Is fiscal decentralisation good for growth?

The relationship between fiscal decentralisation and economic growth is an important but highly controversial issue. Increased revenue autonomy for the Scottish Parliament is seen by many as a key tool to improve the performance of the Scottish economy – see for example, Hallwood and MacDonald (2006) and Steel (2006). In contrast, others such as Ashcroft et al. (2006) are concerned about the possible economic and political risks involved and have argued strongly against such a move. This paper contributes to this discussion by providing an objective evaluation of the existing theory and evidence on the link between fiscal decentralisation and economic growth and its relevance to the Scottish case

Grants Versus Tax Sharing: the Extent of Central Government Control

By spending more than they are able to raise, sub-central governments typically depend heavily upon central transfers to meet their expenditure responsibilities. While grants remain the most popular method of transfer, the possible use of tax sharing arrangements as an alternative method of finance has received increased attention in recent years. In nearly all tax sharing systems that we are aware of, central governments play a dominant role in determining the amount of revenue each sub-central unit receives from the shared source. It has therefore, become common in the academic literature to interpret grants and tax sharing as equivalent tools of central fiscal control over sub-central tiers. However, we caution against this. In our paper, we demonstrate that only in a particular special case is it correct to conclude that the level of central control of sub-central finances is the same under a system of grants as it is under tax sharing.

Fiscal federalism and fiscal autonomy : lessons for the UK from other industrialised countries

The purpose of this article is the following. First, we provide a comparison of the degree of fiscal decentralisation in the UK with that in other countries, and assess the extent to which different areas of public expenditure are assigned to different tiers of government. Second, we assess the degree of fiscal autonomy in the UK compared to that in other OECD countries. We also provide some insights from the theory of fiscal federalism to assess whether the current degree of fiscal autonomy in the UK is optimal, or whether there are useful lessons to be learned from other economies. One key conclusion here is that, although there would seem to be good reasons to increase the degree of fiscal autonomy in the UK, one might want to proceed with caution. We also discuss whether other OECD countries offer useful models in terms of the method of allocation of block grants, the allocation of taxation to other tiers of government, and the way in which are used to achieve the twin objectives of fiscal efficiency and equity. Finally, we consider whether the 'asymmetric nature' of UK devolution, with different national and regional units being assigned different degrees of autonomy, represents a desirable model in the light of experiences elsewhere in Europe. In the next section, we outline the division of spending responsibilities between different tiers of government in the OECD economies. Then we compare the degrees of fiscal autonomy, and assess whether further reform is warranted in the case of the UK. In subsequent sections, we consider how the mixed use of central grants, shared taxation and devolved taxation can impact on the objectives of efficiency and equity; discuss the extent to which different subcentral governments have autonomy on borrowing; and examine how fiscal federalism is evolving in different countries

Fiscal decentralisation in Europe : a review of recent experience

In this paper we review countries' diverse experiences to draw conclusions on the pitfalls and opportunities that are open through decentralisation of governments' fiscal responsibilities to sub-central jurisdictions. We begin by reviewing the theoretical arguments for and against the decentralisation of spending responsibilities. We also provide a cross country comparison of the extent to which spending powers have been devolved in a range of European countries, putting each country's position into a wider context. Second, we review some insights from the theory of fiscal federalism on fiscal autonomy and assess the extent of autonomy at subcentral tiers of government in the same set of countries. We discuss the approaches that have been followed, and a number of the difficulties that particular countries have faced, as the fiscal autonomy of sub-central tiers of government has evolved. Our conclusions are set out in the final section

Outlook and appraisal [December 2017]

December's Scottish Budget comes at a crucial time. Growth remains below trend and Brexit continues to create uncertainty. The political focus will no doubt be on any proposed changes to income tax. But with rising demand for public services and tight resources a wider debate is needed about the sustainability of key spending priorities and how to boost economic growth in Scotland

Outlook and appraisal [June 2017]

The economic news since our March Commentary has continued to paint a relatively disappointing picture of the performance of the Scottish economy. Scotland’s economy shrank in the final three months of 2016, with the slowdown evident across most key sectors. The latest indicators of consumer confidence and business activity suggest that growth has returned during the first half of 2017 but remains fragile

Outlook and appraisal [March 2017]

