Does Fiscal Federalism Promote Regional Inequality? An Empirical Analysis of the OECD, 1980-2005

Regional Studies. This paper explores the relationship between fiscal federalism, understood as institutionalized regional economic self-rule, and convergence in regional per capita incomes. The principal economic argument against fiscal federalism is that, unless paired with generous equalization grants, it will enhance regional inequalities by reducing inter-regional redistribution. Does the evidence support this claim? Multilevel spatial regressions on primary sub-national jurisdictions in twenty-five Organisation for Economic Co-operation and Development (OECD) countries show that lower-income regions tend to catch up with higher-income regions only when they enjoy substantial economic powers. Indeed, there is more convergence across member states of the European Union than across regions within almost any of the European Union member states. Fiscal federalism may pose less serious tradeoffs than commonly assumed.