Decentralization: The Bad Things Have not Happened.... Yet?

Bdf Posted by Luc Leruth

On June 26, 2008, I took part in a Banque de France Workshop on the Impact of Decentralization on Public Finances in St. Germain-en-Laye, near Paris (Download Workshop_programm_decentralization.doc, Download List_of_participants.pdf). The Workshop looked at a number of critical issues related to decentralization, including the role of fiscal rules, the impact of decentralization on economic growth, and the pre-conditions for successful decentralization. It was attended by about 50 senior representatives of international organizations, central banks, the private sector, and academia. The discussions were opened by Mr. Ophele, Deputy Director General of Economic Studies and International Relations at the BdF and I was invited to take part in the concluding roundtable chaired by Mr. Franco of the Banca d’Italia.

Having been asked to be a little provocative, I observed in my presentation (integrating comments from Messrs. Keen and Norregaard of FAD) (Download Decentralization_and_tax_competition.ppt)that the bad things associated with decentralization and discussed in academic circles had not really happened (much) yet. For example:

I argued that the reason for which this had not happened was that the environment in which decentralization had taken place had been largely stable and predictable in the last decades.

Yet, I also argued that there was no reason to believe that vertical tax competition or a shrinking tax base (or something else) would not happen. In other words, vertical tax competition and vanishing tax bases could very well appear if the environment became more volatile. And there were many reasons to believe that there might be shocks just around the corner that could affect all levels of government (and hence the way decentralization was playing out), including:

All of these shocks (and possibly others too) would trigger high fiscal costs, on a far bigger scale than those experienced in the rather mundane environment we have experienced so far, forcing new taxation measures, and inevitably triggering vertical tax competition and other problems.

As for the main sessions of the Workshop, this is what happened.

During the first session on decentralization and government behavior:

The case of decentralization in EU countries was considered during the second session:

The impact of decentralization on fiscal outcomes was addressed in the third session: