Studies in Fiscal Federalism and State-local Finance series
Chapter 3: Fiscal institutions and their effects on public households
In this chapter, I develop an argument about the effects of decentralized fiscal authority, drawing mainly on two branches of literature discussed in Chapter 2 – the budgetary institutions and the fiscal federalism literature. In the existing academic literature, authors generally treat the effects of vertical fiscal decentralization and decentralization of the budget process on the national – horizontal – level as separate problems. Expanding on these contributions, I suggest a different approach to budgetary policy making in a fiscally federal context. My goal is to arrive at a model that allows me to treat the consequences of decentralized budget making – both at the national and subnational levels – in a single analytical framework. First, I start from the premise that vertical fiscal decentralization destabilizes overall government fiscal outcomes under certain circumstances. In line with much of the fiscal federalism literature, I assume decentralization to exert destabilizing effects, as long as there are no hard budget constraints on subcentral budget actors. Without budget constraints on local politicians, a decision to delegate more authority to subnational governments in expenditure sets incentives for local budget actors to draw on the common national tax base to capitalize on it politically, in the local political arena, without bearing the costs of rising public expenditure and debt. One way to solve such common pool resource problems would consist in installing local-level budget constraints. Such an approach seems reasonable in certain political and institutional contexts.
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