The Journey to the Third Basis for Equitable Sharing of Revenue among County Governments

15.4.2022|The Commission on Revenue Allocation (CRA) is an independent Commission set up under Article 215 of the Constitution of Kenya, 2010. The principal mandate of the Commission is to make recommendations on the basis of the equitable sharing of revenue raised by the national government between the national and county governments, and among county governments, as stipulated in Article 216(1)(a) and (b).

Article 216 (2) further mandates the Commission to make recommendations on other matters concerning the financing of, and financial management by, county governments. In making these recommendations, the Commission is required to promote and give effect to the criteria set out in Article 203(1); when appropriate, to define and enhance the revenue sources of the national and county governments, and to encourage fiscal responsibility.

The Commission is also mandated by Article 216 (4) to determine, publish and regularly review a policy in which it sets out the criteria by which to identify marginalised areas for purposes of the Equalisation Fund.  The Equalisation Fund is a twenty-year Fund set up to enable the national government to provide basic services including water, roads, health facilities and electricity to marginalised areas to bring the quality of services in those areas to the level generally enjoyed by the rest of the nation, so far as possible.

The Three Bases for Sharing of Revenue among County Governments

Three bases have been approved by Parliament for revenue-sharing among county governments. Whilst the first two bases were transitional and therefore meant to share revenues for three financial years each, the third basis and future bases are to be used to share revenues for five years in line with Article 217.

The First Basis was approved by Parliament in 2012 and used to share revenue for financial years 2013/14 to 2016/17. The Second Basis was approved by Parliament in 2016 and used to share revenue for financial years 2017/18, 2018/2019 and 2019/2020. The Third Basis was approved in 2020 and will be used for financial years 2020/21 to 2024/25.

The Rationale for the Third Basis

The Third revenue sharing basis sought to address the objectives of enhancing service delivery and promoting balanced development. It aligned revenue sharing to functional assignment as stipulated in Part 2 of the Fourth Schedule of the Constitution; including agriculture, health, county transport, and urban services, among others. The three bases are summarised in Table 1.

Table 1: First, Second and Third Revenue Sharing Bases

Stakeholder Consultations

The Commission held sector-wide consultations with local and international experts, intergovernmental sector practitioners, county governments, the public and Parliament.

A sectoral approach was followed based on the functions assigned to County Governments in the Fourth Schedule of the Constitution, and the criteria provided in Article 203. Accordingly, the Commission’s recommendations submitted to Parliament sought to address four objectives namely: to enhance equitable service delivery; to promote balanced development; to incentivize Counties to optimise capacity to raise revenue and incentivise prudent use of public resources by the counties.

The preparation of the Third Basis for revenue sharing among county governments also relied on experiences and lessons from other countries with a similar decentralised system of governance like Ethiopia, Philippines, India, South Africa, Ghana, Indonesia, Bolivia, Uganda, Nigeria and Brazil.  Cross-sectional data on the counties also provided data for the preparation of the third basis.

Framework for the Third Basis

The Department of Economic Affairs reviewed the Second Basis, for sharing revenues. In developing the Third Basis for sharing revenues, the department relied on lessons learnt from the comprehensive review of the second basis, a comparative analysis of financing transfer systems from other countries, and extensive consultations with the national government, county governments, and public finance experts and the public.

The Commission paid particular attention to incentivising revenue collection and fiscal prudence, in line with the Constitution.

This recommendation had four primary objectives; to enhance service delivery, to promote balanced development, to incentivise counties to optimise capacity to raise revenue and to incentivise prudent use of public resources. These objectives are actualised through a framework that linked revenue sharing to devolved functions through service delivery, balanced development and incentive components.

The framework recommended by CRA for revenue-sharing among the Counties

The service delivery component used a health index constructed from data on health facility gaps, primary health care visits and in-patient days.  The transfer variable for agriculture was based on a county’s proportion of rural households, while that for other devolved functions was based on a county’s proportion of the total population. Further, the service delivery component incorporated a basic minimum allocation to each county.

The balanced development component has four variables; roads, urban services, land area and poverty. On roads, the framework uses a rural access index, while land area uses the proportion of the land size of a county. On poverty, the framework uses the proportion of poor people.

The incentive component of the framework has two measures; the fiscal effort and prudence indices. The fiscal effort index measures a county’s effort to raise own-source revenues from the economic activities within the county. The fiscal prudence parameter is a composite index that measures the county’s fiscal responsibility. It considers the Auditor General’s audit opinion on county utilisation of resources, average county expenditures on development, the establishment of an internal audit committee and the County Budget and Economic Forum by a county.

Determination of Parameter Weights

The specific weights assigned to the transfer variables in each revenue component were guided by existing national policies, triangulation of data on agreed conventions, actual county government expenditures and transfer shares for devolved functions. Experience from countries that have implemented fiscal decentralisation revealed that these weights need to be continuously reviewed to take into account changes in policy priorities and objectives of the transfer framework.

Approval by Parliament

As stipulated in Article 217, Parliament subjected CRA’s Third Basis recommendations to stakeholder consultations. This was in accordance with Article 217 (2), which provides that in determining the basis of revenue sharing the Senate shall: a) take the criteria in Article 203 (1) into account; b) request and consider recommendations from the Commission on Revenue Allocation; c) consult the County governors, the Cabinet Secretary responsible for finance and any organization of County governments; and d) invite the public, including professional bodies, to make submissions to it on the matter.

In reviewing CRA’s recommendations, Senate considered that:

  1. The parameters used in revenue sharing basis provide an allocation framework tool and not an indicative budget nor guidelines as to how County Assemblies should draw the County Government budgets;
  2. Given the impact of COVID-19 on the County Governments, it would be necessary to consider the provisions of Article 203(1)(k) of the Constitution which provides that in considering the Basis for revenue sharing there is a need for flexibility in responding to emergencies and other temporary needs, based on similar objective criteria; and,
  • The FY in which the Third Basis of revenue sharing is to apply had already commenced

The basis was approved by Senate with amendments: the fiscal and prudence measures were excluded and the weight of the roads parameter increased from four per cent to eight per cent.

The framework approved by Parliament for revenue sharing by the Counties 2020/21 to 2024/25

Assessment of counties’ revenue allocation using the Third Basis

After revision to include Parliament’s reviews, the Third Formula was gazetted and used by the National Treasury to develop the Disbursement Schedule for the counties. In the financial year 2021/2022, county governments have been allocated an equitable share of Ksh. 370 billion. This allocation is an increase of Ksh.53.5 billion from the Ksh. 316.5 billion allocated to the counties during the 2020/2021 financial year.

The Equitable Share allocation to the counties in 2021/2022, which is equivalent to 27.3 per cent of the last audited accounts (Ksh. 1,358 billion for FY 2016/17) and as approved by Parliament. The allocation, therefore, meets the requirement of Article 203(2) of the Constitution that equitable share allocation to counties should not be less than 15 per cent of the last audited revenue raised nationally, as approved by the National Assembly.

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