Fiscal Decentralization and The Functional Composition of Public Expenditures

This study examines the relationship between fiscal decentralization and the functional composition of public expenditures. We develop a theoretical model based on a distance-sensitive representative agent model, some applications of the median-voter theorem, and the Tiebout choice model. In our model, higher levels of fiscal decentralization lead indiviuals to demand higher amounts of publicly provided private goods. We empirically test this hypothesis by employing several econometric models on an unbalanced panel data set of 45, developed and developing countries over a 28-year period. The empirical models used in this study improve upon previous empirical studies of expenditure composition by using up-to-date data and the most current estimation techniques for fractional data. We obtain strong evidence that fiscal decentralization increases the share of education and health expenditures over total expenditures. Most of our estimates reveal no statistically significant evidence that the effects of decentralization may differ between developing and industrialized countries. However, for one model we find evidence that the effect of decentralization on the composition of public expenditures is greater in developing countries than in industrialized countries.