Edited by Robert F. Salvino Jr., Michael T. Tasto and Gregory M. Randolph
Chapter 9: Does fiscal decentralization result in a better business climate?
The large literature on the benefits of fiscal decentralization (or “fiscal federalism”) is founded in the idea that greater intergovernmental competition present at lower levels of government, due to “voting with your feet” behavior (Tiebout 1956), results in better government policy than when government activities are centralized at a higher level. In the extreme, competition between governments may approximate market outcomes (Dowding, John, and Biggs 1994). The empirical literature generally, but not unanimously, finds that greater government decentralization is associated with more rapid rates of economic growth. Using both international and sub-national data, studies such as Akai and Sakata (2002), Iimi (2005), Stansel (2005), Thieben (2003), Zhang and Zou (2001), and Desai, Freinkman, and Goldberg (2005) find that decentralization is positively correlated with economic growth. Some other studies, however, have failed to find such a connection (Davoodi and Zou 1998; Zhang and Zou 1998; Jin and Zou 2005; Woller and Philips 1998; Xie, Zou, and Davoodi 1999; Thornton 2007). A separate, but related, strand of literature attempts to empirically examine whether fiscal decentralization constrains the Leviathan (revenue-maximizing) behavior of governments. Like the literature on the effects of decentralization on economic growth, this literature also generally, but not unanimously, finds that greater decentralization results in stronger tax competition that produces a more constrained (smaller) government sector, and results in more efficient government policies – ones that better satisfy the desires of local voter/citizens.
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