Reviving Leviathan: Fiscal Federalism and the Growth of Government

This paper revisits the influential “Leviathan” hypothesis, which posits that tax competition limits the growth of government spending in decentralized countries. It uses panel data to examine the effect of fiscal decentralization over time within countries, attempting to distinguish between decentralization that is funded by intergovernmental transfers and local taxation. First, it sets out a logic whereby decentralization should restrict government spending if state and local governments have wide-ranging authority to set the tax base and rate, especially on mobile assets. In countries where this is most clearly the case, decentralization retards the growth of government. Second, consistent with theoretical arguments drawn from welfare economics and positive political economy, it shows that governments grow faster as they fund a greater portion of public expenditures through intergovernmental transfers. Jonathan Rodden Assistant Professor Department of Political Science MIT E53-433 77 Massachusetts Avenue Cambridge, MA 02139 Phone: 617-253-6261 Fax: 617-258-6164 E-mail: [email protected] Internet : http://web.mit.edu/jrodden/www