Fiscal Decentralisation and the Battle Against Spatial Inequality

Introduction

Often, local needs remain unaddressed by central governments. Consequently, spatial inequality is a prevalent issue in developing countries (Kim 2010). Studies have shown that the causes of spatial inequality (the unequal distribution of resources, services, wealth, and opportunities across different geographical areas) stem from the concentration of investment in urban centers, and the uneven allocation of resources (Sjaf et al. 2025). Many countries such as Denmark, the United States and Canada have adopted fiscal decentralisation to combat this problem. Fiscal decentralisation is the process of transferring budgetary authority from central government to elected subnational governments in order to grant them power to make decisions regarding taxes and expenses (Bahl and Bird 2018). 

Distributing Economic Authority: The Power of Local Knowledge

Fiscal decentralization tackles spatial inequality by authorising local governments to make major economic decisions affecting their region. This can lead to more efficient provision of local public goods and services and it can promote a better match between policies and citizens’ needs (Bartolini, Stossberg, and Blöchliger 2016). Vital public services and investments, including in education, health, water and sanitation services, basic urban services, climate adaptation, and local economic development, commonly take place at the city level (Boex, Williamson, and Yilmaz 2023). As a result, local leaders better understand their region’s specific barriers to equality and economic development in comparison to a central government.

Moreover, fiscal decentralisation promotes downward accountability (Dubrow 2020). Citizens of the region can hold the elected local leaders accountable, preventing local tax revenue from being misallocated (Licha 2004). Citizens of the city can monitor how local government revenue is spent and thus, can ensure the funds are distributed in a way that promotes equitable growth across the region, reducing spatial disparities. 

Decentralizing fiscal power is also linked to improved public sector efficiency and responsiveness (Asante and Ayee 2004) as local leaders can act quickly without layers of central management, leading to fewer bottlenecks. Therefore, problems affecting societal wellbeing and spatial inequality can be addressed faster by identifying regions in need of social services and providing it to them. 

The Fragmentation Risk: Potential Exacerbation of Inequality

While fiscal decentralization can be an effective tool at reducing spatial inequality, it also poses a fragmentation risk. Distributing power to subnational entities diminishes economies of scale and lowers administrative efficiency. Centralized systems have the ability to manage large-scale public services more economically. In practice, re-allocating these tasks to smaller governments can lead to a loss of these efficiencies, increasing administrative weaknesses (Ter-Minassian 1997), leading to a smaller amount of funds being available to spend on development. 

Although spending decentralization and higher regional authority indices are positively related to higher public sector efficiency, tax revenue decentralization has a negative correlation with public sector efficiency (Afonso, Jalles, and Venâncio 2024). So, regional disparities may still persist as wealthier regions that are more developed and are rich in natural resources have a higher tax capacity and thus, more money available to spend, potentially widening the disparity between the wealthier and poorer regions.

Moreover, in the case of developing countries, local governments may face capacity constraints; they may lack the skilled labour necessary to effectively allocate the region’s fiscal funds. Therefore, local government bodies may not be able to use the available funds to reach allocative efficiency, resulting in these regions overspending and exerting fiscal pressure on the rest of the country to satisfy their region’s needs. 

Achieving the Strategic Balance Between Central Oversight and Local Autonomy

The success of implementing fiscal decentralization relies on several factors. Taking advantage of the benefits of decentralization is dependent on the government system structure as a whole, including the capacity of the subnational governments, transparency in their decision-making and framework conditions (OECD 2019). 

In order to bridge the gap between wealthier and poorer regions, the central government must act as a balancer. It must reallocate the country’s total tax revenue to the regions based on an equitable distribution formula, which accounts for population size and developmental needs. For instance, Pakistan adopted fiscal federalism in the form of its NFC Award where 82% of the revenue distribution was made on population, 10.3% on poverty and backwardness, 5% revenue collection/generation, and 2.7% on inverse population density (IPD) (State Bank of Pakistan 2010). 

Effective fiscal decentralisation also requires adequate co-ordination mechanisms among levels of government (OECD 2019). Accountability mechanisms utilising “downward” accountability (between local leaders and citizens) and “upward” accountability (between subnational governments and central government authorities) are key for success. Subnational government bodies need to have clear budgetary limits to ensure overspending is prevented and the national fiscal balance is controlled. 

Conclusion

While fiscal decentralisation can be a vital tool in effectively allocating scarce, government resources in a more equitable manner, its success depends on the balanced distribution of funds, transparency regarding how the revenue is spent and strong accountability mechanisms to prevent poorer regions from having heightened inequality.

References

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Bahl, Roy, and Richard M. Bird. 2018. “Chapter 1: Fiscal decentralization 101.” In Fiscal Decentralisation and Local Finance in Developing Countries, 3-35. N.p.: Edward Elgar. https://doi.org/10.4337/9781786435309.

Bartolini, David, Sibylle Stossberg, and Hansjörg Blöchliger. 2016. “Fiscal Decentralisation and Regional Disparities,” OECD Economics Department Working Papers No. 1330. OECD. https://www.oecd.org/content/dam/oecd/en/publications/reports/2016/10/fiscal-decentralisation-and-regional-disparities_g17a2894/5jlpq7v3j237-en.pdf.

Boex, Jamie, Tim Williamson, and Serdar Yilmaz. 2023. Decentralization, Multilevel Governance and Intergovernmental Relations: A Prime. Washington D.C.: World Bank.

Dubrow, Geoff. 2020. “Accountability for Fiscal Decentralisation at the Sub-national Level,” WFD Financial Accountability Series Briefing Paper 4. WFD. https://www.wfd.org/sites/default/files/2022-02/budget-policy-brief-4.pdf.

Kim, Sukkoo. 2010. “Spatial inequality and economic development : theories, facts, and policies (English).” World Bank Documents. https://documents.worldbank.org/en/publication/documents-reports/documentdetail/803661468330972127/spatial-inequality-and-economic-development-theories-facts-and-policies.

Licha, Isabel, ed. 2004. Citizens in Charge: Managing Local Budgets in East Asia and Latin America. N.p.: Inter-American Development Bank.

OECD. 2019. “Making Decentralisation Work: A Handbook for Policy-Makers,” OECD Multi-level Governance Studies. oecd.org. https://doi.org/10.1787/g2g9faa7-en.

Sjaf, Sofyan, Akmal Malik, Abdurrahman Harits, Sampean, Sayyid A. Maulana, Lukman Hakim, Ahmad A. Arsyad, et al. 2025. “Analysis of spatial inequality and rural development in the supporting region for nusantara capital city, Indonesia.” Wellbeing, Space and Society 9 (July). https://doi.org/10.1016/j.wss.2025.100286.

State Bank of Pakistan. 2010. “Special Section 2: National Finance Commissions Awards – A Review,” First Quarterly Report FY10. sbp.org. https://www.sbp.org.pk/reports/quarterly/fy10/first/specialsection2.pdf.

Ter-Minassian, Teresa. 1997. Fiscal Federalism in Theory and Practice. Edited by Teresa Ter-Minassian. N.p.: INTERNATIONAL MONETARY FUND.