
==== Front
Heliyon
Heliyon
Heliyon
2405-8440
Elsevier

S2405-8440(24)12099-3
10.1016/j.heliyon.2024.e36068
e36068
Research Article
Modeling method of local financial dependence: Evidence from Mongolia
Chuluunbaatar Ankhbayar ankhbayar.ch@num.edu.mn
a⁎
Nadmid Batjargal batjargal_nadmid@num.edu.mn
a
Budjav Bolormaa bolormaa.b@num.edu.mn
a
Wong Wing-Keung bcde
a Department of Finance, Business School, National University of Mongolia, Ulaanbaatar, 14200, Mongolia
b Department of Finance, Fintech & Blockchain Center, Big Data Research Center, Asia University, 500, Lioufeng Road, Wufeng, 41354, Taichung, Taiwan
c Department of Medical Research, China Medical University Hospital, No.91, Hsueh-Shih Road, 40402, Taichung, ROC, Taiwan
d Department of Economics and Finance, The Hang Seng University of Hong Kong, Hong Kong
e Hang Shin Link, Siu Lek Yuen, New Territories, 999077, Shatin, Hong Kong
⁎ Corresponding author. ankhbayar.ch@num.edu.mn
14 8 2024
30 8 2024
14 8 2024
10 16 e3606823 3 2023
4 8 2024
8 8 2024
© 2024 The Authors. Published by Elsevier Ltd.
2024

https://creativecommons.org/licenses/by-nc-nd/4.0/ This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).
Many countries have been striving to equalize the balance between the central government and sub-government financial disparities without considering political interference. This paper aims to summarize the theory of local financial federalism and propose an unprecedented model for identifying the factors that affect local financial dependence. The proposed model is based on a theoretical framework incorporating five assumptions and is applied through panel regression analysis. Utilizing panel data from 2013 to 2022 in 21 provinces of Mongolia, a total of nine variables have been identified and econometrically tested within the proposed model. The findings from the panel regression analysis reveal that local budget investment, local personal income tax, local property tax, and other local taxes positively impact the reduction of local financial dependence. However, it is observed that an increase in local budget expenditures and GDP leads to an escalation in local financial dependence.

Keywords

Decentralization
Local tax structure
Local financial dependence
Rural analysis
Panel regression
==== Body
pmc1 Introduction

Inter-budget reforms in public finance are currently taking place. According to the World Development Report published by the World Bank, development policy in the first half of the 21st century will depend on two factors: globalization and decentralization. In this circumstance, decentralization has become equally relevant to any country [1].

Reducing financial dependence is instrumental to decentralization, which can take many forms: political, financial, fiscal, economic, or market decentralization. A high degree of decentralization is evident if local government expenditures are independent of the state budget. Since the mid-1980s, there has been rapid growth in research on financial autonomy of local governments. Until 2000, many studies on the financial and fiscal decentralization of local governments often relied on government finance statistics released by the IMF and used models that compared local expenditures to total state expenditures or GDP [2]. Local financial autonomy is determined by the relationship between community participation in regional development and external funding sources [3].

Furthermore, as local governments rely on government policies, their financial dependence increases [4]. Salazar and Mollick [5] have concluded that local governments become dependent on the central government due to the high demand for public services and inadequate funding. Rivenbark, Roenigk and Allison [6] calculated local financial dependence by comparing inter-budget revenues or state-local budget revenue transfers to total revenues. A high ratio indicates excessive dependence of local governments on the state budget. To measure the dependence of Ukrainian local governments on assistance from the central budget, Russian economist Valeriеvich [7] compared inter-budgetary transfer income with fixed sources of local budget revenues. Local fiscal dependence can be defined as the ratio of financial assistance to total revenues of the local government. As stated by Pratiwi [3], if the ratio of financial assistance revenues to total revenues is less than 25 percent, financial dependence is very low, while 26–50 percent indicates low financial dependence. Moreover, 51–75 percent signifies high financial dependence, while 76–100 percent means very high financial dependence. While Salazar and Mollick [5] have emphasized the importance of public service and their increasing financial dependence, Riverbank, Roenigk, and Allison [6] have focused on inter-budget revenues and their transfer to total revenues. Furthermore, Pratiwi [3] has calculated financial dependence ratios based on the interconnectedness of factors that affect financial independence.

According to Mongolia's 1992 Constitution, "Provinces, capitals, soums, and districts are administrative, territorial, economic, and social units with their own management and legally assigned functions" and are required to independently address economic and social issues. If a locality does not have a stable source of its own income, it will remain fully dependent on the central government, preventing it from achieving financial autonomy [8]. Essentially, the three key elements that determine a locality's financial independence—revenue, expenditure, and budget autonomy—are not fulfilled.

With the enactment of Mongolia's new Budget Law in 2013, the relationship between state and local budgets underwent a transformative change. This legislation introduced financial support, income, and grant-in-aid transfers designed to ensure sustainable local development, promote regional growth, and maintain long-term financial stability. It also emphasized a commitment to "significantly increase the authorities and financial resources of local governments" within the budgeting process. Under the Integrated Budget Law, the allocation from the sovereign fund, also known as the local development fund, to the local budget for the current year is determined by four equally weighted factors: (1) the local development index, (2) population, (3) population density and territory size, and (4) local tax initiative. This framework highlights Mongolia's unique position as one of the most sparsely populated countries, where local financial management is closely tied to its population and related metrics. Additionally, this approach marks a significant shift towards enhancing local financial self-sufficiency and promoting fiscal decentralization. However, despite these reforms, many provinces continued to depend on financial support from the state budget between 2013 and 2022. Apart from provinces hosting major mining projects, the autonomy and financial independence of local budgets remained inconsistent and weak. This disparity has significantly impacted local development levels, market growth, economic potential, and the livelihoods of citizens [8].

