A study of the relationship between fiscal decentralization and the composition of public expenditures

This study examines the relationship between fiscal decentralization and the composition of public expenditures. We develop a theoretical model based on a distance-sensitive representative agent model, and some applications of the median-voter theorem and the Tiebout choice model. The theoretical model supports the prediction that fiscal decentralization is a determinant of the composition of overall government expenditures, and also a determinant of the overall size of the public sector.; We empirically test two hypotheses derived from the theoretical model by using several econometric models on an unbalanced panel data set of 45, developed and developing countries, over a 28-year period. The empirical models used in this study improve upon previous empirical studies of expenditure composition and government size by using up-to-date data and the most current estimation techniques for fractional data.; We obtain strong evidence that fiscal decentralization increases the share of education and health expenditures over total expenditures. Most of our estimates reveal no statistically significant evidence that the effects of decentralization may differ between developing and industrialized countries. However, for one model we find evidence that the effect of decentralization on the composition of public expenditures is greater in developing countries than in industrialized countries. Consistent with previous literature, we do not find a significant direct relationship between fiscal decentralization and government size. However, we find statistically significant results that fiscal decentralization reduces government size when it is allowed to interact with heterogeneity in tastes within each country.