Budget Allocation Process Key informant interviews during the field visits suggest that SEF allocation is largely driven by the DepEd division superintendents/ district supervisors in sharp contrast to the widely held perception that local chief executives (LCEs) tended to dominate the allocation process in the LSB. LCE control of the LSB budget process is evident in only one of the 25 LGUs visited in the course of the study. Many LCEs and Sanggunian representatives to the LSBs interviewed during the field visits report that they are essentially dependent on the recommendations of the DepEd division superintendent/ district supervisors because the latter knows the “needs” of the schools best. In many LGUs, the division superintendent/ district supervisor initiates the allocation process by preparing a budget proposal which reportedly consolidates the requests submitted by the schools heads/ principals to the division superintendent/ district supervisor. Such a process, however, does not preclude some school heads/ principals from going directly to the local chief executive, or in some instances, to the provincial school boards, to make their needs known and appeal for additional resources. The amount of inputs from the schools themselves in the preparation of the proposed LSB budget varies across LGUs. The process appears to be consultative and participatory in some areas but less so in others. In preparing the budget proposal for LSB deliberation, one or two district supervisors say they refer to school improvement plans (SIP) formulated by the schools but this is not a common occurrence. This is surprising considering that the formulation of the SIP is one of the milestones in the roll-out of the school-based management (SBM) under the BESRA. On the whole, LSB members’ awareness of the indicators of education performance in their LGU is generally low although a few exceptions do exist. Moreover, LSB members’ familiarity on the amount of resources that schools receive from the DepEd appears to be even less. Again, this does not tally with the BESRA call for school-level reporting of learning outcomes to parents and community. The observed lack of awareness of LSB members’ of basic education outcomes and the amount of resources available at public schools in the LGU from other sources may help explain why there seems to be a poor link between SEF spending and improvement in basic education outcome in some areas. For instance, despite high SEF spending per pupil in NCR, in 2005, only 20% of elementary pupils in public schools in NCR achieved at least 60% mastery of subject matter compared to a national average of 37%. In the same year, less than 1% of elementary pupils in public schools in NCR achieved at least 75% mastery of subject matter compared to national average of 8%.


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4.2. Pattern of Allocation Across Schools Key informant interviews during the field visits, albeit limited, reveal no clear pattern on how the LSB budget is allocated across schools. For instance, all public elementary and secondary schools in Quezon City receive a share of the city’s SEF. In Quezon City, the SEF defrays 100% of the cost of electricity and water consumed by all elementary schools and 50% of that of all secondary schools. In contrast, the LSBs of some of the municipalities of CARAGA tended to give greater priority to the bigger elementary schools over the smaller, more remote elementary schools which then are left to rely on the meager resources of barangays and PTCAs. On the other hand, the SEF is distributed equally across all schools. In some LGUs, secondary schools do not receive any allocation from the SEF. Some secondary school principals argue that the district supervisors do not present the needs of the secondary schools well. This arises because the link of the district supervisors with the secondary schools is non-existent. On the other hand, secondary schools in other LGUs do have access to the resources of the SEF just like their counterparts at the elementary level. In some areas, district offices get as much as 25% of the total LSB budget with district supervisors asserting that district offices do not get any allocation from the DepEd budget. In some of these areas, school heads point out that the district offices tend to compete rather unfairly vis-à-vis the schools themselves. 4.3. Lessons from Synergeia The experience of Synergeia project sites indicates a number of elements that are key to “re-inventing” the Local School Boards. It should be emphasized though that many of these elements are also found in the SBM and the BESRA. First, performance assessment at the school level and the reporting of the results of the assessment to the parents and the community tends to improve accountability of the school heads by exerting pressure on them to manage school resources more effectively and efficiently. In turn, such a situation tends to improve subsequent learning outcomes at the school. Second, the holding of participative events like education summits and workshops where school officials, teachers, parents and the community come together to discuss the current status of basic education, the constraints and problems faced by the school and the alternative solutions thereof has been found to be beneficial to the school community itself. These events are seen not only as a good venue for informing the parents and the community at large of the performance of the school in improving learning outcomes but also for generating the support and commitment of various stakeholders.


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Third, the expansion of the LSB membership to include NGOs, business chambers, and private schools as non-voting members is also found to be advantageous. It helps in expanding the pool of allies and advocates, in tapping expertise available outside of the traditional LSB membership, and in securing additional resources. 5. LESSONS FROM INTERNATIONAL EXPERIENCE5 Standard setting, curriculum design. Worldwide, the central government is generally considered to be better equipped than state and local governments to formulate a common minimum educational standard including curriculum design. Central governments are also seen to be best placed to address equity issues. Thus, distribution of teachers and technical assistance to underperforming areas are also commonly considered to be functions of the central government. Some federal governments (for example, the United States) have successfully delegated the monitoring of compliance to standards to the state level of government but in other countries, monitoring and evaluation of the status of the education sector is also assigned to the central government. Textbook procurement. Textbook production and distribution is usually centralized in order to harmonize textbooks with curriculum design and development process. In many countries, textbook distribution is also centralized because of the belief that it will result in greater cost efficiency due to scale economies in centralized procurement, production and distribution. Some experts have, however, countered that while scale economies do exist in centralized procurement of textbooks, the same cannot be said of centralized distribution of textbooks. Teacher salaries. Teacher salaries, even in highly centralized systems, are usually paid from the recurrent budget of the administrative level to which teachers report. The true extent of local control over teachers depends on whether or not the teachers are members of a unified national civil service with pay scales set by the relevant service commission. Thus, in most developing countries teachers are central government civil servants, with conditions of service determined by the public service commission or an independent teacher service commission. In a few countries, mostly federal systems such as Brazil and India, where responsibility for provision of education is fully devolved, some teachers, mainly in primary and secondary education, are civil servants of intermediate governments. In a number of countries, community involvement in financing teachers’ salaries were found to help make schools more responsive to community needs, but the 5 This section draws from the paper of Glendal Wright, one of the international consultants under ADB TA 4778, titled “International Experience on Expenditure Assignment in Education Sector” which is presented in full in Annex 1 of this report.


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practice is controversial with teachers’ unions because it can create inequities in salaries and student-teacher ratios among poorer and richer communities. In many cases, including federal states such as Pakistan, teachers have resisted reforms that would have placed them under the jurisdiction of local or intermediate governments, on the grounds that they lose inter-jurisdictional mobility, comparable conditions of service, and prestige. Constructive dialogue with the relevant teacher unions and groups is an important priority in education reform, because teacher resistance to reforms of conditions of service designed to make them formally accountable to intermediate and local government remains a common impediment to system reform. Construction and Maintenance. School building construction and maintenance are traditionally among the most decentralized education sub-functions in many countries. However, in a few cases, such as Tanzania, the central government finances both construction and maintenance of classrooms. Responsibilities for construction and maintenance are often divided between government levels in some countries. For example, the province provides resources for construction and major rehabilitation while lower level local government units conduct routine maintenance. Communities and their representatives may also share costs. Responsibilities also tend to be divided according to the level of schooling. For instance, in some countries, lower level local governments are responsible for primary schools, mid-level governments for secondary schools, and central governments for tertiary education. 6. RECOMMENDATIONS The evidence from the analysis of BEIS school-level data and the information obtained from the key informant interviews during the field visits as well as the LGU survey conducted under this study indicate some dysfunctions in the utilization of the SEF. Specifically, there appears to be a mismatch between what appears to be the actual needs of the school based on school level data, on the one hand, and the actual pattern of SEF spending by LGUs. This is evident, for instance, in what appears to be an excessive emphasis on the hiring of locally funded teachers and too little priority given to school building construction in the LSB budgets. Meanwhile, the priority currently given to sports competition in the current SEF spending of LGUs appears to be inconsistent with the transfer of all functions, programs and activities of the DepEd related to sports competition to the Philippine Sports Commission (PSC) under RA 9155. Given this, the use of the terms “sports activities” and “sports development” in the LGC when it talks about the utilization of the SEF needs to be further clarified.


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Also, there appears to be a lack of clarity as to what exactly the LGC refers to when it talks of “operation and maintenance of schools.” Related to this, there is a need to clarify expenditure assignment in the education sub-sector across different levels of government overall. 6.1. Improving Guidelines on the Utilization of the SEF The efficiency and effectiveness of the utilization of the SEF may be enhanced by improving the existing guidelines that govern SEF allocation. Corrective action/s in this regard may follow two alternative approaches. The first approach may best be described as a “rules-based” approach. It involves the joint issuance by the DBM, DepEd and DILG of new guidelines containing either a positive list of type of expenditure items that may be charged against the SEF or a negative list of expenditure items that are not allowed to be charged against the SEF. Alternatively, the new guidelines may contain both a positive list and a negative list of expenditure items. In turn, there are two non-mutually exclusive ways of implementing a “rules-based” revision of the SEF utilization guidelines. On the one hand, the oversight agencies may decide to take a “all-or-nothing” track by either strictly prohibiting LSBs from charging specified items of expenditures (e.g., textbooks) or by mandating them to confine their SEF spending to a well-defined list of expenditure items without room for any deviation. On the other, the oversight agencies may take a “conditional” track in improving the SEF utilization guidelines by advising LSBs to restrict their SEF spending on certain items (e.g., teacher salaries, motor vehicle acquisition) on the condition that specific provisions are met, e.g., compliance with results of teacher deployment analysis. The “all-or-nothing” track appears to be appropriate for some expenditure items like textbooks. For instance, international experience clearly suggests that the guidelines on the utilization of the SEF may be improved by prohibiting the use of the SEF for the acquisition of textbooks. The benefits from such a restriction are justified on the basis of the inefficiencies that are associated with LSBs continued use of the SEF to finance textbooks given the existing policy on the centralized procurement of textbooks. However, the “all-or-nothing” track may not be as appropriate with respect to other expenditure items. This is so because it provides a one-size-fits-all solution. As such, it reduces the flexibility to respond to local needs. It may also discourage local initiative in sharp contrast to the “conditional” track. For example, while there appears to be a need to minimize the current priority given to teacher salaries/ honoraria in the LSBs’ budgets, prohibiting the use of the SEF for such a purpose completely as was the case in the 1990s will reduce the capability of LSBs to respond to specific needs of the schools under its coverage.


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In situations like this, the “conditional” track of the “rules-based” approach may allow teacher salaries/ honoraria to be charged against the SEF provided the teacher deployment analysis of the DepEd shows that there is a teacher deficit in the school. In the same manner, the use of the SEF to fund classroom construction may be tied to the classroom availability analysis of the DepEd. Annex 2 illustrates the draft guidelines on the utilization of the SEF that follows the conditional approach. On the other hand, at the other end of the spectrum and directly opposite the “rules-based” approach, the oversight agencies have the option of recalling all existing guidelines on the utilization of the SEF. Instead, LSBs may be given full discretion in the allocation of the SEF while support mechanisms that enhance planning and budgeting of the SEF are strengthened. This approach may be referred to for want of a better term as the “market-based” approach.6 These support mechanisms will generally involved the improved flow of information (including both the “what” and “when” questions) with respect to (i) the results of teacher deployment analysis by school and the assignment of new teacher items, (ii) the results of classroom and school furniture availability by school and the programmed allocation of new classroom construction from the Basic Education Facilities Fund or School Building Program of the General Appropriations Act (or GAA), (iii) the school improvement plans, (iv) the resources available to the schools from the DepEd’s GAA, and (v) the school report card including key performance indicators like drop-out rates and pupil achievement scores. The support mechanisms will also include improvements in the coordination links between the DepEd and the LSBs, between the provincial and municipal LSBs, and between the district supervisors/ division superintendents and the school heads. While the “market-based” approach promotes greater flexibility of the LSBs to address the varying needs of the schools at any point in time, its success is dependent on the successful installation and implementation of the various elements of the school-based management, specifically the formulation of school improvement plans, the establishment of school governing councils and institution of school level reporting of performance. Thus, the application of “market-based” approach may have to be put on hold in the meantime given that the SBM and BESRA are not yet fully in place. Nonetheless, it is critical to provide the LSBs (especially the LGU officials in the board) with good quality information about the specific needs of the schools as well as their performance even if one takes the “conditional” under the “rules based” approach. 6 It should be pointed that the allocations that come out of such an unconstrained allocation process are highly unlikely to conform with those that individuals or indeed schools would have made on their own in a true 'market' or a 'quasi market' where families/schools are simply given vouchers to spend the SEF money.


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6.2. Improving the Institutional Arrangements DepEd representation in the Local School Boards. The discussion in Section 2 above suggests that one of the weaknesses of the existing institutional arrangements governing the use of the SEF arises from the inconsistencies in the provisions for the LGC on the membership in the Local School Board with the provisions of RA 9155 on the roles, tasks and responsibilities of the different units in the education bureaucracy and the empowerment of schools. At present, the LGC provides that the schools district supervisor co-chairs the Municipal School Board together with the mayor. However, the mandate of schools district supervisors under RA 9155 is largely limited to curriculum and instructional supervision. On the other hand, it is the school heads who are responsible and accountable for administering and managing the fiscal resources of the school under RA 9155. The school heads are also tasked to prepare and implement the school improvement plans. While the quality of representation provided by district supervisors in the LSBs may not be optimal in terms of providing a school-based perspective, the situation may be improved in the near term by improving the flow of information between the schools (both at the elementary and secondary level) and the district supervisors. Specifically, there is a need to establish a clearer connection between the various instruments and protocols in the BEIS and the BESRA like the teacher deployment analysis and the school improvement plan, on the one hand, and LSB allocation process, on the other hand. In the medium term, there is a need to re-think DepEd representation in the municipal school boards (MSBs). The need to have school level representation in the MSBs would have to be weighed against the practicality of increasing the number of MSB members. Too big a number tends to be counterproductive as the experience of the Local Development Councils suggest. At the same time, expanding the membership of the LSB to include the head of the cluster of secondary schools in the district as is now done in some LSBs is worth further consideration. This change is indicated because of the observed weak connection between the district supervisors and the secondary schools. Expansion of LSB membership. The experience of the Synergeia suggests the need to expand the membership of the LSB in yet another direction. The expansion of the LSB membership to include NGOs, business chambers, and private schools as non-voting members has been found to beneficial in terms of expanding the pool of allies and advocates, in tapping expertise available outside of the traditional LSB membership, and in securing additional resources for the schools.


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On the other hand, the local treasurer is tasked to disburse funds from the SEF in accordance with LSB budget at present. In this regard, a more symmetrical treatment of the SEF relative to the General Fund with respect to budget execution will help promote better financial management in the utilization of the SEF. The inclusion of the local budget officer in the LSB is a step in this direction. 6.3. Clarifying Definitions and Usage of Terms in LGC and RA 9155 As indicated in Section 2, the LGC provides that the annual school board budget shall give priority to, among other activities, sports activities at the division, district, municipal, and barangay level even while RA 9155 transferred all functions, programs and activities of the DepEd related to sports competition to the Philippine Sports Commission. Given this, there is a need to delineate the line that separate school sports and physical fitness from sports development/ sports competition. This clarification is needed because many division superintendents and district supervisors interpret the provisions of the LGC to mean that participation in the barangay, district, division, regional and national level of the Palarong Pambansa should be one of the priorities of the SEF especially in the light of schools’ continued mandate from the DepEd to participate in the Palaro Pambansa but with little or no budgetary support from the central government. 6.4. Clarifying Expenditure Assignment in Basic Education Sector The use of the term “operation and maintenance of public schools” in Section 272 of the LGC has been the subject of varying interpretations. Thus, actual utilization of the SEF at present indicates a fairly comprehensive overlap with DepEd expenditure items. Given the existing policy on centralized textbook procurement, the need to de-list textbooks from the list of expenditure items chargeable against the SEF is clear. 6.5. Increasing Equity in Education Spending While recommendations in Sub-sections 6.1- 6.4 above will tend to increase the efficiency in the way the SEF is allocated and utilized, they do not address the inequity in the distribution of the SEF across LGUs as a result of the wide disparity in the distribution of real property tax base. If not addressed, this inequity in the distribution of the SEF may result in a widening of the disparity in education outcomes across LGUs. There are two options in addressing the equity concerns. First, one could take the tack taken under RA 5447 and mandate that LGUs contribute part of their SEF collection (say, 10%-20%) to a pool that will then be allocated so as to equalize the real property tax base of all LGUs relative to some standard, say per student SEF income. In other words, part of the SEF income of LGUs with a


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higher real property tax base will effectively be transferred to LGUs which have a smaller real property tax base. Second, one could take the distribution of SEF resources across LGUs as given but instead attempt to adjust the school-level MOOE from the DepEd budget so as to equalize the flow of total resources from the DepEd budget and the LGUs (Atkins and Manasan 2001). The first option is a technically neater solution than the second option. However, the first option is more likely to be met with greater resistance than the second, particularly LGUs given that the SEF is a local imposition. 7. CONCLUSION Beyond the need to further clarify expenditure assignment between the national and the local government and across different levels of local government, it is important that greater accountability be exacted from them. In this regard, the expenditure assignment in other countries as summarized in Section 5 above and as presented in greater detail in Annex 1 provides some guidance and would have to be studied further in the light of the overall thrust towards greater decentralization. Meanwhile, there is a need for a policy change at the national level to remove the disincentives to the efficient and effective use of the SEF. This includes, among others, the need to revisit the Roxas law which gives LGUs an incentive to shirk the LGC mandate for them to construct and maintain school buildings.


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REFERENCES

1. Republic Act No. 5447 (An Act Creating a Special Education Fund to be Constituted from the Proceeds of an Additional Real Property Tax and a Certain Portion of the Taxes on Virginia-type Cigarettes and Duties on Imported Leaf Tobacco, Defining the Activities to be Financed, Creating School Boards for the Purposes, and Appropriating Funds Therefrom)

2. RA 7160 (The Local Government Code of 1991) 3. Administrative Order No. 261 (1992). (Directing the Sanggunian of all

Provinces, Cities, and the Municipalities Within the Metropolitan Manila Area to Enact a Local Tax Ordinance Levying an Annual ”Ad Valorem” Tax on Real Property and an Additional Tax Accruing to the Special Education Fund):

4. DECS-DBM-DILG Joint Circular No. 01, s.1998 (14 April 1998)

5. DECS-DBM-DILG Joint Circular No. 01 – A (14 March 2000)

6. DECS-DBM-DILG Joint Circular No. 01 – B (25 June 2001)

7. DepEd-DBM-DILG Joint Circular No. 04 (29 September 2001)


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Annex 1

International Experience on Expenditure Assignments in the Education Sector

Glendal Wright

1. Introduction This report will examine the expenditure assignment of education services based on a decentralized model of service delivery which has become prevalent during the past twenty years or more in which decentralization has become one of the main governance themes around the world. It will examine the general accepted views about what areas of education should be given to the sub-national units and the allocation of expenditure responsibility for these costs. To the extent possible, examples of the expenditure assignment will be provided to illustrate the different and varied approaches, which is common in this area. It should be apparent that while decentralization of the authority and decision making on education practices is recognized, the decentralization of financial resources from the central to the local levels is not so clear cut. This is due to many complex factors, but primarily the belief that there should be some equity in the quality of education as well as the financial burden should be spread across all segments of the society. Equality of school learning facilities and the consequent financing requires that there be some transfers from the central to the local levels. The exact line were this division is drawn is quite naturally subject to the social and political attitudes prevalent in a country. 2. Aspects of Education Decentralization The process of decentralization education systems has accompanied the world wide effort of choosing the path of decentralization by governments. Education, as well as other sectors, such as health, etc, is one of the primary areas where decentralized delivery of services is considered to be a more efficient and participatory method of delivery. While decentralization has been focused on the decision making of education delivery to the local levels of government, there has been a need to insure that the financing of education, as a critical societal value, will not suffer from the inequalities in the financial capabilities that goes along with the decentralization of education service delivery, particularly at the pre-primary, primary, and secondary school levels. The generally accepted view is that centralized control of education service delivery has failed due to closed decision making by the few central level authorities, the bureaucratic and financial management inefficiencies of a centralized system, and the great differences in the quality of education facilities,


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including teachers and staff, and the inaccessibility of the education services to many of the population, either due to physical geography and in some cases societal values toward females. Due to these circumstances, governments, generally with encouragement from international donor organizations, have pursued decentralization of education, along with other public services as the solution to these problems. Proponents of decentralization believe that the process of decentralization will substantially improve efficiency, transparency, accountability, and responsiveness of service provision; better reflect local priorities and encourage participation; and eventually improve coverage and quality. Governments see decentralization as an opportunity to address some severe fiscal constraints and see decentralization as a method to increase efficiency and lower costs. Cost recovery schemes such as community financing have been used as a means for central governments to offload some of the fiscal burden of education services. There are often competing objectives and the net fiscal result depends to a great extent on the level of accountability that is placed on the national to sub-national leaders. The rule is generally that the more accountable the national and local leaders are to their populations, the more likely that decentralization will lead to better, more responsive services and will not be used as a cost-cutting scheme with little improvements in education quality. 3. Assignment of Responsibilities in Education Sector There is always much debate within the decentralization process concerning the appropriate level of government that has responsibility for functions in the education sector. It is a critical aspect of the expenditure assignment requirements as the location of the control or responsibility for various aspects of the education functions should also follow with the financial support for that function. In the following paragraphs, some aspects of the control or responsibility for education functions are addressed with general application to international practices, which vary from country to country. The process of assigning responsibilities requires that policy makers rationalize and harmonize a complex set of complementary functions that includes curriculum design, teaching methods, student evaluations, textbook production and distribution, teacher recruitment and pay, school construction and rehabilitation, education financing, and parent-teacher linkages. The choices of who does what are further complicated because each of these functions has to be evaluated for primary, secondary, and tertiary education, and often for preschools and adult literacy. Some of the emerging areas of consensus are summarized in the following paragraphs.


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Setting Education Standards The central government is generally considered to be better equipped to address equity issues and ensure a common minimum educational standard. Distribution of teachers and technical assistance to underperforming areas are commonly central functions. Some federal governments (for example, the United States) have successfully delegated the monitoring and standards to the state level of government. Textbook Production and Distribution Textbook production and distribution is usually centralized in order to harmonize textbooks with curriculum design and development process as well as increase cost efficiency due to scale economies in centralized procurement, production, and distribution. Teacher Recruitment and Promotion Teachers are central government civil servants in most developing countries, with conditions of service determined by the public service commission or an independent teacher service commission. In a few countries, mostly federal systems such as Brazil and India, where responsibility for provision of education is fully devolved, some teachers, mainly in primary and secondary education, are civil servants of intermediate governments. In many cases, including federal states such as Pakistan, teachers have resisted reforms that would have placed them under the jurisdiction of local or intermediate governments, on the grounds that they lose inter-jurisdictional mobility, comparable conditions of service, and prestige. Constructive dialogue with the relevant teacher unions and groups is an important priority in education reform, because teacher resistance to reforms of conditions of service designed to make them formally accountable to intermediate and local government remains a common impediment to system reform. Education Financing A large share of education services, particularly primary and secondary schooling, are publicly provided and financed in most countries though some degree of private financing and provision is increasingly common. In devolved education systems where sub national governments have statutory or constitutional responsibility for some education subsectors, central governments either assign taxes or transfer resources to cover these and other devolved responsibilities. Some central and intermediate governments also provide additional matching grants to local governments to increase local expenditures on priority areas. In deconcentrated systems, field offices receive their budgets from the central ministry through the next highest level.


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Many governments have also implemented community management and cost-recovery schemes in response to shrinking central fiscal resources and growing demand for basic education. Partial community financing in the form of contingency fees, reduced (subsidized) school fees, PTA contributions, and ad hoc community contributions in cash or kind are becoming quite common. In rare cases communities are entirely responsible for school financing, usually for a subset of schools. In China, for example, there are government schools and community run schools. On the management side, the communities are increasingly given substantial control over the day-to-day operation of schools. In many countries, local school committees and district education boards and committees composed mainly of community representatives have been set up for this purpose. In rural El Salvador, the elected members of a community education association are vested with legal responsibility for enrolling a specified number of students, establishing classrooms or new schools, and hiring and supervising their teaching staff. Bhutan and Zambia also provide good examples of this trend. Ireland, the United Kingdom, and the United States also have highly developed school-level management systems. PTA roles are highly variable across schools, community income levels, and countries. Construction and Maintenance Although in a few cases, such as Tanzania, the central government finances both construction and maintenance, this is traditionally among the most decentralized education sub functions. Responsibilities for construction and maintenance are often divided between government levels, for example, the province provides resources for construction and major rehabilitation, and the local government conducts routine maintenance; communities and their representatives share costs. Responsibilities also tend to be divided according to the level of schooling: local governments are responsible for primary schools, mid-level governments for secondary schools, and central governments for tertiary education. Teachers’ Salaries Salaries, even in highly centralized systems, are usually paid from the recurrent budget of the administrative level to which teachers report. The true extent of local control over teachers depends on whether or not the teachers are members of a unified national civil service with pay scales set by the relevant service commission. Community involvement in financing teachers’ salaries can help make schools more responsive to community needs, but the practice is controversial with teachers’ unions because it can create inequities in salaries and student-teacher ratios among poorer and richer communities.


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4. Impact of Decentralization The limited available evidence about the impact of decentralization on education services is mixed depending largely on why and how decentralization was undertaken. In some cases, central governments have delegated responsibilities to local governments and communities without providing adequate targeted support to poorer areas. In Brazil the central government has increased overall access (enrollments) but has done little to reverse persistent regional inequities in access to schooling, per capita expenditures, and quality. Chile’s experience also suggests that decentralization does not by itself remove inequalities between localities of varying income, and quality in poorer communities continues to lag. These results are supported by experiences in New Zealand. However, the design of these decentralized systems has been criticized. The initial evidence suggests that decentralization to sub national governments (that is, provinces and states) may not be sufficient and that increased autonomy for communities and school actors may be necessary to improve schools and learning. By increasing the participation of parents, community-managed schools in El Salvador show significantly lower rates of student and teacher absenteeism. While this type of management does not appear to have improved student performance in tests according to recent evaluation, it may be just a matter of time before better student attendance translates in to higher student achievement. In Nicaragua, controlling for similar household background and school inputs, students in schools that make more of their decisions about school functions perform better in tests. These results are derived from ongoing impact evaluations. Because the impact of management reforms such as these may take time to unfold, further empirical analysis is needed. The current consensus is that tertiary education and specific functions such as curriculum design and standards setting are best retained by the center, that secondary and primary education should be devolved as far as possible, and that local participation in school management improves accountability and responsiveness and fosters resource mobilization. 5. Education Expenditure Assignment in 14 EU State The following details the expenditure assignment for certain areas of educational services that are either voluntary or mandatory on the local governments in the original 14 EU states. These have been relatively stable over the years. This is dramatically different to the situation in the new EU member states that originated from the collapse of the soviet bloc in the transition states of the Central and Eastern European region, which has had to make new policies and functional assignments in a democratic transition. The information only indicates the assignment of the various functions on the basis of a voluntary or mandatory requirement on the local government units.


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This only provides some indication of where the primary financial responsibility lies within the governmental structures. While the basis for education financing varies considerable throughout the European Community, the general method is the use of a transfer based system from the central to the local level on the basis of an formula, generally per pupil based with some other factors considered, that is provided to the local government or school authority without restrictions on its use. The main emphasis of the transfer is to provide an equalization basis for education financing and to maintain some minimum standards of quality of the education facilities available across the various rich and poor jurisdictions. As indicated below, the local governments are mandated to provide the pre-primary and primary school costs while there is more voluntary responsibility at the secondary school level. This follows a normal pattern in education expenditures. The mandatory responsibilities are based on the general concept that local schools should be based on the lowest government level that is closest to the community that is served. Placing them as mandatory indicates that the local government or school authority must finance these to the extent of their capabilities. It does not mean that they are fully financed by the local units. The central level provides a general transfer either through the local government or through the school district authority for these purposes. In some cases, for example special education for disabled or disadvantaged children, specific grants may be made to the schools to support the extraordinary costs associated with these students. Some subsidies are also provided for the capital costs of new construction through specific grants to supplement the local financial resources or the debt that is incurred at the local level for this construction. In most cases, the recurrent operating costs of the school must be borne by the local school itself and some portion of the general transfer may be needed to cover any costs that are not covered by the local financial sources. The following education expenditure assignments were as follows: Voluntary Mandatory In 13 EU States: Pre-Primary Schools—Construction 1 12 And Upkeep In 9 EU States: Pre-Primary School Administrative, Teaching and Technical Staff 1 8 In 8 EU States: Primary School Administrative, Teaching or Technical Staff 0 8


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In 7 EU States: Secondary School Construction And Upkeep 4 3 In 4 EU States: Secondary School Administrative, Teaching and Technical Staff 0 4 In 1 EU State: Higher Education Premises Construction And Upkeep 1 0 6. Education Expenditure Assignments in Transition Countries of

Central and Eastern Europe There is an interesting comparison to make with the approaches that the transition countries of Central and Eastern Europe took after the fall of the soviet bloc and communist state control of the education system. The four countries discussed below took different approaches and speed in which they have placed the delivery of education services in a decentralized and democratic system. These differences are summarized. Hungary took a more rapid approach by transferring responsibility for managing and financing pre-primary, primary and secondary education rather abruptly to the devolved local governments in 1990 at the very early stages of transition, whereas Poland took a slower and more deliberate approach in which responsibilities were progressively devolved over a nine year period to 1999. The Czech Republic took a middle of the road approach with the State and local government having shared responsibility a longer stage of devolution into the early part of the new century, and, finally, Slovakia where the State has retained entire responsibility for education, although some degree of devolution has been planned, but yet to be fully implemented. In the following sections below, the specific features of each country’s approach is more fully described with regard to the expenditure assignment and financing of the education sector with a focus on the pre-primary and primary education responsibilities. Hungary. All regular costs fall on county or municipal budgets including teaching salaries. Both counties and municipalities receive general grants, calculated by the Ministry of Finance by a formula which includes fixed sums per pupil in each type of school. These grant elements cover roughly two thirds of actual average costs. Local governments are not obliged to spend this grant according to its service composition. All do in practice spend more than the normative amount on education, contributing the balance from general revenues. In the case of


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municipalities these include the non-service related elements of the formula grant, a declining share of personal income tax, and local taxes of which a tax on business turnover is by far the most important in urban centers. County governments do not levy taxes or receive income tax shares and their discretionary resources are largely confined to the general per capita portion of their normative grant. The Ministry of the Interior has provided grants towards school construction and there are ad hoc grants from the Ministry of Education for innovations, the procurement of professional advice and so on. Where pupils commute to school across municipal boundaries, their home municipality is not obliged to contribute to the receiving authority’s costs. Some do so, but usually only where they offer no equivalent education. The receiving municipality does, of course, receive the normative grant element which is based on pupil numbers, not school age population. In the decentralized system of public education in Hungary the lower tier of government plays a dominant role. Schools are financed by the local governments that at the same time receive subsidies from the central budget. One of the most important characteristics of public education finance is the marked distinction between financial flows from the central to the local or county government level and from the latter to the school level Local governments have two kinds of revenue sources: local revenues and central governmental transfers. Own revenues include local taxes (the most significant being the local business tax), rent revenues, fees, user charges, surplus of financial investment activities and revenues from selling property. The most important types of transfers are shared taxes42 (the dominant in this category is the personal income tax), lump-sum formula grants and earmarked discretionary grants for investment projects. In general, the share of transfers in local governmental revenues has decreased in the last decade. However, one of the key characteristics of the Hungarian local governmental system is the imbalance between the exceptionally wide expenditure assignment and the restricted revenue assignment. Local and county governments receive the central transfers from the Ministry of Interior. Since the central governmental budget is put forward by the Ministry of Finance, probably these two ministries play the most important role in deciding on the amount of grants, but others, like the Ministry of Education are also involved (especially in setting the relative shares of different grants within the category of formula grants for education). However, setting the actual amount of formula grants for education, the central government is constrained by an element of guarantee: the total sum transferred to local and county governments


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can not be less than the 90% of the expenditures on education of lower tiers of government two years anterior (excluding capital expenditures). Formula grants for school maintenance are computed on a per student basis. These grants are not earmarked, i.e. local or county governments may use this amount as they wish, and not exclusively on education services. The only requirement is the continuous compliance with the standards of general legal and educational regulation. However, as the amount of these grants is regularly below the minimum costs of providing education,43 in fact all local and county governments spend more on schools than the grant they receive for this purpose, i.e. formula grants for education have to be supplemented by school owners. Thus local and county governments allocate some of other transfers and/or own revenues to school finance. Note that while maintainers of schools are subsidized on a per student formula basis (excluding development grants), school finance at the local level usually follows a different logic: the method of allocating funds for particular schools in the annual local budget is at the discretion of the local and county governments. The allocation is most frequently the result of a bargaining process between schools and maintainers, based on budget shares of the previous year. The implementation of a local formula financing scheme is a rare exception. It is important to note, that changes in per student formula grants are very poor measures of the fiscal burden that the maintenance of educational institutions imposes on local governments. Formula grants are only one component of central transfers and whether local governments are in a loose or stressed fiscal position can be judged only with respect to transfers as a whole, together with changes in expenditure and revenue assignment (e.g. responsibilities for additional services delegated to local governments and changes in local tax rules). Thus there is no direct relationship between changes in formula grants for education and government spending on education. From the middle of the 1990s the system of formula grants became more and more differentiated. The central government aimed at representing the diversity of average costs in the school system in details; different amounts were assigned to years in primary and secondary school education and several additional elements were introduced (e.g. disadvantaged Roma children taking part in an ethnic program, teaching minority languages, or for students commuting from other settlements). By the second half of the decade the necessity to reduce the complexity of the grant system became evident, and has been implemented so. However, later this shift has been reversed. While the formula grants subsidize the operation of schools, earmarked development grants are for local and county governments to finance investment projects in the physical educational infrastructure. The scope of the potentially subsidized projects and the maximum rate of cost coverage are defined by the central government (e.g. building classrooms or student dormitories). Local


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governmental applications for the grant are evaluated by the Ministry of Interior on a discretionary basis. After the investment projects have been carried out, local governments have to account for the usage of the grant. Poland. The responsibility for schools has been handed over progressively to the various levels of local government between 1990 and 1999, so the State budget’s operating expenditure has been transferred to them by annual grant. These transfers form part of the general grants to the local governments, but there is a legal provision that the education elements must constitute at least 12% of the State Budget revenue. This provision was inserted to reassure the public at large, and teachers in particular, that financial provision for education would not suffer from devolution. Local governments are not obliged to spend their general grants in any particular way and their education spending could, in law, fall below the education element. In practice, it exceeds the education element by an average of 25%. The balance is drawn from general revenues—a combination of tax sharing and local taxes in the case of gmina (local government unit), and tax sharing alone in the case of the two higher tiers. This higher level of expenditure by local governments has arisen from investment costs, payment by larger cities of teachers’ salaries above mandated levels, and by the reluctance of rural gminas to reduce employment despite low and falling pupil teacher ratios. Hopes that local governments might offset part of wage rises by retrenchment have not been fulfilled, due partly to municipal reluctance and partly to the legal impediments to firing teachers. The education elements in the grants to individual local governments have generally been based on the cost to the State Budget at the time of transfer, increased annually by standard percentages. These incorporate historic disparities between territories in the provision and cost of schools. In 2000 allocation was converted to a normative, per pupil basis; but the redistribution was somewhat ‘dampened’ by a provision that no local government should receive less than 100% or more than 110% of the previous year’s amount. Local governments make their own decisions on the criteria for distributing their education budgets to individual schools. Most use incremental methods centered around negotiations on the annual pedagogical plans. The basic feature of these algorithms was a system of per pupil weights or multipliers designed to shift resources to those jurisdictions that had low pupil/teacher ratios. Initially, these multipliers were tied to the average class sizes of primary schools. A multiplier of 1.86 was used for all pupils in rural gminas whose class sizes were less than 15; 1.44 for rural classes of between 15 and 18 pupils; 1.33 for rural class sizes greater than 18 and 1.2 for urban pupils in classes less than 24.


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In other words, the per pupil multipliers were really designed to reflect existing staffing patterns, and not the relative workloads associated with different categories of pupils, such as pupils with disabilities. These multipliers were progressively lowered, and by 1996 decoupled from average class sizes. As a result, in 1996 there was a single multiplier of 1.33 for all pupils attending schools in rural areas and another 1.18 for pupils attending schools in towns with less than 5,000 inhabitants. The rural multiplier reflected the fact that on average the class sizes of rural gminas were one third smaller than those of urban ones (18 to 24). The small town multiplier however had no such justification, as class sizes in small towns were the same as in cities. Czech Republic. Teaching salaries are funded by the Ministry of Education by grants to schools channeled through school offices. These are allocated according to a formula basically comprising the number of pupils divided by a standard pupil/teacher ratio and multiplied by the average national wage for teachers of the respective level. Teachers receive a basic salary on a national scale according to their age, plus responsibility allowances and annual bonus at the director’s discretion. This provides directors with considerable room for maneuver over the numbers and remuneration of staff. If a school’s teachers are younger than average or class sizes above average, there is extra margin for employing more teachers (and shortening hours) or paying them more allowances or bonus. Increases in pupil numbers will be similarly rewarded. The Ministry also provides a grant per pupil for the operating expenses of schools other than teaching salaries. However, in the case of primary and pre-primary schools these only cover roughly one sixth of the cost and the balance has to be provided from municipal budgets along with all investment costs. Municipalities meet these expenses from their general revenues which include shares of income tax and a property tax. Schools are treated as “contributory organizations” so that they may retain unspent balances at the year’s end. Where pupils commute to school across municipal boundaries, their home municipality is obliged to contribute to the receiving municipality’s costs. The financial base for the educational responsibilities of the new regional governments has not been finally resolved. At present they receive targeted grants, but there is an assumption that these will be replaced by shares of state taxes. The funds for the remuneration of directors and other school employees are earmarked by the Ministry. The payment category classification is done by directors at schools that are legal entities. At schools that are not legal entities the responsible school office (regional authorities with transferred capacities) plays the role of employer, which is also responsible for the payment category classification of all other school employees.


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The salary of directors of state schools is determined by the responsible school office (regional body with transferred capacities) in case of schools established by the school office or the municipality, Ministry in case of schools established by the Ministry, and the establishing entity in case of other schools. The wage of school directors consists of a basic tariff component, extra pay for management and personal extra pay. Extra pay for management and personal extra pay is usually recognized for a year, normally from 1 November of the current year to 31 October of the next year. The school offices have been making proposals regarding extra pay so far. Binding rules only exist for the determination of extra pay for directors of schools and school facilities established by the Ministry. Extra pay for management is determined based on the number of pupils in a school, the type of school, school parts and other criteria, on which the person making the proposal has no influence. The exact amount paid for the individual activities is determined by the Ministry. Thus, a director who is not very active receives the same remuneration as a colleague of his who is more active, if they work at facilities of a comparable size. On the other hand, this mechanism has an advantage, which is the limitation of the state employees’ influence on the calculation of extra pay. There is a maximum limit determined for extra pay for management, which cannot be exceeded even if the total amount calculated is higher at large schools. This is a disadvantage for directors of large school complexes. Personal extra pay for directors of schools and school facilities is provided on the basis of very good results of the evaluation of quality of educational activities, the quality of teaching staff, and the excellent fulfillment of a large amount of tasks. The proposed personal extra pay amount can be up to 50% of the basic tariff wage of the director. The methods and the system of remuneration are well-thought out and the remuneration is transparent. However, opportunities to remunerate very good directors with high-quality performance are too limited. The director is entitled to extraordinary extra pay twice a year, the maximum amount of which (per year) is determined. Sometimes a paradox situation occurs—directors of kindergartens receive higher remuneration than directors of secondary schools, which fulfill the function of state administration and are managers of their schools. The Ministry does not approve remuneration for a director that would be higher than the maximum limit. However, in basic schools and kindergartens, the remuneration is recognized by the school office. The remaining funds for wages are used for the remuneration of directors. The remuneration amount depends on the school office’s management of the available finances. Therefore, remuneration recognized by the school office is sometimes higher than remuneration recognized by the Ministry. The situation might be corrected as a result of the establishment of regional authorities, which will be able to distribute the funds


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within the financial package for wages in the educational sector based on the needs and remunerate the work of the best directors. Remuneration of teaching staff and other school employees depends on the establishing entity. In state—(i.e. common) schools, tables determined by law are used for the calculation or the remuneration. Employees are divided into payment categories according to the character of their work and payment grades according to the prescribed education and recognized years of practical work. Only in the lowest qualification classes (1–3), the employer can determine the classification of the employees within the entire range of payment levels by issuing his own rules. This holds true for the remuneration of manual workers. The table only determines the basic salaries. Extra pay for management and replacement, an extraordinary extra pay (extra pay for class teachers and work under difficult conditions) are part of the regular component of the wage. Slovakia. The State Budget currently meets all operating and investment costs of schools, through the regional State Administration budgets. These are allocated to individual schools by the regional and district offices. The Ministry of Education has been trying to convert funding from a discretionary and historic cost basis to a normative formula based on school type and pupil numbers. It has been frustrated, however, by the tightness of state budget allocations and by the reluctance of regional state administrations to follow Ministry guidance. A bill has been submitted to Parliament to subject school funding to normative criteria, based on pupil numbers. As a result, major disparities in per pupil funding exist between regions. Schools have accumulated substantial debts and a major backlog in repair and maintenance. The Ministry contends that the debts are largest in the regions with sparse populations and small schools. Local governments have no financial obligations to education, but have intervened on numerous occasions to carry out emergency repairs neglected by the State Budget. Once ownership of schools has been transferred to regional and municipal governments, they will become responsible for all non-teaching costs. These will be financed initially by targeted grants, but draft legislation envisages replacing these over time with a combination of local taxes (a surcharge on personal income tax in the case of regional governments, property, consumption and unincorporated business taxes in the case of municipalities), and shares of national taxes. The parents also contribute to the financing of education expenditures. In the case of kindergartens, parents contribute to the upbringing, food and educational aid. At the level of primary schools parents pay for meals; the school fees in primary schools specializing in art; the board of children in outdoor pursuit


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schools; accommodation in boarding houses; they also contribute towards the extra-curricular children’s clubs and personal teaching aid. The textbooks for a school year are loaned to pupils (with the exception of pupils in the first grade). The parents also pay the school fees in private schools and educational facilities at all levels. The level of financial means from the state budget necessary for education is partly determined in normative way. The number of students visiting the individual school or educational facility is the basis for the budgeting of wage costs. The District Office Department of Education decides on the number of employees on the basis of the number of pupils and the amount of financial means allocated for given calendar year by the Regional Office in the budget break-down. The office usually discusses the budget break-down with every school and assists also in filling the planned staffing posts. This basic performance unit is modified by uniform indicators in order to establish equal qualitative level of staffing and its remuneration according to an overall Slovak average. This is achieved by using the statistics of an average class size, number of employees per performance unit index, and indicator of the average salary. The areas with national minorities are treated in a special way, in that the indexes are set to a higher level. A similar approach is used in areas with a higher occurrence of small class schools. The school also receives within the break-down of wage means a certain volume for bonuses and allowances, the award of which is decided by the school director. The bonuses and allowances to directors are approved by the Department of Education at the District or Regional Office. The small schools which do not posses the legal entity are in the area of remuneration as well as financing of school operation under the responsibility of the Department of Education of District Office. The finances for operation are supposed to be allocated also on the basis of a normative approach. The real situation in the financing of education at this time does not allow this. The part of financial means determined for fixed expenditures (mainly energy costs and rental) is budgeted according to the needs of the previous year. Often it is not possible to consider an increase in prices of primary energy. The use of calculation according to average temperature in a year in individual regions remains only in theory. A part of further means (current expenditures) is allocated in a form of variable expenditures usually by calculation per pupil. The finances for maintenance are generally provided only in the case of emergency situations. The sources for investment construction are allocated individually, namely on particular building constructions within a limit set in the state budget for every category. The scope of the new school building construction is limited.


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7. Conclusion There is an endless variation in the assignment of expenditure responsibilities among countries around the world. The worldwide trend toward decentralization of authority and responsibility for education services at the pre-primary and primary level has had some measurable success in most countries. The broader participation of the community stakeholders, beyond just the local, provincial and central authorities, has done much to insure the quality of the education available. What has been a serious constraint on furthering of this authority is the lack of sufficient financial resources in most of these developing countries to meet many of the expenditure assignments given to the local authorities. In most cases, the central level has retained the main revenue sources and the local authorities are given a few taxes, fees, and other charges that barely cover the main expenditures areas. The general trend is that the local authorities have to cover the general operating and recurrent costs of the local schools, particularly the salaries and operation and maintenance expenses. The central level will provide a general transfer that allows for the local authorities to use at their discretion and this often covers some of the additional operating expenses that the local authority could not cover or to enhance some educational facilities. The capital investment requirements have a bigger financial input from the central level, but in many cases in the developed world the local authorities have to use their own borrowing and debt capacity to finance these investments. For developing countries, the central level ministry generally provides grants for specific purposes and is largely constrained by the overall national level development budget funds. Since education is a critical sector for a nation’s development, it is appropriate that there is a sharing of the financial responsibility for support of the education system. To this extent, there is always a mix of central and local financial responsibility and where the exact division of financial support is drawn is a policy decision in the political process.


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Annex 2

DEPARTMENT OF EDUCATION DEPARTMENT OF BUDGET AND MANAGEMENT

and DEPARTMENT OF INTERIOR AND LOCAL GOVERNMENT

Joint Circular No. March 31, 2009

TO: GOVERNORS, MAYORS, DIVISION SUPERINTENDENTS AND DISTRICT SUPERVISORS OF SCHOOLS, MEMBERS OF THE LOCAL SCHOOL BOARDS, AND OTHER NATIONAL AND LOCAL GOVERNMENT OFFICIALS CONCERNED

SUBJECT: REVISED/UPDATED JOINT CIRCULAR ON THE BUDGET

ALLOCATION OF THE SPECIAL EDUCATION FUND 1,0 PURPOSE

This Joint Circular is being issued to revise and update the rules and guidelines contained in previous Joint Circulars of the Department of Education (DepEd), Department of Budget and Management (DBM), and Department of Interior and Local Government (DILG) on the use and purpose of the Special Education Fund (SEF) as provided for under RA 7160, the Local Government Code of 1991 and related basic education policies.

2.0 REITERATION OF THE BASIC EDUCATION REFORM AGENDA

AND POLICY Basic education is a shared responsibility of the national government and the local government units, together with the private sector. Local Government Units are thus called upon to support the funding requirements of basic education delivery services with monies coming from the SEF. Towards this end, and in consonance with the objective of greater decentralization of the academic and financial management of schools, it is reiterated that the empowerment of the schools and learning centers calls for greater clarity in their fiscal responsibilities towards more efficient and effective use of resources., particularly that coming from the SEF.


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3.0 RESPONSIBILITY OF THE LOCAL SCHOOL BOARDS (LSBs)

The LSBs in each province, city, or municipality, shall be responsible for determining the annual supplementary budgetary requirements of the public schools in their locality in implementation of the public elementary and secondary education programs, chargeable to the SEF monies of each of the provinces, cities, and municipalities.

4.0 RESPONSIBILITY OF THE DEPARTMENT OF EDUCATION The DepEd, through its regional offices, shall see to it that the LSBs

are furnished with copies of the individual school’s allocation for the year from the national budget, including programmed school buildings and other capital outlays. DepEd approved multi-year school improvement plans shall also be furnished the LSB concerned which will serve as a basis for the LSB budget formulation.

5.0 PRIORITIZATION OF FUNDING ALLOCATION FROM THE SEF

In accordance with the pertinent provisions of the LGC of 1991, the following expenses shall be given priority in the allocation of the SEF budget:

5.1 Construction, repair and maintenance of school buildings and other

facilities of public elementary and secondary schools in schools which are deemed to have a classroom shortage as per the classroom deployment analysis and which have not been identified as recipients of similar funding allocation either in the national budget allocation of DepEd, from the Priority Development Assistance Fund of legislators or from the School Buildings Program/ Basic Education Facilities Fund of the Department of Public Works and Highways;

5.2 Establishment and maintenance of extension classes, where necessary;

5.3 Payment of the salaries and other authorized allowances of teachers and non-teachers hired in connection with the conduct of extension classes in schools that are shown to have a teacher deficiency as per the teacher deployment analysis ;

5.4 Training of teachers; 5.5 Educational research; 5.6 Acquisition/procurement of library books and periodicals; 5.7 Acquisition of equipment, including information technology resources 5.8 Purchase, titling, and improvement of school sites; and


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5.9 Sports activities at the division, district, municipal, and barangay levels which are supportive of school’s physical education programs.

5.0 SEF ALLOCATION PROCESS

The LSBs shall formulate strategic prioritization policies in the allocation of the SEF to the schools. The school improvement plan shall be a major input in this process. It is understood that the DepEd representative to the LSB shall be responsible for coordinating municipal/city school plans with that of the province

6,0 LIMITATION

Expenses not listed in the foregoing shall only be included in the LSB budget estimates/ budget preparation where funds are still available after providing for the priorities, subject to the joint approval of the Chairman and Co Chairman of the Board.

7.0 BUDGET APPROVAL AND IMPLEMENTATION

The SEF Budget shall be subject to the evaluation and approval of the LSB in the form of an LSB Resolution, signed by the Chair and Co-Chair and all the members present during the deliberation.

The implementation of the SEF budget shall follow the same process as the regular budget of the LGU and shall be subject to budgeting, accounting, and auditing rules and regulations.

8.0 APPLICABILITY

This Joint Circular supersedes all other circulars on the prioritization of the expenses chargeable to the SEF.

9.0 EFFECTIVITY This circular shall take effect immediately. JESLI A. LAPUS ROLANDO G. ANDAYA, Jr.

Secretary Secretary Department of Education Department of Budget and Management

RONALDO V. PUNO Secretary

Department of the Interior and Local Government

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STUDY ON LOCAL FISCAL SURPLUS/DEFICIT

Rosario G. Manasan and Cynthia G. Castel 1. INTRODUCTION In the Philippines, while it is generally agreed that financing is a constraint to local service delivery, LGUs in the aggregate have paradoxically registered fiscal surpluses year after year (Table 1). Given this observation, some analysts have argued that the fiscal conservatism exhibited by some LGUs may have been misplaced considering the numerous unmet needs for basic services at the local level. At the same time, there is some anecdotal evidence that some LGUs have incurred debt which they cannot service without exceeding their debt cap. To cope with this problem, these LGUs (with concurrence of the creditor banks) re-structure (i.e., roll-over) their debt. While these two questions are not necessarily contradictory, they suggest the need for a better appreciation and understanding of how the LGU fiscal balance is measured as this would have serious implications on public expenditure management and debt management at the local level. Objective of study. This study is an exploratory one that aims to shed more light on various measures of the LGU fiscal balance. It will do so by first reviewing the existing legal and policy framework related to LGU fiscal balance. The study then proceeds to assess how LGUs measure up with regards to alternative measures of the fiscal balance. This study also comes up with recommendations that will help improve budgeting policies, guidelines, processes and procedures with the end in view of helping promote not only fiscal discipline but also the more effective and efficient use of government resources. In the conduct of this study, fiscal data from two sources were analyzed: (i) the Statements of Income and Expenditure of individual LGUs which are compiled and published by the Bureau of Local Government Finance (BLGF) and (ii) the financial statements submitted by individual LGUs to the Commission on Audit (COA). Field visits to 26 LGUs were also undertaken during which LGU officials were interviewed. These LGUs include the following: the provinces of La Union, Leyte, Iloilo, Guimaras, Davao del Norte, and Agusan del Sur; the cities of Quezon, Marikina, San Jose del Monte, Tagaytay, Tacloban, Iloilo, Butuan, Surigao, Bayugan, Tagum and San Fernando (La Union); and the municipalities of Bauang and Caba in La Union, Asuncion and Sto. Tomas in Davao del Norte,

Study on Local Fiscal Surplus/Deficit

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Basey in Samar, Palo in Leyte, Sta. Barbara in Iloilo, Tubay in Agusan del Norte and Trento in Agusan del Sur. In addition, relevant legislation, manuals and regulations governing local budgeting and the COA Annual Audit Reports for various cities and provinces for the years 2005-2007 were reviewed. 2. LEGAL FRAMEWORK Public expenditure management is anchored on three basic principles: (i) fiscal discipline, (ii) allocative efficiency, and (iii) operational efficiency. Fiscal discipline calls for matching of the demand for government spending with the available resources in the aggregate in order to ensure that LGUs’ fiscal position is sustainable in the medium term. It requires that LGUs come up with honest and good forecasts of revenues and practice good expenditure control. Allocative efficiency refers to the alignment of LGU spending with their policies and priorities. It requires that LGUs allocate their resources in a strategic manner so that the budget system reallocates resources (i) from programs, projects and activities (PPAs) that are of lower priority to those of higher priority, and (ii) from less effective to more effective PPAs. That is, allocative efficiency calls on spending units (i.e., departments and offices) to deliver goods and services in a manner that is effective by selecting the right combination of PPAs (or outputs) that contribute the most to the achievement of the desired outcome. Operational efficiency calls on spending units to deliver goods and services in a manner that is (i) efficient by finding the right combination of inputs so that any given output is produced in the least costly manner (i.e., minimizing cost per unit of output); and (ii) economical by acquiring quality inputs at the lowest cost. The World Bank (1998) underscores the interdependence of the three principles of public expenditure management as one of the most robust findings of both practice and theory. Fiscal discipline help improve the allocation of resources by allowing LGUs to prioritize their activities with a realistic appreciation of their budget constraints. With overly optimistic forecasts of LGU revenue, LGU officials also may not have the incentive to look for more effective and efficient ways of achieving their objectives. LGU officials may not also have the incentive to make hard choices early on during budget preparation, which could lead to the sequestration of appropriations (i.e., expenditure cuts) during the budget year, increased unpredictability in the funding of activities and the possible disruption of local government services. Put positively, fiscal discipline creates an environment that encourages allocative efficiency and operational efficiency. In turn, greater allocative efficiency and operational efficiency feeds back positively into fiscal stability by allowing LGUs to do more with less. Schiavo-Campo and Tommasi (1999), however, provides an insight as to the hierarchy of objectives. They say:


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“If you can’t count the money, you can’t allocate it, and if you can’t allocate it you can’t manage it. Fiscal discipline, in many ways, comes first; resource allocation and operational efficiency come next.”

Given this perspective, it is not surprising that legally stipulated fiscal rules require many governments around the world to balance their budgets or to subject certain fiscal aggregates to very specific targets. For instance, balanced budgets constraints prevail in many US states and many provinces of Argentina and Canada (von Hagen 2007). On the other hand, in the European Union (EU), member states are required to keep their annual government budget deficits below 3% of GDP and their government debt below 60% of GDP. Balanced budget rule. Local governments in the Philippines are likewise subject to some form of balanced budget constraint, albeit somewhat weaker relative to those in other countries. One of the fundamental principles of local fiscal administration set forth in Section 305 of the Local Government Code (Republic Act 7160) of 1991 says:

“The local government unit shall endeavor to have a balanced budget in each fiscal year of operation” (Section 205 - m).

The LGC also provides that the aggregate amount appropriated in the budgets of LGUs for any given fiscal year shall not exceed the estimates of income (Section 324). However, the LGC also allows LGUs to borrow from the credit and the capital markets through loans, credits and other forms of indebtedness as well as through the issuance of bonds, debentures, securities and other obligations for the purpose of financing the construction, installation, improvement, expansion, operation or maintenance of public facilities, infrastructure facilities and self-liquidating, income-producing development or livelihood projects (Section 297 and Section 299). Taken together, these three provisions of the Code have generally been interpreted to mean that proposed and approved budget appropriations for current operating expenditures during any given fiscal year shall not exceed current revenues in that year. In other words, the operating fiscal balance or current fiscal balance (i.e., current revenues less current expenditures) is not allowed to be in deficit.1 For many, these provisions have also meant that LGU borrowing can only be undertaken to finance investment expenditure and that LGUs are forbidden to incur debt of any kind for the purpose of covering current operating deficits. This view is further reinforced by the Updated Budget Operation Manual or UBOM which includes borrowings as one of the income sources which has to be

1 By definition, the current fiscal balance or the operating balance represents government saving. As such, it measures the contribution of government to investable resources and economic growth. Conversely, a current balance deficit represents government dis-saving, and thus the subtraction of resources from resources available for investment (Schiavo-Campo 2007).


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estimated as part of budget preparation and which specifies that the proceeds from borrowings are to be used to finance the development of capital projects (DBM 2005 p. 53). It should be pointed out, however, that Section 296 (b) of the Local Government Code (General Policy on Credit Financing) says:

“A local government unit may avail of credit lines from government or private banks and lending institutions for the purpose of stabilizing local finances.”

