Are Fiscal Adjustments Less Successful in Decentralized Governments?

A common political claim is that decentralized governments undermine policy-makers' ability to resist fiscal imbalance. This paper examines how fiscal centralization influences the likelihood of a successful fiscal adjustment. Using a panel of Swiss cantons from 1981 to 2001, we empirically investigate the determinants of successful long-lasting deficit reductions. Contrary to some results in the literature, we find that fiscal centralization significantly decreases the probability of a successful fiscal consolidation when the contravening effects of competitive and cooperative federalism are disentangled. The results also point to an important role of the economic environment, in particular the size of the primary balance in the years before the consolidation, in determining whether adjustment policy is successful.

[1]  T. Goodspeed.  Bailouts in a Federation , 2002 .

[2]  H. Siebert.  The German Economy: Beyond the Social Market , 2005 .

[3]  Helge Berger,et al.  Central Bank Boards Around the World: Why Does Membership Size Differ? , 2006, SSRN Electronic Journal.

[4]  B. V. Praag,et al.  Perspectives from the Happiness Literature and the Role of New Instruments for Policy Analysis , 2007 .

[5]  Byeongchan Seong,et al.  Cointegration Analysis with Mixed-Frequency Data , 2007, SSRN Electronic Journal.

[6]  A. Sutherland.  Fiscal Crises and Aggregate Demand: Can High Public Debt Reverse the Effects of Fiscal Policy? , 1997 .

[7]  J. Hagen.  A note on the empirical effectiveness of formal fiscal restraints , 1991 .

[8]  Ronald J. Shadbegian.  The Effect of Tax and Expenditure Limitations on the Revenue Structure of Local Government, 1962–87 , 1999, National Tax Journal.

[9]  J. de Haan,et al.  Fragmented Government Effects on Fiscal Policy: New Evidence , 2001 .

[10]  Jonathan Rodden.  The Dilemma of Fiscal Federalism: Grants and Fiscal Performance around the World , 2002 .

[11]  Ulrich Thiessen,et al.  Fiscal Decentralisation and Economic Growth in High‐Income OECD Countries , 2005 .

[12]  F. Schneider,et al.  Shadow Economy, Tax Morale, Governance and Institutional Quality: A Panel Analysis , 2007, SSRN Electronic Journal.

[13]  A. Dreher,et al.  Does Terror Threaten Human Rights? Evidence from Panel Data , 2007, SSRN Electronic Journal.

[14]  C. Fuest,et al.  Corporate Tax Policy and International Mergers and Acquisitions - is the Tax Exemption System Superior? , 2007, SSRN Electronic Journal.

[15]  F. W. Scharpf,et al.  Optionen des Föderalismus in Deutschland und Europa , 1994 .

[16]  A. Alesina,et al.  The Political Economy of Fiscal Adjustments , 1998 .

[17]  H. Winner,et al.  Saving Taxes Through Foreign Plant Ownership , 2007, SSRN Electronic Journal.

[18]  George Tsebelis,et al.  Decision Making in Political Systems: Veto Players in Presidentialism, Parliamentarism, Multicameralism and Multipartyism , 1995, British Journal of Political Science.

[19]  Erik Wibbels,et al.  Beyond the Fiction of Federalism: Macroeconomic Management in Multitiered Systems , 2002 .

[20]  Markus M. L. Crepaz.  Consensus Versus Majoritarian Democracy , 1996 .

[21]  F. Schneider,et al.  The Impact of Tax Morale and Institutional Quality on the Shadow Economy , 2007, SSRN Electronic Journal.

[22]  A. Alesina,et al.  Fiscal Adjustments in OECD Countries: Composition and Macroeconomic Effects , 1996, SSRN Electronic Journal.

[23]  Anne O. Kreuger,et al.  Political Economy of Policy Reform in Developing Countries , 1993 .

[24]  Lars P. Feld,et al.  Do Large Cabinets Favor Large Governments? Evidence from Swiss Sub-Federal Jurisdictions , 2004, SSRN Electronic Journal.

[25]  A. Alesina,et al.  Tales of Fiscal Adjustment , 1998 .

[26]  Benedict Clements,et al.  The Phasing of Fiscal Adjustments: What Works in Emerging Market Economies? , 2006 .

[27]  R. Neck,et al.  Sustainability of Public Debt , 2008 .

