Intergovernmental Fiscal Relations: Coordination Failures and Fiscal Outcomes

Abstract

This article estimates the fiscal impact of coordination failures in intergovernmental fiscal relations. The coordination failures considered here are due to agency problems arising from the delegation of fiscal powers to sub‐national governments, and “common pool” problems associated with funding decentralised government spending through intergovernmental transfers. Particular attention is focused on the trade‐off between coordination and fiscal decentralisation. Evidence provided for a sample of thirty countries suggests that coordination failures are likely to result in a deficit bias in decentralized policy making, particularly in the case of developing countries, for which the benefits of decentralization may be over‐stressed. Developed countries were found to be less adversely affected by coordination failures and have therefore managed to pursue fiscal consolidation in a decentralized setup.

On the link between fiscal decentralization and public debt in OECD countries

“…If there are several independent governments which may spend and tax at their own discretion, a concerted fiscal policy could be impossible to maintain, and might manifest itself in a deficit-bias at all tiers of government (De Mello 1999).…”

Who Honor the Rules of Federalism? Party System Nationalization and Fiscal Performance

“…Some scholars have considered that decentralization contributes to improve fiscal stance (Shah, 2006 Arguments connecting decentralization and fiscal performance have stressed the importance of sub-national politics. On the one hand, scholars sustain that decentralization would induce governments' misbehavior and irresponsibility related with common pool problems and incentive to overspending (de Mello, 1999;Pisauro, 2001;Goodspeed, 2002). Conversely, researchers defending the virtues of decentralization stress the fact that it can encourage more accountable governments, a closer match with citizens' preferences in goods and services provision, can improve general efficiency and avoid excessive taxation (Oates, 2005; Baskaran, 2012; Oto-Perialías et al, 2013).…”

“…When there are fissiparous forces that control regional governments, there are more incentives to freeriding and common pool problems are likely to appear (Riker, 1964). Moreover, those strong local leaders, who rule in a context of soft budget constraints, have tendency to overspending (Goodspeed, 2002) and give rise to inefficiencies with inter-jurisdictional coordination problems (De Mello, 1999). Thus, decentralization could erode country's fiscal sustainability through the prevalence of self-interested local politics.…”

Local Government Finances

“…If the recipient jurisdiction is deficit-prone and has weak incentives to act responsibly, decentralised fiscal management requires incentives for fiscal prudence; otherwise, local fiscal mismanagement may be detrimental to the system as a whole (Qian and Roland, 1998). This macro-financial spillover effect has been at the core of several sub-national financial crises (Tanzi, 1995;Prud'homme, 1995;Ter-Minassian, 1999;de Mello, 1999de Mello, , 2000. Hard-budget constraints, especially in the form of fiscal rules, can be self-imposed, introduced by the central government and/or complemented by market-based scrutiny.…”