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The recent economic and financial crisis put intergovernmental fiscal relations into the limelight. Shrinking revenues and rising spending responsibilities forced many countries to reform their fiscal frameworks thoroughly in order to improve the sustainability of fiscal policy at each level of government. Evidence suggests that stable, sustainable, efficient and equitable public finances depend on effective functioning of intergovernmental fiscal and budgetary frameworks. Whereas reforms are still ongoing, seven years after the crisis it is time to take stock. How successful were intergovernmental fiscal institutions in weathering the fiscal crisis; which reforms did they undertake; how did reforms shape outcomes; and which reforms still lie ahead?
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The recent economic and financial crisis has put a heavy strain on the public finances in many countries. It has also put intergovernmental relations and sub-central governments’ (SCGs) finances under intense pressure. Rapidly shrinking revenues and rising spending responsibilities – partly as a consequence of stimulus programmes – prompted SCG deficits to rise to levels rarely seen before, although central government transfers often protected SCGs from falling into the fiscal abyss. When the stimulus packages ended, SCGs had to bear their share in general governments’ consolidation effort, focusing on spending cuts since tax revenues recovered only slowly and intergovernmental transfers were often frozen. Although consolidation is still ongoing, SCG deficits have returned to pre-crisis levels and debt is stabilising.
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In the literature on fiscal decentralisation – both the first generation and second generation theories – a critical assumption made is that local governments have taxing power over local taxes. Another assumption is that a clear distinction exists between local taxes and intergovernmental grants. Tax sharing, which is widely adopted in the world except in a few countries such as the United States and Canada, makes such assumptions invalid. Tax sharing links the budgets of the central and local governments in a complicated way and creates conflicts of interest among different levels of government. It also may lead to an inefficient tax mix and higher national debt. Compared with the cases where the assignment of tax and expenditure responsibilities are clear cut, understanding the interrelationship between tax sharing, fiscal institutions, and the political system is critical for the success of fiscal decentralisation.
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This chapter documents some key facts on the timing, synchronicity, cyclicality, contribution and composition of central and sub-national governments’ fiscal responses following the global financial crisis among advanced economies. We find evidence that post-crisis fiscal responses across government levels have become more synchronised, suggesting coordinated efforts across government levels to implement fiscal expansions. We then develop and test some hypotheses on the role that fiscal autonomy, transfer dependency and sub-national fiscal rules may have played to foster fiscal coordination in the post-crisis era. Preliminary econometric results show that fiscal coordination improves with the degree of spending autonomy. There is no evidence, however, that additional revenue autonomy, transfer dependency or a smartening of sub-national fiscal rules contributed to improvements in fiscal coordination in the post-crisis years.
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Fiscal constitutions contain a set of rules and frameworks, which are usually enshrined in a country’s fundamental laws. Fiscal constitutions guide fiscal policy and hence shape fiscal outcomes. This chapter describes the empirical approach to assessing the fiscal constitutions of 15 federal countries in a comparative way and provides an overview on the most salient results. The chapter first goes more into the details of what is understood by the term “fiscal constitutions”. The following section then describes the building blocks of fiscal constitutions and assesses them empirically using a common coding framework. Section 4 goes on to combine and link the building blocks to characterise specific types of fiscal constitutions, i.e. to what extent they are decentralised or integrated. Section 5 then traces the development of the fiscal constitutions over time, identifies main trends, and explains the major reforms and their driving forces. Lastly, Section 6 provides basic evidence on the association between types of fiscal constitutions and fiscal outcomes.
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This paper studies the relationship between fiscal decentralisation and the duration of the fiscal consolidation episodes in 17 OECD countries between 1978 and 2009. It appears that consolidation lasts longer when expenditure decentralisation is higher. The paper also finds that transfers from higher levels of government are reduced during consolidation episodes. This suggests that, given a certain institutional structure within the country, central governments are able to shift the burden of consolidation towards lower tiers of government by reducing intergovernmental transfers. This is particularly the case when sub-national governments have little legal autonomy to raise tax revenues and cannot affect executive decisions taken at the central level.
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This paper discusses a novel approach to identify soft budget constraint expectations, exploiting the idea that financial investors rationally incorporate in sub-national bond prices also expectations of future bailouts by the central government. We consider as a testing ground the municipal bond market in Italy. We first build an original dataset of all the 1 388 bond issuances from 1996 (the year when the national legislation provided an organic discipline for municipal bonds) to 2011, involving 529 cities out of about 8 000. We then regress bond yields at issuance on bond characteristics, central government bond yields, and three proxies for bailout expectations on soft budget constraints (an index of vertical fiscal imbalance and of central government budget tightness, plus a dummy for the city being subject to the Domestic Stability Pact). Our results suggest that soft budget constraint problems arise frequently, especially in small cities and those located in the poorer South.
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Fiscal rules are thought to help maintain the sustainability of public finances and underpin fiscal consolidation. This paper estimates a model which regresses the primary balance of local governments in Japan on debt, to the power of debt, the level of temporary government spending, a business cycle indicator and a set of fiscal rules enacted in 2007. Local governments include all prefecture governments over the period from FY1985 to FY2011. Overall, results are consistent with the Bohn (1998) debt sustainability definition. The primary balance initially falls at low levels of debt/GDP. As debt increases beyond certain levels, however, the primary balance rises significantly with increasing debt. The improvement of the primary balance was achieved by expenditure cuts and local tax revenue increases, while intergovernmental transfer played no decisive role. The debt service ratio serves to improve the primary balance of local governments, while net revenue and the current account balance do not play a disciplining role. The introduction of the fiscal rule reduced the explanatory power of fiscal variables.
