For Austria, the political debate regarding federalism comprises potential efficiency gains from both reducing or extending federalist structures. In fact, functional responsibility of sub-national governments was extended without equally transferring financial responsibility (tax/spend) to sub-national authorities.
However, earlier research has indicated that decentralization by a differentiated system of earmarked grants might indeed reduce total government expenditure. Sub-national governments are therefore in a narrow corset for spending.
While decentralization can be said to reduce total government expenditure or increase the efficiency of public funds, fiscal autonomy refers to the sub-national governments’ own authority to tax and spend. In the current paper, we test for the effects of fiscal autonomy by exploring whether sub-national autonomy leads to reductions in total government expenditure. The main determinants of government expenditure are economic growth, fiscal illusion of policy makers, and counter-cyclical policies reacting to the unemployment rate. We account for several variables denoting fiscal autonomy: 1. own taxes denoting the decision power to tax and spend locally and regionally, 2. shared taxes with full sub-national spending autonomy but regulated by central government, 3. non-earmarked grants and 4. ear-marked grants.
Our econometric results for the period of 1955 to 2007 suggest that the often-hypothesized dampening effect of fiscal autonomy cannot be corroborated for the Austrian system. Rather, we partially find non-significant positive effects indicating that fiscal autonomy may increase government expenditure.
The share of revenues and therefore funds available for the provision of local/regional public goods and services at the responsibility of sub-national governments is, however, very limited. In addition, own revenues such as shared non-earmarked taxes, and own taxes for which sub-national governments can set the tax base and the tax rate, dramatically decreased while at the same time, transfers to sub-national governments increased during the last 5 decades.
While our results cannot be readily generalized, the estimations suggest that the extension of fiscal autonomy does not necessarily lead to a more efficient use of public funds. While decentralization seems to bear risks in terms of inefficiency – e.g. transaction costs of transfers and the lack of transparency of the funding system –, fiscal autonomy may add to these risks. An increase in fiscal autonomy also means that all nine federal states of Austria gain responsibility for taxing and spending, and therefore have to set up their own systems for administering these funds. Examples of the inefficiency of autonomy include the nine different building codes, spatial planning laws, and nature conservation regulations, that all lead to a diverse, complicated and inefficient system. For fiscal policies for which national and international priorities are especially relevant, an increase in fiscal autonomy also increases the complexity of the system.