Vertical Fiscal Imbalance Research Articles

Exploring Budget Surpluses: Budget Absorption Problems in Recently Decentralized Macedonian Municipalities

ABSTRACT This study treats operating budget surpluses as an absorption problem rather than a strategic fiscal policy. Applying a system generalized method of moments (GMM) model on panel data from 80 Macedonian municipalities for the period 2006–2020, the study examines the relation of decentralization and vertical fiscal imbalance with these systematic operating surpluses. The findings from the study are mixed. The findings from this study are relevant to all developing countries undergoing fiscal decentralization reforms, especially post-socialist countries. This study fills a void in the literature examining non-strategic surpluses in recently decentralized local governments.

Can digital economy mitigate vertical fiscal imbalances in Chinese local government? The role of fiscal transparency

Can digital economy mitigate vertical fiscal imbalances in Chinese local government? The role of fiscal transparency

Politics of local fiscal discipline with vertical fiscal imbalance

AbstractWe examine the political conditions mediating the effect of vertical fiscal imbalance (VFI) on local government fiscal discipline in Ghana. Based on a panel dataset of 216 local governments in Ghana over the period 1994–2018, we adopt both a static and dynamic approach, in addition to a regression discontinuity design. From the results, while alignment may give “free pass,” local governments could leverage same for effective tax efforts. Further, the benefits of lower political competition may reduce where local governments place reliance on central government grants. There is consistent evidence of a negative effect of VFI on fiscal discipline.

How does vertical fiscal imbalance affect corporate green innovation? Empirical evidence from China

The vertical fiscal imbalance of local governments under the Chinese-style decentralization system affects enterprise decision-making in their jurisdiction. Using the data of A-share listed enterprises in Shanghai and Shenzhen, this paper finds that vertical fiscal imbalance can promote enterprises' green innovation. The analysis of the mechanism of action reveals that the vertical fiscal imbalance positively impacts enterprises' green innovation through tax reduction and government R&D subsidies. In contrast, vertical fiscal imbalance's loss of human capital is a negative channel affecting green innovation of enterprises. Further analysis reveals that the vertical fiscal imbalance has a threshold effect on green innovation; the political and environmental backgrounds of senior executives can significantly strengthen the vertical fiscal imbalance's promoting effect on green innovation activities; in addition, the vertical fiscal imbalance can improve the efficiency and quality of green innovation by enterprises. The research findings are significant for further deepening the fiscal reform and encouraging enterprises to achieve green, high-quality enterprise development.

Fiscal decentralisation and renewable energy development: Inhibition or promotion?

In line with global green development and decarbonisation initiatives, China has prioritized renewable energy advancement in recent decades. Given the critical role of financial support, scholarly attention has increasingly focused on the impact of fiscal decentralisation (FD) within this sector. This study investigates FD's effect on renewable energy development, analyzing data from 30 Chinese provinces between 2008 and 2022. Findings reveal that FD tends to impede renewable energy progress. Specifically, a one-standard-deviation increase in FD leads to a decrease of 23.1775 % of a standard deviation in renewable energy development. However, this hindrance can be mitigated by foreign direct investment and central transfer payments, while research and development intensity exacerbates the negative impact. Notably, regions with limited natural resources, weaker environmental regulations, fiscal transparency, high marketisation, energy demand, and vertical fiscal imbalances experience a more pronounced decentralisation-renewable-energy relationship. Anti-corruption campaigns in China can alleviate but not reverse this effect. Furthermore, the diffusion of technology and cooperative efforts in nearby regions positively influence renewable energy development. Nonetheless, overall effects still turn out negative due to competition among local governments under the FD framework. Based on these findings, policy recommendations for accelerating renewable energy development are summarized.

Vertical fiscal imbalances, environmental regulations and resource allocation — in the Chinese context

ABSTRACT Vertical fiscal imbalances (VFI) in China have created significant challenges for resource allocation and environmental governance. This study investigates the impact of VFI on resource allocation in Chinese cities. Results show that VFI intensifies resource misallocation, particularly at the provincial compared to the municipal level. And VFI influences resource allocation via informal and formal environmental regulations, with public and administrative regulations mitigating effects, while supervisory regulations exacerbate them. The negative impact of VFI is especially pronounced in declining cities, non-industrial hubs, and regions with severe resource misallocation. Additionally, VFI and resource misallocation demonstrate negative spatial spillover effects. Our findings provide valuable insights into the influence of VFI across different administrative levels in China, highlighting the need for policy reforms to address these fiscal disparities.

