In recent years pressures for greater fiscal decentralisation have increased in many countries. Is decentralisation really the right route to take? Are there alternatives which can better address the same objectives? This paper from the Carnegie Endowment for International Peace considers issues around fiscal decentralisation, including potential drawbacks and possible alternatives.
Administrative decentralisation should be distinguished from fiscal decentralisation which generally involves some decentralisation of political decisions. The design of decentralisation policies in developing countries is often defective and made too quickly to allow full consideration of alternatives or potential consequences. Success is more likely when certain conditions are met before the decentralisation process begins, rather than expecting the policy to stimulate needed institutions and incentives. When the conditions for success are absent, more decentralisation will result in lower efficiency and/or less economic stability.
Efficient governance is easier in a small, open economy than in a large territory. Where the government has a small role in the economy, decentralisation is needed less and ‘core’ activities are usually best carried out by a national government. In addition:
- Fiscal decentralisation involves giving subnational jurisdictions more taxing and/or spending responsibilities, and in many cases results in the creation of additional layers of jurisdiction
- Pressures for decentralisation result from deepening democratisation; globalisation creating market areas that differ from states; increased transparency about the regional redistribution of resources; and increasing incomes per capita
- Alternatives to decentralisation include: Making existing national policies more efficient and equitable; privatising some governmental activities; and breaking larger countries down into smaller ones
- More decentralisation can result in excessive regulation; obstacles for tax reform, macroeconomic coordination and fiscal transparency; a fragmented internal market; and more corruption and public sector employment
- Since it is difficult to assign precise responsibilities for tax and spend, decentralisation can lead to confusion and tensions between different levels of jurisdiction.
Successful decentralisation is easier when regional income levels are relatively equal and important natural resources are not concentrated in one region. Other implications are:
- If decentralisation is a political objective for a country it is a good policy when the country can establish institutions which will make decentralisation work reasonably efficiently
- If a country is already decentralised, particularly as a result of its constitution, then policy-makers can only try and make the process as efficient as possible by improving the necessary institutions
- The option of breaking a large country down into smaller countries should be considered when: (a) It is too large to be efficiently administered by one government; (b) there are no military or security threats; and (c) there are no strong cultural, ethnic or historic ties
- When regions’ income levels differ vastly and uniform public services can only be sustained by richer regions subsidising poorer ones, fiscal decentralisation makes it hard to pursue an effective income redistribution policy
- Public activities at the focus of debate about decentralisation are often those most feasible and desirable for privatisation, but part of the decision concerns whether the government should subsidise those activities, e.g. cultural activities
- It is difficult to assign taxes to match the expenditure of subnational governments due to factors including administrative considerations, economies of scale in tax administration, access to and sharing of information, and tax competition.
