Abstract
A rigorous understanding of the developmental effect of fiscal transfers to subnational governments remains an important policy research issue globally. This paper exploits a novel dataset of 20 years of municipal poverty maps and local public finances to study the effects on local welfare of a large fiscal transfer fund earmarked for social investment in more than 2,000 Mexican municipalities. Results show a positive but modest effect on the average household income, and positive effects on seven nonmonetary welfare measures. In contrast, these funds have no significant impact on extreme and moderate monetary poverty. These results provide important lessons for policy on the effects of earmarked funds to reduce territorial poverty and inequality in terms of incentives to design formulas to distribute earmarked fiscal resources to subnational governments.
Highlights
A wide literature documents the importance of and the challenges involved in increasing government revenues in developing countries
A naive ordinary least squares (OLS) equation that studies the impact of the FAIS on poverty without addressing the problem of dual causality finds a spurious correlation and underestimates the possible effect of the FAIS on poverty reduction
The results of an OLS model are counterintuitive because the FAIS has a negative effect on household mean incomes and a positive effect on poverty rates, thereby acting against the purpose of the fund’s transfers (Table 2)
Summary
A wide literature documents the importance of and the challenges involved in increasing government revenues in developing countries (for example, see Besley and Persson 2014). During the 1980s and 1990s, countries around the world moved toward transferring earmarked resources to subnational governments with the objective of providing public services locally, including health care, education, and social infrastructure, such as water and sanitation services or support for urbanization (Habibi et al 2003; Jiménez-Rubio 2011; Litvack, Ahmad, and Bird 1998; Martinez-Vazquez, Lago‐Peñas, and Sacchi 2015; Musgrave 1983; Oates 1972; Ostrom et al 1993; Wallis and Oates 1988). The success of decentralization has been associated with various factors. These include the design and implementation of reforms, the incentives facing local and national stakeholders, local accountability and responsiveness, the budgetary process, and the availability of adequate local capacity (Ahmad et al 2005; Loayza, Rigolini, and Calvo-González 2014; Martinez-Vazquez and Vaillancourt 2011; Robinson 2007). Some studies find that decentralization has an equalizing impact (Sepúlveda and MartinezVazquez 2011; Tselios et al 2012), while others show the opposite (Sacchi and Salotti 2014)
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