The Effects of Local Government Indebtedness: Evidence from Toxic Loans
53 Pages Posted: 12 Mar 2021 Last revised: 7 Feb 2023
Date Written: February 9, 2021
Abstract
We examine the response from municipalities and their voters to a large and exogenous increase in municipal indebtedness. We show that municipalities with "toxic loans" on their balance sheet exhibit a large increase in their debt and interest expenses following the Great Financial Crisis. This large increase in indebtedness causes a twice-as-large reduction in municipal investments, whereas local taxes remain unaffected. The reduction in investments is particularly pronounced for municipalities that are politically contested. These empirical findings are consistent with a model of municipal investment in which electoral competition act as a disciplinary device for local politicians.
Keywords: Public debt, public investments, political contestation, toxic loans
JEL Classification: P16, H74, G11, G32
Suggested Citation: Suggested Citation