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On the Theory and Practice of Fiscal Decentralization

  • Wallace E. Oates


    (Department of Economics, University of Maryland, 3105 Tydings Hall College Park, MD 20742)

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

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Paper provided by University of Kentucky, Institute for Federalism and Intergovernmental Relations in its series Working Papers with number 2006-05.

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Length: 38 pages
Date of creation: Sep 2006
Date of revision:
Handle: RePEc:ifr:wpaper:2006-05
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  1. J. Kornai & E. Maskin & G. Roland., 2004. "Understanding the Soft Budget Constraint," VOPROSY ECONOMIKI, N.P. Redaktsiya zhurnala "Voprosy Economiki", vol. 11.
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  3. Lockwood, Ben, 1999. "Inter-regional insurance," Journal of Public Economics, Elsevier, vol. 72(1), pages 1-37, April.
  4. Prud'homme, Remy, 1995. "The Dangers of Decentralization," World Bank Research Observer, World Bank Group, vol. 10(2), pages 201-20, August.
  5. 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.
  6. Yingyi Qian & Barry R. Weingast, 1997. "Federalism as a Commitment to Reserving Market Incentives," Journal of Economic Perspectives, American Economic Association, vol. 11(4), pages 83-92, Fall.
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  9. Antonio Estache & J. Cremer & Paul Seabright, 1996. "Decentralizing Public Services: What can we learn from the Theory of the Firm?," ULB Institutional Repository 2013/44016, ULB -- Universite Libre de Bruxelles.
  10. 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.
  11. 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.
  12. 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.
  13. 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.
  14. Seabright, Paul, 1994. "Accountability and Decentralization in Government: An Incomplete Contracts Model," CEPR Discussion Papers 889, C.E.P.R. Discussion Papers.
  15. Kornai, J, 1979. "Resource-Constrained versus Demand-Constrained Systems," Econometrica, Econometric Society, vol. 47(4), pages 801-19, July.
  16. 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.
  17. Charles M. Tiebout, 1956. "A Pure Theory of Local Expenditures," Journal of Political Economy, University of Chicago Press, vol. 64, pages 416.
  18. Timothy Goodspeed, 2002. "Bailouts in a Federation," International Tax and Public Finance, Springer, vol. 9(4), pages 409-421, August.
  19. 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, June.
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