This paper uses a fiscal decentralization reform in China, namely the Province‐Managing‐County (PMC) reform, to examine the effects of fiscal decentralization on local economic growth. The PMC reform abolished the subordinate fiscal relationship between prefectures and counties and transferred much of the tax and spending authority from the prefecture to the county level. Exploiting a county‐level panel dataset over 2001–2011, we find that the reform has led to a significant increase in GDP growth rate. The effect is considerably more pronounced in regions with superior initial institutional quality. We also identify channels: the PMC reform induced county governments to exert lower tax burdens on firms and increase spending on infrastructure construction. This article is protected by copyright. All rights reserved