Most domestic researchers view budget decentralization and human development factors as key determinants influencing local autonomy, especially in terms of income, expenditure, and budget independence. As previously mentioned, the revised 2013 Mongolian law assesses local autonomy based on the local development index, population size, population density, territory size, and remoteness. Additionally, Mongolia's local budget law highlights that income-generating taxes, including personal income tax, property tax, vehicle tax, and other taxes, are treated as local financial general income and as investments on the expenditure side.

This paper aims to demonstrate that a detailed examination of local financial dependence using specific indicators aligned with current legal directions, combined with revising the budget law to align with national principles, can accurately determine the financial independence of localities. Furthermore, by thoroughly analyzing the specific current inbound and outbound transactions of central budget, our study will custom-design possible components for the inflows and outflows of income and expenditures for each province based on their unique characteristics, ultimately improving the overall well-being of local residents.

This paper consists of the following parts: Section 2 discusses a literature review. Section 3 formulates a theoretical model that includes five assumptions. In Section 4, the theoretical model is transformed into a regression-based approach. Section 5 explains the data. The empirical results and discussion are presented in Section 6, and the paper concludes with a summary, limitations, and policy suggestions in the final section.

2 Literature review

2.1 Decentralization of expenditure theory

Samuelson's “The Pure Theory of Public Expenditure” asserts that public goods should be provided to those who are unable to meet their basic needs. According to his concepts, public expenditures are optimally determined, and the state budget is profitably formulated [9]. Tiebout shared similar views on public goods expenditures with Paul Samuelson. However, Tiebout's unique contribution was his significant focus on local budget efficiency. His “Pure Theory of Local Expenditures” emphasized a preference for local government expenditures over the central government expenditures to reduce centralization [10]. Musgrave's “The Theory of Public Finance” emphasizes the importance of efficiently allocating revenues, expenditures, and stabilization efforts. He argues that local government is the ideal tier responsible for the efficient allocation of resources [11].

In James Buchanan's “Economic Theory of Clubs”, he explains that people tend to reduce and share their costs by relocating from one residence to another. This movement leads to societal and economic inefficiencies due to the growing number of urban areas and local cities with centralized communities [12]. To address this, Buchanan extended Tiebout's idea, which considered people's migration patterns when analyzing public finance. Additionally, Oates and Olson expanded on Musgrave's perspective. According to Oates' theory, the central government is responsible for efficiently allocating resources and managing revenues. In contrast, the local government is tasked with providing necessary budgets and expenditures to their residents. Furthermore, the central government should correct extravagant spending by local governments and establish an appropriate tax structure through policy [13].

The Principle of Fiscal Equivalence in The Strategic Theory and Its Application: Olson's principle divides responsibilities among various levels of government, demonstrating the need for different tiers of government involvement. This division helps manage overlapping public revenues and expenditures, reducing the number of free riders and define optimal level of public spending. To support his idea, Olson argues that a Pareto-optimal supply of goods should be provided to the localities, requiring significant effort from the government [14].

Local Decentralization and The Theory of Optimal Government by Rothenberg focuses on the welfare of the local governments. Building on Olson's perspective, Rothenberg emphasizes the importance of effectively distributing intergovernmental grants to lower levels of government mitigating the negative effects of poorly distributed externalities [15].

A New Look at Pure Theory of Local Expenditure by Miller and Tabb presents methods to increase local government authority and address local fiscal problems by distributing equal revenues to each local area, urban center, and metropolitan level. Additionally, they highlight the discrepancies between consumer-chosen tax levels and incomes based on residential areas, emphasizing the importance of maintaining local financial independence [16].

Since the 1980s, developing countries have been keenly focused on reforming the public sector, considering budget decentralization as the key mechanism for controlling public sector growth and enhancing the effectiveness of public services. Researchers have since extensively studied fiscal decentralization and federalism. According to Brennan and Buchanan's "Leviathan" hypothesis, the total size of the public sector is inversely related to fiscal decentralization. They argue that there should be less government involvement in the overall economy, with more taxation and spending responsibilities shifted to decentralized levels of government [12].

In his theory of Local Public Goods, Stieglitz defined the conditions for Pareto optimal allocation as an equilibrium of competitive local public goods. Local community landlords can assess whether the types and levels of public goods provided are appropriate and efficient, thereby influencing public jurisdictions. Political participation and voting are crucial in a democratic society, and local administration must demonstrate innovation and efficiency, even with limited provision of public goods to local citizens and voters [17]. Thus, Stiglitz recognized the importance of a decentralized mechanism.

2.2 Decentralization of revenue and expenditure theory

In “The Theory of Local Autonomy”, Clark defined the degree of power in local administration and established two core principles: first, that local citizens are free from the supervision of higher tiers of the state, and second, that the local government has the authority to legislate and regulate the behavior of residents [18].

As a result, the significant changes in local jurisdiction have highlighted the possibility of reduced dependency and increased independence. King defined the role of localities in his Theory of Fiscal Federalism, arguing that local government redistribution intensifies when the efficiency of public goods and services does not reach the national level, leading to an increase in migration among local citizens. He suggested that governments should not be responsibile for distribution; instead, local authorities should incorporate social welfare functions into their policies. The effects of loans and payments influence the centralized duties of expenditures, distribution, and stabilization [19].

