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Posts Tagged ‘fiscal federalism’

My latest for Learn Liberty looks at proposals for starting an equalization program to redistribute from rich to poor states in the U.S. and finds them wanting. Due to the audience for that blog, I kept that post nontechnical and brief. I’ll reproduce part of it here and then elaborate on some of the complexities and possible counterarguments.

[C]ritics of federalism point to one big disadvantage: federalism, they say, is unfair.

This criticism particularly applies to the fiscal aspect of federalism — that is, the ability of states to choose their own tax burdens and spending levels. The argument runs like this: states have different tax bases per citizen (some are richer than others), so richer states can tax their citizens at lower rates than poorer states, offer more benefits and better public services, or both. In this view, federalism is unfair because it helps the residents of rich states and hurts the residents of poor ones.

I will argue, by contrast, that fiscal federalism actually helps people living in poor states more than people living in rich states.

[…]

But there’s a more fundamental problem with the fairness argument for equalization: it ignores migration. Presumably, we care about the welfare of actual people, not the arbitrary geographic categories they live in. In a federal system in which people can easily move across state borders, migration accomplishes everything an equalization program might, without the negative side effects.

Think about a positive productivity shock, like the emergence of a new, highly profitable industry, which raises real wages in one state. Workers will move from other states to the state with the higher wages. The increase in the labor supply will return real wages to their normal level, at which point the migration flow will stop. Those who have moved have become better off, and even those who have remained in the initially poorer states are, at the end of the day, earning just as much as those in the initially richer state. Being able to pay a lower tax rate in a richer state will only accelerate this process — and ultimately eliminate the rich-state tax advantage.

[…]

[S]ome places are just more desirable to live in than others. These places will tend to have higher home prices and rents and lower wages. Think about it: if I take some of my compensation in the form of higher amenities, I’m willing to earn a lower real money wage. For this reason, nice places to live that don’t have a lot of industry, like New Mexico and Maine, have low real wages, while places that are less nice to live in but do have industry tend to have high real wages (see figure 1).

But New Mexico and Maine residents surely don’t deserve to be subsidized simply because they prefer to take their compensation in a nonpecuniary form, just as North Dakotans and Bay Staters don’t deserve to be taxed for choosing to live in unpleasant places where the market demands their labor.

[…]

Certainly, housing regulation is disrupting equalization through migration in the United States. An equalization program that specifically punished costly states and rewarded low-cost states might discourage excessive development restrictions and get migration flowing more freely again.

But housing regulation might end up being a self-correcting problem. As people flow from high-cost to low-cost areas, eventually the latter will enjoy more agglomeration economies that promote economic growth, and the high-cost areas will start to falter by comparison. By regulating housing so strictly, residents of coastal California, the Boston metro area, and elsewhere may be digging their own graves in the long run.

The argument I’m making here about how migration is a more effective equalizer than fiscal transfers makes some simplifications.

One simplification is that the major reasons why some states have higher per person incomes than others are exogenous productivity shocks and amenities (“desirability”). But there is another important reason: different places just tend to suit workers of different skill sets. If you have access to coal deposits and navigable rivers, you might have developed a steel industry and attracted manual laborers. If you have old, prestigious universities and a seaport, you might have developed high-tech export-oriented industries and attracted highly specialized workers. The latter sort of place will tend to have higher average wages, just because the average skill level of workers is higher.

So what changes about the argument if we relax this simplification and allow states to have different skill mixes? Very little. Yes, Massachusetts can have a lower tax rate than Mississippi because it has higher-skilled, higher-wage workers. But as a result, workers will tend to migrate to Massachusetts, driving pretax wages for Massachusetts workers below where they would be in Mississippi (adjusting for cost of living). Importantly, Massachusetts could still end up having much higher average wages than Mississippi, due to a higher ratio of high-skill to low-skill labor, but the posttax income of any particular worker will tend toward equality between the two states, leaving no benefit to moving from one place to the other. You can’t get around the fact that tax differences between jurisdictions will end up being incorporated into market wages and real estate values. (In real estate economics, this process is called “capitalization.”)

