Fiscal Decentralization and the Composition of Local Government Expenditure: Evidence from South Korea

Abstract

The implicit idea underlying theories of fiscal federalism is that fiscal decentralization can change the composition of government expenditure. That is, regardless of whether decentralization enables governments to more readily reflect citizen preferences regarding spending categories or fosters a race to the bottom with reduced taxation and public service levels, change in the composition of government expenditure may ensue. This study indirectly tests the impact of decentralization with respect to allocative efficiency by examining the relationship between fiscal decentralization and expenditure composition. Utilizing data from 224 local governments in South Korea over the period 2008–2018, the study finds that fiscal decentralization exerts downward pressure on welfare expenditure and that it tends to shift spending from the current to the capital account. Specifically, it finds that it is mainly revenue-side decentralization that affects the allocation of government expenditure.