In “Competitive Governments: An Economic Theory of Politics and Public Finance”, Breton emphasized the importance of increasing support and competition among state governments rather than relying on the federal government. He also highlighted the need to avoid rent seeking or rent dissipation of public goods through restrictive measure. In summary, he suggested that decentralization would be the most effective approach for public finance [20]. In “An Essay on Fiscal Federalism”, Oates argued that the consumption and distribution of public goods and services should be limited to the level of government closest to the citizens, as this allows for better alignment with their preferences. He suggested that economic well-being would improve at the federal level when fiscal decentralization is implemented [21]. The benefits of decentralization were first discussed in Tiebout's work, which emphasized that these gains are enhanced by migration but not entirely dependent of the movements of local residents [2].

Most researchers believe that fiscal decentralization is essential for increasing local development competition compared to macroeconomic factors, while simultaneously reducing the size of the public sector [22]. Advanced concepts on fiscal decentralization by Jin and Zou offer a theoretical argument highlighting its ripple effect on government sizes. They argued that centralization reduces the size of government by minimizing political participation, and this reduction in participation ultimately decreases overall government size. Decentralized expenditures and revenues can reduce the size of government rather than expanding local governments [23]. The key determination is that financial independence can be achieved by granting local communities the authority over their revenues and expenditures.

Jha outlines the characteristics of the first and second periods in the analysis of fiscal federalism theory. The classical normative theory of fiscal federalism, also known as the first-generation theory, emphasizes the decentralization of expenditures, the concentration of revenues, and the use of transfers to address issue of equity and efficiency. In contrast, the second-generation theory advocates for the decentralization of both government expenditures and revenues, with less focus on intergovernmental transfers and revenue sharing. Localities can save budgets if the local government generates its own tax revenues; conversely, expenditures tend to increase if funds are transferred from the central government under fiscal decentralization. Thus, research on second-generation fiscal federalism has focused on the importance of "local self-financing capacity" and "establishing hard budget constraints". This theory emphasizes the political and institutional factors that create incentives for responsible local financial decision-making [24].

According to the Agent Theory, local governments are accountable to both the central government and their constituents, making agents and owners stakeholders in social groups [3]. As agents, local governments should independently manage budget formulation, allocation, implementation, and reporting [25]. Similarly, the Stewardship Theory specifies that local governments have a duty and obligation to perform their responsibilities effectively and efficiently, considering the interests of the general public and providing the best possible public services [26].

Critiquing all the cited authors, we find that they are divided between those who advocate for expenditure decentralization and those who support both revenue and expenditure decentralization. Early researchers primarily focused on expenditure. Paul Samuelson's theory, though fundamental, was somewhat idealistic and lacked practical methods for implementing public expenditure measures. Charles Tiebout expanded on Samuelson's idea by emphasizing mobility and information, but his model faced limitations due to financial and residential constraints. Musgrave oversimplified the roles of public sector allocation, distribution, and stabilization. Brennan & Buchanan considered government levels and sizes but did not address the interconnectedness of fiscal failures or the complexities of implementing their suggestions. Oates assumed that local preferences always align with optimal economic outcomes, which can be problematic. Conversely, Olson's principles, although theoretically sound, may be difficult to implement due to political and administrative hurdles, and matching services to preferences is challenging in diverse communities. Jha's classification is useful for understanding the evolution of fiscal federalism theories, but his analysis may lack depth in addressing the practical challenges of implementing these theories, such as political resistance and administrative capacity (see Table 1).Table 1 A Historical perspective in the literature.

Table 1Theoretical Approaches	Researches	
Expenditure Decentralization	
The Pure Theory of Public Expenditure	Samuelson (1954) [9], Tiebout (1956) [10], Miller & Tabb (1973) [16], Stiglitz (1982) [17]	
An Economic Theory of Fiscal Decentralization	Tiebout (1961)	
The Theory of Public Finance	Musgrave (1959) [11], Buchanan (1965) [12], Oates (1968) [13]	
A Theory of Government Grants	Breton (1965)	
Strategic Theory	Olson (1969)	
Local Decentralization and The Theory of Optimal Government	Rothenberg (1970) [15]	
Basic Theory of Fiscal Federalism	Buchanan & Brennan (1981),
Oates (1989)	
Revenue and Expenditure Decentralization	
A Theory of Local Autonomy	Clark (1984) [18]	
A Theory of Competitive Federalism	Breton (1987)	
An Economic Theory of Politics and Public Finance	Breton (1998)	
Fiscal Federalism	Oates (1999) [21]	
Fiscal Decentralization	Jin & Zou (2002) [23]	
Theory of Fiscal Federalism	Jha (2012) [24]	
Source: Authors' summary

In summarizing the various notions of local dependence, factors such as employment, social welfare, cost-effective budgeting, and a developed economy contribute to a financially independent structure by improving the allocation, distribution, and utilization of local resources. To scientifically define local financial independence, it is essential to establish the main conditions for efficient investment in the locality, the development of production and manufacturing, and the support of the local area with optimal policies. The methodological analysis for evaluating local independence considers not only the development of the local economy and the reduction of disparities but also the stability of the population, increased employment, and the reduction of poverty and inequality.

3 The theoretical model

In this section, we consider the following assumptions to identify the factors affecting local financial dependence [27].Assumption 1 A local area operates (n) economic sectors.

