Effects of Fiscal Decentralization on Public Sector Growth in Austria

Abstract

The determinants of the growth of the public sector have drawn significant attention by researchers with an increasing focus on the effects of fiscal federalism. The objective of the paper is to test whether fiscal decentralization contributes to the growth of government expenditure in Austria for the period of 1955 to 2007. The empirical results of this paper suggest that the commonly hypothesized determinants of total government expenditure may bear some explanatory power in Austrian fiscal policies. Government expenditures seem to be determined by GDP with increases of the size of the public sector until about mid-1990s. Expenditures react to active fiscal policies influencing the unemployment rate. There is also some indication of fiscal illusion of policy makers. We find that fiscal decentralization measured by the share of sub-national expenditure to total government expenditure has a dampening effect on total government expenditure, thus corroborating the hypothesis of the efficiency of a federal system. However, decentralization in the Austrian system is mainly attributable to the significant growth of grants from the national to the sub-national levels of government. Our conclusions therefore cannot be generalized in terms of an efficiency advantage of a federal over a centralized system.