Voting, lobbying, and the decentralization theorem

Abstract

This paper revisits the well-known fiscal "Decentralization Theorem" of Oates(1972), by relaxing the role of the assumption that governments are benevolent, while retaining the assumption of policy uniformity. If instead, decisions are made by direct majority voting, the theorem fails. Speci…cally, (i) centralization can welfare-dominate decentralization even if there are no externalities and regions are heterogenous; (ii) decentralization can welfare-dominate centralization even if there are positive externalities and regions are homogenous. The intuition is that the insensitivity of majority voting to preference intensity interacts with the different inefficiencies in the two …scal regimes to give second-best results. Similar results obtain when governments are benevolent, but subject to lobbying, because now decisions are too sensitive to the preferences of the organized group. The conclusion is that the Decentralization Theorem is not robust to relatively minor and standard deviations away from the benchmark of purely benevolent government