International Journal of Scientific and Research Publications, Volume 6, Issue 5, May 2016 26 ISSN 2250-3153 www.ijsrp.org The Effects of Financial Balance Transfer and Regional Own-Source Revenue on Regional Expenditure of Regencies and Municipalities in East Java Province Khubbi Abdillah 1 , Djoko Mursinto 2 1 Doctoral Study Program, Faculty of Economics and Business, Universitas Airlangga, Surabaya, Indonesia 2 Economics Department, Faculty of Economics and Business, Universitas Airlangga, Surabaya, Indonesia Abstract- This study aims to identify the flypaper effect and the effects of financial balance transfer and Regional Own-source Revenue on regional expenditure of regencies and municipalities in East Java Province. The population of this study consists of regional expenditure data of 29 regencies and 9 municipalities in East Java Province collected by Statistics Indonesia (Biro Pusat Statistik/BPS) from 2005 to 2012. The writer conducted analysis on the data using Eviews 7. The findings of this study indicated that Regional Own-source Revenue, General Allocation Fund, and Specific Allocation Fund significantly affect regional expenditure and the flypaper effect occurs on regional expenditure of regencies and municipalities in East Java Province. This conditionis marked by regional spending as the response against the General Allocation Fund is higher than regional spending as the response against Regional Own-Source Revenue. Therefore, it can be concluded that the dependency level of the regions upon financial balance transferred from central government is still relatively high. Index Terms- Regional Own-source Revenue, Financial Balance, Regional Expenditure, Flypaper Effect I. INTRODUCTION ast Java Province is one of provinces in Java. Its region consists of mainland East Java, which covers about 90% of total region and Madura Islands (about 10% of total region). Administratively, East Java Province consists of 29 regencies and 9 municipalities with 662 districts, 785 sub-districts, and 7721 villages (Gubernur Jawa Timur, 2012: 5). In order to implement true and responsible regional autonomy widely, each region requires authorities and abilities to explore its own revenue resources. The authorities and abilities shall be supported by a financial balance distributed by the central government to the local governments (i.e. provincial governments, regencies, and municipalities) as one of pre- requirements of the regional government system. When we analyze further, the source of regional funding is implemented based on the principles of decentralization, delegation, and co- administration. The implementation of regional tasks in terms of decentralization effectuation is funded by the Local Government Budget (APBD) while the implementation of central government tasks carried out by local government based on delegation principle is funded through the State Budget (APBN). Central government tasks carried out by local and village apparatuses (in terms of co-administration) are also funded through the State Budget (Djaenuri, 2014: 87). Transfers of human resources, infrastructure, and fund allocation shall entail delegation of authorities from central government to the local governments as the result of decentralization and de-concentration. Transfers of human resources, infrastructure, and fund allocation are required to assure the fluency of authority delegation. Assignments given by central government to the local governments in terms of co- administration tasks are accompanied by financial allocation (Djaenuri, 2014: 88). Financial balance between central government and local governments that is closely related to financial distribution from central government to the local governments occurs as the effect of distribution of power from central government to the local governments in terms of financial management. Article 18 of Constitution 1945 explicitly states that Indonesia consists of large and small areas which its government structures regulated by laws. Principally, financial balance correlates with balance of authority, balance of surveillance, and financial balance. The financial relationship between central and local governments should be coherent with the implementation of regional autonomy. This relationship becomes the key for successful internal affairs governance by the regions. “Governing its own internal affairs” implies a meaning that every autonomous region must possess its own source revenue to finance its own internal affairs. Central government builds central-local government financial relationship to improve fiscal capability of the regions and creating more conducive situation for the implementation of regional autonomy. Generally, fiscal capability of regions in developing countries is limited. Existing sources of regional revenue are limited to less potential sources and regional taxes that do not contribute much on the improvement of regional revenue. In order to cope with this problem, central government develops a systematic financial relationship with local governments (Djaenuri, 2014: 87). Fiscal autonomy and decentralization implemented for the last 12 years has brought several consequences, including improvements on Regional Own-source Revenue (PAD) and Financial Balance transfer from central government to the local governments, which consists of General Allocation Fund (DAU), Special allocation Fund (DAK), and Revenue Sharing Fund (DBH). Regional Own-source Revenue and Financial Balance transfer are used to finance regional expenditures, which consists of direct expenditure and indirect expenditure. This study aims to E