A liberal interpretation of Section 296 (b) implies that borrowing may also be undertaken by LGUs to bridge short-term cash flow shortfalls that may result in negative actual current operating fiscal balances. Thus, there is a need to clarify exactly how this provision should be read in relation to the more popular interpretation of the so-called “balanced budget” provisions of the LGC. Closer scrutiny of the financial statements of selected LGUs does indicate that the balanced budget provisions are not strictly complied with. In particular, two of the 26 LGUs visited during the field work did borrow to finance current operating deficits in 2006 and 2007. At the same time, RA 7160 mandates “that no cash overdraft in any local fund shall be incurred at the end of the fiscal year” (Section 337). This provision suggests that LGU budget outturns or the actual results of budget execution (not just the proposed and approved budgets) must be balanced in the sense that the total expenditures (i.e., the sum of PS, MOOE and CO in the current period) measured on a cash basis does not exceed the sum of current revenues, “cash at the end of the previous period” and borrowings, provided borrowings are incurred for the sole purpose of financing capital outlays only.. Unexpended appropriations, continuing appropriations and supplementary budgets. Three provisions of the LGC complicate the measurement and interpretation of the balanced budget rule. First, Section 322 (Reversion of Unexpended Balances of Appropriations, Continuing Appropriations) provides that “unexpended balances of appropriations authorized in the annual appropriations ordinance shall revert to the unappropriated surplus of the general fund at the end of the fiscal year and shall not thereafter be available for expenditure except by subsequent enactment. However, appropriations for capital outlays shall continue and remain valid until fully spent, reverted or the project is completed.” Second, Section 328 (Duration of Appropriation) provides that “appropriations for ordinary administrative purposes not duly obligated shall terminate with the fiscal year and all unexpended balances thereof shall be automatically reverted on the thirty-first (31st) day of December of each year to the general fund of the local government unit.” These provisions authorize the carryover of unobligated appropriations for capital outlays into the next year while directing that unexpended balances of appropriations for personal services and


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MOOE2 are to be reverted to the unappropriated surplus of the general fund. This implies that the overall fiscal surplus measured on a cash basis may actually include cash balances that are not available for appropriation because they are meant to finance continuing appropriations for capital outlays and MOOE that have not yet been expended but which are still valid. Third, Section 321 (Changes in the Annual Budget) provides that “after the local chief executive concerned shall have submitted the executive budget to the sanggunian, no ordinance providing for a supplemental budget shall be enacted, except when supported by funds actually available as certified by the local treasurer or by new revenue sources.” The enactment of supplemental budget/s implies that expenditures for the fiscal year may exceed current revenues for that year if the supplemental budget is backed by unappropriated fiscal surpluses that the LGU has accumulated over the years. This implies that a deficit position in the overall fiscal balance measured on a cash basis may be financed by simply drawing down on the LGU’s cash reserves and without the need to go to the credit or capital market. This implies a more nuanced interpretation of the overall fiscal balance than what has been discussed so far. 3. CURRENT PRACTICE AND OUTSTANDING ISSUES 3.1. Measuring and Monitoring Fiscal Balances of LGUs As indicated in Section 2 above, the Local Government Code calls on LGUs to maintain their current fiscal balances measured on a cash basis in positive territory. At present, there appears to be no systematic monitoring of the fiscal balance of LGUs. However, two data sets are available which may be used to track fiscal aggregates at the local level: the Statement of Cash Flows from LGU submissions to the COA and the LGU Statement of Income and Expenditures collated by the BLGF. The former allows the measurement of both the current fiscal balance (i.e., current revenues less current expenditures) and overall fiscal balance (i.e., current revenues less total expenditures3) while the latter provides data that is only able to measure the overall fiscal balance. The Manual on the New Government Accounting System (NGAS) for LGUs (COA 2002) provides that local accountants shall prepare three financial statements for each fund: (i) Balance Sheet, (ii) Statement of Income and Expenses, and (iii) Statement of Cash Flows. The NGAS follows a modified accrual basis of accounting. Under this method, all expenses are recognized when incurred. Thus, income shall be on accrual basis (e.g. Share from Internal Revenue Collections) except for transactions where accrual basis is impractical (e.g. Market Fees) or when other methods may be required by law. 2 More recent provisions allow appropriations for MOOE to remain valid for a period of two years. 3 Total expenditures = personal services expenditures (PS) + maintenance and other operating expenditures (MOOE) + capital outlays (CO).


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The Balance Sheet shows the financial condition of the LGU at a specific date. It presents information on the assets, liability and the government equity of the LGU. The Statement of Income and Expenses presents the detailed information of the income and expenses recognized during the period covered. On the other hand, the Statement of Cash Flows shows the LGU’s cash activities. It reports cash receipts and cash payments and net change in cash resulting from the operating, investing and financing activities of the LGU during a period, in a format that reconciles the beginning and ending cash balances (COA 2002). Unlike the accrual-based Statement of Income and Expenses, the Statement of Cash Flows reflects a cash basis of recording. This means that transactions are captured when cash is received or when cash payments are made. The information on the sources and uses of cash is useful for assessing the liquidity of the government sector that is not possible from the record of flows on an accrual basis (IMF 2001). With the shift to accrual accounting, the current fiscal balance (i.e., current revenues less current expenditures), measured on a cash basis, may be read off the Statement of Cash Flows of LGUs (IMF 2001). The current fiscal balance is simply equal to the net cash flow from operating activities from the Statement of Cash Flows. On the other hand, the overall fiscal balance (i.e., current revenues less current expenditures and capital outlays) is equal to the net cash inflow from operating activities minus the net cash outflow from investments. On the other hand, fiscal data recorded on a cash basis in the Statement of Income and Expenditure of individual LGUs which are compiled and published by the Bureau of Local Government Finance (BLGF 2008) includes the overall fiscal balance but not the current fiscal balance. However, the overall fiscal balance in the BLGF’s Statement of Income and Expenditures is computed as the difference between the sum of current revenue (consisting of taxes, fees, user charges, IRA) and borrowings, on the one hand, and total expenditures (consisting of both current and capital expenditures), on the other hand. To make it comparable to the estimates of the overall fiscal balance that were earlier derived from the COA Statement of Cash Flows, borrowings were netted out of the BLGF measure of the overall fiscal balance. 3.1.1. Current Fiscal Balance Based on COA data, all LGUs in the aggregate posted current fiscal surpluses in 2002-2007. On the average during this period, the current fiscal surplus of all LGUs combined was equal to 16% of total LGU income, implying that about 16% of total LGU income is available to finance capital outlays in these years. Also, cities posted larger current fiscal surpluses (20% of total LGU income) than provinces (14% of total LGU income) and municipalities in 2002-2007. This confirms the larger fiscal capacity of cities relative to provinces and municipalities to finance capital investments .


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Table 1. Fiscal surplus (deficit) from COA Statement of Cash Flow, 2002-20072002 2003 2004 2005 2006 2007 2002-2007

Levels in billion pesosOverall fiscal balance a/ 10.5 5.3 -0.5 9.7 7.8 -5.3 27.6Provinces 1.7 0.6 0.2 2.5 0.0 -1.3 3.7Cities 5.4 3.3 -0.4 4.2 5.1 -3.2 14.4Municipalities 3.4 1.5 -0.3 3.0 2.7 -0.8 9.5

Current fiscal balance 31.5 32.8 27.3 34.6 40.2 36.3 202.7Provinces 7.6 6.5 6.5 7.7 7.0 6.5 41.8Cities 14.5 16.7 14.8 16.3 20.9 19.7 103.1Municipalities 9.3 9.5 6.0 10.5 12.3 10.1 57.8

% of GDPOverall fiscal balance 0.27 0.12 -0.01 0.18 0.13 -0.08 0.10Provinces 0.04 0.01 0.00 0.05 0.00 -0.02 0.01Cities 0.14 0.08 -0.01 0.08 0.09 -0.05 0.05Municipalities 0.09 0.03 -0.01 0.06 0.04 -0.01 0.03

Current fiscal balance 0.81 0.76 0.56 0.63 0.67 0.55 0.66Provinces 0.20 0.15 0.13 0.14 0.12 0.10 0.14Cities 0.37 0.39 0.30 0.30 0.35 0.30 0.33Municipalities 0.24 0.22 0.12 0.19 0.20 0.15 0.19

% of LGU incomeOverall fiscal balance 6.3 2.8 -0.2 4.4 3.2 -2.0 2.42Provinces 4.2 1.3 0.5 4.7 -0.1 -2.1 1.42Cities 8.2 4.3 -0.5 4.8 5.4 -2.8 3.21Municipalities 5.7 2.2 -0.4 3.8 3.0 -0.9 2.24

Current fiscal balance 18.9 17.3 14.5 15.7 16.6 13.6 16.09Provinces 18.6 14.5 14.6 14.5 12.0 10.5 14.11Cities 21.8 21.7 19.2 18.8 21.8 17.4 20.13Municipalities 15.7 14.1 8.9 13.2 14.0 10.9 12.80a/ Overall fiscal balance is computed as net cash inflow from operating activities less net cash outflows from investing activities.Source: COA Annual Financial Report for LGUs, various years However, the aggregate current fiscal surplus of all LGUs combined exhibited what appears to be a regular fluctuation over the period. The current fiscal surplus of all LGUs as a group declined from 0.81% of GDP (or 19% of total LGU income) in 2002 to 0.56% of GDP (or 15% of total LGU income) in 2004. Then, it rose to 0.63% of GDP (or 16% of total LGU income) in 2005 and 0.67% of GDP (or 17% of total LGU income in 2006 before slipping to 0.55% of GDP (or 14% of total LGU income) in 2007. This trend is evident as well for all levels of local government (Table 1). That the troughs in the observed cycle coincide with election years is certainly something that requires further attention from political economists.


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In line with trend in the current fiscal balance of LGUs, the proportion of LGUs which fail to comply with the balanced budget requirement in the LGC increased from 8% in 2006 to 18% in 2007 in the case of provinces, 4% to 18% in the case of cities and 9% to 18% in the case municipalities (Table 2).

2006 2007% of LGUs with current fiscal deficit Provinces 7.6 17.7 Cities 4.3 17.9 Municipalities 9.1 18.3

% of LGUs with overall fiscal deficit Provinces 34.2 51.9 Cities 28.2 59.8 Municipalities 24.4 44.7Source of basic data: LGU Statement of Cash Flows, COA

Table 2. Percent of LGUs with fiscal deficit based on COA Statement of Cash Flows, 2006-2007

3.1.2. Overall Fiscal Balance Overall fiscal balance based on BLGF data. The overall fiscal balance of all LGUs as a group (measured on a cash basis based on BLGF data) also appears to fluctuate in relation to the electoral cycle. The overall fiscal surplus of all LGUs in the aggregate based on the BLGF SIE declined from an average of PhP 17.6 billion (or 10.6% of total LGU income in 2002-2003 to PhP 6.8 billion (or 3.9% of total LGU income) in 2004 (Table 3). Then, it went up to PhP 23.9 billion (or 12% of total LGU income) in 2005 and PhP 32.9 billion (or 15% of total LGU income) in 2006 before dipping slightly to PhP 29.5 billion (or 12% of total LGU income in 2007. On the average, the overall fiscal surplus based on BLGF data is equal to 0.4% of GDP (or 10.9% of total LGU income) in 2002-2007 (Table 3). Cities registered larger overall fiscal surpluses on the average than provinces and municipalities during this period. To wit, the ratio of the fiscal surplus to total LGU income was estimated to be 15% on the average (or equivalent to a little less than two months’ worth of LGU income) in the case of cities and 8% on the average (or equivalent to more than one month’s worth of LGU income) in the case of provinces and municipalities in 2002-2007.


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Table 3. Overall fiscal surplus (deficit) on cash basis based on BLGF SIE, 2002-20072002 2003 2004 2005 2006 2007 2002-2007

Overall fiscal surplus (deficit) a/

(in billion pesos) 17.5 17.8 6.8 23.9 32.9 29.5 128.5Provinces 2.8 3.7 -0.1 5.6 5.5 5.1 22.5Cities 8.6 9.5 7.2 11.8 19.2 16.6 73.0Municipalities 6.1 4.6 -0.3 6.6 8.2 7.9 33.0

Overall fiscal surplus (deficit) as % of GDP 0.5 0.4 0.1 0.4 0.5 0.4 0.4Provinces 0.1 0.1 -0.003 0.1 0.1 0.1 0.1Cities 0.2 0.2 0.149 0.2 0.3 0.2 0.2Municipalities 0.2 0.1 -0.006 0.1 0.1 0.1 0.1

Overall fiscal surplus (deficit) as % of LGU income 11.1 10.2 3.9 12.3 15.0 12.7 10.9Provinces 7.4 9.0 -0.4 12.5 11.1 9.6 8.2Cities 13.7 13.4 10.0 14.4 20.7 16.9 14.8Municipalities 10.6 7.4 -0.4 9.6 10.6 9.7 7.9a/ current revenues net of borrowing less total expendituresSource of basic data: BLGF Statement of Income and Expenditure (BLGF SIE) These averages mask large surpluses in many LGUs. The interquartile ratio4 of the fiscal-surplus-to-LGU-income ratio in 2006 is 9 for cities and 8 for provinces and municipalities (Table 4). Also, 29% of provinces, 32% of cities and 19% of municipalities had fiscal-surplus-to-LGU-income ratios that are equivalent to more than two months’ worth of their annual income in 2006. In view of these findings, some analysts have argued that the fiscal conservatism exhibited by some LGUs may have led them to “underspend” despite numerous unmet needs for basic services at the local level. However, LGU treasurers and budget officers interviewed as part of this study note that the surpluses many LGUs report are in large part attributable to the following factors: (i) the cautious fiscal stance of many LGUs because they are not allowed to incur an overdraft thereby leading them to have overly conservative revenue/ income estimates and/ or excessive expenditure controls, (ii) the unused portion of their calamity fund which they are required to keep intact until the end of the fiscal year unless a calamity/ disaster does occur, and (iii) delays in the implementation of projects. Thus, they argue that such surpluses are to a large extent illusory. They say that once LGUs actually realize a fiscal surplus at the end of any given fiscal year, said LGUs immediately appropriate the full amount that is available for appropriation by enacting a supplemental budget in the year immediately after the year the surplus is

4 The interquartile ratio is the value for the 75th percentile divided by the value for the 25th percentile. It measures the amount of variation that is less influenced by extreme values than the range.


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realized. In 2007 and 2008, LGU budget officers report that the fiscal surplus realized in the previous year was appropriated as supplemental budgets and used to fund the 10% across-the-board salary increase that were mandated in those years. In earlier years, fiscal surpluses were used to fund LGU projects that were not accommodated in the regular annual budget that were typically funded out of current year’s income.

2002 2006Fiscal surplus (deficit) as % of total LGU incomeProvinces First quartile 2.9 2.2 Median 6.5 9.0 Third quartile 13.4 17.4

Cities First quartile 1.8 2.5 Median 8.9 10.2 Third quartile 21.5 22.2

Municipalities First quartile 3.3 1.7 Median 9.5 7.2 Third quartile 16.8 14.0a/ net of borrowingsSource of basic data: 2002 and 2006 SIE, BLGF

Table 4. Variation in fiscal surplus (deficit) based on BLGF SIE a/ as % of LGU income, 2002-2006

Overall fiscal balance based on COA data. The trend in the overall fiscal balance of all LGUs as a group measured based on COA data is generally consistent with that based on BLGF data. This can be gleaned from a comparison of Table 1 with Table 3). Table 1 shows that overall fiscal deficits were registered during election years (2004 and 2007) while fiscal surpluses were posted during non-election years (2002, 2003, 2005 and 2006). However, while the accumulated overall fiscal balance based on COA data is positive (PhP 28 billion) for the entire period 2002-2007, it is not as large when measured relative to total income as BLGF data indicates (2% of total LGU income vis 11% of total LGU ). This finding, therefore, does not appear to support the hypothesis that LGUs are “under-spending” and which appears to be evident from BLGF data. Difference between overall LGU fiscal surplus estimates from COA data and BLGF data. Although the trend in the overall fiscal balance based on estimates based on BLGF data, on the one hand, and that based on COA data on the other, is consistent, they differ on two points. First, the overall fiscal balance for all LGUs in the aggregate using BLGF data is always positive in 2002-2007 and does not show the deficit spending during election years that was evident when the COA data is used. Second, the aggregate LGU overall fiscal balance based


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on the BLGF data is significantly larger than the corresponding estimates based on COA data in 2002-2003 and 2005-2006 regardless of whether it is expressed in nominal levels, relative to GDP or relative to LGU income. To wit, the overall fiscal balance for all LGUs combined based on the BLGF data was 70%-325% higher than the corresponding estimates based on the COA data during the years under study. As a corollary, the proportion of LGUs that posted overall fiscal deficits in 2006 based on the BLGF data was significantly lower than the corresponding estimate when COA data is used (compare Table 5 with Table 2). For instance, 17% of provinces had overall fiscal balance in negative territory in 2006 based on BLGF data compared with 34% when COA data is used. In like manner, 14% of municipalities had negative overall fiscal balances in 2006 based on BLGF data compared to the 24% estimate based on COA data.

2002 2006% of LGUs with overall fiscal deficit Provinces 15.2 16.5 Cities 14.0 17.9 Municipalities 11.2 14.4Source of basic data: BLGF SIE

Table 5. Percent of LGUs with overall fiscal deficit based on BLGF SIE, 2002 & 2006

Given this perspective, there is a need to better understand the sources of the disparity and for the oversight agencies to adopt a common measure. However, due to time constraint, the present study is not able to look into the reasons that will explain the observed differences. This is therefore definitely an area for future research. 3.1.3. Other Fiscal Aggregates: Accumulation of Cash Reserves, Debt

Finance of Capital Outlays, Cash Inflows from New Debt and Cash Outflows to Redeem Existing Debt

The growth in “cash at the end of the period” of all LGUs in the aggregate (which is found in the COA balance sheet) is largely consistent with the movement in the overall balance. The growth in “cash at the end of the period” of all LGUs in the aggregate is still another way of verifying the hypothesis that LGUs are under-spending. Given an overall fiscal surplus of PhP 5.3 billion for all LGUs combined in 2003 (Table 1), “cash at the end of the period” went up in nominal terms from PhP 50.5 billion in 2002 to PhP 57.3 billion in 2003 (Table 6). Then, as all LGUs in the aggregate posted an overall fiscal deficit of PhP 0.5 billion in 2004, their “cash at the end of the period” dipped to PhP 57.0 billion in 2004. Subsequently, “cash at the end of the period” for all LGUs as a group rose to PhP 79.3 billion in 2006 after LGUs registered an overall fiscal surplus of PhP 9.7 billion in 2005


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and PhP 7.8 billion in 2006. However, when expressed relative to GDP or relative to total LGU income, aggregate cash reserves of all LGUs remained fairly stable at 1.2%-1.3% of GDP and 33%-37% of total LGU income during the period. Again, this finding does not appear to support the hypothesis that LGUs are under-spending and, as a result, they are consistently building up their cash reserves over time. Table 6. Cash reserves and amount available for appropriation, 2002-2007

2002 2003 2004 2005 2006 2007Levels (in billion pesos)Cash reservesa/ at end of period 50.5 57.3 57.0 70.1 79.3 77.7Current assets net of payables but not continuing appropriation 24.8 28.7 27.1 35.3 37.5 35.7Amount available for appropriation b/ 14.1 8.5 15.4 17.4 17.6 13.9

% of GDPCash reservesa/ at end of period 1.3 1.3 1.2 1.3 1.3 1.2Current assets net of payables but not continuing appropriation 0.6 0.7 0.6 0.6 0.6 0.5Amount available for appro 0.4 0.2 0.3 0.3 0.3 0.2

% of LGU incomeCash reservesa/ at end of period 32.3 33.5 33.6 36.6 37.2 33.9Current assets net of payables but not continuing appropriation 15.9 16.8 16.0 18.5 17.6 15.6Amount available for appro 9.0 4.9 9.1 9.1 8.3 6.1a/ Includes investment in securities

b/ Amount available for appropriation is equal to the difference of government equity, on the one hand, and the sum of (i) total plant, property and equipment including public infrastructure in process net of total long-term liabilities, (ii) equity set aside to finance capital projects backed up by continuing appropriations, (iii) obligated allotments for which no liability had been recognized as yet,[1] (iv) sinking funds, (v) prepayments, (vi) contingent capital or receivables, and (vii) unused inventories. Continuing appropriaitons (consisting of unobligated balances for capitla outlays) estimated based on previous years' ratio to total income for 2004-2007.

Source of basic data: Consolidated Balance Sheets and SAAOB in COA Annual Financial Reports for LGUs, various years

On the other hand, capital outlays of all LGUs combined were fully financed by the net result of operating activities in 2002-2003 and in 2005-2006 as gleaned from a closer scrutiny of the details of the LGUs’ Consolidated Statement of Cash Flow. This trend is consistent with the observed accumulation of fiscal surpluses by all LGUs in the aggregate during these years as shown in Table 1. In 2004, however, capital outlays were financed by the net result of operating activities (98%) and net borrowings (2%). In contrast, capital outlays were financed by the net result of operating activities (87%), with the drawdown of accumulated surpluses accounting for 10% and net borrowings accounting for 3% of the total LGU financing requirement in 2007. This finding appears to be consistent with anecdotal stories obtained from the field visits that LGU elective officials tend not only to spend the surpluses they have accumulated in earlier years but also to incur more debt during election


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years. Some observers raise the concern that local chief executives tend to borrow more as their terms are about to end at the expense of incoming officials who are left to pay off such indebtedness. However, the trend in outstanding long-term liabilities of all LGUs does not appear to strongly support these apprehensions. Table 7 shows that while outstanding long-term debt of all LGUs in the aggregate did increase between 2002 and 2007 it did so only marginally when reckoned relative to total LGU income. Thus, outstanding long-term debt of all LGUs combined went up from 0.14% of total LGU income in 2002 to 0.17% of total LGU income in 2007 despite the fact that nominal level of outstanding long-term liabilities of LGUs almost doubled during the period. In contrast, a reading of the Annual Audit Reports for individual LGUs for 2006-2007 and key informant interviews during the field visit indicate that the frequent restructuring of LGU debt is another possible manifestation of fiscal distress. For instance, there are anecdotal stories that a number of LGUs have incurred debt which they cannot service without exceeding their debt cap. To cope with the problem, these LGUs (with concurrence of the creditor banks) re-structure (i.e., roll-over) their debt. An indicator of this occurrence is where outflows to redeem past debt are relatively large compared to the inflows of new debt. To validate these stories, the cash inflows from new borrowings are compared with the cash outflows for the redemption of old debt for all LGUs in the Philippines in 2007. It was found that cash outflow for the amortization/ retirement of old debt accounted for at least 50%5 of the cash inflow from loan proceeds in 10% of provinces, 21% of cities and 5% of municipalities in 2007. This finding provides some evidence that indeed the number of LGUs which may be having problems servicing their debt are not as insignificant as one would initially expect given the balanced budget rules in the Local Government Code. Recommendation. In the light of the balanced budget provision in the LGC, the list of fiscal performance indicators in the Local Government Performance Monitoring System should include the current fiscal balance as a measure of LGU savings and its contribution to the pool of resources that is available for investment. Fortunately, this measure can be read off easily from the COA Statement of Cash Flows.

5 Admittedly, the 50% cut-off is arbitrary.


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Table 7. Gross borrowings and outstanding long-term liabilities of all LGUs, 2002-2007 (in billion pesos)

2002 2003 2004 2005 2006 2007

% increase

2002-2007

Gross borrowings 4.2 5.6 6.9 6.7 8.2 10.3 145.3 Provinces 1.5 1.8 1.7 1.4 2.9 2.3 57.9 Cities 1.8 2.0 4.0 3.7 2.9 5.5 200.2 Municipalities 0.9 1.9 1.1 1.6 2.4 2.5 177.3

Outstanding long-term liabilities 24.1 28.2 31.8 37.8 36.8 45.8 90.2 Provinces 5.0 6.7 7.2 7.5 9.4 10.5 110.1 Cities 14.3 14.8 17.5 21.8 17.0 24.1 67.9 Municipalities 4.8 6.7 7.2 8.6 10.4 11.3 136.1

Gross borrowing as % of GDP 0.11 0.13 0.14 0.12 0.14 0.16 0.13 Provinces 0.04 0.04 0.04 0.02 0.05 0.04 0.04 Cities 0.05 0.05 0.08 0.07 0.05 0.08 0.06 Municipalities 0.02 0.04 0.02 0.03 0.04 0.04 0.03

Outstanding LT liabilities as % of GDP 0.62 0.65 0.65 0.70 0.61 0.69 0.65 Provinces 0.13 0.15 0.15 0.14 0.16 0.16 0.15 Cities 0.37 0.34 0.36 0.40 0.28 0.36 0.35 Municipalities 0.12 0.16 0.15 0.16 0.17 0.17 0.15

Gross borrowing as % of LGU income 2.53 2.96 3.64 3.02 3.41 3.87 3.24 Provinces 3.61 3.97 3.84 2.55 5.06 3.81 3.81 Cities 2.74 2.58 5.24 4.22 3.03 4.83 3.77 Municipalities 1.54 2.73 1.65 2.02 2.73 2.73 2.23

Outstanding LT liabilities as % of LGU income 0.14 0.15 0.17 0.17 0.15 0.17 0.16 Provinces 0.12 0.15 0.16 0.14 0.16 0.17 0.15 Cities 0.22 0.19 0.23 0.25 0.18 0.21 0.21 Municipalities 0.08 0.10 0.11 0.11 0.12 0.12 0.11Source: COA AFR, various years Still another measure of fiscal performance which may be included in the list of indicators of fiscal performance that should be tracked is the overall fiscal balance as a summary measure of LGU’s borrowing requirement, i.e., “the extent to which government is either putting financial resources at the disposal of other sectors in the economy or utilizing the financial resources generated by other sectors” (IMF 2001). The overall fiscal balance allows government to focus on the financing constraint which has traditionally been viewed as government’s most binding constraint. In addition, some debt management indicators may also be considered, e.g., a measure that assesses the size of debt service relative to LGU income and one that compares the amount of cash outflows to amortize/ redeem past debt relative to amount of cash inflows from the incurrence of new debt.


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3.2. Measuring Resources Available for Appropriation As discussed in Section 2 above, the provisions of the LGC authorizing (i) the carryover of appropriations for capital outlays into future years, (ii) the reversion of unexpended balances of appropriations for personal services and MOOE to the unappropriated surplus of the general fund and (iii) the enactment of supplemental budgets provided that they are supported by funds that are actually available for appropriation or new sources of revenues, underscores the need for arriving at a good measure of the amount of “resources available for appropriation or operation at the end of previous year” (sometimes also referred to as the amount of free resources) at the end of any given fiscal year. Arriving at good estimates of this measure will contribute significantly to the improvement of public expenditure management system by better defining the LGU resource envelope. This measure is perhaps even more critical than the current or overall fiscal balance not only in enforcing fiscal discipline but also in improving resource allocation and operational efficiency as it promotes total resource budgeting. Unfortunately, the amount of resources available for appropriation at the end of the previous year cannot be read off easily from any of the existing financial reports. In fact, more than a few of the LGU technical staff interviewed during the field visits had difficulty providing estimates of this measure. As a result, the majority of LGU budget officers interviewed as part of this study report that, despite guidance in the Updated Budget Operations Manual (DBM 2005) to the contrary, they do not include an estimate of the amount of resources available for appropriation at the end of the previous year when they prepare the budget proposal for the incoming year. Instead, when they prepare the budget proposal for the incoming fiscal year, they only look at estimates of current revenue/ income vis-à-vis proposed spending for personal services, maintenance and other operating expenditures and capital outlays. In principle, the amount available for appropriation at the beginning of the period is equal to the difference of government equity, on the one hand, and the sum of (i) total plant, property and equipment including public infrastructure in process net of total long-term liabilities, (ii) equity set aside to finance capital projects backed up by continuing appropriations, (iii) obligated allotments for which no liability had been recognized as yet,6 (iv) sinking funds, (v) prepayments, (vi) contingent capital or receivables, and (vii) unused inventories.7 Alternatively, the amount available for appropriation at the end of the year may also be computed as being equal to the amount available for appropriation at beginning of the year plus revenues / income in current year less current and capital expenditures in current year less accounts payable less value of continuing appropriation. Table 6 shows that amount available for appropriation varies from 4% - 9% of total LGU income in 2002-2007. Meanwhile, a comparison of Table 1 with Table 6

6 This amount should be disclosed in the Notes to the Financial Statements. 7 The authors wish to thank Carmen Antasuda of the COA for sharing this formula.


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indicates that the amount available for appropriation is consistently larger than the overall fiscal surplus during the period. The amount available for appropriation was estimated for the 26 LGUs visited for this study. The analysis reveals that the amount available for appropriation is negative in 11 (or 42%) out of these 26 LGUs in 2007. Eight out of the 11 LGUs which had negative “amount for available for appropriation” also registered fiscal deficits while 3 posted fiscal surpluses. However, these 3 LGUs would have also posted fiscal deficits had they reduced their accounts payables. This is perhaps indicative of the extent of creative accounting that is happening on the ground. It is notable that LGUs which have negative “amount available for appropriation” share a common characteristic. Their accounts payable are significantly larger than their cash reserves. A comparative analysis of the 26 LGUs visited for this study reveals that the incidence of fiscal deficit is higher (62%) than the incidence of negative amounts available for appropriation (Table 8). It appears that if the amount of available for appropriation in the LGU is negative, then it is more likely that said LGU will post an overall fiscal deficit. However, if the LGU has an overall fiscal surplus, then it is more likely that the amount available for appropriation in the LGU is also positive.

Negative overall fiscal balance

Positive overall fiscal balance

Total

Amnt available for appro is negative

8 3 11 (42%)

Amnt available for appro is positive

8 7 15 (58%)

Total 16 (62%) 10 (38%) 26 (100%)

Table 8. Relation between Amount Available for Appropriation and Overall Fiscal Balance, 2007

Recommendation. The amount available for appropriation is another important indicator of fiscal performance that should be monitored on a regular basis. It is important for LGUs to be able to arrive at good estimates of this measure in order for them to be able to delimit how much they can legitimately subject to further appropriation. On another level, it would also improve public expenditure management at the local level if simple techniques to forecast the amount available for appropriation


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in the current year are developed so as to be able to include this estimate in the preparation of the budget for the incoming year. These forecasting techniques would require the close monitoring of cash flows and utilization/ obligation of appropriations and allotments which are prescribed in the UBOM and the NGAS even now. At present, many LGUs do not include any estimate of the amount available for appropriation for the year (t-1) in preparing the budget for year t. Instead they simply enact a supplemental budget in year t once the actual amount available for appropriation that is realized upon closing of the accounting books for year (t-1) becomes evident. On the one hand, current practice may be justified on the grounds of fiscal prudence because of the difficulties involved in arriving at a firm determination of the amount available for appropriation. On the other hand, not including this amount in the preparation of the annual budget for year t detracts from the implementation of total resource budgeting and tends to fragment budget preparation. 3.3. Managing the Fiscal Position The guidelines, processes and procedures governing the preparation, review and execution of the budget are well laid out in the Updated Budget Operations Manual (DBM 2005). The UBOM provides a comprehensive step-by-step guidance on budget preparation, budget authorization, budget review, budget execution and budget accountability. It outlines the specific steps LGUs have to take and the specific forms LGUs have to use as they go through the budget cycle in a manner that will ensure that they comply with the process and documentation requirements of law on local budgeting. What is perhaps needed at this point is a handbook to complement the UBOM. The handbook should aim (i) to communicate a policy framework for LGU budgeting that is anchored on the basic principles of public expenditure management, and (ii) to provide LGUs with tools and techniques that will help them incorporate these tenets in their budget processes. The articulation of the policy framework is important because there is a need to provide the proper motivation for the various processes that are part and parcel of the local budgeting. On the other hand, there is also a need to equip LGUs with the tools that will assist them on the more technical aspects of budgeting. 3.3.1. Realistic Income Estimates Good public expenditure management suggests that budget preparation starts with a firm determination of the amount of resources that are likely to be available (i.e., the resource envelope). On the one hand, income estimates that are too easy tend to result in an overly conservative fiscal stance, large budget surpluses, and non-implementation of much needed programs. On the other hand, overly optimistic income estimates lead to the sequestration of allotments


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(especially in the early part of the year), delays in the obligation of expenditure authorization and, subsequently, delays in project implementation. Furthermore, the appropriation does not necessarily reflect actual fund utilization and the budget becomes non-transparent. Related to this, the UBOM provides Local Budget Forms which LGUs shall use in showing their income and revenue estimates. What is missing, however, is guidance on how to develop good income estimates. In practice, income/ revenue estimates on which the annual budget is based tend to be poor. Many local treasurers do not appear to follow a systematic approach in coming up with their income estimates.

It used to be that income/ revenue estimates tended to be generally biased downwards, reflective perhaps of local treasurers’ tendency to use collection targets that are easily within their reach. More recently, pressures from local elected officials appear to have pushed income estimates upward such that in some LGUs the expenditure program has become bloated relative to what can realistically be supported by actual collections. Recommendations. There is a need to upgrade the technical capacity of LGUs in formulating honest and realistic estimates of income and sources of budget finance including the amount available for appropriation at the end of each fiscal year. Pardo and Zipagan (2008) have developed a training module to do just this under ADB TA 4778. It should be emphasized, however, that the problem of arriving at realistic income estimates stems not only from purely technical factors but also from bureaucratic inertia as well as the desire of politicians to keep an excessive number of programs during budget preparation. This underscores the need for communicating the public expenditure management framework at the local level. 3.3.2. Expenditure controls Once the budget is passed into an appropriation ordinance, the budget enters the budget execution phase. Good budget execution calls for: (i) ensuring that the budget will be implemented in conformity with the budget legislation; (ii) adapting the budget to changes in the economic environment; and (iii) managing the use of resources efficiently and effectively. In turn, fiscal discipline, allocative efficiency and operational efficiency require that (i) effective controls at each phase of budget execution are in place to ensure that obligations and disbursements do not exceed appropriations; (ii) an adequate and transparent reporting system showing all movements on appropriation/ allotment/ obligation/ cash expenditure is installed to track transactions at each stage; and (iii) budget funds are released in a timely manner to support implementation of government programs.


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In practice, the allotment system is one way of ensuring that obligations incurred do not exceed spending authorization as embodied in the appropriation ordinance. But perhaps more importantly, the system aligns the release of spending authority with the projected inflow of tax collections and other revenues. The UBOM (DBM 2005) specifies the use of the Local Budget Matrix (LBM), the Cash Program and Physical Performance Targets as the control devices in the allotment system. The Local Budget Matrix (LBM) reflects the overall plan of the LGU for the release of allotments8 pertaining to approved appropriations disaggregated by department/ office/ program/ project and by object of expenditure. It also paces the release of allotment advice by categorizing the different expenditure items in the appropriation ordinance into those not needing clearance (NNC) and those needing clearance (NC) prior to the release of the allotment advice. The “needing clearance” items generally include new programs/ projects, the purchase of motor vehicles/ equipment and the payment of retirement gratuity and terminal leave benefits. Thus, the classification determines the relative ease in securing the allotment advice for the different expenditure items. The release of the “for later release” portion of the allotments for said items depends on the results of the periodic evaluation of the physical and financial performance of the department/ office/ project concerned. The LBM also allows the imposition of reserves. That is, it may set aside a certain portion of the authorized appropriation of every department/ program to cover for any possible shortfall in revenue. As discussed in the UBOM, the allotment system requires a system of cash monitoring and programming through the use of periodic Cash Flow Forecast and Cash Flow Analysis. These tools are essential to ensure that allotments are safely covered by cash or by future collections and that cash is available when it is needed to pay obligations. On the other hand, the Physical Performance Targets contains the targeted performance indicators of each department/ office of the LGU which serves as standards/ guides against which physical and financial performance of a department/ office are measured and evaluated. By focusing on the control of allotment releases, the allotment system forms the first line of defense in expenditure control. While the UBOM outlines the specific steps LGUs have to take and the specific forms LGUs have to use in the preparation of the Cash Flow Forecast and Cash Flow Analysis, there is little guidance available on the technical aspects of cash flow forecasting and cash follow analysis. 8 The allotment advice is the authorization issued by the local chief executive allowing a department/ office of the LGU to incur obligations for specified amounts within its appropriation.


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Recommendation. The discussion above highlights the need to build the technical capacity of LGUs to do cash flow forecasting and cash flow analysis. These are essential inputs to a better functioning allotment system that will assist LGUs strike the right balance between fiscal conservatism and the need to provide the services that local communities are in dire need of. Simple spreadsheet models for cash flow forecasting and cash flow analysis have been developed by Manasan (2006). To further assist LGUs, the DBM may also wish to establish benchmarks against which LGUs can compare the results of their cash flow forecasts and cash flow analysis to aid their decision making process as to the timing of the release of reserves, revisiting the revenue generation strategies of the LGU, and revising the methodology for revenue forecasting. The DBM may also wish to consider providing guidance on what steps LGUs need to take in the event of an impending fiscal deficit. For instance, is there need for Sanggunian action or resolution authorizing the local chief executive to reduce allotments without need for further consultation with the Sanggunian once it is established that actual revenues for the fiscal year will be lower than the estimates of income that were used in preparing the budget? Are the existing guidelines pertaining to the allotment system not enough to address this problem? 4. CONCLUSION Local governments in the Philippines are subject to some form of balanced budget constraint, just like local governments in other parts of the world. While it is generally agreed that financing is a constraint to local service delivery in the Philippines, LGUs in the aggregate have paradoxically registered fiscal surpluses year after year. On the other hand, practitioners argue that such surpluses are to a large extent illusory. They say that once LGUs actually realize a fiscal surplus at the end of the fiscal year said LGUs immediately appropriate the full amount by enacting a supplemental budget. These practitioners also note that the stock of outstanding LGU long-term debt has almost doubled in the five-year period between 2002 and 2007. At the same time, they also point to anecdotal evidence that some LGUs have resorted to the frequent restructuring of their outstanding debt, indicative perhaps of some kind of fiscal stress. The policy problem thus boils down to the extent one can further stretch the fiscal space given existing resources without compromising fiscal discipline. Significant differences in the BLGF and COA data on LGU fiscal aggregates measured on a cash basis have been observed in 2002-2007. There is a need to better understand the sources of the disparity and for the oversight agencies to adopt a common measures and definitions. In the light of the balanced budget


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provision in the LGC, the fiscal performance indicators in the Local Government Performance Monitoring System should include the current fiscal balance as a measure of LGU savings and its contribution to the pool of resources that is available for investment. Still another measure of fiscal performance which may be included in the list of indicators of fiscal performance that should be tracked is the overall fiscal balance as a summary measure of LGU’s borrowing requirement. The overall fiscal balance allows government to focus on the financing constraint which has traditionally been viewed as government’s most binding constraint. In addition, some debt management indicators may also be considered, e.g., a measure that assesses the size of debt service relative to LGU income and one that compares the amount of cash outflows to amortize/ redeem past debt relative to amount of cash inflows from the incurrence of new debt. At the same time, the amount available for appropriation is another important indicator of fiscal performance that should be monitored on a regular basis. It is also important for LGUs to be able to arrive at good estimates of this measure in order for them to be able to delimit how much they can legitimately subject to further appropriation. The guidelines, processes and procedures governing the preparation, review and execution of the budget are well laid out in the Updated Budget Operations Manual (DBM 2005). It outlines the specific steps LGUs have to take and the specific forms LGUs have to use as they go through the budget cycle in a manner that will ensure that they comply with the process and documentation requirements of law on local budgeting. There is a need for a handbook to complement the UBOM. The handbook should aim (i) to communicate a policy framework for LGU budgeting that is anchored on the basic principles of public expenditure management, and (ii) to provide LGUs with tools and techniques that will help them incorporate these tenets in their budget processes. The articulation of the policy framework is important because there is a need to provide the proper motivation for the various processes that are part and parcel of the local budgeting. On the other hand, there is also a need to equip LGUs with the tools that will assist them on the more technical aspects of budgeting. In particular, there is a need to upgrade the technical capacity of LGUs in formulating honest and realistic estimates of income and sources of budget finance including the amount available for appropriation at the end of each fiscal year. Pardo and Zipagan (2008) have developed a training module to do just this under ADB TA 4778. There is also a need to build the technical capacity of LGUs to do cash flow forecasting and cash flow analysis. These are essential inputs to a better functioning allotment system that will assist LGUs strike the right balance


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between fiscal conservatism and the need to provide the services that local communities are in dire need of. Simple spreadsheet models for cash flow forecasting and cash flow analysis have been developed by Manasan (2006). To further assist LGUs, the DBM may also wish to establish benchmarks against which LGUs can compare the results of their cash flow forecasts and cash flow analysis to aid their decision making process as to the timing of the release of reserves, revisiting the revenue generation strategies of the LGU, and revising the methodology for revenue forecasting.


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REFERENCES

Bureau of Local Government Finance (BLGF). 2008. Statement of Income and

Expenditures, 2005-2007. Manila: BLGF Commission on Audit (COA). 2002. Manual on the New Government Accounting

System (NGAS) for Local Government Units. Quezon City: Commission on Audit

Department of Budget and Management (DBM). 2005. Updated Budget

Operations Manual for Local Government Units. Manila: Department of Budget and Management.

Folscher, Alta. 2007. “Local Fiscal Discipline: Fiscal Prudence, Transparency and

Accountability.” in Shah, Anwar (ed.), Local Budgeting. Washington, D.C.: World Bank

Gosling, James J. 2002. Budgetary Politics in American Governments. New

York: Routledge International Monetary Fund (IMF). 2001. Manual on Government Finance

Statistics. Washington, D.C.: International Monetary Fund. Kraan, Dirk-Jan. 1996. Budgetary Decisions: A Public Choice Approach.

London: Cambridge University Press. Manasan, Rosario. 2006. “Budgeting and Public Expenditure Management

Guidebook,” Report submitted to the Asian Development Bank as part of Technical Assistance Strengthening Provincial Planning and Budgeting.

Shiavo-Campo, Salvatore. 2007. “Budget Preparation and Approval” in Shah,

Anwar (ed.), Budgeting and Budgetary Institutions. Washington, D.C.: World Bank

Schiavo-Campo, Salvatore and Daniel Tommasi. 1999. Managing Government

Expenditures. Manila: Asian Development Bank Republic Act (RA) No. 7160. 1991. Local Government Code of 1991 Von Hagen, Jurgen. 2007. “Budgeting Institutions for Better Fiscal Performance”

in Shah, Anwar (ed.), Budgeting and Budgetary Institutions. Washington, D.C.: World Bank

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IMPROVING THE FINANCIAL MANAGEMENT OF LOCAL ECONOMIC ENTERPRISES


1. INTRODUCTION Local economic enterprises (LEEs) may include public markets, slaughter houses, hospitals, public cemeteries, parking areas, sports, recreational and cultural facilities, public utilities such as water and power supply and distribution and telecommunications, garbage collection and disposal, and public transport and terminal services, among others.

Earlier studies (e.g., Pardo and Zipagan 2008, Manasan 2003) have pointed out that although LEEs are meant to be self-sustaining, if not revenue-generating units, many of them actually incur losses on a continuing basis. Current practice in many LGUs does not engender a clear appreciation of the true cost of the local economic enterprise. COA has documented many cases where the operation of LGU economic enterprises was not treated as special accounts in the General Fund contrary to the provisions of the Local Government Code (LGC) of 1991. The less than transparent reporting of the actual financial condition and profitability of these enterprises may have some adverse effect on decisions taken by LGU officials. On the one hand, economic enterprises are oftentimes used as the vehicle for charging casual employees who are utilized elsewhere in the LGU system so as to circumvent the 45%-55% limitations on personal services (PS) expenditures of LGUs. On the other hand, part of the cost of LEE operation and management is sometimes charged under other offices in the LGU. Overall, the less than business-like approach to local enterprise management has resulted in large arrearages and low collection efficiency. Objective of the study. The objective of the study is to review and assess existing financial management and budgeting systems of LEEs with the end in view of providing inputs towards the improvement of existing guidelines and guidance on the financial management of LEEs. In the conduct of this study, a survey questionnaire was sent out by the study team in collaboration with Regional Operations Coordination Service (ROCS) and all the Regional Offices of the Department of Budget and Management (DBM) in the second quarter of 2008 on the types of LEEs operated by LGUs and the results of operation of these LEEs. The response rate was 28% provinces (23 out of 81), 58% for cities (79 out 136) and 40% for municipalities (593 out of 1495).

Improving the Financial Management of Local Economic Enterprises

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As part of this study, field visits to 25 LGUs were also undertaken during which LGU officials were interviewed. These LGUs include the following: the provinces of La Union, Leyte, Iloilo, Guimaras, Davao del Norte, and Agusan del Sur; the cities of Quezon, San Jose del Monte, Tagaytay, Tacloban, Iloilo, Butuan, Surigao, Bayugan, Tagum and San Fernando (La Union); and the municipalities of Bauang and Caba in La Union, Asuncion and Sto. Tomas in Davao del Norte, Basey in Samar, Palo in Leyte, Sta. Barbara in Iloilo, Tubay in Agusan del Norte and Trento in Agusan del Sur. In addition, many other LGUs attended the consultation workshop in November 2008. In addition, a desk review of relevant legislation, manuals and regulations governing LEE operation and COA Annual Audit Reports for various cities and provinces for the years 2005-2007 was also undertaken. 2. LOCAL ECONOMIC ENTERPRISE SITUATIONER 2.1. Increasing Number of LEEs Because there is no baseline information on the total number of LEEs as of any given reference year it is difficult to categorically say that there is a big increase in the total number of LEEs today compared to say, the pre-Code period. However, there are indications that this is in fact the case. First, the character of LEEs appears to have evolved over the years. From traditional LEEs providing municipal services like markets, slaughterhouses, cemeteries and water services, today’s LEEs include enterprises that produce goods and services that are more in the realm of private goods (i.e., good and services which are normally provided by the private sector) like shopping malls, buildings for lease, hotels and recreational facilities.1 Many of the newer LEEs (like state-of-the-art hotels, asphalt batching plants and tomato processing plants) involve more complex operations than the more traditional ones. Markets and slaughterhouses are still the most popular forms of LEEs at present. For instance, 100% of cities and 93% of the municipalities who responded to the LEE survey operate markets while 95% of cities and 71% of municipalities operate slaughterhouses in 2007 (Table 1). On the other hand, 54% of cities and 1 More formally, in economics, private goods (as opposed to public goods) are defined as goods which exhibit two properties: “rivalness” in consumption and “excludability.” A good is said to be characterized by rivalness in consumption if an individual’s consumption of the good necessarily results in a reduction in the supply of that good that is available for the consumption of other individuals. On the other hand, a good is to be non-excludable if the provision of the good to one individual will automatically make it available to other individuals. In more practical terms, excludability means that it is possible/ feasible for producers to charge a price for the good so as to prevent those individuals who are not willing to pay the price from consuming/ enjoying the benefits of the said good.


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44% of municipalities operate cemeteries while 11% of cities and 36% of municipalities operate water utilities. However, a sizable number of LGUs operate the more non-traditional types of LEEs. For example, 34% of cities operate public transport terminals, 23% operate garbage collection and disposal facilities, 18% operate parking lots, 14% operate cultural/ sports/ recreational centers, and 9% operate hotels. On the other hand, 17% of municipalities operate garbage collection and disposal facilities, 12% operate parking lots, 10% operate public transport terminals and 4% operate cultural/ sports/ recreational centers.

Table 1. Proportion of LGUs (as % of total number who responded to survey) operating LEE, by type of LEE, 2007 a/Type of LEE Provinces Cities MunisWater utilities 0 11 36Garbage collection/ disposal 0 23 17Telephone 0 3 2Electric/ power utility 0 3 2Public transport terminal 4 34 10Other utilities, not elsewhere classified 4 18 9Markets 0 100 93Slaughterhouses 0 95 71Cemeteries 0 54 44Commercial center 0 1 0Cultural/ sports/ recreational centers 13 14 4Parking lots 4 18 12Hotels 0 9 1Hospitals 48 16 3Tertiary schools 4 9 3Other LEEs, not elsewhere classified 104 35 39a/ multiple answers allowedSource of basic data: LEE survey

Some cities and municipalities have also ventured into managing their hospitals and special/ tertiary schools as LEEs. For instance, 16% of cities and 3% of municipalities operate hospitals while 9% of cities and 3% of municipalities operate special/ tertiary schools. On the other hand, 48% of provinces run their hospitals as LEEs while 13% of provinces operate cultural/ sports/ recreational facilities. More significantly, a big number of LGUs operate LEEs that belong to the “others, not elsewhere classified” category despite the care taken during the formulation of the questionnaire to include, in the list from which respondents are asked to tick off the type of LEE they operate, many of the newer LEEs. To wit, 35% of cities, 39% of municipalities and 104% of provinces operate LEEs in the said category.


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Second, many LGUs are operating multiple number of LEEs at present. On the average, cities operate more than four LEEs each while municipalities operate more than three LEEs each in 2007. On the other hand, provinces operate around 2 LEEs each on the average in the same year. 2.2. What Drives the Trend Towards Greater Number of LEEs? Key informant interviews undertaken as part of this study suggest that there are primarily three reasons why LGUs create and operate LEEs. First, LGUs are looking for more diversified sources of local revenue. LEEs promise to be one such source. In particular, LEE income account for 11%-12% of total own-source revenue of all LGUs in the aggregate and around 4% of their total income in 2005-2007 (Table 2). Income from LEEs contributes a significantly larger portion of the total own-source income of provinces (20%-24%) and municipalities (19%-20%) relative to that of cities (8%) in 2005-2007 perhaps because the own-source revenue base of provinces and municipalities are more limited than that of cities. In contrast, the contribution of LEE income to total income from all sources is less invariant with the level of government. Income from LEEs accounts for 3%-4% of total LGU income of all provinces combined, 4% of total LGU income of all cities as a group and 4% of total LGU income of all municipalities in the aggregate in 2005-2007. Table 2. LGU Income from Local Economic Enterprises, 2005-2007

million pesos % million pesos % million pesos %Provinces Income from LEEs 1,495 1,602 2,066 Total own-source income 7,414 20.2 a/ 7,663 20.9 a/ 8,456 24.4 a/ Total income 45,515 3.3 b/ 51,535 3.1 b/ 52,611 3.9 b/

Cities Income from LEEs 3,472 4,012 4,406 Total own-source income 45,633 7.6 a/ 52,367 7.7 a/ 53,854 8.2 a/ Total income 83,349 4.2 b/ 95,660 4.2 b/ 100,747 4.4 b/

Municipalities Income from LEEs 2,765 2,957 3,197 Total own-source income 14,155 19.5 a/ 15,378 19.2 a/ 16,411 19.5 a/ Total income 69,064 4.0 b/ 78,638 3.8 b/ 82,018 3.9 b/

All LGUs Income from LEEs 7,733 8,570 9,669 Total own-source income 67,202 11.5 a/ 75,408 11.4 a/ 78,721 12.3 a/ Total income 197,927 3.9 b/ 225,833 3.8 b/ 235,376 4.1 b/

a/ LEE income as % of total own-source revenueb/ LEE income as % of total incomeSource: LGU Statement of Income and Expenditures, BLGF

2005 2006 2007

Unfortunately, many LGUs continue to extol their LEEs for their contribution to LGU coffers in terms of gross receipts even as they turn a blind eye on the net losses that the very same LEEs generate year after year, a point we will go back to later in this report.


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Second, some LGU officials interviewed during the field visits said that LEEs are desirable because of the need for the LGU to have “catalytic” investments in order to generate greater local economic development. In line with this, they argue that local governments should invest and operate economic enterprises because private sector investment is not forthcoming and because said investments will give the necessarily push to generate more private sector investments in allied areas. Needless to say, the direction where LGUs lean on this issue depends on the orientation of LGU officials on the appropriate role of government in local economic development. Put differently, it depends on whether LGU officials believe (i) in having an activist/ interventionist government, or (ii) in having a market-oriented government. While the first group argues in favor of a more aggressive stance in the creation of LEEs on the grounds of “crowding in” or stimulating the increased flow of private sector investments, the second group raises the question; “does government have any business being in business?” Third, some LGUs appear to operate certain activities as LEEs for a number of dysfunctional reasons. On the one hand, many LGUs officials very candidly say that they put up LEEs because they have difficulty complying with the personal services (PS) expenditure cap in the Local Government Code. Note that Section 325 (a) of the LGC provides that the total appropriations for personal services of an LGU for one fiscal year shall not exceed 45% in the case of first to third class provinces, cities, and municipalities, and 55% in the case of fourth class or lower, of the total annual income from regular sources realized in the next preceding fiscal year but the allowances of officials and employees of public utilities and economic enterprises owned, operated and maintained by the LGU shall not be included in computing the maximum allowable expenditure for personal services. On the other hand, some LGUs officials apparently establish certain activities as LEEs because of the perception that doing so allows them increased flexibility in the grant of allowances to employees of the LEEs. 2.3. Many LEEs Incur Losses Year after Year Eighty-nine percent of provinces, 58% of cities and 56% of municipalities posted net losses on their aggregate LEE operations in 2006 (Table 3). Although there was some improvement in net results of operations of LEEs operated by provinces in 2007, there was a movement in the opposite direction in the case of LEEs operated by cities. Thus, the net result of aggregate LEE operations was negative in 77% of provinces, 63% of cities and 56% of municipalities in 2007. At the same time, the projections for 2008 show that LGUs are not expecting the financial positions of their LEEs to be very much different from that in the previous year. In other words, the data suggests that LGUs expect their LEEs will continue to operate in negative territory in the future.


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In the aggregate, the net result of operations of LEEs of all LGUs combined was negative in 2006-2007. The aggregate net loss from LEE operations was PhP 0.9 billion – PhP 1.1 billion for provinces, PhP 9.6 billion - PhP 10.8 billion for cities and PhP 1.3 billion - PhP 1.5 billion for municipalities in 2006-2007 (Table 3). On the average, gross receipts from LEEs cover less than a third of the total cost of their operations. For instance, gross receipts from LEEs accounted for 14%-15% of the total LEE expenditures of the cities that posted net losses in their aggregate LEE operation in 2006-2008 (Table 3). The corresponding figures for provinces and municipalities were 30%-33% and 32%-36%, respectively. Table 3. Results of operation of LEEs, 2006-2008

2006 2007 2008actual actual projected

Provinces % of LEEs posting net loss 89 77 75 Net profit (loss) of LEEs in the aggregate (in mill pesos) (931) (1,071) (1,384) Gross receipts as % of total expd of lossing LEEs 30 33 33 Gross receipts as % of total expd of profitable LEEs 272 113 248

Cities % of LEEs posting net loss 58 63 64 Net profit (loss) of LEEs in the aggregate (in mill pesos) (9,582) (10,881) (13,068) Gross receipts as % of total expd of lossing LEEs 14 15 14 Gross receipts as % of total expd of profitable LEEs 138 144 156

Municipalities % of LEEs posting net loss 56 56 47 Net profit (loss) of LEEs in the aggregate (in mill pesos) (1,265) (1,482) (1,380) Gross receipts as % of total expd of lossing LEEs 36 34 32 Gross receipts as % of total expd of profitable LEEs 136 137 139Source of basic data: LEE survey Based on the detailed information provided in the LEE survey, hospitals and heavy equipment motor pools operated by LGUs as LEEs were unprofitable with no exception. Tertiary schools also had a high likelihood (86%) of posting net losses (Table 4). In contrast, water systems tended to have 60% probability of being profitable. On the other hand, the likelihood that public markets, slaughterhouses and cemeteries will be profitable is less than 50%.


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Table 4. Percentage of LEEs posting net losses, by type LEE, 2007All LGUs combined

Markets 53 Slaughterhouses 56 Cemeteries 55 Water system 40 Heavy Equipment/ Motorpool 100 Hospitals 100 Tertiary schools 86Source of basic data: LEE survey and COA Annual Audit Reports, 2007

Based on the key informant interviews conducted for this study, the reasons for LEE losses are attributable to a number of factors, namely: (i) weak institutional support and technical capability, (ii) low tariffs, (iii) poor collection efficiency. Weak institutional support and technical capability. LGUs have generally shown weak institutional support towards the operations of their LEEs. At times, the needed policy support for the successful operation of an LEE appears to have been overlooked. For instance, in one LGU, the public transport terminal failed because of the ordinance mandating the re-routing of public transport vehicles was not passed. Also, there were a number of cases where the infrastructure support (e.g., rehabilitation/ construction of access road) to a commercial facility was not put in place thereby resulting in low business traffic for the LEE (e.g. Butuan City). Moreover, many Sanggunians have shown a reluctance to pass an ordinance that will set LEE rentals/ tariffs at appropriate levels. For example, four concerts/ shows used the Tacloban City City Convention Center free of charge even if the said shows collected entrance fees in 2006 because of the failure of the Sangguniang Panglunsod to enact an ordinance prescribing rental rates in time for the completion of the said venue. At the same time, the technical capability in assessing feasibility studies of LEEs and overall LEE management appears to be weak in many LGUs. For example, in one of the LGUs visited for this study (San Jose del Monte City), LGU officials reported that the demand for slaughterhouse services projected in the feasibility study was as large as the total demand for the entire province despite the fact that there were already existing slaughterhouses in other LGUs in the province. On the other hand, the COA Annual Audit Report for Danao City (2007) indicates that only 61% of the stalls in its Integrated City Terminal and Public Market are occupied while an additional 14% have been reserved but are not yet occupied). This implies that the 25% of the stalls are either not occupied or not reserved, indicative of unrealistic projection of demand in the feasibility study or poor marketing.


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Baybay City provides another example of poor project identification. Babay City constructed a slaughterhouse in 2005 with loan financing. However, the slaughterhouse was not utilized because there is no water in the vicinity and, due to the high elevation of the area, the Water District is unable to serve the location. Still another illustration of the lack of a feasibility study is provided by the provincial government of Easter Samar. In 2006, the provincial government of Eastern Samar borrowed money from the Development Bank of the Philippines for the acquisition of 340 units of hand tractors for subsequent distribution to farmers on credit.2 However, the Office of the Provincial Agricultural Services (OPAS) of the provincial government neither submitted nor was required to submit a study, proposal or recommendation on the feasibility of this undertaking (COA Annual Audit Report for Eastern Samar 2007). Seven months after the hand tractors were procured and delivered, the province was able to sell 30 units to farmers. The OPAS revealed that a lot of farmers had initially shown interest in obtaining these machines thru loans. However, a number of them backed out for various reasons: (i) unaffordable price and payment scheme, (ii) farmers’ preference for brands with spare parts that are available in the local market, (iii) the hand tractors procured by the province did not include the plow, and (iv) cage wheels of the hand tractors that were actually procured were “narrow/short” and easily submerged in the rice fields when used. Thus, there were no takers for the remaining 310 units as of the end of 2007, resulting in a loss of PhP 28.3 million for the province. Low tariffs and fees. Partly because of the weak policy support and the inadequacies in the technical know-how on LEE operations, the tariffs or user charges charged by LGUs for the good and services provided by their LEEs appear to be low relative to the cost of providing said goods and services for a number of reasons including: (i) the Sanggunian Ordinance authorizing the fees and charges is outdated, (ii) lack of appreciation of the concept of cost recovery on the part of LGU officials, and (iii) some LEEs are established and operated primarily to address social objectives. The COA Annual Audit Report for San Pablo City (2007) noted that income from the City Slaughterhouse could not be increased to support its operations largely because the present rate of fees charged and imposed by the City to the customers is significantly low compared to that of neighboring cities and municipalities. This arise because the fees collected by the San Pablo City Slaughterhouse are still based on the 1992 City Ordinance. Further, there are fees collected in other cities/municipalities which are not collected by the City of San Pablo such as: permit fee, Post Mortem fee, certification fee. At the same time, the City Slaughterhouse has to compete with the many illegal

2 The total cost of the hand tractors was PhP 31.1 million.


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slaughterhouses that are operating in the City as the Sanggunian has not passed an ordinance regulating said entities. In 2003-2007, the operations of the slaughterhouse suffered continuous losses totaling P10 million. In 2007, the gross revenue from slaughterhouse operation was P990,900 while its combined expenses for personal services, and maintenance and operating expenses were PhP 3,356,094, implying a loss of P2,365,194 (COA Annual Audit Report for San Pablo 2007). Because of similar losses in earlier years, LGU officials decided not to utilize some machineries and equipment starting in 1999 to reduce expenses for electricity and maintenance. As a result, the slaughterhouse was downgraded by the National Meat Inspection Commission in 2002 from Class “AA” to Class “A”.

