Fiscal decentralisation is the assignment of taxation, spending and related fiscal responsibilities from central government to subnational governments such as regions, states, provinces, municipalities or other legally recognised local authorities. It concerns who has authority to raise revenue, decide expenditure, manage budgets and sometimes borrow. The OECD defines fiscal decentralisation in terms of assigning tax and spending powers to subcentral governments and distinguishes two principal components: tax autonomy and spending power. Tax autonomy concerns the extent to which subnational governments can influence tax bases, rates and reliefs, while spending power concerns their authority over the allocation and organisation of public expenditure.
Fiscal decentralisation is one dimension of the wider concept of decentralisation. The OECD identifies political, administrative and fiscal dimensions as distinct but interrelated. Political decentralisation concerns decision making and representation, administrative decentralisation concerns the allocation of governmental functions and management responsibilities, and fiscal decentralisation concerns taxation and spending powers. Effective fiscal decentralisation therefore normally requires some institutional relationship between financial authority and political or administrative responsibility. A local authority that is formally responsible for delivering a service but has almost no control over its funding has limited fiscal autonomy. Conversely, giving local governments substantial revenue powers without assigning clear responsibilities can create coordination and accountability problems.
The main mechanisms of fiscal decentralisation include assigning own source taxes, sharing national taxes, providing intergovernmental grants, transferring expenditure responsibilities and permitting subnational borrowing. Own source revenue gives local governments some direct connection between taxation and public services. Tax sharing allocates a predetermined portion of centrally collected taxes to subnational governments. Grants can be unconditional, allowing local discretion, or conditional, linking funds to specified purposes or standards. Borrowing authority can allow local governments to finance long lived capital projects, although it can also create fiscal risks if debt obligations are poorly controlled. The balance among these mechanisms determines how much genuine fiscal autonomy subnational governments possess.
Fiscal autonomy is broader than simply receiving money from central government. The OECD defines fiscal autonomy as the ability of a subnational government to undertake fiscal tasks such as taxing, spending, debt raising and financing without requiring approval from another level of government. Revenue autonomy is stronger when own revenues broadly match responsibilities and higher level transfers are predominantly formula based and unconditional. Spending autonomy concerns the ability to determine sectoral allocations, service standards, delivery methods, procurement and local planning within assigned responsibilities. A local government that receives a large centrally determined grant but cannot decide how it is spent may have substantial financial resources but relatively limited spending autonomy.
Fiscal decentralisation can allow public services to reflect local preferences and conditions more closely. Local governments may possess better information about local infrastructure, transport, housing, environmental conditions, education, social care or other needs than a distant central administration. Local decision making can also increase opportunities for citizens to observe and influence spending decisions. However, decentralisation can create trade offs because local tax bases differ and administrative capacity may vary.
Wealthier jurisdictions may be able to raise more revenue than poorer ones, potentially creating unequal service provision. Fiscal equalisation mechanisms can address some of these differences by transferring resources between jurisdictions with different revenue raising capacities or service costs. The OECD describes fiscal equalisation as a means of offsetting such disparities so that subcentral governments can provide comparable services at comparable tax burdens.
Fiscal decentralisation is closely related to fiscal federalism but the terms are not identical. Fiscal federalism is the broader field concerned with the allocation of taxation and spending responsibilities across levels of government and the economic principles governing those relationships. Fiscal decentralisation describes the process or degree to which fiscal authority is transferred towards subnational levels.
A federal state can therefore have extensive constitutional powers for subnational governments while remaining fiscally centralised if most revenue and spending decisions are controlled centrally. Conversely, a formally unitary state can decentralise substantial fiscal responsibilities to elected local or regional governments. The institutional form of a country therefore does not by itself determine the actual degree of fiscal decentralisation.
Measuring fiscal decentralisation is more difficult than simply calculating the percentage of public spending undertaken by local governments. A high subnational spending share may coexist with strict central controls over how money is spent. Similarly, a high local revenue share may conceal taxes whose rates and bases are determined centrally.
The OECD notes that fiscal decentralisation indicators need to account for tax autonomy, spending authority, intergovernmental grants and other institutional characteristics because simple revenue or expenditure shares can fail to capture genuine decision making power. Vertical fiscal imbalance occurs when subnational expenditure responsibilities substantially exceed their own revenue capacity, creating dependence on transfers from higher levels of government. Such imbalances are common features of decentralised systems and require carefully designed intergovernmental fiscal arrangements.
Fiscal decentralisation has developed in many countries as part of wider reforms involving local government, regionalisation, federalism and public sector modernisation. Its degree varies greatly across countries and across policy areas. The OECD describes decentralisation as involving transfers of powers, responsibilities and resources to subnational governments with some degree of autonomy and notes that decentralisation has become widespread across developed and developing countries. The practical challenge is to align responsibilities, resources, accountability and coordination.
Poorly designed decentralisation can create duplication, weak fiscal capacity, unequal services, excessive local borrowing or coordination failures, whereas carefully designed arrangements can bring public decisions closer to citizens and improve adaptation to local circumstances. Fiscal decentralisation is therefore not simply a matter of moving money downward; it is a restructuring of fiscal authority within a multi level system of government.
