Subnational Finance Research Articles

Subnational public debt sustainability in Mexico: Is the new fiscal rule working?

In 1997, after a costly bailout, the central government of Mexico passed legislation intending to improve subnational finances through fiscal decentralization. As a result, many states rapidly began to accumulate debt during the following decade. Subnational public debt grew threefold between 1996 and 2006. The global financial crisis only aggravated the debt accumulation problem, which increased by 320% between 2006 and 2016. In response, a new law with a set of fiscal rules for subnational governments was enacted in 2016, namely, the Law of Fiscal Discipline (LDF) for states and municipalities. This study evaluates the impact of the fiscal rule alert system on the levels of debt accumulation across Mexican states. Using a quarterly panel dataset comprising the period 2013–2020 and employing difference-in-differences techniques, we observe a significant reduction of 4% in public debt between treated and untreated states and 5.8% in debt per capita. Moreover, we document that even after the first wave of the COVID-19 pandemic, the new fiscal rule effectively reduced the pace of subnational public debt in Mexico.

The Impact of the COVID-19 Pandemic on Subnational Finance: Polish Experience

Abstract In the face of the COVID-19 pandemic, governments worldwide established various mechanisms to facilitate the pandemic response and ensure the state’s functioning. As a consequence, the economic impact of the COVID-19 crisis varies in countries, depending on the region. We are looking for answers to research questions: how the COVID-19 pandemic influenced the finances of local government institutions in 2020–2021; Is it possible to distinguish the types of units where this impact was greater or smaller, and whether and how the pandemic-related legislation influenced the fiscal relations between the state and local government, especially in the context of the local government institutions’ financial independence. We have noticed that financial solutions dedicated to local government units, as well as making local government fiscal rules more flexible, allowed to maintain the potential of the local economic base. They also had a diversified impact on the Polish local government institutions’ income level.

Assessment of regional measures of tax support for business in the context of the COVID-19 pandemic

The implementation of quarantine measures and the decline in economic activity in 2020 became an impetus for the implementation of a stimulating tax policy not only at the federal, but also at the subnational level. The article examines the experience of countercyclical fiscal policy in the OECD countries, highlights the factors of relatively modest tax support provided to small and medium-sized businesses at the subnational level. The object of the study is stimulating tax expenditures provided in accordance with the legislation of the Russian regions to support economic entities in the conditions of restrictive measures caused by the spread of a new coronavirus infection. The research methodology is based on the methods of formal logic, statistical and econometric analysis. The scientific novelty of this study consists in conducting a comprehensive analysis covering all subjects of the Russian Federation in which stimulating tax expenditures were actually provided, and assessing the regional tax policy implemented during the COVID-19 pandemic through the prism of key budget parameters and indicators of socio-economic development. The regional tax policy was carried out in conditions of large-scale fiscal support from the federal center and deterioration of the state of subnational finances due to the growth of deficit budgets. During the 2020 pandemic, the constituent entities of the Russian Federation provided tax benefits on taxes that account for a small share in the revenues of regional budgets. Since the main purpose of tax incentives was to solve liquidity problems and maintain employment, investment tax incentives for corporate income tax were not introduced in Russian regions. The study of the actual and forecast dynamics of GRP allowed us to conclude that the tax support measures implemented in the Russian subjects stimulated economic activity and helped to smooth out the negative consequences of the coronacrisis.

Debt Policy for the Sustainable Development of Russian Regions and Megacities

Relevance. In recent years, the role of ESG (Environmental, Social and Governance) bonds has been rapidly growing in the world. ESGs are used to raise funds for programs for sustainable development of territories. Research objective. The paper studies the cases of Russian regions using green bonds and considers the prospects of this tool in the Russian context. Data and Methods. The analysis focuses on the debt indicators of Russian regions and related budgetary indicators based on open source data from the Ministry of Finance, the Treasury, and independent rating agencies. The methods of comparative and retrospective analysis are used to identify the state and features of regional debt policy. Results. Our analysis of the debt policy of Russian regions and megacities shows a low level of their activity in the stock market as issuers of bonds. This can be explained by the complexity of the system of subnational finances and the role of the Federation in preventing default situations, and therefore the priority use of budget loans. The city of Moscow was a pioneer in this matter in Russia. This determines the uniqueness of Moscow's experience in implementing debt policy. Conclusions. The expansion of the green bond practice will allow Russia to move forward in achieving the goals of ESG agenda, which, despite the large-scale sanctions imposed on Russia at the moment, still remains relevant.