Coordination of monetary and macroprudential policies, land finance behavior and risk prevention in the real estate market

ABSTRACT This paper measures the real estate market risk in China by embedding the relative volatility of stock returns in the real estate industry into the Marginal Expected Shortfall Model. Subsequently, we examine the effectiveness of the coordination of monetary and macroprudential policies in preventing real estate market risk based on panel data from cities. Additionally, we investigate the impact of local government’s land finance behavior on the effectiveness of the coordination of these two policies. The results show that the tightening monetary policy can strengthen the restraining effect of macroprudential policy on real estate market risk. From the perspective of risk prevention in the real estate market, whether it is a quantitative or price-based monetary policy tool, land finance behavior can weaken the regulatory effect of the coordination of monetary and macroprudential policies. Moreover, this weakening effect is more pronounced in the regions with high vertical fiscal imbalance and intense economic competition. One of the important policy implications is that regulatory authorities should strengthen the coordination among local fiscal behavior, monetary policy, and macroprudential policy. This will enhance the effectiveness of the coordination of monetary policy and macroprudential policy to prevent risks in the real estate market.

Vertical fiscal imbalance and public health in China

ABSTRACT Since the outbreak of COVID-19, public health has become a hot topic at home and abroad. This paper provides an empirical analysis aimed at clarifying the role played by vertical fiscal imbalance (VFI) in public health. Utilising China’s provincial panel data from 2002 to 2018, this study finds strong regularities in the effects of VFI. Specifically, VFI is harmful to public health. It also negatively affects public health by inhibiting public health expenditure and aggravating air pollution. In terms of policy implications, governments may improve public health by reasonably controlling VFI between central and local governments.

The Impact of Vertical Fiscal Imbalances and Local Government Tax Efforts on the Quality of Economic Development—A Study Based on Threshold Regression and Simultaneous Equation Models

China’s economy has been growing at a rapid pace in recent years, but the quality of economic development has not been consistent with the quantity, which is not conducive to sustainable economic development. How to improve the quality of economic development and achieve sustainable economic development has become an urgent economic issue for the Chinese government to address. Utilizing panel data encompassing 30 provinces in China from 2008 to 2022, we explore the mechanisms and impacts of vertical fiscal imbalances and tax efforts on the quality of local economic development. For this purpose, this investigation employs threshold regression and three-stage least squares methodologies. The results of the study show that an increase in the level of vertical fiscal imbalance does not contribute significantly to the improvement of the quality of local economic development. However, a vertical fiscal imbalance can suppress the level of tax effort of local government. Moreover, a reduction in local government tax efforts has a favorable effect on the quality of local economic development. As such, a vertical fiscal imbalance promotes economic development indirectly. Therefore, it is necessary to reasonably control the level of vertical fiscal imbalance, build a fiscal relationship between the central and local governments with clear powers and responsibilities, coordinate financial resources and regional balance, and prevent excessive tax efforts from suppressing the production enthusiasm of microeconomic subjects to improve the quality of China’s economic development and realize the sustainable development of the local and national economies.

Local information and the stabilization role of local government: Evidence from a natural experiment in China

AbstractOates, (1972) argues that local governments cannot use conventional policies to stabilize economies, due to fiscal spillovers and beggar‐thy‐neighbor policies. Hayek's theory implies it is efficient for a central government to devolve decision‐making authority to local governments that have informational advantages. This paper tests the different theoretical implications by examining a natural experiment caused by the income‐tax‐sharing reform in China. Our analysis reveals that local government size does have a stabilization effect, but vertical fiscal imbalance (VFI) substantially weakens this stabilizing effect; lack of local information is the key factor leading to this influence of VFI.

The effect of hierarchical medical treatment reform——research based on 205 prefecture-level cities

ABSTRACT The problems, such as difficult and expensive medical treatment, high medical costs, and low efficiency in utilizing medical resources, have been prominent for a long time. The state has taken a series of measures to solve these problems, and hierarchical medical treatment reform is one of the critical measures. This paper uses a staggered DID to empirically analyse the effect of hierarchical medical treatment in 205 prefecture-level cities. The results show that hierarchical medical treatment significantly shortens the hospital day but has no significant impact on visit ratio to primary medical institutions, and average outpatient and inpatient costs in hospitals. The reduction in the hospital stay is smaller in areas with higher vertical fiscal imbalance and fewer medical resources. The important reason for the failure of hierarchical medical treatment to achieve orderly treatment is that, it didn’t effectively improve the resources ratio in primary medical institutions. And the most fundamental reason lies in the incentive of the fiscal decentralization system. Therefore, this necessitates a more targeted approach in the reform to achieve the intended orderly treatment process.