On the other hand, the provincial government of Eastern Samar sold the hand tractors that it acquired for subsequent sale to farmers at a credit sale price of PhP 80,466 per unit. This amount is lower than the acquisition cost of PhP 91,326 per unit, resulting in a total loss of PhP 3.7 million3 if the province were able to sell all the units it bought. At the same time, some LGUs set their fees at rates that are lower than that which will allow full cost recovery right at the start ostensibly because some LEEs (like hospitals, schools, etc.) are deemed to address some social objective. Thus, it is not surprising that 100% of hospitals and 86% of tertiary schools that are organized by LGUs as local economic enterprise are operating at a loss (Table 4). Third, many LEEs also tend to have poor collection efficiency. For instance, the COA Audit Report for Danao City in 2007 suggests that only 50% of the rentals due from occupied stalls was collected. In like manner, 41% of the projected income from stall rentals in the public market of San Carlos City in Pangasinan is not collected (COA Annual Audit Report for San Carlos City 2007). Meanwhile, in Batangas City, not all the stallholders in the public market are issued contracts thus their obligations are not well defined and established and the liabilities of the stallholders cannot be legally imposed. Moreover, uncollected stall rentals account for about 20% of the implied losses (i.e., subsidy from General Fund Proper of PhP 13.4 million) from the operations of the city’s public market (COA Annual Audit Report 2007). 2.4. Increasing Financial Risks Assumed by LGUs and LEEs Gross borrowings of all LGUs as group grew at a rate of 20% yearly on the average from PhP 4.2 billion in 2002 to PhP 10.3 billion in 2007 (Table 5). This 3 This amount does not include the cost of money. Note that the hand tractors were sold to farmers on credit and were payable over a period of 3 years.


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rapid growth in gross borrowings necessarily resulted in increasing LGU indebtedness. Thus, outstanding debt of all LGUs combined nearly doubled from PhP 24.1 billion in 2002 to PhP 45.8 billion in 2007. The debt stock of municipalities grew fastest, with the debt stock of provincial governments coming in a close second. Table 5. Gross borrowings and outstanding long-term liabilities of all LGUs, 2002-2007 (in billion pesos)

2002 2003 2004 2005 2006 2007

% increase

2002-2007

Gross borrowings 4.2 5.6 6.9 6.7 8.2 10.3 145.3 Provinces 1.5 1.8 1.7 1.4 2.9 2.3 57.9 Cities 1.8 2.0 4.0 3.7 2.9 5.5 200.2 Municipalities 0.9 1.9 1.1 1.6 2.4 2.5 177.3

Outstanding long-term liabilities 24.1 28.2 31.8 37.8 36.8 45.8 90.2 Provinces 5.0 6.7 7.2 7.5 9.4 10.5 110.1 Cities 14.3 14.8 17.5 21.8 17.0 24.1 67.9 Municipalities 4.8 6.7 7.2 8.6 10.4 11.3 136.1

Gross borrowing as % of GDP 0.11 0.13 0.14 0.12 0.14 0.16Outstanding LT liabilities as % of GDP 0.62 0.65 0.65 0.70 0.61 0.69Source: COA LGU Annual Financial Report, various years Although there is no systematic information on what part of LGUs’ borrowings were used to finance LEE-related investments, a perusal of COA Annual Audit Reports in recent years suggests that a significant chunk of LGU debt are indeed used for LEEs. The case studies provided below are by no means representative but they are presented here to highlight the financial risks that LGUs take on when they decide to establish LEEs. They show that many LGUs have incurred loans to finance the setting up of their LEEs and that a number of them have encountered in difficulties in servicing these loans. They also illustrate that the there are many instances when the demand projections made in the feasibility studies that are conducted in support of securing a bank loan or issuing bonds are not realized. Case study number 1. A province in the northern part of the country (Cagayan) initially issued bonds worth PhP 205 million for the construction of a commercial complex (known as the “Mall” for short) in 2003. The Mall is a 3-story building located at the provincial capital’s central business district. It is composed of commercial stalls and a department store. It was envisioned to be a major component of the provincial government’s economic enterprise to generate additional revenues for the province while at the same time serving as venue for the promotion and marketing of the province’s major products and industries (COA Annual Audit Report for the Province 2007).


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The proceeds of the bond floatation was subsequently augmented by PhP 69.1 million from the General Fund and PhP 17.3 million from the interest income earned on deposits (Project Fund/Sinking Fund) in order to defray the total construction cost of the Mall which reached PhP 291.4 million. The Mall formally started its operation on June 1, 2006. In April 30, 2006, the bonds were redeemed and the outstanding principal and interest of PhP 166.5 million was paid through the proceeds of a loan of the same amount from the Philippine Postal Savings Bank (PPSB). The buy-out scheme has a 5.25% interest payable in 7 years, and required a hold out deposit equivalent to the amount of the loan until it is fully paid. When a new governor assumed office in 2007, the loan was transferred to the Land Bank of the Philippines, in August of that year, with an outstanding balance of PhP 141.0 with 4.25% interest and payable in 13 quarters or until the year 2010. The buy-out scheme also required a hold out deposit equivalent to the amount of the loan until it is fully paid, earning an interest based on the regular rate of savings deposit (COA Annual Audit Report for the Province 2007). In the first half year of its operations, the Mall posted a net loss of PhP 2.4 million. However, it registered a net income of PhP 6.4 million for the full year of 2007. The COA estimates that from 2008 onwards the total amount to be recouped amounts to PhP 310.3 million, including the interest payments due in 2008-2010. If the yearly income of the Mall is pegged at its 2007 level, the COA then estimates that it will take the province 48 years, which is 32 years beyond the payback period of 12 years in the feasibility study and 18 years beyond the estimated useful life of the building of 30 years. However, the COA notes that there are still unoccupied spaces which could add to the income of the Mall, including a function hall that could be rented out for seminars, weddings, meetings and the like. The COA estimates that the vacant spaces could earn additional rental income equal to PhP 4.0 million per year. Thus, if it is assumed that all the stalls and the function room will be fully occupied from 2008 onwards, the payback period is estimated to be reduced to 30 years, still much higher than what is assumed in the feasibility study. Moreover, the internal rate of return is estimated to be 0.04% instead of the 24% that was shown in the feasibility study. Furthermore, the COA noted that while the loan is not yet fully paid, hold out deposits equal to the total amount of the loan is held by the creditor bank. Although hold out deposits earn interest at the regular rate for savings deposit, the hold out deposits cannot be used for the implementation of projects which deprives the province’s constituents of the benefits from said projects. Case study number 2. A province in the southern part of Luzon (Batangas) borrowed PhP 238 million from the Land Bank of the Philippines (LBP) for the


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construction of a Port and Livelihood Center (called the PLC for short) in 2003. The PLC is located in the port area right in front of the fast craft terminal building. The establishment of the PLC was envisioned to enhance economic activity in the province and serve as a springboard for promotion and investment. It was also initiated to address the socio-economic problems brought about by the re-development of the port area wherein many illegal settlers were displaced. The PLC is a two-storey commercial building with the central passenger terminal as the main feature of the complex. Retailing activity is envisioned to be the main function of this facility, with the small and medium entrepreneurs, especially the displaced settlers benefiting from this project. The rentals/fees for this economic enterprise are to be approved by the Provincial Economic Enterprises Board. Although the construction of the building was completed in the June 2004, the project did not materialize as planned. The COA reports that none of the projections were realized except for nominal parking fees that were collected. The building and other equipment continue to depreciate. In 2007, landing and parking fee collections amounted to PhP 5.2 million. Interest expenses of PhP 19.3 million and other operating expenses totaling PhP 1.1 million were incurred, resulting in a net loss of PhP 15.3 million. In addition to this, the amortization of the loan amounting to PhP 14.8 million was paid to the Land Bank in 2007. The COA, thus, puts forward the following opinion: “The objective of the provincial government in establishing the PLC is not attained for evident reasons:

Poor planning. The feasibility study was haphazardly done, just to comply with LBP requirements. The PLC was built on a borrowed fund with LBP and the projected income is not realizable.

Investors turned-off by the very onerous conditions. Marketing wise, packaging and promotion is weak. The PLC building

lacked the necessary amenities to be taken seriously by investors. Lack of political will in containing the problem brought about by the

stallholders comprised of the illegal settlers. The new administration is proposing to reinvent/ reengineer the PLC from being a “white elephant” to being self-liquidating by:

Negotiating for the restructuring of the province debt-obligation with LBP Considering the possibility of the PLC building as site of the following:

Shipping Lines Call Center Maritime School Hotel “Tiangge: Divisoria Style Regional Offices Combination of the above


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Inviting LBP to put up a branch office at the PLC building Repairing the PLC building.

Case study number 3. A Metro Manila city (Manila) borrowed PhP 450 million in 1995 from the Development Bank of the Philippines (DBP) for the purchase of a lot and building in what used to be its premier financial district for the use of its city college. Subsequently, the city prepaid the balance of the DBP loan by taking out another loan from the Philippine National Bank (PNB) worth PhP 330 million in 2001. The COA reports that the city government did not conduct a feasibility study prior to the acquisition of the building, contrary to sound management practice (COA Annual Audit Report for the City 2007). It further notes that this resulted in lack of adequate guidance in ascertaining the viability and economic sustainability of the project. Moreover, it was found that only 6 floors are being used by the city college in 2007. The remaining floors, the 7th to 13th floors, were left vacant. The COA concludes that the vacant floors and spaces could have been developed for lease or rent in order to generate self-sustaining income to help defray the interest expense on the loan. In addition to the loan for the acquisition of the building for the city college, the city also took out a loan worth PhP 239 million in 2003 and another one worth PhP 176 million in 2006 for the renovation of its public markets. However, the COA reports that all of city’s local economic enterprises generated net losses in 2007. Case study number 4. Another Metro Manila city (Caloocan) issued bonds worth PhP 225 M in 2001 for the construction of a parking and commercial building complex. The operations of the commercial complex generated a total income of PhP 32.5 million in 2003-2007. However, the rental earnings did not sufficiently meet the city’s bond flotation obligations which amounted to PhP 236 million for the same period. Given this, it is estimated that the commercial complex has to almost double its current rental income for it to be able to break even in its operations in the next 15 years assuming a 5% rate of interest. This does not appear to be likely, however, given that 30 of the 51 stalls in the complex are not occupied in 2007. Some city officials attributed the vacancies to the allegedly “excessive” rental rates that were set for the commercial complex. In fact, a reduction in the rental rates was being considered at the time of the audit (COA Annual Audit Report for the City 2007).


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3. OUTSTANDING ISSUES Given this perspective, the outstanding issues that impinge on the financial management of LEEs are examined more closely in this section. These issues include: (i) the need for a clear policy framework for the creation and continued operation of LEEs, (ii) the need for greater clarity in the treatment of LEEs in budgeting; and (iv) the need to strengthen LGU capacity in operating LEEs more efficiently.

3.1. Need for a Clear Policy Framework for the Creation and Continued

Operation of LEEs Central to arriving at a clear policy framework for the creation and continued operation of local economic enterprises is an unambiguous definition of term “economic enterprise.” An appreciation of the rationale or “reason for being” of economic enterprises and the advantages of LEEs over other modalities of service delivery are also important inputs to this process. The term “economic enterprise” is not well defined in the Philippines as we shall see below. Thus, it is useful to start by reviewing how the term is defined in the international literature. In this regard, it is notable that the closest concept to “economic enterprise” in the international literature is that of “state-owned enterprise” or SOE. In the following sub-section, we also review the theoretical and empirical underpinnings for the existence of state-owned enterprises. Review of literature: What are SOEs? Why/ Why not SOEs? In the international literature, the term “state-owned enterprise” (also known as public enterprises, public sector enterprises, government business enterprises, parastatals, or government owned and/ or controlled corporations) is used to refer to government owned or government controlled economic entities that generate the bulk of their revenues from selling goods and services (e.g., Jones 1982, World Bank 1995). This definition emphasizes two distinct characteristics of SOEs, namely: the public dimension and the enterprise dimension. The enterprise dimension relates to government ownership, control and/ or management. On the other hand, the enterprise or “marketedness” dimension limits the application of the term to entities that produce marketable outputs (i.e., goods and services for which prices/ fees may be charged). The enterprise dimension implicitly relates to the achievement of some level of cost-recovery, if not profit-orientation, and the potential for the enterprise to earn a return on investment. In a more restricted sense, the enterprise dimension is sometimes used to refer to production entities that “operate according to commercial principles.” Shirley (1989), however, clarifies that since many entities that have the potential to be financially viable may also have non-commercial objectives, sometimes with the latter dominating the commercial objectives, SOEs may have to be categorized in terms of “their potential to earn a positive return as well as the way such enterprises commonly operate elsewhere.” In other words, the term public


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enterprise or SOE may refer to entities which have both social and commercial objectives. Other analysts (e.g., Shirley 1989) use the term “state-owned enterprise” in a more limited sense by defining an “SOE as a publicly owned entity with a separate legal personality and separate accounts that earns the bulk of its revenue from the sale of its goods and services.” This definition thus adds a third dimension to the basic SOE definition by putting emphasis on SOEs having “separate legal personality” and implying that SOEs take the corporate form. The economic justification for SOEs essentially says that public enterprises are a better alternative to their private sector counterpart (i) if they overcome market failures and (ii) if they are superior to regulatory alternatives (Shapiro and Globerman 2004). On the one hand, the argument for government ownership rests primarily on the potential of government of public enterprise ownership to correct the inefficiencies that arise from various types of market failures, e.g., natural monopoly, underdeveloped capital market, and externalities. First, it is argued that government ownership allows government to prevent a natural monopoly from setting prices so high that their products are no longer affordable to a wider segment of the community while at the same time avoiding the difficulties associated with the regulation of natural monopolies.4 Second, private sector investors may be unwilling to invest in projects that have high returns in the long run but carry high risks in the short term because capital markets have an inherent bias towards short-term gains and do not like risky, large-scale projects with long gestation periods. Third, private sector investors may not have the incentive to invest in industries which benefit other industries without being paid for the service thus provided (Chang 2007). On the other hand, the case against government ownership (through SOEs) recognizes market failure but argues that the risk of government failure may even be greater. Public ownership of the SOE implies that “no one has a clear stake in SOE returns, hence no one has the responsibility and motivation to set clear performance goals and assure they are attained. Instead, politicians, bureaucrats, employees, and other interest groups thrust upon SOEs multiple and often conflicting goals (e.g., profit maximization, employment maximization, and a host of other social objectives) while simultaneously imposing a bewildering and sometimes contradictory collection of constraints (e.g., restricting layoffs, price increases, and the choice of suppliers or markets). Multiple objectives and multiple constraints increase transaction costs, distort the incentives facing SOE managers and reduce managerial effort” (World Bank 1995). However, government regulation involves contractual arrangements that are difficult to manage. For example, all contingencies and certain aspects of performance are difficult to define in advance. The contract negotiations and the 4 Government ownership of many public utilities is often justified on this ground.


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legal disputes that sometimes occur as part of contract enforcement may involve substantial transactions costs (Chang 2007). Many of the arguments in favor of SOEs are premised on the assumption that political markets are efficient.5 However, some analysts (e.g., Boycko, Shleifer, and Vishny 1996) assert that “political intervention in public enterprises is likely, since politicians who manipulate SOE operations for political reasons receive all of the benefits of such interventions, but bear little of the direct (subsidies) or indirect (inefficiencies) costs.” It is also argued “that it is more transparent and difficult for politicians to overtly subsidize private firms than to slant SOE operations so as to serve their political goals” (Shirley and Walsh 2000). Thus, the choice between private and government ownership depends on the tradeoff between market failure, on one hand, and government failure, on the other. The World Bank (1995) notes that the empirical evidence show that private regulated firms tend to perform the same as or better than SOEs in most studies (Shirley and Walsh 2000) 3.1.1. Need for a greater clarity in the use of term “economic enterprise” Both the Local Government Code and Manual on the New Government Accounting System (NGAS) for Local Government Units (COA 2002) do not provide an explicit definition of the term “economic enterprise”. However, the NGAS Manual implicitly defines the term by way of enumerating the various types of public utilities and economic enterprises that LGUs operate and assigning each one a sub-code number (Section 108). The Updated Budget Operations Manual or UBOM (DBM 2005) provides an explicit, if still ambiguous, definition of the term “economic enterprise.” The UBOM says economic enterprises are “income-generating establishments created for the purpose of improving production & delivery of basic goods and services for a specified market or client group” while public utilities are “revenue-raising undertakings created for the purpose of providing a basic need or service to the general public which otherwise cannot be provided adequately by the private sector” (p. 188, FAQS-A). This definition of an economic enterprise/ public utility in the UBOM is vague and may be interpreted to mean that any activity that delivers goods/ services and

5 In turn, the arguments against efficient political markets are coach in terms of the principal-agent problem between voters and politicians. On the one hand, voters are not well informed about the actions taken by politicians and the consequences of said actions because of information asymmetry. On the other hand, the incidence of the benefits of “good” policy tends to be widely dispersed while the incidence of losses tends to be more concentrated in a few. Thus, the potential beneficiaries tend to free ride on any effort to support the “good” policy but the potential losers have the incentive to work harder to defeat said policy. Moreover, elections are not good mechanisms for producing information on voter's preferences because they are held infrequently and are not constrained to deal with any specific issue (Shirley and Walsh 2000).


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generates some income/ revenue should be classified as such. As a result, even income from traffic management is considered as LEE income by some LGUs. Also, the “enterprise” dimension of public enterprise that we find in the international literature is not quite as evident in UBOM definition. First, the use of the phrase “the production and delivery of basic goods and services” may be interpreted to be a reference to the production and delivery of public goods instead of “marketable goods and services.” Second, the use of the qualifiers “income-generating” and “revenue-raising” falls short of saying that public utilities and economic enterprises receive the bulk of their revenues from selling their outputs. The “enterprise” dimension of LEEs is also not obvious from the Local Economic Enterprise Codes and the ordinances creating LEEs that have been enacted by many LGUs. For example, the LEE code of a small city in Mindanao states:

“Policy statement – It is the policy of the city government to be self-reliant and self-sustaining by engaging in viable and stable economic enterprises that provide a wide range of opportunities that will uplift the socio-economic well being of its constituents, improve fiscal management and enhance good governance.”

Recommendation. The oversight agencies (DBM, DOF/ BLGF, DILG, NEDA) should adopt a common definition of the term “local economic enterprise” emphasizing enterprise dimension. In this regard, the definition of Jones (1982) and the World Bank (1995) may be adopted: LEEs are local government owned economic entities that generate the bulk of their revenues from selling goods and services. 3.1.2. Elements of New and Improved Policy Framework for LEEs There is considerable ambiguity with regards to the intent for the creation of or “reason for being” of LEEs. The NGAS manual makes an oblique reference to enterprise nature of LEEs. It states that objective of maintaining special accounts in the General Fund for public utilities and economic enterprises is “to determine whether the income these entities generate is sufficient to meet their respective operating costs” (Section 106 of NGAS Manual). The UBOM does provide a clearer articulation of the enterprise nature of LEEs. It states that “economic enterprises and public utilities shall be established after the conduct of a feasibility study showing proof of its economic and social viability in the long run” (UBOM, FAQS-A.2.2, p. 188). It also provides that “a business development plan shall be prepared (long-term, medium-term and annual plan) stating its mission or purpose, clients or beneficiaries, strategies, activities and projects, organization structure, financial plan or budget and expected returns” (UBOM, FAQS-A.2.3, p. 189). The UBOM says further: “After two years of operation, or as reflected in its business development plan, the funding


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requirements of economic enterprises and public utilities shall be sourced from its operating income or user fees” (UBOM, FAQS-A.2.8, p.189).

The UBOM further elaborates on the rationale and criteria for the establishment and operation of local economic enterprises and public utilities as follows:

LEE satisfies both the economic and social objectives of the concerned LGU.

It fills in service gaps not adequately provided by the private sector. It shall operate with a lean and mean staffing complement to satisfy the

income objective of the economic enterprise/ public utility. It shall operate like a corporate body with a separate strategic plan and

budget. (FAQS-A.2.4 p. 189).

The guidance on LEEs found in the LGC, the NGAS and the UBOM is generally consistent with conceptual framework found in the international literature. However, existing policy framework as best articulated in the UBOM appears to lean more towards the public ownership model. In this regard, two items appears to be missing: (i) guidance on what the different alternatives to the creation of LEEs are, and (ii) cautionary statement on potential government failures that may arise with the establishment and continued operation of LEEs. As a result of the weaknesses in the LEE policy framework, the use of the term LEE is not actually limited in practice to activities that produce goods/ services that are not being provided by the private sector as FAQS – A.2.4 of the UBOM indicates (refer to Section 2 above). In fact, many LEEs compete directly with private sector enterprises. On the other hand, while FAQS – A.2.8 seems to imply that LEEs should be self-sustaining with full recovery of at least their operating costs, in practice many LEEs are not deemed or have not been officially declared by concerned LGUs to attain some degree of cost recovery. Many LGUs report that their LEEs are established to address social objectives as well. And, in fact, many LEEs post net losses year after year as shown in Section 2 above. Also, there is a need for the UBOM to clarify what it means when it says that LEEs should operate like a corporate body. Admittedly, the corporate form is arguably effective in promoting more business-like behavior of public enterprises by providing their managers greater operational autonomy and flexibility to “manage for results.” The corporate form is also said to help public enterprises mimic the corporate discipline available in private sector through the application of commercial principles in their operation. Furthermore, the corporate form may help in shielding the enterprise from political interference. To date, there are only three chartered LEEs – the Pamantasan ng Lungsod ng Maynila, the Quezon City General Hospital, and the La Union Medical Center. These LEEs were created as corporations by Congressional legislation.


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At present, there are outstanding legal issues pertaining to the use of the corporate form for LEEs when Congress is not inclined to pass a law creating one (Box 1). Because of this, most of the discussion that follows would concern itself with how to improve the policy framework for LEEs given the existing legal framework, i.e., one where the use of the corporate modality for LEEs is limited. It is also worth emphasizing that good results are possible even if the LEE operates as an organic part of the LGU. There are many examples in this regard. Tagum City is one such example. In many of these good practice examples, the establishment of a dedicated to oversee LEE operations appears to promote good outcomes.

BOX 1. Can LGUs create corporations? A number of LGUs (e.g., Misamis Oriental and Quezon City) have attempted to operate their LEEs by registering their LEEs as corporation with the Securities and Exchange Commission (SEC) under the Corporation Code. However, the Department of Interior and Local Government (DILG) in an opinion dated July 22, 1997 (as cited in Pardo and Zipagan 2008) asserts that an LGU, being a juridical person by virtue of it being a corporation itself, cannot be an incorporator of a private corporation. This opinion is based on the fact that Section 10 of the Corporation Code provides that: “Any number of natural persons not less than five but more than fifteen, all of legal age x x x may form a private corporation for any lawful purpose or purposes x x x.” On the other hand, the COA points out government corporations can only be created by Congress (Sec. 16 Art. XII of the Philippine Constitution). It also says that the LGC does not vest in the Sangguniang Bayan the power to create corporations (Supreme Court in Engr. Ranulfo Feliciano, Leyte Metropolitan Water District vs. COA, GR No. 147402, dated January 14, 2004). In response to the aforementioned opinion of the COA, the Quezon City government maintains that the jurisprudence cited is not on all fours applicable to the case of the QC-Housing and Urban Renewal Authority (QC-HURA). It further asserts that only a competent court can declare a law/ ordinance unconstitutional. In its rebuttal, the COA insists that the principle laid down by the Supreme Court (SC) Feliciano versus COA is applicable to QC-HURA where the SC clarified the Local Government Code did not delegate in the Sangguniang Bayan the authority to create corporations. Furthermore, the COA states:

“While it is concurred that only competent courts can declare whether or not a law or ordinance is constitutional, the COA is not precluded in the exercise of its constitutional duty to review the propriety of the investment in question since it involves the disbursement of public funds. …. Considering that creation of QC-HURA is infirmed, consequently therefore, any investment made for the purpose has no leg to stand on.”


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Recommendations. Given this perspective, the need to establish a clearer and more comprehensive policy framework to govern the creation of new LEEs and continued operation of existing ones is critical. Many of the elements of the existing framework will still be part of the new framework but a number of new features will have to be put in place. Basic principles First, the new policy framework should be anchored on the basic principle that LGUs need to focus on their core functions. It should also be premised on the superiority of private-sector led development unless a strong case can be made for government intervention. The framework should thus establish guidelines when government provision of marketable output is justified.6 These guidelines should take into account the tradeoffs between market failures and government failures as elaborated in the review of literature above. The new policy framework should also recognize that some marketable goods/ services are better delivered by the government central7 and that the LEE modality is but one of a number of alternative service delivery modes. The LGU decision making process with respect to the creation/ continued operation of LEEs under the new policy framework is illustrated graphically in Figure 1.

6 These guidelines may simply provide criteria that will assist LGUs decide whether it should be engaged in the direct provision of marketable goods/ service and may include either a positive list of what marketable goods/ services are appropriate or not appropriate for LGU provision. 7 The assignment of expenditure responsibilities across levels of government is largely defined by the Local Government Code.


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Figure 1. Graphical Presentation of LGU Decision Making Process Relative to Creation of LEEs

Does the service contribute to achievement of LGU goals?

Is there a legitimate and necessary role for government in this service?

Should the LGU have primary responsibility for this service?

Could, or should, this service be provided in whole or in part by the private or voluntary sector?

Is the service affordable within fiscal realities?

Abandon

Pass to NG

Partner

LGU creates LEE

Privatization

Service Shedding Divestiture

Public Partnership – i.e. Shared Services

Contracting Out Service, Management, Lease & Concession Contracts Built Operate Transfer i.e. BT, BLT, BOT, BOO Public/Private Partnerships & Joint Ventures Including with private-not-for-profit entities (NGOs/CSOs)

Government Owned and Controlled Corporations i.e., LGU Inc.

Local Economic Enterprise Organic Unit in LGU

Is corporatization feasible and desirable?

Alternative Service Delivery Options

Yes

Yes

Yes

No

Yes

No

No

Yes

Yes

Adapted from: SEQUUS. 2003. “Developing the Public Economic Enterprise in the Philippines – The LGSP Way”, Draft report submitted to the Local Government Support Program (LGSP), Canadian International Development Agency (CIDA).

No Abandon

No

Congress creates GOCC

Thus, when an LGU is confronted with the need to decide whether to provide a given good/ service, the LGU should be advised to first check the alignment of said good/ service with its goals and core functions. Once the LGU deems it appropriate to provide a given service, it should then assess the suitability of the alternative service delivery modalities in the context of its own particular situation. Such an evaluation should take into account the financial risks, managerial problems and political realities that come into play against the inherent strengths and weaknesses of each of the various alternative service delivery modes. Service delivery can be done either (i) through organizations external to the LGU like private sector enterprises and non-governmental organizations (NGOs) via various types of public-private partnerships arrangements like service contracts, management contracts, leases, concessions, and licenses or (ii) directly by the


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LGU either through an LEE or through a regular unit or office in the LGU. In other countries, public service delivery through external organizations is commonly used for public utilities and social services like education. The different public-private partnership modalities are discussed in some detail in Box 2.

Box 2. Alternative Service Delivery Modalities Using Private Enterprises/

NGOs The alternative service delivery options using the private enterprise sector or non-government organizations differ in terms of how the contractual arrangements between the LGU and the private sector/ NGO are defined with respect to the following areas: (i) ownership of the assets, (ii) responsibility for capital investment, (iii) responsibility for operation and maintenance, (iii) relationship to the consumer/ citizens, (iv) regulation of user charges or tariffs, (v) receipt of operating revenue, (vi) sharing of financial risks, (vii) degree of LGU subsidy, and (viii) extent of monopoly rights. Service contracts. The LGU may contract an external organization to delivery the service. The scope of this service contract can vary from a fairly limited one involving just part of the service to a more extensive one involving the entire service itself. Under the service contract approach, the LGU continues to own the assets but the service contractor is responsible for the repair and maintenance of the assets and usually for the replacement of some equipment necessary for the delivery of the service. The operating income is controlled by the LGU and goes to its accounts. The contractor is simply paid for the service based on the agreed price. As an example, a service contract might be issued for the reading of water meters. The revenue collected from the water meters belongs to the LGU while the service contractor is paid based on the amount agreed in the service contract. Management Contracts. The use of management contracts can take two forms: (i) without sharing of the service income or (ii) with sharing of the income received from the delivery of the service. If there is no sharing of income, the LGU maintains ownership of the assets and is responsible for investments in construction and other capital requirements. The LGU also sets the tariffs for the service, is directly responsible to the citizen for the service and assumes all financial risks. The operation and maintenance are met from the income received for the service and any operating surplus or deficit is the responsibility of the local government unit. The service contractor, on the other hand, is simply paid a fixed fee for the service. Therefore, under this option, the LGU bears all responsibilities and financial risk.


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Box 2. Con’t (2) In contrast, the revenue received from the delivery of the service is shared between the LGU and service contractor under the income sharing option. While the LGU has the same responsibilities and risks as in the “no-income-sharing” approach, two additional features are generally present under the income sharing option. One, the service contractor usually has discretion to charge less (but not more) than the regulated tariffs. Two, the service contractor receives a fixed percentage share of the operating surplus on top of the fixed contract fee. The income sharing option is usually considered for those activities that are not expected to need an operating subsidy from the LGU although it is also used in some cases for services that may collect fees or charges while also receiving a subsidy. The contractor might still receive some share of the operating surplus after the subsidy is received into the funds. Leasing. The LGU may lease some of the assets it owns to a service provider in exchange for a rental price that the service provider will pay. The service provider is directly responsible to those consuming the service and not to the LGU. The service company thus bears all the financial risks associated with the operation of the service. In this approach, the LGU still owns the assets and is responsible for the investment and debt service associated with the assets. The service provider is responsible for operation, repair and maintenance, and for replacement of short-life equipment. The service provider must return the assets to the LGU in good condition at the end of the lease period, less normal wear and tear on equipment. The service contractor collects the operating income and meets the operating costs. In some cases, the LGU may regulate the tariffs for the service. The payment options for the service provider may take the following forms: (i) a straight rental price for the use of the asset, or (ii) a percentage share of the revenue, or (iii) both, a fixed fee for the asset use and a share of the income generated from the use of the asset. Concessions. In a concession, a service contractor is given an exclusive right to provide a service for a fixed period of time, but has to invest capital in the constructing and providing the necessary infrastructure. The service contractor is responsible for all costs, including capital, repair, operation and maintenance, and is responsible to the consumers of the service. All the financial risks are borne by the service contractor. A concession may be useful for large scale infrastructure projects, such as public utilities, toll roads, and communication networks.


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Box 2. Con’t (3) The competitive approach to awarding the concession is generally used and the concession award may require service levels and charges/tariff limits. Tariffs may be reviewed periodically and indexed to inflation or return on investment calculations. Essentially, tariffs and the period of the concession is calculated based on the recovery of operating costs, full amortization of the initial capital investment, and a reasonable rate of return on the investment. Thus, the period of the concession is generally for a long period of time, from 15 to 30 years. At the end of the concession, the assets become the property of the local government unit. A Build-Operate-Transfer (BOT) is a form of concession. The financial arrangements may take several forms. The LGU may provide initial subsidy or funding for the undertaking of the investment. In this case, the LGU may have some claim to the operating income. The LGU may also pay a subsidy to the service contractor as a means of lowering the charges/tariffs to the public for the delivery of the service. This is often used for public transport service delivered by a service contractor under a concession arrangement. Licensing. A service provider may be licensed to invest in and operate a service on the same conditions as a concession, but the licensed service contractor does not have the exclusive rights that a concession agreement has for the service contractor. This approach is often used where there is potential for competition and the service requires lower investment costs. Licenses are often used for transport services, such as taxis, buses, etc or even refuse collection. In these cases, the service contractor retains the assets used for the delivery of the service at the expiration of the license period. Funding Agreement. LGUs may enter into a contract with a non-profit organization to provide to the service organization a grant to provide certain services, such as social, sports, recreation, or cultural activities. The service organization is responsible for all investment and operating costs, owns the assets used and bears the financial risks. This type of contract normally covers a particular program or activity, and not the whole operations of the service contractor. The agreement would cover the broad content of the program and set standards of quality to be maintained. Payment of the grant would be dependent on adherence to these standards and to periodic review of the activities being undertaken. ------------------ Source: Wright, Glendal. 2008. “A Review of Alternative Service Delivery Options.” Report submitted to the Asian Development Bank (ADB) under the Technical Assistance 4778 Project.


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Criteria for evaluating pros and cons of using external providers versus direct service delivery by LGU

Second, the new policy framework should also provide LGUs guidance on the criteria that they may use in analyzing the advantages/ disadvantages of using external organizations to deliver public services as opposed to direct service delivery by the LGU itself. In this respect, two factors have to be taken into account: (i) market orientation, and (ii) alignment with the public interest. On the one hand, the fixing of tariffs or prices in the LEE is normally done by fiat or through an administrative process and is thus more subject to political interference. Political pressure also tends to be strong on the LGU service provider in the area of staffing and personnel administration. In contrast, external service providers tend to operate in a more competitive environment and are thus subject to the discipline of the market place when they determine the appropriate number of their personnel complement as well as the level of tariffs that they should charge. Consequently, the LGU service provider and external providers tend to be substantially different in terms not only of the incentives for efficiency and economy but also in terms of their cost structures (Wright 2008). On other hand, it is usually assumed that direct delivery of service by the LGU can be more easily aligned with the public interest in terms of access and coverage (e.g., servicing of areas with low traffic volume), tariffs/ service charges (e.g., lifeline pricing and subsidization of poorer segment of the population), quality of service (e.g., LGU service providers directly accountable to clients but compliance to service standards is typically part of contractual agreements between LGU and external service provider), and innovations in service delivery (e.g. external provider might be more willing and capable of introducing service improvements especially if contractual arrangements provide the incentives to do so (Wright 2008). However, the feasibility of public-private partnership type arrangements may be limited by two factors: (i) the availability and capacity of the private sector/ non-government organizations to undertake the delivery of these services, and (ii) the capacity of the LGU to manage the necessary contractual and regulatory arrangements which can be both complex and costly at times. Wright (2008) notes that the international experience tends to show that the use of contracting/ concession methods and joint ventures yields favorable results when (i) the LGU does not assume all of the financial risks that come with the operation of the external service providers while being able to maintain control over the delivery of the services, (ii) the LGU is able to come up with a precise definition of the required service delivery levels, (iii) there is transparency in the regulation of the external providers’ performance, and (iv) the LGU has access to the technology, expertise and experience that is more often available to the external provider. However, these advantages are only available if the following conditions exist: (i) there is some level of competition in the market with several providers capable of


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providing the service at comparable cost and performance, (ii) there is a fairly high level of expertise in LGU to formulate the metrics for outputs/ service performance assessment, and (iii) corruption and other ethical infringements do not come into play. Guidance on creation of LEEs If the LGU deems it best to provide the service directly by itself, it then has to choose whether to do so via an LEE or through a regular unit or office in the LGU. These two approaches differ in terms of (i) staffing, (ii) tariff setting, (iii) investments in capital assets and maintenance of the same and (iv) overall performance orientation in the delivery of services. LEEs are less subject to restrictions on staffing and have some flexibility in terms personnel remuneration allowing them to better attract professional and technical personnel. However, this approach opens up the possibility for abuses in hiring of staff and paying of the staff. On the other hand, LEE tariffs are set by Sanggunian legislation and are determined, in principle, with some degree of cost recovery in mind because by their very definition LEEs raise the bulk of their revenues from the sale of their outputs. Given these considerations, LEEs tend to have greater inclination and wherewithal to make the necessary investments to maintain the equipment and facilities needed to deliver the service. Also, LEEs may have greater drive for results and performance especially when the performance measures are clearly defined and monitoring/ evaluation systems are established and enforced. The new policy framework should provide explicit guidance on the creation of LEEs. The guidance should specify that LEEs should be established by enacting an ordinance that specifies in unequivocal terms: (i) LGU policy on degree of cost-recovery of LEE up front in terms of what percent of cost will be recovered from user charges, (ii) tariff rates or user charges that will be charged for goods/ services provided by LEE, and (iii) who will be subsidized and by how much;8 including schedule of rates by income bracket of clients where applicable. Note that the need for ordinance is provided in the UBOM (FAQS-A.2.5, p.189) but the UBOM does not call for the specification of the cost recovery rate up front. In this regard, the government has the option to provide guidance on minimum rate of cost recovery for different classes of LEEs. For example, guidelines may be issued suggesting that full cost recovery is a must for markets/ slaughterhouses and enterprises engaged in purely commercial operations like hotels, resorts, malls, commercial buildings but allowing less than full cost recovery for certain types of public utilities and enterprises with social service orientation. If this is followed then there is a need to revise FAQS-A.2.8 (p.189)

8 This means that subsidy given to LEEs is an ex-ante conscious decision on the part of the LGU rather than an ex-post item that finances whatever the resulting gap between revenue and expenditure is. The La Union Medical Center provides a good example of how a well articulated policy on providing subsidy to the poor contributes to the efficient operation of the LEE.


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of the UBOM to allow for less than full cost recovery as may be provided in the LEE ordinance. The new policy framework should then distinguish between LEEs created by ordinance with well articulated policy on cost recovery as described above and “LEE-like” activities (i.e., activities that are commercial in nature but from which LGU has little or no intent to recover cost). Subsequently, the policy framework should provide for the differential treatment of these two groups of activities in terms of budgeting and need for the maintenance of special accounts.

Institutionalization periodic review of existing LEEs Third, the new policy framework should reiterate and re-emphasize the importance of the maintenance of special accounts for LEEs as prescribed by the COA under the NGAS. The maintenance of special accounts for LEEs is essential in tracking the results of LEE operations and how closely LGUs follow their intent for creating LEEs. In addition, the framework should also institutionalize the periodic review of the operation of existing LEEs to help LGUs decide whether these LEEs deserve to continue their operation especially in the light of changing market environment. For instance, some LEEs may have been created at a time when no private sector providers were present in the LGU jurisdiction but in the interim the private sector has entered the marketplace. If the review shows that the continued operation of some LEEs is no longer justifiable, the new policy framework should then provide guidance on what the alternative options available to the LGUs in LEE divestment. 3.2. Need to Clarify Treatment of LEE in the LGU Budget A number of LGC provisions related to budgeting create some confusion. At the same time, we argue that the budget format sends signals on how budget execution should proceed and thus affects LGU spending behavior, particularly as it relates to LEE operations. 3.2.1. LGC provisions not quite clear on use of LGU income First, one of the fundamental principles of local fiscal administration in the Local Government Code of 1991 states:

“No money shall be paid out of the local treasury except in pursuance of an appropriations ordinance or law” [Section 305 (a)]

Second, the Local Government Code also provides that:

“Profits or income derived from the operation of public utilities and other economic enterprises, after deduction for the cost of improvement, repair and other related expenses of the public utility or economic enterprise


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concerned, shall first be applied for the return of the advances or loans made therefore. Any excess shall form part of the General Fund of the LGU concerned” (Section 313 – second part).

Third, FAQS-A.2.7. of the UBOM provides:

“The budget for and economic enterprise and a public utility shall be presented separately under the General Fund Annual Budget of the local government subject to the usual budgetary process.”

Section 313, particularly the part quoted above, appears to be a source of confusion among LGUs as it seems to suggest that some degree of “use of income” or even some degree of “income retention” for the purpose of funding “cost of improvement repair and other related expenses” (which may be interpreted to include other types of operating expenses) of LEEs. However, it should be stressed that such an interpretation of the Section 313 directly contradicts the basic principle of local fiscal administration set out in Section 305 (a) of the LGC. It will be seen below that this confusion appears to have caused a number of LGUs much grief. In practice, different LGUs exhibit different ways of treating their LEEs not only when they prepare their budgets but also when they execute their budgets. On the one hand, there are LGUs (e.g., Tagum City) that treat their LEEs just like any other unit/ office when they prepare their budget such that the income of the LEEs are shown as part of the income estimate for the General Fund and all expenditure proposals related to LEE operation are shown as part of the expense items in the proposed budget. As a corollary, the same budget format is carried over in the appropriation ordinance. This way of preparing the LGU budget proposal is shown as Option 1 in Box 3. On the other hand, key informant interviews and discussions on the floor during the consultation workshops conducted as part of this study reveal that some LGUs essentially treat their LEEs off-budget. LEE income does not form part of the total income estimate that is use as basis for budget preparation. In like manner, proposed expenditures of LEEs do not form part of the spending proposals in the proposed budget of the Executive. However, proposed subsidies to LEEs (if any) are shown as an expenditure item in the proposed budget. This same budget format is carried over subsequently in the appropriation ordinance. This way of preparing the LGU budget proposal is shown as Option 2 in Box 3. During budget execution, revenues earned from an LEE’s operation are credited to an intra-agency receivable account known as “due from operating units account” while the operating expenditures of the LEE are debited from the same account by the LGUs that prepare their budgets in the manner of Option 2 above. In this way, income derived from the operation of LEEs is utilized in the payment of operating expenses without passing the usual budget procedures in direct


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violation of the basic principle of local fiscal administration that no money shall be paid out of the local treasury except in pursuance of an appropriations ordinance.

Box 3. Alternative Options for the Treatment of LEEs in Budgeting Using Numerical Illustration

In this short note, the implications of alternative budget formats especially as they relate to LEEs are assessed not only in terms of their form and appropriation language but, more importantly, in terms of the implications on budget execution and overall financial management of the LEE and the LGU itself. To foster a better appreciation of the alternative ways of treating LEEs in the budget, this short note makes use of a numerical example. Suppose the budget of LGU A for the year 2009 is being prepared. Further suppose that the income estimates for 2009 are as follows:

Total income of the General Fund Proper (IP) including IRA, local tax revenues, service income but excluding receipts from LEE – PhP 500 M

Receipts from LEE (IL) – PhP 75 M Suppose also that the proposed expenditures for 2009 are as follows:

Total personal services (PS) expenditure for all offices in GF Proper (PSP) excluding PS expenditure for LEE – PhP 200 M

Total MOOE for all offices in GF Proper (MOOEP) excluding MOOE of LEE and subsidy to LEE from GF Proper – PhP 155 M

Total capital outlay in GF Proper (COP) excluding capital outlay for LEE – PhP 100 M

Total PS expenditure of LEE (PSL) – PhP 50 M Total MOOE for LEE (MOOEL) – PhP 70 M Subsidy from GF Proper to LEE (SPL) – PhP 45 M

Three alternative ways of treating LEEs in the budget are presented below. The following sections outline different ways of presenting the LGU budget for 2009 corresponding to these different options. OPTION 1 Description. Under Option 1, estimates of income from various sources, including income from LEEs, are explicitly shown in the income estimate portion of the proposed budget. On the other hand, the expenditures for each of the different offices in the General Fund (broken down as to PS, MOOE and CO) are shown in the expenditures portion of the proposed budget. Moreover, spending proposals for LEE (also broken down as to PS, MOOE and CO) are shown explicitly in the expenditure portion of the proposed budget. The budget presentation for Option 1 using the illustrative data given above is shown below.


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Box 3. Con’t (2)

GENERAL FUND BUDGET FOR 2009 (in million pesos)

Income estimates: IP 500 IL 75 Total income 575 Expenditures: PSP 200 MOOEP 155 COP 100 Total expd for GF Proper 455 PSL 50 MOOEL 70 Total expd for LEE 120 Total expd in GF 575 Assessment. This presentation is consistent with one-fund principle. Although PS expenditure for the LEE is shown explicitly in the budget, it is not difficult to exclude it from the computation to check compliance from the PS cap. However, the subsidy to LEE operations is not obvious/ transparent from the presentation although it can be derived. During budget execution, if actual collections of IP were to fall short of the estimate in the course of the budget year, then it is likely that actual expenditures both for the GF proper and the LEE will be affected. The same holds true for shortfalls in actual collections of IL. OPTION 2 Description. In this presentation, only expenditures under the General Fund Proper are appropriated. Because subsidy to LEE is part of General Fund Proper), it is also appropriated. However, LEE expenditures for PS, MOOE and CO are not appropriated. Although an annex is included showing LEE operations, this annex is presented just for information purposes and does not form part of the appropriation ordinance per se. Under this option, LEEs are allowed to use their receipts/ income without need for the Sanggunian authorization. The budget presentation for Option 2 using the illustrative data given above is shown below.


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Box 3. Con’t (3)

GENERAL FUND BUDGET FOR 2009 (in million pesos)

Main Body

Income estimates: IP 500 Expenditures: PSP 200 MOOEP 155 COP 100 SPL 45 Total expd 500 Annex: Information on LEE Operations Income estimates: IL 75 SPL 45 Total income 120 Expenditures: PSL 50 MOOEL 70 Total expd for LEE 120 Assessment. This budget presentation runs counter to the one-fund principle. Thus, the incentives for efficiency under Option 2 are weaker relative to Option 1 above and Option 3 below. During budget execution, if actual collections of IP were to fall short of the estimate in the course of the budget year, then it is likely that the impact on LEE spending will be limited to the extent that subsidy from the General Fund Proper might be affected. However, if actual collections of IL were to fall short of the estimate in the course of the budget year, then it is likely that only actual expenditures for the LEE will be affected. Conversely, if actual collections of IL were to be exceeded, LEE spending may increase correspondingly even if they are not necessary, a problem common to revenue earmarking.


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Box 3. Con’t (4) Because LEE operations are essentially treated off-budget, the actual results of operations of the LEE will not be apparent. Also, since the expenditures of the LEE are not appropriated, PS spending of LEE is clearly excluded from computation of compliance with PS cap. OPTION 3 In this presentation, the budget is divided into three parts. Part 1 shows the income estimates and spending proposals (including subsidy to LEE) for the General Fund Proper. Part 2 shows the income estimate and spending proposal for the LEE. Part 3 shows the consolidation of Parts 1 and 2. This implies that Sanggunian authorization for LEE spending is required. Moreover, LEE spending is broken down by object of expenditure. The budget presentation for Option 3 using the illustrative data given above is shown below.

LGU BUDGET FOR 2009 (in million pesos) Part I: General Fund Proper Income estimates: IP 500 Expenditures: PSP 200 MOOEP 155 COP 100 SPL 45 Total expd for GFP 500 Part II: LEE Income estimates: IL 75 SPL 45 Total income 120 Expenditures: PSL 50 MOOEL 70 Total expd for LEE 120


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Box 3. Con’t (5) Part III: General Fund (Consolidated) Income estimates: Total income 575 Expenditures: Total expenditures 575 Assessment. This presentation is consistent with one fund-principle. It is also the most transparent of the three options considered. Although PS expenditure for the LEE is shown explicitly in the budget, it is not difficult to exclude it from the computation to check compliance from the PS cap. During budget execution, this presentation is able to build a firewall of sorts between the General Fund Proper and the LEE. For instance, if actual collections of IP were to fall short of the estimate in the course of the budget year, then it is likely that only expenditure items in GF proper will be affected. In like manner, if actual collections of IL were to fall short of the estimate in the course of the budget year, then it is likely that only expenditures items for the LEE will be affected. However, if actual collections of IL were to exceed the estimate, the LEE can automatically increase their spending beyond what has already been appropriated without first enacting a supplemental budget. This presentation defines an unambiguous demarcation line that separate the LEE from the GF proper. It also fosters greater transparency and provides clearer signals/ incentives for efficient use of resources. The COA annual audit reports for 2007 for the two provinces, that were earlier referred to as case study numbers 1 and 2 in Section 2, uncover that these provinces follow Option 2 as well. The COA also reports that the province in the southern part of Luzon (case study number 2) passed a provincial ordinance that provides that separate accounts for each individual economic enterprise shall be maintained in the General Fund. The same ordinance also provides that only the net receipts from the LEE (i.e., revenue less expenditures, improvement, repair, personal services, MOOE, capital outlay and other related expenses) shall form part of general fund. The COA audit also disclosed that the collection from each LEE is deposited in a separate bank account. In the accounting books, the collections were credited to an “other payables” account and the account was simply debited for the payment of operating expenses and acquisition of assets pertaining to the LEE.


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In both cases, the COA audit reports rendered an unfavorable opinion and argued that as a result of the way the LEE income and expenditures are treated in budget preparation and budget execution, the financial position of the LGUs’ LEEs, the results of the LEEs’ operations and cash flows for the reference year cannot not be ascertained. As such, the lack of financial information rendered difficult the measurement and evaluation of the financial performance and viability of the LEEs. It should also be pointed out that the way LEEs are treated in the budget when Option 2 is used is not consistent with the “one fund” principle. Under this principle, the government’s budget should in principle cover all transactions financed with public financial resources. Schiavo-Campo (2007) asserts that “it is impossible for the government budget to reflect the preferences and choices of society and to incorporate the principles of good governance if it includes only a small proportion of revenues and expenditures. If the budget excludes major expenditures, there can be no assurance that scarce resources are appropriately allocated to priority programs and that legal control and public accountability are properly enforced. Only if all proposed expenditures are on the table at the same time does it become possible to review them in relation to one another and to choose those that have higher relative benefits for the community.” It should be stressed that one-fund principle applies to LEE expenditures because LEEs do not have a separate legal persona since they do not partake of the corporate form under the existing legal framework. Instead under the Local Government Code, LEEs are still part of the General Fund but special accounts within the General Fund should be maintained for each LEE. Of course, it would have been an altogether different story if LEEs are established as a corporation with separate legal personality and full operational autonomy. Note that expenditures and revenues of government corporations are not submitted to the same scrutiny and approval mechanisms as the government budget. Rather, the government’s budget should only include the net transfers between the government and the government corporation (i.e., subsidies, equity contributions).

Recommendation. Some LGU officials and some analysts argue in favor of Option 2. They assert that government entities which provide quasi-private goods and services and which charge for said goods/ services should be allowed to retain at least a significant portion of it. Otherwise, these government entities would have no incentive to improve their efficiency if they could not use freely some of the revenues they earn from selling their services. For instance, these officials refer to the increase in income of DOH retained hospital after the income retention policy was put in place to illustrate their point. In order to take this concern into account, at least partially, while at the same time putting emphasis on transparency and accountability, it is recommended


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that LEE income and spending be treated following Option 3 in Box 3. In this presentation, the budget is divided into three parts. Part 1 shows the income estimates and spending proposals (including subsidy to LEE) for the General Fund Proper. Part 2 shows the income estimate and spending proposal for the LEE. This implies that Sanggunian authorization for LEE spending is required. Part 3 shows the consolidation of Parts 1 and 2. This budget format is not only more transparent than current practice, it also provides incentives for LEE managers to improve their collections since they are better able to isolate their earnings from the rest of the General Fund Proper. 3.2.2. LGC provision on personal services spending of LEEs creates

perverse incentives The LGC also provides that:

“The total appropriations, whether annual or supplemental, for personal services of a local government unit for one fiscal year shall not exceed 45% in the case of first to third class provinces, cities, and municipalities, and 55% in the case of fourth class or lower, of the total annual income from regular sources realized in the next preceding fiscal year. The allowances of officials and employees of public utilities and economic enterprises owned, operated and maintained by the local government unit shall not be included in the annual budget or in the computation of the maximum amount for personal services. The appropriations for the personal services of such economic enterprises shall be charged to their respective budgets” (Section 325 - a).

The preferential treatment given to personal services expenditures of LEEs by exempting the same in the computation of compliance with the PS cap has given rise to perverse incentives. Said preferential treatment of LEEs may be justified on the grounds that LEEs being self-sustaining deserves some flexibility in their staffing. However, interviews with LGU officials during the field visits affirm that many LGUs abuse this provision and use it as a means to feign compliance with the PS cap. Recommendation. It is recommended that the favorable treatment given to the personal services spending of LEEs as provided under under Section 325 (a) be retained but that its application be limited to LEEs which are created by ordinance and which have well articulated policy on cost recovery. 3.3. Need to Strengthen LGU Capability Relative LEE Creation and Operation The discussion so far highlights the need to capacitate LGUs in the following areas:

evaluating alternative modes of public-private partnerships


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evaluating when to create new LEEs or when to continue operations of existing ones

drafting of ordinances for the creation of new LEEs including formulation of subvention policy

improving LEE operations development/ evaluation of feasibility studies, especially forecasting

of demand tariff setting collection procedures and systems evaluating alternative organizational structures for the management

and monitoring of LEEs conduct of periodic review of existing LEEs evaluating alternative divestment modes.

At the same time, there is a need to information dissemination/ advocacy campaign targeting LGU and oversight agencies officials to generate better appreciation and understanding of the new policy framework for LEEs. 4. SUMMARY AND CONCLUSION An unambiguous definition of term “economic enterprise” is key the formulation of a clear policy framework for the creation and continued operation of local economic enterprises. In this regard, we that the oversight agencies (DBM, DOF/ BLGF, DILG, NEDA) adopt a common definition of the term “local economic enterprise” emphasizing enterprise dimension: LEEs are local government owned economic entities that generate the bulk of their revenues from selling goods and services. The guidance on LEEs found in the LGC, the NGAS and the UBOM is generally consistent with conceptual framework found in the international literature. Perhaps by being silent on what the alternative options are, the existing policy framework appears to lean more heavily towards the public ownership model. Also, the existing policy framework does not provide cautionary statement on potential government failures that may arise with the establishment and continued operation of LEEs. Given this perspective, the need to establish a clearer and more comprehensive policy framework to govern the creation of new LEEs and continued operation of existing ones is critical. Many of the elements of the existing framework will still be part of the new framework but a number of new features will have to be put in place. The new policy framework should be anchored on the basic principle that LGUs need to focus on their core functions. It should also be premised on the superiority of private-sector led development unless a strong case can be made for government intervention. The framework should thus establish guidelines


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when government provision of marketable output is justified, taking into account the tradeoffs between market failures and government failures. The new policy framework should also recognize that some marketable goods/ services are better delivered by the government central and that the LEE modality is but one of a number of alternative service delivery modes. After considering the different alternatives, if an LGU deems it best to create an LEE, the new policy framework should provide explicit guidance in doing so. This guidance should specify that LEEs should be established by enacting an ordinance that specifies in unequivocal terms: (i) LGU policy on degree of cost-recovery of LEE up front in terms of what percent of cost will be recovered from user charges, (ii) tariff rates or user charges that will be charged for goods/ services provided by LEE, and (iii) who will be subsidized and by how much;9 including schedule of rates by income bracket of clients where applicable. The new policy framework should then distinguish between LEEs created by ordinance with well articulated policy on cost recovery as described above and “LEE-like” activities (i.e., activities that are commercial in nature but from which LGU has little or no intent to recover cost). Subsequently, the policy framework should provide for the differential treatment of these two groups of activities in terms of budgeting and need for the maintenance of special accounts. The proposed treatment of the chartered LEEs, LEEs in the General Fund, and regular LGU units delivering “LEE-like” services with respect to budgeting, use of income and PS spending is summarized in Figure 2.

9 This means that subsidy given to LEEs is an ex-ante conscious decision on the part of the LGU rather than an ex-post item that finances whatever the resulting gap between revenue and expenditure is. The La Union Medical Center provides a good example of how a well articulated policy on providing subsidy to the poor contributes to the efficient operation of the LEE.


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Figure 2. Chartered LEEs, LEEs in the General Fund and Regular LGU Unit Delivering “LEE-like” Services

Form/

Modality Nature of Service

Extent of Cost Recovery as per

Statement of Policy

Legal Basis for Creation

Treatment in the Budget

Treatment of PS Spending Relative

to PS Cap

Need for Special Account in

General Fund

Use of Income

Chartered LEEs

(GOCC-like) e.g., LUMC, PLM & QCGH

Commercial with intent to recover

cost fully or partially

Variable but significant; extent depends on social service orientation

Act of Congress

LGU appropriations for GOCC shown as subsidy/ equity/

transfers/ net lending

Not applicable Not applicable Yes

LEE

Commercial with intent to recover

cost fully or partially

Variable but significant; extent depends on social service orientation

Act of Sanggunian

Option 1: Three part presentation of

GF budget – GF proper and LEEs – more transparent but some kind of firewall between

the two

Option 2: : LEE essentially treated off-budget. Only

subsidy to LEEs is part of spending

proposal/ appropriations.

PS spending of LEE not included in computation of compliance to PS

cap.

Yes

Option 1: No

Option2: Yes

Regular office/ unit delivering LEE-like service

Commercial with little or no intent to

recover cost Nil None

Treated just like any other LGU

department/ office in the budget;

appropriation for unit shown as PS,

MOOE, CO in LGU annual budget

PS of LEE-like activities included in computation of compliance with

PS cap

Yes No


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REFERENCES Chang, Ha-Joon. 2007. State-Owned Enterprise Reform. New York: United

Nations Department for Economic and Social Affairs (UNDESA) Commission on Audit (COA). 2002. Manual on the New Government Accounting

System (NGAS) for Local Government Units. Quezon City: Commission on Audit

Department of Budget and Management (DBM). 2005. Updated Budget

Operations Manual. Manila: Department of Budget and Management Jones, Leroy. 1982. Public Enterprise in Less-Developed Countries. London:

Cambridge University Press.

Pardo, Erlito and Romulo Zipagan. 2008. “Study on the Corporate Powers of Local Government Units.” Report submitted to the Department of Interior and Local Government and the Asian Development Bank under ADB Technical Assistance 4778.

Republic Act 7160. Local Government Code of 1991

Schiavo-Campo, Salvatore. 2007. “The Budget and its Coverage.” In Shah, Anwar, ed. Budgeting and Budgetary Institutions. Washington D.C.: World Bank

Shapiro, Daniel and Steven Globerman. 2004. “The International Activities and Effects of State-Owned Enterprises.” (http://business.sfu.ca/files/Office_Documents/cibc-centre/soes.ppt)

SEQUUS. 2003. “Developing the Public Economic Enterprise in the Philippines –

The LGSP Way”, Draft report submitted to the Local Government Support Program (LGSP), Canadian International Development Agency (CIDA).

