For decades, debates on economic growth have largely focused on national policies: monetary policy, trade policy, industrial policy, labor markets, or macroeconomic stability. Yet, economic activity does not occur in an institutional vacuum: businesses operate in places, workers live in communities, and infrastructure is built locally. And a growing body of research suggests that local governments may play a far greater role in shaping economic development than is commonly recognized.
A recent report by the European Commission’s Joint Research Centre (JRC), Local taxes and economic growth, makes this argument in unusually direct terms. The report argues that municipalities are not merely administrative units responsible for delivering local services. Rather, they are critical actors in shaping local business climates, facilitating investment, coordinating infrastructure, managing development conflicts, and fostering the conditions under which economic growth can occur.
Perhaps most importantly, the report argues that local governments are more likely to support economic growth when they directly benefit from it fiscally.
Local governments as developmental actors
One of the report’s most valuable contributions is that it takes local governments seriously as developmental institutions. Much of the literature on economic growth treats “government” as a national phenomenon. But the practical realities of economic development are deeply territorial.
Local governments shape land use and zoning decisions. They provide local roads, public transport, water systems, waste management, childcare, schools, public spaces, and—in some contexts—health services. They manage building permits and often implement or enforce regulations that affect businesses on a daily basis. They mediate conflicts between residents and developers. They coordinate local actors and provide a degree of predictability and trust within local economies.
The report describes municipalities as “greenhouses” for local economic activity. While the metaphor may sound somewhat romantic, the underlying point is important: local governments often determine whether economic activity encounters friction, delay, uncertainty, and resistance—or whether local conditions support innovation, investment, and productivity.
This insight resonates strongly with broader discussions within the multilevel governance community. Development outcomes are rarely determined by national policies alone. The effectiveness of public investment, service delivery, climate adaptation, local economic development, or even democratic inclusion frequently depends on the quality and incentives of territorial governance systems.
Why incentives matter
The report’s central argument is not simply that local governments matter in achieving economic development, but specifically, that local fiscal incentives matter.
Municipalities often bear the political and administrative costs of economic development. New investments may generate traffic, environmental concerns, land-use conflicts, or “not in my backyard” resistance from local residents. Supporting local development requires administrative effort, political capital, coordination, and sometimes conflict management.
Yet in many countries, local governments receive little direct fiscal benefit when the local economy grows. Additional tax revenues may largely accrue to national governments, while municipalities continue to depend heavily on intergovernmental transfers that are disconnected from local economic performance. Under such circumstances, local governments may have weak incentives to actively support growth-oriented policies or investments.
The JRC report argues that the political entrepreneurship of city leaders, as well as the incentives provided by local revenue generation, matter. When local governments retain a meaningful share of revenues linked to local economic activity—whether through shared personal income taxes, corporate income taxes, business taxes, or other locally retained revenues—they are more likely to invest in the quality of local governance, infrastructure, and business environments. Local economic success becomes a shared local interest rather than merely a national objective.
The report further suggests that local tax retention can reduce resistance to development. When communities see visible local benefits from economic activity, opposition to new development may become less severe. The report points, for example, to evidence that municipalities are more willing to host renewable energy projects when local governments retain meaningful tax benefits from them.
Governance quality and economic performance
Another important theme running through the report is the relationship between governance quality and economic outcomes. The report reviews a growing body of European research suggesting that higher-quality local and regional governance is associated with greater innovation, stronger productivity, better business performance, and improved economic outcomes.
This should not necessarily be surprising. Businesses value predictability, administrative efficiency, reliable infrastructure, skilled labor, and responsive institutions. In practice, many of these conditions are shaped as much by local governments as by national ministries.
Interestingly, the report goes further than traditional fiscal decentralization debates by drawing on insights from behavioral economics and social capital theory. It argues that local governments operate within dense networks of peer-to-peer interactions, trust relationships, and informal accountability. Because local officials, businesses, and citizens interact repeatedly in close territorial settings, local governments may be particularly sensitive to social pressure, reputation, and community expectations.
Important caveats
The report should not be read as a simplistic argument that “more decentralization” or “more local taxes” automatically generate growth. Local tax autonomy can reinforce territorial inequalities, empower local elites, or deepen disparities between richer and poorer jurisdictions. Strong local incentives work best where local governments possess sufficient administrative capacity, accountability, transparency, and democratic legitimacy.
Instead, the report presents interesting comparative indicators, case studies, and suggestive evidence. And care should be taken not to generalize the report’s insights and conclusions beyond the European context: the country cases and examples considered in the report tend to have an extensive degree of political and institutional autonomy that is rare in many other global regions.
Yet too often, decentralization debates focus narrowly on expenditure assignments, transfer formulas, or administrative structures without sufficiently considering how intergovernmental fiscal systems shape local incentives and local political behavior. If local governments are expected to facilitate development, manage urbanization, support climate adaptation, strengthen service delivery, and improve local business environments, then fiscal systems should arguably provide meaningful incentives for them to do so.
Toward a more developmental understanding of local governance
One of the report’s most valuable contributions may simply be that it reframes local governments as developmental actors rather than merely administrative delivery units. This insight is critical to countries that have sought to harness the power of urban areas as engines of economic growth in a top-down manner. Economic growth doesn’t just “happen” in urban (or rural) places. Public trust is built locally, and infrastructure, land use, regulation, and public services intersect territorially. And the quality of local governance–reinforced by local autonomy along with fiscal resources and incentives–often determines whether local economic progress succeeds or fails in practice.
For those working on decentralization, multilevel governance, and local public finance, the report provides a useful reminder that the structure of local fiscal systems is not merely a technical matter of revenue assignment. It is also a question of institutional incentives, territorial governance, and the broader political economy of development.
Read the full report: Preyer, E., Kalcheva, D., Curtale, R. et al. (2026) Local taxes and economic growth. Publications Office of the European Union. https://data.europa.eu/doi/10.2760/1826247
