ISP Working Paper Number 05-01

Fiscal Decentralization and the Functional Composition of Public Expenditures

F. Javier Arze del Granado, Jorge Martinez-Vázquez, and Robert McNab, September 2005

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Abstract:

We examine the relationship between fiscal decentralization and the functional composition of public expenditures. Using a distance-sensitive representative agent model, we hypothesize that higher levels of fiscal decentralization induce agents to demand increased production of publicly provided private goods. We test this hypothesis using an unbalanced panel data set of 45 developed and developing countries covering a 28-year period. We find strong evidence that decentralization increases the share of education and health expenditures in total government expenditures. We note that the influence of decentralization on the composition of public expenditures may be greater in developing countries relative to industrialized countries.