Shirley, Mary M., 1989. The Reform of State-Owned Enterprises: Lessons from

World Bank Lending. Washington D.C.: World Bank. Shirley, Mary M. and Patrick Walsh. 2000. Public Versus Private Ownership: The

Current State of the Debate. Washington D.C.: World Bank. World Bank. 1995. Bureaucrats in Business: the Economics and Politics of

Government Ownership. Washington D.C.: World Bank. Wright, Glendal. 2008. “A Review of Alternative Service Delivery Options.” Report

submitted to the Asian Development Bank (ADB) under the Technical Assistance 4778 Project.


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Annex 1

A REVIEW OF ALTERNATIVE SERVICE DELIVERY OPTION10

Glendal Wright 1. INTRODUCTION The requirements placed on local governments to deliver the services that are needed by their citizens require that these governmental organizations have a full complement of authorities and powers to meet these needs. Because local governments are charged with providing a wide range of services, from police, fire, cultural, health, infrastructure, and economic development, there is a need for the local government to have a wide range of options in performing these service delivery functions. If local governments are constrained in the service delivery options, they will be unable to provide these services in the efficient and cost effective manner. Therefore, the local governments cannot meet the needs of their citizens in performing their financial management responsibilities, deliver these services, and promote the interests of their citizens. In many of the developing and transition countries where decentralization is being undertaken to give more authority and power to local governments to deliver services, they are often given a wide range of mandated services to deliver but are not given either the financial resources or the service delivery options to meet these needs. Very often the local government is confined to performing these functions by having to provide these services directly to the citizens. That is they are the producer/provider of the service within the organizational structure of the local government unit. This does always lead to the most efficient and effectively delivery of these services. The scope of options available to local government units ranges from the direct delivery of the services through their own internal organizational structures and staffing. These are primarily the departments and budget units of the local government unit. At the next level, the local governments often use some quasi-governmental entities formed by the legal authorities of the local government, but has some distinct legal separation from the local government. These might be comparable to private sector organizations, but are connected to the local government by the creation and financing of these quasi-government organizations. The financing might be direct to the enterprise or as a subsidy to the operation of the enterprise to maintain its financial viability. These options represent a situation where the local government unit bears full legal responsibility and financial risk in this situation. 10 Report submitted to Department of Budget and Management and Asian Development Bank under ADB Technical Assistance 4778, August 6, 2008.


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Other options are also available to the local government units that minimize the legal and contractual relationship as well as the financial risk. These include the use of service and management contracts, the leasing of local government assets to the service provider, public-private partnership, joint ventures, build-operate-transfer options, as well as the licensing and concessions approaches that provide the local government some options without assuming direct financial risks. It also keeps the local government from competing with the private sector or non-governmental sector to deliver these services. In should be added that these service delivery options are often limited due to the lack of legal authority being given to the local governments to engage the private sector or the non government sector to provide these services, the absence of qualified private sector or non government providers for these services, and the technical capacity of the local government staff to assume a role of regulator and monitor of services, rather than being the direct provider of the services. Overcoming these limitations requires a substantial amount of effort and capacity building from the national to the local government level. The purpose of this paper is to identify other potential service delivery options that might be utilized to enhance service delivery at the level of the local government units. The main focus is to determine if a full range of options are available and being utilized by the local government units. 2. ALTERNATIVE METHODS OF DELIVERING PUBLIC SERVICES

The method of delivering public services at the local government level has under gone revolutionary transformations over the past decades. The possibilities of local governments delivering services, other than directly to the citizen, has expanded significantly as new needs for services beyond the traditional public safety, education and health has greatly increased. The worldwide trend toward decentralization to service delivery and financial resources to local governments has meant that local governments have had to increase their service delivery capacities. This has often been difficult to achieve through the resources available, so in many cases new approaches, particularly through the use of the private sector and the non governmental organizations to deliver services has meant that new legal, organizational, and financial systems have had to be adapted to these situations. In this short paper, the use of some new innovations, commonly used in the developed and transitional countries, to deliver services is addressed. The intent is to expand the possible range of these service delivery methods to local governments in the Republic of the Philippines, beyond the existing traditional service delivery methods and the corporate methods that are being used. In many cases, the risk exposure of the local governments in both legal and financial terms is quite high. This is typically viewed negatively in the developed countries for local governments to assume their responsibilities. Therefore, this


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paper will address some methods that may be used to reduce this risk to the local government and the citizen-taxpayer. 2.1. Service Delivery Issues There are a number of issues that need to be addressed in determining the possible arrangements for the delivery of services. These include the following: Does a task or service need to remain within the public sector? If so, does it need to remain under local government control and what is the

best organizational structure for the control and monitoring of these services? How will the financial arrangement be structured between the local

government and the service delivery organization? How will the charges for services be determined and by whom? Who will be responsible for the capital expenditures and how should these be funded? If a local government subsidy is needed how should it be calculated?

What should happen to the ownership and maintenance of the assets? What controls should be exercised over the service delivery organization?

What contractual form should be implemented? How can performance be measured to ensure compliance with contractual requirements?

As can be seen these involve a complex set of problems and issues that need to be addressed by the national and local governments levels. The legal frameworks need to be implemented that will allow for the greatest flexibility but also insure that the potential for liability, financial risks, and other difficulties can be minimized to the local citizens who ultimately bear the burden of supporting these service delivery methods. 2.2. What Services Should be Delivered There is a continuing debate about what services should be delivered by the local governments. This is one of the key determinants of what the legal and organizational structure should be in order that these services can be delivered. In the developing and transition countries, the central and local governments have had to decide what types of activity should be retained in the public sector and what should be decentralized to the lower units. The key distinguishing factor is to determine those services which involve and element of public service and those that are more oriented toward private sector commercial delivery. The generally accepted approach is to limit the government sector to those that have some well defined and significant public interest in providing to the citizens. In many of the transition countries, and this seems the case in the Philippines, there is a temptation to hold on to old state owned enterprises as profit making entities and to even undertake new commercial enterprises that will bring additional revenues to the local government. This possibility is generally based


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on the belief that these enterprises will produce a profit to the local treasury and overcome the lack of local tax base and difficulties of the intergovernmental transfer systems that may not be based on objective formula and subject to political manipulation. This approach can produce unnecessary consequences on the local government and the private sector development that should be promoted. A local government owned and operated enterprise most likely will compete unfairly with the potential private sector providers through subsidization of the enterprise. A second problem is that the so-called profits may be illusory in the sense that not all costs or efficiency of the service delivery is being factored and calculated into the “profit.” The general principle that has been applied in the more developed countries with local governments engaging in the full delivery of public services is that the local governments should not engage in commercial activities, with the possible exception of an activity that supports a genuine public service. An example might be the situation in which a museum, park or recreation facility might also provide food services as part of ensuring that the facility meets the needs of those using the public service. While the food service is generally accepted commercial enterprise, the provision of this service serves to improve the attraction of the facility to those visiting. The provision of public services can also be addressed by examining the following classification approach: 1. Identify services which benefit all citizens without exclusion of anyone and

therefore makes charging for these services impossible. These are the classical services, such as police, fire, streets, and environmental protection.

2. Identify services which should be provided as they have benefit to all citizens who receive the services. These include education, health, water and sewerage, among other services.

3. Identify services that are considered essential to the quality of life of the citizens and require a large funding investment so that only one provider, a monopoly position, would be feasible. Examples include piped water supply, as opposed to communal well or other water source.

4. Identify services which are essential to the quality of life, but too expensive for some income groups, the poor, to have access to if there were charges for the services and delivered at market rates. These services fall under the categories of schooling and provision of public transport or recreational facilities that might be too expensive for many of the citizens to access.

While these guiding principles seem straightforward and clear in their application, the actual decision making is greatly influenced by national and local political situation, values and cultures that are inherent in the society. Consequently, there are always exceptions to applying these general principles.


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2.3. How Public Services Are Provided If a service is determined that it should be provided the question arises as to what are the best methods to provide this service. Traditionally, it has been considered that the local government should provide this service through it financial and human resources and the organizational structure is within the local government structure. However, the international trend has been to transfer this function to the private sector or non governmental organizations for delivery. This has been a significant trend in that new legal and regulatory frameworks are being devised to provide these services outside the direct delivery by the local government through its ownership and control of the service delivery. Under the newly emerging trend the local governments still are responsible for the service to be delivered, but it is not essential that they are the direct provider of the service and instead use the private sector to deliver the service. Private enterprises are becoming involved in delivering public services. These often are structured through joint ventures, public-private partnerships, or contractor agreements. These are often used for the delivery of utility and other services. The non-governmental organizations are often able to deliver services in the fields of education, cultural, and social services. Therefore, local governments have a broader and more flexible options for providing services that their citizens may require. These service delivery arrangements provide an advantage to the local governments in overcoming a significant conflict in the delivery of these services. This conflict arises from the divided interest of the local government to be responsible for the delivery of the service at a cost efficient level, and the responsibility to maintain its interest as the owner of the assets and the employer of the human resources that are used to provide this service. This conflict often results in contradictory policies. That is the local government may be overly influenced to maintain the assets and staff at an unnecessary level over the requirement to provide the citizens with these services at the lowest and most efficient cost level. However, this conflict can be avoided if the local government unit allows for the service to be delivered by an outside organization, and confines it role to regulating, monitoring and, if necessary, subsidizing, this activity. This situation provides for a competitive environment and the discipline of the private sector to provide the service at the lowest cost, while not exploiting its economic position. There are two limitations on the local governments in employing this policy option of using the private sector. First, is the availability and capacity of private sector organizations to undertake the delivery of these services. Hopefully, there should be some possibility that several providers would be available to provide this


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service at the local government level. If this is not possible, the advantages of using the private sector are more limited. A second limitation is the capacity of the local government itself to manage the contractual and regulation requirements and oversee the private enterprise delivery of these services. The cost and complexity of the service to be delivered largely dictates the capacity needs of the local government administration. 2.4. Possible Service Delivery Relationships The organizational form of service delivery can be divided between the direct delivery by the local government structure or the use of organizational forms, primarily private enterprises and non governmental organizations. The policy option here is rather straightforward between the two alternatives. However, depending on which option is chosen, the legal and contractual relationship involves much more complex issues. There has to be established an agreement formulated into a legally recognizable contract that will ensure both parties understand the requirements. Should conflicts arise the legal system can address these conflicts through the legal process. There are a number of issues that need to be examined in determining how this contractual relationship will be defined in the agreement. These include the following: Ownership of the assets Responsibility for capital investment Responsibility for operation and maintenance Relationship to the consumer/citizens Regulation of the charges or tariffs Receipt of operating revenue Responsibility for financial risks Degree of municipal subsidy The extent of monopoly rights

Each of these issues has to be addressed in determining what option is the most feasible and practical for the local government to minimize its risk and maximize the potential for service delivery at the lowest possible cost. 2.4.1. Direct Service Delivery by the Local Government If services are provided directly by the local government through its own organizational structures the local government is consequently responsible for all areas of ownership, investment, financial operations, and service delivery efficiency to the citizens.


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2.4.2. Service Contracts with External Organizations An option that allows for service provision other than directly by the local government organization is the use of service contracts. The local government may contract the delivery of the service to an external organization. The scope of this service contract can be quite extensive from operating public housing to parking services to vehicle maintenance. The key feature of the service contract approach is that the local government continues to own the assets, but the service contractor is responsible for the repair and maintenance, and usually for the replacement of some equipment necessary for the delivery of the service. The operating income is controlled by the local government and goes to its fund accounts. The contractor is simply paid for the service based on the agreed price. As an example, a service contract might be issued for the reading of parking or water meters. The revenue collected from the parking meters belongs to the local government, while the service contractor is paid based on the amount agreed in the service contract. 2.4.3. Management Contracts The use of management contracts can take two forms. The first is without sharing income of the service and the second is the sharing of the income received from the delivery of the service. If the contract takes on the form of not sharing the income the local government units maintains ownership of the assets and has responsibility for investing in construction, and other capital requirements. The local government unit sets the tariffs or charges for the service and is directly responsible to the citizen for the service and has to assume all financial risks. In addition, the service contractor is given a fixed fee for the service. The operation and maintenance are met from the income received for the service and any operating surplus or deficit is the responsibility of the local government unit. Therefore, in the option without income sharing the local government bears all responsibility and financial risk. The alternative option of income sharing arranges a division of the revenue received from the delivery of the service. The conditions of the without income/revenue sharing apply, but generally, the following conditions are also featured. The service contractor usually has discretion to charge less (but not more)

than the regulated tariffs The service contractor receives a fixed percentage share of the operating

surplus on top of the fixed contract fee. The income sharing option is usually considered for those activities that are expected to not need an operating subsidy from the local government unit, such as water supply or refuse collection. It is used in some cases for services such as swimming pools that may collect fees or charges while also receiving a


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subsidy. The contractor might still receive some share of the operating surplus after the subsidy is received into the funds. 2.4.4. Leasing The most common leasing approach is when the lease agreement allows for the local government unit to lease to a service provider the assets owned by the local government in exchange for a rental price that the service provider will pay. The service contract provider is directly responsible to those consuming the service, and not to the local government unit. The service company thus bears all the financial risks associated with the operation of the service. In this approach, the local government units still owns the assets and is responsible for the investment and debt service associated with the assets. The service contractor is responsible for operation, repair and maintenance, and for replacement of short life equipment. The service contractor must return the assets to the local government unit in good condition at the end of the lease period, less normal wear and tear on equipment. The service contractor collects the operating income and meets the operating costs. In some cases, the local government may regulate the pricing or tariffs for the service. The service contractor will pay to the local government unit one of the following options: A straight rental price for the use of the asset, or A percentage share of the revenue, or Both, a fixed fee for the asset use and a share of the income generated from

the use of the asset. 2.4.5. Concessions A concession is when a service contractor is given an exclusive right to provide a service for a fixed period of time, but has to invest capital in the constructing and providing the necessary infrastructure. The service contractor is responsible for all costs, including capital, repair, operation and maintenance, and is responsible to the consumers of the service. All the financial risks are borne by the service contractor. A concession maybe useful for large scale infrastructure projects, such as operation of convention centers or sport stadiums, tolls roads, communication networks, and public utilities. The competitive approach to awarding the concession is used and the concession award may require service levels and charges/tariff limits. These charge/tariffs may be reviewed periodically and indexed to inflation or return on investment calculations. Essentially, the charges/tariffs and the period of the concession should be calculated based on the recovery of operating costs, full amortization of the initial capital investment, and a reasonable rate of return on the investment. Due to these consideration, the period of the concession is


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generally for a long period of time, from 15 to 30 years. At the end of the concession, the assets become the property of the local government unit. A Build-Operate-Transfer is a form of the concession. The financial arrangements may take several forms. The local government may provide initial subsidy or funding for the undertaking of the investment. In this case, the local government may have some claim to the operating income. The local government may also pay a subsidy to the service contractor as a means of lowering the charges/tariffs to the public for the delivery of the service. This is often used for public transport service delivered by a service contractor under a concession arrangement. 2.4.6. Licensing Under licensing a service provider may be licensed to invest in and operate a service on the same conditions as a concession, but the licensed service contractor does not have the exclusive rights that a concession agreement has for the service contractor. This approach is often used where there is potential for competition and the service requires lower investment costs. Licenses are often used for transport services, such as taxis, buses, etc or even refuse collection. In these cases, the service contractor retains the assets used for the delivery of the service at the expiration of the license period. 2.4.7. Funding Agreement Another option is the situation where local government units enter into a contract with a non-profit organization to provide to the service organization a grant to provide certain services, such as social, sports, recreation, or cultural activities. The service organization is responsible for all investment and operating costs, owns the assets used and bears the financial risks. The BOT scheme comes under this type of agreement. This type of contract normally covers a particular programme or activity, and not the whole operations of the service contractor. The agreement would cover the broad content of the programme and set standards of quality to be maintained. Payment of the grant would be dependent on adherence to these standards and to periodic review of the activities being undertaken. 2.4.8. Unregulated Provision At the extreme end of this spectrum of public service delivery options would be the instance when a private organization provides a public service with no formal or contractual relationship with the local government unit. This may occur in the example of charitable organizations that may offer food or accommodations to those in need or other welfare services. The organization has to comply with all relevant legal requirements for delivering this service, such as for construction of


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facilities, employment conditions of staff, environmental regulations, and health and safety requirements. The organization is subject to all inspections as any other commercial provider would be for the same services. 3. DETERMINING THE ORGANIZATIONAL METHODS FOR SERVICE

DELIVERY Along with the choices of determining the appropriate contractual approach to delivering services, there are also choices that need to be made with regard to the most appropriate organizational form for delivering the services. The choices can be divided into two different methods. The first is to provide the service through the direct local government delivery and control by the local government departments and budgetary organizations or through the creation of a municipally owned company or companies that will be responsible for delivery of the services. The second method is to use external organizations, such as private commercial firms or non governmental organizations, which will be contracted to deliver the service through the various contractual approaches discussed above. In the following sections these different approaches are examined with the advantages and disadvantages identified and discussed. 3.1. Local Government Organizations Versus Local Government

Companies Delivering Services If the initial assessment is that the local government should maintain control and provision of the services the choice that must be made is to whether to deliver the service through the internal organizational departments and budgetary units. The main differences in choosing either of these two approaches is in the areas of employment status, property ownership and the investment in the capital assets required for delivery of the services. The use of local government companies provides that they will not be subject to any special restrictions on the employment of the staff and will be competing for employees in the employment market for the needed professional and technical staff. This approach opens up the possibility for abuses in hiring that may not be acceptable if there is not a merit based system that is used for hiring the staff. There may also be abuses in terms of paying the staff through the company method at a higher salary rate than in the market and thus increasing the costs of the service. There may also be excessive staffing of the company that is more than necessary to provide the services in a cost effective approach. The issues related to the assets employed are more clearly established when the local government company is responsible for these. The local government


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assets that are used by a company can be transferred or leased to the company. The method chosen must specify the ultimate disposition of the assets and whether they are to be retained by the local government as an asset in its inventory. A local government company would potentially be more inclined to make the necessary capital investments to maintain the equipment and facilities needed to deliver the service. The company should be in a position to raise the capital to acquire these assets. Even more critical in this approach would be to use joint ventures approaches so that a portion of the local government company will be owned by the private operators. This is often the case with large service delivery areas, such as waste management, water and other services where the capital costs are high but the services are delivered for a substantial period of time. It is expected that a local government company, either a sole ownership or joint venture operation, would be more interested in professional management and the use of cost effective service delivery methods. Some incentive toward performance based bonuses based on profitability or return on investment can promote this advantage of using local government companies. In some cases the use of a company owned by several local government units may make economic sense as the service area is too small for just one jurisdiction, but the wider service delivery area across several jurisdictions may make economies of scale possible. While there are some substantial advantages in using a company to deliver these services with the local government structure, there are also some significant disadvantages as well. Among these are the following: Companies may not feel the sense of public duty or service ethic that goes

with being an internal part of the local government unit The profit motive might force the company to not deliver services to those

areas where the economic cost and return is minimal and, therefore, some citizens may not receive the service

The monopoly position of the company may mean that it ignores market forces that would otherwise control its economic behavior

There is also the potential for corruption and nepotism if the company ownership is directly tied to the political leadership and under its influence

The transparency and accountability of the local government company may not be sufficient to ensure the public and the media can fully examine its operation and financial management.

The potential for the local government company formed in a joint venture operation is another risk that can create a very complicated situation with regard to the future risks of using a local government company.


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3.2. The Use of External Providers for Service Delivery The use of external providers allows for private sector commercial enterprises and non governmental organizations to deliver the services. The contractual relationships for use of external providers includes the service contracts, management contracts, leases, concessions, licenses and unregulated operation that were described in the preceding section. There are quite a number of issues that must be addressed in analyzing the use of external providers as opposed to a local government owned and operated companies. These will be addressed in the following sections. 3.2.1. Influence of the Market The basis for establishing the pricing for the delivery of services is different between the two choices. The local government owned company will normally be subjected to the fixing of service pricing by the administrative procedures and possibly the political decisions within the local government system. The external provider is more concerned with utilizing economic and market analysis for determining the appropriate level of pricing and service charges. The dynamics of the decision making is varied and significant depending on the choice of a local government company or external providers. The cost structures are substantially different and the motivations for efficiency and economy in the delivery of the service are also different between these two choices. 3.2.2. Defining the Public Interest Determining or defining the public’s interest in choosing the alternative methods should also be considered in making the choice. It is assumed that the local government direct delivery of services would more easily insure that the public’s interest in the service would be maintained. There are a number of considerations that need to be addressed in determining if the public interest is being served. These include the following areas: Access and Coverage: the public interest is presumably served by providing

the service to all eligible citizens regardless of the cost of this service. The external provider may be more concerned to deliver the services to those most able to pay or in such numbers that they are insured that a profit will be made. The issue of access to and coverage for a given population to be served must be factored into the calculation of which service provider is more capable of delivering that service to those most needing the service.

Pricing or Service Charges: the delivery of the service by the municipal organization may be based on low charges for the service and subsidization of the loss making operations. This may not produce the most efficient and effective service delivery options and may mean that the whole population of taxpayers may ultimately pay more for the service. An external provider must balance the pricing with the level of competition, the alternative services


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available and the extent to which it must set pricing to achieve some profit or return on investment. Therefore, the external provider may be more sensitive to cost and pricing than the local government company. The use of competitive methods of bidding and contracting for services also puts some discipline into the process.

Quality of the Services Delivered: The issue of which provider may be best able to provide the service at a level of quality desired has some interesting comparisons. It is generally felt that since the local government is more directly accountability to the citizens through the elected officials that the quality of service would be insured. The lack of the profit motive would also mean that services are not sacrificed to achieve the profit on the service. However, the external provider may be able to deliver the same quality of service if these are clearly established and made part of the contractual agreement and penalties applied if the service is not delivered to the established levels. Also, since an external provider knows that the contract can be terminated if performance standards are not met; there are additional incentives for them to maintain the level of service required. The knowledge that the service will be competed again with the possibility that poor performance will be taken into account in this competition serves as another incentive for the external provider to maintain the quality of the service.

Environmental Impacts: The general quality of life in a local government may be impacted in terms of the environmental impacts that may result from the choice of either a local government company or an external provider. The need for construction, maintenance and operation of many local public services can have impacts on the air and water quality in the community. These are costly impacts that need to be factored into the decision. There is often a claim that the external provider would be little interested in assuming the environmental costs as this would reduce the profitability of the operation. Therefore, they are less sensitive to the environmental impacts or the need to avoid these problems. This may be overcome by specifying in the contractual agreement the provisions for maintaining environmental quality as well as provision for the costs of incorporating these into the cost of the service. Having said this, it is not always the case that the local government company will be even more disciplined in maintaining environmental quality. If the local government is also responsible for monitoring and regulating its environmental impact, it may well be that the internal organizational dynamics of the local government structure may hinder this enforcement. The local government environmental protection department may be more willing to enforce the environmental standards against the external provider than against another department of the same local government.

Service Delivery Improvement: There is a need for constant innovation and renewal of the services being provided. New technologies that improve productivity and efficiency need to be constantly introduced. There is a difficult balance to be made in deciding which organizational approach that will provide for constant service delivery improvement. The external provider might be more willing and capable of introducing these service improvements.


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The use of the contracting, concession and licensing agreements may provide this opportunity. There is a need to introduce into the contracting environment the flexibility to provide incentives to have the external provider incorporate new service delivery improvements. This means provisions for improvements in service delivery will be rewarded, costs mitigated in introducing these new methods, and flexibility in the contractual agreements will not hinder the introduction of these improvements.

3.3. Non Governmental Organizations The choice of an external provider between a private sector commercial firm and a non profit/governmental organization deserves some consideration. The financial advantages of the non profit and the use of volunteer human resources provide advantages to the non governmental organization. The non governmental organizations are also good at introducing innovations into service delivery and have substantial expertise in several areas; such as health, education, and social service delivery. They have more limited experience or capabilities in the delivery of more infrastructure related services, such as the water, sanitation, and other services. 3.4. Making the Choice The above has provided a discussion of the advantages and disadvantages of the choice between using a local government company or the use of an external provider of these services. There are many factors to consider in making this choice. The international experience has been that on balance the use of contract or concession methods to achieve the external provision of local government services is more favorable. The use of a mixed approach in which the local government and external providers may jointly operate and deliver the services also has significant advantages. The important point to be made here is that the local government is able to maintain control over the delivery of the services and not assume the financial risks that come with that operation. The use of the external provision of service delivery puts into the decision equation the affects of competition, the more precise definition of the required service delivery levels, a situation where there is more transparency and regulation of the providers performance, and the access to the technology, expertise and experience that is more often available to the external provider. However, these advantages are only available if the following conditions apply to the local government situation. There must be some level of competition in the market with several providers capable of providing the service at comparable cost and performance. The development of the outputs or service performance requires a high level of expertise that may be lacking in the local government


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personnel. There is a great need to insure that corruption or other ethical infringements may not come into the situation. The enforcement of public integrity standards is needed to a high degree. Finally, the access to expertise and experience typically required by the external provider to deliver the service needs to be assessed. If this is missing in the potential providers, then other alternatives need to be considered. If the above conditions are absent, the local government may not have any alternative other than the direct provision of the service to the community. Even if the choice is to use a local government company, there is still a need to ensure that the contractual arrangements are clearly specified and performance monitored by the municipal political and professional management. The use of contracts and service agreements can still be utilized even with a local government company.


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Annex 2

SYSTEMS OF BUDGET AND FINANCIAL MANAGEMENT OF LOCAL GOVERNMENT ENTERPRISES11

Glendal Wright

1. ORGANIZATIONS OF LOCAL GOVERNMENTS

It is useful before beginning the analysis of local budgets and financial management of local government enterprises to provide some definition of the types of organizations that come under the purview of local government functions and services that are delivered.

As a starting point a local government organization can be defined as one that has a public purpose (or several public purposes), is controlled by an elected legislative body representing a particular political (geographic) jurisdiction, and usually has special powers like taxing, tax-exempt borrowing, use of eminent domain, and so forth. There can be two types of local governments that could fit under this definition.

The first of these are the “general purpose governments” which provide the traditional services, such as police and fire protection, along with other purposes, such as provision of streets and public lighting, public buildings, garbage collection, along with some inspection services, such as building construction, restaurants, hazardous materials, etc. In some cases, the general purpose governments may also provide education services through the public schools, and medical services, such as hospitals, and ambulance services.

In addition to these types of government organizations that provide the traditional services and are largely financed by broad based taxes, such as property, income or business related taxes, there are also what are termed “limited-purpose” (or single purpose) government organizations. These are usually created by the authority of the general purpose governments that often confer on these limited purpose governments special taxing, borrowing or other powers, including eminent domain. These limited purpose governments can be created by one or more general purpose governments to cover a larger geographic area for providing a certain function. This is often the case with sanitation services, such as landfill serving several political jurisdictions, or transportation services that cover several geographic areas and political jurisdictions.

Limited purpose governments often operate as what are called government enterprises. Governmental enterprises are usually limited purpose public 11 Report submitted to Department of Budget and Management and Asian Development Bank under ADB Technical Assistance 4778, 27 January 2009


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organizations or parts of governments that produce public goods or services that are sold to the public, with such fees or user charges providing most or all of the revenues of the organization. Although these enterprises sometimes have specific taxing and borrowing rights, they are distinguished by their reliance on fees or user charges to make them “self-sustaining.” They are often intended to run without subsidy or even to generate a profit. Government enterprises include, for example, water and sewer systems with local general-purpose governments, public hospitals or utilities run as special districts, and state or regional transportation authorities. 2. OBJECTIVES OF GOVERNMENT ORGANIZATIONS

Governmental organizations provide a wide range of public goods and services—housing, public safety, health services, education, utilities, highways, etc,-- and they have several general objectives they hope to satisfy in providing these goods and services.

First, governments, no matter the purpose, try to raise and spend resources efficiently, in the lowest-cost, highest benefit fashion. This requires that a particular government strive to minimize the levels of resources used, or the costs of these resources, in providing a given set of goods and services. This objective prompts the governments to evaluate continually how it is raising its money, (taxes, fees, etc) and how it is spending its money (personnel, materials, equipment, etc) to keep it use of resources and their costs down.

Second, governments try to raise and spend resources equitably—distributing costs and benefits of government activities “fairly” among the individuals and groups they serve. “Fairness” obviously means different things to different people, and governments reflect this sense of fairness of their constituencies. But in the analysis of government actions, “fairness” usually means distributing costs in a manner that recognizes that different individuals and groups have different abilities to pay them.

Third, governments try to maintain a healthy financial condition-being able to meet their financial obligations as they come due, in both the short run and the long run, while raising resources and providing public goods and services. Governments are not established to make profits or amass fortunes, but they are expected to take those steps needed to ensure that they have the financial strengths to carry out their public responsibilities.

Finally, governments have public accountability as an objective—responding to the needs of the government’s clientele and the requirements of its environment in an open, informative, and involving fashion and being held responsible for its actions. This objective requires that the government develop the information needed to evaluate its operations, put this information into an understandable


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and accessible form, and provide mechanism for the appropriate public review of its activities. 3. INTERNATIONAL PRACTICES ON LOCAL GOVERNMENT

ENTERPRISES

In the following sections some presentation of international practices as they relate to the treatment of local government enterprises within the financial systems of local government accounting systems. This is intended to represent some of the variations in this complicated subject area and does not represent any advocacy of how the local government units in the Philippines should address this issue. Further analysis of the situation in the Philippines is required in order that further clarification of the extent, and potential consequences, of the present methods in the Philippines can be assessed with proper recommendations. 3.1. International Accounting Standards for Government Business

Enterprises International Public Sector Accounting Standards (IPSAS) 6 addresses Consolidated Financial Statements and Accounting for Controlled Entities. Under this Accounting Standard Government Business Enterprises have the following characteristics: Government Business Enterprise means an entity that has all the following characteristics: (a) Is an entity with the power to contract in its own name; (b) Has been assigned the financial and operational authority to carry on a business; (c) Sells goods and services, in the normal course of its business, to other entities at a profit or full cost recovery; (d) Is not reliant on continuing government funding to be a going concern (other than purchases of outputs at arm’s length); and (e) Is controlled by a public sector entity. The IPSAS standard defines an economic entity, inclusive of what are termed government business enterprise, as an economic entity, which may include entities with both social policy and commercial objectives. For example, a government housing department may be an economic entity which includes entities that provide housing for a nominal charge, as well as entities that provide accommodation on a commercial basis. Consequently, many of the activities of local governments can be included under both a public and private (commercial) accounting context. The trend in the past years has been toward the governmental accounting systems coming more closely to commercial oriented accounting through the application of accrual accounting and fixed asset cost accounting methods. Government Business Enterprises (GBEs) are required to comply with International Accounting Standards (IASs) issued by the International Accounting


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Standards Committee. The Public Sector Committee’s Guideline No. 1, “Financial Reporting by Government Business Enterprises” notes that IASs are relevant to all business enterprises, regardless of whether they are in the private or public sector. Accordingly, Guideline No. 1 recommends that GBEs should present financial statements that conform, in all material respects, to IASs. This Standard establishes requirements for the preparation and presentation of consolidated financial statements, and for accounting for controlled entities in the separate financial statements of the controlling entity. Although GBEs are not required to comply with this Standard in their own financial statements, the provisions of this Standard will apply where a public sector entity that is not a GBE has one or more controlled entities that are GBEs. In these circumstances, this Standard should be applied in consolidating GBEs into the financial statements of the economic entity, and in accounting for investments in GBEs in the controlling entity’s separate financial statements. Public sector entities may create other entities to achieve some of their objectives. In some cases it may be clear that an entity is controlled, and hence should be consolidated. In other cases it may not be clear. The following paragraphs provide guidance to help determine whether or not control exists for financial reporting purposes. In examining the relationship between two entities, control is presumed to exist when at least one of the following power conditions and one of the following benefit conditions exists, unless there is clear evidence of control being held by another entity. Power Conditions (a) The entity has, directly or indirectly through controlled entities, ownership of a majority voting interest in the other entity. (b) The entity has the power, either granted by or exercised within existing legislation, to appoint or remove a majority of the members of the governing body of the other entity. (c) The entity has the power to cast, or regulate the casting of, a majority of the votes that are likely to be cast at a general meeting of the other entity. (d) The entity has the power to cast the majority of votes at meetings of the board of directors or equivalent governing body. Benefit Conditions (a) The entity has the power to dissolve the other entity and obtain a significant level of the residual economic benefits or bear significant obligations. For example the benefit condition may be met if an entity had responsibility for the residual liabilities of another entity. (b) The entity has the power to extract distributions of assets from the other entity, and/or may be liable for certain obligations of the other entity.


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When one or more of the circumstances listed above does not exist, the following factors are likely, either individually or collectively, to be indicative of the existence of control. Power Indicators (a) The entity has the ability to veto operating and capital budgets of the other entity. (b) The entity has the ability to veto, overrule, or modify governing body decisions of the other entity. (c) The entity has the ability to approve the hiring, reassignment and removal of key personnel of the other entity. (d) The mandate of the other entity is established and limited by, legislation. The entity holds a “golden share” (or equivalent) in the other entity that confers rights to govern the financial and operating policies of that other entity. “Golden share” refers to a class of share that entitles the holder to specified powers or rights generally exceeding those normally associated with the holder’s ownership interest or representation on the governing body. UBLIC SECTO Benefit Indicators (a) The entity holds direct or indirect title to the net assets/equity of the other entity with an ongoing right to access these. (b) The entity has a right to a significant level of the net assets/equity of the other entity in the event of a liquidation or in a distribution other than a liquidation. (c) The entity is able to direct the other entity to co-operate with it in achieving its objectives. (d) The entity is exposed to the residual liabilities of the other entity. The above provides the recognized standards and basis for defining the relationship between a municipal government and any created and/or controlled entities, such as local economic enterprises and would define the requirements for financial reporting and budgeting. 3.2. Commercial and Corporatization of Local Governments in Australia It is always instructive to examine the experience from other countries of the Asia region to identify how they have handled similar problems and dealt with these issues. Australia, and particularly the state of New South Wales (NSW), has paid some attention to the issues of how to deal with the increasing levels of effort by local governments to engage in more commercially oriented functions by their local governments. The same dynamics that is driving the Philippines local governments to engage in these activities is approximately the same as the situation in New South Wales a few years ago. Local governments were increasingly not receiving sufficient funds from the central level to finance their activities and at the same time were being asked to provide more services. The issues surrounding the approach by local governments toward providing these


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services through commercial or enterprise type organizations is identified and described in the following paragraphs Issues • What local government activities are commercial in nature? • To what extent do their prices recover their costs? • Should more services be commercialized? • What are the pros and cons of extending the corporatization model to local

government businesses?

What does it mean for a government business unit to be corporatized? A 1988 report by a senior committee of NSW public officials advocated that a government business should meet conditions such as: (1) Have clear and non-conflicting commercial objectives; (2) Be stripped of regulatory powers; (3) Be compensated for having to do community service obligations; (4) Have an independent board and management; (5) Be subject to arm’s length performance monitoring by the owner-government; (6) Have effective rewards and sanctions related to performance; and (7) Be exposed to competition in both input and output markets The first six attributes made such an enterprise “commercial”, whereas the addition of the last condition made it fully “corporatized”. In the early 1990s many Australian state governments had been investigating reform of public enterprises; however it took a Council of Australian Governments (CoAG) meeting in1995 for a nationally consistent framework for ‘competition’ reform to emerge. The result of this meeting was the National Competition Policy (NCP). The NCP agreement called on governments to implement a raft of reforms designed to increase the competiveness of the Australian economy, ranging from governance of government businesses to forcing third party access to monopolized infrastructure. One of those reforms aimed to prevent government businesses from having an unfair advantage over the private sector due to issues such as tax treatment and preferential borrowing arrangements. This particular plank of the policy was called competitive neutrality, and applied, among other things, corporatization principles to government trading enterprises, including local government businesses. This agreement only required the principles to be applied to a council’s significant business activities. Part of the challenge in implementing the reforms was to define significance. After consultation with local government the NSW State government settled on a threshold approach. Those businesses that earned revenue in excess of $2m\ per year, known as Category 1 Businesses, were to be subject to the same reforms, as


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State Government owed businesses. Those requirements were: _ Adopt a corporate model; _ Include debt guarantee fees; _ Factor into prices an appropriate return on capital invested; _ Quantify and make explicit Community Service Obligations; _ Operate in the same regulatory framework as other businesses; and _ Include in costs the same taxes faced by private businesses. Businesses with a sales turnover of less than $2M are known as Category 2 businesses. Councils were to apply full cost attribution to as many Category 2 activities as was practicable. The extent to which these businesses were to adopt a corporate model was at the discretion of council; essentially due to the limited impact such businesses were thought to have on resource allocation decisions. At the same time as the NCP came into being, the National Competition Council (NCC) was formed to assess compliance with the reform agenda, and to recommend so-called ‘competition payments’ to the States upon positive assessment by the NCC5.

Pros and Cons of further applying corporatization principles to local government business Applying corporatization principles to a greater range of local government businesses brings a number of benefits to council. Have clear and non-conflicting objectives Identifying clear and non-conflicting objectives can assist councils to determine the extent to which they view a service as a commercial, social or regulatory venture. For example, the supply of childcare services may meet both social and commercial objectives. Corporatization can assist local government to determine the trade-off between these two objectives. If childcare services are primarily driven by social policy, then any cross-subsidy can be justified on these grounds. If in the future the service is viewed as essentially commercial, fee increases can be similarly justified. Allow managerial responsibility, authority and autonomy Managerial autonomy allows major decisions regarding the performance of various business units to be made at arms length from councillors, who, despite best intentions, may object to increased fees or reduced service levels due to their position. This may be a particular problem in rural and regional areas where councilors are relatively closer to their communities than in metropolitan areas. Have effective performance monitoring by the owner-government Effective performance monitoring can assist local government business units to assess their performance against agreed and measurable benchmarks. Since local government businesses are not scrutinized by the equity and debt markets,


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the owner-government must replicate this function to ensure its business units meet the set objectives. Have effective rewards and sanctions related to performance Effective monitoring combined with appropriate reward and sanction mechanisms can help ensure local government businesses are governed to meet the objectives of council, rather than those of management or other self-interested groups. There are a number of costs associated with imposing a corporatization model. First, implementing the four principles to a business that is insignificant in terms of both revenue and expenditure is likely to incur transactions costs that far outweigh the efficiency gains. Second, the consequences of corporatization may impact upon more the council’s balance sheet. For instance, a council service may be able to be provided more efficiently by an external agency. The financial benefits of this shift, however, may be outweighed by impact on the local economy due to a loss of employment. The following were identified in the New South Wales study that indicated possibilities for applying a corporate model to local government supplied activities. Opportunities to increase fee income While mindful of the pros and cons of further implementing the corporatization model, it would seem that a number of services provided by NSW councils are worthy of investigation. For example: Childcare Many councils either provide childcare services directly or subsidize rental by private operators. These services appear to be able to earn council an economic return, particularly now that many employers pay childcare fees through benefits such as salary sacrifice. Of course, councils may wish to cross-subsidize this service on equity grounds. Public halls Public halls are often rented to community groups for minimal rates. While some may argue that such fees do recover costs, council may wish to investigate charging rents comparable to those charged in the private sector for equivalent facilities. Sports grounds Although they maintain sporting facilities, many councils do not charge fees for the use of those fields, particularly in rural and regional areas. These facilities should be reexamined for revenue opportunity.


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Hire of earthmoving equipment Road service is one function that may be difficult to corporatize due to the limited income streams. Councils might explore hiring idle earth moving equipment to private enterprise. The above discussion represents some general guidance and policies that can be established with regard to the treatment of those services delivered by local government enterprises that may reflect their commercial orientation. This may provide a basis for a clearer definition and development of a policy on this issue in The Philippines. 3.3. Treatment of Local Government Enterprises in Finland Finland has one of the most well developed structures of local government provision for delivery of public services to their citizens. There are many small local governments that lack the necessary capabilities to support some public services directly and this has created the possibility and potential to utilize commercial type enterprises, authorized and sanctioned by the local governments to delivery these services on a cost reimbursable basis. This reflect the traditional and classical approach to the delivery of public services that may be outside of the general government functions. The following provides some narrative on the definition and structure of municipal enterprises and how they are treated in the budgets and financial reports at the local and central level. The example of Finland provides a model based on the more traditional market economy orientation practiced by developed economies.

Municipal enterprise Municipal enterprises following the so-called municipal enterprise model are independent units in terms of accounting to which the council of the municipality or joint municipal board has granted a more independent budgetary status than that of other municipal functional units. According to the instructions of the Municipal Section of the Accounting Board, municipal enterprises draft separate financial statements containing a profit and loss account, a funds statement and a balance sheet. A municipal enterprise is part of the municipal administration and finances; it is not a separate legal person and it does not have an independent legal obligation to keep books. Only a part of municipal enterprises follow the municipal enterprise model. In statistics on the finances of municipalities and joint municipal boards other municipal business operations (incl. enterprises treated as so called other balance sheet units and business with separate accounts) are treated in the same way as other municipal activities. Income and expenditure from joint-stock or other such business operations are not included in the statistics on the finances of municipalities even if the municipality owns the entire capital stock of the enterprise.


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The profit and loss account in the municipal budget includes settlements between the municipality and a municipal enterprise (internal interest paid and return on the municipal enterprise's fixed capital) but not the municipal enterprise's "own" profit and loss estimates. Hence a municipal enterprise is not linked to the municipal budget "line by line". According to the budget recommendation of the Association of Finnish Local and Regional Authorities, the municipality must also compile for its budget a profit and loss statement that includes the profit and loss estimates of the municipal enterprise line by line and from which the interest paid on internal loans and the return on fixed capital have been eliminated. The municipality can use this profit and loss estimate in communicating about its budget to the public. The separate financial statement of a municipal enterprise is integrated "line by line" into the municipality's or joint municipal board's financial statement to form an overall financial statement. Since a municipal enterprise is treated differently in the budget than in the financial statement, the figures in the budget and the financial statement may not be comparable. In order to compile statistics on financial statement estimates and budgets, Statistics Finland collects separate data from the municipal enterprises' financial statement estimates and budgets. This enables the combining of the municipalities' and their municipal enterprises' budgets and financial statement estimates into a comprehensive budget/financial statement estimate for the entire municipality, whose figures are comparable with those of the financial statement. In Statistics Finland's budget publications the budgets of municipalities and joint municipal boards are published without the budgets of enterprises following the municipal enterprise model. Combined budgets, or budget data comparable with financial statements, are also published on the Statistics Finland website.

Budget

A budget is the plan for the financial administration of the municipality or joint municipal board. The budget for the budgetary year is approved before the end of the previous year by the council of the municipality or joint municipal board. According to the Local Government Act the budget includes the appropriations required by the operational targets and revenue estimates and indicates how the financing needs will be met. According to the budget recommendation of the Association of Finnish Local and Regional Authorities, the budget is divided into the operational economy, investments, the profit and loss account, and financing. The structures of the profit and loss account and financing parts correspond to the formats for the profit and loss account and the funds statement of the municipality and joint municipal board.


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The Local Government Act stipulates that the budget must be observed in municipal activities and financial administration. The council decides on revisions to the budget. The accounting of the municipality or joint municipal board monitors the realization of the budget and the financial statement includes a comparative report on the realization of the budget. If the municipality or joint municipal board has enterprises following the municipal enterprise model, the profit and loss statement part of the budget includes the settlements between the municipality or joint municipal board and their municipal enterprises (internal interests paid and return on the municipal enterprise's basic capital) but not the municipal enterprise's "own" profit and loss estimates. The profit and loss statement part of the budget is therefore not comparable with the profit and loss statement of the financial statement, as municipal enterprises are entered into the latter line by line, eliminating internal items. If a municipality has municipal enterprises, it must, according to the budget recommendation of the Association of Finnish Local and Regional Authorities, publish also a profit and loss statement part in its budget which contains the municipal enterprise's profit and loss statement estimates and from which interest paid on internal loans and returns on basic capital have been eliminated. Only a part of municipal enterprises follow the municipal enterprise model. 3.4. Fund Accounting in the USA Governments obtain resources, use these resources (inputs) produce goods and services (outputs) and then distribute these goods and service to their constituencies. Unlike for-profit organizations, government revenues are usually not generated by the sale of goods and services, and capital is not obtained by selling shares of stock that promise future financial returns. Thus governments are concerned with “bringing in as much money as goes out” (balancing the budget) and being accountable for the use of resources, but not maximizing financial profit. Fund accounting is the basic framework that has been developed and used by accountants to record financial transactions in governments. Fund accounting was developed primarily for control purposes and is designed to record where resources come from and what they are used for, and to help ensure that governments conform to the legal constraints placed upon them. What distinguishes fund accounting from conventional for-profit accounting is that the government is divided for accounting purposes into separate accounting entities, or funds, whereas for-profit accounting makes no similar divisions. Each fund is usually set up to record and account for the uses of specific group of assets or sources of revenue, reflecting the control orientation of fund accounting. A government may have one or more funds.


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Funds in government often correspond to activities and objectives of the organization, but they do not necessarily correspond to operating divisions such as departments or programs within the government. These activities or objectives are often specified by external organizations, such as higher levels of governments providing revenues with restrictions on their use, or by a government’s legislative branch requiring that funds raised in a certain way be put to a specific use. Although funds are independent accounting entities, transactions between funds are permitted and occur frequently. A complete definition of fund is as follows:

“A fund is defined as a fiscal and accounting entity with a self-balancing set of accounts recording cash and other financial resources, together with all related liabilities and residual equities or balances, and changes therein, which are segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations.”

There are three broad categories of funds—governmental funds, proprietary funds, and fiduciary funds—and there are specific types of funds in each broad category.

Governmental funds typically include most of the ordinary or routine activities of a government. They are primarily designed to keep track of the revenues and expenditures related to these activities—what comes in and what is spent by the government in the conduct of these activities. As a result, governmental funds usually employ either an accrual expenditure or a modified accrual basis of accounting. Governmental funds are sometimes referred to as expenditure funds.

Proprietary funds are designed to account for those specific governmental activities for which a profit orientation is appropriate. This does not mean that a profit should be realized but only that the measurement of profit is possible and desirable. In fact, many activities that are run on a break-even basis or with operating subsidies are still set up as a proprietary fund. Activities set up as proprietary funds often involve an exchange of resources for a product or service similar to a commercial venture. The accrual expense basis of accounting, the same one used by for-profit organizations, is accepted practice in proprietary funds. Proprietary funds are also referred to as self-sustaining, nonexpendable, or commercial-type, funds.

Fiduciary funds are established when the government must hold assets for individuals (such as employees in a pension fund) or for other organizations (as when a county collects sales tax for a city). Fiduciary funds are set up either as governmental or proprietary funds, depending on their specific purpose.


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The following are specific types of funds within these categories:

Governmental Funds: 1. The General Fund to account for all financial resources except those

required to be accounted for in another fund. 2. Special Revenue Fund is used to account for the proceeds of specific

revenue sources that are legally restricted to expenditure for specified purposes

3. Capital Projects Funds are used to account for financial resources to be used for the acquisition or construction of major capital facilities

4. Debt Service Funds are used to account for the accumulation of resources for , and the payment of, general long-term debt principal and interest

5. Special Assessment Funds are used to account for the financing of public improvements or services deemed to benefit the properties against which special assessments are levied.

Proprietary Funds:

1. Enterprise Funds are used to account for operations (a) that are financed and operated in a manner similar to private business enterprises—where the intent of the governing body is that the costs (expenses, including depreciation) of providing goods and services to the general public on a continuing basis be financed or recovered primarily through user charges; or (b) where the governing body has decided that periodic determination of revenues earned, expenses incurred and/or net income is appropriate for capital maintenance, public policy, management control, accountability, or other purposes.

2. Internal Service Funds are used to account for the financing of goods or services provided by one department or agency to other departments or agencies of the government unit, or to other government units, on a cost-reimbursement basis.

Fiduciary Funds: Trust and Agency Funds are used to account for assets by a government unit in trustee capacity or as an agent for individuals, private organizations, other government units, and/or funds. These include (a) Expendable Trust Funds, (b) Nonexpendable Trust Funds, and (c) Pension Trust Funds, and (d) Agency Funds.

The number of funds in any single governmental unit may vary considerably. Small towns may use only a few of the above mentioned funds, whereas states and larger cities may break the funds down further into an even larger set. Although the general fund is defined in a residual manner to handle resources not restricted to other uses and funds, this fund is central in governments. For the most part, the general fund contains the resources that are used for the operational activities of the government.


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Note that most long-term assets and liabilities are not counted for within the fund structure. The only exceptions are those long-term assets and liabilities associated with enterprise, internal service, and certain trust funds. Although not part of a fund subject to the accounting equation, it is still recommended that governments keep a record of their long-term assets and liabilities.

An excerpt from governmental funds and enterprise funds for a local government in the USA is provided in Appendix A for further illustration of how fund accounting presented in the financial statements.

The differences in the accounting systems of the governmental funds and proprietary (enterprise) fund are presented in the box below. It is important to recognize the differences in the basis of accounting between the two types of funds and the financial statement requirements of the two funds.

GOVERNMENTAL FUND FINANCIAL STATEMENTS

Governmental Fund Financial Statements including general fund, and special revenue, debt service, capital projects, and permanent funds will be prepared using the current financial resources measurement focus and modified accrual basis of accounting.

The required governmental fund financial statements are a balance sheet, a statement of revenues, expenditures and changes in fund balances.

PROPRIETARY FUND FINANCIAL STATEMENTS

Proprietary fund financial statements that include enterprise funds and internal service funds will be prepared using the economic resources measurement focus and the accrual basis of accounting.

The required proprietary fund statements are a statement of net assets, a statement of revenues, expenses, and changes in fund net assets and a cash flow statement that is prepared using the direct method.

These statements should also report capital contributions, contributions to permanent and term endowments, special and extraordinary items, and transfers separately at the bottom of the statement to arrive at the all-inclusive change in fund net assets.

In principle, local government accounting systems must address through the types of accounts that they utilize and their budgeting systems the following: (a) identification, comparison, verification and control of costs; (b) the manner in which prices, taxes or inter-governmental transfers are determined; (c) adequacy and appropriateness, or otherwise, of prices or taxes; (d) measurement of efficiency and effectiveness of public services; (e) comparison and contrast of


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costs and prices: among entities, over time, and against budgets and other expectations; (f) costs and benefits of providing services in different ways, especially by comparison between in-house provision and contracting-out; (g) costs and benefits of projects, to determine and then to achieve the least-economic-cost technically feasible solutions to the concerns they address; (h) the manner of funding capital expenditure and its impact on current accounting and financial management; and, (i) providing necessary – albeit not always sufficient – cost data, to facilitate efficient and credible financial and economic analysis of activities. 3.4.1. Illustration of Balance Sheet Under Fund Accounting Method

One basic purpose of accounting is to report on the stock of resources of a government. The primary document in this area is the balance sheet. The balance sheet lists the assets, liabilities, and fund balances at any single point in time for an individual fund or group of funds. For governments, balance sheets are usually presented in the financial reports for all funds (governmental, proprietary, and fiduciary) for the beginning and end of the fiscal year, and often the balance sheets for all funds are presented in a single combined statement. A combined balance sheet contains the balance sheets of every individual fund and account group and sometimes displays a total of each account—asset, liability, and fund balance—for the organization as a whole. The following illustrates a combined balance sheet that reflects the use of the general fund and several enterprise fund accounts based on the fund accounting method used in the US. This is a very simplified version of a balance sheet for the purposes of illustration, while actual combined balance sheets might well have several enterprise fund, as well as what are termed account groups for fixed assets and debt accounts.

Combined Balance Sheet for Local Government, January 1, 2--- ($000) General Water & Municipal Parking Fund Sewer Fund Fund Assets: Cash on Hand 50 100 120 Property Tax Rec 100

Accounts Rec 25 30 40 State Aid Rec 50 Due from Other Funds 10 12 15 Other Assets Inventories: Materials/Supplies 2 20 25


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Equipment (net Depreciation) 10 5 Land 10 100 200 Buildings (net of depreciation For enterprise fund) 50 50 40 Total Assets: 297 322 445 Liabilities: Vouchers Payable 10 15 5 Salaries Payable 15 20 10 Due to Other Funds 20 15 5 Bond Anticipation Notes 100 100 Revenue Bonds Payable 25 15 Total Liabilities: 45 175 135 Reserves: Reserve for Encumbrances 100 Total Reserves 100 Fund Balances 152 Retained Earnings 147 310 Total Liabilities, Reserves and Fund Balances or Retained Earnings 297 322 445 There are several aspects of the combined balance sheet that should be highlighted. First, each fund will have a different set of assets and liabilities. Fixed assets and long term debt are now included in the general fund based on the changes to the accounting standard issued the Government Standards Accounting Board (GASB) Statement 34. Second, there can be interfund transfers and obligations among the funds. Cash is common to all the funds, but the cash accounts are not commingled into one bank account in most cases. In addition there is a reserve account that is placed between the liabilities and the fund balances. Reserves consist of those portions of the fund balances that are segregated for a specific future use and not available for further expenditure. The reserve for encumbrances represents the portion of the fund balance that is set aside to meet certain types of financial obligations not yet fulfilled. If the government has encumbered funds for certain items that have been ordered but not yet delivered, then the reserve shows that these orders are outstanding.


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Finally, and very important, the enterprise funds use retained earnings to describe the difference between assets and liabilities, while the governmental funds, the general fund, use a fund balance. The use of the two accounts is similar when viewed from the accounting equation perspective; however, the distinction is helpful because the governmental funds use expenditure accounting while the enterprise funds use expense accounting. 3.4.2. Representation of Balance Sheet of Local Government in the

Philippines The following balance sheet is utilized as a comparison of how a balance sheet is presented under a one fund approach too accounting for local government finances and the multi-fund approach that is utilized by the local governments in the USA. The balance sheet presented for the town of Ati-Atihan does not purport to be representative of all local governments, cities or municipalities, in the Philippines. It is strictly used to illustrate the differences in how the financial condition is presented between the two methods. As is evident from the balance sheet, the comparison is made from one year to another and there is no breakdown by any governmental and/or enterprise activities of the local government unit. The assets of the local government are presented although it is not clear as to whether these assets are used for general government purposes or for enterprise purposes. There is a retained earning/surplus account, but this does not indicate if this surplus was a result of any increases in revenues, any savings in general government operations, or through the operation of the local government enterprise. This comparison is presented to illustrate the differences in the transparency and accountability that can be provided by the presentation of local government financial activities. The breakdown of the fund accounting approach in the USA provides much more detail and possibility of analysis than the balance sheet for the local government in the Philippines. Given the increasing level of commercial related activity that seems to be the trend in the Philippines, there is a need for more detailed identification of the financial activity of the various components of the local government functions, including those of a general government nature and those of a more commercial and profit oriented focus.


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Republic of the Philippines Province of Aklan

ATI-ATIHAN TOWN OF KALIBO

MUNICIPAL GOVERNMENT OF KALIBO, AKLAN

CONSOLIDATED BALANCE SHEET As of December 31, 2007

(With Comparative Figures for CY 2006)

2007 2006

ASSETS Current Assets Cash P 29,892,415.25 29,455,120.06 Receivables 15,718,411.90 7,956,398.49 Inventories 14,414,286.50 10,885,901.58 Prepayments 138,982.25 555,151.68 Other Current Assets 0.00 0.00 Total Current Assets P 60,164,095.90 48,852,571.81 Investments Investment in Securities 0.00 0.00 Sinking Fund 0.00 0.00 Total Investments P 0.00 0.00 Property,Plant and Equipment (net of Depreciation) Land 1,502,413.33 1,502,413.33 Land Improvements 2,547,163.62 2,068,883.86 Buildings 51,703,061.83 45,911,211.05 Leasehold Improvements 0.00 0.00 Office Equipment, Furnitures and Fixtures 10,202,176.73 9,533,673.96 Machineries and Equipment 5,492,862.67 5,510,143.98 Transportation Equipment 4,674,054.96 4,875,026.92 Other Property, Plant and Equipment 2,520,551.03 2,605,123.50 Public Infrastructures 28,950.00 767,110.71 Reforestation Project 0.00 0.00 Construction in Progress 19,225,085.83 18,664,833.28 Total Property,Plant and Equipment P 97,896,320.00 91,438,420.59 Other Assets P 2,116,523.42 1,549,598.81 TOTAL ASSETS P160,176,939.32 141,840,591.21


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LIABILITIES AND EQUITY LIABILITIES Current Liabilities P 24,576,629.74 21,962,458.99 Long-term Liabilities 2,685,797.89 4,779,499.21 Deferred Credits 10,725,132.58 6,100,552.64 Total Liabilities P 37,987,560.21 32,842,510.84 EQUITY Government Equity, Beginning 108,998,080.37 99,817,542.28 Add/Deduct: Retained Operating Surplus 16,767,972.29 10,713,319.48 Prior Year's Adjustments 4,724,389.11 284,616.41 Transfers to Registry (10,283,022.88) (4,092,950.71) Transfer of PPE/Completed Projects from Trust Fund/ General Fund/Other Fund 1,981,960.22 2,275,552.91 Government Equity, End 122,189,379.11 108,998,080.37 TOTAL LIABILITIES AND EQUITY P160,176,939.32 141,840,591.21


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4. FINANCIAL ANALYSIS OF GOVERNMENT ENTERPRISES There is a fundamental difference in the manner in which government enterprises are analyzed on a financial basis that a general government operational activity. The analysis of the finances of the government enterprises is more closely related to the analysis of the commercial profit oriented corporations and businesses. Given the reflection of the financial condition of local economic enterprises presented in the main body of this report, the significance of the losses and the debt of these enterprises indicates that there has not been sufficient attention to the financial analysis of these enterprises to determine if, or even when, they might be self-sustaining as is indicated by the laws concerning the establishment and operation of these enterprises. For these reasons, a short description of the elements of financial analysis of government enterprises is provided in the following sections. It is assumed that the purpose of a governmental enterprise is to provide a public good or service in exchange for payments from the users of that good or service. Utilities, airports, transportation systems, convention centers, and recreational facilities are examples of activities organized on an enterprise basis. The major question to be addressed is how do government enterprises affect the financial condition of a government. If an enterprise operates on a break-even basis without subsidies from other parts of the government, the enterprise should have no adverse affect on the financial condition of the government. Moreover, by providing a valued good or service to the community and thereby meeting a need that might not be met without the enterprise, the operation of the enterprise should result in an improvement in the financial condition of the government. Finally, a government enterprise may produce a surplus or profit which may be available for use elsewhere in the government. If an enterprise fails to operate at least on a break-even basis, it may weaken the financial condition of the government by requiring subsidies from other funds in the form of money or services. But just because the enterprise puts a financial burden on the government does not mean that the goods or services from the enterprise are not “worth” the cost. Subsidies for certain public enterprises may be socially desirable. What it does mean is that the enterprise has an effect on the financial condition of the government, and that this financial effect should be recognized. The analysis of the financial conditions of a government enterprise can be examined in the following four areas: (1) assessments of demand and supply, (2) operational performance, (3) capital structure, and (4) liquidity.


