Tax decentralisation, labour productivity and employment

Tax decentralisation should improve the efficiency of local governments and ultimately boost output growth. The empirical evidence is however mixed. The current work looks at two channels through which tax decentralisation may affect economic growth: labour productivity and employment rate. The empirical analysis conducted on 20 OECD countries over the period 1980-2010 shows that the ultimate effect of fiscal decentralisation on growth depends on which channel prevails, thus rendering the direct estimation of tax decentralisation on growth ambiguous. Tax decentralisation make the employment rate grow faster, while it has either no effect of reduces labour productivity growth. When the analysis is conducted using an IV approach with instruments based on institutional similarities and geographic distance, the positive and significant effect on employment rate growth is offset by the reduction of labour productivity growth, resulting in the absence of any statistically significant effect on output growth.