Decentralization and Overborrowing in a Fiscal Federation

69 Pages Posted: 24 Aug 2018 Last revised: 21 Feb 2019

See all articles by Si Guo

Si Guo

International Monetary Fund (IMF)

Yun Pei

University at Buffalo, SUNY

Zoe Xie

Federal Reserve Banks - Federal Reserve Bank of Atlanta

Date Written: 2018-08-23

Abstract

We build an infinite horizon equilibrium model of fiscal federation, where anticipation of transfers from the central government creates incentives for local governments to overborrow. Absent commitment, the central government over-transfers, which distorts the central-local distribution of resources. Applying the model to fiscal decentralization, we find when decentralization widens local governments’ fiscal gap, borrowings by both local and central governments rise. Quantitatively, fiscal decentralization accounts for from 19 percent to 40 percent of changes in general government debt in Spain during 1988–2006. A macroprudential tax on local borrowing that implements Pareto optimal allocation would reduce debt by 27 percent and raise welfare by 3.75 percent.

Keywords: fiscal federalism, time-consistent policy, decentralization, public debt

JEL Classification: E61, E62, H74

Suggested Citation

Guo, Si and Pei, Yun and Xie, Zoe, Decentralization and Overborrowing in a Fiscal Federation (2018-08-23). FRB Atlanta Working Paper No. 2018-9. Available at SSRN: https://ssrn.com/abstract=3237928 or http://dx.doi.org/10.29338/wp2018-09

Si Guo (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Yun Pei

University at Buffalo, SUNY ( email )

415 Fronczak Hall
Department of Economics
Buffalo, NY 14260
United States

HOME PAGE: http://sites.google.com/site/yunpei99

Zoe Xie

Federal Reserve Banks - Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

HOME PAGE: http://zoexie.weebly.com

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