Fiscal equalisation schemes and sub-central government borrowing

Résumé

This paper analyses the role played by the fiscal equalisation scheme in determining subnational public borrowing in decentralised countries. We show theoretically how the regional income redistribution modifies the intertemporal budget constraint of the regions and discuss the conditions under which the federal equalisation arrangements are likely to lead to diverging borrowing between rich and poor regions. We test empirically the link between regional government primary balances and the level of GDP per capita in Canada, Germany and Spain. Our econometric analysis shows that this relationship can be either positive (as in the German case) or negative (as in the Canadian and Spanish cases), thus suggesting that either poor or rich regions can display higher regional public borrowing on average. We attribute these results to the differences in the design of the fiscal equalisation schemes and illustrate this through numerical simulations of our model. These results suggest that reforms of the federal financing schemes can prove instrumental in reducing regional heterogeneity in public borrowing.