 Countercyclical central government transfers incentivize local government overborrowing: Theory and evidenceYan Liu, Guowei Wu and Chen Xiong Economic Modelling, 2024, vol. 132, issue C Abstract: Local governments in China have strong incentives to overborrow, leading to unsustainable local debt. Recent research suggests that higher central government transfers serve as a key incentive for local governments to overborrow. This paper constructs a theoretical model and shows that it is the countercyclicality of central government transfers, that is, the negative correlation between transfers and local revenues, that act as the main incentive for local governments to overborrow. We test the model predictions using hand-collected provincial data on local government debt and budgets. The empirical evidence strongly supports the prediction that the negative correlation—not the magnitude—of central government transfers is the main driver of the incentive for local governments to borrow excessively. The countercyclical nature of central government transfers provides insurance against local government debt service, thereby increasing the incentive for local governments to borrow. The findings suggest the need to change the central government transfer policy framework. Keywords: Local government debt; Local government fiscal structure; Central government transfer (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:132:y:2024:i:c:s0264999323004376 DOI: 10.1016/j.econmod.2023.106625 Access Statistics for this article Economic Modelling is currently edited by S. Hall and P. Pauly More articles in Economic Modelling from Elsevier |
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