A Dynamic Model of Fiscal Decentralization and Public Debt Accumulation
This paper develops a dynamic infinite-horizon model with two layers of governments to study theoretically and quantitatively how fiscal decentralization affects local and central government debt accumulation and spending. In the model, the central...
| Main Authors: | , , |
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| Language: | English |
| Published: |
World Bank, Washington, DC
2022
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| Subjects: | |
| Online Access: | http://documents.worldbank.org/curated/en/734581644250111392/A-Dynamic-Model-of-Fiscal-Decentralization-and-Public-Debt-Accumulation http://hdl.handle.net/10986/36968 |
| Summary: | This paper develops a dynamic
infinite-horizon model with two layers of governments to
study theoretically and quantitatively how fiscal
decentralization affects local and central government debt
accumulation and spending. In the model, the central
government makes transfers to local governments to offset
vertical and horizontal fiscal imbalances. But the
anticipation of transfers lowers local governments’ expected
cost of borrowing and leads to overborrowing ex ante. Absent
commitment, the central government over-transfers to reduce
local governments’ future need to borrow, and in the
equilibrium both local and central debts are inefficiently
high. Consistent with empirical evidence, when fiscal
decentralization widens vertical fiscal imbalances, local
governments become more reliant on transfers, and both local
and central debts rise. Applied to Spain, the model explains
39 percent of the rise in total government debt when the
vertical fiscal imbalances widened during 1988–1996, and 18
percent of the fall in debt when the imbalances narrowed
during 1996–2006. |
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