Chapter 2: The political economy of decentralization
This chapter surveys recent contributions to the study of fiscal decentralization which adopt a political economy approach. By a political economy approach, I mean a systematic attempt to think about the behavior of government – whether at the national or local level – taking into account institutions and processes, such as elections, political parties and legislatures, which determine the choice of fiscal policies in practice. This is in contrast to the earlier approach to the study of fiscal decentralization, which is summarized in Oates’s classic book, Fiscal Federalism (1972), and which explains the benefit of decentralization in terms of increased preference-matching. Following both Oates (2005) and Weingast (2009), we call this earlier approach the first-generation theory (FGT) in what follows. The FGT is broad in scope, and covers the questions of which level of government should supply a particular public good or service (expenditure assignments), which level of government should have which taxing power (tax assignments), the role of redistributive taxation, and macroeconomic stability. This chapter focuses mostly on the part of the FGT that concerns expenditure and tax assignments. So, this chapter is complementary to broader surveys such as Oates (2005), in that it focuses in greater depth on how the new political economy approach impacts on the FGT account of expenditure and tax assignments. The FGT view on expenditure assignment can be very briefly summarized as follows (for more details, see section 2 below). Take a particular public service, like education, health or transport.
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