As the number of economic sectors in a local area increases, the local economy will expand, leading to a corresponding increase in tax revenue. Therefore, we considered the number of sectors (n) in the modeling framework. The total sum of the sectors represents the local GDP (Y). Based on Assumption 1, the local GDP (Y) is determined by the sum of these sectors:(1) Y=∑i=1nYi,i=1,2,…,n.

Assumption 2 The main inputs of production are labor and capital.

It is assumed that the basic inputs of labor and capital are used in the production of each of the (n) sectors of the economy. These two inputs are subject to personal income tax and property tax. For other inputs, such as human capital and technology, the effects of taxes are indirect and therefore limited in the model. In Assumption 2, labor is represented by (Li) and capital is represented by (Ki).Assumption 3 Local procurement has an impact on the added value of each sector in the local economy.

Within the scope of the right to manage the local budget, necessary purchases such as furniture, fixtures, inventory, and equipment will be made from domestic manufacturers. Domestic producers will fully meet the needs of local procurement. In Assumption 3, procurement can be represented by the total expenditures of the local budget, denoted by (E).Assumption 4 Assume that local investments will be financed by the local budget.

Infrastructure assets such as roads, buildings, electricity, heat, and water supply needed by the locality will be provided by the locality. These investments will be funded by local taxpayers and the state budget. State budget investments are denoted as (G) in accordance with Assumption 4.

Using the notation discussed in Assumption 1, Assumption 2, Assumption 3, Assumption 4, local production (Y) can be written as follows [28]:(2) Yi=Fi(Ki,Li,E,G),i=1,2,…,n.

Total labor supply is measured by the sum of the labor in each sector, while the total capital in each sector is represented by the total capital of the local area. Hence, it is written as follows:(3) L=∑i=1nLi,i=1,2,…,n,

(4) K=∑i=1nKi,i=1,2,…,n.

Assumption 5 Local tax revenue consists of (m) taxes.

As the local economy expands and develops, the variety of tax revenues will increase. The local tax structure is composed of personal income tax (τ1), capital tax (τ2), vehicle tax (τ3) and so on. The last tax measures grant-in-aid income (τm). Therefore, the average tax collection percentage can be expressed as the following functions [29]:(5) τ=f(τ1,τ2,…,τm),j=1,2,…,m.

Personal income tax and capital taxes are applied correspondingly to labor and capital. The tax rates for each sector are as follows:(6) Li=μiL(τ)L,

(7) Ki=μiK(τ)K,

where μiL(τ): the percentage of taxes imposed on employees of a sector (i) out of total labor supply, μiK(τ): the percentage of tax levied on capital in a sector (i) out of the total capital. Moreover, μiL(τ), μiK(τ) are between 0≤μiL(τ), μiK(τ)≤1.

Substituting equations (2), (6), (7) into equation (1), we have:(8) Y=∑i=1nFi(Ki,Li,E,G)=∑i=1nFi(μiK(τ)K,μiL(τ)L,E,G).

With the difference operator by Δ, the change in output (8) is written as:(9) ΔY=∑i=1nFikμiK(τ)ΔK+∑i=1nFiLμiL(τ)ΔL+∑i=1nFiEΔE+∑i=1nFiGΔG,

where∂Fi∂K=Fik,∂Fi∂L=FiL,∂Fi∂E=FiE,∂Fi∂G=FiG.

Dividing both sides of equation (9) through (Y) and rearranging yields the expression for the rate of growth in GDP:(10) ΔYY=βK(τ)ΔKY+βL(τ)ΔLY+γEΔEY+γGΔGY,

whereβK(τ)=∑i=1nFiKμiK(τ),

βL(τ)=∑i=1nFiLμiL(τ),

γE=∑i=1nFiE,

γG=∑i=1nFiG.

In equation (10), the parameters βK(τ) and βL(τ) represent factors the total marginal averages of each sector in the weighted average of taxes on labor and capital. (γE) is the change of local procurement, and (γG) is the change of local budget.

The change in βK(τ) can be written as:(11) ΔβK(τ)=∑i=1n∑j=1mFiK∂μiK(τ)∂τjΔτj,j=1,2,…,m.

Also, the change in βL(τ) is defined by:(12) ΔβL(τ)=∑i=1n∑j=1mFiL∂μiL(τ)∂τjΔτj,j=1,2,…,m.

Further, we can write equations (11), (12) as follows:(13) βK(τ)=βK(τ‾)+∑i=1n∑j=1mFiK∂μiK(τ)∂τjΔτj,j=1,2,…,m,

(14) βL(τ)=βL(τ‾)+∑i=1n∑j=1mFiL∂μiL(τ)∂τjΔτj,j=1,2,…,m,Δτj=τj−τ‾j.

Rearranging βK(τ) and βL(τ) yields:(15) β‾K=βK(τ‾)−∑i=1n∑j=1mFiK∂μiK(τ)∂τjτ‾j,j=1,2,…,m,

(16) β‾L=βL(τ‾)−∑i=1n∑j=1mFiL∂μiL(τ)∂τjτ‾j,j=1,2,…,m.

Substituting equations (13), (14) into equation (10) results in the following:ΔYY=(β‾K+∑i=1n∑j=1mFiK∂μiK(τ)∂τjτj)ΔKY+(β‾L+∑i=1n∑j=1mFiL∂μiL(τ)∂τjτj)ΔLY+γEΔEY+γGΔGY.

If μiL(τ)=1−μiK(τ), then the result is as follows:(17) ΔYY=β‾KΔKY+ΔKY∑i=1n∑j=1m(FiK−FiLΔLΔK)∂μiK(τ)∂τjτj+β‾LΔLY+γEΔEY+γGΔGY.

