Table of Contents

  • The rules and practices that govern fiscal relations among different levels of government administration, such as their respective responsibilities in tax, spending and debt management, have a bearing on economic efficiency and ultimately growth. A growing body of evidence also links intergovernmental fiscal arrangements with income distribution within countries.

  • Over the last decade or more, many countries have experienced slowing productivity growth and a rising concentration of income. Concerns about these developments have motivated a broadening of the policy discussion about how to ensure that economic growth is made more inclusive and multidimensional. One important channel for addressing these concerns is through intergovernmental fiscal relations. By providing the “right” incentives and improving rules and practices in policy making, these institutions can shape fiscal policy and multidimensional outcomes at all government levels.

  • Inclusive growth is now high on government agendas in many countries. This chapter provides an overview of the role of fiscal decentralisation for inclusive growth. Considering the large size of sub-national spending, the potential of fiscal decentralisation to enhance efficiency and equity is significant. But there are competing theories on the effect of fiscal decentralisation: according to normative public finance theory, fiscal equalisation has an important role to play for equity and efficiency. On the other hand, political economy theory suggests that reducing the vertical fiscal gap is good for government performance and economic growth. The empirical literature also shows mixed results. However, many empirical studies show that the interaction between fiscal decentralisation and institutions, the stage of economic development and political economy constraints exercise important roles in determining the success of fiscal decentralisation. Rather than rely on “one size fit all” prescriptions, policymakers should consider the importance of institutional complementarities to reap the full potential of fiscal decentralisation.

  • This chapter deals with the relationship between fiscal decentralisation and economic growth. Using a novel empirical approach, the analysis suggests that decentralisation tends to be supportive of economic growth. Decentralisation of tax revenues tends to have a stronger impact than spending decentralisation, especially when government is small. Intergovernmental transfers, covering a large part of sub-central spending in most countries, are associated with slower growth, which could point at common-pool problems and a lack of incentives for own-source development. Balanced decentralisation – i.e. when the various policy functions are decentralised to a similar extent – is conducive to growth. Balanced decentralisation allows sub-national governments to better co-ordinate policy and to reap economies of scale and scope across functions. While public investment tends to have a positive growth effect overall, its decentralisation is negatively associated with growth.

  • This chapter extends the analysis of decentralisation and inclusive growth to capture the role of globalisation. Country specificities turn out to matter: while countries have already decentralised spending and revenues more than enough given their openness and scale, other countries are excessively centralised given their fiscal profile, and these would benefit from more decentralisation. Depending on a country’s characteristics and its public finance mix, the scope for further improvements of both growth and equity outcomes varies widely. Spending and revenue decentralisation tend to boost economic growth for economies that have a relatively higher degree of trade openness. Fiscal decentralisation has a more ambiguous and possibly even negative effect on inequality than on growth, especially for economies with a higher degree of globalisation. Moreover, for some countries, there is an apparent trade-off between growth and equity, when it comes to the “optimal” degree of spending and revenue decentralisation.

  • India has witnessed an impressive growth performance since the market-based reforms were introduced in 1991. However, its regional spread has been uneven. Considering the fact that over 63% of the population lives in economically lagging states and they have over 67% of children in the age group 0-14 demographic dividends can only be realised when a system of intergovernmental transfers is designed to offset their fiscal shortfalls. The present paper analyses the design and implementation of general and specific purpose transfers in India. The general purpose transfers are given to enable the states to provide comparable levels of services at comparable tax rates. However, given the large differences in the revenue-raising capacities of the states with the richest large states having five times the per capita income of the lowest, it is politically infeasible to offset the differences in revenue-raising capacities completely. Therefore, the specific purpose grants which are meant to ensure minimum standards of meritorious services with strong externalities are extremely important. However, the analysis shows that there are too many specific purpose transfers, they are poorly targeted and inclusion of multiple objectives in each of the specific purpose transfers makes the compliance by the states difficult. Inclusive development requires a reform of the transfer system.

