Does Fiscal Federalism Promote Regional Inequality? An Empirical Analysis

This paper explores the relationship between fiscal federalism, understood as institutionalized regional economic self-rule, and convergence in regional per capita incomes. The principal economic argument against fiscal federalism is that, unless paired with generous equalization grants, it will enhance regional inequalities by reducing inter-regional redistribution. Does the evidence support this claim? Multilevel spatial regressions on primary sub-national jurisdictions in 25 OECD countries show that lower-income regions tend to catch up to higher-income regions only when they enjoy substantial economic powers. Indeed, there is more convergence across member states of the EU than across regions within almost any of the EU members. Fiscal federalism may pose less serious tradeoffs than commonly assumed.