Testing regional intergovernmental transfers effects in Uruguay

Using an unbalanced panel of 18 Uruguayan regional governments from 1991 to 2017, we explore the hypothesis of flypaper and asymmetrical effects on the regional public expenditures. Specifically, the flypaper hypothesis states that the propensity of sub-national governmental units to spend intergovernmental unconditional transfers is higher than the propensity to spend on the demand for regional public services by local private agents. The application of panel data techniques with the use of instrumental variables highlights the presence of sizeable flypaper effect but not asymmetry ones. Our estimations also identify that political economy factors play an important role in the regional budgeting processes in Uruguay. This paper contributes to the scarce empirical evidence about the effects of unconditional central government transfers on subnational finances for middle-income countries.

Performances in COVID-19 Management across Countries: Do Subnational Finances Matter?

The spread of the COVID-19 pandemic has emphasized the role of governments in a public health emergency not only in developing countries but in the developed world as well. This paper has a two-fold objective. First, we investigate the efficiency of COVID management using state-level data from three of the worst affected countries, the USA, India, and Mexico, in three time periods in the pre-vaccine phase. Next, we explore the extent to which state government financial, sociodemographic, and governance indicators can explain the difference in efficiency. We use a two-stage non-parametric method. The first stage comprises meta frontier analysis to derive efficiency scores for each state. We analyze state governments in these countries together (grand frontier) and separately (group frontier). Overall, grand efficiency continuously increased from August to November 2020. The grand efficiency scores of Mexico and the USA gradually increased on 3rd October and 29th November 2020. The results reflect that the USA was holding the leading position in terms of COVID-19 pandemic management at that time. In terms of group efficiency, American states performed consistently well with respect to their own country as well as other countries. However, if we compare the grand and group efficiency scores of all three countries, we find that states in India and Mexico performed well in their own countries but worse than USA states in terms of the global scenario. The states of India always performed better within their own country than the states of the other two countries. The second analytical stage uses an exploratory median analysis to investigate the impact of different indicators on efficiency. State finance variables are positively associated with the grand efficiency score for all three time periods, while the association is negative for the expenditures to own revenue ratio and expenditures to total revenue ratios, debt ratios with respect to different fiscal indicators, and percentage of health expenditure over total expenditures and GSDP. These patterns are less consistent among countries when we look at group efficiency over time. We find a positive association of per capita total revenue with group efficiency scores for all countries over all time periods.

Examining the implications of classical budget theories in the local government budgeting process: Union councils in Bangladesh

Background: In many countries, local governments are neither well equipped nor properly accountable for performing their functions smoothly. They have also failed to become effective strategic partners of the national government and other levels of subnational governments. They have neither sufficient tax-base and local resource-entitlement nor full-bodied intergovernmental support. But the demands for services and goods continue to exceed the supply at local-government level in Bangladesh and elsewhere. As a result, the local government planning and budgeting issues become centrally positioned in the debate on the subnational level decentralisation, especially concerning fiscal decentralisation and political economics of local governments.Aim: Keeping this fact in mind, the study examined the implications of classical budget theories in the local government budgeting process, particularly in the budgetary process and decisions of local government union councils in Bangladesh.Setting: The data collection period was January 2018 to February 2018. The units of analysis of this study are ‘the classical budget theories’ and the lowest tier of the rural local government institutions in Bangladesh – that is, ‘the union. councils’.Methods: The study followed ‘focused synthesis’ and ‘qualitative case research’ methods for data collection and used the epistemological view ‘positivism’ for data analysis.Results: The study contributed to the literature stream of local government studies, public budget theory, subnational finance and budgeting, and the political economics of the local government.Conclusion: This research reveals that ‘budgetary incrementalism’ and ‘high conditionality’ to inter-governmental transfers undermine the essence of community stakeholders’ consultations and spirit of local governance. It also unveils that central limitation towards effective functioning of a local government union council in Bangladesh is more related to the crisis of ownership and competence of the elected council rather than just to the external influences that somewhat affect their autonomy in the budgeting process and decisions.

Starting from scratch? A new approach to subnational public finance

ABSTRACT The arrangements for lower level governments to finance public goods are complex. Combinations of grant mechanisms and local taxes are often regarded as unfair, opaque or ineffective, and therefore tend to lack legitimacy. This paper explores the design of a new fiscal framework for regional public finance, building from principles rather than an ad hoc political process. It also considers the possibility that a region may choose to leave the federation or union. To offset this possibility, and within certain bounds, our framework allows subnational jurisdictions to decide unilaterally how much tax autonomy and fiscal responsibility they wish to adopt.

