Full Characterisation of the Political Economy of Fiscal Adjustment: Evidence from Spanish Municipalities

By means of a dynamic panel data analysis, and using a database from municipalities of the province of Barcelona (1993-99), we describe their process of fiscal adjustment to a shock in tax capacity. About 25% of the shock is internalized through an increase in tax effort, 35% through a reduction in public expenditure (mainly investment), while the rest (40%) is covered by an increase in the level of debt (i.e., the adjustment is delayed). However, this process of fiscal adjustment is very much influenced by the political situation of the municipality. Coalition and minority governments (“weak” governments) tend to delay the (unavoidable) fiscal adjustment, and 70% of their shock is covered by an increase in the level of debt, while the rest of municipalities (“strong” governments) adjust immediately (80% reduction in public expenditure and 20% increase in tax effort). Leftist governments mostly tend to react through increases in tax effort, while rightist governments tend to reduce public expenditure to a greater extent. Finally, we find that municipalities tend to react differently to a negative (28%) and a positive (26%) shock with regard to the level of tax effort. Municipalities are thus relatively reluctant to decrease taxes. JEL Code: D78, H61, H62, H71, H72 Postal address: Departament d'Hisenda Pública Facultat de Ciències Econòmiques, Universitat de Barcelona Avda. Diagonal, 690, Torre 4, Pl. 2a 08034-Barcelona (SPAIN) Phone/Fax: 0034934034646/ 0034934021813 * We thank the participants in the ALPES Workshop “Reforms of local fiscal equalization in Europe", Speyer (Germany), in the 2 International Conference of the Japan Economic Policy Association, Nagoya (Japan), and in the XI Spanish Public Economics Meeting, Barcelona (Spain), specially to G. Congleton, P. Else, G. Gilbert, S. Lago, M. Nishikawa, and A. Solé-Ollé for helpful comments and suggestions, although the usual disclaimer applies. Financial support of 2001-SGR30 (Generalitat de Catalunya) and SEC2003-1388 (Ministerio de Ciencia y Tecnología) are gratefully acknowledged.