Evaluation of Fiscal Decentralization as an Effective Tool for Government Reform

4062 words (16 pages) Essay in Economics

08/02/20 Economics Reference this

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1. Introduction

Fiscal decentralization is the re-formation of governments where power is being transferred from the central government to local government authorizes. Fiscal decentralization enhances corporation, participation, transparency and accountability in public service delivery (Kwon, 2012; Faguet, 2014). The last few decades have seen a lot interest in fiscal decentralisation globally by public administration scholars, development experts and governments. Fiscal decentralisation has been used by developed countries to reform their intergovernmental fiscal activities in order to provide public goods and services to their citizens (Bennett, 1990; Wildasin, 1997; Manor, 1999; Faguet, 2004; Arowolo, 2011; Faguet, 2014). Several developing countries have also used fiscal decentralisation to promote to effective and efficient governance, macroeconomic stability, economic growth and development (Bird and Vaillancourt, 1999). Some countries have also used fiscal decentralisation to improve governance by strengthening their relationships with private sector and civil society (Arzaghi and Henderson, 2005; Shah, 2005; Faguet, 2014). Studies over the past few decades have provided important information on the effects of fiscal decentralisation on government reforms. The purpose of this study is to critically evaluate the role of fiscal decentralization as an effective tool for government reforms. This study is divided into five (5) sections and section one (1) is the introduction to the study. Section two (2) discussed literature on the concept of fiscal decentralisation. Section three (3) reviewed relevant literature on the effects of fiscal decentralization on government revenue. Section four (4) contains literature on the effects of fiscal decentralization on government accountability and corruption, and section five (5) reviewed literature on economic growth local development and economic development.

2. Concept of Fiscal Decentralization

It is necessary to clarify exactly what is meant by fiscal decentralisation before talking about the effects of it. Fallati (2004) sees fiscal decentralization as the set of procedures intended to increase the revenues or fiscal independence of local government. Fiscal decentralization is the process of using applying the principles that helps in designing financial relationship between the central government and local government (Sharma, 2005). Fiscal decentralization enhances the transfers of revenue from the central government and the creation of new local taxes to local government authorities (Kokor and Kroes, 2000). Fiscal decentralization is the transfer of fiscal authority to local governments. Fiscal decentralization gives empowerment to local authorities to generate and spend revenue (Bahl, 2008). Bird (2009), conceptualised the fiscal decentralization theory focused on situations where different levels of government provide public goods and services in their jurisdictions.

 

3. The effects of fiscal decentralisation on government revenue

The academic literature on the effects of fiscal decentralisation on government revenue has revealed several contrasting views. Fiscal decentralization has the potential to ensure a more equitable distribution of resources due to local competitiveness and attention on critical local preferences. The inputs and incomes must be monitored to ensure that the intended objectives of fiscal decentralization to achieved (Rodriguez-Pose & Ezcurral, 2010). One of the vigorous principles of fiscal decentralization is that the absent of various sorts of externalities, decentralized governments that rely on own-source revenues should be more fiscally efficient than decentralized governments that rely on grant financing (Goodspeed, 2011). Local governments being closer to the people are more accountable to its citizens. The measure of fiscal decentralization that best reflects incentive effects at the sub-national level is revenue autonomy, or the share of local government expenditure financed by own-source revenue (Ahoi, 2010). This means that sub-national governments must have the authority to own-finance locally provided services. More complete revenue autonomy requires at a minimum, the authority to set tax rates, and an assignment of at least one significant tax source. Another study was conducted by Guang (2018) on the revolutions in China’s inter-governmental fiscal system. The study found that tax-sharing system (established in 1994) provides for revenue centralization, spending decentralization, and large central transfers to local governments. Fiscal decentralization may unpredictably increase both central and local government size even when they are funded by their own taxes (Cassette and Paty, 2010). The influence of fiscal decentralization instruments on local government size shows that only property taxes have a negative and significant impact on the size of the local public sector (Liberati and Sacchi, 2013). Property tax is normally assigned on tax separation schemes at a local level. Fiscal decentralization raises trust not only in government but also for other political entities such as political parties and parliaments (Ligthart and Van Oudheusden, 2015).

