Vertical Fiscal Imbalances and the Accumulation of Government Debt
SAFE Working Paper No. 61
38 Pages Posted: 11 Jul 2014 Last revised: 18 Sep 2014
Date Written: July 2014
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.
Keywords: fiscal decentralization, vertical fiscal imbalances, panel data, public debt, GFSY
JEL Classification: H60, H74, H77, C33
Suggested Citation: Suggested Citation