Fiscal decentralization and regional income inequality: evidence from Indonesia

This paper investigates the effects of fiscal decentralization on regional income inequality in Indonesia. Using provincial-level data over the period 2001–2014, this paper concludes that fiscal decentralization reduces regional income inequality. A simultaneous equation model (SEM) is employed to circumvent possible endogeneity. It follows that the extent to which fiscal decentralization decreases reginal income gap was greater than that in the opposite direction. A possible explanation for this is that compared with a centralized system, it granted the local governments with autonomy in designing development programmes that match unique characteristics of a particular region and distributing more balanced resources within it. Further, decentralization enables a local government to efficiently provide public services in need. Finally, decentralization motivates local politicians to effectively allocate local public goods and services. This is because regional heads are selected through a direct election in Indonesia and that they are keen on being re-elected by better serving the voters.