Now, what happens if we assume away labor migration? This is indeed an important change, and it may well make some sense once we talk about multinational federations like Canada. Anglophones might be willing to move to any one of the nine anglophone provinces, while Francophones are stuck in Quebec. Thus, a supporter of equalization could defend the program on the grounds that it is a legitimate way of preventing Francophones from being forced to migrate to anglophone areas or fall irretrievably behind the rest of the country economically.

Still, I wonder whether places like Montreal and Quebec City do not have very different economic profiles from, say, Chicoutimi or Trois Rivieres. There is ample room for labor migration within Quebec. If Quebec itself is large enough that some parts of the province tend to do well while other parts of the province do poorly, it may not need equalization to protect itself from economic shocks.

But let’s say it isn’t large enough. Let’s say there are economic shocks — like import competition, new technologies, and resource discoveries — that could cause Quebec either to race ahead of the rest of the country for 10 or even 20 years or fall behind for a similar length of time. Let’s say the Quebec economy is really volatile. If we don’t want Quebeckers moving out after every adverse shock (or Anglophones moving in when times are good?), an equalization program can help, right?

Possibly. But here’s another alternative: a rainy-day fund. If equalization is really supposed to be insurance against economic volatility, then don’t redistribute from rich to poor provinces, redistribute from rich to poor time periods. The provincial government itself could put away lots of money in cash or retire debt when times are good and take on debt or draw down cash when times are bad. Or if we think provincial governments aren’t competent and far-sighted enough to do this, we could have a program forcing provinces going through better-than-normal times for them to subsidize those going through worse-than-normal times, with the idea that each province comes out balanced over the long run. This insurance-type program might not have as bad incentive effects as equalization, not to mention the unfairness of subsidizing high-amenity places. Still, a publicly run insurance program for provincial budgets will likely create some moral hazard, a reluctance among provincial governments to take politically difficult steps to reduce economic volatility and therefore expected future payouts.

So there you have it. Instead of equalization programs, federal systems should facilitate equalization through migration, or when that is not possible, encourage rainy-day funds or possibly intertemporal insurance for regional budgets.

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In my latest blog post for Learn Liberty, I take on arguments against decentralizing health care policy to the states on the grounds of fiscal capacity:

So if federal ACA spending were cut or even zeroed out, why couldn’t states that like the legislation simply reinstate the same taxes and spending that the federal government currently uses under the law? If the net budgetary impact of the health care law really is zero, there is no inconsistency with state balanced-budget requirements…

[T]he federal government faces a stricter constraint than the states in one crucial respect: its total debt burden is much larger. Federal debt is already greater than 100% of GDP, leading to higher interest costs and crowding out private investment. Expanding the debt even further would only exacerbate these serious problems.

State and local debt is much lower, at about 16% of GDP. State and local governments are much more fiscally responsible than the federal government, and that’s precisely what gives them room to spend if there’s a good reason for it.

More here.

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On September 27, Catalonia, an “autonomous community” of Spain, votes in a regional election that will likely determine whether the region declares independence from Spain. The Economist and other global news outlets have generally not taken the movement very seriously, which is a grave mistake. According to a series of new polls, the independentists are likely to win this election, and if they do win, they will pursue a roadmap ending in a proclamation of independence within 18 months. It would be the first secession from an industrialized democracy since either Iceland (1944) or Ireland (1922), depending on how you count (Iceland had full internal self-government from 1918).

Catalan independence may well be a good outcome for the world. There are several reasons why Catalonia is likely to be more successful as an independent state than Scotland would have been.

First, Catalonia is significantly wealthier than the rest of the Spain and suffers a significant annual net fiscal drain to the Spanish treasury, on the order of 6-10% of GDP. Catalonia is also the least corrupt region of Spain.

