Incentives to Provide Local Public Goods: Fiscal Federalism, Russian Style

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Abstract
This paper investigates how the institutional structure of the government affects the incentives of local governments to provide public goods both to individuals and private businesses. Using a unique data set on budgets of Russian cities, I show that the existing revenue sharing schemes between regional and local governments provide local governments with no fiscal incentive to increase their tax base and, therefore, to foster the growth of businesses. The main result is that in Russia, any change in local government's own revenues is almost entirely offset by changes in shared revenues. This situation leads to predatory governmental behavior towards private businesses. This finding is compared to the structure of federalism in China, where fiscal incentives are very strong. Some evidence is provided that local governments' fiscal incentives are an important determinant of (1) the formation of private businesses, (2) the allocation of local public finances among different uses, and (3) the efficiency of public goods provision at the local level. These findings shed some light on the puzzle of why Russia has grown more slowly and has less efficient public goods provision, compared to other countries undertaking economic reforms.

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