Fiscal Federalism in Nepal: Revenue Sharing, Grants and NNRFC

Fiscal federalism is how revenue, spending responsibilities and grants are divided among federal, provincial and local governments. After the Constitution of 2072, Nepal set up a three-tier fiscal system. This is an important topic for Section Officer Papers I and II.

1. Constitutional basis

• Article 59: financial powers of the federation, provinces and local levels.
• Article 60: distribution of revenue sources and fiscal transfers.
• Schedules 5–9: powers of each level (5 federal, 6 provincial, 7 federal–provincial concurrent, 8 local, 9 concurrent for all three).
• National Natural Resources and Fiscal Commission (NNRFC): Articles 250–251.
• Law: Intergovernmental Fiscal Arrangement Act 2074.

2. Types of fiscal transfers (grants)

3. Revenue sharing

4. Budget calendar

5. Key concepts

• Vertical fiscal imbalance: gap between a level’s spending responsibilities and its own revenue (sub-national governments usually spend more than they collect).
• Horizontal fiscal imbalance: differences in capacity among provinces or local units.
• Musgrave’s three functions of public finance: allocation, distribution and stabilisation.
• Oates’ decentralisation theorem: services should be provided by the lowest level that can do it efficiently.
• Local revenue examples: property tax, house and land rent tax, land revenue (malpot), business tax, advertisement and entertainment tax.

6. Worked example: how a divisible fund is shared

The figures are an example only. Suppose the federal government collects Rs 100 billion from VAT and internal excise in a year. This money goes into the divisible fund (विभाज्य कोष).

The Rs 15 billion for provinces is not split equally. It is divided among the seven provinces using the basis recommended by the NNRFC, such as population, area, human development index, expenditure needs, revenue effort and infrastructure. The local share is divided among the 753 local levels in the same way.

For natural resource royalty (for example from a hydropower project), the federal government keeps 50%, and 25% goes to the affected province and 25% to the affected local levels.

7. Main functions of the NNRFC (Article 251)

• Recommend how revenue from the federal divisible fund is shared among federal, provincial and local governments.
• Recommend the amount and basis of fiscal equalisation grants to provinces and local levels.
• Recommend how royalty from natural resources is shared.
• Recommend the limit of internal loans that each level can take.
• Study and recommend ways to settle disputes over natural resources between governments.
• Recommend measures to improve revenue collection and spending at each level.

8. Challenges of fiscal federalism in Nepal

• High dependence on grants: most provinces and local levels get a large part of their budget from federal transfers, not their own revenue.
• Weak own-source revenue: many local levels do not fully collect property tax or business tax.
• Late release of grants and low spending capacity, which adds to the Asar spending rush.
• Overlapping concurrent powers (Schedules 7 and 9), which cause confusion about who should do and pay for what.
• Shortage of skilled staff for planning, accounts and procurement at the local level.

Ways to improve: strengthen local tax collection, release grants on time, make performance-based grants, clarify concurrent powers through laws, and train staff in public financial management.

9. How this topic is asked in the exam

• Objective: Articles 59, 60 and 250–251, the 70/15/15 and 50/25/25 shares, the Act of 2074, and the four types of grants.
• Short answer: “What is a fiscal equalisation grant?” or “Write the functions of the NNRFC.”
• Long answer: “Explain fiscal federalism in Nepal with its challenges.” Cover the constitutional basis, grants, revenue sharing with the example in section 6, then the challenges and solutions in section 8.