Fiscal Decentralization and Income Distribution

A major challenge of fiscal decentralization is its effects on income distribution. Theoretical discussions have questioned whether decentralization increases regional disparities when subnational governments with different natural endowments compete for labor and capital. According to Jorge Martinez-Vazquez and Cristian Sepulveda, however, very little attention has been given to theoretical and empirical assessments of the effects decentralization has on household income distribution at the national level.

In trying to identify the linkages between decentralization and income distribution, they conclude that it seems almost impossible to state their association a priori because of the numerous direct and indirect channels through which decentralization can improve or worsen income distribution. Martinez-Vazquez and Sepulveda also examine the relationship empirically, using data from 48 countries for the period from 1970 to 2000. They suggest that public expenditure decentralization exacerbates income inequalities in countries where the government’s share of real GDP per capita is small. As the size of the government increases, decentralization begins to have a significant positive effect on income distribution.

This paper was presented at the Lincoln Institute’s annual Land Policy Conference in 2007 and is Chapter 11 of the book Fiscal Decentralization and Land Policies.