[28]  Political and Economic Determinants of Budget Deficits in the Industrialdemocracies , 1988 .

[29]  Raising Taxes,et al.  RAISING TAXES THROUGH EQUALIZATION , 2007 .

[30]  R. Inman,et al.  Balanced Budget Rules and Public Deficits: Evidence from the U.S. States , 1996 .

[31]  H. Zou,et al.  The Macroeconomic Impact of Decentralized Spending and Deficits: International Evidence , 2000 .

[32]  John Lewis.  Hitting and Hoping? Meeting the Exchange Rate and Inflation Criteria During a Period of Nominal Convergence , 2007, SSRN Electronic Journal.

[33]  George Tsebelis,et al.  Veto players and the structure of budgets in advanced industrialized countries , 2004 .

[34]  F. W. Scharpf,et al.  Politikverflechtung: Theorie und Empirie des kooperativen Föderalismus in der Bundesrepublik , 1976 .

[35]  Burkhard Heer,et al.  On the Modeling of the Income Distribution Business Cycle Dynamics , 2007, SSRN Electronic Journal.

[36]  Richard Jong‐A‐Pin,et al.  Do political variables affect fiscal policy adjustment decisions? New empirical evidence , 2007 .

[37]  M. Pagano,et al.  Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and the Swedish Experience , 1995 .

[38]  Torben M. Andersen,et al.  The Scandinavian model—prospects and challenges , 2007 .

[39]  Gerdie Everaert,et al.  Success and Failure of Fiscal Consolidation in the OECD: A Multivariate Analysis , 2000 .

[40]  M. Freitag,et al.  Decentralization and Fiscal Discipline in Sub-national Governments: Evidence from the Swiss Federal System , 2007 .

[41]  Michele Bernasconi,et al.  Redistribution or Education? The Political Economy of the Social Race , 2007, SSRN Electronic Journal.

[42]  A. Velasco.  Debts and Deficits with Fragmented Fiscal Policymaking , 1997 .

[43]  Michel André Maréchal,et al.  Framing Effects in Political Decision Making: Evidence from a Natural Voting Experiment , 2007, SSRN Electronic Journal.

[44]  Aleksander Berentsen,et al.  Monetary Policy in a Channel System , 2008, SSRN Electronic Journal.

[45]  B. Jacobs,et al.  Analyzing a Flat Income Tax in the Netherlands , 2007, SSRN Electronic Journal.

[46]  W. Groot,et al.  The Compensating Income Variation of Social Capital , 2007, SSRN Electronic Journal.

[47]  H. Pitlik.  Institutionelle Voraussetzungen marktorientierter Reformen der Wirtschaftspolitik , 2004 .

[48]  Jozef M. van Brabant.  The Political Economy of Policy Reform , 1994 .

[49]  Kenneth A. Shepsle,et al.  The Political Economy of Benefits and Costs: A Neoclassical Approach to Distributive Politics , 1981, Journal of Political Economy.

[50]  J. Wallis.  Understanding the role of leadership in economic policy reform , 1999 .

[51]  Erik Wibbels.  Federalism and the Politics of Macroeconomic Policy and Performance , 2000 .

[52]  M. Pesaran,et al.  Long Run Macroeconomic Relations in the Global Economy , 2007, SSRN Electronic Journal.

[53]  K. Staehr,et al.  Fiscal Policies and Business Cycles in an Enlarged Euro Area , 2007, SSRN Electronic Journal.

[54]  A. Velasco,et al.  Where are we in the Political Economy of Reform , 1996 .

[55]  Hans Jarle Kind,et al.  Newspapers and Advertising: The Effects of Ad-Valorem Taxation Under Duopoly , 2007 .

[56]  D. Rodrik,et al.  Resistance to Reform: Status Quo Bias in the Presence of Individual-Specific Uncertainty , 1991 .

[57]  Rolf R. Strauch,et al.  Fiscal Consolidations: Quality, Economic Conditions, and Success , 2001 .

[58]  H. Sinn.  The Welfare State and the Forces of Globalization , 2007, SSRN Electronic Journal.

[59]  R. Frey,et al.  Finanzausgleich und Föderalismus: Zur Neugestaltung der föderalen Finanzbeziehungen am Beispiel der Schweiz* , 2003 .

[60]  M. Dahan,et al.  The effect of benefits level on take-up rates: evidence from a natural experiment , 2007 .

