Revenue Decentralization and the Probability of a Fiscal Crisis: Is There a Tipping Point for Adverse Effects?

Abstract

Does government revenue decentralization affect the probability of a fiscal crisis? Is there a tipping point where revenue decentralization worsens the probability of a fiscal crisis? To answer these questions, we use cross-country panel data on 66 countries from 1982 to 2019. The binary choice models show that revenue decentralization is positively associated with crisis probability when countries exceed a certain threshold of decentralization. When more than approximately 16 percent of general government revenue is decentralized to local governments, this adverse effect of revenue decentralization occurs. This is consistent with the recent theoretical prediction that tax revenue collection efforts weaken as the government decentralizes revenue more. The adverse effects of revenue decentralization are large in low-income countries. Our finding implies the benefits of revenue centralization, such as economies of scale for revenue agencies, eliminating externalities due to tax competition, and the intergovernmental insurance role of federal transfers against local shocks.