Pollution consequences of vertical fiscal imbalance: Evidence from China

The implementation of fiscal decentralization reform and resulting vertical fiscal imbalance, which is not beneficial for local governmental administration, have been widely observed in the world. This study analyzes how vertical fiscal imbalance affects urban environmental pollution in China. To investigate this relationship, we construct a theoretical model and use prefecture-level panel data from China over the period 2003–2009. We find the emissions intensity of urban pollution to be positively associated with vertical fiscal imbalance. The empirical results hold across various econometric specifications, including instrumental variable estimation and the difference-in-differences method. We also determine that vertical fiscal imbalance increases urban environmental pollution through increased local investment and decreased local effective tax rate. The results call for the normalization of direct access mechanisms for fiscal funds, in the context of sustainable development priorities. Our study provides a theoretical foundation and practical reference for local governments in developing countries to make better decisions regarding fiscal expenditure and the environment.

Why land urbanization is faster than population urbanization: an explanation of vertical fiscal imbalance

ABSTRACT Population urbanization is usually faster than land urbanization from the development process of developed countries, but a completely opposite phenomenon has emerged in China. This article attempts to analyse the potential causes of the above-mentioned imbalances from the perspective of vertical fiscal imbalance through fixed effect model. It is found that for every 1% increase in vertical fiscal imbalance, the urbanization imbalance increases by approximately 14.2%, indicating that the phenomenon of population urbanization lagging behind land urbanization is related to the intensification of vertical fiscal imbalance. In addition, there is a threshold effect of vertical fiscal imbalance, and only when vertical fiscal imbalance exceeds the threshold value will it exacerbate the urbanization imbalance. This study is of great significance for the coordinated development of land urbanization and population urbanization in developing countries.

Health Expenditure Decentralization and Health Outcomes: The Importance of Governance

Abstract Does health expenditure decentralization improve a nation’s health? Should countries care about governance quality when they decentralize healthcare spending to local governments? We answer these questions using cross-country data comprising fifty countries from 1996 to 2018. We find that health spending decentralization worsens health outcomes, which are offset by better governance of government. We calibrate the maximum feasible degree of health expenditure decentralization to have positive effects on health outcomes for a given percentile distribution of governance quality. Countries should be mindful of this negative consequence of health spending decentralization and should ensure that the quality of their governance exceeds a certain threshold to offset this negative externality. We also find that vertical fiscal imbalance is negatively associated with health outcomes, underscoring the role of revenue decentralization in improving the fiscal discipline of local governments by avoiding moral hazard caused by soft budget constraints and the common pool problem.

Fiscal crises, decentralization, and indiscipline

AbstractHow does fiscal decentralization influence fiscal discipline and the probability of a fiscal crisis? Discrete choice analysis used with panel data reveals that crisis probability is associated positively with spending decentralization and negatively with vertical fiscal imbalance. These effects are prevalent in countries with a higher degree of tax revenue decentralization, while a stronger rule of law mitigates such adverse decentralization effects. The findings imply that reduced risk sharing against local shocks under tax revenue decentralization destabilizes the sustainability of a nation's fiscal system. Therefore, policymakers should be cognizant of the undesirable impacts of decentralization on fiscal crisis and indiscipline.

How gubernatorial budgetary power and interest groups affect vertical fiscal imbalances in the US states: Focusing on fiscal centralization and decentralization

AbstractThis study empirically examines the roles of gubernatorial budgetary power and interest groups in vertical fiscal imbalances across US states via a two‐step generalized method of moments estimation during a 22‐year period (1987–2008). States' share of intergovernmental transfers and the local share of intergovernmental transfers are often affected by interaction between governors and interest groups, as are expenditure centralization and revenue/expenditure centralization. Revenue decentralization and the local share of intergovernmental transfers are frequently influenced by cooperation between governors and interest groups via mutual support. Long‐term cooperation and gridlock each influence expenditure centralization, revenue/expenditure centralization, and revenue decentralization. Long‐term cooperation is not statistically significant in terms of the state and local shares of intergovernmental transfers; that is, governors and interest groups cooperate in pursuit of short‐term benefits rather than long‐term results. Long‐term political influence also has no impact, affirming a short‐term‐oriented political viewpoint.

