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On the Theory and Practise of Fiscal Decentralization

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  • Wallace E. Oates

    ()
    (Department of Economics, University of Maryland)

Abstract

The traditional theory of public finance has made a strong case for a major role for fiscal decentralization. This case is based on an improved allocation of resources in the public sector. And it has four basic elements. First, regional or local governments are in a position to adapt outputs of public services to the preferences and particular circumstances of their constituencies, as compared to a central solution which presumes that one size fits all. Second, in a setting of mobile households, individuals can seek out jurisdictions that provide outputs well suited to their tastes, thereby increasing the potential gains from the decentralized provision of public services (Tiebout 1956). Third, in contrast to the monopolist position of the central government, decentralized levels of government face competition from their neighbors; such competition constrains budgetary growth and provides pressures for the efficient provision of public services. And fourth, decentralization may encourage experimentation and innovation as individual jurisdictions are free to adopt new approaches to public policy; in this way, decentralization can provide a valuable Alaboratory for fiscal experiments. However, this basic economic rationale for decentralization of the public sector is not quite so simple and compelling as it appears. Some of the more recent literature provides, first, a thoughtful and provocative critique of the traditional view of fiscal decentralization, and, second, some new approaches that reveal its dark side, especially in practice. There is emerging, in short, a broader perspective on fiscal decentralization that raises some serious questions about its capacity to provide an unambiguously positive contribution to an improved performance of the public sector. My purpose in this paper is twofold. First, I want to review the basic theory of fiscal decentralization. There are some loose ends to the traditional argument that open up some intriguing issues. Second, I want to turn to some of new literature on fiscal discipline in multilevel government. This literature has focused attention on some basic and destructive forces that can undermine the economic performance of a relatively decentralized public sector. I find it helpful to begin by revisiting a Decentralization Theorem that I formulated long ago. As a point of departure, I want to explain briefly why I introduced the proposition and the rationale for its particular form and proof.

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Bibliographic Info

Paper provided by CREI Università degli Studi Roma Tre in its series Working Papers with number 0701.

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Length: 20 pages
Date of creation: 2007
Date of revision: Jan 2007
Handle: RePEc:rcr:wpaper:07_01

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Keywords: Fiscal Decentralization; Public Finance;

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References

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  1. Jonathan A. Rodden & Gunnar S. Eskeland (ed.), 2003. "Fiscal Decentralization and the Challenge of Hard Budget Constraints," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262182297, December.
  2. Janos Kornai & Eric Maskin & Gerard Roland, 2002. "Understanding the Soft Budget Constraint," Economics Working Papers 0019, Institute for Advanced Study, School of Social Science.
  3. Timothy Goodspeed, 2002. "Bailouts in a Federation," International Tax and Public Finance, Springer, vol. 9(4), pages 409-421, August.
  4. Lockwood, Ben, 1997. "Inter-Regional Insurance," Discussion Papers 9703, Exeter University, Department of Economics.
  5. Prud'homme, Remy, 1995. "The Dangers of Decentralization," World Bank Research Observer, World Bank Group, vol. 10(2), pages 201-20, August.
  6. Charles M. Tiebout, 1956. "A Pure Theory of Local Expenditures," Journal of Political Economy, University of Chicago Press, vol. 64, pages 416.
  7. Antonio Estache & J. Cremer & Paul Seabright, 2005. "Decentralizing Public Services: What can we learn from the Theory of the Firm?," ULB Institutional Repository 2013/44017, ULB -- Universite Libre de Bruxelles.
  8. Seabright, Paul, 1994. "Accountability and Decentralization in Government: An Incomplete Contracts Model," CEPR Discussion Papers 889, C.E.P.R. Discussion Papers.
  9. Besley, Timothy & Coate, Stephen, 2003. "Centralized versus decentralized provision of local public goods: a political economy approach," Journal of Public Economics, Elsevier, vol. 87(12), pages 2611-2637, December.
  10. Yingyi Qian & Barry R. Weingast, 1997. "Federalism as a Commitment to Preserving Market Incentives," Working Papers 97042, Stanford University, Department of Economics.
  11. Weingast, Barry R, 1995. "The Economic Role of Political Institutions: Market-Preserving Federalism and Economic Development," Journal of Law, Economics and Organization, Oxford University Press, vol. 11(1), pages 1-31, April.
  12. David E. Wildasin, 2001. "Externalities and Bailouts: Hard and Soft Budget Constraints in Intergovernmental Fiscal Relations," Public Economics 0112002, EconWPA.
  13. Flatters, Frank & Henderson, Vernon & Mieszkowski, Peter, 1974. "Public goods, efficiency, and regional fiscal equalization," Journal of Public Economics, Elsevier, vol. 3(2), pages 99-112, May.
  14. Robin W. Boadway & Frank R. Flatters, 1982. "Efficiency and Equalization Payments in a Federal System of Government: A Synthesis and Extension of Recent Results," Canadian Journal of Economics, Canadian Economics Association, vol. 15(4), pages 613-33, November.
  15. Rubinfeld, Daniel L., 1987. "The economics of the local public sector," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 2, chapter 11, pages 571-645 Elsevier.
  16. Kornai, J, 1979. "Resource-Constrained versus Demand-Constrained Systems," Econometrica, Econometric Society, vol. 47(4), pages 801-19, July.
  17. James M. Buchanan & Richard E. Wagner, 1970. "An Efficiency Basis for Federal Fiscal Equalization," NBER Chapters, in: The Analysis of Public Output, pages 139-162 National Bureau of Economic Research, Inc.
  18. Yoram Barzel, 1969. "Two propositions on the optimum level of producing collective goods," Public Choice, Springer, vol. 6(1), pages 31-37, March.
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Citations

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Cited by:
  1. George Hammond & Mehmet S. Tosun, 2006. "Local Decentralization and Economic Growth: Evidence from U.S. Metropolitan and Non-Metropolitan Regions," Working Papers 06-002, University of Nevada, Reno, Department of Economics & University of Nevada, Reno , Department of Resource Economics.
  2. Vito Tanzi, 2010. "Revenue Sharing Arrangements: Options and Relative Merits (The Mahbub ul Haq Memorial Lecture)," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 49(4), pages 311–332.
  3. Liesbet Hooghe & Gary Marks, 2012. "Beyond Federalism - Estimating and Explaining the Territorial Structure of Government," KFG Working Papers p0037, Free University Berlin.
  4. Eyraud, Luc & Lusinyan, Lusine, 2013. "Vertical fiscal imbalances and fiscal performance in advanced economies," Journal of Monetary Economics, Elsevier, vol. 60(5), pages 571-587.
  5. Lars-Erik Borge, 2006. "Centralized or decentralized financing of local governments? Consequences for efficiency and inequality of service provision," Working Paper Series 7806, Department of Economics, Norwegian University of Science and Technology.
  6. Torrisi, Gianpiero & Pike, Andy & Tomaney, John & Tselios, Vassilis, 2011. "Defining and measuring decentralisation: a critical review," MPRA Paper 51441, University Library of Munich, Germany.
  7. Ichiro Aoki, 2008. "Decentralization and Intergovernmental Finance in Japan," Finance Working Papers 23074, East Asian Bureau of Economic Research.
  8. David Wildasin, 2009. "State and Local Government Finance in the Current Crisis: Time for Emergency Federal Relief?," Working Papers 2009-07, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  9. David E. Wildasin, 2006. "Disasters: Issues for State and Federal Government Finances," Working Papers 2006-07, University of Kentucky, Institute for Federalism and Intergovernmental Relations.

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