Paper #549

Title:

Fiscal decentralization policies and sub-national government debt in evolving federations

Authors:

Teresa Garcia-Milà, Timothy J. Goodspeed and Therese J. McGuire

Date:

July 2001 (Revised: May 2002)

Abstract:

As part of a process of democratization, many countries spanning Europe, Latin Amertica, Africa, and Asia are reorganizing their governments by devolving fiscal responsibility and authority to newly empowered regional and local governments. Although decentralization in each country proceeds differently, a common element tends to be an initially heavy reliance on central government grants to fund regional spending. We develop a theoretical model of regional borrowing decisions in which the incentives for regional borrowing depend crucially on how the regions expect the federal system of finance to evolve. We examine the implications of the model using data on Spanish regions for the period 1984-1995 and find evidence that regions may be borrowing inefficiently in response to incentives imbedded in the Spanish system of fiscal decentralization.

Keywords:

Fiscal decentralization, borrowing incentives

JEL codes:

H3, H7

Area of Research:

Macroeconomics and International Economics

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