Decentralization, Vertical Fiscal Imbalance, and Political Selection

Abstract

In a career-concern model of politics with endogenous candidacy and different types of politicians, following a decentralization reform, politicians with different skills are attracted and elected in municipalities characterized by different levels of autonomous resources. As an effect consumer welfare increases only, or mainly, in richer municipalities. We test these predictions by exploiting the differentiated reduction in Vertical Fiscal Imbalance in Italian municipalities, due to the strong difference in the tax base, following the decentralization reforms of the ’90s. Results strongly support our predictions and are robust to several alternative stories. They may help explain the common empirical observation that fiscal decentralization generally works better when VFI is low.