18 it may occur as a result of inadequate enforcement as these groups in effect opt to take themselves out of the tax base by hiding in the informal economy (Alm, MartinezVazquez and Wallace 2004). At least in some situations, subnational governments may have the potential – and, provided the intergovernmental system is properly designed, the incentive -- to try to reach this part of the tax base in ways that the central government cannot. If so, increased subnational government tax revenues need not come at the expense of reduced central revenues. Indeed, the latter might conceivably even gain if increased subnational revenue mobilization reduces the need for central transfers to subnational governments.<sup>35</sup> There is at least some small-scale evidence in support of this optimistic view (Bahl and Wallace 2005). In some countries, subnational governments, especially at the local level, do seem to have broadened the tax base somewhat through a variety of tax and related non-tax measures such as levies on the sales of assets of firms, licenses to operate, betterment charges and various forms of property taxation. Subnational governments may have a comparative advantage when it comes to such levies. Often, for instance, local governments oversee licensing and regulatory activities and track property ownership and land-based transactions for a variety of reasons.<sup>36</sup> They thus have ample opportunity to identify businesses in the community and to gain some knowledge about their assets and scale of operation. Moreover, because the potential revenue is much more important for them in relative terms local governments presumably have more incentive to carry out such activities than do national governments. However, such local levies (and regulation) on business may create high compliance costs and a significant barrier to new business activities (World Bank 2007, 2009).

# **4.4. The Stabilization Issue**

Central governments may be reluctant to give too much discretion to subnational governments for other reasons as well. One such reason is the fear of losing macroeconomic control.<sup>37</sup> Subnational governments may, for example, borrow recklessly -- even to the point of causing major macroeconomic imbalances, as notoriously occurred in some Latin American countries in the 1990s (Dillinger, Perry and Webb 2003). However, as von Hagen and Eichengreen (1996) note, countries in which subnational governments do not have adequate own-source revenues seem more prone to stabilization 35 Offsetting any such possible gains, however, some argue that decentralization may end up wasting resources both through duplicating central services and especially by increasing the chance of corruption. Given that more governments are involved, there may indeed be more instances of corruption, but it is far from clear that decentralization increases the loss of public revenues owing to corruption: a few big bites at the center may easily outweigh a thousand little nibbles on the periphery. Empirical work on the relationship between decentralization and corruption is extensive but inconclusive. Fisman and Gatti (2002), for example, find that corruption is lower in more decentralized countries; Treisman (2000) finds corruption to be higher in federal than in unitary countries. For a useful review of this extensive literature, see Martinez-Vazquez, Arze del Granado, and Boex (2007).

36 A possible way to alleviate such problems is discussed in Section 6.6 below.

37 See Tanzi (1996) as well as the more balanced treatment of the potential macro impact of decentralization in Boadway and Shah (2009). Rodden, Eskeland and Litvack (2003) provide a number of interesting case studies of the links between subnational finance and stabilization problems in Brazil, India and China, among other countries.