Welfare Gains from Fiscal Federalism:

Fiscal federalism with its inherent structure of decentralization of spending and revenue sources promotes efficiency and welfare. The decentralisation theorem propounded by Oates (1972) demonstrates fiscal federalism ensures that public services are provided corresponding to the diversified demand conditions in a federation.  The provision of public services by a central government will be of uniform nature throughout the country.  The state and local governments being much closer to their people and geography of their respective jurisdictions possess better knowledge of both local preferences and cost conditions unlike a central government. The state and local governments will be more responsive to particular preferences of their constituencies and will be able to find new and better ways to provide these services.

The economic condition and level of development in different jurisdictions tends to be different depending upon many factors and thus requirements of public services differ across regions, which the state Government will be able to recognize unlike the central government.

The gains from decentralization, as propounded by Charles Tiebout (1956) were due to highly mobile households. They choose a jurisdiction as their residence based upon its fiscal package that suits their tastes. The consumer-voter exercises his/her preferences by influencing public policies through some political mechanism.

The larger the number of jurisdictions, the wider is the consumer choice.  Also, the more diverse the demand for public services in different jurisdictions, the greater is the welfare gains from fiscal decentralization.