As one of central government’s tools to equalize fiscal disparities between regions in Indonesia, current allocation mechanism of intergovernmental grant has been a major issue in regional public finance. Specifically, specific grant (DAK) was proven not much more specific than general block grant (DAU). Furthermore, the effectiveness of the specific grant allocation mechanism on poverty alleviation, economic growth, unemployment, and several others specific indicator has not met the desirable condition of the program’s outcome. This paper tries to propose alternatives on the allocation mechanism of specific grant that could effectively fulfill the objectives of affecting the local policy of poverty alleviation, economic growth, and unemployment. Employing sub national data at city and district level, we perform a simulation utilizing panel data regression of 458 cities/districts during period of 2001-2007. The result shows that existing DAK allocation on public investment program has not been able to meet development objectives in the long term economic development. Specifically, specific grant (DAK) was proven not much more specific than general block grant (DAU). This study also provides an efficiently simple, matching grant allocation mechanism which is conditional open-ended matching grants, along with intensive ongoing evaluation and monitoring to align the allocation of funds to regions with regional macroeconomic targets and promoting the level of community welfare; and at a certain level, using a bottom-up approach where the allocation of the fund should was based on local government interests and initiatives. The study consider that DAU per capita is a better main criteria for determining which areas are considered eligible as a recipient of DAK is districts that have a low fiscal capacity (general criteria). The simulation provides better estimation result than one from existing mechanism; the expected sign of DAK toward economic growth, poverty rate, and unemployment are in accordance with the theory and common knowledge. This brings consequences that DAK should be give to less region with higher amounts.

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