[29] denoted that:FiK−FiLΔLΔK>0.

Consider the following notes in equation (17):b1=β‾K>0,

b2j=ΔKY∑i=1n(FiK−FiLΔLΔK)∂μiK(τ)∂τj>0,j=1,2,…,m,

b3=β‾LLY>0,

b4=γEΔEE>0,

b5=γG>0.

Then, we have(18) ΔYY=b1IpY+∑j=1mb2jτj+b3ΔLL+b4EY+b5IGY,

where ΔK=IP represents private investment in local area, and ΔG=IG represents investment from the state budget to the local areas. Subsequent methods will appear if b1=0, b2j=0, b3=0 for j=1,…,m [27], and b2j=0 j=1,…,m [28], and b2j=0 for j=1,2 [19]. Equation (18) can be represented as:ΔYY=b1IpY+∑j=1m−1b2jτj+b2mτm+b3ΔLL+b4EY+b5IGY.

The ratio of grant-in-aid income (τm) is obtained as:(19) τm=b1b2mIpY−1b2m∑j=1m−1b2jτj+b3b2mΔLL+b4b2mEY+b5b2mIGY−1b2mΔYY.

4 Regression methodology

The proposed model (19) uses the change in output to determine the equilibrium level of economic sectors (n) and tax impacts (m). Consider the following notes in equation (19):δ0=(b1/b2m)(I0p/Y0)>0,b1>0,b2m>0,

δ1j=−b2j/b2m<0,b2j>0,b2m>0,

δ2=b3/b2m>0,

δ3=b4/b2m>0,

δ4=b5/b2m>0,

δ5=−1/b2m<0,

where (I0p/Y0) is defined as the ratio of local private investment to GDP. Due to the lack of quantitative information, we consider this indicator as an exogenous variable.

After incorporating these notes into equation (19), we have:(20) τm=δ0+∑j=1m−1δ1jτj+δ2ΔLL+δ3EY+δ4IGY+δ5ΔYY

δ0>0,δ1j<0,δ2>0,δ3>0,δ4>0,δ5<0,j=1,m−1‾.

The variable definitions for equation (20) are presented in Table 2.Table 2 Variable definitions.

Table 2Notes	Variables	Acronyms	Definitions	Sources	
τm	Local dependence rate	LDR	The ratio of grant-in-aid income to total revenues	Ebel & Yilmaz [22], Meloche, Vaillancourt & Yilmaz [30], Blöchliger & King [31], Valerievich [7], Fafurida & Pratiwi [32]	
τ1	Local personal income tax ratio	LPETR	The ratio of local personal income tax revenue to local GDP	Skinner [29], Ebel & Yilmaz [22], Meloche, Vaillancourt & Yilmaz [30], Kotarba & Kolomycew [33]	
τ2	Local property tax ratio	LPRTR	The ratio of local property tax revenue to local GDP	Meloche, Vaillancourt & Yilmaz [30], Kotarba & Kolomycew [33]	
τ3	Local vehicle tax ratio	LVTR	The ratio of local auto vehicle tax revenue to local GDP	Meloche, Vaillancourt & Yilmaz [30]	
τ4	Local other tax ratio	LOTR	The ratio of local other tax revenue, payments, and fees to local GDP	Meloche, Vaillancourt & Yilmaz [30], Kotarba & Kolomycew [33]	
ΔL/L	Local employment growth	LEG	The annual growth rate in the labor supply	Skinner [29], Ogawa &
Yakita [34]	
E/Y	Local budget expenditure ratio	LBER	The ratio of local budget expenditure to local GDP	Ebel & Yilmaz [22], Meloche, Vaillancourt & Yilmaz [30], Beer-Toth [2], Sawitri, Perdanawati, Sudiyani & Setini [35]	
IG/Y	Local budget investment ratio	LBIR	The ratio of local budget investment to local GDP	Skinner [29], Meloche, Vaillancourt & Yilmaz [30], Sawitri, Perdanawati, Sudiyani, & Setini [35]	
ΔY/Y	Local RGDP growth	LRGDPG	The annual increase in local real GDP	Skinner [29], Sawitri, Perdanawati, Sudiyani & Setini [35]	
Source: Authors' summary

With the help of Table 2, local financial dependence can be described as follows:(21) LDR=δ0+δ11LPETR+δ12LPRTR+δ13LVTR+δ14LOTR+δ2LEG+δ3LBER+δ4LBIR+δ5LRGDPG,

As seen from the outcomes of the negative and positive coefficients in equation (21):• An increase in local personal income taxes decreases local financial dependence due to δ11<0,

• An increase in local property taxes reduces local financial dependence due to δ12<0,

• An increase in local vehicle taxes decreases local financial dependence due to δ13<0,

• An increase in local other taxes reduces local financial dependence due to δ14<0,

• An increase in the local employment growth increases local financial dependence due to δ2>0

• An increase in the local budget expenditure ratio increases local financial dependence due to δ3>0

• An increase in the local investment ratio increases local financial dependence due to δ4>0,

• An increase in local RGDP decreases local financial dependence due to δ5<0.

5 Data

We consider a total of nine variables, as specified in equation (21). The datasets for these variables were obtained from the National Statistics Office (NSO) of Mongolia, covering the period from 2013 to 2022 in the 21 provinces. Table 3 presents the variables, including LDR, LPETR, LPRTR, LVTR, LOTR, LEG, LBER, LBIR, and LRGDPG.Table 3 Annual average of variables by Province, for the period of 2013–2022.

