Intergovernmental Fiscal Relations: Coordination Failures and Fiscal Outcomes

This article estimates the fiscal impact of coordination failures in intergovernmental fiscal relations. The coordination failures considered here are due to agency problems arising from the delegation of fiscal powers to sub-national governments, and "common pool" problems associated with funding decentralised government spending through intergovernmental transfers. Particular attention is focused on the trade-off between coordination and fiscal decentralisation. Evidence provided for a sample of thirty countries suggests that coordination failures are likely to result in a deficit bias in decentralized policy making, particularly in the case of developing countries, for which the benefits of decentralization may be over-stressed. Developed countries were found to be less adversely affected by coordination failures and have therefore managed to pursue fiscal consolidation in a decentralized setup.