The Impact of Fiscal Decentralization on Climate Change and the Mediating Role of Political Institutions

This paper analyzes the impact of fiscal decentralization on climate change and how this impact can be mediated by political institutions. Decentralization has remained an important shift in governance structure throughout the world in the past several decades. The literature, thus far, has not provided conclusive evidence regarding the impact of fiscal decentralization on combating climate change. Decentralized decision-making may seem as antagonistic to the large externalities that typically characterize climate change policies. However, the under-provision of public goods with externalities by subnational governments may be mediated by the presence of certain political institutions. In particular, national integrated political parties have the ability to provide the right incentives to shape the choices of subnational elected officials to consider those externalities. This paper exploits two databases to test the significance of those effects. First, using a large panel cross-country data set from 1971 to 2019, we find that the presence of strong party institutionalization significantly improves the functional role of fiscal decentralization in combating climate change. Second, we exploit a new OECD/European Commission database on subnational climate finance measuring the level of fiscal decentralization in climate-related expenditure and investment. The results support our primary findings and are robust to alternative specifications.