The stock markets also suggest that independence might benefit or at least not hurt Catalonia. I examined the INDEXCAT produced by the Barcelona stock exchange, an index of all Catalan-owned, publicly traded companies on its exchange, to see how its prices responded to changes in the probability of independence. Since September 11, 2012, when the independence movement reached a popular crescendo on the streets, the INDEXCAT has grown 48.7%, compared to 26.2% for the IBEX 35 index of major Spanish firms, to 31% for the German DAX, to 24.4% for the Dow, and 21.6% for the EUROSTOXX index. This chart produced by the Catalan Business Circle shows that the fastest growth for the INDEXCAT occurred during the period when independence seemed most likely to occur, the late 2012 to late 2013 period when support for independence generally topped 55% of those expressing an opinion in yes-no questions and it still seemed possible a true referendum might be held.
CCN_Indexcat

Then I looked at how the INDEXCAT responded to the recent turnaround in polling for the September 27 elections. After several months of declining support for independence and independentist parties, public opinion started to turn around dramatically just two weeks ago. (Right after I predicted it would!) There have been three “polling shocks” since September 1. (The English-language Wikipedia article on these polls is rapidly and accurately updated.) The first and most significant occurred on the night of September 3, when three polls were released, all showing a pro-independence majority, after a series of July and August polls showing the independentist lists well short. We should expect investors to update their views about the likelihood of independence immediately and to trade on those views as soon as possible. Within a few minutes, the new market prices should reflect the public information. The INDEXCAT dropped just 0.31% between close on September 3 and five minutes after opening on September 4. That is consistent with a small negative impact of independence on major Catalan firms, but let’s look at the other shocks.

On the morning of September 9, a modest negative polling shock occurred, as following a string of four polls showing a clear independentist seats majority, a poll from the respected Spanish government research outfit CIS showed the slenderest of possible majorities for the independentists, just 68 out of 135 seats. It’s hard to figure out exactly when that information went public. A single tweet with the results went out at 9:00 AM exactly, but it seems to have broken an embargo, and those results weren’t confirmed until 9:30. In any event, between 9:00 and 9:10 AM, the INDEXCAT fell 0.22% and didn’t change much over the following hour. These results are consistent with a small positive impact of independence on major Catalan firms.

Finally, over last weekend a new series of polls seemingly have shown the CIS result to be an outlier, once again confirming a clear seats majority for independentists. Between market close on Friday and 9:05 AM Monday, INDEXCAT rose 0.26%. This outcome is consistent with a small positive impact of independence on major Catalan firms.

Unfortunately, I cannot calculate the expected value of independence for publicly traded Catalan firms as I did for Scottish companies, because there are no betting markets on Catalan independence or the majority in the coming election. (Unbelievable but true.) Still, on balance, the results suggest that investors expect Catalan companies to become more, not less, profitable with independence. In turn, that finding implies that the transition costs of independence are excessively hyped.

The second reason why I think Catalan independence may be good for the world is that the Spanish government has not given any concessions to Catalans to prevent them from voting for independence. To the contrary, Spain has tried to recentralize powers and has even hinted at using military force against Catalans (almost certainly a bluff). The contrast with Britain’s response to Scotland could not be stronger. If Catalans vote against independence, it would send a bad signal to Spain: that threats work to deter secessionism. Moreover, it would leave Catalonia and all the other autonomous communities vulnerable to even more severe recentralization policies. Unilateral disarmament more often invites aggression than defuses it.

The final reason why Catalan independence would be good for the world is that Spain’s existing pattern of decentralization is dysfunctional, as just about everyone recognizes. Spain’s autonomous communities racked up excessive debt during the 2000s boom and have required bailouts from the central government (PDF). Those bailouts establish a moral-hazard incentive for autonomous communities to continue profligate spending and rely on the central government for assistance when borrowing becomes difficult. Why did the autonomous communities rack up excessive debt in the first place? Stanford political scientist Jonathan Rodden has shown that when there are no external balanced-budget requirements on lower-level governments in decentralized systems, the only way to encourage fiscal discipline is to require the lower-level governments to pay for their own spending mostly out of own-source revenues and to make credible promises to let these governments go bankrupt if they cannot pay back their bondholders. The bond markets then provide fiscal discipline: subcentral governments maintain fiscal discipline because if they borrow too much, they will end up paying higher interest rates. But what happened in Spain was that the autonomous communities (with the exception of Euskadi and Navarre) had vast spending rights and responsibilities but few sources of independent income. They depended on central government grants, and thus had little incentive to spend the money responsibly. So you got things like this.

