Fiscal federalism

The basic idea

Fiscal federalism starts from a simple question: which level of government (central, county, local) should decide and pay for each public service? The economist Charles Tiebout showed in 1956 that when citizens can move freely between localities, competition between local administrations to offer an attractive mix of taxes and services can produce efficient outcomes: each locality “votes with its feet” on who moves where, depending on what the local administration offers^[1].

Wallace Oates formalised and extended this framework, summarised in what is called the “decentralisation theorem”: providing a public service through local governments, tailored to each community's needs and preferences, is at least as efficient as uniform centralised provision, provided that economies of scale are not significant and the costs of coordination between jurisdictions are low^[2].

Where the theory explains fragmentation as a problem

The condition Oates highlights is exactly what is missing in a commune of a few hundred inhabitants: general public administration (population records, accounting, procurement) has real economies of scale, costing almost the same regardless of population, while coordination between thousands of small administrative units has significant costs (each with its own systems, procedures and staff). The theory does not say that decentralisation is wrong; it says its advantages depend on a minimum scale threshold, below which the negative effects dominate.