Local Taxation, Governance Quality, and Sustainable Development Outcomes: A Structural Equation Modelling

Abstract

This study examines the structural relationship between local taxation and sustainable development outcomes in the context of Indonesia's fiscal decentralisation. Using path analysis with Structural Equation Modelling (SEM) software on a balanced panel dataset of 34 provinces in Indonesia for the period 2019-2023 (n = 170 observations), the research evaluates the mediating role of governance quality in transforming fiscal capacity into sustainability performance. The findings indicate that local tax revenue significantly strengthens fiscal independence (β = 0.71, p < 0.001), which subsequently improves governance quality (β = 0.67, p < 0.001) and enhances sustainability outcomes (β = 0.79, p < 0.001). The indirect effect of local taxation on sustainability through fiscal independence and governance quality is 0.38, confirming a significant mediation pathway. The model explains 68% of sustainability performance variance. Bootstrapped mediation analysis (5,000 replications) with 95% confidence intervals confirms the stability of indirect effects. These findings suggest that fiscal autonomy must be accompanied by institutional strengthening to generate sustainable development impacts. The study contributes to fiscal decentralisation and sustainability governance literature by empirically demonstrating the critical mediating role of governance quality in Indonesia's decentralised fiscal system.