La desigualdad estructural de la inversión educativa por alumno en Argentina entre 1991-2019

Basic education in Argentina is organized under a federal and decentralized scheme. The concern for equity and redistributive justice in educational financing under this scheme presents particularities and complexities that need to be understood in order to address the inequality around educational investment. The decentralization of educational institutions to subnational jurisdictions generated two institutionalized effects. The structural inequality of educational investment per student under state management at the subnational level and, at the same time, it has been almost three decades that the national state has not directly managed the Educative offer. From the perspective of the theory of fiscal federalism, intergovernmental fiscal tools are designed that allow an impact on inequities and inequalities between both levels of government. The educational investment gap with subnational financing increased from 5 to 8 times between the lowest and highest investment. The national State, established with funds of national origin to reduce it to between 3 and 5 times, remaining constant throughout the period. The incidence of transfers of national origin made it possible to reduce the gap of structural inequality in educational investment between subnational jurisdictions, although the challenge consists in planning financing in the search for equity and distributive justice under this federal and decentralized scheme.

Public investment versus government consumption: how FDI shocks shape the composition of subnational spending in Mexico

During the 1990s, many developing countries underwent simultaneous processes of global economic integration and decentralization. As a result, subnational governments became increasingly important actors in the international economy, including through policies to secure investments from multinational corporations (MNCs). These efforts have the potential to affect the management of public resources at the subnational level. Breaking from the literature's focus on fiscal incentives, we highlight how “active” foreign investment incentives—including commitments to build new infrastructure and develop worker training programs—have shaped subnational public finances in Mexico. We demonstrate that FDI attraction affected how subnational governments exercised their growing policy authority and fiscal resources. Based on panel data from Mexican states between 1998 and 2017, we find that FDI shocks are associated with statistically and economically significant increases in public investment by state governments, and decreases in public sector consumption of goods and non-personnel services. A case study of a representative investment project in Puebla highlights the importance of active investment incentives as a causal mechanism linking FDI attraction and subnational spending outcomes. Our results illustrate how FDI attraction can affect the distribution of subnational public spending and also develop a theoretically-relevant distinction between passive and active investment incentives.

Can subnational accounting give an early warning of fiscal risks?

The early detection of state and local fiscal problems can help in resolving them quickly before they turn into crises. Early detection should be easier if subnational governments prepare high-quality accounts. A survey and case studies were therefore undertaken to investigate the nature of subnational accounting in OECD and key partner countries, as well as the use of subnational accounts by national governments that monitor subnational finances. The results show that in many countries subnational accounting has characteristics that should help in the early detection of fiscal problems, including the use of accrual accounts prepared according to largely harmonised standards. Many national governments use a wide range of indicators from the accounts to monitor the financial health of subnational governments. However, there is room for progress including in the monitoring of non-financial assets and reporting of currently off-balance sheet liabilities.

Descentralización subnacional, autonomía y disparidades fiscales en Brasil

Este trabajo es un estudio aplicado de finanzas públicas subnacionales enfocado en los aspectos de descentralización, autonomía e incidencia fiscal territorial en Brasil. Se presentan mediciones y estimaciones de descentralización, autonomía e igualdad territorial de oportunidades (de gastos, ingresos propios y transferencias) en el sector subnacional y se evalúa el impacto regional de políticas fiscales alternativas. Los resultados muestran que los Estados y Municipalidades son un conjunto muy heterogéneo, que existen fuertes desequilibrios fiscales horizontales, que las transferencias tienen un componente distributivo que los atenúan, pero no los compensan totalmente, y que puede esperarse un rol creciente de los gobiernos municipales.

Decentralisation and income inequality in Central and Eastern European countries

This paper provides empirical evidence for the association between fiscal decentralisation and income distribution for a panel of 11 economies from Central and Eastern Europe (CEE) during 1992–2016. We focus on three research topics: the effect of decentralisation on income inequality; the effects of the structure of subnational government finance on income inequality; and the validity of the Kuznets hypothesis. The main findings from the empirical exercise are as follows: first, we provide firm evidence on the presumed favourable effects of fiscal decentralisation on income distribution in the CEE countries; second, our empirical model suggests that the effects of fiscal decentralisation on income inequality are dependent on the source of finance of subnational governments, i.e. intergovernmental transfers may have a role in income equalisation; third, we cannot confirm the validity of the Kuznets hypothesis in CEE countries.

Distributive Politics under Institutionalized Authoritarianism: Evidence from China's Subnational Land Finance

In this research we advance a theory to explain the distributive politics under an institutionalized single-party regime. We argue that the need of support from below, and therefore the need of support-buying, varies with the degree of power concentration among the authoritarian leadership. Compared with the scenario in which a few leaders have concentrated more power in their hands, when power are dispersed more evenly among political leaders, they face more competition, more uncertainties and risks, providing them with greater incentive of dispensing benefits to their constituents in exchange of their loyalty and support. To test the theory, this study uses a provincial-year panel data spanning 2003-2012 to examine how provincial power concentration in a provincial leadership is related with land finance within its jurisdiction, a policy practice that tilts the interest distribution disproportionately towards local politicians at the costs of the marginalized and powerless groups. The empirical results robustly show the less (more) power concentrated in the provincial leaders, the greater (less) extent the province will allow the practice of land finance to please the local officials.

