Determinants of local government deficit: evidence from Spanish municipalities

Abstract

Understanding the determinants of fiscal deficits is justified by the fact that persistent deficits rapidly lead to the accumulation of public debt. Therefore, the aim of this paper is to analyze the factors that explained the fiscal deficits of Spanish municipalities in the period 2011–2020. The deficit at the municipal level for Spain is explained by considering several determinants covering socioeconomic and political dimensions, such as GDP per capita, unemployment rate, population, political participation, political sign of the ruling party or political force, among others. The method of moments quantile regression (MMQ) and mean group (MG) estimator are applied for the overall sample and for each group of municipalities. In addition, the causality between the deficit and the explanatory variables is analyzed using the Juodis et al. (2021) test. It is found that economic growth only has a long-term beneficial effect on the deficit as it reduces the deficit at all quantile levels except at the 10% quantile. Unemployment increases the deficit in both the short and long run. Political participation and right-wing political parties contribute to the growth of the deficit in the higher quantiles. To reduce the budget deficit, the analysis shows that unemployment should be reduced and economic growth should be boosted. The results are robust to those based on mean group estimators. With this paper, we contribute to the scarce literature on deficit determinants by analyzing the determinants for Spanish municipalities. Furthermore, our findings have important implications for politicians, citizens and stakeholders.