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Regarding the bilateral relationship between financial decentralization and regional development at the national level, this study examines the relationship between regional inequality and vertical balance financial decentralization across the provinces of Iran. For this purpose, the calculations are carried out in two stages: in the first stage, the Composite Index of Regional Development (CIRD) is calculated in five dimensions (macroeconomics, science and innovation, environmental sustainability, human capital and public services) by using the two-stage principal components analysis (PCA) during 2006-2016. In the second stage, the interactions between vertical balance financial decentralization and regional development are estimated using the simultaneous equations and error component two-stage least squares (EC2SLS). The results of the first stage analysis show that Tehran province is at the highest level of development, and Sistan and Baluchestan province is at the lowest level of development, and these two provinces practically reflect the wide inequality in the provinces of Iran. In addition, the highest regional inequality is related to the dimensions of science, innovation and human capital. The results of the second stage indicate that the effect of vertical balance financial decentralization on negative regional development is significant and negative, meaning that if provinces spend based on their income, a slight decrease in provincial development has it Because provinces play lesser role in determining tax rates and bases, less developed provinces are not able to generate sufficient revenue to cover their provincial expenditures. Financial decentralization also increases with an increase in regional development, meaning that provinces with different levels of development are likely to have different tendencies toward the quality and quantity of public goods.

Keywords: Regional development, CIRD Combined Development Index, Financial Decentralization, Two-Step Principal Component Analysis (PCA), Error component two-stage least squares (EC2SLS)

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