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Demand and Supply A distinguishing feature of enterprises, compared with the other activities of governments, is that they operate in markets where resources are exchanged for goods and services. Thus it is important to examine the enterprise’s role in the supply of and demand for the services in question. An important aspect of the market is the degree of competition. In some respects the financial riskiness of the enterprise increases with the competition in the market. For example, if as is often the case the enterprise is in a monopoly position, then there will be no actions by direct competitors, such as price cutting or product enhancement, that could affect the financial condition of the enterprise in a negative way. While many public enterprises approximate monopoly suppliers, such as airports and water systems, others face direct competition, such as recreational facilities. Thus an examination of the enterprise should include an investigation of the nature of the direct competition. The public enterprise’s market share should be examined over time to determine whether its position in the market is growing or declining. The market should also be examined to understand the nature of indirect competition. For example, a city may operate the only commuter rail line, but the railway may fact competition from automobiles and private express buses. Similarly, a municipally owned cable television system may face competition from satellite systems and home video recorders. Again, competing products and prices may lower the revenues to a public enterprise. In addition to a general market analysis, many enterprises operate in industries that are faced with special regulations, and these affect the supply of and demand for products. Regulations may improve or worsen the finances of an enterprise, and as a result, they must be assessed on a case-by-case basis. Examples include the environmental regulations that affect sewer systems, nuclear regulatory effects on electric utilities, and the move away from cost reimbursement toward prospective reimbursement in the health industry. Finally, the market analysis should include an estimate of the relationship of the quantity of the product demanded to the price charged for the product. This relationship can be represented by the specification of a demand curve and/or estimation of the elasticity of demand with respect to price. This elasticity is specified as the percentage change in the quantity of the product demanded that associated with a percentage change in price. If the percentage change in the product demanded is less (more) than the associated percentage change in price, the demand is called inelastic (elastic) with respect to the price. Enterprises that face an inelastic demand are in a better position from a financial perspective because they will receive more revenues for a given price increase than they would if their demand were more elastic.


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Operational Performance The analysis of the operational performance of an enterprise is most analogous to internal resource analysis, since it involves the assessment of revenues and expenses. In general, the better the operational performance of the enterprise, the less likely it is that the government will become involved in subsidizing the enterprise. Since the financial goal of enterprises is assumed to be break-even operations, at the least, this can be used as a benchmark in the analysis of operational performance. Although break-even performance may be the financial goal, there are several reasons why a positive net income may be appropriate. Most of the reasons stem from the notion that break-even performance is the long run goal rather than the objective for any particular year. The excess of revenues over expenses may be needed for capital purposes, either for capital expansion or for replacement, or to pay back contributed capital that is sometimes used to start up a public enterprise. In growing enterprises there may be a need for additional working capital, which can be generated by operating with a positive net income. Or the enterprise may wish to operate with a positive net income in some years as a contingency for those years in which unexpected events have a negative effect on its earnings. For this reason, it is better to examine the enterprise’s revenues and expenses over several years rather than for a single year. The ability of an enterprise to raise its rates or prices to improve its operational performance should also be examined. There are a number of measures available to assess an enterprise’s operational performance. Most enterprises report their income in at least two parts. The first part is typically labeled operating income, or net income from operations. This is the difference between operating revenues and operating expenses where operating refers to those flows which are directly related to the enterprise’s primary service activities. The second part is net income or total net income, and includes nonoperating revenues and expenses as well as operating income. Sometimes, in order to compare the income data for enterprises of various sizes, operating income and net income or divided by revenues. This ratio is called the operating margin in some industries. Another measure of the enterprise’s operational performance is the return on investment. This ratio assesses the earnings of the enterprise compared with the asset base generating the earnings. The numerator of this ratio may be based on operating income or total income. Usually interest expense is added to the income figure in the numerator because interest is part of the total return on assets, the part paid to the debtholders. The denominator is the total assets of the enterprise. Thus the return on investment from operations equals (net income from operations plus interest expense) divided by total assets; the total return on investment equals (total net income plus interest expense) divided by total assets. Since assets are typically measured by historical cost less


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depreciation, asset valuations are affected by inflation. Financial ratios that use assets measured in this way are less reliable than those that use more current data, so they have to be interpreted more cautiously. A final type of ratio that is useful in the evaluation of operational performance is the activity ratio, even though it often uses a measure of enterprise assets measured in historical terms. Activity ratios usually compare a measure of the enterprise’s input with its output. For example, the total asset turnover ratio is computed by dividing total annual operating revenues by total assets. If this ratio is high it suggests that every dollar of assets is generating a high value of assets, implying efficient use of assets.

Capital Structure The ability of the enterprise to raise capital depends, in part, on its current capital structure. For government enterprises that cannot issue equity (e.g. common stock), an analysis of the enterprise’s capital structure usually means measuring the degree to which it relies on debt. Enterprises that are heavier users of debt are generally considered to be financially riskier than those that borrow less (recognizing that average levels of debt vary across industries). The use of debt, per se, is not a signal of poor financial condition, but all else being equal, the greater the level of enterprise debt, the greater the possibility that unexpected changes in enterprise revenues and expenses may require general fund contributions to the payment of the enterprise’s debt service. Moreover, in terms of capital expansion, all else being equal, the greater the debt carried by the enterprise, the greater the difficulty of raising additional debt. For these reasons, we need to examine the stock of debt outstanding and debt service flows to assess an enterprise’s capital structure. The likelihood that an enterprise will be able to repay its debt depends on the annual payments required by existing debt levels. A ratio that is commonly used in this assessment is the debt service coverage ratio, which is used to compare the funds available in a given period (normally a year) for the repayment of debt with the amount of debt and interest on the debt that must be repaid over that period. For an enterprise, the debt service coverage ratio can be defined as [Total net income plus depreciation plus interest payments] divided by [Principal payments plus interest payments]. The numerator represents the annual cash flow available to pay debt service (depreciation is included in the numerator because although it is an expense, it is not a cash flow), and the denominator is the annual debt service. Higher values of the debt service coverage ratio indicate that the enterprise has more funds available in any given year (more coverage) to pay back the debt, so that the risks of not being able to pay debt service are less.


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For an enterprise, a measure of the amount of debt outstanding is the debt to assets ratio, the stock of long-term debt outstanding to the total fixed assets of the enterprise. This ratio measures the proportion of the fixed assets of the enterprise that is financed by long-term debt but again suffers from the use of assets measured by historical costs.

Levels of Liquidity of Internal Resources The analysis of the levels and liquidity of internal resources for enterprises follows the same approach as for other government funds, with some exceptions that will be noted. To analyze levels of internal resources it is necessary to examine the levels and trends of fund balances (sometimes termed the net worth or retained earnings in government enterprises), but it is also necessary to use debt to asset ratios (rather than a fund balance to revenue ratios) to determine the adequacy of this “equity” (nonborrowed) capital cushion. Too high a debt to asset ratio implies that the enterprise needs more internal resources in the form of net worth or retained earnings, relative to its debt. Internal resources can increase by transfers from other funds and/or surpluses (profits) earned by the enterprise. Thus enterprise fund surpluses and deficits are analyzed as a primary source of the increases and decreases in the enterprise’s fund balances or net worth. To analyze the liquidity of the enterprise’s internal resources, we start by estimating the expected levels and timing of cash flows to and from the enterprise, and the probability of cash flow problems, using cash budgets and information on past surpluses and deficits and sources and uses of cash from existing financial statements. Liquidity measures, such as net working capital, and the current and quick ratios can also be used. Following this we can try to assess the extent to which the enterprise can change the magnitude of its cash flows, through additional borrowing or increasing revenues and/or decreasing its expenditures, and the timing of its cash flows by speeding up cash inflows (like collection of water bills), and/or slowing down cash outflows (like payment of bills). In the last case, it is necessary to turn to collection rates and payment rates. Finally, standard methods of comparing changes in current assets and liabilities over time and/or between organizations can be used for evaluating the liquidity of government enterprises. 5. BUDGETING METHODS There is a need to clarify the basis on which budgets are prepared within the local government units. The local government code does not specify whether a


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cash based or accrual basis of accounting will be employed by the local governments. The standard international practice is that local governments will use a modified accrual basis for accounting of local government expenditures and revenues. On this basis, expenditures are recorded on an accrual basis meaning the period in which the obligation is incurred rather than paid, while revenues are recorded on the basis of actual cash receipts of the taxes in the budget period. First, it must be stressed that the process of budgeting is the planning of financing for future activities and acquisitions. For municipalities, this is an important pricing exercise, one that determines the tax rate that local councils will be asked to approve for the year. The budget is not an accounting exercise. The budget and financial statements are both important financial documents that have obvious linkages. For example, the financial statements provide a measure of a government's performance in the achievement of its objectives as set out in budget documents. The budget and budget bylaw include direct authority to staff to provide services at specified costs, to spend, to raise revenue, to invest and to borrow. Financial statements provide assurance to users that financing and operations were carried out in accordance with the authorities and powers granted. Financial statements also assist users in assessing the municipality’s performance in the management of financial affairs by identifying variances that need explanation. A government's budget is a critical element in the accountability cycle and the standard against which subsequent performance is judged. To facilitate meaningful comparisons, planned results need to be reported on a basis and for a scope consistent with that used to report the actual results of the current period. The US Government Accounting Office has conducted at least two surveys of the use of accrual budgeting around the world. It is utilized to varying degrees in Australia, Canada, Iceland, The Netherlands, New Zealand, the United Kingdom and the United States. Denmark and Switzerland recently expanded the use of accrual budgeting. On the other hand, Norway and Sweden considered it, but ultimately decided against using it altogether. To put it bluntly, the international jury on accrual budgeting is still deliberating, even though the verdict has long been in with regard to accrual accounting. Implementations range from the most limited, such as at the government-wide level, to full accrual budgeting at all levels and agencies of the government. It was found that cash-based and accrual-based budgeting are useful for different purposes. In particular, cash-based budgeting was more useful for determining fiscal flexibility, whereas accrual-based budgeting proved useful in costing of programs, and where it is believed that a cash basis does not provide adequate information for tax levies or user rates.


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Cash-based Budgeting Accrual-based Budgeting Advantages Disadvantages Advantages Disadvantages Easily understood by current Councilors and Taxpayers - and by staff

Budgets for tax purposes only – fails to focus on the long-term

Consistent with the new financial reporting requirements

Difficult to understand, especially for non-accountants

Ensures cash is available in the period

Large projects look expensive and may be delayed due to an unfavourable view of large upfront costs

Long-term focus on asset renewal, which will lead to full capital budgeting (e.g. tangible capital assets, post-closure costs)

Without cash-flow budgets, it may lead to under-funding

Budget authority for current full price of asset

Short-term view of Council leads to budgets based upon affordability rather than need

Any under-funding of or provision for future replacements becomes obvious

Complexity of accrual budgeting may lead to misunderstanding by Councils

Provides decent view of government sustainability in the short-term

Inconsistent with the new financial reporting requirements – may be difficult to monitor, especially if the daily accounting is on an accrual basis

May be difficult to monitor, depending upon budget-system design

First are the serious disconnects between cash-based budgeting and accrual accounting. Variance reports would be comparing apples and oranges as the budget numbers would include repayment of debenture principal, whereas the actuals would include only repayment of debenture interest. Second, and perhaps more important, is that a cash-based budget is excellent as a financing plan, because expenditures should match the revenues or financing that is available. However, as the US GAO survey discovered, it may be quite inadequate in providing for the true cost of providing a service, as there is no consideration of the consumption of tangible capital assets over time or other non-cash expenses. Thus the pricing derived or used from cash-based budgeting is perhaps only part of the story, whereas accrual-based budgeting provides a more comprehensive view of the costs involved in providing a service or a product, resulting in a more sustainable price or tax rate being determined. Further, by highlighting the consumption and de facto using up of assets through the recording of amortization expense, the focus will shift more to the need to provide for on-going maintenance and future sustainability of services than is perhaps the case at present.


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Appendix A: Illustrations of Financial Statements of Local Government in the USA NOTE: This is illustration of fund accounting practices prior to the issuance of the GASB Statement 34 which redefined the method in which fixed assets or infrastructure were reported on the balance sheets of local governments. This is shown for illustration purposes.


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STUDY ON THE CORPORATE POWERS OF LOCAL GOVERNMENT UNITS

Erlito R. Pardo and Romulo R. Zipagan

I. INTRODUCTION

By tradition, the Central Government has been tasked with the

responsibility of promoting economic development in a community. However, in more recent years, such responsibility has been shifted to local governments as they are now cognizant of their bigger and proactive role in securing the economic wellbeing of their constituents. Thus, the traditional role of local governments as service provider has been expanded to include economic promotion as a necessary function of local governance.

Local economies are the building blocks of the national economy. Thus, while national economic development is principally the task of the Central Government, local governments also have to assume a significant role in national economic development to complement the efforts at the National level. Thus, the emerging reality is that local governments will have a part to play in steering their local economies to be ready to confront the challenge of globalization.

It is in this light that the Department of the Interior and Local Government

(DILG) has requested technical assistance from the Asian Development Bank (ADB) to enable it to study the local government units’ (LGUs’) exercise of corporate powers in tandem with their governmental and regulatory powers, and how this exercise of corporate, governmental and regulatory powers has affected their ability to confront the challenges of poverty alleviation and ensuring local economic development. Such support was provided by ADB under Local Governance and Fiscal Management Project (TA 4778-PHI).

This study sought to document the exercise of the LGUs’ corporate

powers and review aselected group of LGUs that have exercised their corporate powers through the operation of public utilities, economic enterprises and other service facilities (e.g., business incubators) . Based on the results of thereview, a set of guidelines and a program strategy design will be formulated. These recommendations can be used by the DILG in harnessing the LGUs’ corporate capacities.

Study on the Corporate Powers of Local Government Units

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II. THE POLITICAL AND CORPORATE NATURE OF LOCAL GOVERNMENT UNITS

The 1987 Philippine Constitution upholds the autonomy of local

governments by laying down the general framework for the existence and operations of local government units (LGUs). Section 1 of Article X of the Constitution states: “The territorial and political subdivisions of the Republic of the Philippines are the provinces, cities, municipalities and barangays. There shall be autonomous regions in Muslim Mindanao and the Cordilleras as hereinafter provided.”

In 1991, Congress enacted a new Local Government Code (LGC). The

Code embodies all existing laws and statutes concerning local governments and their powers, functions, structure, personnel, taxation, budget, services and facilities. It also provides for the transfer of certain authorities and functions from the national government to local governments.

Dual Nature of Local Governments Local governments in the Philippines are political subdivisions of the state vested with substantial powers to manage local affairs and whose officials are directly elected by their respective constituencies. As agents of the state, local governments exercise two kinds of power: governmental powers to protect and promote public interest and welfare, and corporate or proprietary powers to provide local necessities and conveniences for its community. Section 15 of the LGC underscores the dual nature of LGUs. It states: “Every local government unit created or recognized under this Code is a body politic and corporate endowed with powers to be exercised as a political subdivision of the National Government and as a corporate entity representing the inhabitants of its territory.” The phrase “political subdivision” appropriately covers the exercise of governmental functions, while the phrase “corporate entity” properly refers to the exercise of proprietary functions (Nolledo, 1993).

Creation of Local Government Units Local governments may be created, merged, and abolished through a legislation enacted by Congress, or an ordinance passed by the local legislative body, subject to approval by majority of the votes cast in a plebiscite in the LGU/s directly affected. Provinces, cities, and municipalities are LGUs created through the acts of Congress while barangays are created through ordinances passed by the concerned city or municipality that has jurisdiction over them. Under the LGC, the criteria for the creation of LGUs are population, land

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Lidasan v. COMELEC, 21 SCRA 496 (1967) Torio v. Fontanilla, 85 SCRA 59 (1978) City of Manila v. IAC, G.R. No 71159, 179 SCRA 428, 434 (1989) Municipality of San Fernando v. Firme, G.R. 52179, April 8, 1991


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area and income. Minimum requirements are established to ensure the viability and capacity of new units in providing essential services to the people (Table 1).

Table 1. Criteria for Creating Local Government Units

LGU Population Land Area Annual Income

Province * 250,000 2,000 sq. m. P20M City * 150,000 100 sq. m. P20M *** Municipality 25,000 50 sq. m. P2.5M Barangay 2,000 ** Highly Urbanized Cities 200,000 P50M * Province and city must comply with income criterion and with either

the population or land area requisite. ** For barangays within Metro Manila and highly urbanized cities, the

requirement is at least 5,000 people. *** Starting Calendar Year 2001, for municipalities to be converted to

cities, they should have at least P100 million local-source income. Source: Local Government Code of 1991.

Powers and Functions The functions and responsibilities of local governments are specifically delineated in Section 17 of the Code for the provinces, cities, municipalities and barangays, taking cognizance of the viability of the unit to perform the assigned powers and functions. The section assigns to the provinces the role of being “a dynamic mechanism for developmental processes and effective governance of local government units within its territorial jurisdiction.” Cities and municipalities, meanwhile, are to serve as “a general-purpose government for the coordination and delivery of basic, regular, and direct services and effective governance of the inhabitants within its jurisdiction.” The barangays, for their part, are viewed as the “primary planning and implementing unit of government policies, plans, programs, projects and activities in the community, and as a forum wherein the collective views of the people may be expressed, crystallized and considered, and where disputes may be amicably settled.” 1 In general, the powers and functions of local governments range from the provision of basic services and facilities to revenue generation, regulation, and other governmental and corporate powers. They include levying and collecting fees, taxes and other impositions; budgeting; development planning; land use planning; enacting and implementing ordinances; enforcement of building code; reclassification of agricultural lands; regulation of real estate trade; and provision of certain services, facilities and infrastructure within their jurisdictions like roads

1 Cabo, Wilhelmina L. “Overview of Local Governments in the Philippines”, in Local Government Center-College of Public Administration, U.P. and Public Administration Promotion Center-German Foundation for International Development, Local Economic Promotion in the Philippines, Manila: Philippines, 1996


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and bridges, markets, waterworks, slaughter houses, sewerage and drainage, health centers, garbage collection and disposal, and parks. Police and fire protection are national functions but local chief executives are empowered with operational supervision and direction over those who are stationed in their areas. The scope of functions performed by local governments has been expanded under the Code. The provision of certain services and facilities and the exercise of some regulatory powers previously performed by the National Government have been transferred to the purview of local governments. These cover certain services and facilities in health, social welfare, agriculture, public works, and natural resources and environment. Local governments are now responsible for the maintenance of day-care centers, enforcement of forestry and pollution control laws, implementation of primary health care, and prevention and control of plant and animal pests and facilities, to name a few. Public housing may now be undertaken by local governments under the LGC. They are also authorized to approve subdivision plans, regulate the operations of cockpit and cockfights, and regulate tricycle operations, among other authorities.

The widening of the scope of local governments’ functions is accompanied by increased fund allocation from the Central Government, through the Internal Revenue Allotment, to help them finance the devolved services. It also involved the transfer of Central Government personnel performing the devolved functions from their mother agencies to the local units they are assigned. The devolution also required the transfer of assets and properties, as far as the devolved services are concerned, of the affected agencies.

Economic Activities Agriculture is the economic base of most LGUs, as the Philippines is basically an agricultural country. The limited practice of agriculture is even noticeable in the peripheries of urban areas in the countryside. The development of real and industrial estates across the country is, however, rapidly encroaching on agricultural lands. This potentially diminishes the agricultural base of many LGUs whose economy and livelihood draw heavily from tilling the land. This also increases the threat to the environment. With the authority to reclassify agricultural lands now transferred to local governments, subject of course to certain national guidelines, LGUs have to face the challenge of keeping a good balance between attaining the economic objectives and ensuring food security, as well as promoting sustainable living. Small and medium-sized enterprises that cater to domestic and foreign markets like handicraft, furniture making, jewelry making, garments manufacturing, and leather craft, are thriving in many LGUs. These economic enterprises are usually owned and operated by independent family entrepreneurs.


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Tourism activities, in one form or another, are also not uncommon in most local units. The celebration of local religious rites and feasts, as well as agricultural fairs and similar community activities, are popular tourist attractions. There are many areas where tourism remains a major component of their local economy, particularly those that are endowed with natural attractions. Thriving tourism in most places is usually operated by private entities, especially those involving capital-intensive resort developments. Local governments, for their part, are also involved in economic activities as they operate public enterprises and utilities. Most cities and municipalities operate and maintain public markets which are a regular source of revenues for the local units. Slaughterhouses are also common enterprises; however, they do not generate substantial revenues, compared, for example, with public markets. The public good that may be derived from slaughterhouses include the inspection of meat products and the regulation of the processes in the slaughter of animals, all to safeguard public health. Some LGUs also operate commercial centers and bus terminals as part of their corporate and proprietary powers. While commerce and trade are common features of the economic base of any local unit, the extent of these activities substantially vary among them. Higher levels of trade are expected in the more developed parts of the municipality such as the center or “poblacion”, the provincial capital, cities, and in locations functioning as centers of services and facilities as well as transshipment points for the movement of goods across boundaries. The strategy of the National Government of establishing autonomous special economic zones and growth areas in selected regions outside Metro Manila to attract investments and disperse industries to the countryside, increases the opportunities for local units to promote economic development in their areas. The establishment of Regional and Provincial Industrial Centers is in line with this economic strategy. The designation of certain regions in the country as growth areas and special economic zones has significant implications on the economic development of affected LGUs. The most visible impact is the improvement in infrastructure and utilities in these areas, such as roads and bridges, power supply, telecommunications, airports, and seaports. LGUs will need to position themselves to take full advantage of the economic potentials of these regional developments, and be able to leverage them in the pursuit of their governmental and corporate functions.

III. THE CORPORATE POWERS OF LGUs The Local Government Code of 1991 contains the provisions for the nature, scope and origins of the corporate powers of LGUs. Its Section 14 defines the onset of an LGU's existence as a corporate entity, stating that "When


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a new local government unit is created, its corporate existence shall commence upon the election and qualification of its chief executive and a majority of the members of its Sanggunian, unless some other time is fixed therefor by the law or ordinance creating it." The succeeding section, Section 15, prescribes the nature of the LGU as both body politic and body corporate. The LGUs’ corporate character springs from its nature as an “entity representing the inhabitants of its territory” as opposed to being a political subdivision of the National Government. Furthermore, Section 22 outlines the scope of LGUs’ corporate powers as follows:

1. to have continuous succession in its corporate name; 2. to sue and be sued; 3. to have and use a corporate seal; 4. to acquire and convey real or personal property; 5. to enter into contracts; and 6. to exercise such other powers as are granted to corporations, subject

to the limitations provided in the Code and other laws. More specifically, the following corporate powers are vested on LGUs:

1. to create their own sources of revenues; acquire, develop, lease, encumber, alienate or otherwise dispose of real or personal property held by them in their proprietary capacity; and to apply their resources and assets for productive, developmental or welfare purposes in the exercise of their governmental or proprietary powers and functions(Section 18):

2. to negotiate and secure grants to support basic services and

community facilities (Section 23); 3. to borrow from financial markets, through loans, credits and other

forms of indebtedness, in advance of revenues (Section 297); 4. to acquire property, plant, machinery equipment and such necessary

accessories through a supplier’s credit, deferred payment plan, or other financial scheme (Section 298);

5. to issue bonds, debentures, securities, collateral notes and other

obligations to finance self-liquidating, income-producing development or livelihood projects pursuant to the priorities established in the approved local development plan (Section 299);

6. to extend loans, grants, or subsidies to other local government units

(Section 300);

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SECTION 15. Political and Corporate Nature of Local Government Units. - Every local government unit created or recognized under this Code is a body politic and corporate endowed with powers to be exercised by it in conformity with law. As such, it shall exercise powers as a political subdivision of the national government and as a corporate entity representing the inhabitants of its territory.

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R.A. No. 7160 SECTION 22. Corporate Powers. - (d) Local government units shall enjoy full autonomy in the exercise of their proprietary functions and in the management of their economic enterprises, subject to the limitations provided in this Code and other applicable laws. R.A. No. 7854 SECTION 3. Corporate Powers of the City. - The City constitutes a political body corporate and as such is endowed with the attribute of perpetual succession and possessed of the powers which pertain to a municipal corporation to be exercised in conformity with the provisions of this Charter. The City shall have the following corporate powers: (e) To enter into contracts;

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SECTION 18. Power to Generate and Apply Resources. - Local government units shall have the power and authority to establish an organization that shall be responsible for the efficient and effective implementation of their development plans, program objectives and priorities; to create their own sources of revenue and to levy taxes, fees, and charges which shall accrue exclusively for their use and disposition and which shall be retained by them; to have a just share in national taxes which shall be automatically and directly released to them without need of any further action; to have an equitable share in the proceeds from the utilization and development of the national wealth and resources within their respective territorial jurisdictions including sharing the same with the inhabitants by way of direct benefits; to acquire, develop, lease, encumber, alienate, or otherwise dispose of real or personal property held by them in their proprietary capacity and to apply their resources and assets for productive, developmental, or welfare purposes, in the exercise or furtherance of their governmental or proprietary powers and functions and thereby ensure their development into self-reliant communities and active participants in the attainment of national goals. See also Sec. 458(a)(2), LGC; and Sec. 10(b), R.A. No. 7854


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7. to enter into contracts with any duly pre-qualified individual or contractor for the financing, construction, operation and maintenance of financially viable infrastructure facilities under the Build-Operate-Transfer (BOT) agreement, subject to the applicable provisions of Republic Act 6957 as amended by Republic Act 7718 (Section 302);

8. to enter into joint ventures and other cooperative arrangements with

non-governmental organization (NGOs) and People’s Organization (POs) for social and economic purposes (Section 35);

9. to, through the local Sanggunians:

authorize the lease to private parties of buildings held in a

proprietary capacity (Sections 447(2)(v), 457(2)(v), and 468(2)(v) for municipalities, cities and provinces , respectively);

establish markets, slaughterhouses of animal corrals and authorize the operation thereof (Sections 447(5)(ii) and 458(5)(ii) for municipalities and cities, respectively);

establish, maintain, and operate ferries, wharves, and other structures and marine or offshore activities intended to accelerate productivity (Sections 447(5)(iii) and 458(3)(vii) for municipalities and cities, respectively);

provide for the establishment, operation, maintenance, and repair of an efficient waterworks system (Sections 447(5)(vii), 458(5)(vii), and 468(4)(ii), for municipalities, cities, and provinces, respectively);

establish and provide for the operation of vocational and technical schools and similar post-secondary institutions (Sections 447(5)(x), 458(5(x), and 468(4)(iii) for municipalities, cities and provinces, respectively); and

Regulate the use of Barangaymulti-purpose halls, multi-purpose pavements, barangay markets, parking areas, or other similar facilities (Section 391(7));

Section 33 provides the legal mantle for inter-LGU cooperation. The Code stipulates that “Local government units may, through appropriate ordinances, group themselves, consolidate, or coordinate their efforts, services, and resources for purposes commonly beneficial to them” (cf. Section 33). This provision allows the LGUs to consolidate and integrate their resources and efforts in constructing infrastructure facilities for economic development


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purposes. This would compensate for the inadequate resources of individual LGUs which constrain their efforts in generating more economic activities in the local area. (Editor's Note: The cohesion among the succeeding 4 paragraphs is weak.) LGUs’ exercise of their corporate powers is manifest in their initiatives at resource mobilization through the operation and maintenance of local economic enterprises (LEEs) and the mobilization of non-traditional forms of financing. Their power to mobilize resources is anchored on their dual nature – corporate/proprietary powers, and taxing and police (governmental) powers. The collection of fees and charges from the operation of public markets, bus terminals, wharfs, waterworks systems, and other utilities, generally fall within the corporate or proprietary powers of LGUs. The other examples the exercise of LGU corporate powers are the different modes of establishing and managing schemes and mechanisms to undertake LGU entrepreneurial activities such as joint venture arrangements and build-operate-transfer schemes. The novelty of such mechanisms stems from their ability to address and overcome the paralysis of bureaucratic processes. The involvement of the private and voluntary sectors is deemed strategic and desirable as these sectors could facilitate quick, relevant and client-driven responses. Organization and management of mechanisms and arrangements that are not the exclusive responsibilities of LGUs but are shared with the private sector or civil society organizations (e.g., BOT schemes) are normally modes equated with LGUs’ exercise of corporate powers. IV. CURRENT TRENDS IN THE EXERCISE OF LGU CORPORATE POWERS

Extent of LGU Borrowing The LGU corporate powers are exercised at all levels of local government, with the exception of the barangay. For the past 16 years, LGUs have been exploring the use of grants, loans, bond flotations, public-private partnerships and inter-LGUl cooperation to finance the delivery of services, the development of enterprises (e.g., business incubators), and the establishment and operation of LEEs. Data from the Bureau of Local Government Finance of the Department of Finance (BLGF-DOF) revealed that total LGU borrowing from government financing institutions (GFIs) and bond floats grew from P2.8 billion in 1992 to P92.3 billion in 2007. The information on LGU borrowings and issuance of debt


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come from government financing institutions (GFIs) and bond floats as evidenced by formal memorandum of agreements on LGU credits furnished to the BLGF-DOF. A total of 972 LGUs have outstanding loans from GFIs. Of these LGUs, 81 are those of provinces; 124, cities; and 767, municipalities.2 LGUs prefer loans more than any other form of financing. Loans represent about 97% of monitored LGU borrowings, while bond flotations represent only 3%. This preference for credit financing could be attributed to the simplicity of the bank borrowing and the LGUs’ long familiarity with it. Despite the perception among local executives that bond flotation a lengthy and complex process, it taking from 9 to 12 complicated steps to accomplish, a number of LGUs have resorted to it to raise funding for various projects. Some of these LGUs are those of: Urdaneta City (Pangasinan) for the upgrading of its abattoir; Victorias (Negros Occidental) for a mass housing project; Boracay (Aklan) for the construction of its jettyport and terminal building; Puerto Princesa City (Palawan) for its socialized housing project; Caloocan City for the construction of its general hospital, public market and city hall; Tagaytay City for the construction of its convention center; and Iloilo City for its government employees’ housing project. The significant borrowings of the LGUs resulted in local economic infrastructures like public markets, slaughterhouses and transport terminals, which appear to be the common justification for borrowing. However, while LGU borrowings paved the way for the establishment and operation of LEEs, it also posed a challenge to make these economic enterprises “revenue positive” since these borrowings had to be repayed. Financial Performance of Local Economic Enterprises

The financial performance of LEEs, as shown by the experience of cities is

not encouraging. Based on data from the Bureau of Local Government Finane, total receipts from these enterprises in 2004 amounted to P2.8 billion, while expenditures totaled P4 billion, for a deficit of P1.2 billion, leading most cities to subsidize their operations. In spite of this, the establishment and operation of LEEs remain high on the governance agenda of LGUs because these enterprises provide LGUs the opportunity to pursue the two-fold mandate of revenue generation and service delivery. It is also an expression of LGUs corporate powers.

2 It is not known, however, how many of the LGUs cited are repeat borrowers.


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V. EMERGING MODELS OF LGUs’ EXERCISE OF CORPORATE POWERS

Public-Private Partnership Public-private partnerships are collaborative efforts of government and the private sector to deliver services and/or engage in enterprises. Considering the dearth of technical and financial capabilities at the local level, the participation of civil society organizations (CSOs) and private sector organizations (PSOs) in promoting and developing economic enterprises is a much welcome move. CSOs and PSOs can supplement the LGU resources in order to undertake more economic activities in more diverse sectors.

Among the public-private partnership arrangements that are slowly becoming popular among LGUs in the country are the "Build-Operate-Transfer" (BOT) and "Build and Transfer (BT) schemes, and partnerships with community organizations. Provided for by Section 302 of the LGC, the BOT and BT mechanisms enable the LGU to avail of the resources of either CSOs or PSOs in the construction of extensive infrastructure facilities or in establishing public enterprises which it normally cannot undertake single-handed.

The LGC also encourages CSOs to participate in the implementation of livelihood projects in order to provide job opportunities for rural folks. However, most community organizations do not have sufficient resources to embark on viable projects. In most cases, therefore, the LGU allocates grants or loan funds to these organizations to support the livelihood projects they wish to undertake.

Public-private partnerships have not yet to gain wide acceptance among LGUs. Nonetheless, there have been a few examples that could be cited, such as: the construction of the Mandaluyong City public market through the BOT scheme; the upgrading of Bohol's water and power utilities through a joint venture; the construction of the Bulacan Toll and Packaging Center, which was undertaken to promote micro small-medium enterprises (MSMEs); and the management contract of the Misamis Oriental Telephone Systems, Inc. (MISORTEL) with Bayantel.

Inter-LGU Cooperation Schemes Inter-LGU cooperation schemes involve two or more LGUs in collaborative efforts in planning and implementing projects and programs, and in service delivery. A classic example of this collaborative effort is the Metro Naga Development Council. At the initiative of the City Government of Naga, the council was formed with the city and its outlying municipalities as members. Through the Council, member-municipalities coordinated in the implementation of a number of Council-identified projects/activities in their respective localities. The private sector has participated in some of the council's activities.


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The case of Gingoog Bay Development Council is also an example of inter-LGU cooperation based on common interest rather than a legalized partnership. It involved the contiguous LGUs surrounding the Gingoog Bay and is focused mainly on protecting the sustainability of the bay. On the other hand, the case of Partido Development Administration in Camarines Sur is an example of a Congressional initiative providing the legal framework for inter-LGU cooperation. Corporatizing Service Facility

The case of La Union Medical Center is an example of corporatizing a service facility (the La Union Provincial Hospital) through the act of Congress which meant that they legal personality was created through a Republic Act. On the other hand, the Provincial Government of Misamis Oriental corporatized the operation of MISORTEL by registering themselves with the Securities and Exchange Commission (SEC). Case Studies of Models The above are some of the emerging trends and models in LGUs’ exercise of their corporate powers. Hereunder are some selected brief case studies on the emerging models.

1. The La Union Medical Center

A. Introduction

The La Union Medical Center (LUMC) is a local government-owned and -controlled corporation (LGUGOCC) created by Republic Act No. 9259. The Medical Center was a Galing Pook awardee in CY 2004 and an E-NGAS awardee in CY 2007.

The LUMC is located in the town of Agoo. Formerly named Doña Gregoria Provincial Hospital, it was devolved to the Province of La Union as mandated by the LGC. At the time it was turned over to the provincial government, it only had a capacity of 50 beds as a result of the devastating earthquake on July 16, 1991.In 2004, a Php 650 million, 100-bed modern hospital, a “gift of love” from the European Union according to Governor Victor Ortega, was inaugurated.

B. Significance of the Special Charter

The authority of Congress to create or establish, by special charter, government-owned and -controlled corporations is vested by the Constitution (Article XII, Section 16).

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Under Article IX B, Section 2[1 of the 1987 Philippine Constitution, officers and employees of government owned and controlled corporations with original charters are placed under the Civil Service, subject to Civil Service Law. Employees of corporations incorporated under the Corporation Code are governed by the Labor Code. In fact, Section 9 of the LUMC Charter guarantees the security of tenure of civil service officers and employees in the implementation of Government reorganization under Republic Act 6656.

l Under the Charter, LUMC has the right to acquire, own or dispose

property or assets; the power to enter into transactions and contracts; and is assured of continuity of operations and stability unaffected by changes in local government administration.

C. Hospital Administration

The LUMC is administered by a Board of Trustees composed of fifteen members who serve ex officio. The Board is composed of:

1. the Governor of the Province of La Union 2. the Vice Governor of the Province 3. the Chairman of the Committee on Budget and Appropriations of the

Sangguniang Panlalawigan of La Union 4. the Chairman of the Committee on Ways and Means of the

Sangguniang Panlalawigan of La Union 5. the Chairman of the Committee on Health and Sanitation of the

Sangguniang Panlalawigan of La Union 6. the Chairman of the Committee on Trade and Industry of the

Sangguniang Panlalawigan of La Union 7. the Provincial Health Officer of the Province of La Union 8. The Municipal Mayor of the host town of Agoo 9. the Regional Director of the Department of Health Region I 10. two representatives from the private sector engaged in the medical

profession, one coming from the first district and the second from the second district of La Union to be appointed by the Provincial Governor with the concurrence of the Board of Trustees

11. two representatives form social, civic or religious sector organizations in the Province to be appointed by the Governor with the concurrence of the Board of Trustees

12. the President of the Liga ng mga Barangay of La Union; and 13. the Chief of Hospital of the LUMC

D. Mandates

Among the significant and important responsibilities of the LUMC are:


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to promote and develop a center for the delivery of quality and affordable medical and surgical care to the people of La Union and Region I

to promote, develop and undertake a comprehensive family medicine

program with emphasis on the preventive and curative aspects of health care

to develop a multi-specialty center with focus on the diagnostic and

therapeutic components of difficult cases

to promote and develop a research center for locally-based health concerns

to extend medical services to the general public, to help prevent,

relieve or alleviate afflictions and maladies of the people, especially the poor and less fortunate, without regard to race, creed or political belief

The preferential option for the poor is emphasized in the Program for

Indigents. The Board of Trustees is mandated to institute a program for indigents. The number of beds allocated for indigent patients shall not be less than 20% of the total number of hospital beds.

E. Financial Management

The average provincial subsidy for the former 50-bed hospital was Php 30 million. The Province continues to subsidize the LUMC by about the same amount, but with a difference. In CY 2006, 52% of the patients were charity patients; 40% were Philhealth members; and 8% were patients who paid in full under a policy of “fee for service” from those who can afford. Poor patients are allowed to pay in kind. By prudent management of its finances, out of earnings, the LUMC has built a dormitory for families of patients who stay to look after the needs of their patients. It has also added a new wing for 32 additional beds.

The LUMC has made available quality hospital services to the people of

the Province of La Union. The Galing Pook award attests to this achievement.

F. Success Factors

The success of the La Union Medical Center can be attributed to the following factors:

the unqualified support of the political leadership of the Ortega family the support of the Sangguniang Panlalawigan the “gift of love” from the European Community


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the appointment of US-trained physician, Dr. Fernando Astom, as Chief of Hospital, over the objection from certain sectors

G. Next Steps

The LUMC model can be offered to LGUs experiencing financial

difficulties and deteriorating level of services in the operation of their hospitals. 2. LGU Experience in the Operation of Economic Enterprises: An

Evolving Institutional Arrangement - The Tagum City Model

It is the policy of the City Government of Tagum to be self-reliant and self-sustaining through engaging in viable and stable economic enterprises that provide a wide variety of opportunities that will uplift the socio-economic well-being of its constituents, improve fiscal management and enhance good governance. (

Tagum Policy Statement, Code of Economic Enterprises)

A. Introduction

Tagum City is located at the southern part of Mindanao. It is a component city of Davao del Norte, consistingof twenty-three barangays.Tagum has a population of approximately 200,000, and a land area of 19,580 hectares predominantly devoted to agricultural production that includes banana plantation, rice cultivation and cash crops.

To pursue the objectives of “engaging in viable economic enterprises that

provide a wide variety of opportunities that will uplift the socio-economic well-being of its constituents, improve fiscal management and enhance good governance”, the City relied on the creative and innovative exercise of its corporate/proprietary powers.

B. The Enterprises

Tagum City Public Market. This enterprise is a Php 54 million investment covering 4.6 hectares that was constructed in two phases. The modern market serves as the trading area for marine and agricultural products, agro-based raw materials, meat and poultry products, root crops, fruits and vegetables coming from Tagum and neighboring municipalities.

Tagum City Overland Transport Integrated Terminal Section. This enterprise is a Php 25 million central public transport terminal that contributes significantly in the flow of goods, commodities and services. It has made travel by commuters to different destinations more convenient.


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Tagum City Slaughterhouse. A modern “AA” slaughterhouse, it is a joint project with the National Meat Inspection Commission, worth Php 8 million and is located in 5,000 square meters of land.

Tagum City Livestock Auction Center. A facility for trading livestock raised in the barangays and neighboring municipalities, it has a total land area of 3,500 square meters. It has a litsonan area as an integral feature of the Center.

Tagum City Cultural Trade Center. The Center is a Php 22 million project established to support the small and medium scale enterprises through the provision of display areas primarily for items produced in the City.

Tagum City Public Cemetery. A 2.7 hectare area developed as a burial ground. It is presently being rehabilitated and improved. The Bottomline It has been held that a municipal corporation has a public character as regards the state at large insofar as it is the agent in government, and private (so called) insofar as it is to promote local necessities and conveniences for its community.3 In the case of Tagum City, the economic enterprises have undoubtedly promoted local necessities and conveniences in a highly satisfactory manner. The next hurdle is what is known as the bottomline. How viable, profitable were the economic enterprises? The CY 2007 Receipts from Economic Enterprises appear as follows:

In Million Pesos Markets 25.55 Slaughterhouse 5.18 Bus Terminal 13.05 Cemetery 1.33 Other economic enterprises 6.41 Total 51.52 Against these receipts, total expenditures for the same period amounted to Php 28.46 million, or an excess of receipts over expenditures of Php 23.06 million, a hefty amount.4

3 Torio V. Fontanilla 85 SCRA 599 (1978) 4 Source: BLGF Data Bank


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Another measure is debt service. In a PowerPoint presentation during the Roundtable Conference on LGU Corporate Powers held on October 29, 2008, the following were shown: In Million Pesos Principal Payments Balance Public Market 54.5 22.0 32.5 Bus Terminal 25.6 13.1 12.5

Enlightened and principled leadership. Led by Mayor Uy, the political leadership of Tagum City has advocated strategic management principles in the exercise of the City’s corporate powers. Mayor Uy has articulated his leadership creed as embodied in the 4 Es, namely:

Envision – establishing a vision then developing a plan to achieve it Enable – putting the right people with the right skill to get the job done,

and initiating capacity enhancement trainings to improve their skills Empower – providing the freedom to get the task completed, the space

to innovate, and the feedback mechanism to improve results Energize – building understanding and desire for action

Supportive Sanggunian. The Sangguniang Panlunsod has

demonstrated a high degree of support and cooperation through the enactment of the necessary enabling legislation.

Community support. Tagum City has developed a strong partnership and collaboration with civil society organizations and local groups actively involved in economic enterprise activities. Among the latter groups are: the Market Vendors Association, the Bus and Jeepney Transport Operators, the Livestock and Poultry Raisers Association and the Local Traders Association.

Modern infrastructures. The economic enterprise infrastructures are modern, adequate and well maintained.

Access to technical assistance. Tagum City has benefited from technical assistance extended by National Government agencies and foreign-funded institutions, e.g., DILG, ADB, MBUSSP, NMIC.

Enabling mechanisms; efficient management system. The City has created an Economic Enterprises Department focused on managing and operating the economic enterprises. A Code of Economic Enterprises has been enacted through an ordinance.


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D. The Organizational Structure of the Economic Enterprises Department

The City Mayor exercises executive direction and control over the

management and operation of the economic enterprises.

An Economic Enterprises Regulatory Board was constituted to formulate and adopt specific and related rules and regulations; develop plans, programs and strategies; serve as advisory body to the Chief Executive; conduct raffles and award vacant stalls and spaces; conduct pre-qualification of applicants for vacant stalls; propose adjustment and/or increase of fees and rentals; and to perform such other functions as the Sangguniang Panlunsod may authorize. The Board is composed of Sangguniang Panlunsod Committee Chairmen, City Officials and representatives from the NGO.

The Economic Department is headed by an Economic Enterprise

Manager. He is assisted by an Assistant Economic Enterprise Manager and is supported by an Administrative Division; and Revenue Collection, Maintenance and Security and Enforcement Sections.

Operations and Services Divisions oversee the operation of the City’s six

economic enterprises. Each of the enterprise is headed by a Section Chief.

The organizational structure is schematically illustrated in Figure 1.


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Figure 1: Organizational Structure. OFFICE OF THE CITY ECONOMIC ENTERPRISE

1 – CO DEPARTMENT HEAD 1 SG – 25 1 – CO ASST DEPARTMENT HEAD 1 SG – 23

PERSONAL STAFF

2 – Clerk 2 SG – 4 1 – Driver 1 SG – 3

ADMINISTRATIVE AND SUPPORT DIVISION

1 – Administrative Officer IV SG – 22 1 – Clerk II SG – 4

OPERATTIONS AND SERVICES DIVISION

1 – Operations and services Officer IV SG – 22 1 – Clerk II SG – 4

ADMINISTRATIVE SECTION

1 – Administrative Officer III SG – 18 1 – Cashier II SG – 10 1 – Administrative Assistant SG – 8 1 – Bookkeeper SG – 8 1 – Storekeeper SG – 6 1 – Utility Worker SG – 3

REVENUE COLLECTION SECTION

1 – Revenue Collection Officer III SG – 18 1 – Local Revenue Collection Officer 1 SG – 11 25 – Revenue Collection Clerk III SG – 9

MAINTENANCE SECTION

1 – Public Services Officer III SG – 18 1 – Labor General Foreman SG – 8 2 – Electrician SG – 6 2 – Carpenter SG – 5 2 – Plumber SG – 5 20 – Laborer SG – 3

SECURITY ENFORCEMENT SECTION

1 – Security Officer III SG – 18 1 – Security Agent II SG – 10 36 – CSU/Market Guard

PUBLIC MARKET SECTION

1 – Market Supervisor III SG – 18 1 – Market Supervisor II SG – 14 1 – Market Inspector II SG – 8 9 – Market Inspector I SG – 6 1 – Clerk II SG – 4

TOTIT SECTION

1 – SPURO SG – 18 1 – Parking Aide III SG – 6 1 – Parking Aide II SG – 4 1 – Clerk II SG – 4 4 – Ticket Checkers SG – 3 1 – Traffic Aide I SG – 3 2 – Utility Workers SG – 3

PUBLIC SLAUGHTERHOUSE SECTION

1 – Slaughterhouse Master III SG – 18 1 – Slaughterhouse Master II SG – 14 4 – Meat Inspectors II SG – 8 2 – Livestock Inspector SG – 8 1 – Clerk II SG – 4 4 – Laborer II SG – 3

TAGUM CITY LIVESTOCK AUCTION CENTER SECTION

1 – Animal Keeper III SG – 8 1 – Livestock Inspector I SG – 6 1 – Clerk II SG – 4 2 – Laborer II SG – 3

CULTURAL AND TRADE CENTER SECTION

1 – Market Supervisor III SG – 18 1 – Market Inspector II SG – 8 1 – Clerk II SG – 4

PUBLIC CEMETERY SECTION

1 – Public Services Officer III SG – 18 1 – Public Services Foreman SG – 6


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E. Observations and Issues

1. A Revenue Collection Section has been established in the Economic Enterprises Department. The Code of Economic Enterprises of Tagum City provides that the Economic Enterprises Manager shall “act as a collection deputy of the City Treasurer for the collection of charges, tolls and fees in the operation of the enterprises.” As a “collection deputy”, the Economic Enterprise Manager is assisted by a Local Revenue Collection Officer II, and a Revenue Collection Clerk III.

The New Government Accounting Manual (NGAS) prescribes detailed procedures in the receipt and collection process. How does the “Alternative Collection Mechanism” mentioned by Mayor Uy in the Davao Forum on Harnessing LGU Corporate Capacities for Mindanao Development, held in Davao City on 27 October 2006, fit into NGAS requirements?

2. The Code of Economic Enterprises imposes fees and charges, e.g. market rental fees, market entrance fees, fees for livestock and poultry products, corral pen rentals, toll fees, bus terminal fees, slaughterhouse fees, public cemetery fees.

Issue: The proper place for these impositions is the City Revenue Code. The Local Government Code Implementing Rules and Regulations prescribe procedural guidelines in the imposition of local taxes, fees and charges, among others; posting and/or publication before public hearing; public hearing; review by a higher sanggunian; posting and/or publication after approval. The Supreme Court has consistently ruled in a series of rulings that “notice and actual conduct of public hearings with respect to a tax measure/ordinance as well as its publication are indispensable requirements for its validity.”

F. Next Steps

The Tagum City Model is a good work for replication by way of technical

assistance extended to LGUs. 3. A Non-Traditional Approach to Local Economic Enterprise Management

The Municipality of Malabon in the Metropolitan Manila Area (now Malabon City) chose a non-traditional approach in the operation of the Malabon Central Market. The LGU entered into a lease agreement with the Malabon Central Market Development Cooperative for the management and operation of the Market.


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Under the terms of the lease contract, for and in consideration of an annual rental of One Million Five Hundred Thousand Pesos (Php 1,500,000.00), the Malabon Central Market Development Cooperative managed and operated the Malabon Central Market for twelve (12) years or from January 1, 1955, up to December 31, 2006. (According to the City Treasurer, the Cooperative continues to manage and operate the Market, while new arrangements are being worked out to modernize the buildings and facilities, and for the management and operation of the economic enterprise.) Among the salient provisions of the lease contract are:

The property leased included the market building, stalls, other facilities, and premises, except the premises occupied by municipal and national offices.

The property leased shall be used for “market” purposes only.

The Cooperative agreed to shoulder all expenses for repairs necessary

to maintain the facility in good condition, provided that all repairs and/or improvements shall have the prior consent of the lessor.

Water, electricity, telephone, and repair charges shall be borne by the

Cooperative.

In case the stall rental fees are increased, the Cooperative agreed to pay an additional rental equivalent to twenty percent (20%) of the increase.

During the 12-year period, the LGU received a total rental of Php

18,000,000.00 without incurring any overhead. 4. Corporatization of Economic Enterprise: LGU Initiative – Misamis Oriental Telephone Systems, Inc.

A. Background

The Misamis Oriental Telephone System began its operations before the outbreak of the Second World War by virtue of a Certificate of Public Convenience and Necessity authorizing the operation and maintenance of a telephone system in the province of Misamis Oriental. It was damaged during the War but was restored in 1947 with the use of an army-type switchboard left behind by the US Army. The System was manually operated and all calls were made through a switchboard operator.


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In 1958, the telephone switchboard was changed to a common battery-run system, which was still operator-assisted but still an improvement over the old army-type switchboard. New equipment and improvements have been introduced since then; services were extended to Gingoog City, and a province-wide system linked to the rest of the country and the world is expected soon with the installation of a “point to multi-point radio communication system.

Up to August 2002, the system was operated and financed as an

economic enterprise by the provincial government of Misamis Oriental which, in 1991, secured a Php 144 million loan from the Eximbank of Korea for the system’s expansion project. The provincial government continues to service this loan, as well as a loan from the Development Bank of the Philippines which it also secured for the system’s upgrade.

C. The Corporation

On July 4, 2002, the Misamis Oriental Telephone Systems, Inc. or MISORTEL was created to take over the operation and management of the old telephone system. On that day, Misamis Oriental officials led by Governor Antonio P. Calingin, along with Vice Governor J. Miguel C. de Jesus and thirteen members of the Provincial Board approved MISORTEL’s Articles of Incorporation and By-Laws.

The creation of MISORTEL was a reaction to the increased competition

that resulted with the entry of competitors. The telephone system’s present competitors include Philcom, Cruz Telco, Bayantel wireless, Globe landline, Sotelco and the DOTC’s Telecom. A management contract with Bayantel to operate the system in 2002 did not help in making MISORTEL competitive.

The corporation’s Articles of Incorporation and By-Laws were duly

approved by the Securities and Exchange Commission with the issuance of the Certificate of Incorporation on August 26, 2002, giving the company Registry No. CS200253967.

The Corporation is capitalized at Php 200 million, divided into 2 million

shares with a par value of Php 100. It has a total of 500,000 subscribed shares, 499,985 of which are owned by the Proincial Government of Misamis Oriental, and the rest is owned by the fifteen incorporators who own one share each. The incorporators are the governor, vice governor, and 13 members of the Sangguniang Panlalawigan of Misamis Oriental.

The Articles of Incorporation provide that “The shares of stocks being

assigned to and held in trust by the Provincial Government of the Province of Misamis Oriental, the Provincial Governor, Vice Governor and all the members of the Sangguniang Panlalawigan … shall in no case be sold, assigned or transferred to any person.” The Board of Directors consists of the same officials


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who are the fifteen incorporators, as well as the Provincial Treasurer as elected Treasurer, and the Provincial Attorney as Secretary of the Corporation.

In effect, therefore, what the corporatization accomplished was to transfer

management from Provincial Officials to the Corporate Officers who are the same persons.

D. Financial Operations

From an interview with MISORTEL’s General Manager, Relio B. Acero, the following information were gleaned:

There has been a marked improvement in services. Telephone rates are fixed by the Board of Directors. The rates are

lower than existing commercial rates. Employees are considered “government personnel” covered by Civil

Service Rules. The Board has, however, taken steps to exempt employees from the jurisdiction of the Civil Service Commission.

Collections are turned over daily to the Treasurer. Current operating income exceeds current operating expenses, but

there are liquidity problems arising from indebtedness incurred prior to incorporation.

Disbursements are made by the Treasurer. Financial transactions comply with government accounting and

auditing regulations. The Provincial Government assumes loan repayments to the

Eximbank of Korea and the DBP through IRA intercepts.

E. Observations and Issues

MISORTEL had as its incorporators the Provincial Governor, the Provincial Vice Governor, and thirteen Provincial Board Members. Issue: It is beyond the scope of this Study to resolve the legal issues surrounding the creation of private corporations owned and/or controlled by LGUs; this is the domain of the Courts of Law. They are raised here as topics for discussion and possible resolution by proper authorities.

Two opinions were gathered from DILG:

o . . . the law governing stock corporations is the Corporation Code of the Philippines. Section 10 thereof provides that: “Any number of natural persons not less than five but more than fifteen, all of legal age x x x may form a private corporation for any lawful purpose or purposes x x x.” (Underlining ours.) a corporation like that of a province cannot, for reasons thereof, be an incorporator of another


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corporation, it being a juridical person or more appropriately a public corporation. (Opinion No. 80, July 22, 1997)

o . . . private corporations owned or controlled by the Government

can only be created by a special law, that is through Congress. (Opinion No. 97, September 6, 1995)

MISORTEL was incorporated by natural persons, that is, the Provincial Officials. The Provincial Government of Misamis Oriental became a majority and controlling stockholder by subscribing stocks of a private corporation, MISORTEL in this case.

COA has not rendered financial audit to MISORTEL since it was corporatized and registered with the SEC.

F. Lessons Learned

1. The financial viability of an economic enterprise is not assured by the creation of a private corporation under the Corporation Code of the Philippines.

2. Services have improved by the appointment of a professional

manager. 3. The experience of MISORTEL may serve as a learning example to

other LGUs. Although spinning off economic enterprises as private corporations has some appeal, care should be taken in selecting the enterprise to corporatize.

G. Next Steps

1. Steps should be taken to clear the issue of LGU owned and controlled

corporations. 2. Technical assistance should be provided to LGUs wishing to

corporatize economic enterprise operations.

5. Good Service Delivery andTaking the Lead in Inter-LGU Cooperation: Naga City

A. Background

Naga City, Camarines Sur, is known as the heart of Bicol – the center of commerce and trade in the region. Recently, it was dubbed by the Lonely Planet traveler’s guide as Luzon’s best-kept secret for its interesting tourist attractions

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like the Peñafrancia Festival in September and Mt. Isarog which is popular as a mountain trekking desitnation and for its hot springs.

It is, however, for innovative approaches in good governance that Naga

City is better known for and is a class of its own. These approaches, focused on participatory governance and people empowerment, has elevated the city as a model LGU as earned its Mayor, Jesse Robredo, the 2000 Ramon Magsasay award for Government Service. Among the more notable innovations is the Metro Naga Development Council (MNDC).

B. Challenges

Financial Problems. Before 1988, the City had a huge budgetary deficit due to poor tax collection, graft and corruption, etc. City government employees were underpaid and had very low morale.

Poor Service Delivery. Aside from the City experiencing the typical problems of urban areas, namely urban blight, rampant crimes, etc., the dismal financial state has caused service delivery a downhill turn. In addition, bureaucratic red tape delays the service delivery even more.

At that time, Naga City was very far from being a model local government.

C. Factors that Contributed to the Success of the Innovation

Transparency, Accountability and Empowerment

Two core programs undertaken by Mayor Jesse Robredo have propelled development in the City: (1) the Productivity Improvement Program/Public Service Excellence Program (PIP/PSEP) and (2) the People Empowerment Programs (PEP).

The PIP/PSEP, which aims to professionalize the City Government’s

workforce by improving its responsiveness, effectiveness and efficiency in delivering basic services, was able to streamline bureaucracy, institutionalize quick response systems, and remove incidence of red tape – resulting in the increase of targeted beneficiaries.

In fact, the productivity improvement program was able to resuscitate the

city government’s finances wherein income increased from Php 19 million in 1988 to Php 330 million in 2002. Local income generated by the city’s fiscal agencies contributed 40% or Php 132 million of the total income in 2002, which is a whopping 10-fold increase from their contribution in 1988. At that time, the city’s economic growth was 6.5% – a rate higher than the national level. Related to this, investors have found confidence on the city government with the improved fiscal discipline and more efficient system of service delivery. During


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the period of 2001 to 2003, at least Php 612 million of investments were approved by the Naga City Investment Board. These new investments translated to new jobs for the citizens of Naga.

The PIP was also responsible for empowering the Naga City Government

Employees Association (NACIGEA). The PIP was able to raise the morale of the city’s employees, leading to inspired and highly productive LGU personnel through negotiating additional fiscal and non-fiscal benefits, as well as incentives to employees.

On the other hand, the PEP, initiated by the city government in 1989, had

institutionalized partnerships and participatory mechanisms in Naga City. It aims to empower marginalized sectors by enabling their participation in the policy-setting and decision-making processes of the city government. The City Mayor believed that involving the stakeholders will ensure sustainability, acceptability and success of the projects initiated by the city government. A People Empowerment Ordinance was enacted which created the Naga City People’s Council (NCPC) composed of around 100 representatives from different non-government organizations (NGOs) and people’s organizations (POs) who participate in direction-setting, policy-making, program and projects implementation, and monitoring and evaluation. Representatives of the NCPC sit in all local special bodies, propose legislations and vote at the committee level of the city council.

