This paper attempts to answer some questions about the financial capacity of local governments to implement regional autonomy. In the early stages of the implementation of autonomy, financial aspects have been crucial for every kabupaten and kota administration¹. According to Laws No.22, 1999 and No.25, 1999, financial management is an important indicator of local government performance in determining whether they can continue as autonomous entities or should be merged with other neighboring kabupaten or kota.

Some of the related issues to be discussed include: what is the regional budget allocation that each local government is to receive and what is the formula applied by the central government to determine this allocation? Is the allocated budget smaller than the amount received by local governments prior to regional autonomy? Is the allocated budget from the central government less than the amount required for local civil servant salaries and routine bureaucratic and administrative expenses? Why have local governments been so eager to increase local revenues? What is the likely impact of this on the business climate?

Based on the results of field studies conducted by SMERU in twelve kabupaten and kota across nine provinces, it is apparent that in many cases, local governments at the kabupaten and kota level have received an allocation of funds from the central government that exceeds routine expenditures. However, this level of funding is substantially less than the total transferred into the regions (including funds received by central government offices operating at the kabupaten and kota level) during the period before regional autonomy. It is a different matter, however, at the province level where the allocation of funds from the central government is much smaller than their routine expenditures. The size of the budget allocation is one the key reasons given by local bureaucrats to explain why local governments, both at the kabupaten and kota level as well as at the provincial level, have been working hard to increase local revenues by imposing more local taxes and levies.

The negative impact of these levies on the business and investment climate has not been fully captured by recent field studies. Local businessmen have pointed out that most levies have not yet been fully imposed and there is some variation between regions in the degree of their commitment to the creation of these new taxes. But it is widely accepted by local businessmen that all these new levies will create distortions in the market and a high-cost economy in the near future. Some indications of these potential distortions can be already identified and will be discussed in detail in the paper.

If this pattern continues without any amendments by local government or if the central government fails to intervene, another fundamental question arises: will regional autonomy be able to achieve its important goals of improving the quality of public services and increasing the participation of local business in the local economy in the regions throughout Indonesia?

¹ Kabupaten is the Indonesian term for district under province level while Kota is the term applied to municipalities.