The Dilemma of Fiscal Federalism: Grants and Fiscal Performance around the World

Abstract

This paper uses cross-national data to examine the effects of federal fiscal and political institutions on the fiscal performance of subnational governments. Balanced budgets among subnational governments are found when either (1) the center imposes strong borrowing restrictions or (2) subnational governments have both wide-ranging taxing and borrowing autonomy. Large and persistent aggregate deficits occur when subnational governments are simultaneously dependent on general-purpose intergovernmental transfers and free to borrow-a combination found most frequently among constituent units in federations. Time-series cross-section analysis reveals that as countries increase their reliance on transfers over time, subnational and overall fiscal performance decline, especially when subnational governments have easy access to credit. These findings illuminate a key dilemma of fiscal federalism and a more precise notion of its dangers: When constitutionally constrained or politically fragmented central governments take on heavy co-financing obligations, they cannot credibly commit to ignore the fiscal problems of lower-level governments.

Determinants of government size: evidence from China

“…In literature, there are several ways of defining vertical imbalance. Jin and Zou (2002) employ the share of central transfers in subnational expenditure, and Rodden (2002) proposes the share of central transfers in total subnational revenue as a proxy for vertical imbalance. In this paper, we adopt the method suggested by Jin and Zou (2002); thus, vertical imbalance is measured by the ratio of central transfers to subnational expenditure.…”

The dynamics of municipal fiscal adjustment

“…One important topic of previous research (e.g., Wilcox, 1989, Trehan and Walsh, 4 See, e.g., Prud'homme (1995), Tanzi (1996), Dillinger and Webb (1999), Rodden (1999), and references therein.…”

The Political Economy of Equalization Transfers

“…In many developing countries that are newly decentralizing, and where local jurisdictions have little own-revenue potential, over-dependence on national transfers undermines the accountability of local governments to their citizens. Rodden (2002) finds that in a large cross-section of countries over time dependence of subnational governments on transfers is positively associated with higher sub-national fiscal deficits, evidence that is consistent with the idea that greater dependence on transfers creates conditions for reduced accountability of local governments to their local electorate.…”