In addition to the (PIP/PSEP) and the PEP, enhancement and use of the

information and communication technology allowed for a more transparent, responsive and competitive city government operations. The Naga City Government Computerization Program (CGCP), implemented in 1996, streamlined internal processes and provided information to support decision-making. It also helped increase local government income by 112% and reduced operating costs. Also, the I-Governance project of the city encourages participatory governance among the residents of Naga. Relevant public information is readily available and easily accessible. Also, citizen feedback is made possible through the city website and through text messaging. It is important to note that internet facilities are made available in barangay halls and public schools.

Resolving Urban Poor Issues. Urban poor groups were made to

participate in addressing urban poor issues through the Naga Kaantabay sa Kauswagan (Partners in Development) Program. The program was able to improve the plight of the city’s urban poor since intervention is more targeted. Presently, at least 5,000 former informal settlers have been given security of tenure and are now proud owners of home lots in good neighborhoods. In addition, land tenure problems since 1950s have been resolved. A livelihood component was also institutionalized to ensure the success and sustainability of the program. Moreover, the urban poor are now represented in the City


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Development Council, and in the Naga City Urban and Housing Development Board. Naga’s urban poor program has become a model for replication in other areas in Bicol. The program’s overwhelming success was recognized by the United Nations Center for Human Resettlements and was declared a model for the Habitat II Conference in 1996.

Providing Access to Quality Education. Naga City pursued various

approaches to ensure that education is made available for all.

The city established the Naga Early Education Development (NEED) Program to accommodate children from different socio-economic background and mental/physical health. Moreover, day-care workers were trained to handle mentally and physically disabled students in a day-care center called the Naga School for Early Education and Development (SEED). With cooperation among local stakeholders and other concerned organizations strengthened, the city launched the Adopt-A-School program, where various professional organizations, NGOs, and business organizations financially supported the depressed elementary schools. Similarly, the city government set up the Parent Education Program to promote a conducive learning environment for the pre-schoolers starting at their own homes where parents also take part in the education process of their children. The NEED program also touched issues on malnutrition by conducting feeding programs at the preschool level. With all these initiatives, the NEED Program received Child-Friendly City Awards at the regional level and has been replicated in at least four municipal daycare centers in the province of Camarines Sur.

In addition, the Local School Board has been reinvented and strengthened

to ensure effective targeting of interventions. The composition of the Local School Board members was expanded to include multi-sectoral stakeholders. The City’s Local School Board now includes representatives from the academe, private sector, religious organizations, NGOs and other professional organizations. The diverse membership of the Local School Board allows to have a Local Education Plans to aid in the planning and budgeting process transparently and systematically.

Furthermore, a performance-based system for educators/teachers, was

also developed by the city. The feedback mechanism is being used by the city government to promote a service-oriented culture among the education officials in Naga City.

Pooling resources through inter-LGU cooperation and partnership with NGOs/private sector. The Metro Naga Development Council (MNDC) is one good example where Naga City shares its ambulance to the other 12 member-LGUs (municipalities of Pili, Calabanga, Bombon, Magarao, Canaman, Gainza, Camaligan, Milaor, San Fernando, Pasacao, Pamplona and Minalabac). Also, Naga City, Pili and Pamplona share their fire-fighting facilities to the other


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member-LGUs. Low-income LGUs may not have all the necessary equipment and facilities to promote urban safety (ambulance, fire trucks, etc.), and pooling resources through inter-LGU cooperation is one effective way to provide services for a lesser cost. Similarly, the Naga Emergency Rescue Network (ERN) also brings together resources of various city departments, barangay councils, mass media groups, and even government and private medical practitioners. The MNDC has become a model for collaborative initiatives influencing the establishment of the Metro Naga Livelihood Fund, Metro Naga Equipment Pool, Enterprise Development, Trade and Exhibition Center, ERN and Isang Irog Environmental Movement.

D. Results and Lessons Learned

The experience of Naga City in participatory governance and people empowerment which was made possible through: (1) visionary and strong political leadership, (2) active stakeholders’ participation, (3) fiscal prudence, transparency and accountability, and (4) competent staff translated to improve service delivery, increase in government savings, and even a long-term benefit- inter-LGU cooperation which is reflected through pooling of resources of neighboring towns in pursuit of common governance agenda. 6. Bond Flotation for Tourism Development: The Boracay-Aklan

Provincial Bonds

A. Background

Tourism is the major industry in the Province of Aklan since Boracay, its world-class beach resort island, registers close to 500,000 tourist arrivals annually. However, the transportation infrastructure could not keep up with the influx of people and goods brought about by the tourism industry in Boracay. Terminals and docking facilities had become chaotic and unsafe for passengers. Also, enterprising pump boat and outrigger owners had abused passengers by charging excessive fees for the short rides from Caticlan to Boracay and back.

The Provincial Government would like to maximize the economic potential

of the tourism industry in Aklan, specifically in Boracay. Hence, improvement of the transportation infrastructure was deemed necessary to make travel to the island more efficient, safe and comfortable. A new all-weather jetty port and passenger terminal building which can accommodate bigger and modern vessels, and more passengers, is proposed to be the solution to the transportation problem in the Province.

B. Challenges

Disturbance of Status Quo. The pump boat and outrigger owners are the most affected among the stakeholders in the Province. They have openly


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protested to the idea of the jetty port and passenger terminal because having these improved structures will take away their control over the transportation system in the island.

Source of Funds. Clearly, Aklan needed to explore other sources of funds for the proposed project as the coffers of the Provincial Government could not afford the project. The nation was experiencing the Asian financial crisis and thus the Provincial Government would need an innovative financing option to fund the project. Also, given the magnitude of the proposed project, it seemed that the investment should be long-term in order to fund both the jetty port and the passenger terminal. Unfortunately, during the height of the Asian financial crisis, long-term investments were not attractive to investors.

Lack of Technical Capability of the Provincial Government. Selection of the appropriate innovative financing options and undergoing through the procedures required a level of technical capability that the Provincial Government has not quite reached yet.


Political Will. The Provincial Governor and the Sangguniang

Panlalawigan worked together in finding the best strategy to implement the proposed jetty port and passenger terminal. Political harmony between the executive and legislative branches is key to the success of any local government endeavor. Necessary ordinances were passed, and terms and conditions were established to safeguard the Province’s resources and ensure that the objectives of the project are achieved.

Stakeholders’ Participation. Dialogues between the government and the concerned sectors were conducted to ensure the public’s full support on the implementation of the proposed project. The Provincial Government had to convince the pump boat and outrigger owners, the stakeholders who are most anxious about the project, that there is no way Boracay will reach its full economic potential if the local government will rely merely on “bancas” for transportation of people and goods. The Provincial Government reassured the pump boat and outrigger owners that they could operate exclusively in certain areas.

Selection of Best Financing/Service Delivery Option. The Provincial Government knew that they needed to carefully explore alternative financing options to fund the proposed project because the Province’s resources are not sufficient for the construction of the proposed jetty port and passenger terminal. Among the financing/service delivery options, bond flotation was chosen as the most ideal scheme for the Province given the following reasons: (1) Government Financing Institutions (GFIs) require 25% equity which the Province could not afford; (2) lending rates of commercial banks of 16.2-18% were too prohibitive;


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and (3) guidelines for Build-Operate-Transfer (BOT) Scheme and its variants were not clearly provided during that time and thus did not attract investors.

Based on the financial resources of the Province, the Provincial Governor and the Sangguniang Panlalawigan realized that they had to limit the amount of the bonds to P40 million. The Sangguniang Panlalawigan passed an ordinance on 8 April 1997, approving bond flotation amounting to P40 million with a seven-year maturity as the financing option to fund the proposed jetty port and passenger terminal.

Technical Assistance. The Province engaged the services of a financial adviser to help in the preparation of the bond flotation, i.e. conduct of feasibility study, design of features and implementing strategies, negotiation with trustee banks and concerned national government agencies. Consequently, through the technical assistance provided by the financial adviser, the Provincial Government employees had a deeper appreciation of various innovative financing options, particularly the mechanics and dynamics of bond flotation.

The feasibility study conducted by the financial adviser showed that: (1) the Province has the financial capability to pursue the project; (2) the project is viable; and (3) the return of investment (ROI) of the project through passenger terminal fees, cargo and stall rentals, and lease of docking rights is sufficient, not only to support the debt service obligations which the Province will incur if they pursue the project, but also the Province’s prospect of earning a net income of P69.2 million during the seven-year operation of the project.

Fiscal Prudence and Discipline. Proceeds from the project’s revenues (i.e., passenger terminal fees, cargo and stall rentals, and lease of docking rights) are sources of repayment. Also, another ordinance was passed by the Sangguniang Panlalawigan authorizing the appropriation of a certain percentage of the Province’s internal revenue allotment (IRA) as the sinking fund to be used for the redemption of the bonds when they mature.


Use of Local Government Unit Corporate and Proprietary Powers. In the past, tax revenue has been the biggest source of local income in Aklan. However, since the operation of the new jetty port and passenger terminal, non-tax revenue (i.e. passenger terminal fees, cargo terminal fees, rolling cargo fees, etc.) emerges as the main source of local income of the Province. This underscores the increasing significance of the Provincial Government’s use of its corporate and proprietary powers. The passenger terminal fees, cargo terminal fees, and rolling cargo fees contributed significantly to the increase in the Province’s income. It was estimated that there was a 62% increase from the Province’s income after one year of the project’s operation compared to its total income in 1995.


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Adherence to National Objectives. The Provincial Government’s decision to embark on this project was perfect timing. The construction of the jetty port and the passenger terminal was coincidental to the roll-on roll-off (RORO) operations in Western Visayas. As a result of the improvement in the transportation infrastructure in the island, Caticlan has become the center of RORO operations in the region which evidently contributed to the further success of the project. 7. Privatization of Power and Water Utilities: The Joint Venture Project

of the Province of Bohol

A. Background

The Bohol Province, home to the famous Panglao beach and Chocolate Hills, has become one of the fastest growing eco-tourism industry in the country. Annual population growth rate of Bohol has become higher than the national average and tourism development in the area has prompted a steady increase of tourist arrivals.

Starting the mid-1920s, the Province has been operating and maintaining

the Provincial Waterworks System (PWS) and the Provincial Electric System (PES). Both the PWS and PES served Tagbilaran City and the neighboring towns. While the PWS and PES were the largest sources of local income of the Province, huge money is spent on their maintenance and operations. Water and power supply had become unreliable and inadequate for the growing demand. The Province experienced limited hours of water supply, power surges and blackouts. Bohol was dealing with saltwater intrusion, problems with watershed management, high systems losses, and antiquated and insufficient facilities. Maintenance and operations costs of the PWS and PES were steadily increasing and had become the biggest expense of the Provincial Government, comprising approximately one-third of the total expenditure of the Province.

The Provincial Government would like to improve the water and power

services in Bohol to keep up with the demand brought about by increasing population and tourist arrivals.

B. Challenges

Source of Funds. The Provincial Government learned that it would be very costly for the Province to shoulder the costs of rehabilitating, upgrading and expanding the coverage area of the water and power supply facilities, as well as regularly maintaining them. The estimated costs of the improvement works were P968 million for water and P212 million for power. There was no way the Provincial Government could fund almost P1.2 billion the necessary improvement works. Thus, the Province needed to explore alternative financing options to fund the proposed improvements.


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Disturbance of Status Quo. The residents have benefited from the PWS

and PES as they could afford to be delinquent with their payments because they easily bargained their way with the Provincial Government. Given the perks the residents get and the history of PWS and PES in Bohol, the idea of an outright sale or any possibility which will lessen the control of the Province over the two utility departments would not be taken lightly by the Boholanos. In fact, during the selection of financing or service delivery options, litigation between the Provincial Government and a certain opposition group transpired. A Class Action for Prohibition with a Prayer for Preliminary Injunction was filed and an Issuance of a Temporary Restraining Order was requested by the opposition group.

Similarly, the Provincial Government has a stake in the PWS and PES. The Provincial Government benefited from the income generated from the two utility departments. The PWS and PES had become an extension of the Provincial Government’s bureaucracy, where a portion of the personnel services expenses had been charged to both utility departments.

Lack of Technical Capability of the Provincial Government. Managing, operating and maintaining the utility departments properly required skilled personnel and highly modernized technologies which would be difficult for the Provincial Government to provide. Also, the Provincial Government employees did not have the necessary technical skills to properly choose the most suitable innovative financing or service delivery option, more so go through the required procedures.


Political Will. The Provincial Government was serious in its intention to improve the water and power services in Bohol, particularly Tagbilaran City and the nearby towns which the PWS and PES had been servicing. Moreover, the Provincial Government aimed to be able to distribute the Province’s support for basic service delivery across the Bohol Province and not for its resources to be pinned down by the exorbitant costs of maintaining and operating the utility departments. A technical working group (TWG), composed of the staff of the Office of the Governor and the Provincial Planning and Development Office, was created by the Provincial Government to further evaluate the viability of the operations and the conditions of the facilities of both utility departments.

In addition, despite the fact that a certain group of residents blatantly opposed the possibility that the stake of the Province in the PWS and PES will be reduced or totally removed in light of the proposed improvement works on the utilities, the executive and legislative branches of the Provincial Government continued to support each other.


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Stakeholders’ Participation. The residents certainly agreed that there is a need to improve the services of the PWS and PES. However, the Provincial Government had quite a difficulty convincing them of the possible strategies to which the Province would have to evoke to realize the very costly improvement works given its limited financial resources. Despite the difficulty in soliciting support from the residents, the Provincial Government still consulted its stakeholders.

Selection of Best Financing/Service Delivery Option. Among the options considered by the TWG, Joint Venture (JV) through Rehabilitate-Own-Operate-and-Maintain (ROOM) arrangement was deemed most ideal to achieve the Province’s plan to expand, modernize and more efficient the water and power supply services and facilities. Through the JV option, (1) funds required for the improvement works on the utility departments are provided; (2) the Province is able to retain ownership (as part owner) and its share in the profits of the utility departments; (3) efficient, highly skilled and modernized technologies for management, operations and maintenance of the utility departments are provided; and (4) the procedures and negotiations that the Provincial Government will undergo is protected by law.

Technical Assistance. The Province engaged the services of the Associates in Rural Development, Inc. (ARD) consultants. The fund for the technical assistance was provided by the Governance in Local Democracy (GOLD) project of the United States Agency for International Development (USAID).

The ARD consultants assisted the TWG in the selection of the most suitable options that will allow the Province to achieve its twin goals: improve services and facilities of the utility departments and at the same time improve basic service delivery in the whole Province.

Since joint venture was the option chosen by the Province, the consultants

provided technical support in undergoing the procedures on privatization, namely (1) validation of the initial assessment made by the TWG on the PWS and PES operations and facilities; (2) tendering of documents (or offering the project for bidding); (3) selection of and negotiation with the best bidder; and (4) actual transfer of the operations and maintenance of the utility departments.

Resource Mobilization. The Provincial Government had the best of both worlds when it opted for a public-private partnership to improve the Provincial water and power utility departments. It was liberated from the very high cost implications of improvement works on the utilities and income loss from delinquent payments, thus allowing it to use its resources to benefit the whole Province and improve provision of other basic services. At the same time, the Provincial Government was able to keep its ownership and its share in the


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profits. The Province has a 30% equity share in what is now called the Bohol Water Utilities, Inc. (BWUI) and Bohol Light Company, Inc. (BLCI).


Financial Freedom. The Province did not only gain financial freedom from shouldering the maintenance and improvement works on the utility departments as well as the burden of income losses brought about by delinquent payments, but it also experienced expansion of tax revenue base as soon as the BWUI and BLCI were set up. Both BWUI and BLCI, which are part of the private consortium Salcon, pay real property tax and other assessments to Tagbilaran City, where the offices and facilities are located.

More Efficient System. On top of the Provincial Government’s direct financial gains, service delivery was spared with the usual bureaucracy that hindered efficient and effective systems in managing, operating and maintaining utilities. Gone are the days that replacements of even the smallest spare parts would take so long.

Paradigm Shift on Conservation of Resources. While water and power supply greatly improved and allowed the residents the little luxuries of life and businesses more room for expansion and growth, since the water and power utilities are now privatized, every single drop of water and every surge of power are charged and failure to settle accounts promptly will result to immediate sanction, i.e. penalties or disconnections.

8. Capitalizing Private-Pubic Sector Investment Venture: The Bulacan

Packaging Service Center

A. Background

Bulacan, dubbed as the Gateway to the North, is a progressive province. Micro, Small and Medium Enterprises (MSMEs) in agri-aqua industries, garments, jewelry, tannery, pyrotechnics, tourism services, information technology, and other service industries significantly contribute to the province’s economic growth. The Provincial Government would like to further sustain strong local entrepreneurship by providing assistance in packaging of local products to make them more marketable, thus the establishment of the Bulacan Packaging Services and Toll Center (BPSTC) project. The services of the BPSTC include label design, packaging, supply of packaging materials and technical services on packing technology.


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B. Challenges The growing number of small and medium entrepreneurs in Bulacan

needs institutional assistance to make their products marketable, thus ensuring their viability and competitiveness in a highly competitive market environment.


Political Will. The development goal of the province is aimed at empowering the middle class of Bulacan. The Provincial Government was very focused with its intervention and conceptualized a project that would directly impact the local entrepreneurs which are the province’s middle class. The fact that the Province was able to allocate a budget for this project shows: (1) the willingness of the Provincial Government to venture on non-traditional sources of funds to promote further local economic development, and (2) the political harmony between the legislative and executive branch.

Stakeholders’ Participation. The Provincial Government decided to establish the BPSTC project because of the clamor of the 43,896 local entrepreneurs seeking for technical assistance to further increase their sales whose needs were packaging technology, in particular.

Technical Assistance and Partnership with Concerned National Government Agency. The total cost of the BPSTC project amounted to PhP12 million. The Provincial Government acquired loans from government financing institutions (GFIs) to fund the project on top of the share from the Provincial Development Fund. The Provincial Government was assisted by the Department of Science and Technology (DOST) by providing technical support and providing 15% share in the counterpart financial contribution.

Public-Private Partnership. While the project was funded by the Provincial Government, the Bulacan Chamber of Commerce and Industry (BCCI) has been the one managing the BPSTC project. The BCCI has been in-charge of the daily operations and maintenance of the center.


Employment Opportunities and Sustained Economic Growth. With a mere PhP12 million worth of a project, the BPSTC was able to generate close to PhP14 billion of investments. Subsequently, the center has also provided approximately 149,000 jobs. The effects of investment growth and increase in employment opportunities will definitely spillover to the whole Province.


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VI. CHALLENGES CONFRONTING LGUs’ EXERCISE OF CORPORATE POWERS

The LGC calls for accountable and responsive local government units.

Under the provisions of the Code, certain authorities and responsibilities have been transferred from the Central Government to the local governments. The Code put into effect the policy of the State that “the territorial and political subdivisions of the state shall enjoy genuine and meaningful local autonomy to enable them to attain their fullest development as self-reliant communities and make them more effective partners in attainment of national goals.”

Section 17 of the Code further states that “local government units (LGUs)

shall endeavor to be self-reliant and shall continue to discharge the duties and functions currently vested upon them . . . and also to discharge the functions and responsibilities of national agencies devolved to them pursuant to this Code.” The Code entrusted to the LGUs the financing and management of a wide range of services and facilities and for providing leadership and innovation in community and economic development.

The Code has set the policy environment necessary for LGUs to exercise

their corporate powers and develop local economic enterprises. It also vested individual LGUs had been vested by the Code, with powers to set aside funds for development projects as well as to maintain a special account under the General Fund for the operation of local economic enterprises. LGUs may likewise forge strategic alliances with other LGUs and private sector organizations. They may borrow funds and securitize their assets. They may also provide grants or credit to other LGUs. With the advent of the BOT Law, they may enter into contractual agreement with the private sector.

While all these are possible, the public policy environment, as it relates to

particular modalities and/or methods of operations, may still require the strategic inputs of public policy officials. Further, LGUs need technical assistance in institutional capacity building to be able to enhance the exercise of corporate powers.

The following are some constraints identified in the LGUs’ exercise of

corporate powers: 5

Institutional Arrangements

o LGUs’ lack of financial and other resources o Unpreparedness in terms of understanding the dynamics of organization,

structures, resources and people 5 Taken from The Local Government Support Program Public Economic Enterprise Development Model of Sequus, “Developing the Public Economic Enterprise in the Philippines – The LGSP Way”, 2003.


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Enabling Environment

o Vague mandate of LGUs to establish and disengage in the operation of public economic enterprises

o Unclear policies on financial systems for economic enterprises o Poor culture for managing economic enterprises within the LGU

Political Will

o Political succession risk o Change of management approaches o Absence of committed and dynamic champions

LGU Capacity

o Inadequate management skills o Lack of enterprise identification and business planning o Poor quality of service

Systems and Structure

o Absence of formal organization structure o Absence of effective financial system

Information Generation

o Lack of knowledge on financing modalities o Poor information and data banking

The plethora of LGU-operated public markets, slaughter houses, bus terminals, cemeteries, waterworks system, etc. has exhibited a set of common problems namely:

o Poor financial performance o Inadequate management o Rigid adherence to traditional policies and practices in operating such

enterprises o Ineffective accounting and financial reporting o Poor service delivery o Absence of committed and dynamic champions

The operation of most local economic enterprises (LEEs) is usually subsidized by the LGUs. The challenge is to make these LEEs revenue positive or viable. Here are some steps that LGUs can embark on to make LEEs viable.


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The Issue of Cost Recovery

The exercise of LGU proprietary powers includes the promotion of local necessities and convenience for the community.6 Under this, purely legal point of view local economic enterprises should not be operated for profit. On the other hand, LGUs face the ever-present dilemma of shortage of funds to finance the provision of other basic needs, the prosecution of development projects and activities, and the cost of running government. Therefore, the establishment and operation of local economic enterprises if properly managed can be a source of additional income for the LGU.

The private sector is supposed to be the “engine of growth” of our economy. The government should not compete with the private sector, but in reality the playing field is not level. LGUs enjoy certain privileges and advantages not extended to the private sector. LGUs are not subject to the payment of regulatory fees, are exempt from taxes, and goods and services they provide are generally not competitively priced.

Subsidizing local economic enterprises should not be an accepted policy and cost recovery should be the preferred option. A subsidy should be seen as what it is – a diversion of funds to support the operations of a losing LEE at the expense of other priorities. Cost Recovery Schemes for Existing LEEs

There are a number of strategies that LGUs can adopt to recover costs in the operation of their LEEs.

LGUs should adopt corporate business practices.

Use competitive/market-oriented pricing

a. use of public bidding in awarding abandoned or delinquent market stalls7

b. pricing based on market surveys c. pricing based on identified cost to be recovered, e.g.,

MOOE, depreciation, amortization of capital and interest expense

d. pricing should also factor the inherent advantage of LGUs in operating economic enterprises (e.g., exemption from taxation and some regulatory requirements, best sites/locations and security arrangements)

6 Torio v. Fontanilla, 85 SCRA, 599 (1978) 7 The ruling then in the adjudication of stalls or booths views public bidding as “transferring” the authority to fix . . . rates to private persons”.. This ruling should, however, be revisited in the light of present.realities.


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Establish sound financial management

a. improve collection performance

regular and prompt collection of monthly charges enforce collection of arrearages strict enforcement of internal control measures, e.g., closer

supervision of collectors thru regular reshuffling and daily liquidation of collections

b. preparation by the Accountant of quarterly statements of income

and expenses and year-end financial statements consisting of the following for each local economic enterprise

Balance Sheet Statement of Income and an Expense Statement of Cash Flows

Under-pricing and poor collection performance are the main causes

of losses in the financial operations of LEEs.

The accounting for the income and expense of LEEs under the Special Accounts within the General Fund as provided by Section 313 of the Local Government Code and Chapter 6 of the New Government Accounting System is not considered an impediment in the operation of LEEs. The above financial reports provide adequate financial information for management and decision makers. It is timeliness and easy access to the reports that is needed.

Proper asset inventory and management

a. renting out of under-utilized assets b. leverage for more productive use of assets and facilities that are

not effectively utilized Cost Recovery for New LEEs

In planning for new LEEs, LGUs should adopt corporate business practices.

Project identification and justification as articulated in the approved Local Development Plan

Conduct pre-feasibility analysis embodying the following:

a. technical viability and preliminary design b. financial viability tested against


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project revenue project cost to include cost of mitigating environmental, social

and other impacts and of course risks other quantitative indicators of profitability or non-profitability,

e.g., discounted cash flow, internal rate of return, payback period, cost-benefit analysis

c. economic viability measured against local and national economics.

The impact is formally measured by the Economic Internal Rate of Return (EIRR). EIRR is measured based on the project’s effect on local employment and the public and health sectors;

The LGU should identify the best possible use of resource (land,

labor, funding). Further it should explore all reasonable alternatives for the use of the very same resources as part of responsible asset management. Administratively Feasible Interventions Capability building on the following:

Identifying investment potentials for LGUs


Managing local economic enterprises Various modes of LGUs’ exercise of corporate powers

Institutionalization of Local Economic Enterprise Office

The Organization of Local Economic Enterprises

The increase in the scale and varieties of economic enterprises established by local governments point to the need for organizational structures and management systems that would contribute to ensuring the financial viability of the enterprises, as well as promote the efficient delivery of services. To be sure many LGUs through experimentation and innovation have in introduced models that have proven appropriate and effective for their particular needs. This Chapter looks into how structures and systems had been modified and improved. The Beginnings

Markets and slaughterhouses were the common and traditional forms of

local economic enterprises and the city or provincial treasurer was responsible for overseeing their operations prior to the advent of the Local Government


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Code. The provincial treasurer exercised this responsibility through a market superintendent and the municipal treasurers. The operation of toll roads, bridges and ferries, and transportation were likewise under the charge of the provincial treasurer. The operation of public utilities under the jurisdiction of the Public Service Commission was generally under the city/district engineer.8 However, these arrangements were changed upon the enactment of Batas Pambansa Blg. 337 (The first Local Government Code) and Republic Act No. 7160, the Local Government Code of 1991. The Evolving Structures

The first attempt to standardize structures and personnel complement was undertaken by the Bureau of Local Government of the Ministry of Local Government and Community Development.9

The recommended administrative structure is illustrated in Organizational Chart I.

Chart I 8 Revised Manual of Instructions to Treasurers, 1954 edition. 9 Public Market Manual for Local Units, 1979.

MAYOR

Sanguniang Bayan

Municipal Treasurer

Municipal Health

MDC

Meat Inspector

Asst. Mun. Treasurer

Junior Clerk

Butcher

Market Collector

Mkt. Guard

Market Cleaner

Asst.. Mkt. Collector Market

Cleaner

Market Cleaner

Asst.. Mkt. Collector

Mkt. Guard


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In A Guidebook on Cost Recovery Scheme for Local Enterprises and Utilities, by the Bureau of Local Government and Development, Department of the Interior and Local Government, three “Models” were suggested.10

Model 1

LOCAL ENTERPR5ISE UNIT

Model 2

10 Annex II of the Guidebook issued in 1994.

MAYOR

Administrator

Local Eco Ent.

Unit

Budget Officer

Accountant

Planning & Devt. Officer

Treasurer

Personnel Officer

MAYOR

Administrator

Budget Officer

Accountant

Planning & Dev. Officer

Treasurer

Personnel Officer

Local Eco. Ent. Unit


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Model 3

Chart I typically represents the then prevailing view that economic enterprises was properly the domain of the local treasurers. Batas Pambansa Blg 337 and later Republic Act No. 7160 changed this set-up by making the local economic enterprises under the executive supervision of local executives and the policy directions promulgated by the local sanggunians.

In Model 1 the local economic enterprise unit (LEEU) is placed in the

office of the local mayor under the immediate supervision of the local administrator. This arrangement is appropriate for some LGUs with markets and slaughterhouses only as their economic enterprises.

Model 2 reverts to the local treasurer the supervision of the LEEU. This

arrangement would be acceptable in small LGUs where the office of the local mayor is not adequately staffed.

Under Model 3 LEE operations are under a separate department in the

LGU. This is the preferred structure where a number of enterprises have been established by the LGU.

A Contemporary Model An example of a full-blown separate department to manage and operate local economic enterprises is illustrated in Figure 1.

Under the executive direction and control of the City Mayor, an Office of the City Economic Enterprise was created headed by an Economic Enterprise Manager with the rank of department head. The enterprises are:

1. Public Market, a Php 54 million investment 2. Overland Transport Integrated Terminal, costing Php 25 million 3. Slaughterhouse, costing Php 8 million

MAYOR

Administrator

Accountant

Treasurer

Planning & Devt. Officer

Local Eco. Ent.. Unit

Personnel Officer


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4. Livestock Auction Center 5. Cultural Trade Center, in which Php 22 million was invested; and 6. Public Cemetery

The Economic Enterprise Manager is assisted by a Personal Staff and he

supervises two major Divisions, the Administrative Division and the Operations and Services Division.

Under the Administrative Division are four Sections: Administrative

Section, Internal Control Section, Maintenance Section and Security Enforcement Section.

The Operations and Services Division is composed of six Sections: Public

Market Section, Overland Transport Integrated Terminal Section, Public Slaughterhouse Section, Livestock Auction Center Section, Cultural and Trade Center Section, and Public Cemetery Section. All in all, the Department has a personnel complement of 155. Professionalization of LEE Management

Recruitment of qualified and competent personnel is an important aspect of local economic enterprise management. To maintain service competence and efficiency, a continuing program of staff development has to be in place. For sustainability, progressive practices in human resource development should be an overriding concern of top management. Financial Viability

The financial viability of local enterprises should not escape the attention of local decision-makers and those who craft local policies. While subsidies are sometimes the result of responding to local necessities and promoting the convenience of the community, losses in the operation of local economic enterprises should be avoided.

Local Economic Enterprise Office can be created in cases where economic enterprise management has become significant, e.g., LGU operating at least 2 LEEs and has plans to expand.

Professionalization of LEE management.

a. Selection of qualified and competent personnel b. Provide adequate staffing with regularly appointed personnel


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Legal Issues in the Operation of LEEs Regular review and renewal of contracts

Enforcement of terms, conditions and sanctions stipulated in the contracts

Exploring a New Mindset in Local Economic Enterprise Management The need for a clear policy framework in the establishment, operation and management of economic enterprises is very evident from the experience of local governments. The establishment of economic enterprises has been generally viewed as an exercise of the corporate, proprietary or private function of LGUs. (Section 15, Local Government Code) Economic enterprises are so denominated, because they are “income-generating establishments created for the purpose of improving production and delivery of basic services”. (Updated Budget Operations Manual) The Revised Government Chart of Accounts further describes Income from Economic Enterprises as “Share of General Fund from income generated by LGUs from its economic enterprises such as hospitals, markets, slaughterhouses, transportation, irrigation, livelihood projects, etc.” Income generation is, therefore, the principal objective of economic enterprises. But income is realized only when costs are recovered; where receipts exceed operating expenses. Cost-recovery, however, is an ideal not attained by many LGUs. In a separate study it has been established that in CY 2007, 53% of municipalities, 63% of cities, and 88% of provinces incurred losses in operating their economic enterprises. The payment of fees for government services seems to be the characteristic that defines a government activity as an economic enterprise. Many local executives and sanggunian members, however, do not see it this way. Providing services and not profit is in their minds. This is disclosed in writeshops for the updating of revenue codes and drafting of market codes.

The determination as to whether or not an activity aims to provide basic services and facilities or for profit should be appropriately left to local authorities. Under the Local Government Code one of the responsibilities of municipalities is to provide “Public markets, slaughterhouses and other municipal enterprises.” (Section 17) A deliberate act to identify an activity as an economic enterprise should be promulgated through an ordinance, thus explicitly providing the appropriate policy


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and financing framework for the operation and management of such economic enterprise. A good financial management system of the economic enterprise must also be set in place.

A survey conducted by the Office of Project Development Services of DILG on models of LGU corporate projects indicates that the development of local business or enterprises will involve: (a) businesses of enterprises needing to mature in an environment of risks; (b) operation of sound financial systems to educate LGUs analyze and manage the flow of finances and redistribution of risks in the use of internal and external financing; (c) identification of particular products and services; (d) an effective organization and human resource led by an empowering local leaders; and (e) the use of untapped and under-utilized LGU assets.

Legal Impediments in the Exercise of LGU Corporate Powers Lack of a clear statutory provision authorizing LGUs to form LEE corporations

Only natural persons may form a private corporation. Local officials are

acting only as agents of the corporate entity which is the LGU. (DILG Opinion No. 80, series of 1997)

Private Corporations owned or controlled by the government can only be

created by special law (DILG Opinion No. 97, series of 1995) Exercise of LGU Corporate Powers through Public-Private Partnership

Part of the declared policy of government is to recognize the indispensable role of the private sector as the main engine for growth and development and provide the most appropriate incentives to mobilize private resources for the purpose of financing the construction, operation and maintenance of infrastructure and development projects normally financed and undertaken by government. The Local Government Code (RA 7160), particularly Sec. 17, mandates LGUs to be self-reliant in exercising their powers, duties and functions. The Code also authorizes LGUs to mobilize private sector participation in the operation of public economic enterprises through sale, lease, management contract and other arrangements.

There are significant advantages of the private sector participation

arrangements for the LGUs.

It enables the LGUs to implement priority projects without having to raise the funds for its construction


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It frees LGU funds for other priority development projects which may not be eligible for credit financing, e.g., social and environmental projects

It allows flexible financing and private sector partnership in local

development

It provides access to superior technology transfer and training

It enables LGU to own the infrastructure facility after the fixed term

It hastens project implementation and assures operating efficiency

It provides potential source of funds if revenue sharing scheme is built into BOT contract

There are four possible arrangements of public-private partnerships that

could be used by LGUs.

Management contract/ service contract

Lease contract

Concession contract, and

BOT and its variants

The four models differ in terms of ownership, financing and operation.

Management contract • LGU engages the services of another company (the contractor) to

operate and maintain the system • The contractor assumes operational responsibility but does not

assume commercial risks • The contractor acts at all times on behalf of the LGU

One particular benefit of contracting out is that measurable

performance requirements can be specified, with appropriate penalties for failure to meet them.


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Lease Contract • The LGU is responsible for replacement of major works, for debt

service and for tariffs, and cost recovery projects. • The contractor leases the existing facilities and is responsible for all

normal operations and maintenance, including offices, vehicles, spare parts, replacements, billings, collections and financial working capital.

Concession Agreement • The contractor is responsible for operations, maintenance, major

repairs and additional capital financing, as needed.

• Existing fixed assets remain the property of the LGU.

BOT Contract • A private entity receives a franchise from the public sector to finance,

design, construct, and operate a facility for a specified period after which ownership is transferred back to the public sector.

• During the time the project proponent operates the facility, it is allowed

to charge facility users appropriate tolls, fees, rentals, and charges stated in the contract to enable the project proponent to recover its investments and operating and maintenance expenses in the project.

Pre-Contract Analysis First Stage: Several questions should be raised prior to venturing into partnership with the private sector: • Clarify objectives for the project

• Determine whether private sector participation is appropriate and

affordable.

o Conduct a rough financial feasibility analysis o Conduct a preliminary analysis of the political support for and

opposition to private sector participation. Once a government has determined that private sector participation

appears financially and politically feasible, it needs to move on to the second, more in-depth stage of analysis, focusing on the following questions:

What is the state of the existing utility?


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How compatible is the regulatory regime with private sector

participation?

How committed – or opposed – to private sector participation are key stakeholders?

What are the main risks that need to be allocated or mitigated to

ensure that private sector participation can succeed?

Pre-Contract analysis is vital.

• not only in deciding on the form and timing of private sector involvement,

• but also in designing the contract and the accompanying regulatory regime.

Typical Responsibility Distribution for Each Model Institutional Arrangements – Private Sector

Functions and

Responsibilities Management

Contract Lease Concession BOT

Policy Formulation Government Government Government Government

Policy Enforcement Government Government Government Government

Asset Ownership Government Government Government Government Debt Service Obligation Government Government Contractor Contractor

Technical Tasks Contractor Contractor Contractor Contractor Social Preparation Government Government Government Government

Marketing Contractor Contractor Contractor Contractor

O & M Contractor Contractor Contractor Contractor

Billing/ Collections and Receivables

Contractor Contractor Contractor Contractor

Commercial Risk Government Contractor Contractor Contractor


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Another mode of public-private partnership is the Joint Venture Arrangement.

A Joint Venture is a contractual arrangement whereby a private sector

entity or a group of private sector entities and government contribute money/capital, services, assets (including equipment, land or intellectual property), or a combination of any or all of the foregoing. Parties to a JV share risks to jointly undertake an investment activity in order to accomplish a specific, limited or special goal or purpose with the end view of facilitating private sector initiative in a particular industry or sector, and eventually transferring ownership of the investment activity to the private sector under competitive market conditions. It involves a community or pooling of interests in the performance of the service, function, business or activity, with each party having a right to direct and govern the policy in connection therewith, and with a view of sharing both profits and losses, subject to agreement by the parties. A JV may be a contractual JV, or a corporate JV.

A JV company is an entity registered with the Securities and Exchange Commission (SEC) by the JV partners that shall perform the primary functions and obligations of the JV as stipulated under the JV Agreement.

A contractual JV is a legal and binding agreement under which the JV

partners shall perform the primary functions and obligations under the JV Agreement without forming a JV Company. Consistent with the findings of the study that there are legal impediments for LGUs to establish private corporations, it is recommended that Joint Venture Agreements with the private sector be in the form of contractual Joint Venture, adopting applicable provisions of Executive Order (E0) No. 423 dated 30 April 2005 (See Annex C) VII. SETTING THE STAGE TO ENHANCE LGUs’ EXERCISE OF CORPORATE POWERS

Poverty alleviation remains the main goal of local development. More organized economic activities in the community are believed to generate more jobs and thus, provide more income for the people and the LGU. Higher income implies greater purchasing power, more access to efficient and better services that lead to better quality of life. On the part of the LGU, the higher the income, the greater the chance for the LGU to be able to provide more and improved infrastructure facilities, more efficient and better goods and services, and more organized interventions for a stronger and more diverse local economy that is capable of generating sustainable growth and opening a range of permanent job opportunities across the locality.


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The above measures point to yet another significant objective of governance, which is, to increase the competitiveness of the community in establishing more economic activities. A local area needs to compete with other localities in promoting inward investments. The local government spearheads in performing this catalytic function. It assists in providing the sites and premises necessary for local industrial growth and the required investment. It also needs to continuously maintain support for the local economy through policies consistent with local industrial growth and investment, such as policies encouraging establishment of economic enterprises. Taking into account the level of economic development in the country, the promotion of small- and medium-sized enterprises at the local level seems to be foremost in the agenda. The promotion of these enterprises can be supported by setting up incubation centers or common services facilities, establishing Investment Promotion Centers, training the labor force as well as providing advisory and information services to business establishments and to individuals. Local governments can provide these support mechanisms to increase its competitiveness.

The Local Government as an Economic Unit Traditionally, the local government is viewed as an employer and provider of basic goods and services. It is tasked with the responsibility of: (a) providing employment opportunities to the citizenry; (b) providing efficient and better quality of goods and services; (c) building more and better infrastructure facilities; (d) extending better and more accessible social services, especially to the disadvantaged sector of the society; and (e) providing such services that cannot be provided by other sectors of the community. The role of the LGU as an employer has constrained its capacity to operate efficiently and effectively. Every time a new local administration is sworn in, a host of new employees are also recruited. While this is considered as “political patronage”, the local government takes it upon itself to provide jobs to the unemployed in the locality. Since the private sector cannot create enough job opportunities for them, it becomes imperative for the LGU to provide them jobs. More often than not, the LGU becomes a “welfare” institution, accommodating just anybody, whether there is legitimate work for them or not. Recently, the concept of re-engineering or re-inventing the government has somewhat changed the role of the local government as an employer and provider of goods and services. This conventional role has been de-emphasized in favor of a role treating the local government more as a catalytic entrepreneurial enterprise engaged in economic activities that are aimed at developing and facilitating the diversification of local economic structure. Under this new role, the local government now performs functions such as planner, broker and promoter of inward investments as well as playing the role of an investor in


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enterprises where the private sector is absent. In certain situations, the LGUs may have to take the lead role in jump-starting local economic development. This happens when there are insufficient private or voluntary/social sector providers of a service or when the capacities of these providers are inadequate. A case in point is the provision of electricity and water. Another occasion for LGU intervention is in the case of the so-called “market failures” like cartels when private sector players conspire to bid up the prices of critical commodities to the detriment of the public good. LGUs’ operation of local economic enterprises could be viewed as two-pronged: first, as stand-alone investment by improving the returns realized directly from the use/operation of such enterprises; and second, as a catalyst for economic growth by utilizing the enterprise as a strategic and deliberate tool for local economic development. However, it has been observed that LGUs are more effective if they play the catalytic and regulatory roles and do not compete with the private sector. LGUs currently involved in public economic enterprises must have a well-defined exit strategy. The local government needs to take an active role in attracting more investments into the local area. It has to promote the advantages and benefits of investing in the community and make the location attractive to the investors by providing infrastructure facilities needed for the latter’s economic enterprises to operate successfully in the area, i.e., roads, transport, telecommunications, etc. But before investments could come in, the local government has to do some “house cleaning” by addressing the perceived weaknesses in various aspects of the local economy and governance, e.g., land supply, finance, skills and training, labor supply, bureaucratic systems and processes, administrative inefficiencies and peace and order. The above emphasizes the necessary shift in the role the LGU plays- from merely an employer and provider of public goods and services into an economic entity that promotes and facilitates wider latitude of economic activities and advocates good governance to further improve the local economic base and the delivery of basic services. Undoubtedly, the Local Government Code of 1991, to a certain extent, has laid down the legal framework for the LGUs’ active involvement and participation in development. The Code has provided more avenues for flexibility in making decisions and in undertaking projects leading toward local economic development. The Code has also granted LGUs with additional powers making them more equipped and their participation in economic development more meaningful. Some advocates of LGUs’ corporate powers are aiming for a larger objective of corporate governance among LGUs. This means the adoption of


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policies, systems and operational standards and adherence to transparency and accountability in local governance in pursuit of development objectives. The challenge at hand is to develop and apply a framework that recognizes the imperative need of key corporate behaviors and roles on the part of the LGU and support agencies that will ensure and promote a healthy exercise of corporate powers among the LGUs. VIII. PROGRAM STRATEGY

The envisioned role for LGUs in economic development is that of an enabler and creator of an environment conducive to sustainable development. The basic goal of an enabler is to create a social, physical and economic environment favorable to the development and growth of the locality, and to structure this environment through appropriate policies, regulations and enforcement to ensure the dynamic and efficient interplay of market forces and private initiatives.

Harnessing and enhancing LGUs’ corporate capacities must be anchored

on a strategy, inspired by some guiding principles to serve as guideposts. It requires the dynamic interplay of policy support, capacity building sustaining actions through advocacy, technical assistance and funding support, monitoring and evaluation, and an institutional framework to galvanize stakeholders’ support.

Guiding Principles

LGUs must act primarily as planner, broker and promoter of inward

investments and play the role of an investor in basic enterprises where private sector is absent. LGUs’ operation of local economic enterprises could be viewed as two-pronged:

o As stand-alone investment by improving returns realized directly

from the use/operation of such enterprises. o As a catalyst for economic growth by utilizing the enterprise as a

strategic and deliberate tool for local economic development.

Building the Promotional Structure

As the lead oversight government agency for the local government sector, the DILG can advocate improvement in technical and financial capacities of LGUs for preparing and managing local development investments in a corporate manner. The different bureaus and offices of the Department can provide the policy and promotional support for the program. The Office of Project Development Services (OPDS), as DILG’s conduit with multilateral and bilateral


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institutions, can take the lead in the promotional and advocacy initiatives in LGUs exercise of corporate powers. Further, the OPDS can assist LGUs in packaging programs and projects and in conduiting funding support along these initiatives. The Bureau of Local Government Development (BLGD) can be the focal office in terms of policy review, policy consultation and policy formulation, with respect to LGUs’ corporate powers. The Local Government Academy (LGA), in collaboration with other institutions, on the other hand, can take the lead in LGU institutional capacity building initiatives to enhance LGUs’ exercise of corporate powers. The Bureau of Local Government Supervision (BLGS) can provide the framework for effective monitoring and evaluation of LGUs’ initiatives in the exercise of corporate powers.

Establishing the Policy Support System

There are numerous factors that impact on LGUs’ ability to exercise

corporate powers- some are internal, while others are external. The internal factors include organizational and managerial culture, financial and other organizational systems and the overall notion of LGU capacity, among others. Visionary and committed Local Chief Executives (LCEs) with entrepreneurial mindset are needed to trigger a paradigm shift in LGUs operation and culture.

On the other hand, there are external factors that impact on LGUs’

exercise of corporate powers, and these pertain to policy and oversight support and to market forces as well. There are a number of laws and policies govern LGUs’ exercise of corporate powers. Some of them are vague as to LGUs’ mandate to establish LEEs, and policies on organizational and financial systems for LEEs are not in tune with industry standards. The policy environment needs to be reviewed against the backdrop of the above-mentioned guiding principles and of the rapid changes in the public and private domain. Indeed, the policies on LGUs’ exercise of corporate powers must be responsive and more enabling to LGUs’ initiatives. Further, major gaps are encountered not necessarily in the policies themselves, but often in their interpretation and implementation at the operational/local level. Developing a framework for policy reform therefore has to take into consideration the institutional, organizational and competency implications of policy implementation. Likewise, proper consultation with stakeholders (e.g., the LGUs by the DILG Regional Offices) by oversight agencies as they issue policy directives and guidelines would ensure healthy central-local dynamics and goal congruence. It is envisioned that the BLGD will take the lead in this aspect of policy support. Capacity Building

Equally important is the need for a capacity building framework, a crucial

ingredient in harnessing and enhancing LGUs’ corporate powers. Capacity building should be viewed in three inter-related dimensions: a) institutional interrelations; b) organizational capacities; and c) individual competencies.


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Addressing one (e.g., personal training) without the others will not be completely effective. However, attempts at rationalizing or strengthening institutional interrelations and organizational capacities are often viewed as threatening and thus resisted. In contrast, training in individual competencies is generally viewed as non-threatening and is thus often supported. This prevailing organizational culture (absence of entrepreneurial culture, rigid policy framework based on tradition and past precedence and top-down approach to management, among others) needs to be reformed if capacity building is to become truly effective. In any case, training in identifying investment and economic potentials and potential economic niches, in entrepreneurship and enterprise management, business planning, management skills, financial management and risk management, among others, can be used as an “entry point” for pursuing the other dimensions of capacity building. Further, provision of broad-based information on LGUs’ exercise of corporate powers through documented good practices and improved approaches is also an integral part of capacity building. This is the area of intervention where the LGA can provide the necessary support with the active participation of the DILG Regional Offices. The capacity building interventions in the inter-related dimensions of: (a) institutional interrelations; (b) organizational capacities; and (c) individual competences are appropriately the concern of the LGA. Linking with academic institutions can be considered in the following highly technical areas:

identifying investment potentials for LGUs


Managing local economic enterprises

Various modes of LGUs’ exercise of corporate powers

Institutionalization of Local Economic Enterprise Offices In the non-traditional exercise of LGU corporate powers, e.g., public-

private partnerships, joint venture and bond flotation, coaching and mentoring by or engaging the services of practitioners and experts will probably be necessary to help LGU in the following areas, among others:

Identification and valuation of assets Risk allocation and risk mitigation Contract design Analysis and identification of appropriate regulatory regime Timing and form of private sector involvement


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The experience of some LGUs in finding use for their under-utilized assets is worth replicating. Appendix B is a sample listing of how LGUs generated income from the use of idle assets. The use of LGU assets in public-private partnerships, especially in joint ventures, offers opportunities for expanding service delivery, employment generation and economic promotion.

Sustaining Actions

a. Advocacy and Technical Assistance

The successful exercise of LGU corporate powers would require not only the necessary policy support but sustained advocacy and adequate technical and funding assistance as well. LGUs would need some assistance in identifying investment potentials of their respective communities. The OPDS can take the lead in collaboration with the DILG’s Regional Offices, DTI, and Small and Medium Enterprise Development (SMED)11 Council in promoting LGUs’ exercise of corporate powers and in providing them the necessary technical assistance in identifying its economic potentials, potential economic niches, needs and demands, provide assistance in managing LEEs. and act as broker for LGUs in sourcing financing for its projects and initiatives in line with LGUs’ exercise of corporate powers.

b. Monitoring and Evaluation

In collaboration with the DILG Regional Directors and Local Government Officers, the BLGS shall have overall responsibility for collecting data and monitoring results. The baseline data shall be established by BLGS in collaboration with the concerned DILG and local officials; this could be part of DILG’s LGPMS. The results of monitoring system will be incorporated as part of DILG’s overall management information system, and shall be used to implement the performance-based grant on LGUs’ exercise of corporate powers. Community monitoring tools could also be developed by DILG to be actively used by accredited civil society organizations and private sector organizations to promote better governance and transparency in project activities. A. Indicative Activities by Component

The following are the envisioned indicative activities of following offices:

11 Includes micro-enterprises


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Bureau of Local Government Development:

Indicative Activities o Review of existing policies on LGUs’ exercise of

corporate powers o Identifying areas of reform o Organizing consultative workshops o Formulating appropriate policies o Review and approval of proposed policies by the

Coordinating Council for LGU Corporate Powers (CCLCP) 12

o Issuing appropriate guidelines by BLGD-DILG (for policies that can be promulgated through Administrative Issuances)

o Drafting the proposed legislation for policies that would need Congressional Action

Local Government Academy:

Indicative Activities o Conduct survey to determine/identify training needs

on local enterprise management and ,public-private partnerships

o Development of the training design and appropriate capacity building interventions

o Development and printing of training materials o Central Office (CO) and Regional Office (RO) staff

training workshop on LGUs’ corporate powers o RO roll-out to provinces and cities o Development of orientation and promotional materials

on LGUs’ corporate powers for municipalities o Roll-out to municipalities (c/o LGU) o Documentation and compilation of best

practices/models in LGUs’ exercise of corporate powers (“Kaban Galing” and “Galing Pook”)

o Replication of best practices/models in LGUs’ exercise of corporate powers–Good Governance-Facility for Adoption and Replication (GO-FAR)–through mentoring and coaching in collaboration with OPDS

[P500,000 per model]

12 Composed of DILG, NEDA, DOF, DBM, DTI, DOJ, DA, TESDA, ULAP and PCCI


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Bureau of Local Government Supervision:

Indicative Activities o Develop performance indicators on LGUs’ exercise of

corporate powers o Establish performance standards for LEEs

(benchmarking) o Monitor LGU performance against the indicators o Monitor LGU compliance with DILG guidelines on

LGUs’ exercise of corporate powers o Summarize findings for management purposes

Office of Project Development Services:

Indicative Activities o Assist in packaging proposed LEEs for possible funding o Provide technical assistance in project identification,

pre-feasibility study, and assessment of both financial and technical viability

o Assist LGUs in identifying various options for the operation of LEEs

o Assist LGUs in identifying appropriate options for financing and service delivery under the principle of public-private partnership

o Document good practices on LGUs’ exercise of corporate powers in collaboration with LGA

o Replicate models on LGUs’ exercise of corporate powers in collaboration with LGA

[P500,000 per model as per GO-FAR] o Hire a corporate lawyer/consultant to draw a legal

roadmap on how to engage in public-private partnership on certain LGU service deliveries

Financing Options A. Establishing the LGU Corporate Powers Challenge Fund (LCPCF)

The LCPCF shall be set up to provide financial support for LGUs’ innovative exercise of corporate powers to promote economic development and key corporate behaviors, adopting policies, systems and operational standards with strict adherence to transparency and accountability in local governance.

The LCPCF is proposed to be capitalized with P300M from budgetary

appropriation to be sourced by DILG. It is to be established as a window in the Municipal Development Fund Office (MDFO):


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- 10% of LCPCF, or P30M, for capacity building; - 90% of LCPCF, or P270M, as grant to LGUs to promote LGUs’

exercise of corporate powers

General Criteria

The LCPCF will support a wide range of initiatives in LGUs’ exercise of corporate powers such as waterworks system, wharves and fish ports, post-harvest facilities, food production, projects related to environment (eco-tourism, sanitary landfill, watershed management), one-stop shops and IT related projects, projects that promote inter-LGU cooperation and those that enhance public-private partnership, as well as investment promotion, enterprise development, programs that institutionalize service cost and standards in service delivery, as well as transparency and accountability, skills and manpower development and employment and improvement in the operation and maintenance of the traditional LEEs such as public markets, bus terminals and slaughterhouses, among others.

The following is a matrix of LGU Corporate Powers Reform Areas and the

corresponding grant amount.


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POLITICAL

Easy Difficult

Quadrant I

Public markets Bus terminals Slaughterhouses Post-harvest facilities

Investment Promotion Program Food Production Program Crafting an LGU vision and molding a

corporate identity as an LGU marketing strategy

Quadrant III

Public markets Bus terminals Slaughterhouses Post-harvest facilities

Providing adequate land supply

through efficient zoning, land banking and proper area management

Formulate LGU employment policies in collaboration with local firms in order to initiate job creating processes

Investment Code Promotion of audit committees to

enhance transparency and accountability

Quadrant II

Incubation centers/common services

facilities Environment projects Eco-tourism Brokering

o Business matching and joint venture search

o Skills & manpower development and employment

o Product development, packaging and marketing

One-stop shops o Streamlining of business

registrations

o Facilitating speedy issuance of construction, planning, building and other regulatory requirements through one-stop-shop centers

Quadrant IV

Establishment and

institutionalization of service cost and standards in service delivery with customer feedback mechanism

Establishment of Citizens’ Charter or Service Delivery Contract

Inter-LGU cooperation o Establishing center for

facilitating partnership and inter-LGU alliances

o Communal farming and forestry o Irrigation and water impounding

system Public-private partnerships Wharves Fish ports Waterworks Corporate farming using inter-

LGU cooperation and public-

AD

MIN

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ATI

VE

Diff

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t

new

old existing

Easy


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IT-based projects Establishing Investment Promotion

Centers Establishing center for agro-fisheries

and marine industry development Establishing packaging development

center Strategic business planning Entrepreneurship Training Camps and

Enterprise Development Program Institutionalization of Local Economic

Enterprise Office

private partnership to ensure food security

Description of the LGU Corporate Powers Reform Areas and Corresponding Grant Component Quadrant I

These are typical local economic enterprises that LGUs would normally

operate and maintain which are politically acceptable and within their administrative capability. The above proposed LEEs should meet the following tests: 1) technical viability and appropriate design; and 2) financial viability tested against the following:

a. project revenue b. project cost, to include cost of mitigating environmental, social

and other impacts and of course risks. c. economic viability-measured against local and national

economics. The impact is formally measured by the economic internal rate of return (EIRR). EIRR is measured based on the project’s effect on local employment and the public and health sectors.

The grant would be an amount equivalent to 5% of the project cost but not to exceed P1M.

Fund Release

First tranche 30% upon signing of the agreement Second tranche 30% upon 50% completion Third tranche 40% upon completion and final acceptance of the project


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Quadrant II

These are projects that are politically acceptable, and are challenging to the administrative capabilities of the LGUs.

The grant would be in the amount equivalent to 10% of the project cost but

not to exceed P2M. Fund Release

First tranche 30% upon signing of the agreement Second tranche 30% upon 50% completion Third tranche 40% upon completion and final acceptance of the

Project.

Quadrant III

These are typical LEEs that LGUs are normally operating and maintaining which are mostly financially weak and where political leadership is challenged to adopt measures to improve their financial viability.

The grant would be in the amount equivalent to 15% of the increase in

receipts of these LEEs over the average receipts of the previous 5 years, but not to exceed P3M. But in no case shall the previous 5-year average operating expenses exceed 30% of the previous 5-year average operating receipts.

Fund Release

The grant would be released upon certification by the Local Treasurer as

to the actual receipts.

Quadrant IV

These are projects which would entail visionary, collaborative and strong political leadership to undertake and which would challenge LGUs’ administrative, political and networking capabilities.

The grant would be in the amount equivalent to 20% of the project cost but

not to exceed P4M.

Institutional Framework

To set the stage and create a platform for LGUs’ effective exercise of corporate powers, an institutional framework is hereby envisioned where the DILG, in collaboration with the other oversight agencies and concerned


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institutions such as NEDA, DOF, DBM, DTI, DA, DOJ, ULAP and PCCI, shall establish a Coordinating Council for LGU Corporate Powers (CCLCP).

1. The CCLCP shall formulate promotion policies and provide guidance

on LGUs’ exercise of corporate powers. 2. It shall serve as the clearinghouse of policies and implementing rules

and regulations as regards LGUs’ exercise of corporate powers. 3. It shall act as a collegial body to review, approve or disapprove

applications of LGUs to LCPCF. 4. It shall review and amend LCPCF policy guidelines after a prescribed

period of operation. 5. The CCLCP shall be assisted by a core support group composed of

representatives from OPDS, BLGD, BLGS and LGA which shall serve as CCLCP’s secretariat.

6. The CCLCP shall be created through an Executive Order.

B. Other Financing Support

1. The Local Economic Development Project funded by the Canadian International Development Agency (CIDA) to support LGU capacity building for the next eight years.

2. The Spanish Grant intended for Regions 5 and 13 to support capacity

building on resource mobilization, financial management and economic enterprise management.

3. The forthcoming Philippine Basic Urban Services Sector Project

funded by the Asian Development Bank 4. The Municipal Development Fund particularly the PROLEND Program,

a program lending window designed to promote and support policy reforms in local governance.


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References

Agra, Alberto C. and Vincent Edward R. Festin, Compilation of Recent Legislation on Local Governments 1991 to 2005, USAID and The Asia Foundation, 2006.

Build-Operate-Transfer Manual, 1995. Department of the Interior and Local Government, Mindanao Economic

Development Council and Asian Development Bank, Emerging Trends: Harnessing LGU Corporate Capacities for Mindanao Development, 2007.

Developing the Public Economic Enterprise in the Philippines, LGSPA, 2003. Joint Venture Guidelines and Procedures, NEDA. Legaspi, Perla E., Wilhelmina L. Cabo and Ma. Ernita T. Joaquin, Local

Economic Promotion in the Philippines, Local Government Center-College of Public Administration, U.P. and Public Administration Promotion Center-German Foundation for International Development, Manila: Philippines, 1996.

Legaspi, Perla E. and Wolfgang Meyer, eds., Economic Promotion by Local Authorities in the Philippines and in Germany: A Reader, German Foundation for International Development and Local Government Center-U.P. College of Public Administration, 1994.

