Abstract
This study provides an empirical investigation of fiscal interactions in the context of a developing country. I examine three fiscal components—budget balance, tax revenue, and public spending—to measure spatial interactions between Colombian municipalities from 2000 to 2010. I am using variables on municipalities’ general characteristics, fiscal variables, and variables related to the conflict. I use a quasi-experimental identification strategy exploiting exogenous variation from global oil price shocks that affect Colombian municipalities to different degrees depending on local oil endowments. I find significant spatial interaction in taxes but no significant interaction concerning budget balance and total public spending. This suggests that even though there is local tax competition, municipalities do not mimic their neighbors to decide whether to offset tax changes by changes in borrowing or spending.
Highlights
Fiscal decentralization reform in developing countries has been advancing, in the last two decades
The results show that the spatial interactions of budget balance and total public expenditure are not significantly different from zero when identifying the spillover effects based on the quasi-experimental variation
The results indicate that municipalities have a higher budget balance and spend more when receiving royalties from oil extraction
Summary
Fiscal decentralization reform in developing countries has been advancing, in the last two decades. The goal of fiscal decentralization in developing countries focuses primarily on revenue transfer and reassigning expenditure decisions to the sub-national level. Many developing countries have been involved in fiscal decentralization by providing local governments with different fiscal autonomy levels with the possibility of fiscal interaction among local jurisdictions in those countries. Local government budgets are required to be balanced by law in many developing countries. In some developing countries, there is no budget balance requirement, resulting in a severe fiscal gap to maintain the budget balance with the controlled revenue capacity of local government. Most developing countries’ local governments run a deficit budget instead of a surplus because of their limited revenue source and the degree of revenue autonomy
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