Partial Fiscal Decentralization and Sub-National Government Fiscal Discipline: Empirical Evidence from OECD Countries

The fiscal inefficiencies associated with the soft budget constraint problem of sub-national governments have long been recognized as one of the critical pitfalls of fiscal federalism. Recent theoretical research suggests, however, that weak local-level budget incentives and excessive borrowing can be overcome when the financial implications of spending decisions are internalized within a jurisdiction, and that the latter can be achieved by assigning (a sufficient degree of) revenue autonomy to sub-national governments. We test this proposition on a sample of 23 OECD countries over 1975-2000 period, and find evidence supporting the hypothesis that higher revenue decentralization (measured as the sub-national governments' share of own source tax revenues) is associated with improved sub-national government budget balances. This finding is cross-validated with a more recent and independent sample consisting of all 34 OECD member states from 2002 to 2008.

Asatryan, Zareh, Lars Feld and Benny Geys (2013), Partial Fiscal Decentralization and Sub-National Government Fiscal Discipline: Empirical Evidence from OECD Countries, Europäische Kommission, Brussels