Fiscal decentralization: a review of theories, evidence, and policy implications

This study systematically reviewed theories, empirical evidence, and policy implications of fiscal decentralization through a comprehensive analysis of literature and case studies. Fiscal decentralization, which transfers fiscal responsibilities from central to subnational governments, aimed to enhance governance efficiency, improve public service delivery, and foster economic growth. The review drew on foundational theories by Oates (1972) and Tiebout (1956), which emphasized allocative efficiency and competitive federalism, as well as second-generation theories that highlighted institutional incentives and market-preserving federalism. Empirical findings revealed that decentralization improved service delivery in education and healthcare, particularly in middle-income countries with strong institutions, as seen in Bolivia and Argentina. However, its effectiveness varied across contexts, with developing nations often facing challenges such as weak administrative capacity, fiscal mismanagement, and regional disparities. The study identified key success factors, including balanced revenue-sharing mechanisms, hard budget constraints, and robust accountability systems, as demonstrated by Germany and China. Conversely, Latin American cases illustrated the risks of rapid decentralization without adequate safeguards, leading to fiscal instability and elite capture. The review also highlighted the importance of political decentralization in democratic settings, where it enhanced accountability but required careful design to avoid short-termism and fragmentation. Policy implications emphasized the need for phased reforms, capacity building, and anti-corruption measures in developing countries, while advanced economies benefited from institutionalized equalization mechanisms. Emerging challenges, such as climate change and digital governance, underscore the necessity for adaptive fiscal frameworks. The study concluded that fiscal decentralization was not a universal solution but a context-dependent tool, requiring tailored approaches to achieve equitable and efficient outcomes. Future research directions include exploring digital tools, gender equity, and climate-responsive systems to address evolving governance needs.