Local government finances in Hungary: From the culprit of fiscal slippages to a source of stability?

While in the decade prior to 2010 Hungarian local governments had been a notorious contributor to budgetary slippages and growing public indebtedness, the sector’s balance has subsequently turned to positive in the context of a wide-ranging centralisation effort and the corresponding revamp in subnational financing arrangements. The fiscal indicators therefore, prima facie, point to a transformation of a regular sinner into a source of stability. Based on a detailed account of the recent reform steps and the preliminary assessment of their first impacts, this study argues that it is too early to conclude that the observed positive developments are the structural results of the measures taken over the last five years. The enacted institutional streamlining, the new debt authorisation rule and the increased tapping of the local tax potential should all have a lasting positive impact on public finances. Nonetheless, the intended efficiency gains due to economies of scale in service provision are not yet apparent, insofar as no reduction has been achieved in the headcount of the concerned branches. Moreover, the observed non-differentiation in the debt assumption may raise the spectre of moral hazard for the municipalities in the longer run.

Subnational fiscal sustainability, risk sharing and "fiscal fatigue" in Colombia

Colombia has engaged in a sustained process of fiscal decentralisation over the past decades. This paper analyses three aspects of fiscal performance for Colombia’s departments. First, it studies the sustainability aspects of subnational finances by estimating a fiscal reaction function. Evidence is presented that the current framework is conducive to fiscal sustainability, especially after the reforms in the late 1990s and early 2000s. Second, the paper analyses the impact of transfers and oil and mining royalties and the effort to raise own tax revenues at the departmental level. Overall, there is little evidence of a negative effect of transfers from the central government on departmental tax revenue, the so-called “fiscal fatigue”. Finally, the paper presents evidence of a limited degree of risk sharing of departmental idiosyncratic shocks, as transfers from the central government are mostly pro-cyclical.

Revenue Pressure on Mexican Municipalities: Does it Lead to Greater Accountability?

subnational finance; local public finance; local accountability; local taxation; property tax; fiscal federalism; fiscal decentralisation; Mexican municipalities; tax bargaining.

Destined to be defaulted: Local government insolvency and bailout in post-transition Hungary

This paper reviews the waves of democratization and the development of the public administration and public finances in Hungary, with special attention municipalities caused by the changes in sub-national finance regulation since 2010. During the transition yeas, Hungary was very forward looking and the first among CEE countries to end central planning and to introduce market rules into the economy. Everybody expected the decentralization to be a success story. 25 years later, Hungary not only failed to meet the expectations, but also undergone though a situation in 2008 to start a massive recentralization process. This paper puts fiscal decentralization in Hungary in a historical context while critically investigating the findings of recent literatures on decentralization process in Hungary. The critical investigation of past experiences and reform steps of the current government suggest possible reform measures to solve the financial problems of Hungarian municipalities.

Fiscal Decentralization and Economic Integration in Mercosur: Argentina and Brazil

ABSTRACT This article examines the relationship between economic integration and fiscal decentralization for Argentina and Brazil. Economic openness adds costs and benefits to fiscal decentralization, beyond those analyzed in closed economies. The relationships among variables with panel data for the period 1988–2005 are estimated. The innovation of the article lies in considering decentralization at the level of states/provinces. In Brazil, the effect of openness on decentralization is negative and significant, both for expenditures and revenues; in Argentina, the effect is negative or not significant. This difference between countries is based on the different structure of subnational government financing.

Problems of regional development as the reflection of the effectiveness of public administration

Abstract. Economic policy of extreme neoliberalism, having been held in Russia for more than twenty years, has led to the present stagnation of socio-economic development of the country. Its concentrated expression has resulted in a rapid deterioration of the budgetary system, especially at the regional level. In the next three-year budget cycle (2014–2016) a great number of Russian regions will be with the deficit and debt load on the verge of bankruptcy. The Russian government doesn’t take any action to prevent crisis processes. On the contrary, the Ministry of Finance, as the conductor of rigid conservative policy, in a less degree is interested in making regionally oriented decisions. Trying to shift the blame for what is happening in the public sector to the regional authorities, the Minister of Finance has offered to the President to dismiss regional governors who have chronic debts. However, this is unlikely to solve the debt problem, because at the present time, the regions have more expenditure commitments than resources for their providing. On the basis of the analysis of the situation in the field of subnational finance, the authors have come to the conclusion that it is necessary to change the approaches to fiscal policy in the system of regional regulation and offer a number of measures in this direction.