Table 3№	Province	LDR	LPETR	LPRTR	LVTR	LOTR	LEG	LBER	LBIR	LRGDPG	
1	Arkhangai	81.28 %	1.13 %	0.10 %	0.07 %	0.49 %	−0.49 %	13.59 %	1.52 %	5.22 %	
2	Bayan-Ulgii	83.96 %	1.67 %	0.07 %	0.09 %	0.28 %	2.58 %	19.28 %	1.46 %	7.94 %	
3	Bayankhongor	80.46 %	1.70 %	0.11 %	0.12 %	0.59 %	3.21 %	18.27 %	1.02 %	6.38 %	
4	Bulgan	56.01 %	1.43 %	0.21 %	0.09 %	4.56 %	−1.09 %	16.31 %	1.84 %	5.84 %	
5	Darkhan-Uul	58.42 %	3.63 %	0.30 %	0.14 %	0.62 %	−0.08 %	13.23 %	1.97 %	4.97 %	
6	Dornod	64.06 %	1.50 %	0.10 %	0.05 %	0.66 %	2.54 %	8.00 %	1.33 %	12.12 %	
7	Dornogovi	55.62 %	3.87 %	0.21 %	0.17 %	1.76 %	3.39 %	15.08 %	3.21 %	5.21 %	
8	Dundgovi	81.63 %	1.26 %	0.09 %	0.09 %	0.32 %	0.67 %	14.87 %	2.81 %	6.57 %	
9	Govi-Altai	83.57 %	1.85 %	0.10 %	0.10 %	0.29 %	−3.02 %	20.00 %	3.28 %	8.27 %	
10	Govisumber	61.55 %	3.55 %	0.32 %	0.10 %	1.36 %	5.69 %	16.68 %	3.61 %	8.41 %	
11	Khentii	75.46 %	1.92 %	0.13 %	0.09 %	0.74 %	1.68 %	15.50 %	1.91 %	7.26 %	
12	Khovd	77.71 %	1.82 %	0.11 %	0.11 %	0.32 %	0.88 %	15.49 %	1.75 %	12.57 %	
13	Khuvsgul	82.40 %	1.40 %	0.12 %	0.10 %	0.56 %	−1.02 %	16.54 %	2.03 %	7.43 %	
14	Orkhon	37.20 %	2.05 %	0.45 %	0.05 %	0.81 %	0.23 %	5.56 %	1.52 %	7.59 %	
15	Selenge	66.63 %	1.94 %	0.19 %	0.09 %	0.86 %	−6.11 %	11.02 %	1.19 %	4.36 %	
16	Sukhbaatar	73.12 %	1.41 %	0.18 %	0.09 %	0.38 %	0.69 %	12.81 %	1.91 %	7.08 %	
17	Tuv	68.84 %	1.59 %	0.39 %	0.07 %	1.12 %	−1.95 %	13.22 %	1.54 %	6.35 %	
18	Umnugovi	24.78 %	6.70 %	2.98 %	0.57 %	3.96 %	3.06 %	22.84 %	9.99 %	15.48 %	
19	Uvs	82.71 %	1.71 %	0.13 %	0.08 %	0.33 %	1.60 %	18.70 %	2.50 %	6.47 %	
20	Uvurkhangai	78.32 %	1.55 %	0.11 %	0.11 %	0.48 %	−1.53 %	15.42 %	1.51 %	7.94 %	
21	Zavkhan	81.61 %	1.62 %	0.10 %	0.08 %	0.42 %	−1.26 %	16.63 %	1.28 %	6.79 %	
Source: Authors' calculations

The dependent variable in our model is the local dependence rate. Most provinces exhibit high financial dependence rates, with a mean rate of 76–100 percent [3]. Provinces such as Arkhangai, Bayan-Ulgii, Bayankhongor, Dundgovi, Govi-Altai, Khovd, Khuvsgul, Uvs, Uvurkhangai, and Zavkhan are highly financially dependent. Bulgan, Darkhan-Uul, Dornod, Dornogovi, Govisumber, Khentii, Selenge, Sukhbaatar, and Tuv have high financial dependence rates, with a mean rate of 51–75 percent. Umnugovi and Orkhon have low financial dependence rates, with a mean rate of 26–50 percent.

Darkhan-Uul, Dornogovi, Govisumber, and Umnugovi are the provinces where personal income taxes exceed 3 percent of their GDP. Provinces experiencing the highest employment growth include Govisumber, Dornogovi, and Bayankhongor. Conversely, Selenge, Tuv, Uvurkhangai, and Zavkhan have negative employment growth.

In Umnugovi and Govi-Altai provinces, budget expenditures account for more than 20 percent of their GDP on average. The provinces with budget investments exceeding 3 percent of their GDP include Dornogovi, Govi-Altai, Govisumber, and Umnugovi. Dornod, Khod, and Umnugovi are provinces with annual RGDP growth of more than 10 percent.

Table 4 presents descriptive statistics for the variables. A total of 210 samples were collected from 21 provinces spanning the years 2013–2022. Personal income tax averages 2.16 percent of local GDP, while property tax, motor vehicle tax, and other taxes average 0.31 percent, 0.12 percent, and 1 percent respectively. The average local RGDP growth is 7.63 percent, and the average employment growth is 0.46 percent.Table 4 Descriptive statistics.

