The effects of horizontal fiscal equalization on the expenditures of local governments: the case of Seoul, Korea
Date
2022
Authors
Journal Title
Journal ISSN
Volume Title
Publisher
University of Delaware
Abstract
The role of Fiscal Equalization (FE) transfers in economic development has been discussed extensively in studies of local/regional public finance. In a fiscally decentralized system, FE aims not just at reducing fiscal imbalance between jurisdictions, but also at enhancing productivity by leading efficient allocation of public resources. From this viewpoint, FE can be seen as a policy that brings about positive economic development by achieving both equity and efficiency in local tax and expenditure policies. However, the questions regarding the role of FE in the allocation of financial resources in transfer-receiving governments has long been debated. How does FE influence the allocation of resources for various services? Does FE change the recipient governments’ investments and policy priorities? The most dominant assumption is that FE is a disincentive for transfer-receiving governments to focus on growth-enhancing policies. ☐ Such a disincentive effect is also possible with Horizontal Fiscal Equalization (HFE), a transfer between units at the same level of government, but there is little empirical evidence to validate this. In particular, there is scarcer research on how the expenditure decisions of local governments respond to HFE implementation. HFE designates a participating government as either a donor (transfer-giving) or a recipient (transfer-receiving); this distinction can affect the two groups differently when it comes to spending choices. Although the donor-recipient issue is often discussed by scholars, it has not been tested empirically. ☐ Based on these ideas, this study aimed to investigate the effects of HFE on the public expenditures of local governments. Specifically, this study examines the effects of HFE on economic development expenditures and on social development expenditures by local governments, both individually (the donor and the recipient governments) and collectively (donor-recipient combinations). In this study, the Shared Property Tax System (SPTS), an HFE system enacted in Seoul, South Korea, was used as a case study. ☐ The Difference-In-Differences (DID) method and the triple difference (DDD) method were used to evaluate the effects of SPTS. For these two analyses, the annual data were collected and sampled from 25 local districts in Seoul and its comparison group (44 local districts in Korea); these data spanned public expenditures as well as socioeconomic and political conditions between 2002 and 2013. ☐ The findings from DID and DDD modeling of local government’s expenditures in Seoul were generally consistent with theoretical predictions. Consistent with the reduced motivational effect hypothesis, EDE declined in donor and recipient combined group after SPTS implementation, and the decline was much greater in recipient districts than in donor districts. Consistent with the income-effect hypothesis—along with the normative premises put forward as policy rationales for HFE schemes— recipient districts shifted their relative expenditure priorities away from economic development and toward social development services, while donor districts placed more weight on economic development services. The SPTS is still too recent to comprehensively observe its long-term effects on Seoul’s economic and social development patterns. But the effects so far seem consistent with the behavioral premises upon which advocates based their arguments for HFE as a means of enhancing efficiency and equity within metropolitan areas (through reducing inter-municipal economic development competition and ensuring a community's quality of life and environmental well-being).
Description
Keywords
Difference-in-difference-in-differences, Difference-in-differences, Horizontal fiscal equalization, Intergovernmental transfer, Local public finance, Panel data, Seoul, Korea