A dynamic model of fiscal decentralization and public debt accumulation
Si Guo,
Yun Pei and
Zoe Xie
Journal of Public Economics, 2022, vol. 212, issue C
Abstract:
This paper develops a dynamic infinite-horizon model with two layers of governments to study theoretically and quantitatively how fiscal decentralization affects local and central government debt accumulation and spending. In the model, the central government makes transfers to local governments to offset vertical and horizontal fiscal imbalances. But the anticipation of transfers lowers local governments’ expected cost of borrowing and leads to overborrowing ex ante. Absent commitment, the central government over-transfers to reduce local governments’ future need to borrow, and in the equilibrium both local and central debts are inefficiently high. Consistent with empirical evidence, when fiscal decentralization widens vertical fiscal imbalances, local governments become more reliant on transfers, and both local and central debts rise. Applied to Spain, the model explains 39 percent of the rise in total government debt when the vertical fiscal imbalances widened during 1988–1996, and 18 percent of the fall in debt when the imbalances narrowed during 1996–2006.
Keywords: Fiscal decentralization; Public debt; Time-consistent policy; Soft budget constraint (search for similar items in EconPapers)
JEL-codes: E61 E62 H74 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:pubeco:v:212:y:2022:i:c:s0047272722000949
DOI: 10.1016/j.jpubeco.2022.104692
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