Countries that are emerging from a period of conflict are typically faced with a significant loss in real output, high rates of inflation and low foreign reserves. The population is reluctant to hold local currency to conduct daily transactions and there is a large flight of capital from the country. Conflicts also damage a country’s institutions, which can make the task of stabilisation and growth even more challenging.

The reconstruction of fiscal institutions does not have to wait until the economy is fully stabilised; rather, these two processes can go hand in hand. In fact, efforts to strengthen fiscal institutions can contribute to macroeconomic stabilisation, which in turn provides a conducive environment for further institution building. Well functioning institutions and sound economic policies also reduce the risk of future conflicts and allow these countries to absorb more aid.

Key elements

In any strategy to rebuild fiscal institutions in a post-conflict setting, the principal objective is to make fiscal policy and management effective and transparent. The first element in such a strategy is the creation of a proper legal and regulatory framework for fiscal policy. For example, if a new constitution is prepared after the conflict ends, the taxing powers of different levels of government will need to be defined within it. Tax and budget laws may need to be established from scratch or revised in order to take into account the complexity of implementing and administering these laws in a post-conflict situation.

The second element in rebuilding fiscal institutions is to establish or strengthen a central fiscal authority (the ministry of finance) and a mechanism for coordinating foreign assistance. Ideally, such an authority/ministry should include a budget department, a treasury department, and customs and revenue administrations. Some countries have also found it useful to set up a separate unit for coordinating donor support within the ministry of finance.

The final element of the strategy is to reform revenue and expenditure policies, as well as the associated administrative arrangements, and to ensure the most effective use of scarce human resources.

This three-step approach is generally valid for all post-conflict countries. The order in which the steps are taken, however, will vary according to the starting conditions and needs in each case. In some countries, rebuilding the basic infrastructure of the ministry of finance comes first, and only later creating/strengthening the proper legal framework for fiscal policy. In other countries, the legal system may have been unscathed by the conflict, allowing them to immediately move to such steps as implementing measures to simplify existing systems and to make the fiscal regime more market friendly. Whatever their sequence, the reforms should be realistic, consistent with the country situation, and should take into account the existing human resource capacity for implementing the plan. The strategy should lay out a plan of action setting out priorities and identifying technical assistance requirements. This plan should also facilitate the coordination of donor activities.

Fiscal decentralization

In some countries, the issue of fiscal decentralisation is an integral part of the peace process. For decentralisation to be successful, it is important that sub-national governments have the administrative and institutional capacity to implement spending programmes. In this regard, donors may have to assist sub-national governments to build this capacity as revenues and spending responsibilities are transferred to lower levels of government. In some cases, it may become necessary to clarify revenue and expenditure assignments among the different levels of government and to ensure that they have the means to fulfil their obligations.

A phased-in approach

Initial steps to rebuild fiscal institutions and systems have to take into account the weak administrative capacity that exists in post-conflict countries. This implies beginning the process with simple policies and administrative procedures which can be upgraded as national capacity improves. In the early post-conflict stages, countries may have to resort to taxes that are suboptimal from an efficiency point of view to help finance immediate spending needs. For example, some countries have introduced a withholding tax on wages and a presumptive tax on small businesses; others have imposed an export tax or an import surcharge. These should be viewed as short-term measures to be refined later as a country’s capacity develops further. To the extent possible, the short-term measures have to be consistent with the long-term objective of moving towards an efficient and modern fiscal system.

Further reading

This article is drawn from S. Gupta, S. Tareq, B. Clements, A. Segura-Ubiergo, R. Bhattacharya, and T. Mattina (2005) Rebuilding Fiscal Institutions in Postconflict Countries, Occasional Paper 247, IMF.