Vertical Fiscal Imbalances and the Accumulation of Government Debt

Abstract

The implications of delegating fiscal decision making power to sub-national governments has become an area of significant interest over the past two decades, in the expectation that these reforms will lead to better and more efficient provision of public goods and services. The move towards decentralization has, however, not been homogeneously implemented on the revenue and expenditure side: decentralization has materialized more substantially on the latter than on the former, creating "vertical fiscal imbalances". These imbalances measure the extent to which sub-national governments' expenditures are financed through their own revenues. This mismatch between own revenues and expenditures may have negative consequences for public finances performance, for example by softening the budget constraint of sub-national governments. Using a large sample of countries covering a long time period from the IMF's Government Finance Statistics Yearbook, this paper is the first to examine the effects of vertical fiscal imbalances on fiscal performance through the accumulation of government debt. Our findings suggest that vertical fiscal imbalances are indeed relevant in explaining government debt accumulation, and call for a degree of caution when promoting fiscal decentralization.

Analyzing Political and Systemic Determinants of Financial Risk in Local Governments

“…Second, the two models we use meet all the statistical requirements specifi ed in the Basel II rules (BCBS, 2006) and in Bank of Spain Circular 3/2008 for calculating PD.  ird, the European Commission (2015), Aldasoro and Seiferling (2014), the World Bank Group (2015) and the US Department of the Treasury (2013) have all recognized the need to study the joint eff ect of idiosyncratic factors (or individual ones, for a single entity) and systemic factors (such as the macroeconomic cycle, fi scal policy, and the electoral cycle) in the measurement of government credit risk.…”

“…Despite the valuable conclusions presented in the above papers, many organizations in the fi eld of public fi nances argue that a comprehensive analysis of government credit risk should include, besides political factors (which are specifi c to each entity and may be dependent on election outcomes), systemic ones, such as the macroeconomic cycle, fi scal policy, and the electoral cycle, in view of the vulnerability of individual government entities to macroeconomic changes and the volatility of non-controllable variables (Aldasoro and Seiferling, 2014; Local Government Association of South Australia, 2019; Federal Accounting Standards Advisory Board, 2014; World Bank Group, 2015; US Department of the Treasury, 2013).…”

“… e debt crisis produced great concern about credit risks, among policymakers, fi nancial regulators, and fi scal authorities. Researchers concluded that it was necessary to study the causes of high levels of local government (LG) default in order to design and implement corrective and preventive policies and thus put government fi nances on a sound footing and in a position to meet debt and defi cit targets (Aldasoro and Seiferling, 2014; World Bank Group, 2015; European Commission, 2012; Council of the European Union, 2011; Federal Accounting Standards Advisory Board, 2018; Navarro-Galera et al, 2015; Balaguer-Coll, Prior and Tortosa-Ausina, 2016; Beetsma and Vermeylen, 2007).…”

Vertical fiscal imbalance and local fiscal indiscipline: Empirical evidence from China

“…1 Additionally, a few studies analyze the link between VFI and the overall fiscal balance at the national level. For instance, using cross-country panel datasets, Rodden (2002), Neyapti (2010), Eyraud and Lusinyan (2013), Aldasoro and Seiferling (2014), Asatryan et al (2015), and Lago-Peñas et al (2019) find supporting evidence that higher VFI levels are detrimental to governments' fiscal performance and increase fiscal deficits (or government debt). De Mello (2000) also argues that the presence of VFI is likely to result in a deficit bias in decentralized policy-making, especially in the case of developing countries, where the central government exercises less stringent control on subnational finances.…”

Fiscal Governance, Information Capacity, and Subnational Capital Finance

“…The legal environment that governs subnational borrowing sets the parameters—and enforcement of those parameters—of what is politically feasible as well as allowed or prohibited for both governments and nongovernment market actors (M. E. Freire 2013; de Mello 2001; Webb 2004; Aldasaro and Seiferling 2014; de Mello and Barenstein 2001; Bird and Smart 2002; Lewis 2003; Ahmad, Albino-War, and Singh 2005). The legal environment addresses the extent to which legal norms are upheld and the capacity in the system to enforce the rules.…”