[61]  Carlos Mulas-Granados,et al.  What makes fiscal consolidations last? A survival analysis of budget cuts in Europe (1960–2004) , 2008 .

[62]  J. Buchanan,et al.  The power to tax : analytical foundations of a fiscal constitution , 1981 .

[63]  Roberto Perotti,et al.  Fiscal Policy in Good Times and Bad , 1999 .

[64]  Huntley Schaller,et al.  Fundamentals, Misvaluation, and Investment: The Real Story , 2007 .

[65]  Lars P. Feld,et al.  Decentralized Taxation and the Size of Government: Evidence from Swiss State and Local Governments , 2003, SSRN Electronic Journal.

[66]  Silvia Ardagna.  Fiscal Stabilizations: When Do They Work and Why , 2004 .

[67]  Panu Poutvaara,et al.  Unemployment and Gang Crime: Could Prosperity Backfire? , 2007, SSRN Electronic Journal.

[68]  Rune Stenbacka,et al.  Equilibrium Unemployment with Outsourcing Under Labour Market Imperfections , 2007, SSRN Electronic Journal.

[69]  Thomas Strobel,et al.  The Ifo Industry Growth Accounting Database , 2007, SSRN Electronic Journal.

[70]  T. Eicher,et al.  Unraveling the Fortunates of the Fortunate: An Iterative Bayesian Model Averaging (IBMA) Approach , 2007 .

[71]  R. Pollak,et al.  Efficiency in Family Bargaining: Living Arrangements and Caregiving Decisions of Adult Children and Disabled Elderly Parents , 2006, SSRN Electronic Journal.

[72]  A. Alesina,et al.  Fiscal Adjustments in OECD Countries: Composition and Macroeconomic Effects , 1997 .

[73]  A. H. Hallett,et al.  Budgetary consolidation in EMU , 2001 .

[74]  Michael Funke,et al.  Environmental policy under model uncertainty: a robust optimal control approach , 2007, SSRN Electronic Journal.

[75]  P. McNelis,et al.  The Money-Age Distribution: Empirical Facts and Limited Monetary Models , 2007, SSRN Electronic Journal.

[76]  J. Stiglitz.  Distinguished Lecture on Economics in Government: The Private Uses of Public Interests: Incentives and Institutions , 1998 .

[77]  J. Poterba.  Do Budget Rules Work? , 1996 .

[78]  R. Veugelers,et al.  Higher Education Reform and the Renewed Lisbon Strategy: Role of Member States and the European Commission , 2007 .

[79]  A. Ciccone,et al.  Resistance to Reform: Status Quo Bias in the Presence of Individual-Specific Uncertainty: Comment , 2004 .

[80]  E. Sadka,et al.  On the Desirability of Taxing Charitable Contributions , 2007, SSRN Electronic Journal.

[81]  Barry Eichengreen,et al.  Restraining Yourself: The Implications of Fiscal Rules for Economic Stabilization , 1995 .

[82]  Sascha O. Becker,et al.  Endogenous product versus process innovation and a firm’s propensity to export , 2007 .

[83]  L. Mello.  Fiscal Decentralization and Borrowing Costs: The Case of Local Governments , 2001 .

[84]  Uwe Serdült,et al.  Kaleidoskop Volksrechte : die Institutionen der direkten Demokratie in den schweizerischen Kantonen (1970-1996) , 1999 .

[85]  U. Woitek,et al.  To React or Not? Fiscal Policy, Volatility and Welfare in the EU-3 , 2007, SSRN Electronic Journal.

[86]  Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries , 1990, NBER Macroeconomics Annual.

[87]  Yin-Wong Cheung,et al.  Does the Chinese Interest Rate Follow the US Interest Rate? , 2007, SSRN Electronic Journal.

[88]  Gabriel Felbermayr,et al.  Does WTO Membership Make a Difference at the Extensive Margin of World Trade? , 2007, SSRN Electronic Journal.

[89]  Wilhelm Kohler,et al.  The Bazaar Effect, Unbundling of Comparative Advantage, and Migration , 2007, SSRN Electronic Journal.

[90]  Allan Drazen,et al.  Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity , 1991 .

[91]  W. Oates,et al.  An Essay on Fiscal Federalism , 1999 .

