Fiscal Decentralization and Economic Growth Reconsidered: The Role of the Institutional Setting

Abstract

Most of the empirical analysis explores the relationship between fiscal decentralization and economic growth within a constitutional void. This paper investigates the connection between fiscal decentralization and income growth across different institutional settings in 20 OECD countries over the period 1973-2007. We find that the pro-growth effects of tax decentralization depend critically on the nature of the administrative institutions and political system in place: fiscal decentralization leads to higher (lower) rates of economic growth when coupled with high (low) administrative and high (low) political decentralization. This provides evidence of institutional complementarities at work, as well as new insights on how local tax structures should be designed and combined with administrative and political settings to support economic growth.

Keywords: Fiscal decentralization; Institutions; Political decentralization; Economic growth; Comparative studies

JEL Classification: H71, H77, O43, O57