If Catalonia leaves Spain, it will be a significant fiscal shock to Spain. One relatively easy way for the Spanish central government to deal with the shock is to reduce transfers to the autonomous communities and allow them more independent taxation powers. The autonomous communities will complain about the burden-shifting, but the more nationalist communities will be happy to enjoy more fiscal autonomy. Moreover, fiscal competition between independent Catalonia and rump Spain could encourage both governments to adopt more efficient and less corrupt policies.

Catalonia isn’t a free-market paradise. For instance, the regional government passed a protectionist law limiting shop hours that the Spanish government wisely overruled. Politics throughout the Mediterranean region are toxic right now, and Catalonia is not immune. The European Central Bank’s unconscionable policies of monetary austerity have kept southern Europe in economic crisis for years, and the region’s voters have turned against wealth creation and free markets as a result. That’s a different problem with different solutions. But in the medium term, would you rather see Catalonia as part of a Spain ruled by a coalition between the corrupt left (PSOE) and the extreme left (Podemos), since the PP will lose the next election, or would you rather see an independent Catalonia in which the largest party has always been of the center-right (Convergence)?

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In the U.S., states have full authority over local government. Some states strictly centralize power and leave local government little to do. For instance, Hawaii has a single school district for the entire state, so that different localities cannot choose to spend different amounts on the government schools. Michigan effectively has a similar system, because it requires every school district to spend the same amount of money per student and redistributes tax funds across districts to make that possible. Vermont has also centralized school funding.

At the other end of the spectrum, states like New Hampshire let local governments pretty much decide their own level of funding for schools and other programs (about half of all local spending in the U.S. goes toward schools), and towns differ widely. If you want to live in a low-tax, low-spending town or a high-tax, high-spending town, it isn’t terribly difficult to find one. In the middle are states like Texas, where local governments are responsible for their own tax and spending decisions, but the most important level of local government is the county, much larger than the town, and it is therefore difficult to choose where to live based on local taxes and services.

Can we measure how decentralized each state is? I’ve tried to do so. The first measure of decentralization looks at how important local taxes are compared to state taxes. It divides local taxes by state and local taxes put together. This is a familiar variable to scholars of “fiscal federalism,” and it is typically called “tax decentralization.” Here is how the states rank on tax decentralization, as of fiscal year 2011-12, the most recent year for which data on local taxes are available from the U.S. Census Bureau:

New Hampshire 0.62475539
Alaska 0.584999114
Texas 0.555497037
Colorado 0.5420195
New York 0.540915308
Louisiana 0.520062304
South Dakota 0.514664958
Florida 0.508526077
New Jersey 0.503867865
Georgia 0.502739018
Missouri 0.490816162
Nebraska 0.486587041
Rhode Island 0.483462474
Ohio 0.47233672
Virginia 0.468452418
Illinois 0.466955731
Wyoming 0.465238453
South Carolina 0.459566438
Maryland 0.451067476
Pennsylvania 0.449406333
Arizona 0.440699694
Iowa 0.437082825
Oregon 0.434834984
Kansas 0.434319401
Washington 0.431347838
Wisconsin 0.423486277
Tennessee 0.421965652
Utah 0.420621904
Maine 0.411333699
Massachusetts 0.398031363
Connecticut 0.397670719
Montana 0.389680799
California 0.387518844
Nevada 0.383740954
Oklahoma 0.383081024
New Mexico 0.382245601
Alabama 0.382121115
North Carolina 0.366066432
Michigan 0.361458412
Indiana 0.352963108
Kentucky 0.33512693
Idaho 0.325219717
North Dakota 0.312465478
Mississippi 0.306727915
West Virginia 0.29895431
Minnesota 0.282530032
Hawaii 0.258739008
Arkansas 0.220173834
Delaware 0.215201394
Vermont 0.152464302

