Institute for Research in Economic and Fiscal issues

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The effects of fiscal decentralization on working hours: Does it matter which government level taxes and spends?

IREF Working Paper No. 201307: Alexander Fink

The traditional argument in favour of decentralization focuses on tax competition and on the quality of public expenditure. In a sentence, it is argued that a decentralized environment enhances the policymakers’ accountability and thus restrains abuse. The consequences are higher disposable incomes (lower taxes) and higher-quality services (better expenditure). Most of the literature, however, tends to study the tax component, and the extent to which decentralization lowers the tax burden through competition.

In this paper, Alexander Fink explores another set of consequences related to decentralization – working effort. In particular, the author examines whether decentralization leads to greater working effort by the residents. In a word, do the better public services provided in a decentralized political context encourage people to work harder? And does it matter whether decentralization takes place within a federal political system, or within a unitary state, in which decentralization is more akin to decentralized administration, rather than to decentralized decision-making?

This empirical study considers two sets of OECD data, covering 1990-2011 and the 1980-2000 periods, respectively. By means of a sophisticated empirical enquiry, the author concludes that

• In general, decentralization does lead to greater working effort (measured by the annual number of hours worked)
• This result is however valid only for countries in which decentralization occurs within a federal political structure. In unitary states, working effort is by and large independent of decentralization, which in some cases could actually lead to harmful consequences. The cause for that is that in unitary states decentralized government bodies are not really accountable to the citizen, and might exploit their decentralized condition – i.e. weaker control from the centre —, engage in wasteful expenses, and rely on bail-outs by the central authorities.

The lesson for the policymaker is thus twofold. Decentralization does promote growth, not only because it is usually associated with a lighter tax burden, but also because it leads to better services, higher productivity and more intense working effort. However, there are many kinds of decentralization. In particular, when decentralization boils down to an administrative reform, the result can be negative, since the decision-making structure is fragmented and the policymakers involved feel less – rather than more – accountable. In other words, unless it takes place within a federalist environment, decentralization may be useless, if not harmful.

IREF Working Paper No. 201307: Alexander Fink

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