FISCAL RELATIONS ACROSS LEVELS OF

GOVERNMENT AND REGIONAL

DISPARITIES

David Bartolini, OECD Fiscal Network

ZEW Public Finance Conference, Mannheim 25-26 April 2016

Motivation 1: Regional disparities

• Why is it important?– Impact on economic growth: overall growth depends

on the contribution of each region (dynamic and size)

– Impact on income inequality: geographical inequality adds to overall inequality (national GINI)

• How to measure regional disparities?– Unit of analysis: OECD TL2 regions (NUTS2 regions)

– Coefficient of variation: ��� ���.�

� �

– Using regional per capita GDP in constant PPP 2005 US$

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Inequality between countries is reducing …

… BUT inequality WITHIN countries is on the rise

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On the right-hand side of the Kuznets curve (?)

• Low income countries seems to display larger regional disparities

• Inequality is picking up again for high levels of development – signal the importance of high-tech activities and services that tend to be concentrated in cities

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• Fiscal decentralisation might increase the efficient provision of local public goods, but there is fear that it would also increase regional disparity

• Main goal: investigate the impact of several indicators of fiscal decentralisation on regional disparities

Motivation 2: fiscal decentralisation

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Fiscal decentralisation indicators (from OECD Fiscal Decentralisation database):• Revenue• Tax• Expenditure• Tax autonomy• Tax Authority (RAI)

Increases disparities

Less endowed regions will suffer – no level playing

field for competition

“race to the bottom” (Prud’homme, 1995) and “self selection”(Tiebout,

1956)

Corruption at the local level (Tanzi, 1996)

Decreases disparities

Efficiency (Oates, 1972) , Public choice (Brennan &

Buchanan, 1980), transparency/political

economy (Salmon, 1987)

Incentive for growth-enhancing policies (Qian &

Weingast, 1997)

Larger potential of endogenous growth in

poor regions (Baldwin & Krugman, 2004; Barankay

& Lookwood, 2007; Rodriguez-Posé & Ezcurra,

2010)

Fiscal decentralisation framework:existing literature

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Fiscal autonomy, balanced fiscal

structure

Incentive to increase tax base

Competition

More inequality

Less inequality

Better use of existing

resources

Less inequality

• Key channel: better use of existing resources – there is more scope for improvement in lagging regions than in top performers, which are closer to the productivity frontier

Importance of tax decentralisation and vertical fiscal “balance”

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Tax decentralisation may change the spending decision of SNG

• Period 1995-2011• Countries with large SNG tax share experience larger SNG spending

on economic affairs

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���� � � � ������ � ����� � �� � �� � ���

Empirical strategy

Dependent variable (cv) • Coefficient of variation = ��.�

� �

Fiscal decentralisation (FD) • SNG Revenue share• SNG Tax share• SNG Expenditure share• Vertical fiscal imbalance (1-Rev/Exp)

Control variables (X) • GDP per capita of country i at time t• Human capital, gross capital formation• Trade openness• Population concentration, pop, urbanisation• Public expenditures, public debt

Fixed effects • Country ��• Year ��

Unbalanced panel of 20 OECD countries over the period 1995-2011

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Empirical results: fiscal decentralisation

(1) (2)

COV of per capita GDP robust SEIV (2/3year

lag)

Tax decentralisation -0.278* -1.904***(0.145) (0.707)

Revenue decentralisation -0.364* -0.433***(0.189) (0.144)

Expenditure decentralisation 0.179*** 0.206***(0.055) (0.069)

Vertical imbalance 0.127** 0.284***(0.059) (0.085)

Fiscal autonomy -0.012*** -0.022***(0.004) (0.005)

Observations 274 252

Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1

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Empirical results: control variables

(2)

COV of per capita GDP

GDP pc 0.00163***(0.000432)

Square GDP pc -1.55e-08**(5.84e-09)

Capital formation -0.457***(0.130)

Trade openness 5.204(4.666)

Pop concentration -2.343**(1.063)

Government expenditure size 0.157***(0.0387)

Observations 274

Standard errors in parentheses *** p<0.01, ** p<0.05, * p<0.1 11

Robustness

• Reverse causality – instrumental variable estimation

• Different time periods: (1995-2007) (2008-2011)

• Exclusion of one country at a time from estimation

• Different measure of regional disparities:• Weighted CV• GINI index• percentile ratios (75/25 and 90/10)

• GDP per worker (labour productivity)

All these robustness checks provided results similar to the baseline model

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• Cross section analysis

– Shankar and Shah (2003) decentralisation may increase disparities in “unitary” countries

– Rodriguez-Posé & Gill (2004) cross section analysis of OECD countries –decentralisation increases regional disparities because it favours economies of agglomeration

• Panel data models:

– Lessman (2006, 2009): panel OECD countries (1980-2001) = all indicators of fiscal decentralisation reduce regional disparity

• Differences in the level of development

– Rodriguez-Posé and Ezcurra (2010): impact of decentralisation depends on the level of development of a country = political and expenditure decentralisation reduces disparity only in developed countries

– Lessman (2012): panel of 54 countries (1980-2009) interaction decentralisation and GDP pc has a negative impact on disparity

• Differences in the quality of government

– Kyriacou et al (2013): the quality of government rather than the level of development may affect the impact of decentralisation on regional disparity

Selected literature review

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Highest impact on “low income” regions (catching up)

• Take regional income corresponding to the top (bottom) 25th percentile• Use it a s dependent variable in the regression:

∆ ��� !"#$% � &'(# �)�*'+ � &',-�)�*'+ � &./�� � 0� � 1� � 2��

(1) (2) (3) (5) (6) (7)

VARIABLES bottom bottom bottom top top top

SNG tax share 0.137* 0.0769

(0.0751) (0.0778)

SNG exp share 0.00188 0.0274 0.0692 0.0857*

(0.0578) (0.0595) (0.0526) (0.0508)

SNG rev share -0.00926 -0.0196

(0.0978) (0.108)

Fiscal authority 0.0112*** 0.0058

(0.00392) (0.00430)

• SNG tax share and Fiscal authority significant impact only on the bottom 25th percentile

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1. FD reduces regional disparities, if it does not increase vertical fiscal imbalance

2. Tax decentralisation stimulates SCG to implement pro-growth policies

3. Tax decentralisation favours catching-up of lagging regions

4. FD stimulate regional mobility in the distribution

Main conclusions

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THANK YOU

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david.bartolini@oecd.org

http://www.oecd.org/tax/federalism

Most of TL2 regional disparity depends on labour productivity

3-4

5"5�3-4

675∙675

9:4∙9:4

5"5

Productivity Employment rate

Activity rate

Note: coefficient of variation for the year 2010 17