This isn’t the only way we can measure decentralization, though. After all, some states have more “competing jurisdictions” from which a prospective homeowner can choose than others do. To get at this concept was a little more complicated. I first counted the number of county, municipal, and township governments for each state from the U.S. Census Bureau. Then I looked at what proportion of local taxes came from each level of government and created a weighted average of number of local governments for each state. So if a state had 100 towns, 10 counties, 0 townships, and towns raised 20% of local taxes, while counties raised 80% of local taxes, the formula for the weighted average would be 10*0.8+100*0.2. The formula “rewards” states for letting lower-level, more numerous governments raise more taxes.

Then I thought about the decision of a homeowner in choosing a government to live under. Typically, your general location is set by where you have a job, say, a metropolitan area. But there may be several jurisdictions in that metro area to choose from. So I divided the “effective number of competing jurisdictions” described in the last paragraph by the state’s privately owned land area in square miles and multiplied by 100. So the resulting variable is the effective number of competing jurisdictions per 100 square miles of privately owned land. Higher values mean there is a lot of choice among governments.

Here is how the states come out on this variable measuring choice among governments:


New Jersey 5.619216533
Massachusetts 4.644661232
Pennsylvania 4.458726121
Rhode Island 4.016477858
Connecticut 3.634408602
Vermont 3.315789474
New York 2.934484963
New Hampshire 2.529344945
Wisconsin 2.189851779
Illinois 1.823655675
North Dakota 1.699505873
Delaware 1.586429725
Ohio 1.522032431
Maine 1.515194346
South Dakota 1.21988394
Missouri 1.105963152
Iowa 1.092652689
Indiana 0.972491305
Michigan 0.968708835
Kentucky 0.818674996
Minnesota 0.789141489
Arkansas 0.724807709
West Virginia 0.709066369
Oklahoma 0.693505752
Alabama 0.684705931
Georgia 0.551970462
North Carolina 0.535369811
Tennessee 0.506450581
Maryland 0.49052107
Kansas 0.479065166
Virginia 0.475682594
Florida 0.453352937
Nebraska 0.444783283
South Carolina 0.431428983
Louisiana 0.427531008
Utah 0.382243912
Mississippi 0.375744252
Washington 0.373979057
Texas 0.326573652
California 0.301273953
Colorado 0.284535146
Idaho 0.275746556
Oregon 0.273392409
Arizona 0.094351369
New Mexico 0.087975845
Montana 0.077669113
Hawaii 0.070909413
Wyoming 0.058851844
Alaska 0.042298043
Nevada 0.036335668

In general, the northeastern states score highly, largely because of a historical legacy of strong town government.

We can multiply both variables, tax decentralization and effective number of competing jurisdictions per 100 sq mi, together to get a single measure of how decentralized each state is.


New Jersey 2.831342639
Pennsylvania 2.003779755
Rhode Island 1.941816321
Massachusetts 1.848720839
New York 1.587307839
New Hampshire 1.580221888
Connecticut 1.44529788
Wisconsin 0.927372178
Illinois 0.851566468
Ohio 0.718911807
South Dakota 0.627831517
Maine 0.623250495
Missouri 0.54282459
North Dakota 0.531036915
Vermont 0.505539528
Iowa 0.477579724
Michigan 0.350147957
Indiana 0.343253553
Delaware 0.341401889
Georgia 0.277497088
Kentucky 0.274360038
Oklahoma 0.265668894
Alabama 0.261640594
Florida 0.23054179
Minnesota 0.22295617
Virginia 0.222834661
Louisiana 0.222342761
Maryland 0.221258101
Nebraska 0.216425781
Tennessee 0.21370475
West Virginia 0.211978447
Kansas 0.208067296
South Carolina 0.198270281
North Carolina 0.195980916
Texas 0.181410696
Washington 0.161315058
Utah 0.160780162
Arkansas 0.159583693
Colorado 0.154223598
Oregon 0.118880584
California 0.116749334
Mississippi 0.115251251
Idaho 0.089678217
Arizona 0.041580619
New Mexico 0.03362838
Montana 0.030266162
Wyoming 0.027380141
Alaska 0.024744317
Hawaii 0.018347031
Nevada 0.013943484

