transfer. It is necessary to enact a law or issue a central government ordinance on fiscal transfer that obliges local authorities to submit accurate data on a timely manner. Naturally, incentives exist for local governments to under-repor **t** heir tax bases in order to receive more transfers. To prevent such practices, it is necessary to include penalty clauses on fraud in the law or ordinance. Equally important is that the central government audits the statistical reports submitted by local governments (either by directly sending officials to local governments or hiring independent auditors).

A general principle for the application of formulas is that the most recent data should be used to calculate fiscal transfers. In other words, the previous year's data on tax bases and expenditure needs should be used, whenever available. In calculating fiscal capacities, a possible approach is to use forecasted tax bases to calculate the preliminary amounts of transfer, and base the current year's (e.g., 1996) initial disbursements on these forecasts. When the actual tax base figures of 1996 become available in 1997, the final amounts of 1996 transfer are recalculated with the actual figures. If the 1996 initial disbursement to a locality is lower/higher than the final amount, then the difference is added/subtracted to/from the 1997 disbursement.

# **3.5.** Institutional Requirement for Introducing a Formula-Based Transfer System

For a country that has no experience with a formula-based transfer system and is interested in adopting one, the first step is to set up a team to work out the methodology and to conduct the detailed calculations. The staff needed for such a tearn will include: (1) officials from the Ministry of Finance who understand the basic concerns of the Ministry on the overall budgetary impact of transfers; (2) technical experts who understand the models used by other countries and the applicability of these models to the country in question, and who have the ability to revise/design their own models that will be appropriate under local conditions; (3) statisticians who are familiar with the data availability and who are able to conduct simulations with alternative models. The whole team should be able to interpret the simulation results to the Finance Minister and the concerned provincial leaders in an accurate yet non-technical manner.

In terms of administrative affiliation of the team, a possible arrangement is that the team be part of the Ministry of Finance at least in the initial stage of designing the transfer system. In the long run, the desirability of creating an independent grants commission (such as those in Australia, India, and Pakistan) can be considered. The main advantages of an independent grants commission include: (1) reduced political influence from both the central and the regional governments and, as a result, (2) the possibility of exercising fair judgements over disputes among different subnational governments and between levels of governments; and (3) that the recommendations made by the independent commission are easier to be accepted by the parties involved. The disadvantage of an independent grants commission mainly has to do with its limited authority in obtaining data and other supports from the subnational governments.

21 See Searle (1994) for a detailed discussion on Australia's Grants Commission.

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