5. The effects of fiscal decentralisation on corruption

Fiscal decentralization that is accompanied by revenue decentralization is likely to discourage corruption while expenditure decentralization that is funded by grants tends to encourage corruption (Goodspeed, 2011). Fiscal decentralization may affect governments’ quality is through its effect on corruption. Goodspeed (2011) reports that better informed citizens and more reliance on own source revenue reduces corruption. He argues that poverty which is interpreted as measuring uninformed citizens leads to greater corruption as suggested by political agency models. He further argues that greater use of own tax revenues lowers corruption while greater use of grants increases corruption. This suggests that fiscal decentralization that is accompanied by revenue decentralization is likely to discourage corruption while expenditure decentralization that is funded by grants tends to encourage corruption. Fan, Lin, and Treisman (2009), used cross-country data and revealed that countries with a greater number of government tiers or a greater number of public employees are associated with more corruption, although countries with governments that constitute a larger share of GDP are associated with less corruption.

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Fisman and Gatti (2001) found that countries with a greater fiscal measure of fiscal decentralization are associated with less corruption. Lockwood, (2005), ague that fiscal decentralization may reduce centralized regimes’ incentives to corruption; national officials in centralized regimes would seek re-election by selectively pooling on a minimum majority of regions while extracting maximum rents from the rest. Ivanyna and Shah (2011) used data from 158 countries and revealed that decentralization has a significant and robust negative effect on corruption regardless of the estimation technique or the measures of corruption used. Similarly, Altunbas and Thornton (2012) found, for a data set comprising 64 developing and developed economies, that the larger the share of sub-central fiscal revenues and expenditures the lower the country’s corruption index. Moreover, when financial decentralization is applied to both side of the budget, it reduces corruption over time (Padovano et al., 2013). This means fiscal decentralization has both negative and positive impact on corruption.

Decentralized systems are more corrupt, in part because local politicians are more likely to give in to pressure from local interest groups (Bahl and Wallace, 2005). Lessmann and Markwardt (2009) in a study on corruption in sixty four countries concluded that the level of corruption is found to be lower in decentralized countries as decentralization has been assumed to be an appropriate instrument for tackling the issue of corruption. This study also confirms previous literature on corruption that effectiveness in monitoring bureaucrats’ behaviour is an important determinant of the relationship between decentralization and corruption. In another study conducted by (Fisman and Gatti, 2002), looking at the cross-country relationship between fiscal decentralization and corruption suggests that devolution in government expenditure is strongly and significantly associated with lower levels of corruption when decentralization emanates out of the country’s legal system. Decentralization is therefore a feasible instrument for reducing corruption if the monitoring of bureaucrats works they perceive. Otherwise, if those institutions don’t work sufficiently well, decentralization can contribute to high levels of corruption. Studies have shown that in Russia in the absence of monitoring at the local level there was high scale corruption (Blanchard and Shleifer, 2000, Lessmann and Markwardt, 2009) as against other previous communist countries where there was monitoring of local corruption was less.

Kwon (2012) Fiscal decentralization: An effective tool for government reform? The study used regression analysis using data 17 developing and 17 developed countries. The study found that fiscal decentralization reduces government effectives in developed economies. The study also found that budget for both developed and developing countries increases when through fiscal decentralization. The study further revealed that fiscal decentralization reduces corruption in developed countries and increase corruption in developing countries.

 

6. The effects of fiscal decentralisation on government accountability

Accountability is lower when expenditure but not revenue is decentralized, leading to more corruption in this type of decentralized setting (Goodspeed, 2002; Rodden, Eskeland, and Litvack, 2003). A soft budget constraint influences both accountability and corruption in decentralized local governments. This happens when local governments are financed by grants and the central government is unable to commit to not increase grants in the face of local government extravagance (Goodspeed, 2002; Inman, 2003). Fiscal decentralization has the tendency of improving local governance through accountability (Blair, 2000). A comprehensive fiscal decentralization reform improves accountability and responsiveness of government by increasing citizen voice and the incentives those public officials (Faguet, 2012). Fiscal decentralization also makes local governments more responsive to citizens’ needs (Faguet, 2014). Kyriacou and Roca-Sagalés (2011) posit that fiscal decentralization involves a positive effect on institutional quality in a sample of OECD countries, but this positive effect is mitigated in the presence of regional elections and multi-level government. Electoral accountability of government officials may be undermined when individuals do not know whom to assign blame or praise for policy outcomes. When different parties rule at the national and sub-national level, political accountability decreases because voters face difficulties assigning responsibility among different levels of government (Lago Peñas and Lago Peñas, 2010). Elected officials face substantial incentives to exploit the fiscal common by over-borrowing in order to increase local public goods provision (Goodspeed, 2002). More taxing power and more autonomous taxes may induce responsible local spending behaviour and governments’ accountability (Martinez Vazquez, 2008). Fiscal decentralization therefore has greater impact on accountability. Proponents of fiscal decentralization argue that if sub-national governments are responsible for administering their own tax revenues, they will be held accountable by local populations (Golem, 2010). The decentralized form of government, therefore, brings about welfare-enhancing results and makes local officials more accountable and responsible. With fiscal decentralization, sub-national governments are closer and more responsive to the needs and preferences of local residents, thereby allowing a closer match between the preferences of the population and the mix of public goods and services delivered by government.

