Vertical Fiscal Imbalances and the Accumulation of Government Debt

Delegating fiscal decision making power to sub-national governments has been an area ofinterest for both academics and policymakers given the expectation that it may lead to betterand more efficient provision of public goods and services. Decentralization has, however,often occurred on the expenditure and less on the revenue side, creating "vertical fiscalimbalances" where sub-national governments' expenditures are not financed through theirown revenues. The mismatch between own revenues and expenditures may haveconsequences for public finance performance. This study constructs a large sample of generaland subnational level fiscal data beginning in 1980 from the IMF's Government FinanceStatistics Yearbook. Extending the literature to the balance sheet approach, this paperexamines the effects of vertical fiscal imbalances on government debt. The results indicatethat vertical fiscal imbalances are relevant in explaining government debt accumulationsuggesting a degree of caution when promoting fiscal decentralization. This paper alsounderlines the role of data covering the general government and its subectors forcomprehensive analysis of fiscal performance.