Fiscal Federalism Remains Elusive as Resources Stay Centralized

Nepal’s transition to a federal system was expected to empower citizens by strengthening local and provincial governments financially. In principle, fiscal federalism is not merely about dividing budgets among different tiers of government; it is about enabling people’s economic empowerment through decentralized financial decision-making. However, years into federal implementation, the promise of fiscal federalism remains largely unfulfilled, as financial authority continues to be tightly controlled at the center.

Fiscal federalism involves the sharing of revenue generation, expenditure responsibilities, and financial administration among multiple levels of government. In Nepal’s case, this responsibility is constitutionally divided among the federal, provincial, and local governments. While the legal framework—supported by constitutional provisions and intergovernmental fiscal laws—appears robust on paper, practical implementation tells a different story. Financial powers may be distributed in theory, but in practice, local governments continue to operate with limited autonomy.

One of the most pressing issues lies in budget execution. Although the federal, provincial, and local governments are required to present their annual budgets within fixed constitutional deadlines, the actual flow of funds does not always match these plans. Grants allocated in the budget are frequently reduced or delayed during disbursement. As a result, local governments struggle to implement approved programs, undermining both planning credibility and public trust.

The absence of clear functional boundaries between government tiers has further complicated matters. While the intent of federalism was to prevent overlapping responsibilities, all three levels of government continue to introduce similar projects, often within the same local jurisdiction. Federal and provincial authorities routinely allocate funds for small-scale projects that could be more effectively managed at the local level. This duplication raises questions about priority-setting and efficient use of public resources.

Local governments argue that development priorities are best identified at the grassroots level, where elected representatives interact directly with citizens. However, planning decisions are often overridden by politically driven projects imposed from higher levels of government. These projects frequently reflect the preferences of political leaders rather than the actual needs of local communities, leading to weak outcomes and limited long-term impact.

A practical illustration can be seen in municipal-level planning, where dozens of projects are introduced without alignment to local priorities. When local governments are forced to implement externally selected projects, they face a dilemma: rejecting them risks public backlash, while accepting them diverts resources away from genuinely urgent needs. This dynamic has weakened accountability and diluted development results.

Coordination failures are not limited to project selection alone. Revenue-sharing mechanisms also suffer from inconsistency. Although local governments are entitled to a share of revenues such as land registration fees and natural resource royalties, disbursement is often delayed or incomplete. In some cases, municipalities report receiving little to none of the royalties they are legally entitled to, reinforcing perceptions that fiscal federalism exists more in form than in substance.

The imbalance becomes more pronounced when expenditure responsibilities are considered. Local governments have been assigned extensive duties—including education, health, agriculture, cooperatives, and basic infrastructure—without receiving adequate financial resources. While responsibilities have been decentralized, revenue authority has largely remained centralized, creating a structural mismatch that limits local effectiveness.

Revenue generation at the local level remains constrained by economic realities. Many municipalities, particularly those formed through administrative restructuring rather than organic urban growth, lack sufficient economic activity to generate internal revenue. Large geographic jurisdictions with predominantly rural populations struggle to raise funds through property taxes, rentals, or commercial activity, further increasing dependence on federal transfers.

Urban classification without corresponding infrastructure investment has compounded frustration among residents. Municipalities designated as cities or sub-metropolitan areas often lack basic urban services such as paved roads, drainage, and reliable utilities. Citizens, expecting improved services under federalism, instead face unmet expectations and growing dissatisfaction.

Another critical concern is the method of project implementation. A heavy reliance on consumer committees for executing small projects has drawn criticism for encouraging inefficiency and rent-seeking behavior. While community participation can be effective in certain contexts, the fragmentation of projects into numerous small contracts has, in many cases, prioritized political patronage over development outcomes.

Local governments contend that true fiscal federalism requires not only the transfer of funds but also respect for local planning authority. They argue that even if budgets are allocated centrally, projects should be selected based on local needs and feasibility. Development becomes result-oriented only when financial resources align with locally identified priorities.

The current revenue-sharing formula further limits local capacity. With a significant share of national revenue retained by the federal government, provinces and municipalities are left to divide a relatively smaller portion. Without meaningful involvement in federal budget prioritization, local governments find it difficult to address development gaps or respond to citizen demands.

Economic development at the local level depends on infrastructure investment, which in turn requires predictable funding. Without adequate roads, markets, and utilities, local governments cannot stimulate trade or expand their tax base. This creates a cycle where low revenue leads to underdevelopment, which then further constrains revenue generation.

Municipal budgets remain modest relative to their responsibilities. With limited resources, local governments are expected to deliver services across multiple sectors, often spreading funds thinly across numerous programs. Such fragmentation reduces impact and reinforces perceptions of inefficiency.

Local leaders argue that if the federal government retains control over resources, it should also take responsibility for project execution. Alternatively, if responsibilities are devolved, financial authority must follow. The current arrangement—where projects are centrally selected but locally implemented—has emerged as one of the core weaknesses of Nepal’s fiscal federalism.

Ultimately, federalism was introduced to bring government closer to the people. However, without genuine fiscal decentralization, local governments remain constrained, unable to act independently or respond effectively to community needs. Until resource allocation aligns with responsibilities and local priorities are respected, fiscal federalism will remain an unfulfilled promise rather than a transformative governance model.