Handbook of Multilevel Finance
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Handbook of Multilevel Finance

Edited by Ehtisham Ahmad and Giorgio Brosio

This Handbook explores and explains new developments in the “second generation” theory of public finance, in which benevolent rulers and governments have been replaced by personally motivated politicians and the associated institutions. Following a comprehensive introduction by the editors, the renowned contributors present fresh and original perspectives on the key multi-level issues, along with recent developments in theory and practice, as they relate to taxes, budget systems, the management of liabilities and macroeconomic stability. The book also explores special issues concerning the poor and marginalized, structural change and the environment, natural disasters, and the task of overcoming conflicts whilst keeping countries together.
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Chapter 17: Promoting responsible and sustainable fiscal decentralization

Teresa Ter-Minassian


Traditional (first-generation) theories of fiscal federalism (Tiebout, 1956; Musgrave, 1959; Oates, 1972) emphasized the potential efficiency gains from fiscal decentralization. Based on the key assumptions of benevolent governments, differences in preferences and significant citizen mobility, they argued that expenditure functions should be assigned to the lowest level of government capable of internalizing the benefits from those functions. This would improve preference matching, because local governments can be expected to know their citizens’ preferences better than the central government, and because citizens unsatisfied with their local government’s performance can vote local officials out of office, or even move to a different locality (‘vote with their feet’). The normative prescriptions of first-generation theories have been subject to a broad array of criticisms, especially over the last two decades. Second-generation theories (Quian and Weingast, 1997; Oates, 2005; Weingast, 2009) have focused on political economy influences on decentralization processes, such as: _ Political motivations for decentralization and its timing, pace and sequencing, that go well beyond a quest for efficiency gains in resource allocation. Such motivations may include helping keep countries together in the face of ethnic or other conflicts; reducing ‘excessive’ powers of central government; and promoting ‘yardstick’ competition among or within government levels. _ Representation failures in electoral processes, reflecting voters’ information asymmetries and the power of economic elites to buy influence. _ De facto limitations to citizens’ mobility.

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