The Impact of Green Finance on High-Quality Economic Development in China: Vertical Fiscal Imbalance as the Moderating Effect

The vigorous development of green finance has become a national strategy in China. Green finance is gradually becoming a key driver of high-quality economic development and a key area of concern for China’s economy and ecological environment. Based on the panel data of 30 Chinese provinces from 2001 to 2019, we analyzed the impact and mechanism of vertical fiscal imbalance (VFI) and green finance (GF) on high-quality economic development (HQD) and then used the fixed-effect model and spatial Durbin model for empirical testing. We found that GF can significantly contribute to HQD, but VFI has a negative moderating effect in contrast to the positive effect of GF on HQD. This negative moderating effect is strongest in the central region. According to the analysis of the spatial econometric model based on geography, economy, and the nested spatial weight matrix, we found that the local GF has a negative spatial transmission effect on the HQD of other regions. Therefore, it is recommended that the coordinated development of green finance among regions be promoted, while affairs and expenditure responsibilities be reasonably distributed between the central and local governments to drive HQD effectively.

Effects of Vertical Fiscal Imbalance on Green Total Factor Productivity—Evidence from China

Green development is the key to safeguarding and improving people’s livelihoods and promoting sustainable development. Based on the provincial data of China for 2004–2019, we developed a general panel model and spatial Durbin model to test the effects of vertical fiscal imbalance (VFI) on green total factor productivity (GTFP). The results show that VFI has a significant inhibitory effect on GTFP; decomposing GTFP into the green technical efficiency change (GEC) and green technological change (GTC) indices reveals that the inhibitory effect of VFI on the GEC and GTC indices is significant and non-significant, respectively; the dampening effect of VFI on GTFP is more significant in regions with high economic growth target, low marketization, or high levels of VFI, and in Midwest, resource-based, or non-municipalities regions. The results of the spatial spillover effect analysis show that VFI has a suppressive effect on GTFP in regions with similar levels of economic development. This study enriches the existing literature by exploring the institutional causes affecting GTFP levels and provides theoretical and practical implications for comprehensively promoting a new round of fiscal system reforms in China and building a modern fiscal system with clear authority and responsibility, thereby promoting sustainable development.

Federal transfers: Leeway to higher regional debt?

The research focuses on the impact of substituting own revenues in Russian regions by federal intergovernmental transfers on the amount of public debt using the concept of vertical fiscal imbalance (VFI). Vertical imbalance emerges as a result of spending assignment exceeding revenue streams at the lower levels of the budgetary system. It leads to a lack of own revenues and creates risks of accumulating deficits and debt buildup. Vertical imbalance is analyzed as a whole and by its components — the deficit of a subject of the Russian Federation and the types of intergovernmental transfers. Shared revenue sources with sharing rates differentiating among regions and allotted at the discretion of regional authorities to local administrations are considered to be regional intergovernmental transfers as well. Quantitative analysis was carried out by panel regression with fixed effects of regions and observation periods based on the data for 2011—2020. It is found that vertical imbalance does not have a significant impact on the amount of debt, as federal intergovernmental transfers do not restrain growth of tax base or efficiency of spending, as laid out by the theory. We refer the low risk of negative consequences to the low powers of regions in generating revenues and big primary spending obligations.

Vertical Fiscal Imbalance and Public Service Expenditure: Effects on Economic Growth Before and During Covid-19 Pandemic

Since 2020, Indonesia has been facing the Covid-19 pandemic for 2 years. Many impacts caused by the Covid-19 pandemic, especially on the economy, have led to a recession. Regional revenues are disrupted during a recession so local governments depend on central government transfer funds. From these issues, researchers suspect that there was a change in the decentralization conditions in East Java province during the Covid-19 pandemic as it was the province with the second largest GDP and has also experienced the greatest impact in Indonesia. This research method uses multiple linear regression with cross-sectional data from 38 district/city data units in East Java province. The results of this study are that the Decentralization Fund, Civil Service Capital Expenditure and the Human Development Index did not change before and during the Covid-19 pandemic. While the vertical fiscal imbalance has a positive influence on economic growth before the Covid-19 pandemic, the vertical fiscal imbalance has no influence on economic growth. This shows that there is another shift in priority in the use of central government finances, as state money is refocused and reallocated to deal with Covid-19. This makes development programs in other health sectors postponed.