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Decentralization and Overborrowing in a Fiscal Federation

Author

Listed:
  • Si Guo

    (International Monetary Fund)

  • Yun Pei

    (University at Buffalo, SUNY)

  • Zoe Xie

    (Federal Reserve Bank of Atlanta)

Abstract
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 government’s fiscal gap, borrowings by both local and central governments rise. Quantitatively, fiscal decentralization accounts for 19–40% 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% and raise welfare by 3.75%.

Suggested Citation

  • Si Guo & Yun Pei & Zoe Xie, 2019. "Decentralization and Overborrowing in a Fiscal Federation," 2019 Meeting Papers 1229, Society for Economic Dynamics.
    • Handle: RePEc:red:sed019:1229
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    More about this item

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H74 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Borrowing

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