Local Government Code of 1991. Manual on the New Government Accounting System for Local Government Units,

Commission on Audit, 2002. Public Market Manual for Local Units, Ministry of Local Government and

Community Development, l979. Revised Manual of Instructions to Treasurers, l954 Edition. Rules and Regulations Implementing the Local Government Code of 1991. Supreme Court Reports Annotated. The Philippine Constitution, 1987.


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APPENDIX A

ISSUES ON LGU EXERCISE OF CORPORATE POWERS

1. Emerging Models of LGUs’ Exercise of Corporate Powers

LGU Corporation granted a Charter by Law (R.A. 9259)

The La Union Medical Center (LMUC)

LGU capitalized corporations organized under the Corporation Code of the Philippines

Misamis Oriental Telephone Systems, Inc. (MISORTEL) Quezon City Housing and Urban Renewal Authority, Inc. (HURA)

1.3 Inter-LGU Corporate Body

Partido Development Administration (RA 7820, as amended by RA 8989)

2. DILG Opinions

The law governing stock corporations is the Corporation Code of

the Philippines. Section 10 thereof provides that, “Any number of natural persons not less than five but not more than fifteen, all of legal age, x x x may form a private corporation for any lawful, purpose x x x” (Underscoring ours). A corporation like that of a province cannot for reasons thereof, be an incorporator of another corporation, it being a juridical person or more appropriately a public corporation. (Opinion No. 80, 22 July 1997)

x x x private corporations owned or controlled by the Government

can only be created by a special law, that is through Congress. (Opinion No. 97, September 6, 1995)

3. Current Jurisprudence

Proprietary powers, arising from its existence as legal persons and

not as public agencies, are those exercised for the special benefit and advantage of the community and include those which are ministerial, private and corporate. x x x The following are corporate in character: municipal waterworks, slaughter houses, markets, stables, bathing establishments, wharves, ferries, fisheries,

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maintenance of parks, golf courses, cemeteries, and airports. (SC Decision 2nd Division, City of Manila v. Intermediate Appellate Court G.R. No 71159, November 15, l989, 1st Division, Municipality of San Fernando v. Firme G.R. 52179, April 8, 1991) Source: Hector S. de Leon, The Corporation Code of the Philippines Annotated, 2002 ed.

The Congress shall not, except by general law, provide for the

formation, organization, or regulation of private corporations. Government-owned or controlled corporations may be created or established by special charters in the interest of the common good and subject to the test of economic viability. (Article XII, Section 16, Philippine Constitution) A special law creating a private corporation which is neither owned nor controlled by the government is void for being violative of the constitutional provision. (See National Development Co. vs. Phil. Veterans Bank, 192 SCRA 257, 1990) Source: Aguedo F. Agbayani, Commentaries and Jurisprudence on the Commercial Laws of the Philippines, Vol. III, 1964 ed., Quezon City: AFA Publications.

Incorporators are natural persons with contractual capacity who are

signatories to the articles of incorporation.

Corporators are either stockholders in stock corporations or members in non-stock corporations. Source: Lorenzo F. Jorge, Bar Review Materials in Commercial Law (Tenth ed 1993)

As members of a corporation, the government never exercises its

sovereignty; it acts merely as a corporator. (18 Am. Jur 2d 584) And the mere fact that the government happens to be a majority stockholder does not make it a public corporation. As a private corporation, it has no greater rights, powers, or privileges than any other corporation organized for the same purpose under the Corporation Code. (National Coal Co. vs. Collector of Internal Revenue, 46 Phil. 583 (1924)

Source: Hector S. de Leon, The Corporation Code of the Philippines Annotated, 2002 ed.

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4. Corporatization of Economic Enterprises

Name of Enterprise

Nature

Services Offered

Governing

Body

Financial

Management

Status of Personnel

Auditing

La Union

Medical Center (LUMC)

LGU Owned & Controlled Corporation (RA 9259)

Modern General Hospital Services

15 Member Board of Trustees, headed by the Prov. Governor

Budget enacted by Board of Trustees, reviewed by PBO

Officers and employees covered by CS rules and regulations

Audited by Provincial Auditor of La Union

Misamis Oriental

Telephone Systems, Inc. (MISORTEL)

Private Corporation, SEC Reg. No. CS200253967

Telecommunica-tions and multi-media services

15 Member Board of Directors composed of the PG, VG & SP Members

Provincial Treasurer is Corporate Treasurer, receives & disburses funds

Not covered by CS Rules

Not clear

Quezon City Housing and

Urban Renewal Authority, Inc.

(HURA)

Private Corporation, Ord. 1236, s. 2003

Low-cost housing, urban renewal and redevelopment

Seven Member Board of Directors headed by City Mayor

Board “act(s)” on budget submitted by GM

Appointed by General Manager

Independent Auditor

Partido

Development Authority

Inter- Local

Corporate Body

Integrated and Coordinated

Development of 10 Municipalities of Camarines Sur

Board of Directors composed of 22 members , including the Mayors of the member LGUs

Budget approved by the Board

Appointed by Administrator in accordance with CS Rules and Regulations

Audited by COA


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5. Issues on Audit Jurisdiction

a. Current Practice

LUMC – Audited by the Provincial Auditor of La Union MISORTEL – Not clear. (Corporate Audit or LGU Audit?) HURA – Independent Auditor Partido Development Administration - COA

COA’s Mandate

Examine, audit, and settle all accounts pertaining to the revenues

and receipts of, and expenditures or uses of funds and property, owned or held in trust by, or pertaining, to the Government, of any of its subdivisions, agencies, or instrumentalities, including government-owned or controlled corporations with original charters (Section 2, Article IX-D, Section 2, Philippine Constitution)

. . . those for which the government has put up a counterpart fund

or those partly funded by the government. (Section 26, Government Auditing Code of the Philippines)

. . . where applicable as in the case of stock corporations, to the

extent of at least fifty-one percent (51%) of its capital stock. (RA 7656, November 09, 1993)

6. Oversight Agencies on Employment and Personnel

Civil Service Commission

The civil service embraces all branches, subdivisions,

instrumentalities, and agencies of the Government, including government-owned or controlled corporations with original charters. (Article IX-B, Section 2(1), Philippine Constitution)

Department of Labor and Employment

Those incorporated under the general incorporation law, the

Corporation Code, are governed by the Labor Code.

7. Compensation

GOCCs – Salary Standardization Law Private Corporations – Fixed by Governing Body


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8. Applicability of the Government Procurement Reform Act

. . . shall govern and apply to the procurement of a) infrastructure projects; b) goods; and c) consulting services, by any branch, agency, department, bureau, office, or instrumentality of the Government, including government-owned and/or –controlled corporations (GOCC), government financial institutions (GFIs) state universities and colleges (SUCs), and local government units (LGUs). (Implementing Rules and Regulations (IRR) Part A of the Government Procurement Reform Act, Republic Act 9184)

9. Establishment of Economic Enterprises Within the LGU Structure as LGU

Exercise of Corporate Powers

Policy Issues

On the creation of separate corporations

Special Charters must pass the test of economic viability (Article XII, Section 16, Philippine Constitution)bbbb

What are the conditions that justify the establishment of a separate

corporation to manage and operate an economic enterprise?

On the retention by the economic enterprise of part of the earnings Section 313 of the Local Government Code provides that profits or

income from the operation of, public utilities and economic enterprises, after deduction of the cost of improvements, repair and other related expenses shall be applied for the return of the advances or loans and any excess shall form part of the general fund of the LGU

In the proposed Market Code of the ,Philippines, SB 279, Senator

Aquilino Q. Pimentel, Jr., “After deducting statutory or contractual obligations, a minimum of fifty percent (50%) of the remainder of the income of the public market owned by the government shall be reserved and set aside as a capital and management development fund for the maintenance and improvement of the market and for staff development.

Comment: “of the remainder of the income” should be “profits or

net income”. Retaining fifty percent (50%) of the income even if the enterprise is losing money would only increase the LGU’s subsidy.


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APPENDIX B

INVESTMENTS OF UNDERUTILIZED ASSETS

LGU NAME OF ENTERPRISE LGU ASSETS UTILIZED

Buguias, Benguet, CAR

The Public Market Improvement Project

A vacant municipal lot used to display goods and services by traders and vendors

La Union Province, Region I

La Union Medical Center

A P650M European Union funded hospital turned-over to the Provincial Government

Quirino Province, Region II

Capitol Plaza Hotel and Restaurant

The enterprise is construction on a 1,097.50 province-owned lot valued at P7M.

Olongapo City, Zambales, Region III

Solid Waste Management Program

A cleanliness drive since 1964 and Systematized in 1989 to generate income.

Magdalena, Laguna, Region IV-A

The Magdalena Water Supply and Sanitation Project

Expansion and rehabilitation of a 1950 American constructed system.

El Nido, Palawan, Region IV-B

Renewable Energy- Based Village Power System

A UNDP grant project with the LGUs providing counterpart funds and land (Barangay for Plant site) and a Cooperative managing the enterprise

The Puerta Galera, Mindoro Oriental, Region IV-B

The Puerto Galera Waterworks System

An improvement of a 2"m pipe built by DPWH into 4"CD pipe, a reservoir and 2 Distribution tanks through an LBP loan.

Naga City, Daraga, Region V

The Bicol Science and Technology Centrum

The City Government donated a 2,000 square meters of lot located at the City Hall Compound.

Legaspi City, Albay, Region V

Ibalong Village Socialized Housing Project

An undetermined site for 362 housing units was declared an area for socialized housing by the LGU and approved by DAR for conversion into residential land.

Bacolod City, Negros Occidental, Region VI

Bacolod Celine Homes

A 14.45 hectares owned by the LGU was converted into a housing site by a private developer through a Joint Venture Agreement.

Barotac Viejo, Iloilo, Region VI

The Barotac Viejo Nutri-Food Plant, Inc.

A provincial government feeding plant project turned-over to the municipal government and now operating commercially through a Board of Trustees (SEC-registered).


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Tubigon, Bohol, Region VII

Tubigon Community Hospital

An earning municipal hospital built through grants and donations, local resources and loan.

Dauin, Oriental Negros

Coastal Resource Management Program

Application of a systematized and regulated method of collecting user's fees in the use of nine Marine Sanctuaries.

General MacArthur, Eastern Samar, Region VIII

The Gen. MacArthur Community-Based Resource Management Project

The use of 294 hectares of government lands for the establishment of seed nurseries and 230 hectares for tree plantation.

Basey, Samar, Region VIII

Balantac Resort and Rawis Cave

The development of natural resources for ecotourism and other economic activities.

Lawaan, Eastern Samar

Lawaan Coastal Resource Management

Use of protected marine sanctuaries as areas for mudcrab ranching and seaweed farming.

Jimenez, Misamis Occidental

Jimenez Municipal Economic Enterprise Development Office JMEEDO)

Consolidating six existing public economic enterprises into one economic enterprise office.

Source: OPDS/DILG

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LGU ACCESS TO OFFICIAL DEVELOPMENT ASSISTANCE (ODA): STATUS, ISSUES AND CONCERNS

Alex B. Brillantes, Jr., Gilberto M. Llanto

and Ruperto P. Alonzo

I. INTRODUCTION

A. Rationale of the Study

This study addresses a general concern of local governance in the Philippines: given the regime of devolution and local autonomy, and given further that financial autonomy and the imperative to augment local resources continues to be a primordial concern among local governments, the question has always been asked: how can local government units (LGUs) complement their financial resources from sources other than the traditional Internal Revenue Allotment (IRA)? Various modalities for doing so have been identified, and these range from the exercise of the LGUs’ corporate powers through public-private partnerships, build-operate-transfer, privatization, and other such schemes, to availing of loans and grants from both local and international sources.

This study addresses one particular modality: that of local governments

accessing Official Development Assistance (ODA) resources.

Statistics on the distribution of ODA loans show that the local government sector is the smallest direct recipient of this funding source. As of 2006, national government agencies held the biggest share of the ODA pie at 65%, with government-owned and controlled corporations and government financing institutions getting 22% and 13%, respectively, and LGUs receiving less than one percent (1%) (NEDA 15th Annual ODA Portfolio Review). While it has been observed that the amount of ODA grants and the number of ODA grant projects have been declining over the years, several factors could explain why LGUs have not been able to have a substantial share in ODA funds. One major factor is the fact that LGUs, with very few exceptions, have inadequate capacity to

LGU Access to Official Development Assistance (ODA): Status, Issues and Concerns

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prepare feasibility studies, access and manage ODA funds. There is also a perception among LGUs that the process of accessing ODA is complex and cumbersome. They may also lack information on the procedures to be followed in availing themselves of ODA funds. Recognizing these ODA accessibility concerns, the Department of the Interior and Local Government (DILG) commissioned a study, with support from the Asian Development Bank Technical Assistance No. 4778 on Local Governance & Fiscal Management Project that would recommend measures to improve the LGUs’ access to ODA.

B. Approach and Methodology This ODA Study focuses on the current status of LGU access to ODA and

attendant issues and concerns. Specifically, it analyzes the LGUs’ access to both the grant and loan components of the ODA. It also provides a historical background and legal basis of LGU access to ODA.

In assessing the current status of LGU access to ODA, the study looks

into ODA funds, which are composed of (a) ODA grants, and (b) ODA loans , including equity considerations in the distribution of ODA resources for LGUs. Additional concerns including managing and monitoring of ODA at the local level and difficulties in the implementation of the LGU financing framework are also addressed.

The conduct of the study involved a desk review of available documents

on ODA, basic descriptive and statistical analysis, the conduct of workshops among stakeholders, a simple survey among LGUs, and formal and informal interviews with key persons of responsible national government line agencies1 and the various leagues of local government authorities.

C. ODA Policy Framework of the Philippines ODA is defined as a loan or loan and grant administered with the

objective of promoting social and economic development and welfare in the

1 Key officials interviewed included Rolando Tungpalan and Rhoderick Planta of NEDA; Helen Habulan of the MDFO; Maloy Malvar, formerly of BLGF; and the technical staff of LBP and DBP. See also Appendix 1 for the participants of the workshop.


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Philippines. More specifically, ODA funds are meant to achieve equitable growth and development in all provinces through priority development projects for the improvement of economic and social service facilities taking into account such factors as land area, population, scarcity of resources, low literacy rate, infant mortality and poverty incidence in the area. (Section 4, RA 8182- ODA Act)

The underlying law for of the use of ODA in economic development is

Republic Act (RA) No. 8182, or the Official Development Act of 1996, as amended by RA 8555. Foreign loans may be contracted with governments of foreign countries with whom the Philippines has diplomatic and/or trade relations or bilateral agreements, or which are members of the United Nations (UN), their agencies and international and multilateral lending institutions.

Sources of ODA. ODA comes either from multilateral institutions or

bilateral programs. The former include the UN system, the European Community, the International Atomic Energy Association (IAEA), the International Fund for Agriculture (IFAD), and regional development banks, e.g., the World Bank (WB) and the Asian Development Bank (ADB). The latter include the programs of the following countries: Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Italy, Japan, South Korea, Kuwait, The Netherlands, New Zealand, Norway, Spain, Sweden, United Kingdom, and the United States of America. The major bilateral sources are Japan, USA, Germany, Italy, France, Canada and Australia.

Forms or Types of ODA. The National Economic and Development

Authority (NEDA) classifies ODA under two categories: 1) soft loans, and 2) grants. “Soft loans" have interest rates ranging from 0%-7%; maturity periods of from 10 years to 50 years; and grace periods of from 5 years to 10 years. ODA “grants,” on the other hand, have no repayment obligations unlike soft loans. They are given in the form of technical assistance services, equipment, commodities and training.

NEDA has established the guidelines for the use of soft loans and grants.

Soft loans are to be used for projects which are revenue generating and lead to capital formation. On the other hand, grants and highly concessional financing

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/austral.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/austria.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/belgium.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/canada.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/czechrep.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/czechrep.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/denmark.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/finland.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/france.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/germany.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/italy.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/japan.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/kuwait.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/nederlnd.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/nzealand.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/norway.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/spain.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/sweden.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/ukingdom.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/ukingdom.htm

http://www.neda.gov.ph/Subweb/oda/ODA/donor%20profiles/usa.htm


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are preferred for development projects in the social sectors as well as for technical assistance types of projects.

Process of Accessing ODA Funds. The ODA Grant Programming

Process, which particularly refers to local governments, seeks to maximize the benefits of ODA on sectoral and local/regional development by matching these with the needs of priority programs. It envisages beneficiaries obtaining the required goods and services available through ODA in the appropriate form, quality and cost. This process involves two main activities: the Country Program Review and project submission, negotiation and ODA availment. Figure 1 illustrates the flow of ODA Grant Programming.

Figure 1. ODA Grant Programming Flowchart

Source: National Economic and Development Authority.

The Country Program Review (CPR) involves the assessment of projects by the Government of the Philippines (GOP) and the ODA funding agency, wherein they identify the common areas of concern and agree on the directions for future grant aid. Later, the ODA donors would pledge indicative ODA resources to the Philippine government as a whole. The project negotiation is the result of prior country programming exercises wherein the available ODA pledge


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is designated to a particular programmed project. Based on the CPR, project proposals are submitted or resubmitted; after which renegotiations on the nature, features and/or implementation modalities of the project. After the processing of the proposal which usually runs from three months to one year, ODA may then be availed of by the local government concerned.

D. Local Government Unit Access to Official Development

Assistance

The Local Government Code of 1991 (LGC) provides the rationale behind availment of the ODA grant by LGUs. It empowers LGUs to directly propose projects and negotiate for grants with donor agencies. More specifically, Section 23 of the LGC states that local chief executives (LCEs) are accorded with the “authority to negotiate and secure financial grants or donations in kind -- from local and foreign assistance agencies without necessity of securing clearance or approval therefore from any department, agency or office of the national government or from any other higher local government units xxx.”

Project Identification and Project Preparation. Project identification

and preparation are two prior major steps that need to be undertaken by LGUs before submitting, negotiating and securing ODA grants. These steps form the core planning activity referred to as "local investment programming" (See Figure 2) The process makes operational the strategies of local medium-term development plans into area-specific, viable and implementable packages of medium-term programs and projects. 2

2 Parts of the section are drawn from the NEDA Guide on Availment of ODA Grants by LGUs.


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Figure 2. Local Investment Programming Process

Source: Based on the Guide on Availment of ODA Grants by LGUs. In March 2007, Joint Memorandum Circular (JMC) No 1. Series of 2007

was jointly issued by the DILG, NEDA, DBM and DOF. It specifically aims to: (1) provide guidelines on the harmonization and synchronization of planning, investment programming, budgeting and expenditure management, and revenue administration at the local level; (2) strengthen the interface between LGUs and national line agencies (NLAs) and the complementation between and among all levels of the LGU in planning, investment programming, budgeting, revenue administration, and expenditure management; (3) clarify responsibilities and supportive roles of the oversight agencies following the principles of Rationalized Local Planning System (RPS) of the DILG, the Provincial Planning and Expenditure Management (PPEM) of the NEDA, the Updated Budget Operations Manual (UBOM) of the DBM and the upcoming local revenue guide of the DOF (DILG-NEDA-DBM-DOF JMC No. 1; NEDA).

As such, JMC No. 1 provides for the medium and long-term planning and

implementation framework and instruments for LGUs. The matrix below indicates the key planning and investment programming instruments. Figure 3 shows the planning framework for LGUs.


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Matrix 1. LGU Planning Instruments Planning

Instrument Content Timeframe

CLUP Policy guide for the regulation of land uses embracing the LGU’s entire territorial jurisdiction. It covers policies on settlements, protected areas, production areas, and infrastructure

10 to 15 years

CDP A multi-sectoral plan to promote the general welfare of the LGU. Sectoral goals, objectives, strategies, programs, projects and legislative measures

6 years

ELA A term-based component of the CDP. Sectoral goals, objectives, 3-year strategies, prioritized programs and projects, prioritized legislative measures

3 years

LDIP Principal instrument for implementing the CDP and ELA and to some extent, certain aspects of the CLUP prioritized PPAs and program planned financing

3 years

AIP Yearly investment program of the LDIP. Prioritized PPAs proposed for inclusion in the annual local budget.

1 year

Source: Drawn from the Roll-out Plan for JMC No. 1, Series 2007, DILG-NEDA-DBM-DOF. Legend: CLUP=Comprehensive Land Use Plan; CDP=Comprehensive Development Plan; ELA= Executive Development Plan; LDIP= Local Development Investment Plan; AIP= Annual Investment Program

Figure 3. LGU Planning Framework

Source: Drawn from the Roll-out Plan for JMC No. 1, Series 2007, DILG-NEDA-DBM-DOF.


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LGU-NGA Linkage. After the local investment programming process has been undertaken, the medium-term Local Development Investment Plans (LDIPs) of concerned LGUs are integrated into a Regional Development Investment Program (RDIP). This is done through a formal forum on regional planning and development participated in by local government executives, legislative representatives, national government officials and private sector representatives. It must be remembered that after the LGUs have identified and planned the development and implementation of their projects in their respective LDIPs, they must then ensure that these projects are prepared for financing, whether through local or foreign ODA sources. These are covered by the Preparation of Programmed Local Development Projects. The LDIP will be translated into the Annual Investment Program and the Local Finance Committee (LFC) will identify funding sources, that is, whether it will be externally or internally sourced.

LGUs may acquire financial assistance through NEDA Regional Offices

(NRO). Financial assistance may sourced from the different NGAs depending on its availability and NEDA regional offices may just provide information on the ODAs and other available windows. This is another process which facilitates the preparation of programmed local development project for eventual financing and implementation. The LGUs may request for assistance through the preparation of the following activities:

a) Assisting in enhancing the capability of LGUs in project

identification, preparation, evaluating and appraisal, implementation, monitoring and ex-post evaluation;

b) Reviewing the concerned LGUs programmed local development projects to develop project concepts into detailed project proposals and implementation plans;

c) Coordinating the provision of technical expertise of specific national government agencies either to develop project development capabilities of LGUs or to match necessary technical or financial resources of these national agencies in support of local development projects; and

d) Monitoring the implementation and evaluating the impact of on-going and completed local projects respectively to flag potential


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or existing problems in project development, and to derive lessons for improving the LGUs project development capability.

As to fund sources, the LFC determines the amount of total allocation for

the budget including the fund sources for the priorities included in the LDIP and AIP. They normally coordinate with NGAs on available fund sources as to whether it is a loan or a grant. No single agency coordinates available financing for LGUs.

Table 1 describes the broader policy framework of LGU financing support

from the national government (NG). The financing framework provides directional focus on the type of assistance to LGUs. It broadly segmented the market to two types of LGU clusters and rationalized MDFO to concentrate on less creditworthy LGUs. This framework, which was formulated under a technical assistance managed by DOF, provides that social and environmental projects are eligible for grants. Such projects are expected to have positive spillovers to other LGUs, On the other hand, revenue generating projects, even if these may have positive externalities, are classified as ineligible for national government grants other than technical assistance.

Table 1. LGU Financing Framework Social/Environmental Projects Revenue-Generating Projects

Creditworthy LGUs MDFO, GFI Loans BOT Projects Commercial bank loans Bonds Limited MDFO grants GFI, Commercial bank loans

Marginally Creditworthy or Non-Creditworthy LGUs MDFO grants and technical assistance (TA)

BOT Projects GFI, limited MDF Loans and TA

Source: Department of Finance. There have been several minor revisions in the LGU financing policy

framework since its formulation, but the basic principles underlying it have remained the same. The issues associated with this framework will be discussed later in this report.


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II.BACKGROUND3

A. National Government Involvement in Devolved Functions The early years of decentralization and devolution in the Philippines saw

a strong hesitation by the NG oversight agencies (e.g., DOF, DBM and NEDA) to continue NG support to devolved activities. The flow of ODA to local development activities was thus significantly affected. Meanwhile, the line agencies (national government departments) continued to provide local public goods and services like school buildings, rural roads, communal irrigation, and health services with their locally funded projects, although at a smaller scale than before.

However, the NG realized the need to have clear and definite policy

guidelines on: (1) defining the conditions that warrant NG support for devolved functions; (2) determining the appropriate form and level of this support; and (3) identifying mechanisms for channeling funds to LGUs for such assistance. Two studies were commissioned by the NEDA and the DOF with the support of the World Bank. The NEDA study identified policy options on the respective roles of national and local governments in the development and financing of local development projects that have high spillover effects and are not “bankable,” especially those addressing social and environmental concerns, and recommended an action program that specifies the regulatory and institutional measures needed to facilitate the flow of foreign assistance to such projects. The DOF study looked into modes of LGU access to capital markets and prepared an action plan for the development of a municipal credit system.

3 Some parts of this section draw from Alonzo R. Channeling Resources to Local Development Concerns: Issues and Options. Philippine Review of Economics and Business, vol. XXXIV, No. 2, December 1997; reprinted as Chapter 4 in Studies in Governance and Regulation: the Philippines, edited by D.B. Canlas and S. Fujisaki, Tokyo: IDE, 1999 (48-76).


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B. The Policy Framework for Selective National Government Intervention

1. The Rationale for NG Involvement

The first study proposed that continued NG intervention in LGU responsibilities is necessary as the devolution process poses problems for LGUs in fully undertaking devolved activities on their own, foremost of which is the lack of financial resources. Even if the IRA has risen and grant funds are made available to LGUs, some local public investment activities are so lumpy that LGUs have to source out funds through loans or credit financing. Loan programs are made available to LGUs from different sources, e.g., ODA, commercial, NG-administered programs, and programs of government financial institutions or GFIs, depending on the financial capacity of the LGUs to repay the loans.

ODA is often considered the best source of external financing made

available to LGUs given the concessional terms under which it is given (high grant element or soft terms). The LGC 1991 does not prohibit LGUs from applying for loans from foreign financing sources (commercial or ODA) to finance local infrastructure and other socioeconomic development projects in accordance with the approved local development plan and public investment program. What constrains LGUs from contracting ODA funds is the NG “guarantee” required of LGUs by the international lending institutions. The Foreign Borrowings Act (R.A. 4860) states “that the guarantee of the Philippine Government could be issued only for loans granted to government-owned and -controlled corporations (GOCCs) and GFIs. Based on the results of the first study, the inter-agency Investment Coordination Committee (ICC) of the NEDA Board, the body that approves all foreign-assisted projects, issued, in 1998, the Policy Framework for National Government Assistance for the Financing of Local Government Projects with Environmental and Social Objectives.

The policy framework identifies the following grounds for NG intervention:

(a) externalities or spillover effects, (b) economies of scale, and (c) equity. Externalities or spillover effects. Intervention by NG is justified by

spatial externalities, or when benefits or costs of public services provided by an


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LGU are realized by non-residents. In cases such as these, the jurisdiction that would be providing the service may not consider the benefits accruing to non-residents and thus may give low priority to such service. Similarly, the costs of providing the service may spill over to other jurisdictions, thus necessitating higher-level intervention.

Economies of scale. The provision of some services may be made

more cost-effective if designed for a service area larger than the jurisdiction of a single LGU. A national agency can help LGUs with small jurisdictions undertake investments jointly with adjacent LGUs to realize such economies of scale. However, if this criterion is the only basis for NG intervention, the NG share in the cost shall have to be very limited.

Equity considerations. If LGUs that are faced with tight budgetary

constraints are unable to provide the minimum level of services to their constituents, NG intervention may be warranted. The eligibility of LGUs will be based on their respective income and economic classifications, the latter to be measured by poverty incidence. Programs of assistance should give priority to the needs of relatively disadvantaged LGUs in the allocation of resources.

2. The Nature of National Government Assistance

Providing assistance to LGUs under the Policy Framework for National Government Assistance for the Financing of Local Government Projects with Environmental and Social Objectives shall be in the form of matching, specific and closed-ended grants. The grants shall be conditional on the participating LGUs putting up their share of the cost and preparation work. They shall be for specific and authorized expenditures in line with the intentions of the national program, and cannot be used to finance deficits of LGUs arising from spending decisions that are outside of the scope of the program. Finally, they are meant to be temporary and limited where costs are well known to both LGUs and the national agency at the outset.

In cases where LGUs need to tap external financing for devolved

projects, NG intervention is necessary and LGU borrowings shall be governed by the standing ICC policy on LGU access to ODA funds. Under this policy, ODA


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loans for devolved activities are to be channeled as loans to LGUs through either two conduits, namely, the Municipal Development Fund (MDF) or through a GFI under relending terms to be determined by their respective policy making bodies.

3. Principles for Designing NG Assistance

A set of considerations and parameters were formulated in order to

ensure the effectiveness of LGU programs being partly supported by NG, and to make sure that ODA facilities guaranteed by NG cater to the needs of the LGUs.4 These are:

a. The role of community involvement cannot be taken for granted.

Consultation with, and participation of, communities ensures that programs are need-based and appropriate for the local resources and capabilities.

b. LGUs are, in principle, better implementers of local projects than national line agencies because they have a closer feel of the people’s needs. National programs should allow LGUs to make decisions in targeting interventions based on their awareness of the different conditions and preferences of communities within their respective jurisdictions.

c. Community equity contributions and LGU counterpart are essential to the quality of project outcomes. Imposing local counterpart induces a degree of local involvement and accountability for the spending, even as it is supported by the NG.

d. Cost recovery through user charges shall be encouraged; recurrent operation and maintenance expenditures shall be given low priority for NG grants. National programs should develop mechanisms to enable LGUs to collect user charges to raise revenues for the operation and maintenance of local public facilities.

e. Implementing arrangements shall promote inter-agency coordination. Inter-agency coordination is needed for programs that may overlap in target areas and beneficiaries. NG agencies shall seek to harmonize

4 Based on Alonzo R. Channeling Resources to Local Development Concerns: Issues and Options 1999.


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their prioritization criteria in order to convey consistency in NG policies for supporting LGU investment activities.

f. Private sector participation shall be elicited whenever feasible. Private sector participation shall be harnessed at all levels of government through, among other modalities, competitive bidding, build-operate-transfer schemes, franchising and volunteerism.

g. The grantors’ objectives shall be safeguarded. The NG shall monitor the implementation of programs against stated national objectives for the sector. The national line agencies shall take the lead role in the sponsorship of such programs and the sectoral justification that shall usher the program through the investment appraisal process to the mobilization and release of funds for them.

C. The Foreign Borrowings Act of 1966

Republic Act No. 4860 or better known as the Foreign Borrowings Act of

1966 authorizes the President of the Philippines to obtain foreign loans and credits to finance approved economic development projects or purposes. It also allows the President to guarantee, on behalf of the Philippine government, foreign loans or bonds issued by government-owned and controlled corporations for economic development purposes. The Act however has no provision either for foreign borrowings of local governments or for the issuance of a guarantee from the President, on behalf of the Philippine government, for such loans. Since this law was enacted in 1966 (prior to the passage of Decentralization Act of 1967 and the 1991 Local Government Code), this deficiency is understandable.

D. The LGU Grant Financing Framework and Cost-Sharing Principles

Within the policy framework adopted by the ICC, the national line

agencies, in consultation with the LGUs, shall be responsible for the preparation of sectoral projects and programs that shall contain priority LGU activities eligible for NG grant assistance. These activities shall be financed through NG-LGU cost-sharing arrangements. The implementation of the program activities, however, shall always be the responsibility of the LGUs, with NG providing technical assistance.


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A set of sectoral guidelines for the financing of devolved activities with social or environmental objectives was formulated by DOF to provide more specific guidance to NG agencies as well as LGUs in the preparation of programs and projects.

The four sectors covered by the initial guidelines are: a) water supply; b)

rural infrastructure, e.g. roads, communal irrigation, public markets, abattoirs, etc.; c) health; and d) the environment. The said guidelines are:

a. Water supply – Only 5th and 6th class LGUs shall be eligible for a 50%

grant from the NG, and the grant shall apply only to level 1 (source development) systems.

b. Rural Infrastructure – Given the large investments involved in communal irrigation projects, all LGUs, irrespective of income class, shall be eligible for NG grants for such projects. The maximum NG grant shall be 50% for 5th and 6th class LGUs. First class LGUs shall receive a maximum of 20%. These NG grants shall be applied as a percentage of capital costs, i.e., exclusive of O&M expenditures. Meanwhile, revenue-generating projects such as public markets and bus terminals, as well as provincial and municipal roads shall not be eligible for any NG grant.

c. Health – For health projects, all LGUs are eligible for NG grants, which range from 50% to 90%, depending on the LGU’s income class. These NG grants shall also be applied as a percentage of capital costs. LGUs shall be required to shoulder operating costs to ensure that the project can be sustained.

d. Environment – Projects under the green and blue sub-sectors (e.g., forest management, protected area management, soil conservation, watershed protection, and coastal resource management) require less capital costs and the environmental concerns they address usually cut across several LGUs. For these sub-sectors, therefore, NG grants shall be based on total project cost. Personnel services as well as maintenance and operating expenses are eligible cost items under the NG grant. These grants range from 20% to 70%, depending on the LGU income class. “Brown” projects (solid and industrial waste management and pollution control projects) are expected to be located


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in urbanized areas and may be designed as revenue generating. Environment-related projects, e.g., sanitary support facilities for public markets, will also be eligible for NG grants. Third to sixth class LGUs that require sanitary support facilities may avail of 50%-70% grant for the total cost of these support facilities. Annex 1-A contains the different NG-LGU cost-sharing schemes.

The cost-sharing scheme between NG and LGUs for devolved activities is meant to be temporary. As the LGUs’ financial resources improve, or as factors affecting LGUs’ capacity to provide for devolved activities change, this ICC policy would be adjusted accordingly.

In 2009, DOF issued DO 40-09 adopting the revised guiding principles and NG-LGU Cost-Sharing Policy, which covers the cost of civil works only for devolved activities. It excludes pre-implementation activities, e.g., FS, detailed engineering design, site development and right of way, among others; and the post-implementation costs for operation and maintenance. It maintains the ICC policy that the maximum allowable grant should not be more than 50% of the total subproject cost. It also provides that of the total equity requirement of the LGU, 10% of the total subproject cost should be a cash component.

Moreover, the financing policy included the newly-approved NG-LGU Cost Sharing Policy for Solid Waste Management project, excluding Metro Manila LGU since they have special SWM requirements and management arrangements.

The new policy categorizes civil works into three (3) clusters and

classifications with an indicative list of subprojects. Cluster 1 covers “public economic enterprises” subprojects such as

public markets, slaughterhouse, bus and jeepney terminals, municipal wharves and fish ports, post harvest facilities, cold storage facilities, ice plants, water supply level III, and public memorial parks.

Cluster 2 is further classified into social subprojects and green/blue

subprojects. “Social” subprojects include health centers, lying in clinics, schools


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buildings, water supply level I and II, communal irrigation, farm to market roads, rural roads or local roads, bridges, among others. Green/blue subprojects may include reforestations, forest related activities, soil conservation, mangrove and watershed protection, review and seashore protection, etc.

Cluster 3 consists of brown environment-related subprojects, which are

sub-categorized as water waste facilities and projects, e.g. drainage, sewerage and sanitation support; and SWM facilities and projects such as materials recovery facilities, sanitary landfill and transport systems. Annex 1-B the revised Loan-Grant-Equity for the three clusters.


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II. CURRENT SITUATION

A. LGU Access to ODA

This part of the study report presents the general picture of LGU access to ODA as it covers both the loan and grant components of the facility. It is based on a rapid survey conducted by the authors among NG agencies with ODA funded projects accessed by LGUs for the period 1998 to 2008. The survey did not include the Department of Education (DepED) and the attached agencies of the Department of Agriculture (DA). It also did not cover the GFIs (Development Bank of the Philippines or DBP and Land Bank of the Philippines or LBP) and the GOCCs (e.g., Local Water Utilities Administration or LWUA, Subic Bay Metropolitan Authority or SBMA, Bases Conversion and Development Authority or BCDA, and Laguna Lake Development Authority or LLDA). These government agencies and financial institutions were not present in the workshop-meeting convened by NEDA-PMS and the authors.

Among the agencies surveyed were the following: National Irrigation Administration Department of Social Welfare and Development Department of Agriculture Department of Agrarian Reform Department of Health National Economic and Development Authority

Aside from the survey conducted in the aforementioned NGAs, another

source of data for ODA funded projects is the Asian Development Bank. Results of the survey reveal that, from 1998 to 2008, there were 1,625

ODA funded projects in the 80 provinces across the country. Table 2 presents the 10 provinces with the most number of ODA funded projects, while Annex 2 shows the complete ranking of provinces based on the number of ODA funded projects per LGU.


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Table 2. The Ten Provinces with the Most Number of ODA funded projects, 1998-2008

Province Regional Location No. of ODA funded projects

1. Agusan del Sur Region XIII 43 2. Negros Occidental Region VI 39 3. Antique Region VI 37 Iloilo Region VI 37 Surigao del Sur Region XIII 37 4. Cebu Region VI 34 5. Bohol Region VII 33 North Cotabato Region XII 33 Zamboanga del Sur Region IX 33 6. Zamboanga del Norte Region IX 32 7. Maguindanao ARMM 31 8. Albay Region V 30 Misamis Occidental Region 30 9. Leyte Region VIII 28 10. Agusan del Norte Region XIII 26 Bukidnon Region X 26 Capiz Region VI 26 Lanao del Sur ARMM 26 Pampanga Region III 26 Sultan Kudarat ARMM 26

Of the top ten provinces, only Albay and Pampanga are in Luzon. The

majority is in Mindanao (11) and the rest, in the Visayas (7). The province with most ODA funded projects is Agusan del Sur with a total of 43 ODA-funded projects, followed by the province of Negros Occidental with 39 ODA-funded projects. The provinces of Antique, Iloilo and Surigao del Sur tied for the third slot with 37 projects each.

Meanwhile, of the seven (7) provinces with the least number of ODA

funded projects, the majority is located in Luzon (Table 3). The fact that Dinagat Island had the least number of ODA funded projects could be explained by the fact that the province is a newly created one.


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Table 3. Provinces with the Least Number of ODA funded projects, 1998-2008 Name of Province Regional Location Number of ODA funded

projects 1. Dinagat Island Region XIII CARAGA 2 2. Marinduque Region IV-B 3 3. Batanes Region II 5 4. La Union Region I 7 5. Catanduanes Region V BICOL 8 Siquijor Region VII 8 Zambales Region III 8

Mindanao and the Luzon had two each of regions with the most number of ODA funded projects (Table 4). Region VI or Central Visayas had the highest number of projects assisted by ODA at 167. Next in rank was Region XIII (CARAGA) with 133 ODA funded projects. (Also see Annex 3)

Table 4. Top Five Regions Based on ODA funded projects, 1998-2008 Rank Region No. of ODA funded

projects 1 Region VI (Central Visayas) 167 2 Region XIII ( CARAGA) 133 3 Region V (Bicol) 122 4 ARMM 120 5 Region III (Central Luzon) 117

Except for one, the five regions with the least number of ODA funded

projects are all in Luzon. Ilocos region had the least number of ODA funded projects with 60, followed closely by Cagayan Valley with 62. Zamboanga Peninsula had the fifth least number of ODA funded projects, but this could be explained by the fact that there are only three (3) component provinces in this region. (Table 5) In reality, two provinces of Zamboanga Peninsula are among the 10 provinces with the most number of ODA funded projects. (Table 2)

Table 5. Bottom Five Regions Based on ODA funded projects, 1998-2008 Rank Region No. of ODA funded

projects 1 Region I – Ilocos Region 60 2 Region II – Cagayan Valley 62 3 Region IV-A – Calabarzon 75 4 Region IV-B – Mimaropa 77 5 Region IX- Zamboanga Peninsula 84


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The ODA accessed by LGUs funded projects in the following sectors: health, social services, infrastructure, environment, agriculture and others (energy, rural development, and good governance). Of these sectors, agriculture/agrarian reform accounted for the most number of ODA funded projects (421 or 26%). It was followed closely by infrastructure (413 or 25.4%) and then by health (218 or 13.4%). Education (115 or 7.1%) and social services (132 or 8.1%) had the least number of projects (Table 6, Figure 3, and Annex 4, with the latter containing the sectoral distribution of ODA funded projects by province).

Table 6. Number of ODA funded projects by Sector, 1998-2008

Sector Number of ODA funded projects

Percentage to Total

Agriculture/Agrarian Reform 421 26.0% Infrastructure 413 25.4% Health 218 13.4% Environment 153 9.0% Social Services 132 8.1% Education 115 7.1% Others 173 11.0%

Total 1625 100.00%

Figure 3. ODA funded projects by Sector, 1998-2008

Source: Survey.

0

50

100

150

200

250

300

350

400

450

Agri Educ Env Health Infra Soc Others


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All the provinces with the most number of ODA funded projects in

agriculture/agrarian reform are in Mindanao except for Leyte (Visayas) and Albay (Luzon) (Table 7). The rest of the provinces in the country had less than 10 projects except for Dinagat and Rizal which had no agriculture/agrarian reform projects that were ODA funded (Annex 5).

Table 7. Provinces with the Most Number of ODA-Funded Agriculture/ Agrarian Reform Projects, 1998-2008

Provinces No. of ODA funded projects in Agriculture/Agrarian Reform

1. Agusan del Sur 13 Davao del Norte 13 Zamboanga del Norte 13 2. Davao del Sur 12 Misamis Occidental 12 Misamis Oriental 12 3. Albay 11 Zamboanga del Su 11 4. Leyte 10 Surigao del Norte 10

Most of the provinces with 10 or more infrastructure projects funded by

ODA are in Luzon (5) and in the Visayas (4) while only Surigao del Sur and Zamboanga del Norte are in Mindanao (Table 8). On the other hand, the eight (8) provinces with no infrastructure projects funded by ODA are mostly in Mindanao (Basilan, Dinagat Island, Siquijor, Sulu, Tawi-tawi and Zamboanga Sibugay) (See Annex 6).

Table 8. Provinces with the Most Number of Infrastructure Projects, 1998-2008

Provinces No. of ODA funded projects in Infrastructure

1. Negros Occidental 23 2. Antique 20 3. Iloilo 19 4. Surigao del Sur 16 5. Pampanga 14 6. Cebu 12 Rizal 12 7. Ilocos Norte 11 8. Albay 10 Pangasinan 10 Zamboanga del Norte 10


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While the 2008 survey was certainly not exhaustive due to resource and time constraints, and did not cover all government agencies availing of ODA and offering LGUs access to the ODA funds, the survey results nevertheless indicate that practically all provinces have received ODA assistance. At lower units of jurisdiction, however, one will invariably find a municipality or barangay that has not received any direct support from ODA funds. This arises from the sheer number of municipalities (more than 1,500) and barangays (more than 40,000) around the country. These LGUs nevertheless are likely to have benefitted indirectly from ODA through government projects that are national or regional in scope but with strong local benefit incidence (such as arterial roads, railroads, ports and airports, and irrigation facilities).

B. LGU Access to ODA Grant Funds

While Section 23 of the LGC grants authority to LGUs to negotiate and secure grants from foreign agencies without needing to get a clearance from any NG entity, the reality is that there is not much ODA grant funds to move around. ODA grants have historically comprised at most 10% of total ODA flows (Table 9).5 The average value of a grant project is also much less than the average value of a loan project.

Table 9. Value and Number of ODA Loans and Grants,1997, 2002, and 2007 1997 2002 2007 Loans ($ mln) 11,400 11,900 9,747

Number 187 204 130 per project value 61.0 58.3 75.0

Grants ($ mln) 1,230 940 723 Number 237 211 89 per project value 5.2 4.5 8.1

Grants/Total ODA 10.8% 7.9% 7.4% Grant/loan size 8.5% 7.6% 10.8%

Source: NEDA, ODA Portfolio Reviews, various years. The relative amounts of ODA grant funds are even smaller in terms of budgetary obligations and appropriations. Grant proceeds from ODA, as reflected in the national government’s budget, comprise less than 2% of allocations for 5 Based on NEDA ODA Portfolio Reviews.


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foreign-assisted projects (Table 10), which accounted for less than 10% of all projects for 2008 and 2009 (Table 11).

Table 10. Appropriations and Allocations for Foreign-Assisted Projects (In

thousand pesos) GAA 2008 Share BESF 2009 Share Peso Counterpart 10,393,080 31.2% 11,897,150 29.2% Loan Proceeds 22,401,683 67.2% 28,486,473 69.8% Grant Proceeds 538,815 1.6% 423,756 1.0% Total 33,333,578 100.0% 40,807,379 100.0%

Source: DBM, Budget of Expenditures and Sources of Financing, 2009.

Table 11. Obligations for Projects, by Type, 2007-2008 (In thousand pesos)

Project Type 2007 2008 2009 Amount % Amount % Amount %

Locally-Funded 304,698,010 88.6% 490,122,756 93.6% 557,414,406 93.2% Foreign-Assisted 39,235,689 11.4% 33,333,578 6.4% 40,807,379 6.8% Total Projects 343,933,699 100.0% 523,456,334 100.0% 598,221,785 100.0% Source: DBM, 2009 National Expenditure Program.

Thus, the likelihood of an LGU securing an ODA grant is low relative to getting a locally-funded project. Not only have the absolute amount and relative share of grant funds in total ODA commitments been declining, but the absolute number of grant projects has also been falling (from 237 projects in the 1997 ODA portfolio to only 89 projects in the 2007 ODA portfolio).

At the same time, the number of LGUs (provinces, cities, and

municipalities) has been growing. Making the situation worse for LGUs is that they have to compete with the large number of agencies of the NG, both line and oversight for the limited amount of grants. As the 16th ODA Portfolio Review notes, however, some grants (e.g., for the 2007 ODA Portfolio, 26 out of the 89 grant projects) “have no indicated amounts as assistance from multilateral and bilateral partners and come in the form of experts, equipment and studies.” In the 2007 ODA Portfolio, practically all reported grants were coursed through the line agencies of the NG (Table 12), with the notable exception being the grant assistance to the Supreme Court. What this implies is that much of what ODA grant funds the LGUs may expect would ordinarily pass through the national government agencies (NGAs). Incidentally, the NGA with the biggest share of grant aid, the Department of Transportation and Communications (DOTC), is one


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that is not likely to have subprojects at the local level. The Department of Health (DOH) and the Department of Environment and Natural Resources (DENR), received the second and third largest grant amount, are actually departments with many devolved functions under the 1991 LGC.

Table 12. ODA Grants, by Implementing Agency, (2007 ODA Portfolio)

Implementing Agency Grant Amount (In US$)

Share (in %)

DOTC 196,472,143 27.2% DOH 178,845,461 24.7% DENR 109,065,631 15.1% DepEd 89,760,000 12.4% DAR 35,050,000 4.8% DOE 33,516,761 4.6% DSWD 22,550,000 3.1% DOF-BIR 19,557,224 2.7% DTI-SBGFC 7,580,000 1.0% DA 7,000,000 1.0% MWSS 2,000,000 0.3% PNP 1,540,000 0.2% PRRC 1,000,000 0.1% DILG 511,409 0.1% Supreme Court 18,869,866 2.6% TOTAL 723,318,495 100.0%

Source: NEDA, 16th ODA Portfolio Review.

The average grant amount per project among the top four donor institutions (Table 13) is huge compared to the size of the economy of the typical LGU. In peso terms, for example, the average JICA grant project amounts to more than P1 billion, of the typical LGU – whether it be a province, city, or municipality.

Table 13. ODA Grants, by Funding Source (2007 ODA Portfolio) Donor

Agency Grant Amount

(in US$) Share in

Total Amount per

Project (US$) JICA 228,940,239 31.7% 25,437,804 USAID 148,286,180 20.5% 13,480,562 UN 141,195,885 19.5% 14,119,589 EC 67,310,000 9.3% 22,436,667



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Perhaps mainly because of the initiatives of the Philippine Development Forum’s Working Group on Decentralization and Local Government, the NEDA website now carries a listing of ODA facilities for LGUs (dated 31 March 2009). The 11-page downloadable document gives the name of the project, the implementing agency, the donor, the project objectives and main areas of assistance, the target regions and LGUs, the eligibility criteria for assistance, the project duration and status, and the contact details.

Only five of the 19 projects are managed directly by the donors and the

rest involve an NGA or a GFI. Not all projects in the list are grant projects as nine are credit facilities for relending to LGUs. These nine relending facilities involve the GFIs Land Bank and the Development Bank of the Philippines and the Municipal Development Fund Office (MDFO) as conduits (Table 14).

Table 14. ODA Facilities for Local Government Units, (as of 31 March 2009) No. Program/project Development

Agency 1 Perez-Guerrero Trust Fund for Economic and Technical

Cooperation DFA/UNDP

2 LGU Investment Program LBP/KfW

3 Philippines-Australia Community Assistance Program (PACAP) AUSAID

4 Small Projects Scheme (SPS) NZAID

5 Secondary Education Development and Improvement Project (SEDIP) DEPED/JBIC/ADB

6 Grant Assistance for Grassroots Human Security Project GOJ/EMBASSY

7 Mindanao Basic Urban Services Sector Project DILG/LBP/ADB/NDF

8 Infrastructure for Rural Productivity Enhancement Sector Project DA/ADB

9 Credit Line for Waste Management Program for LGUs DBP/KfW

10 Health Sector Reform Agenda Support Program DOH//MDFO/KfW 11 Japan Fund for Poverty Reduction (JFPR) ADB 12 Local Governance Support Program in ARMM DILG/CIDA 13 EIB-DBP Global Loan Facility DBP/EIB 14 Credit Facility for Environmental Management Project DBP/SIDA

15 LGU Finance and Development (LOGOFIND) Project MDFO/WB

16 Support for Strategic Local Development and Investment Project LBP/WB

17 Mindanao Rural Development Project, Phase 2 DA/WB

18 Credit Line for Energy Efficiency and Climate Protection DBP/KfW

19 Dialogue on Governance: Strategic Project Facility 2 EC

Source: www.neda.gov.ph/progs_prj.asp

http://www.neda.gov.ph/progs_prj.asp


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The above list, though partial, may be indicative of the directions that LGUs should pursue in view of their known capacity constraints and the limited amount of ODA that is channeled to local governments. There will be a need for greater collaboration with oversight agencies (NEDA, DILG and DOF) and donor agencies to improve the access of LGUs to ODA facilities.

C. Other ODA Resources Available to LGUs

Other than grants, LGUs may wish to consider loans as fund sources for

their development projects. Loans constitute a much bigger share of ODA resources (Table 9) and there are many loan projects that are meant for collaboration with LGUs. And, the share of ODA loan-financed projects with LGU participation to total ODA loan projects have been increasing, from 16.7% in 2000 to 21.1% in 2008 (Table 15). In the context of the NEDA’s ODA Portfolio Reviews, a project with LGU participation is one where the LGU enters into an agreement with the executing agency (an NGA, a GOCC, or a GFI, or a combination of two or three institutions) as co-implementer of a subproject, with the LGU committing to put up equity as its contribution to the subproject cost. Especially (but not exclusively) for projects that are revenue generating, the LGU is also expected to assume a sub-loan to help finance the subproject. Loan-financed projects with LGU participation that are undertaken by the GFIs invariably involve relending to the LGUs. Most projects of the MDFO also involve relending.

Table 15. ODA Loans with LGU participation, 2000-2008 Year With LGU

Participation Total, Projects % LGU

2000 1,977.3 11,846.3 16.7% 2001 1,846.9 11,963.3 15.4% 2002 1,910.4 10,790.9 17.7% 2003 1,866.2 10,129.5 18.4% 2004 1,898.8 10,531.2 18.0% 2005 1,826.9 9,844.1 18.6% 2006 1,633.6 8,167.0 20.0% 2007 1,387.7 7,575.5 18.3% 2008 1,722.9 8,155.9 21.1%

Source: NEDA, ODA Portfolio Reviews, various years.


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However, the absolute amount of loans with LGU participation has been declining, even without adjusting for inflation. One reason for this phenomenon is that in recent years, the Philippine Government and its major donor partners, particularly the multilateral agencies, have been moving away from project loans towards program loans (Table 16). The surge in program loans since 2006 may also be attributed to the “easing up” on the policy reform conditionalities that go with them, as the Philippine fiscal situation has begun to show substantial improvements.

The total amount of ODA commitments has also been declining, from

US$13.3 billion in 2000 to only US$9.7 billion in 2007, bouncing back only slightly to US$10.0 billion in 2008. This is partly the outcome of the improving fiscal situation in the country, with domestic interest rates and the spread on commercial borrowings from the international financial markets declining.

Table 16. Project vs. Program Loans, 2000-2008 Year Projects Programs % Programs

$ mln No. $ mln No. $ mln No. 2000 11,846 196 1,467 7 11.0% 3.4% 2001 11,963 195 1,211 7 9.2% 3.5% 2002 10,791 198 1,065 6 9.0% 2.9% 2003 10,129 184 788 5 7.2% 2.6% 2004 10,531 176 150 1 1.4% 0.6% 2005 9,844 160 350 2 3.4% 1.2% 2006 8,167 135 1,310 6 13.8% 4.3% 2007 7,576 119 2,171 11 22.3% 8.5% 2008 7,906 119 2,131 11 21.2% 8.5%

Source: NEDA, ODA Portfolio Reviews, various years.

D. Equity in the Distribution of ODA Resources Much concern has been expressed about the distribution of ODA across

the different regions of the country. There is often the presumption that the National Capital Region has been getting the lion’s share of public investments, including those from ODA.

Luzon’s share in foreign assisted projects is almost equal to its share in

the total population of the country. The imbalance is between the Visayas and Mindanao, the latter having a smaller share of the ODA funded projects while


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having a bigger share in the total population. However, Luzon’s share in ODA funded projects is not matched by its share in the GDP. The ratio of share in ODA funded projects to share in GDP favors the Visayas and Mindanao, with the Visayas having a 24.5% share in ODA funded projects while having a 16.4% share in the GDP. Mindanao meanwhile has a 19.1% share in ODA funded projects and a 17.8% in GDP (Table 17). Thus, relative to their regional GDP, the poorer regions do get more ODA-funded projects than the richer ones. The distribution seems to reflect the conscious effort of the national government and the donor agencies to channel most of the ODA resources to the poorer regions of the country.

Table 17. Shares in ODA funded project Costs*, Population, and GDP by Region (Based on 2003 ODA Portfolio)

LUZON 56.4 55.9 65.7I 6.3 5.5 3.0II 2.0 3.7 2.1III 14.2 10.5 9.0IV 8.6 15.2 15.9V 3.5 6.1 2.9NCR 19.1 13.0 30.5CAR 2.7 1.8 2.4

VISAYAS 24.5 20.3 16.4VI 10.0 8.1 7.1VII 8.5 7.5 7.0VIII 6.1 4.7 2.3

MINDANAO 19.1 23.8 17.8IX 3.0 3.7 2.6X 3.2 4.6 4.8XI 3.3 4.8 4.5XII 3.0 4.2 3.6ARMM 1.4 3.7 0.9CARAGA 5.2 2.7 1.4

Share in 2003 Popularion

Share in ODA Projects

Share in 2003 GDPArea


* Includes loan proceeds and GOP counterpart.

Table 18 compares resources per capita from ODA-funded projects with poverty incidence (percent of poor families) across regions. No clear pattern is discernible concerning the relationship between poverty incidence and project presence. In fact, a regression analysis using data from Tables 17 and 18 indicate that neither poverty incidence nor per capita gross regional domestic product (GRDP) has any statistically significant influence on per capita ODA-financed public investment across regions. Thus, while at initial glance Tables 17 and 18 may initially suggest that poorer regions get more ODA-funded public


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investment, statistical analysis does not show any significant affirmative action bias in favor of poorer regions. Neither is there a bias in favor of the richer regions.

Table 18. Per Capita Cost* of ODA funded projects by Region vs. Poverty Incidence (Based on 2003 ODA Portfolio)

Area P million* P/capita % Poor LUZON 12,874 4,989 17.9

I 23,675 5,636 24.4 II 7,450 2,648 19.3 III 53,595 6,674 13.4 IV 32,647 2,805 19.5 V 13,350 2,849 40.6 NCR 72,112 7,260 4.8 CAR 10,044 7,356 25.8

VISAYAS 92,590 5,963 29.4 VI 37,735 6,075 31.4 VII 31,934 5,596 23.6 VIII 22,921 6,349 35.3

MINDANAO 72,006 3,971 38.1 IX 11,159 3,941 44.0 X 12,055 3,439 37.7 XI 12,425 3,380 28.5 XII 11,230 3,485 32.1 ARMM 5,429 1,937 45.4 CARAGA 19,707 9,405 47.1

Source: NEDA, 12th ODA Portfolio Review. * Includes loan proceeds and GOP counterpart. Provincial, subproject-level data on ODA utilization are available from a

survey of line agencies that have projects involving LGU participation. An earlier section of this paper describes the results of the survey and analyzes the survey data in detail. Here the analysis is extended by way of appending additional variables onto the provincial database and running multivariate analysis on the revised set of data. The new variables added are: (a) the 2001 fiscal income class of the province, (b) population, and (c) 2003 poverty incidence among families.

Table 18 reports the average number of subprojects per province, by fiscal

income class of province. Based on this table, the poorer (lower-class) provinces


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tend to have fewer subprojects than the richer ones. For example, 4th class provinces have, on average, 13 subprojects each, while 1st class provinces have 22 subprojects each. The same pattern is observed across the three major island groupings.

Table 19. Average Number of ODA Subprojects per Province, by Area by

2001 Income Class Class Luzon Visayas Mindanao Total

1 17.6 27.5 27.8 22.2 provinces 19 6 10 35

2 16.6 20.7 25.6 21.6 provinces 8 6 11 25

3 15.0 28.0 20.5 17.0 provinces 9 1 2 12

4 4.0 20.7 11.3 13.0 provinces 2 3 3 8

Total 16.1 23.7 24.4 20.3 provinces 38 16 26 80

Source: survey data.

As one corrects for provincial population, however, the opposite pattern emerges. Table 20 gives the number of projects per million residents per province, across fiscal income class. It shows that the poorer LGUs in fact have access to more ODA-funded subprojects.

Table 20. ODA Subprojects per Million Residents per Province, by Area by 2001 Income Class

CLASS Luzon Visayas Mindanao Total 1st 14.2 38.8 34.7 24.3

provinces 19 6 10 35 2nd 31.0 39.2 46.0 39.6

provinces 8 6 11 25 3rd 82.8 6.26 37.5 69.7

provinces 9 1 2 12 4th 163.0 75.5 62.8 92.6

provinces 2 3 3 8 Total 41.8 44.4 43.0 42.7

provinces 38 16 26 80 Source: Survey data.