Table 4Variable	Observation	Mean	Std.Dev	Minimum	Maximum	Jarque-Bera	
LDR	210	0.6930	0.1968	0.0503	0.9077	56.8	
LPETR	210	0.0216	0.0142	0.0097	0.1339	4098.3	
LPRTR	210	0.0031	0.0063	0.0003	0.0444	3681.8	
LVTR	210	0.0012	0.0011	0.0003	0.0075	2808.1	
LOTR	210	0.0099	0.0123	0.0014	0.0723	685.2	
LEG	210	0.0046	0.1311	−0.4712	0.6174	190.5	
LBER	210	0.1519	0.0534	0.0395	0.3787	10.1	
LBIR	210	0.0234	0.0263	0.0009	0.2621	10353.3	
LRGDPG	210	0.0763	0.1578	−0.5247	0.6825	86.4	
Source: Authors' calculations

The overall average of local budget expenditure is 15.19 percent of local GDP, and with local budget investment averaging 2.34 percent. For the total samples, the average ratio of grant-in-aid revenue to total revenue is 69.3 percent, indicating a high level of financial dependence in the provinces. Among these variables, the most significant standard deviations compared with the mean are observed in the local property tax ratio, local other tax ratio, local employment growth, and local real GDP growth. According to the Jarque-Bera test, none of these nine variables exhibit a normal distribution.

As shown in Table 5, the correlations of LPETR, LPRTR, LVTR, and LOTR with LDR are negative. This negative correlation is consistent with the coefficients δ11<0, δ12<0, δ13<0, and δ14<0 of equation (21). However, the coefficients such as δ2>0, δ4>0, and δ5<0 of LEG, LBIR, and LRGDPG on LDR are not consistent in terms of the sign.Table 5 Correlation coefficients Matrix for variables.

Table 5Variables	LDR	LPETR	LPRTR	LVTR	LOTR	LEG	LBER	LBIR	LGDPG	
LDR	1.000									
LPETR	−0.635	1.000								
LPRTR	−0.602	0.720	1.000							
LVTR	−0.449	0.771	0.878	1.000						
LOTR	−0.540	0.463	0.592	0.528	1.000					
LEG	−0.026	0.055	0.033	0.049	0.065	1.000				
LBER	0.406	0.232	0.241	0.421	0.194	0.040	1.000			
LBIR	−0.311	0.575	0.652	0.660	0.451	0.083	0.488	1.000		
LRGDPG	0.041	0.029	0.048	0.057	−0.041	0.003	−0.007	0.006	1.000	
Source: Authors' calculations

The correlation results indicate high correlation coefficients, with values of 0.720 for the correlation between LPRTR and LPETR, 0.771 for the correlation between LVTR and LPETR, and 0.878 for the correlation between LVTR and LPRTR. The variance inflation factors (VIFs) for these values are 2.076, 2.469, and 4.359, respectively. In other words, these values are less than the VIFs’ threshold value of 10, indicating that multicollinearity does not cause problems in the regression.

6 Empirical results and discussion

Prior to estimating regression models, we ran unit root tests, such as the Augmented Dickey-Fuller (ADF) and Phillips-Person (PP) tests, on panel datasets. The test results are summarized in Table 6. The results indicate that the LPRTR, LBER, and LBIR variables have a unit root at I(1), while the other level variables have a unit root at I(0). However, for the purposes of equation (21), we have decided to estimate the regression models using levels of the explanatory variables.Table 6 Results of unit root tests.

Table 6H0: The variable has a unit root	ADF Test	PP Test	Order of Integration	
Level	First difference	Level	First difference	
LDR	65.7164**	23.0936	71.8078***	30.2756	I(0)	
LPETR	72.9081***	105.011***	63.2741**	149.535***	I(0)	
LPRTR	34.6279	98.0048***	26.0430	114.078***	I(1)	
LVTR	93.2977***	138.032***	106.777**	162.058***	I(0)	
LOTR	68.1725***	140.211***	61.0906**	180.632***	I(0)	
LEG	171.251***	204.481***	238.821***	313.227***	I(0)	
LBER	45.4131	111.188***	42.0013	101.651***	I(1)	
LBIR	93.1998	152.576***	92.1446	217.762***	I(1)	
LRGDPG	123.434***	123.296***	127.407***	164.066***	I(0)	
Notes: ***p < 0.01, **p < 0.05, *p < 0.1. The selection of lag length in the regression used in the tests is based on the Schwarz Criterion. Tests for level data and differenced data are computed from regressions with intercept and none terms.

Source: Authors' calculations.

Table 7 shows an estimation of equation (21). We first estimated a panel least squares regression to determine the direct impact of explanatory variables on our locally dependent rate. Model (1) in Table 7 lists the outcomes. Model (2) in Table 7 displays the random effects results.Table 7 Effects of local financial dependence (LDR).

Table 7Variable	Model (1)
Panel least squares	Model (2)
Random effects	Model (3)
Fixed effects	
δ0	0.536*** (0.018)	0.549*** (0.017)	0.566*** (0.017)	
LPETR	−6.596*** (0.567)	−6.028*** (0.494)	−5.504*** (0.505)	
LPRTR	−7.621*** (1.874)	−8.608*** (1.619)	−9.356*** (1.637)	
LVTR	16.699 (11.88)	16.458 (10.18)	15.798 (10.22)	
LOTR	−4.669***(0.504)	−4.598*** (0.431)	−4.549*** (0.431)	
LEG	0.010 (0.038)	0.008 (0.033)	0.003 (0.033)	
LBER	2.415***(0.117)	2.230***(0.111)	2.035***(0.121)	
LBIR	−0.955***(0.282)	−0.782***(0.254)	−0.616**(0.265)	
LRGDPG	0.071**(0.032)	0.086*** (0.029)	0.093*** (0.031)	
R-squared	0.874	0.868	0.912	
Durbin-Watson stat	1.054	0.936	0.788	
Observations	210	210	210	
Number of provinces	21	21	21	
Hausman Test (Prob)	–	Fixed (0.000)	–	
Notes: Standard errors in parentheses, ***p < 0.01, **p < 0.05, *p < 0.1.

