Fiscal adjustments at the local level: evidence from Colombia

Abstract

Recent research suggests that intergovernmental grants, own-source revenues, and changes in government investment play a crucial role in helping local governments in advanced economies to adjust their fiscal positions in response to budget shocks. Little is known, however, about the dynamic of local fiscal adjustments in emerging economies, and there are reasons to expect distinct fiscal stabilization patterns, for instance, due to lower fiscal capacity. A panel dataset of more than 900 municipalities in Colombia shows that in line with some of the results for developed countries: (1) intergovernmental grants react significantly to increases in government spending; (2) the response of own-source revenues to innovations in government spending in large cities is higher than in the small ones; (3) government investment is highly volatile and responds to innovations in all other budgetary components; and (4) there is no empirical evidence of a reduction in fiscal effort following increases in intergovernmental grants.