New Jersey is the state where the taxpayer has the most choice of government. While local property taxes are generally high there, that may simply reflect the preferences of local homeowners who want to spend money on services. It would be unsurprising if there are also some local jurisdictions in New Jersey where taxes are especially low.

In general, northeastern states, which are mostly left of center and high-tax, have a heretofore unseen advantage in their fiscal systems, letting competing local governments do much or even most of the taxation, making them responsive to local property owners. Perhaps it is precisely because of that responsiveness that overall tax burdens are allowed to be high in some of these states (New Hampshire aside): homeowner voters are more content with the way government uses their tax money there.

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This paper of mine is now available online in Constitutional Political Economy. It empirically investigates competing theories of how fiscal federalism constrains government. The main conclusion is that different federal systems conform roughly to different theoretical models, with the U.S. – a bit surprisingly – coming closest to “market-preserving federalism.” Some of the early findings from this paper were blogged here at Pileus some time ago.

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Having finally turned the corner on a brutal, 11-day (and counting) cold, I feel up to getting back to my blogging routine. First up: a followup to last month’s post, “Why So Little Decentralization?”

To review, that post posed a puzzle (a problem for political scientists to ponder, you might say). The puzzle is this: developing countries are far more centralized than developed countries. That is so despite the fact that some developing countries are much larger and more diverse than developed countries, and many of them have now been democratic for quite some time. Furthermore, if decentralization were simply a relict of post-medieval state-building (some might venture that sort of claim about Switzerland, for instance), then the fact that developing countries have lower state capacity and a more recent independence than almost all developed countries deepens the puzzle.

I went through two explanations that do not actually explain the puzzle very well: shallow local talent pools and illiberalism. In particular, they cannot explain why developing countries are often very decentralized along some dimensions (allowing discrimination against goods and workers from other regions, linguistic and cultural rights, etc.), but not others (chiefly tax policy).

I think there are two explanations that actually work: secession prevention (in ethnic federations) and excessively personalist electoral systems (in nonethnic federations). In this post I’ll talk about secession prevention.

Some developing democracies are ethnoregionally diverse, that is, they contain minority ethnic homelands that could form the basis of independent states. Examples include (more…)

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Many scholars (for instance) have noted a trend around the world of greater decentralization, at least on certain dimensions. Many non-federal, unitary states have tried to devolve some spending and decision-making authority on local or regional governments. Virtually every democratic government nowadays at least feigns some interest in decentralization.

Yet what strikes me is how little decentralization there has been, especially in the developing world. Some developing democracies that are sometimes described (or describe themselves) as “federal” or “semi-federal” include Mexico, India, Indonesia, Brazil, Argentina, Venezuela (before it went authoritarian some time in the 2000s), South Africa, Malaysia, Pakistan, Iraq, Nepal, and Nigeria. Yet none of these countries, other than Mexico, affords its constituent state or regional governments autonomy commensurate with that found in federal and semi-federal “Western liberal democracies” like Spain, Canada, the U.S., Switzerland, Belgium, Germany, Austria, Australia, and Italy. For instance, in Brazil, states do not have exclusive powers, and the federal government may overrule any state law with its own legislation. In India, the federal government may suspend state governments from operating at all and impose “President’s Rule.” Of all developing democracies, only India, Mexico, and Brazil routinely allow subcentral governments to raise significant revenue through autonomous taxation policies. (I count 9 Western democracies with such fiscal autonomy.)

Some of these developing countries are both huge and ethnically and regionally diverse, India and Indonesia most notably. One might think that these governments would have even more reason to decentralize than would the governments of comparatively homogeneous Western democracies. Therefore, the relative lack of decentralization in developing countries remains a puzzle.

