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Decentralization is a common public sector reform in developing countries. Its basic rationale is that local governments have an informational advantage regarding the needs and preferences of consumers. However, decentralization also has drawbacks. Foremost is the efficiency advantage of the central government in providing public services because of economies of scale and better access to resources. This study looked at the relationship between decentralization and poverty using data from Philippine cities and municipalities. Results suggest that decentralization, as represented by fiscal independence and measured by the share of locally sourced revenues to total local government revenues, is indeed associated with lower poverty. However, this effect is not linear—the marginal effect of decentralization on poverty diminishes as decentralization increases. Moreover, decentralization moderates the positive effect of good governance on poverty reduction and the magnitude of the relationship between poverty and decentralization is stronger in poorer municipalities than in richer ones.

AbstractDecentralization has been a common public finance reform among developing countries in the past few decades. Some advocates pushed for decentralization reform as an answer to the growing problem of income inequality. The primary argument for decentralization is that subnational governments have better information on the needs and preferences of local citizens, while the primary argument against it is that the central government has better economies of scale in delivering public services and usually has better access to important resources. This study tested for the relationship between decentralization and income inequality using both panel data and an annual averaged cross‐section data of countries with varying income levels. The results suggest that revenue decentralization is weakly associated with lower income inequality. In addition, there is also a weak evidence that fiscal independence is associated with higher income inequality, although this is moderated by government effectiveness. Expenditure decentralization has no significant relationship with inequality. © 2020 John Wiley & Sons, Ltd.