The relationship between fiscal federalism and fiscal discipline: panel quantile regression approach

In recent times, a strand of macro-stabilization experts has been expressing great concern about the move towards fiscal federalism being embraced by many countries over the past three decades. They argue that it could endanger fiscal discipline because it is incompatible with prudent fiscal management. However, some other experts disagree and believe the impact on fiscal discipline could be positive. But, despite the lack of unanimity in the theoretical discourse on the fiscal discipline impact of fiscal federalism, empirical studies on the relationship are still scarce and mixed in conclusions. Using a panel quantile regression estimation approach for a sample of twenty countries over the period 1996–2018, this study establishes that the impact of fiscal federalism on fiscal discipline may not be constant on the conditional mean of the fiscal discipline but varies along its conditional distribution. Moreover, it reveals that quality institutional framework and federalism, each improves the fiscal discipline impact of fiscal federalism, and that countries with a history of low fiscal discipline stand to benefit more from this. The policy implication of this is that in the design and operation of the fiscal federalism apparatus, policy decision-makers should take into consideration the fiscal discipline history of the country. The design of fiscal decentralization apparatus should be appropriately tailored towards each country’s peculiar characteristics and government fiscal stance. Also, it is essential that a quality institutional framework be put in place to support the fiscal decentralization apparatus.