Another way of ascertaining if access to ODA funded projects has been


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equitable is by comparing the number of subprojects per province (absolute and per capita) with poverty incidence. It must be noted that a 1st class province does not necessarily have a low poverty incidence. Zamboanga del Norte, for example, is a 1st class province in terms of LGU income, but 65% of its resident families were poor in 2003, the highest poverty incidence among provinces. On the other hand, Batanes, a 4th class province, had a poverty incidence of only 6% in 2003.

In Table 21, provinces are grouped by quintile in terms of poverty

incidence; the richest provinces, grouped in the first quartile have poverty incidences above or below the national mean of 24.4%. No discernible pattern emerges.

Table 21. Subprojects per Province and per Million Residents per Province

by Quintile in Poverty Incidence Quintile % Poor, 2003 Projects Per million Richest 3.4% - 20.9% 15.1 46.7 Second 21.6% - 30.3% 20.1 32.8 Third 31.1% - 34.5% 23.3 45.5 Fourth 34.6% - 41.5% 20.3 35.6 Poorest 43.1% - 64.6% 22.8 52.8 Total 3.4% - 64.6% 20.3 42.7

Regressions were run on the survey data aggregated by province, with

the dependent variables composed of the overall number of projects and the sectoral breakdowns. The first row of Table 22 below shows that population, income class, and poverty incidence together explain more than one-fourth of the variation in the number of subprojects across provinces. All the three explanatory variables are significant at the 2% level or better. The bigger the population, the poorer the LGU, and the higher the poverty incidence in the province, the more ODA-funded projects there are. Across sectors, health has the poorest fit. Of the explanatory variables, poverty incidence is the one most consistent in its influence on the number of projects, overall and by sector, within the province. It would seem, therefore, that indeed, there is a pro-poor bias in ODA-funded projects, at least at the subproject level.


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Table 22. Significance Levels of Regression Coefficients

Dependent Variables Independent Variables POPN CLASS POV03 F adj R2

All Projects 0.016 0.020 0.000 0.000 0.280 Infrastructure 0.001 0.829 0.070 0.002 0.144 Education 0.198 0.740 0.048 0.035 0.071 Social Services 0.703 0.659 0.000 0.001 0.172 Agric/Agrarian Reform 0.264 0.000 0.002 0.000 0.230 Health 0.249 0.830 0.472 0.654 -0.018 Environment & Nat Res. 0.000 0.815 0.041 0.000 0.366

E. Summary

The empirical evidence gathered by the study shows that: (a) LGUs should not pin much hope on access to ODA grants as the total amount of ODA grants has historically been small relative to the number of LGUs and their corresponding development needs; (b) the much bigger ODA pool open to LGUs is the portfolio of loans for relending to LGUs coming from the GFIs and MDFO, as well as the matching grant projects of some NGAs like DOH, DepEd, DAR, and DENR; and (c) there does not seem to be any bias in access in favor of either the rich or the poor LGUs. However, there may be a case for enlarging the share of LGUs in the limited pool of ODA grants. To do this there is a need not only to address the capacity constraints of LGUs but also to argue this point among policy makers and the oversight agencies. A good forum to discuss the goal of expanding the access of LGUs to ODA grants and of generating support from donors and oversight agencies is the Working Group on Decentralization of the Philippine Development Forum,


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III. CERTAIN ISSUES AND CONCERNS

A. Seeking, Managing, and Monitoring ODA at the Local Level

1. Positive Stories and Good Practices to Share

Section II of this report has shown that ODA grant funds are scarce and

getting scarcer. Yet stories of successful LGU-ODA donor partnerships abound, especially with those involving the bilateral aid agencies. The high visibility of successful projects is attributable to the advocacy conducted for them by the donor, the LGU concerned, and the project itself.

As mentioned earlier, most of the bilateral grant projects are small

relative to loan projects. Their coverage is therefore limited initially to a few LGUs so that they could be more focused, with their project design often involving some innovative aspects of local development. The idea is to identify and develop new modes of intervention that, if proven to be successful, may be graduated or scaled up to the national level. A project that is deemed worth replicating may get picked up by a multilateral agency (ADB or the World Bank) or by the same bilateral donor agency that developed it.

The geographical spread and coverage of ODA grants is the outcome of

the regular country assistance programming meetings between the GOP and the donor partner. All donor partners, multilateral or bilateral, take off from the GOP’s own official statements of development goals and strategies, as enunciated in the current Medium-Term Philippine Development Plan (MTPDP), Medium-Term Public Investment Program (MTPIP), the President’s State of the Nation Address (SONA), and other major policy pronouncements that the President and the Cabinet may have made. The MTPDP contains the President’s agenda for the nation, which may cover such areas as the following: better health outcomes, better access to education, fiscal strength, poverty reduction, national harmony and other development objectives.

In the country assistance programming meetings, the GOP, which is

represented by NEDA (as lead agency), other oversight agencies and some line


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agencies, especially those with which the donor agency has an ongoing project or program, may suggest particular areas of assistance or projects. Generally, however, donor agencies are given much leeway in choosing their LGU partners. The bilateral donor agencies often propose projects to be implemented at the local level, particularly some parts of the Visayas and Mindanao, or areas where they may have had some previous exposure, so as to “build on” earlier assistance.

Drawing from a presentation made by the program director of the Local

Governance Development Program of AusAID during the workshop on “Enhancing Coordination and Management of ODA by LGUs,”6 the following are the “success factors” for effective LGU access to ODA funds and facilities:

Dynamic leadership of the local chief executive United vision and ability to gain consensus Clear development goals Competence of the PPDO – effective human resource selection, training

and development Good information to support decision making and funding applications Proactive effort to attracting ODA -- marketing of needs, demand driven Counterpart support that anticipates needs to make the partnership work,

including a specific allocation of counterpart funds Active effort to coordinate projects at all levels Active seeking of ways to develop public-private sector partnerships Policy environment that encourages building on initiatives of previous

administrations

2. Scaling Up and Avoiding Duplication

Precisely because donor agencies want to have nice and positive stories to tell to illustrate the success of their assistance, careful planning and selection of pilot sites or LGUs for project implementation are conducted by both donor agencies and the recipient LGUs, sometimes with the collaboration of certain

6 The Workshop was sponsored by the PDF Working Group on Decentralization and Local Government, held in Tagbilaran City on November 23, 2006. The enumeration above is slightly edited.


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national government agencies. Equipment and technical experts are supplied by the donors while counterpart personnel and sometimes, counterpart funds too, are provided by the pilot LGUs. However, it may happen that when the pilot project is replicated or expanded to include more LGUs project performance may fall short of the level of success achieved in the pilot LGUs. The LGUs in the expansion or scaling up phase may not have the same technical and managerial resources present in the pilot LGUs. Here is where weak local capacity arises as a constraint to successful project implementation.

There is also the problem of finding a sufficient number of LGUs to

participate in the scaling up as the LGUs are now expected to put up most of the resources (that is, equity in cash or in kind) to complement the grants or given by the donor partner to the pilot LGUs.

Moreover, because LGUs with those desirable traits are not that easy to

find, donor agencies sometimes converge on the (already) financially and technically capable LGUs with offer of more technical assistance, loans or grants, which results in wasteful duplication of assistance. A decade ago, for example, there were several competing ODA grant facilities on poverty monitoring and local development planning, such that one province in Mindanao had four such facilities going on at the same time, all on how to prepare a medium-term provincial development plan and install a community-based poverty monitoring system.7 Because donor assistance often comes with resources such as computers, office equipment and sometimes even vehicles, some LGUs just keep quiet and accept the assistance despite the duplication (and confusion when the various advisors offer conflicting advice). The system installed by the Bohol Provincial Government, one of the most successful provincial governments insofar as accessing ODAs is concerned, to program, implement, and monitor ODA flows to the province, which is depicted in Figure 4 below, helps avoid this duplication, with the “clearinghouse” and with the LGU having a clearly defined and well-articulated local development plan.

7 This information was shared by the Planning and Project Development Officer (PPDO) of the province with NEDA at a workshop on poverty monitoring for local officials back in 1999.


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Figure 4. Bohol ODA Coordination Framework

Project Proposal

Stage

Project evaluation & approval by PDC

(for strategic alignment w/ dev’t

framework)

Project Funding

Project Implemen-

tation

Project Monitoring & Evaluation

Project Convergence

Endpoint evaluation by ODA agency & Provincial Gov’t

Shaded area shows the stages where BoholDev will assist the PDC, by avoiding duplication and facilitating alignment of programs & projects with Prov’l Dev’t Framework.

BoholDev as clearing

house for all ODA (to avoid duplication)

Project Proposal

Stage

Project evaluation & approval by PDC

(for strategic alignment w/ dev’t

framework)

Project Funding

Project Implemen-

tation

Project Monitoring & Evaluation

Project Convergence

Endpoint evaluation by ODA agency & Provincial Gov’t

Shaded area shows the stages where BoholDev will assist the PDC, by avoiding duplication and facilitating alignment of programs & projects with Prov’l Dev’t Framework.

BoholDev as clearing

house for all ODA (to avoid duplication)

Source: PDF Working Group on Decentralization and Local Government, Tagbilaran City, 23 Nov 2006.

3. Monitoring ODA Flows to LGUs

At the national level, probably the best venue for installing a tracking and monitoring mechanism for ODA funds going to LGUs is the DILG, as chair of the PDF Working Group on Decentralization and Local Government. While NEDA-PMS is the agency with the official mandate to monitor ODA funded projects, the subprojects that trickle down to the LGUs (especially at the municipal level and below) are so many and so widely dispersed across the country that monitoring could tax this agency beyond its capacities. DILG, on the other hand, has offices down at the local level.

Whether or not the DILG would be given the responsibility of monitoring

ODA flows, or the NEDA-PMS gets to retain its mandate, or whether or not there would be monitoring jointly done by DILG and NEDA the tracking and monitoring system should gather information not just from the LGUs but from the donor agencies as well. It is noted that grant aid recipients in many instances are not informed by the donors on the magnitude of assistance, especially on financial matters.


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It is not just grant assistance that should be monitored. As discussed earlier, the bulk of ODA funded projects with LGU participation is in the form of sub-loans and sub-grants. Sub-loans are often for those activities that have been devolved (e.g., the provision of local social and environmental infrastructure) while sub-grants are for those activities that are the responsibility of the national government, such as basic education.8

B. On the Foreign Borrowings Act of 1966 and on Programming

Foreign Assistance

The Foreign Borrowings Act has to be amended since it only recognizes national government agencies as the major players in the pursuit of economic development. Since the time of its enactment into law, the development agenda has included decentralization and devolution as key strategies for development, in particular local development. It does not contain a provision allowing local governments to borrow from foreign sources (e.g. ODA) with national government guarantee. Under the existing decentralized set-up, the local governments now serve as an important partner of the national government in achieving the country’s socio-economic development goals. Thus, the national government should now consider giving guarantee to local government foreign loans. This is a possibility but the LGC and foreign borrowings act must be amended. We suggest selective guarantee for LGUs based on certain parameters in order to avoid abuse of the borrowing route to finance local development activities. It is noted that recent developments show that a few LGUs have borrowed without sovereign guarantee.

On programming development assistance, donors overlook the inclusion

of local governments in the exercise. Considering the enhanced role of local governments in countryside development, donors should also consider the involvement of LGUs in the programming process, and not limit it to national government agencies.

One foreign aid agency, the Asian Development Bank (ADB), recognizes

the increasing role of local governments in promoting economic development and

8 For the poorer LGUs, the sub-loans often are accompanied by grants.


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it has now expressed its willingness to lend directly to LGUs. This is indeed a welcome development since it could serve as a wake-up call for other donor agencies to do the same.

C. Challenges in the Implementation of the LGU Financing

Framework

Practically all of the NEDA’s annual ODA Portfolio Reviews in recent years point to the same implementation issues plaguing ODA loans with LGU participation. The list from the 13th ODA Portfolio Review (2005) is typical:

(a) Funds for the transfer of NG grants to LGUs with ongoing projects

are available, but there is no mechanism acceptable to both MDFO and DBM. This statement has to be explained by NEDA in view of possible disagreement coming from the MDFO and DBM.

(b) The lack of LGU equity is a major problem. A number of local government units (LGUs) withdrew participation in projects due to the inability to shoulder the NG-LGU cost sharing scheme for LGU-devolved programs.

(c) The limited technical capacity of LGUs likewise delayed implementation. A number of LGUs had difficulties in complying with pre-qualification requirements, documentary requirements for clearances, and preparation of detailed engineering designs.

(d) Other LGU financing facilities exist, e.g. GFI- and NGA-led facilities as funding options for LGUs. The LGU Financing Framework is supposed to guide the focus of GFIs and NG but is lightly regarded by all parties because DOF has not strongly monitored and supported the implementation of the financing framework.

These issues are interrelated, stemming mainly from the perception held

by national oversight agencies, i.e. the Department of Finance (DOF), Department of Budget and Management (DBM), and NEDA, that there is too much national government support to LGUs in the devolved activities. There should be an empirical study and policy analysis of this perception in order to guide national government policies toward LGUs.


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Thus, while the basic principles underlying the LGU Financing Framework remain the same, at various times the Investment Coordination Committee (ICC) would revise the parameters defining NG support to LGUs, such as raising the minimum share of LGU equity or lowering the maximum share of NG grant in subproject financing. But the fact that target LGUs withdraw participation because of lack of counterpart equity should be taken as indication that perhaps the rules should be revisited. Current maximum grant for devolved responsibilities is 50%, however, there is an emerging view to allow additional grants but these should be based on performance. A performance-based grant system is currently under analysis by a technical committee chaired by the DILG.

Table 23 shows the November 2002 NG-LGU cost sharing scheme

under MDFO for environmental projects. The scheme represents a substantial “tightening” from the 1996 ICC policy resolution on the NG grant component, where only 5th and 6th class cities could get a grant (and only for “brown” projects at that). This was tightened further by a joint ICC-DBCC memorandum issued in August 2004 that declared a zero grant policy on devolved activities. The zero grant policy was reversed back to the 2002 cost-sharing scheme mainly because of LGUs protests. There is an updated version of the cost-sharing scheme but essentially the sharing is the same.

Table 23. MDFO Loan-Grant-Equity Mixes, by Project Category, By Type and Fiscal Class of LGU, 2002, (In percent)

Municipality/Province City Green/Blue Loan Grant Equity Loan Grant Equity 1st & 2nd 50 30 20 80 0 20 3rd & 4th 45 40 15 80 0 20 5th & 6th 40 50 10 80 0 20 Municipality/Province City Brown Loan Grant Equity Loan Grant Equity 1st & 2nd 60 20 20 80 0 20 3rd & 4th 45 40 15 80 0 20 5th & 6th 40 50 10 60 20 20

Source: ICC Secretariat.

How would a market-based or market-inspired mechanism ration a given supply? When there are hardly any takers, the NG grant component is probably too low or the LGU equity component too high. On the other hand, if the national


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grant component is too high, queuing is likely to result. How then shall the limited grant funds be rationed? It is tempting to suggest that the NG share be lowered iteratively until the excess demand vanishes. But the ones who would drop out with this procedure may be those most in need of assistance. Richer LGUs and communities with the financial capacity to put up the higher counterpart would be the ones getting access to the NG grant funds. A strategy is to create a window for LGUs eligible for full grant. However, the LGUs are always taking advantage of single window for all LGUs.

The creation of separate sub-windows for different income classes

addresses this problem, but only partially. The common approach is to rank project proposals within a given sub-window according to some simple, transparent criteria that take levels of community needs and resources into consideration, together with benefit and cost effectiveness indicators. For "small" projects, actual community needs may be generated through rapid appraisal techniques, for the conduct of which guidelines may be disseminated to the proponents.

The “competition” among the different LGU on-lending and other forms of

co-financing facilities is perhaps partly due to eligibility criteria that favor the “exemplary” LGUs, i.e., the ones with the “ideal” traits described earlier. These LGUs, after two or three subprojects of the on-lending or co-financing type, soon run out of local resources for counterpart equity. After a few projects on highly concessional terms, the LGUs should be able to generate capacity to put up the counterpart requirement and not depend on continuing subsidy. The different ODA facilities therefore run out of “eligible” LGUs willing and able to participate.

Another form of competition is in the financing charges being assessed

by the different LGU lending facilities. The on-lending rates may differ across lending facilities e.g., the Municipal Development Finance Office (MDFO), Development Bank of the Philippines (DBP), and Land Bank of the Philippines (LBP), because of differences in the interest rates being charged by the ODA funding sources. The World Bank, ADB, and Japan International Cooperation Agency (JICA) (formerly JBIC) impose different rates. There are also differences in the “hidden” costs to the LGUs, in terms of processing time, access to the loan officers, documentary requirements, and the like.


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There have been suggestions that this “competition” should be removed and that there should be only one LGU financing window for ODA (and that would be MDFO). Centralizing ODA to MDFO may bring along operational issues such as budgetary allocation and inability to handle so many LGUs because of organizational constraints. However, from the LGU standpoint, competition even among different agencies of government is healthy in that it encourages the sub-loan or co-financing providers to be more efficient. While the NG oversight agencies would call it forum shopping by LGUs, it is but natural for the LGUs to seek the best terms from the variety of sources. Monopoly, in government as well as in the private sector, almost always works against the interest of the consumer.

The limited technical capacity of LGUs is a perennial problem that cannot

be solved simply through more training and capability building. The local planning and project development officers who perform well sometimes get pirated by the donor agencies themselves. The compensation package for local government personnel should thus have a performance-based component, which will create a motivation for good personnel to stay with the LGU. While this is more easily said than done, the LGUs should not be deterred from exploring various options to increase local revenues thereby creating opportunities for an appropriate incentive system for local personnel. We note that the third phase of the Salary Standardization Law (SSL III) shall substantially raise the salaries of government employees, both at the national and local levels, but fears have been expressed that the poorer LGUs may not be able to afford the higher pay scales. This and other local issues deserve a closer look by the PDF Working Group on Decentralization and Local Government.

D. On Access to LGU Financing and the MDFO facility

Consultations with stakeholders revealed that the major i concerns

pertaining to LGUs’ availment of ODA financing are the following: the lack of technical support, limited staff and financial capacity, and the length of the ODA availment process.9

9 Also see Annex 9 for other issues raised by members of the League of Cities of the Philippines based on the Philippines-Australia Local Governance Development Program PDF Consultations held in Tagbilaran City, Bohol on November 23, 2006.


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The study also identified major bottlenecks that limit the access of LGUs to ODA, with special reference to the MDFO loans facility, include: a) lack of technical capacity of LGUs to prepare for loan requirements; b) partisan politics getting in the way of technical decisions; c) cash flow problem of the national government (NG); d) perceived high interest rates; e) failure by LGUs to meet the Bureau of Local Government Finance (BLGF) certification requirement.

Lack of technical capacity of LGUs to prepare for loan requirements. On the demand side, it appears that many LGUs lack the technical capacity to prepare the documentary requirements for loan availment. These requirements include completed application forms, financial statements, feasibility study/studies, preparation of detailed architectural and engineering design (DAED), and proof of borrowing capacity. LGUs normally hire consultants to help them prepare all the requirements. This also reflects weak planning capability of the LGUs. Partisan politics getting in the way of technical decisions. Once some LGUs are ready with their pre-loan activities and documents, partisan politics at the local level come into play. To be able to implement local projects, including those supported by ODA, the LCE needs to secure the support of the sanggunian to enact an ordinance or resolution. Here partisan politics may get in the way of getting support for a good project. On the other hand, opposition by the sanggunian (local councils) may also be a good deterrent for bad projects submitted by the LCE. Some bargaining and compromise inevitably happen and project specifications, which have been determined mainly on technical considerations, may be altered and compromised. In some cases, projects do not secure approval. The rather uninspiring perception is of some local officials who seek personal gain out of the loan proceeds; in other cases, sanggunian approval of a proposed loan by the LCE may be withheld pending satisfaction of parochial political objectives. It is noted that the risk of not being able to secure approval for the project is high in LGUs where the LCE and the sanggunian are not political allies.

Some LGUs feel that the requirements, processes and procedures set by the MDFO to enable LGUs to gain access to ODA loan funds are tedious and lengthy as compared to those of GFIs and private banks, which also offer loan


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facilities to LGUs. Some of these financial institutions even provide technical assistance to LGUs to facilitate the latter’s access to expedient financing assistance. There are cases of project loans, with technical plans for funding through the MDFO, being cancelled by the LGU loan applicants.

On the other hand, the MDFO supports the applicant LGUs by providing

technical assistance in the preparation of FS and DAED. The preparation of these required documents take time and may have been seen by the applicant LGUs as a lengthy processing from time of loan application to approval. The MDFO points out that there are instances when once all the requisites for loan approval have been completed, other creditors take over with a promise to immediately release project funds.

There is also the perception that MDFO’s lengthy processing of loans,

which takes at least 9 months, gets lengthier as an election period approaches. A forty-five day ban on infrastructure projects is imposed before the election period with exceptions for foreign assisted projects. Either because a project is vital for the development of the municipality or city concerned, or because the LCE and all other politicians involved with the project need “visible” projects to increase their chances of getting elected, or both, there arises the inevitable greater pressure for the MDFO to process projects more expeditiously.

NG cash flow problem. The national government (NG) sometimes faces cash flow problems. This somehow delays access to funds by qualified LGUs. However, there has been some improvement in bridging the cash flow gap by the NG through various fiscal measures. Additionally, the MDFO can use the so-called second-generation funds at its disposal to cover the financing gap. High interest rates. The interest rates of MDFO are seen to be higher compared to those of other financial institutions, primarily due to some built-in technical assistance and capability building activities for recipient LGUs. However, the MDFO has taken note of this and is taking steps to provide more competitive interest rates. Failure to meet the BLGF certification requirement. The perception among LGUs is that there is a relatively slow issuance of the Certificate of Debt Service Capacity and the disclosure of the loan that LGU is going to avail. The provision of LGC allows the LGU to allocate


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20% of regular income for debt service. A Bangko Sentral ng Pilipinas (BSP) letter circular required the attachment of a BLGF certification of a debt service capacity to inform the MDFO Policy Governing Board if the scheduled loan amortization is below the mandatory ceiling. Some LGUs have the tendency to manufacture their own certifications of borrowing capacity in order to be granted access to the MDFO facility. These certifications have not been honored because the mandate to issue such certification of borrowing capacity lies with a third party institution, that is, the BLGF. The BSP urges all financial institutions to ensure that entities to be granted loans have good debt service capacity. Because of this exhortation from the BSP, the BLGF has been collecting the Statement of Receipts and Expenses (SREs) of LGUs and has created and maintained a database of such submissions. It is noteworthy that this database for SREs of LGUs has a three-year lag. This is not a welcome situation because it has implications on determining the creditworthiness of the LGUs and one aspect of this is the debt service capacity. The BLGF has to attend to these concerns in order to expedite the loan application process for LGUs.

E. Other policy issues

There are also other overarching policy issues which may be considered in setting the appropriate LGUs financing framework. Firstly, NG has provided funding – mostly dole out for LGUs – for various sectoral programs, e.g. health, etc. without appropriate screening or identification of the most needy and financially incapable LGUs. This serves to stunt the initiative in most LGUs as they simply await fiscal transfers from the NG agencies and do not raise nor allocate resources for the delivery of local services, which are funded by dole outs. Second, LGUs fail to maximize their revenue raising potential; they would rather continue to be dependent on NG fiscal transfers. Finally, there seems to be no monitoring nor evaluation of the development impact of individual sub-projects of LGUs financed by either grants or the MDFO loan facility. Inasmuch as the NEDA monitors total ODA and program portfolio, individual projects of LGUs needs further attention not only by NEDA but also by other oversight agencies such as DBM (on the budgetary aspects of the LGU project) and DILG (on the impact of such sub-projects to the community being served by the LGU).


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IV. CONCLUSIONS AND RECOMMENDATIONS

A. Recommendations on Policies, Processes and Procedures

1. On Policies

At the policy level, the government needs to seriously consider the

following: i) allow LGUs to use private commercial banks as depository institutions; ii) fast-track the implementation of Executive Order 809; and, iii) establish a monitoring system to be established and based among NEDA, DILG, DBM, and DOF for ODA funded local government projects.

Allow LGUs to use private commercial banks as depository

institutions. With proper safeguards to be developed by the DOF and BSP, the prohibition against LGUs using commercial banks as depositories should be lifted. This will allow LGUs to develop a working relationship with private commercial banks, which are expected to compete for LGU business by way of offering higher interest on deposits, lower interest on loans, and better banking services in general. For many areas in the countryside, the LGU has been the single biggest potential banking client. With access to LGU accounts, more private banks could be motivated to establish branches in areas with limited banking facilities, thereby providing financial services not only to the LGU but also to a wider client base as well.

There seems to be some scope for this recommendation to prosper

because many sectors including those from the different PDF Working Groups and even some high-level DOF officials themselves have supported this recommendation.

It is noted that as early as 1998, Llanto and his colleagues at the

Philippine Institute for Development Studies have made this recommendation. This recommendation and a few others in their landmark study10 have been picked up by other analysts who echoed very similar recommendations. The 10 Llanto, Gilberto M and others (1998). Local Government Units’ Access to the Private Capital Markets. Makati City: The Philippine Institute for Development Studies.


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curious fact is that despite the good reason behind this practical recommendation and the widespread support for it, the national government has failed to act on it.

An idea worth exploring is the proposal from the League of Provinces of

the Philippines to allow LGUs direct access to ODA without any sovereign guarantee by the national government. This used to be a moot issue before, when practically all donor partners, multilateral and bilateral, refused to lend without sovereign guarantee. Lately, however, ADB has been open to relaxing this condition. The fear of most central governments in allowing direct sub-national foreign borrowing is that, even without sovereign guarantee, a default by the LGU may negatively affect the country’s sovereign risk rating. Studies of experiences in other countries would help policy makers have a better appreciation of the merits and demerits of the proposal and enable them to make an informed decision.

Fast-track the implementation of Executive Order 809. Executive

Order 809 issued on June 9, 2009 (“Implementing the Financing Policy Framework for Local Government Units by Identifying New Sources of Funding for First Tier LGUs under Republic Act No. 7160”) directs the DILG and the DOF to implement the LGU Financing Framework, whereby first-tier LGUs, or those provinces, cities, and municipalities whose average regular and locally-sourced funds for the past three years comprise 60% of their total income, may borrow directly from multilateral agencies to ensure that they have sufficient funding sources for their vital projects.

The EO stresses that “any such loan obtained shall be on a stand-alone

basis, without any direct or indirect National Government guarantee.” The LGUs are expected to enjoy a lower cost of funds if they are able to borrow directly from ODA sources. However, a loan guarantee such as that provided by the LGU Guarantee Corporation (a private corporation that was established by the government and private commercial banks to guarantee LGU indebtedness, e.g., bonds) that those lending agencies may require may increase the cost of funds for LGUs. The LGU Guarantee Corporation charges a guarantee fee of 1.5 percent.


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But perhaps the greater benefit to the LGU comes from being able to define its own public investment needs and priorities and have direct access to multilateral lending institutions. Under existing arrangements where the borrower is a national government agency or a GFI that then relends to the LGU, not only do the borrowing costs of the LGU get inflated, but local priorities also sometimes get distorted by national concerns.

To jumpstart this initiative, the first project should be an “easy,” well-

prepared one that would serve as a showcase for emulation by other LGUs. Among the Philippines’ ODA partners, the ADB is probably the one most ready (and willing) to lend directly to LGUs. The ADB also has the advantage of having its headquarters in Manila.

Establish a monitoring system among NEDA, DILG, DBM and DOF

for ODA-funded individual LG projects. The heads of concerned government agencies need to agree that there is a need to establish such a system and develop an institutional arrangement that would monitor not only the disbursement of ODA funds, but also their utilization and development results. For ODA funded projects still in the pipeline, information on which LGU access is covered by a particular project is at best indicative, as such projects are often demand-driven, and the list of participating LGUs included in the project proposal may change upon implementation. For ongoing foreign-assisted projects, however, coordination among the oversight agencies will help towards greater transparency and accountability for both the government and the donor community.

Under the ODA Act of 1996, NEDA is the agency mandated to monitor

foreign-assisted projects (through its Projects Monitoring Staff, or NEDA/PMS). NEDA’s monitoring, however, is at the agency and project levels. It does not have the personnel and other resources to monitor subprojects. It is at the LGU subproject level that DILG can help in the monitoring process. DBM, meanwhile, would have data on the financial flows, while DOF (through BLGF and MDFO) would have the broader fiscal picture for the LGU (such as borrowing capacity and projected amortization of LGU loans). A database can be created to determine distribution, availment and implementation performance of specific LGUs.


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A byproduct of such an ODA monitoring system that goes down to the

LGU level is transparency in the award of subprojects. It sometimes happens that an LGU may already have expressed interest in getting a subloan from, say MDFO or LBP, to finance its domestic water supply project. Then, the local officials hear that the neighboring town is getting a grant from a donor agency for a similar project. They cancel the subloan application, hoping that they would get a grant as well. The ODA monitoring system, aside from simply providing a database, may be tapped to apprise the LGU if the expectation of getting a grant is realistic or not.

2. On Processes and Procedures

At the organizational level, efforts should be exerted to: i) acquaint LGUs

of sources of local public investment funds other than direct ODA grants; ii) develop both LGU capabilities and LGU capacities in local planning and project development; iii) streamline the development and approval processes for small subprojects; iv) involve LGU representatives in the programming exercises with donors; and v) improve the monitoring system on ODA flows, particularly grants.

Acquaint LGUs with sources of public investment funds other than

direct ODA grants. LGUs should be reminded that they have access to external resources other than the ODA grants. By far the bigger resources are in the programs, activities, and projects (PAPs), whether foreign-assisted or locally funded, that are undertaken by the line agencies of the NG in their respective localities and jurisdictions. The NG, for strategic reasons, often reserves ODA for those large projects that, if funded from the President’s budget, may stir much debate and have a rough sailing in Congress.

Another source is the Priority Development Assistance Fund (PDAF) or

congressional initiatives (CIs) which are allocated by congressional district and run into billions of pesos.11 The PDAF is a significant extra-budgetary source for many small and poor LGUs. The national government, particularly DBM, has been trying to “rationalize” the uses of the PDAF by defining the set of local 11 The PDAF or CIs reached their highest levels in 2003 (P19.5 billion) and 2004 (P19.7 billion)


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infrastructure projects that may be funded by the facility. Lobbying by the local chief executive (usually the mayor, as the governor is often a rival of the congressman) helps assure that the small local project is consistent with the local development plan.

For the bigger projects, locally funded or foreign-assisted, the immediate

venue for the LGUs’ influence on design and implementation is the regional development council (RDC), where the regional directors of the national line agencies sit as members. But not all LGUs are members of the RDC. The smaller LGUs (the municipalities) have to course their requests through the governors or lobby with the regional directors. If the regional directors have less influence in their respective central offices, LGU representation or lobbying may have to be with the central officials themselves. These are political realities with which LGUs have to contend.

Develop LGU capabilities and capacities in local planning and project

development. As mentioned earlier, the limited technical capacity of LGUs is a perennial problem that cannot just be solved simply through more training and capability building. The donor agencies themselves complicate the situation as they compete for the services of local planning and project development officers who perform well. It is within this context that the Local Government Academy (LGA) of the DILG can also play a key role in providing a framework for sustainable LGU capacity building.

The compensation package for local government personnel should have a

performance-based component, but while this is more easily said than done, LGUs should explore various options for raising their revenue intake, e.g., improve the collection of real property taxes through better valuation of properties, improve the administration of local business taxes even as they deliver better local public services. The third phase of the Salary Standardization Law (SSL III) substantially raises the salaries of government employees, both national and local, but fears have been expressed that the poorer LGUs may not be able to afford the higher pay scales.

A possible way of stemming the outflow of good, trained LGU technical

personnel is a temporary, periodic cross-posting or special secondment scheme


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with the major donor agencies. At present, this may be observed at the more senior level among NGAs (oversight and line), where a bureau director or division chief goes on leave to join a foreign-assisted project for, say, six months or one year. A similar arrangement may be developed for capable LGU technical personnel. This suggestion deserves a closer look by the PDF Working Group on Decentralization and Local Government.

Again, the DILG’s LGA may enter into partnership with other training institutions, especially in the regions, so that the supply of training services could be sustained and made more easily accessible.12

Establish a Project Feasibility Studies Fund for LGUs. Side-by-side with the capacity and capability building initiatives, especially in the short run, is the need to set aside a Project Feasibility Studies Fund, especially for the smaller LGUs. It may be unrealistic for these small LGUs to build up their own internal capability to conduct full-blown project studies, as the typical municipal development office may have only one or two technical persons. The ODA Act actually says that “NEDA shall endeavor to obtain ODA funds from donor countries, which shall approximately be five percent (5%) of the total ODA loan from the immediately preceding year. Said funds shall be administered by the NEDA for project identification, feasibility studies, master planning at local and regional levels, and monitoring and evaluation.” Unfortunately, this has not been implemented. Nevertheless, the NEDA Regional Offices (NROs) have a facility to assist LGUs in project preparation, but these resources are limited. The establishment of a Project Feasibility Studies Fund, lodged within NEDA or DILG, would go a long way towards helping LGUs gain better access to ODA funds.

Streamline the development and approval processes for small

subprojects. For the on-lending facilities of the GFIs and MDFO, templates can probably be developed for small sub-loans,(e.g., P3 million and below), such that full-blown feasibility studies may be dispensed with. For example, school-building projects are fairly standard and a checklist-type template on the market,

12 In fact, LGA has been working with local training institutes and the Philnet which is based on the Local Government Training and Research Institutes (LOGTRI) network in the Asia region. The network of the Association of Schools of Public Administration in the Philippines (ASPAP) may also be tapped.


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technical, financial, and economic aspects may be easily developed. This would substantially reduce the project development costs and make the ODA on=lending facilities more accessible for the lower-tier LGUs.

Involve LGU representatives in the programming exercises with

donors. A common question asked by LCEs is why a neighboring town received a grant from a particular donor while his own town was apparently bypassed. While DILG participates in most (if not all) of the bilateral and multilateral consultations on country programming, in accordance to the basic spirit of transparency and participation, it may be good to invite representatives of local government leagues to attend, even as observers.

Improve the monitoring system on ODA flows, particularly grants. As

discussed earlier, probably the best venue for installing a tracking and monitoring mechanism for ODA funds going to LGUs is the DILG, as chair of the PDF Working Group on Decentralization and Local Government. The subprojects that trickle down to the LGUs, especially at the municipal level and below, are many and widely dispersed across the country. It must be emphasized that DILG as a national government agency is uniquely positioned since it has presence all the way down to the local level.

The tracking and monitoring system should gather information not just

from the LGUs but from the donor agencies as well. Especially on financial matters, grant aid recipients in many instances are not informed by donors on the magnitude of the technical assistance involved. In the interest of transparency and accountability, a common reporting system should be devised and installed that would allow the Philippine government (and the donor governments themselves) to say, with a reasonable degree of confidence, how much aid flowed in and where it went.

3. Other Recommendations

The study team likewise recommends the following: i) establishment of an

MDFO website for greater transparency and wider reach of the facility, with the site having an appropriate easy-to-follow steps and procedures on LGU ODA availment; ii) making available a ready pool of consultants to assist LGUs in


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preparing for the necessary financing application requirements through MDFO; iii) use ODA for better access to performance-based LGU financing; and iv) build-up of the SRE database within the BLGF and harmonizing this with those of other concerned agencies.


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Alonzo, Ruperto. A. Channeling Resources to Local Development Concerns: Issues and Options. Philippine Review of Economics and Business, vol. XXXIV, No. 2, December 1997; reprinted as Chapter 4 in Studies in Governance and Regulation: the Philippines, edited by D.B. Canlas and S. Fujisaki, Tokyo: IDE, 1999 (48-76).

Congress of the Republic of the Philippines. "Foreign Borrowings Act of 1966." 8 September 1966. NEDA. October 2008 <http://www.neda.gov.ph/progs_prj/oda/odaAct.htm>.

—. "Official Development Assistance Act of 1996 ." 11 June 1996. NEDA. October 2008 <http://www.neda.gov.ph/progs_prj/oda/odaAct.htm>.

—. "Republic Act No. 8555 An Act Amending RA NO. 8182, and for other Purposes." 26 February 1998. NEDA. October 2008 <http://www.neda.gov.ph/progs_prj/oda/odaAct.htm>.

Department of Finance. Department Order No. 40-09. “Revised National Government-Local Government Unit (NG-LGU) Cost Sharing Policy. 3 December 2009.

Khan, Kamran M. "LGU Financing Framework in the Philippines." Powerpoint presentation. The World Bank, 2008.

Llanto, Gilberto M. and others Local Government Units’ Access to Private Capital Markets. Makati: Philippine Institute for Development Studies, 1998. National Economic Development Authority. "12th Annual ODA Portfolio Review."

2003. NEDA. October 2008 <http://www.neda.gov.ph/progs_prj/12thODA/12th_odamain.htm>.

__. "13th Annual ODA Portfolio Review." 2004. NEDA. October 2008 <http://www.neda.gov.ph/progs_prj/13thODA/13th_odamain.htm>.

—. "15th (2006) Annual ODA Portfolio Review." 2006. NEDA. February 2009 <http://www.neda.gov.ph/progs_prj/15thODA/15th_odamain.htm>.

—. “16th (2007) Annual ODA Portfolio Review.” 2007. National Economic Development Authority Website. February 2009 <http://www.neda.gov.ph/progs_prj/16thODA/16th_odamain.htm>.

—. "17th (2008) Annual ODA Portfolio Review." 20008. National Economic Development Authority Website. October 2009 <http://www.neda.gov.ph/progs_prj/17thODA/17th_odamain.htm>.


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—. "ICC Guidelines and Procedures ." 4 March 2005. NEDA. January 2009 <http://www.neda.gov.ph/progs_prj/ICC/ICC_March2005/Revised%20ICC%20Guidelines%20and%20Procedures%20(as%20of%204%20March%202005).pdf>.

—. "Implementing Rules and Regulations (IRR) for Republic Act (R.A.) 8182, Otherwise Known as "The Official Development Assistance (ODA)." 23 July 1996. NEDA. October 2008 <http://www.neda.gov.ph/progs_prj/oda/odaAct.htm>.

Manasan, Rosario. "Decentralization and the Financing of Regional Development." In The Dynamics of Regional Development: The Philippines in East Asia, by Arsenio Balisacan and Hal Hill, 275-315. Cheltenham: Edward Elgar Publishing Ltd., 2007.

National Economic Developmetn Authority. "14th (2005) Annual ODA Portfolio Review." 2005. <http://www.neda.gov.ph/progs_prj/14thODA/14th_odamain.htm>.

Pellegrini, Anthony and Ma. Celia Soriano. A Study to Revisit the LGU Financing Framework and Its Implementation. A study commissioned by the Department of Finance. Manila: unpublished, 2002.

Philippines, Office of the President of the Republic of the. Executive Order 809. Executive Order. Manila: Malacanang, Implementing the Financing Policy Framework for Local Governmnent Units by Identifying New Source of Funding for First Tier Local Government Units under Republic Act No. 7160.

Shah, Anwar. "Institutional Arrangements for Intergovernmental Fiscal Transfers and a Framework for Evaluation." In Intergovernmental Fiscal Transfers: Principles and Practice, by Robin Boadway and Anwar (eds) Shah, 293-318. Washington, D.C.: The World Bank, 2007.

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Annexes Annex 1-A. NG-LGU Cost Sharing Schemes (Financing Mixes), 1990s

Sector/Activity LGU Income Class NG Share (%)

Remarks

Water Supply (only for Level 1)

1st 2nd 3rd and 4th 5th and 6th

0 0 0

50

No National Government grants for Levels 2 (communal faucet) and 3 (house connection) water systems.

Rural Infrastructure Public Market Bus Terminal Provincial Roads Municipal Roads Communal Irrigation

1st – 6th 1st – 6th 1st – 6th 1st – 6th

1st 2nd and 3rd 4th 5th and 6th

0 0 0 0

20 30 40 50

Revenue-generating Projects will not be provided National Government grants. NG support only possible for access roads, farm-to-market roads covered by approved national programs (e.g. environment or agrarian reform). The cost-sharing arrangement applies only to capital costs.

Health

1st and 2nd 3rd and 4th 5th and 6th

50 70 90

The cost-sharing arrangement applies only to capital costs.

Environment Blue (watershed protection, municipal fishery mgt, coastal resource mgt, mangrove protection and rehabilitation Green (reforestation and Forest-related activities, soil conservation, protected area mgt, wildlife conservation) Brown (solid waste mgt, Vehicular emission control, water pollution control, traffic engineering Sanitary support facilities for public markets and slaughterhouses

1st 2nd and 3rd 4th – 6th 1st 2nd and 3rd 4th – 6th 1st and 2nd 3rd and 4th 5th and 6th 3rd and 4th 5th and 6th

20 50 70

20 50 70

0 0 0

50 70

Cost-sharing based on total project cost (PS & MOOE included in the National Government grant). Cost-sharing based on total project cost (PS & MOOE included in the National Government grant). NG shoulders costs of rehabilitation of ecosystems. LGU shoulders all other costs (enforcement, investment, O&M)


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Annex 1-B. Revised Loan-Grant-Equity Mix for Provinces/Municipalities, and for

Cities, 2009

Cluster LGU Income Class

Municipalities and provinces Cities

Loan % Grant % Equity % Loan % Grant % Equity %

Cluster 1 1st & 2nd 0 0 0 0 0 0 3rd & 4th 70 20 10 0 0 0 5th & 6th 40 50 10 0 0 0

Cluster 2 1st & 2nd 50 30 20 80 0 20 3rd & 4th 45 40 15 80 0 20 5th & 6th 40 50 10 50 30 20

Cluster 3 - Water waste

1st & 2nd 60 20 20 80 0 20 3rd & 4th 45 40 15 80 0 20 5th & 6th 40 50 10 60 20 30

LGU Income

Class Grant LGU share

(Loan/equity) Grant LGU share

(Loan/equity)

Cluster 3- SWM

1st & 2nd 20 60/20 40 60 3rd & 4th 40 45/15 25 75 5th & 6th 50 40/10 20 80


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Annex 2. Ranking of Provinces Based on ODA funded projects


1. Agusan del Sur Region XIII 43 2. Negros Occidental Region VI 39 3. Antique Region VI 37 Iloilo Region VI 37 Surigao del Sur Region XIII 37 4. Cebu Region VI 34 5. Bohol Region VII 33 North Cotabato Region XII 33 Zamboanga del Sur Region IX 33 6. Zamboanga del Norte Region IX 32 7. Maguindanao ARMM 31 8. Albay Region V 30 Misamis Occidental Region 30 9. Leyte Region VIII 28 10. Agusan del Norte Region XIII 26 Bukidnon Region X 26 Capiz Region VI 26 Lanao del Sur ARMM 26 Pampanga Region III 26 Sultan Kudarat ARMM 26 11.Camarines Sur Region V 25 Davao del Sur Region 25 Surigao del Norte Region XIII 25 12. Compostela Region 23 Southern Leyte Region 23 13. Davao del Norte Region 22 Davao Oriental Region 22 Ilocos Norte Region 22 Lanao del Norte Region 22 Negros Oriental Region 22 Oriental Mindoro Region IV-B 22 Palawan Region IV-B 22 Sorsogon Region V 22 South Cotabato Region 22 Tawi-tawi ARMM 22 14. Basilan Region 21 Eastern Samar Region 21 Masbate Region V 21 Nueva Ecija Region III 21 Pangasinan Region I 21 15. Benguet CAR 20 Romblon Region IV-B 20 Sulu ARMM 20 16. Aurora Region III 19 Batangas Region IV-A 19 Isabela Region II 19


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Quezon Region IV-B 19 Saranggani Region XII 19 Zamboanga Sibugay Region IX 19 17. Misamis Oriental Region 18 Mt. Province CAR 18 18. Abra Region I 17 Biliran Region 17 Ifugao CAR 17 19. Bulacan Region III 16 Camarines Norte Region V 16 Guimaras Region 16 Northern Samar Region 16 Rizal Region IV-A 16 20. Kalinga CAR 15 21. Cagayan Region II 14 Nueva Vizcaya Region II 14 Tarlac Region III 14 22. Bataan Region III 13 23. Aklan Region 12 24. Apayao CAR 11 Laguna Region 11 25. Camiguin Region 10 Cavite Region IV-A 10 Ilocos Sur Region I 10 Occidental Mindoro Region IV-B 10 Quirino Region II 10 Western Samar Region 10 26. Catanduanes Region V 08 Siquijor Region 08 Zambales Region III 08 27. La Union Region I 07 28. Batanes Region II 05 29. Marinduque Region IV-B 03 30. Dinagat Island Region XIII 02

TOTAL 1,625


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Annex 3. Ranking of Regions Based on ODA funded projects Rank Regions LGUs (Provinces) Total Number of

ODA Projects Per Province

Total # of ODA funded Projects

Per Region

1 Region 6 Aklan 12 167 Antique 37 Capiz 26 Guimaras 16 Iloilo 37 Negros Occidental 39

2 Region 13 Caraga

Agusan del Norte 26 133 Agusan del Sur 43 Dinagat Island 2 Surigao del Norte 25 Surigao del Sur 37

3 Region 5 Albay 30 122 Camarines Norte 16 Camarines Sur 25 Catanduanes 8 Masbate 21 Sorsogon 22

4 ARRM Basilan 21 120 Lanao del Sur 26 Maguindanao 31 Sulu 20 Tawi-tawi 22

5 Region 3 Aurora 19 117 Bataan 13 Bulacan 16 Nueva Ecija 21 Pampanga 26 Tarlac 14 Zambales 8

6 Region 8 Biliran 17 115 Eastern Samar 21 Leyte 28 Northern Samar 16 Western Samar 10 Southern Leyte 23

7 Region 10 Northern Mindanao

Bukidnon 26 106 Camiguin 10 Lanao del Norte 22 Misamis Occidental 30 Misamis Oriental 18


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Rank Regions LGUs (Provinces) Total Number of ODA Projects Per Province

Total # of ODA funded Projects

Per Region

8 Region 12 Soccsksargen

North Cotabato 33 100 Sarangani 19 South Cotabato 22 Sultan Kudarat 26

9 CAR Abra 17 98 Apayao 11 Benguet 20 Ifugao 17 Kalinga 15 Mt. Province 18

10 Region 7 Bohol 33 97 Cebu 34 Negros Oriental 22 Siquijor 8

11 Region 11 Davao Region

Campostela Valley 23 92 Davao del Norte 22 Davao del Sur 25 Davao Oriental 22

12 Region 9 Zamboanga Peninsula

Zamboanga Del Norte 32 84 Zamboanga Del Sur 33 Zamboanga Sibugay 19

13 Region 4-B MIMAROPA

Marinduque 3 77 Occidental Mindoro 10 Oriental Mindoro 22 Palawan 22 Romblon 20

14 Region 4-A Calabarzon

Batangas 19 75 Cavite 10 Laguna 11 Quezon 19 Rizal 16

15 Region 2 Batanes 5 62 Cagayan 14 Isabela 19 Nueva Viscaya 14 Quirino 10

16 Region 1 Ilocos Norte 22 60 Ilocos Sur 10 La Union 7 Pangasinan 21

Total ODA Projects 1625 1625


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Annex 4. Distribution of ODA funded projects by Sector, By Province LGU

(Provinces) Infra Educ Social

Services Agriculture/

Agrarian Reform

Health Environment Others (e.g.

Energy, Govern

ance etc.)

Total Number of ODA funded projects

Abra 7 3 3 2 1 1 17 Apayao 4 2 2 2 1 11 Benguet 3 3 2 10 2 20 Ifugao 2 2 3 2 7 1 17 Kalinga 6 2 3 2 1 1 15 Mt. Province 4 3 3 2 6 18 Ilocos Norte 11 4 5 1 1 22 Ilocos Sur 6 4 10 La Union 3 4 7 Pangasinan 10 4 4 3 21 Batanes 2 2 1 5 Cagayan 6 3 1 4 14 Isabela 5 2 6 3 2 1 19 Nueva Vizcaya 2 3 6 3 14 Quirino 4 3 1 2 10 Aurora 8 4 1 2 2 2 19 Bataan 2 5 1 5 13 Bulacan 4 2 2 8 16 Nueva Ecija 5 4 2 9 1 21 Pampanga 14 2 2 7 1 26 Tarlac 3 4 1 6 14 Zambales 1 5 1 1 8 Batangas 8 3 1 3 4 19 Cavite 2 2 3 2 1 10 Laguna 3 3 1 2 2 11 Quezon 4 1 3 6 2 2 1 19 Rizal 12 1 3 16 Marinduque 1 1 1 3 Occidental Mindoro 1 2 6 1 10 Oriental Mindoro 8 3 6 5 22 Palawan 7 6 1 3 5 22 Romblon 4 2 3 3 7 1 20 Albay 10 1 4 11 1 2 1 30 Camarines Norte 6 2 4 1 1 2 16 Camarines Sur 8 1 2 9 4 1 25 Catanduanes 3 2 2 1 8 Masbate 7 2 2 4 4 1 1 21 Sorsogon 6 1 2 7 3 1 2 22


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LGU (Provinces)

Infra Educ Social Services

Agriculture/ Agrarian Reform


Energy, Govern

ance etc.)


Aklan 4 4 2 2 12 Antique 20 2 3 7 1 4 37 Capiz 5 2 3 5 7 1 3 26 Guimaras 2 2 1 7 1 3 16 Iloilo 19 4 4 3 5 2 37 Negros Occidental 23 1 2 5 2 4 2 39 Bohol 3 2 6 8 4 6 4 33 Cebu 12 1 5 4 5 7 34 Negros Oriental 2 1 6 7 3 3 22 Siquijor 2 2 2 2 8 Biliran 1 3 2 2 8 1 17 Eastern Samar 5 2 2 4 7 1 21 Leyte 7 3 3 10 5 28 Northern Samar 2 1 3 6 2 2 16 Western Samar 2 4 3 1 10 Southern Leyte 5 2 7 6 1 2 23 Zamboanga Del Norte 10 2 3 13 1 3 32 Zamboanga Del Sur 6 5 5 11 1 1 4 33 Zamboanga Sibugay 3 3 9 1 3 19 Bukidnon 9 1 1 8 2 1 4 26 Camiguin 1 2 5 1 1 10 Lanao del Norte 4 1 4 7 1 5 22 Misamis Occidental 5 4 12 4 5 30 Misamis Oriental 3 1 12 2 18 Compostela Valley 5 2 3 9 2 2 23 Davao del Norte 3 1 3 13 2 22 Davao del Sur 7 1 12 2 3 25 Davao Oriental 4 2 2 9 1 4 22 North Cotabato 1 6 3 8 7 3 5 33 Saranggani 3 2 3 5 1 2 3 19


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LGU (Provinces)

Infra Educ Social Services

Agriculture/ Agrarian Reform


Energy, Govern

ance etc.)


South Cotabato 1 2 3 7 3 3 3 22 Sultan Kudarat 4 2 3 6 4 2 5 26 Agusan del Norte 5 1 5 9 1 4 1 26 Agusan del Sur 6 3 6 13 9 3 3 43 Dinagat Island 1 1 2 Surigao del Norte 5 2 2 10 1 1 4 25 Surigao del Sur 16 3 4 9 3 2 37 Basilan 5 3 4 1 8 21 Lanao del Sur 1 6 5 3 2 9 26 Maguindanao 2 5 2 6 2 14 31 Sulu 4 3 4 9 20 Tawi-tawi 4 4 5 9 22

Total ODA funded projects

413 115 132 421 218 153 173 1625

Sources of Data:

1 DA (Infres) - Department of Agriculture (infrastructure for Rural Productivity Enhancement Sector)

2 DAR - Department of Agrarian Reform 3 DBP - Development Bank of the Philippines

4 DENR (FAPSO) - Department of Environment and Natural Resources (Foreign-Assisted and Special Projects)

5 DepEd - Department of Education 6 DOH - Department of Health

7 DPWH (BOC) - Department of Public Works and Highways (Bureau of Construction)

8 DSWD (Kalahi-CIDDS) - Department of Social Welfare and Development 9 LBP - LandBank of the Philippines 10 NEDA - National Economic and Development Authority 11 NIA - National Irrigation Administration


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Annex 5. Ranking of Provinces with ODA funded projects in Agriculture/

Agrarian Reform Rank LGU (Provinces) No. of

Agriculture/Agrarian Reform Projects

1 Agusan del Sur 13 1 Davao del Norte 13 1 Zamboanga Del Norte 13 2 Davao del Sur 12 2 Misamis Occidental 12 2 Misamis Oriental 12 3 Albay 11 3 Zamboanga Del Sur 11 4 Leyte 10 4 Surigao del Norte 10 5 Agusan del Norte 9 5 Camarines Sur 9 5 Compostela Valley 9 5 Davao Oriental 9 5 Surigao del Sur 9 5 Zamboanga Sibugay 9 6 Bohol 8 6 Bukidnon 8 6 North Cotabato 8 7 Lanao del Norte 7 7 Sorsogon 7 7 South Cotabato 7 7 Southern Leyte 7 8 Isabela 6 8 Negros Oriental 6 8 Northern Samar 6 8 Occidental Mindoro 6 8 Oriental Mindoro 6 8 Palawan 6 8 Quezon 6 8 Sultan Kudarat 6 9 Bataan 5 9 Camiguin 5 9 Capiz 5 9 Cebu 5 9 Lanao del Sur 5 9 Negros Occidental 5 9 Saranggani 5 9 Zambales 5

10 Aklan 4 10 Camarines Norte 4 10 Eastern Samar 4 10 Ilocos Norte 4


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Rank LGU (Provinces) No. of Agriculture/Agrarian

Reform Projects

10 Ilocos Sur 4 10 Iloilo 4 10 La Union 4 10 Masbate 4 10 Nueva Ecija 4 10 Pangasinan 4 10 Tarlac 4 10 Tawi-tawi 4 11 Antique 3 11 Basilan 3 11 Batangas 3 11 Cagayan 3 11 Laguna 3 11 Nueva Vizcaya 3 11 Quirino 3 11 Romblon 3 11 Sulu 3 11 Western Samar 3 12 Abra 2 12 Apayao 2 12 Aurora 2 12 Batanes 2 12 Benguet 2 12 Biliran 2 12 Bulacan 2 12 Catanduanes 2 12 Cavite 2 12 Ifugao 2 12 Kalinga 2 12 Maguindanao 2 12 Mt. Province 2 12 Pampanga 2 12 Siquijor 2 13 Guimaras 1 13 Marinduque 1 Dinagat Island Rizal

Total ODA funded projects 421


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Annex 6. Guidelines for Grant Design

By Anwar Shah 1. Clarity in grant objectives. Grant objectives should be clearly and precisely

specified to guide grant design. 2. Autonomy. Subnational governments should have complete independence

and flexibility in setting priorities. They should not be constrained by the categorical structure of programs and uncertainty associated with decision making at the center. Tax-base sharing—allowing subnational governments to introduce their own tax rates on central bases, formula-based revenue sharing, or bloc grants—is consistent with this objective.

3. Revenue adequacy. Subnational governments should have adequate revenues to discharge designated responsibilities.

4. Responsiveness. The grant program should be flexible enough to accommodate unforeseen changes in the fiscal situation of the recipients.

5. Equity (fairness). Allocated funds should vary directly with fiscal need factors and inversely with the tax capacity of each jurisdiction.

6. Predictability. The grant mechanism should ensure predictability of subnational governments’ shares by publishing five-year projections of funding availability. The grant formula should specify ceilings and floors for yearly fluctuations. Any major changes in the formula should be accompanied by hold harmless or grandfathering provisions.

7. Transparency. Both the formula and the allocations should be disseminated widely, in order to achieve as broad a consensus as possible on the objectives and operation of the program.

8. Efficiency. The grant design should be neutral with respect to subnational governments’ choices of resource allocation to different sectors or types of activity.

9. Simplicity. Grant allocation should be based on objective factors over which individual units have little control. The formula should be easy to understand, in order not to reward grantsmanship.

10. Incentive. The design should provide incentives for sound fiscal management and discourage inefficient practices. Specific transfers to finance subnational government deficits should not be made.

11. Reach. All grant-financed programs create winners and losers.


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Consideration must be given to identifying beneficiaries and those who will be adversely affected to determine the overall usefulness and sustainability of the program.

12. Safeguarding of grantor’s objectives. Grantor’s objectives are best safeguarded by having grant conditions specify the results to be achieved (output-based grants) and by giving the recipient flexibility in the use of funds.

13. Affordability. The grant program must recognize donors’ budget constraints. This suggests that matching programs should be closed ended.

14. Singular focus. Each grant program should focus on a single objective. 15. Accountability for results. The grantor must be accountable for the design

and operation of the program. The recipient must be accountable to the grantor and its citizens for financial integrity and results—that is, improvements in service delivery performance. Citizens’ voice and exit options in grant design can help advance bottom-up accountability objectives.

[Some of these criteria may be in conflict with others. Grantors may therefore have to assign priorities to various factors in comparing design alternatives (Shah 1994b); Canada 2006).]


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Annex 7. Experiences of LGUs surveyed on their ODA Experience

Some of the issues and concerns on accessing ODA funds as raised by two survey respondents from the League of Cities of the Philippines (LCP) are the following:

lack of technical support; limited staff and financial capacity length of the ODA availment process

Other issues not related to the ODA process were also identified. A survey respondent stated that one impediment to pursuing local priorities is that ODA priorities can skew local priorities placing projects of lesser importance to an LGU on its priority list simply because of the availability of ODA funds. The province of Bohol has also identified the following issues based on its experience:

differing requirements of development partners start-up processes involving NGAs can take some time need to properly decentralize the approach and allow more ODA to go

directly to LGUs need to emphasize a demand driven approach rather than an ODA driven

approach success breeds success—hard for the less fortunate and less capable LGUs

to attract ODA need for accurate information to make investment decisions and

demonstrate results

While the case of Iloilo province has raised several issues and observations, including:

underinvestment in infrastructure is threatening economic and environmental development in Region VII

infrastructure and investment still appear to be piecemeal and ad-hoc unreliable statistics as a basis for policy development and decision-making unclear guidelines on LGU partnership formation and operation majority of ODAs implemented through NGAs which involve individual LGUs ODA information is monitored by NGAs and obtained on request ODA coordination is semi-formal or informal; LGUs participate through

consultation meetings, information gathering and M & E activities LGUs generally have inadequate knowledge of effective ODA management and

coordination

.

Published by: Department of the Interior and Local Government

Francisco Gold Condominium II, EDSA cor. Mapagmahal St., Quezon City

http://www.dilg.gov.ph

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