Fiscal decentralization and fiscal discipline

Abstract

In this thesis, the effects of fiscal procedures, fiscal centralization and fiscal decentralization, on fiscal discipline are analyzed in a theoretical framework. A model of two optimization problems is established: central government’s optimization problem and local government’s optimization problem representing the two fiscal procedures; fiscal centralization and fiscal decentralization respectively. Comparative static analysis is performed, and moreover ambiguous results are calibrated. Our results indicate that in fiscal decentralization fiscal discipline increases with the number of localities. Furthermore, the portion that goes to the pool of the central government has a positive effect on the size of redistribution in fiscal centralization, but it has a negative effect in fiscal decentralization. Similarly, whereas income tax rate affects the size of redistribution positively in fiscal centralization, it has a negative effect in fiscal decentralization.