The Consequences of Fiscal Decentralization on Poverty and Income Inequality

Many countries around the world are currently pursuing policies for poverty reduction and improving income distribution. Many of these same countries are also aggressively implementing fiscal decentralization reforms. Although fiscal decentralization, poverty and the distribution of income have been the subject of extensive separate theoretical and empirical research, to date we have little understanding of what may be the impact of fiscal decentralization on poverty and inequality. This paper sets out to shed some light on those relationships. After reviewing the literature addressing different aspects of these relationships, the paper describes the possible channels through which fiscal decentralization might affect poverty and income inequalities. We also carry out an empirical analysis with panel data for a large number of countries at different stages of development covering the period 1971-2000. We find that fiscal decentralization may have significant effects on poverty and inequality. In particular, fiscal decentralization appears to reduce poverty as long as the share of sub-national expenditures is not greater than one third of total government expenditures. Fiscal decentralization appears to also help reduce income inequality only if the general government represents a significant share of the economy (twenty percent or more).