Our recent economic forecasts and analysis of the Scottish economy have been set against a period of significant uncertainty. Political uncertainty is not unusual and for the most part, businesses and investors are used to dealing with changes in government priorities and indeed governments. However, the current level of such uncertainty is unprecedented. It is also different from normal in that the debates around Brexit and a possible further independence referendum concern the fundamental basis on which the Scottish economy has grown and developed over the last 40 years. That being said, with so little clarity around many businesses appear to be ‘looking through the uncertainty’ and are continuing to press ahead with day-to-day activities. Whilst the Scottish economy continues to lag the rest of the UK, a number of recent business surveys point to a welcome pick-up in activity toward the end of 2016 and into 2017. However, consumers appear wary about the outlook. Indicators of Scottish consumer confidence are much more negative than for the UK as a whole. It would appear that this, and not just the challenges in the North Sea, is one of the key reasons for Scotland’s relatively weaker recent performance. On balance, we forecast that the Scottish economy will continue to grow over the forecast horizon and more quickly than in 2016. The weight of probability suggests that it is likely to remain below-trend as policy uncertainties act as a headwind on growth. The Scottish labour market continues to hold up remarkably well. Employment rates are close to record highs, whilst the current unemployment rate of 4.7% is well below its long-run average. However with a rise in inactivity over the year, weak earnings growth and reduced average hours worked, the underlying picture is less positive than the headline figures suggest. Ultimately, whilst the policy focus will undoubtedly be dominated by ongoing debates around the EU and Scottish independence, it is important not to lose sight of the importance of domestic economic policies. Over the ten years since the start of the financial crisis in 2007, the Scottish economy has grown by just under 7% - equivalent to an average annual growth rate of 0.7% (less than a third of its long-term trend). GDP per head is just 2% higher over the same ten year period and the incomes of many households remain worse off. Strategies, action plans and ambitions around inclusive growth will only take us so far. What really matters are clear practical policy actions to support businesses, boost productivity, attract investment and create jobs. A renewed focus on how both the Scottish and UK Governments can use the current powers at their disposal to support the Scottish economy is needed

Fiscal Federalism, Fiscal Consolidations and Cuts in Central Government Grants: Evidence from an Event Study

In this paper we examine financial interactions between tiers of government. Whilst most existing empirical evidence has focused on the US, it is difficult to generalize conclusions obtained to countries where the position and remit of lower tiers of government is evolving or is less clear constitutionally. Applying event study methodology to a dataset covering 15 countries we examine the timing, extent and composition of fiscal changes around consolidation attempts and central government grant cuts. Highlighting the participation of central and sub-central tiers of government, our analysis also sheds light on key outcomes, including decentralized service provision and macroeconomic adjustment.

Fiscal Federalism, Fiscal Consolidations and Cuts in Central Government Grants: Evidence from an Event Study

This paper contributes to a developing literature that examines financial interactions between different levels of government. More specifically, we investigate the use of grants, shared tax revenues, and their impact on fiscal outcomes, including decentralized service provision. Most existing empirical evidence has focused on individual country studies, and has predominantly been US based. However, it is difficult to generalize the conclusions obtained for the US to countries where the position and remit of lower tiers of government has recently been evolving or is less clear constitutionally. We use a panel dataset covering 15 OECD countries to investigate how central and sub-central expenditures, taxation, and intergovernmental grants change in response to central governments' attempts to correct their fiscal positions. We adopt an event study methodology to examine the timing of expenditure, taxation and intergovernmental grant shifts around the periods of fiscal consolidation. In addition to highlighting issues regarding the interaction between central and sub-central tiers of government, our analysis also sheds light into the extent to which sub-central tiers of government participate in fiscal consolidations, and hence to macroeconomic adjustment. Our key results can be summarized as follows. First, successful fiscal consolidations are generally driven by similar, and sustained, falls in expenditure at both central and sub-central tiers. Moreover, our evidence counters that identified by Gramlich (1987) for the USA, in that when central governments cut intergovernmental grants sub-central tiers do not take redress through offsetting increases in other forms of revenues. Second, unsuccessful consolidations tend to be characterized by increased central government taxation, with no fall back in grants and no tendency for sub-central taxation to change. It does appear that there is strong correlation between success in consolidating central fiscal deficits and similar actions from lower tiers of government. Third, we find that where consolidations are successful sub-central tiers of government are typically forced to cut back on capital expenditure. This suggests that in this regard the burden of adjustment falls onto lower tiers of government and central governments worry less about the long-term (i.e. public investment) consequences of consolidation if these decisions are taken at local level. We also find that when faced with cuts in intergovernmental grants, sub-central governments tend to maintain expenditures on wages at the expense of capital expenditure, reflecting a definite compositional switch towards public consumption. This might be interpreted as a variant of the effect identified by Gramlich (1987): sub-central governments seeking to defend current services rather than spending on infrastructure or raising taxation. This may reflect the greater constraints on sub-central tiers’ tax raising powers in many of the OECD countries in our sample, relative to those in the USA. Finally, our results shed some light, at least indirectly, on the ‘Fly-paper Effect’, by showing that it operates in reverse. Successful consolidations are characterized by cut-backs in grants that are more than offset by cut-backs in sub-central expenditures. In contrast, periods of unsuccessful consolidation are characterized by increases in central taxation, no change in grants, and small, temporary reductions in sub-central expenditure.