Fragmentation and Vertical Fiscal Imbalances Lessons from Moldova

Abstract

Using a novel municipality-level panel dataset, this paper investigates the empiricalcharacteristics of vertical fiscal imbalances (VFIs) in Moldova over the period 2005–13. Theresults show that the extent of variation in VFIs across 898 municipalities can be explained bythe level of per capita income, fiscal capacity, and demographic characteristics, as well as thecentral government’s fiscal behavior that reflects fiscal constraints and policy preferences atthe national level. Political affiliation does not appear to be a significant factor, and the resultsare inconclusive in terms of direction. While some model specifications show larger VFIswhen the mayor of a municipality belongs to the same party ruling the central government,other models suggest better coordination and thus lower VFIs. Altogether, these findingsunderscore the need for well-coordinated reforms to create economies of scale, enhancerevenue collection, and improve the composition of spending at the subnational level.