Incentives or Regulation? The Effects of Fiscal Rules and Subnational Tax Autonomy on Government Finances

Abstract

An important problem for governments around the world is how to deal with the balance of public finances. Especially during the last 30 years, public finances have come under considerable strain, due to high spending obligations, for example for pensions or health care. To deal with raising deficits and debts, many countries regulated their own discretion to run deficits and debts. In addition, encouraged by research on fiscal federalism, governments delegated taxation powers to subnational and municipal governments. This paper examines the impact that fiscal rules and tax autonomy have on national deficits during the time period 1995-2012, based on a sample of 29 OECD countries. The results suggest that, overall, fiscal rules come along with lower government deficits. Contrary to existing research, the results show that higher tax discretion for member states in federal countries and municipalities are correlated with higher overall government deficits. These results provide insights into fiscal governance that are important for researchers and policymakers alike.