Source: Authors' calculations.

After examining the Hausman test with random effects, it is appropriate to choose the fixed effects model. Model (3) in Table 7 shows the results for fixed effects.

In all models, the local employment growth and the local vehicle tax ratio are statistically insignificant for the local dependent rate, as shown in Table 7. At the 1 % and 5 % levels, all other variables are statistically significant under all models, and some parameter signs in the estimated model align with equation (21). Specifically, local personal income tax, local property tax, and local other taxes have a negative effect on local financial dependence, according to the findings of panel least squares, random, and fixed effects regressions. Additionally, the local budget expenditure ratio has a positive effect on local financial dependence. However, the parameter signs for local RGDP growth and budget investment ratio diverge from those predicted by equation (21).

The fixed effects model of local financial dependence exhibits similar results to the PLS regression in terms of signs, with the main difference being the estimated coefficients.

According to the fixed effects model, the following explanation are possible.• If the ratio of local personal income tax to local GDP is 2.16 percent on average, then the local dependence rate decreases by −11.89 percent on average.

• When the ratio of local property tax to local GDP is 0.31 percent on average, then the local dependence rate declines by −2.90 percent on average.

• While the ratio of local other taxes to GDP is 1 percent on average, the local dependence rate will decrease by −4.55 percent on average.

• When the ratio of local budget expenditure to GDP is 15.19 percent on average, the local dependence rate will increase by 30.91 percent on average.

• The local dependence rate will decrease by −1.44 percent when the average local budget investment in GDP is 2.34 percent.

• If the average local RGDP growth is 7.63 percent, the local dependence rate will increase by 0.71 percent.

The results of the study align with our expectations. Detailed local budget investment, local personal income tax, local property tax, and other local taxes positively affect mitigating local financial dependence. Conversely, local budget expenses and GDP increase the level of local financial dependence.

7 Conclusion, limitation and policy suggestion

Most research on fiscal decentralization focuses on the budget expenditures-to-GDP ratio, local investments, tax revenues, local characteristics, local financial dependence, and their impact on economic growth. Our research shares similarities with these studies in terms of calculating and determining these factors. However, our approach differs significantly. Our research is based on the premise that as income independence increases, local dependency decreases. We argue that the revenue of the local budget will rise with the growth in the number of economic sectors, where the main inputs are labor and capital, including purchases and investments from the locality. We develop a model that conditions investment and income growth. The modeling we have created calculates the impact of local private investment, local budget investment, tax revenues, local per capita income, and public expenditure on the financial dependence of that locality. Unlike other studies, our research does not account for the impact on government growth, providing a unique perspective on fiscal decentralization.

This study proposes a theoretical and empirical model for measuring the impact of local financial dependence. The proposed theoretical model is based on five assumptions and utilizes changes in output as key factors. Subsequently, we transition from the proposed theoretical model to the panel regression equation by substituting the corresponding notations. Lastly, the regression equation empirically examines the effects of local personal income tax, local property tax, local vehicle tax, other local taxes, local employment growth, the local budget expenditure ratio, the local budget investment ratio, and local real GDP growth on local financial dependence, employing panel least squares, random effects, and fixed effects models.

The study reveals that local budget investment, local personal income tax, local property tax, and other local taxes positively impact reducing local financial dependence. Conversely, an increase in local budget expenditures and local GDP leads to a rise in local financial dependency. According to the fixed effects model, local budget expenditure has the most significant influence on local financial dependence.

Based on these findings, we conclude that to mitigate financial dependence, the local government should implement an appropriate decentralization strategy for local budget revenue and expenditure.

A limitation of our study is that it was conducted within the framework of the budget structure of revenue and expenditure. Thus, provincial and local investments are calculated based on the local budget, while state budget investments in the respective provinces and localities are not included due to limited access to data. Additionally, local characteristics such as natural resources, geographical conditions, population, education, migration, economic activity, residents' behavior, political conditions, and other factors like elections, local authority, and corruption are not considered.

According to the results of this study, the following policy measures are recommended to improve the financial independence of local governments in Mongolia.• To reduce local financial dependence, it is crucial to focus on managing expenses more effectively than increasing income.

• Rather than merely increasing local tax revenue, efforts should be made to raise local per capita income.

• Enhancing access to local loans is more effective than increasing tax revenue.

• Local financial dependence can be assessed based on tax revenue collection, investment, spending, and local lending.

• The financial dependence of localities can be determined by analyzing the structure of local tax revenue and expenditures.

Funding statement

This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.

Data availability statement

Data will be made available on request.

CRediT authorship contribution statement

Ankhbayar Chuluunbaatar: Writing – original draft, Methodology. Batjargal Nadmid: Investigation, Data curation. Bolormaa Budjav: Writing – original draft, Supervision. Wing-Keung Wong: Writing – review & editing, Supervision.

Declaration of competing interest

The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.

Acknowledgments

We thank the anonymous reviewer for very helpful comments that improved the paper.
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