Strengthening Somalia’s Fiscal Foundations in the Absence of Fiscal Federalism

Issue 2

Overview

In FY2024, Somalia’s Ministry of Finance reported total revenues of $912.7 million, with 59.5% sourced from external grants and only 40.5% from domestic revenue. Tax revenues accounted for 29.2% of total revenue, while non-tax revenues contributed 11.2%.

This revenue structure reflects both progress and persistent structural challenges — particularly the absence of a formal fiscal federalism framework, which has significant implications for equity, efficiency, and sustainability.

Why this is disappointing

Somalia’s current revenue structure reveals a troubling overreliance on external aid, with grants comprising nearly 60% of total revenues in FY2024. While these funds offer short-term fiscal relief, they expose the country to volatility and undermine fiscal sovereignty — a classic symptom of aid dependency. According to the Musgrave framework, sustainable public finance requires a gradual shift toward domestic taxation. Yet Somalia’s low tax-to-GDP ratio signals untapped potential in broadening the tax base, improving compliance, and strengthening administrative capacity.

The Tanzi model explains the dominance of trade taxes and indirect levies — easier to collect in fragile contexts but regressive and distortionary. Meanwhile, the absence of a fiscal federalism framework compounds the problem. The federal government collects most revenues, while states should deliver most of public services, creating a vertical fiscal imbalance. This contradicts Oates’ Decentralization Theorem, which emphasizes the efficiency of local decision-making.

Subnational governments lack incentives to mobilize their own revenues, leading to fragmented, informal taxation and overdependence on grants and aid transfers. This entrenches soft budget constraints, where states expect transfers rather than building fiscal capacity. Without a formal intergovernmental transfer system, regional disparities widen, and opportunities for horizontal equity are missed.

Institutional ambiguity over revenue assignments — such as customs, telecoms, and fisheries — fuels intergovernmental disputes and deters investment. These challenges reflect the assignment problem in fiscal federalism, where unclear roles erode efficiency and accountability.

In sum, Somalia’s fiscal architecture remains fragile, centralized, and externally driven. The lack of a coherent fiscal federalism framework not only limits domestic revenue potential but also undermines equity, efficiency, and long-term resilience.

What should be done

• Diversify revenue sources to reduce aid dependency

• Invest in tax administration and digital systems

• Formalize the informal economy to expand the tax net

• Enhance transparency and accountability to build public trust in taxation

• Establish a transitional fiscal federalism framework

  • Define revenue assignments and expenditure responsibilities

  • Introduce intergovernmental fiscal transfers based on equity and need

  • Pilot revenue-sharing mechanisms in key sectors (e.g., ports, telecoms)

• Strengthen domestic revenue mobilization

  • Invest in tax administration and digital systems

  • Formalize the informal economy

  • Expand property and income tax bases

• Reduce grant dependency

  • Use grants strategically to build domestic capacity

  • Improve transparency and reporting to enhance donor confidence

• Promote horizontal equity

  • Design equalization transfers to support lagging regions

  • Ensure predictable and rules-based funding for states

• Clarify institutional roles

  • Finalize intergovernmental fiscal compacts

  • Establish a Fiscal Federalism Commission to mediate disputes and guide reforms.

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