Fiscal Decentralization and Borrowing Costs: The Case of Local Governments

Abstract

Borrowing costs vary across different levels of government. Local governments often face costlier borrowing than their higher level counterparts. This article shows that the decentralization of expenditure functions and revenue sources to lower tiers of government has a bearing on local government borrowing costs. Empirical evidence is provided for a sample of industrial and developing economies in the period 1970 to 1995, using three different fiscal decentralization indicators and two different borrowing cost indices. The findings are robust to the inclusion of controls for additional determinants of subnational borrowing costs. An important implication of these results is that policies aimed at disciplining subnational finances in the process of fiscal decentralization also tend to reduce subnational borrowing costs.