Does fiscal decentralization mitigate the adverse effects of corruption on public deficits?

- Fiscal decentralization mitigates the perverse effects of corruption on public deficits.
- Corruption increases public deficits when fiscal decentralization is low.
- As fiscal decentralization increases, the effect of corruption on public deficit vanishes.
- Our results imply heterogeneity in the effect of fiscal decentralization.
- Decentralization is related to lower deficits only in relatively corrupt countries.

Corruption is harmful for public finances and appears closely related to fiscal deficits. We open a new avenue in addressing the effects of corruption on public deficits through fiscal decentralization. For a sample of 31 OECD countries over the period 1986-2010, we find that fiscal decentralization contributes to mitigating the adverse effects of corruption on public deficits. In addition, our findings indicate diversity in the effects of fiscal decentralization, in that it appears related to lower deficits in countries with higher levels of corruption but not in less corrupt countries. Our results suggest that bringing the government closer to the people through fiscal decentralization in relatively corrupt countries leads to more responsible fiscal management.