Fiscal crises, decentralization, and indiscipline

Abstract

How does fiscal decentralization influence fiscal discipline and the probability of a fiscal crisis? Discrete choice analysis used with panel data reveals that crisis probability is associated positively with spending decentralization and negatively with vertical fiscal imbalance. These effects are prevalent in countries with a higher degree of tax revenue decentralization, while a stronger rule of law mitigates such adverse decentralization effects. The findings imply that reduced risk sharing against local shocks under tax revenue decentralization destabilizes the sustainability of a nation's fiscal system. Therefore, policymakers should be cognizant of the undesirable impacts of decentralization on fiscal crisis and indiscipline.