Decentralization and Overborrowing in a Fiscal Federation
Yun Pei () and
No 2018-9, FRB Atlanta Working Paper from Federal Reserve Bank of Atlanta
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 (search for similar items in EconPapers)
JEL-codes: E61 E62 H74 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-ure
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Working Paper: Decentralization and Overborrowing in a Fiscal Federation (2019)
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