Fiscal decentralization has an effect on government reform by increasing accountability in governance. It make government official more accountable by transferring responsibility of service delivery to the citizens in their jurisdictions (Bahl, 2008). As populations migrate to urban areas with increased demand for services, fiscal decentralization provides the opportunity to reinforce local government involving it more closely (Shah 1994, McCluskey and Franzsen 2005) in the provision and delivery of demanded services. Having increased property tax revenues would go a long way in providing these needed services. This makes the localisation of the tax a critical issue in many developing countries (Manor 1999, World Bank 1999, Fjeldstad and Semboja 2000; McCluskey and Franzsen 2005). Additionally, fiscal decentralisation brings other expected benefits such as enhanced transparency, accountability, probity, frugality, efficiency and equity (McCluskey and Franzsen 2005) improved accessibility, local responsibility, and the effectiveness of government (Bird and Vaillancourt 1999) and increased citizen voice (Fauget 2012, 2014).

Oyun, G. (2016) Interstate spillovers, fiscal decentralization, and public spending on Medicaid home – and community-based services. Traditionally, central government is given the responsibility of stabilization and distribution while allocation is assigned to local government based on the demand for local public services (Smoke 2001).

This study examines the interstate spillover effect of Medicaid expenditures for home- and community based services (HCBS) and tests the relationship between fiscal decentralization and public spending. The study is estimated by applying spatial econometric methods to panel data for the 50 U.S. states for 2000–2010. The study reveals that there is a positive interdependence in state HCBS expenditures that is contingent on similarity in citizen ideology between states. The study further show that there is a positive relationship between fiscal decentralization measured by transfer dependence and revenue autonomy and Medicaid HCBS spending.

Midwinter (2012) Fiscal autonomy in Scotland: An assessment and critique. The Scotland Bill’s proposals to increase the tax powers of the Scottish Parliament are currently under scrutiny. Although the Calman Commission rejected full fiscal autonomy within the UK as a viable option under devolution, the Scottish Government is considering its inclusion in the independence referendum, as a fallback position should independence fail to attract majority support. The real choice for Scotland is between devolution and independence: there is no middle way.

Muldoon-Smith abd Greenhalgh, (2018) Real estate value – what next for fiscal decentralization in England? There is a rabid interest in the value of land and property and its potential taxation as a panacea for the largely unfunded requirements of welfare, infrastructure and economic development. Land value capture, infrastructure premiums, local asset backed vehicles, direct property investment, more efficient exploitation of local authority assets and the sweating of local anchor institutions, have all received new attention in recent years.

One of the flagship policies for this agenda in the UK is the 50% Business Rate Retention

Strategy (BRRS), introduced in 2013, and the more recent announcement of the 100% BRRS (planned for introduction in 2020). Rarely has a policy been so ill-defined, and received so little scrutiny, aside from the political corridors of central government, the technical environment of the Local Government Association (LGA) and the opaque deal-making of privileged locations. More recently, the future of the BRRS has been put in doubt. Perhaps reflecting the lack of detail on, and realistic pathway for, fiscal decentralization in England, none of the major political parties mentioned BRRS in their election manifestos.

Raidla, R., Douglas, J.W., Randma-Liiv, T. & Savi, R. (2015) “The impact of fiscal crisis on decision-making processes in European governments: Dynamics of a centralization cascade”. Public Administration Review, 75(6).

