FISCAL ASPECTS OF EVOLVING FEDERATIONS Issues for Policy and Research

There has been a resurgence of interest, in many parts of the world, in problems of multi-level government finance. Recent and ongoing political and economic developments raise questions about the role of the nation, subnational governments, and supranational public authorities in the provision and financing of public-sector programs. This paper presents a selective survey of some of these developments and identifies issues for research. Problems of fiscal decentralization and intergovernmental fiscal relations are of wide-spread concern in developing countries. These issues also arise in the context of European economic integration. However, established federations in developed countries, particularly the United States and Canada, have been the traditional focus of economic research on fiscal federalism. This paper reviews selected major policy issues and trends involving multi-level government finance and intergovernmental fiscal relations in different parts of the world. Widely varying political and economic systems, levels of economic development, and legal, constitutional, and fiscal traditions form the milieu within which the responsibilities of different levels of government are determined. Since specific local historical and institutional factors vary widely across the world, the specific problems confronting policymakers also vary substantially. Economic analysts and policymakers can potentially benefit from the broader perspective that can be obtained from study of the problems of intergovernmental fiscal relations encountered in other countries and regions. Recent experience with fiscal decentralization in numerous developing and transition economies has led many observers to question whether fiscal decentralization undermines macroeconomic stability. In several countries, central government transfers to lower-level governments have increased fiscal deficits at the central level, creating pressures on central banks to monetize additional debt and thus jeopardizing price stability. In other countries, central governments attempting to control their deficits have reduced transfers to lower-level governments, creating fiscal distress at lower levels. By contrast, these issues of macroeconomic fiscal stability have not featured prominently in North American policy debates concerning fiscal federalism, nor has much academic research been devoted to them. An important question both for policy and research is to identify those institutional structures of mature and stable federations which help to sustain satisfactory macroeconomic performance. Establishing ``hard" rather than ``soft" budget constraints in intergovernmental fiscal relations appears to be one important institutional development that can allow fiscal decentralization to proceed without loss of essential fiscal restraint. FISCAL ASPECTS OF EVOLVING FEDERATIONS Issues for Policy and Research