Vertical intergovernmental relationship and economic growth

This paper constructs a multi-region endogenous growth model with productive government spending to examine vertical intergovernmental relationship. Specifically, we analyze the contribution of fiscal decentralization on the optimal tax rates of national and local taxes and on the economic growth rate. In this model, when the behavior of the governments is taken into consideration, the national tax rate results in an overtaxation and the local tax rate results in an undertaxation compared to the optimal tax rates. In this case, promoting fiscal decentralization increases economic growth. This result is consistent with Oates' claim and with the results of recent studies about the decentralization effect on economic growth.