The objective of this study was to explore how European governments reacted during the recent crisis. The study focused on the interlinkages between shifts toward more centralized decision making. The study used the survey of thousands of public sector executives in 17 European countries. The reveals evidence of a centralization cascade, such that centralizing one element of the decision-making process leads to greater centralization throughout the system. The study also found that having a high number of organizational goals and facing clear sanctions for failing to achieve goals lead to greater centralization, but greater organizational commitment reduces the need to centralize.

Sharma, C.K. (2011) Beyond gaps and imbalances: Re-structuring the debate on intergovernmental fiscal relations. Public Administration, 90(1).

The paper aims to clarify the multiple usages of the symbolically loaded terms VFI and VFG (Vertical Fiscal Gap) by critically engaging the fundamental assumptions and premises underlying these ostensibly similar notions. It proposes an alternative conceptual framework and introduces the concepts of Vertical Fiscal Asymmetry (VFA) and Vertical Fiscal Difference (VFD) that have the potential to better structure public debate on issues of vertical fiscal relations and stimulate a sensible appreciation of the problem and possible remedies.

Wang Li, Y.H. & Jerry, Z.Z. (2018) Central-provincial sharing of financial responsibilities for China’s social safety-net. Public Money & Management, 38(6).

Using Chinese provincial panel data from 2004 to 2014, this paper describes the division of fiscal responsibilities in basic social assistance and services (BSAS): China’s social safety-net programme. The results suggest that there has been a recentralization—provinces with weaker economic conditions rely more on central governmental transfers, showing signs of fiscal equalization. The authors did not find any evidence of ethnicity-based preferential treatments.

Xie, D. & Zou, H. (1999) Fiscal decentralization and economic growth in the United States. Journal of Urban Economics, 45, pp.228-239.

In a simple model of endogenous growth with spending by different levels of government, we demonstrate how fiscal decentralization affects the long-run growth rate of the economy. Applying the model to the U.S. economy, we find that the existing spending shares for state and local governments have been consistent with growth maximization. In this sense, further decentralization in public spending may be harmful for growth.

Zhang, T. & Zou, H. (1998) Fiscal decentralization, public spending, and economic growth in China. Journal of Public Economics, 67(2) pp.221-240.

This study of China demonstrates how the allocation of fiscal resources between the central and local governments has affected economic growth since reforms began in the late 1970s. We find that a higher degree of fiscal decentralization of government spending is associated with lower provincial economic growth over the past fifteen years. This consistently significant and robust result in our empirical examinations is surprising in light of the argument that fiscal decentralization usually makes a positive contribution to local economic growth.

Zhao, Z.J. (2009) Fiscal decentralization and provincial-level fiscal disparities in China: A Sino-U.S. comparative perspective.

Since China’s 1994 fiscal reform, increasing concerns have been voiced about fiscal disparities across the country. Can local governments fairly and effectively fulfill basic public services such as primary education, public health, and social welfare? This essay traces the evolution of intergovernmental relations in China since 1978. The fluctuation of provincial level fiscal distribution over time and the underlying factors behind fiscal inequality, as compared to a decentralized American revenue system, are analyzed.

 

5. The effects of fiscal decentralisation on economic growth and economic development

Fiscal decentralization is very critical to a successful delivery and implementation of government policies and programs globally especially at the local level. Fiscal decentralization has contributed immensely to the growing of middle class in developing countries (Wibowo, 2011).

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Davoodi and Zou (1998) Fiscal decentralization and economic growth: A cross-country study. The objective of the study was to evaluate the effect of fiscal decentralization on economic growth. The study used panel data from 46 countries from 1970-1989. The study found that there exist a negative relationship between fiscal decentralization and economic growth in developing countries. The study also found no relationship between fiscal decentralization and economic growth in developed countries.

Guess (2007) Adjusting fiscal decentralization programs to improve service results in Bulgaria and Romania. This study explores how the design of fiscal decentralization programs, in the form of assigning intergovernmental expenditure roles and responsibilities, affects service performance. The study found that fiscal decentralization needs an appropriate transfer of power meet the expenditure policy and administrative capacity.

Conclusion

The study critically evaluated the role of fiscal decentralization as an effective tool for government reforms. The study used 30 articles and reviewed relevant literature on the effects of fiscal decentralization on government revenue, government accountability, corruption, economic growth and development. On a careful review of relevant literature it was observed that little studies have been done on the effects of fiscal decentralization in Africa especially Ghana. th

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