[92]  José Tavares.  Does Right or Left Matter? Cabinets, Credibility and Fiscal Adjustments , 2004 .

[93]  Thomas Moutos,et al.  Human Capital and the Feldstein-Horioka Puzzle , 2007, SSRN Electronic Journal.

[94]  Gaute Torsvik,et al.  Irreversible Investments, Dynamic Inconsistency and Policy Convergence , 2007, SSRN Electronic Journal.

[95]  Lars P. Feld,et al.  Tax Morale After the Reunification of Germany: Results from a Quasi-Natural Experiment , 2007, SSRN Electronic Journal.

[96]  Lars P. Feld,et al.  Budget Referendums and Government Spending: Evidence from Swiss Cantons , 2000 .

[97]  Marc-Andreas Muendler,et al.  Labor Reallocation in Response to Trade Reform , 2007, SSRN Electronic Journal.

[98]  Hans Jarle Kind,et al.  Price-Dependent Profit Sharing as an Escape from the Bertrand Paradox , 2007 .

[99]  C. Keuschnigg,et al.  Self-Selection and Advice in Venture Capital Finance , 2007, SSRN Electronic Journal.

[100]  A. Haughwout,et al.  On the optimal design of disaster insurance in a federation , 2007 .

[101]  V. Grossmann,et al.  Growth, Development, and Technological Change , 2007, SSRN Electronic Journal.

[102]  Gary Chamberlain,et al.  Analysis of Covariance with Qualitative Data , 1979 .

[103]  Gebhard Flaig,et al.  Does the Euro-Zone Diverge? A Stress Indicator for Analyzing Trends and Cycles in Real GDP and Inflation , 2007, SSRN Electronic Journal.

[104]  Henry Ohlsson,et al.  Political determinants of budget deficits: Coalition effects versus minority effects☆ , 1991 .

[105]  J. de Haan,et al.  Political Regime Change, Economic Reform and Growth Accelerations , 2007, SSRN Electronic Journal.

[106]  D. Rodrik.  Understanding Economic Policy Reform , 2007 .

[107]  M. Pesaran,et al.  On Econometric Analysis of Structural Systems with Permanent and Transitory Shocks and Exogenous Variables , 2007, SSRN Electronic Journal.

[108]  Andrea Zaghini,et al.  Fiscal adjustments and economic performing: a comparative study , 2001 .

[109]  Lars P. Feld,et al.  On the Effectiveness of Debt Brakes: The Swiss Experience , 2006 .

[110]  Giacomo Corneo,et al.  A Theory of Tolerance , 2006, SSRN Electronic Journal.

[111]  Richard E. Wagner,et al.  Democracy in Deficit: The Political Legacy of Lord Keynes , 1977 .

[112]  M. Beine,et al.  Intervention Policy of the Boj: A Unified Approach , 2007, SSRN Electronic Journal.

[113]  Daniel J. Wilson,et al.  State Investment Tax Incentives: A Zero-Sum Game? , 2007, SSRN Electronic Journal.

[114]  J. García-Solanes,et al.  IN SOME NEW MEMBER STATES , 2007 .

[115]  Mattias Polborn.  Competing for Recognition through Public Good Provision , 2007, SSRN Electronic Journal.

[116]  Balázs Égert,et al.  Real Exchange Rates in Small Open OECD and Transition Economies: Comparing Apples with Oranges? , 2006, SSRN Electronic Journal.

[117]  Marc Schramm,et al.  The Development of Cities in Italy 1300 - 1861 , 2007, SSRN Electronic Journal.

[118]  Barry R. Weingast,et al.  The Industrial Organization of Congress; or, Why Legislatures, Like Firms, Are Not Organized as Markets , 1988, Journal of Political Economy.

[119]  James M. Buchanan and Gordon Tullock.  The Calculus of Consent , 1962 .

[120]  J. Poterba.  Budget Institutions and Fiscal Policy in the U.S. States , 1996 .

[121]  Wolfgang Ochel,et al.  The Free Movement of Inactive Citizens in the EU - A Challenge for the European Welfare State? , 2007, SSRN Electronic Journal.

[122]  Nathaniel Beck,et al.  Taking Time Seriously: Time-Series-Cross-Section Analysis with a Binary Dependent Variable , 1998 .

[123]  Ludger Woessmann,et al.  The Role of School Improvement in Economic Development , 2007 .