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Austria’s federal fiscal constitution is heavily centralised. A consensus-driven political system serves as a counterweight. While the federal parliament has overwhelming taxing authority and decides on tax sharing, cost bearing rules and transfers, legislation is usually drafted on a consensual basis across government levels and amended every four to six years. Within this framework each Land (regional government) or local government is responsible for its own budget. To coordinate budgetary policies the Internal Austrian Stability Pact sets well-defined budgetary goals for each government and ensures compliance through potential sanctions. The intergovernmental framework does not provide tax autonomy for Länder governments, which are financed via federal tax-sharing and transfers. The lack of accountability towards taxpayers as well as a lack of fiscal transparency due to federal co-financing reduce efficiency, and the considerable political clout of the Länder leads to soft-budget constraints. Reforms towards more tax autonomy and efficiency are planned, but are difficult to adopt given that strong vested interests have to be overcome.
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Despite a gradual, intermittent trend toward greater centralization, the United States remains one of the world’s most decentralized federal systems. The federal government has nonetheless had a growing fiscal influence over time, thanks to the increase in federal grants to state and local governments since the 1930s and the unprecedented number of federal mandates handed down over the past five decades. As fiscal interdependence has grown, the institutional structures that helped knit together the levels of government have eroded or disappeared altogether. This chapter will explore each of these facets of fiscal federalism in the United States, including the role of state fiscal rules and the implications of national policies – especially intergovernmental grants – for state and local government. It will particularly examine the paradox of deinstitutionalising intergovernmental consultation mechanisms in an era of rising interdependence, and it will explore its implications.
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This chapter discusses and analyses the factors behind successful and failed local government reforms in Finland. The reforms investigated include the municipal merger reform, health care reform and grant system reform, pursued by the Finnish government during 2011-15. The reforms are studied from the reform context, timing, scope and reform design angles. The main observation is that the successful reforms have been prepared by experts and civil servants, and political decision-making became involved only at the last phase. Also, it seems important that a single ministry was in charge of the reform. The failed reforms were tightly steered politically from the beginning, without clear political agreement on the process and target of the reform.
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This chapter describes fiscal co-operation institutions in Switzerland, which go beyond traditional vertical top-down co-ordination. Switzerland is an example of intergovernmental co-ordination of fiscal policy in a highly decentralised country. The country is characterised by a highly fragmented structure of sub-national entities. The cantons (state level) have significant policy, organisational and financial autonomy. Due to the fragmented structure and considerable autonomy, vertical co-operation between the federal and cantonal levels as well as between the cantonal and municipal levels is indispensable. This co-operation is based on the following elements: independent financing of cantonal tasks, fiscal equalisation between financially strong and weak cantons, as well as fiscal assistance between the federal and cantonal levels. In this respect, the role of vertical co-ordination of stabilisation policy and particularly of debt policy is limited. Horizontal co-operation is based mainly on inter-cantonal agreements and conferences.
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This chapter provides an overview of the Swedish budgetary policy framework with special attention to the local level. The financial crisis that hit the Swedish economy in the early 1990s was a trigger for several political and structural reforms. The reform of the budgetary policy framework, which is part of the fiscal framework, had a great impact on the central and local level. The reforms had large support from society and during the last financial crises starting in 2008 support grew even stronger together with a lot of international recognition. For the local level the balanced budget requirement is the anchor. There are no sanctions involved if budgets are not balanced but most municipalities and county councils have reached the target. During the last years the central government surplus target has been hard to reach and a debate has started to change it to a balance target.
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Economically robust municipalities are of great importance to the decentralised Danish public sector. The size of municipalities and the extensive equalisation system contribute to this objective, but moreover a mechanism to avoid local bail-outs and bailout-like situations has been developed since the 1980s. This institutional mechanism consists of formula-based elements with a minimum of administrative discretion. The mechanism has worked well since the late 1980s involving a number of cases, and the success originally explained by at least three factors: the thorough application of the mechanism, the local distaste for legal conflict with the central government, and the local stigma of being “under administration” by the upper level of the public sector. In recent years, the need for the mechanism seems to have diminished, because fewer and economically more sustainable municipalities accompanied by structural reforms of local governments from 2007 and the Danish budget law. The budget law has established a top-down economic control of local governments’ finances, where non-compliance with expenditure ceilings implies possible use of economic sanctions to both the municipalities in general and to specific municipalities.
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Many countries are tempted to copy fiscal multi-level organisations and institutions that operate in the more advanced OECD countries, and they are often recommended by international organisations regardless of the type of economy under consideration. This generally overlooks the context under which the institutions have evolved and function. A case in point is the segmentation of tax administrations for the implementation of the income tax in the United States that was replicated in Mexico for both the income tax as well as the value-added tax. Firms with a relatively high threshold of MXN 2 million were assigned to the states, which had very few incentives to collect the taxes, but provided a “shelter” that generated a large “informal” sector that thrived around “cheating and avoidance” including by larger firms. Recent theoretical research also assumed that the large taxpayers are honest, and therefore recommended increasing the threshold. The Mexican 2013 fiscal reforms, however, eliminated the threshold and closed the “informality” channels used by medium-sized and large taxpayers. The full VAT chain was instrumental in providing information to “close the income tax gaps” and facilitating the removal of measures that add to the costs of doing business. Consequently, the design of appropriate institutions should closely reflect the context in which they are being introduced.
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