  • This chapter explores the link between the decentralisation of education funding to the local level and inequality in outcomes. In most countries, autonomous local taxes fund, at most, a small share of education expenses. They play a significant role, however, in a few Nordic countries and in Switzerland. The economic literature suggests that local funding makes educational systems more efficient at the expense of equity. However, inequality is not systematically larger in more decentralised countries. This finding does not appear to be driven by differences in socio-economic homogeneity, but rather by a range of policies that mitigate or offset any adverse impact. Some of these policies may still bear an equityefficiency trade-off.

  • This chapter focuses on whether fiscal decentralisation can help to promote the sustainability of education funding. The linkage between fiscal decentralisation and education expenditure and performance is examined using data from OECD countries. The results clearly show the positive effect of fiscal decentralisation on education expenditure. In addition, the results reveal how regional disparities in the distribution of the total national budget, affects education expenditure. The findings suggest that fiscal decentralisation and balanced regional development may increase the solidity of education expenditure. Regional disparities reduce the efficient allocation of the national budgets and may cause declining education expenditure. This empirical study confirms that OECD countries tend to spend more money on education in order to provide educational opportunitites for lower income populations, when income inequality worsens.

  • For revenues, sub-national governments rely on a mix of grants from central government; locally-raised taxes; and locally-raised user fees and charges. It is not only the balance of these sources, but also the rules around tax and fee policy and fiscal equalisation that affect funding outcomes and the fiscal incentives faced by subnational governments. We use an ongoing shift in England’s local government finance system from equalising grants to a greater reliance on local tax revenues, aimed at incentivising growth, as a case study of the trade-offs between equalisation and incentives inherent in sub-national finance. In particular using data from 2006–07 to 2013–14, we show the significant fiscal disparities between local government units in England, and the factors that correlate with the size and changes in these disparities over time. We model proposed reforms to England’s local government finance system and show that even if revenues are initially fully equalised relative to assessed spending needs, significant fiscal disparities can re-emerge in just a few years. However, the scale of these balances depends significantly on specific design choices such as marginal equalisation for those units seeing the largest shortfalls in revenue, and revenue sharing in areas with two-tier local government.

  • Fiscal decentralisation is widely advocated as a means to enhance allocative efficiency and accountability at the local level. Moreover, several countries seek to shift taxes from earned income to more “growth-friendly” bases such as immovable property, which is usually levied at the local level. Yet large distributional effects may well impede such tax reforms. In this chapter, we use simulations to explore the distributional effects of a shift from the national earned income tax to either a local tax on the use of residential real estate or a local head tax in the Netherlands. The analysis shows that distributional effects may be reduced considerably by design. Policy scenarios in which distributional effects are minimised, and the tax burden is shifted towards immovable property show that the tax shift yields a moderately positive impact on employment.

  • This chapter explores the impact of fiscal decentralisation on the efficiency of public service delivery. It uses a stochastic frontier method to estimate time-varying efficiency coefficients and analyses the impact of fiscal decentralisation on those efficiency coefficients. The findings indicate that fiscal decentralisation can improve the efficiency of public service delivery but only under specific conditions. First, the decentralisation process requires adequate political and institutional environments. Second, a sufficient degree of expenditure decentralisation seems necessary to obtain favourable outcomes. Third, decentralisation of expenditure needs to be accompanied by sufficient decentralisation of revenue. Absent these conditions, fiscal decentralisation can worsen the efficiency of public service delivery.

  • This chapter discusses the relationship between intergovernmental fiscal frameworks and inclusive growth, encompassing the several channels through which such a relationship could take place. The key variables directly affected by the decentralisation process are economic variables such as gross domestic product (GDP) and its distribution but also other social outcomes, such as educational attainment. All of these contribute to shaping economic growth and its inclusiveness. Inclusiveness means that the gains from growth in economic output, income or other forms of material well-being benefit all members of society. This includes all parts of a country, e.g. growth in a territory as well as the distribution of income across territories. In this context, sub-central and central authorities can contribute to inclusiveness within a country, contributing to an even distribution of economic gains across jurisdictions and income groups, ultimately enhancing well-being for all. Moreover, the quality of the public sector also depends on how responsibilities and functions are shared between government levels. The issue at stake is that the design of fiscal decentralisation does matter for inclusive growth.