One explanation might be the smaller talent pool in developing countries. Decentralization might not be feasible because uneducated or politically unsophisticated local officials require close supervision from a small cadre of Western-educated central administrators. While this explanation might have some weight in very poor democracies like Mali (before the recent coup), it likely does not apply to the majority of the cases just mentioned. If the talent pool in developing democracies were desperately shallow, then small developing democracies should have little state capacity plus all the adverse sequelae political scientists typically attribute to state weakness. Yet many small democracies in the developing world have performed fairly well: Costa Rica, Jamaica, Trinidad, Botswana, Mauritius, and Namibia, not to mention Slovenia and the Baltic republics in central and eastern Europe. There is no obvious positive relationship between country size and economic or political performance in the developing world.

Furthermore, many of the cases just mentioned do boast significant decentralization along some dimensions. For instance, India and Indonesia lack a unified internal market, allowing local and state or provincial governments to impose trade barriers on products from other regions. This is an economically perverse form of decentralization and one that has been nearly stamped out in the West, apart from certain discriminatory government procurement regulations. In addition, many developing democracies feature significant decentralization of expenditures: local and regional governments control significant budgets, but those budgets are funded by central grants, and most policy authority lies with the center. This set of policy choices is also likely economically perverse, as “vertical fiscal imbalance,” whereby subcentral governments depend heavily on grants or mandatory revenues from the center, tends to encourage fiscal irresponsibility. In Argentina in the 1980s and 1990s, provincial governments established their own banks, which were forced to lend money to those governments, leading to repeated fiscal crisis.

Another explanation might be that there is something about the Western liberal tradition of political philosophy that encourages decentralization. Many developing democracies fit within the category of “illiberal democracies,” where majorities use their political power to trample the rights of minorities. Sri Lanka might be just such a country, where the Sinhalese majority has repeatedly refused to countenance significant autonomy for the Tamil minority, and the central government fought a brutal civil war against Tamil rebels, complete with vast numbers of civilian killings and other human rights violations.

There may well be something to this explanation, but there are also hazards. As Vito Tanzi noted (PDF), demand for decentralization rises with size of government. A nightwatchman state can afford to be centralized because no one really cares about who controls it. Developing countries have bigger governments than Western democracies, not in the government spending as a share of GDP sense, but in the sense that the distribution of resources in such societies is more elastic with respect to the distribution of political power. So demand for decentralization should be higher there. True, the constraint might instead be supply: the views of political leadership in such societies. But then why the “perverse” decentralization in some countries?

To examine the extent and form of decentralization in developing democracies, I have, with the help of University at Buffalo Ph.D. student Govinda Bhattarai, developed a new dataset of regional self-rule in consolidated democracies worldwide. The coding scheme extends that introduced by Liesbet Hooghe, Gary Marks, and Arjan Schakel for Western democracies and various postsocialist European countries. Without going into details here, I will simply note that we coded the scope of policy powers of subcentral governments, the scope of taxation powers of subcentral governments, the local electoral accountability of subcentral officials, and the ability of the central government to veto subcentral laws.

Using those indicators, I then construct two higher-level, multiplicative indices of economic self-rule and political self-rule. Economic self-rule takes into account political self-rule as well as the tax autonomy of subcentral governments. Economic self-rule ranges from 0 (none) to 48 (maximum). Political self-rule ranges from 0 (none) to 16 (maximum).

The scatter plot below shows regional self-rule on the economic (Y axis) and political (X axis) dimensions in 2006, the latest year for which data on regional self-rule in the Hooghe, Marks, and Schakel dataset are available (our data go to 2010, however). Each observation in this plot is a type of region: either a particular region with its own autonomy statute (like Aaland in Finland or Scotland in the UK), or a type of regional government with the same autonomy arrangement (like states in the U.S. or in India).

economic & political self-rule(You can click the image to get a better view.)

Look at how few (more…)

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