FISCAL CONSOLIDATION AND DECENTRALISATION: A TALE OF TWO TIERS



the general government total in Denmark. Even in the UK, still a relatively centralised
country, this figure was 22%. Financing responsibilities also vary, with at least some
countries avoiding passing on major revenue raising responsibilities. It is relevant to ask
whether the central tier retaining control over financing obligations makes fiscal consolidation
attempts more or less likely to succeed. In what follows we analyse the roles played by central
and sub-central tiers of government during general government fiscal consolidation attempts
and show that it is possible to gain a more refined view of both the mechanics of the
consolidation process and of the conditions conducive to success.

To anticipate our key results, we begin by verifying a result from the existing literature that
successful consolidations tend to be based upon expenditure cuts as opposed to increases in
revenue. We show however, that this result is robust to a more refined measure of the success
of consolidation attempts, and holds at both central
and sub-central tiers, indeed the majority
of consolidations involve shared effort across tiers of government. Compositional analysis
confirms another existing result; that tackling the government wage bill helps achieve lasting
consolidation. We demonstrate that the involvement of sub-central tiers of government is
crucial to achieving these cuts in the wage bill. However, our results also demonstrate that a
consolidation attempt is less likely to be successful if the relative brunt of the consolidation is
skewed toward the sub-central tier. Moreover, we show that high levels of expenditure
decentralisation may result in a fiscal environment that is not conducive to successful
consolidation attempts, by limiting the ability of central governments to sufficiently tighten
their expenditures. Our analysis of revenue by source reveals that many central governments
exert a strong influence on the expenditure of sub-central tiers through their grant allocations.
Changes in these allocations essentially ‘force the hand’ of the sub-central tiers to adjust
expenditures so have a considerable impact upon the successfulness of consolidation attempts.

An apparent downside is revealed in the analysis of the composition of expenditure in that
there is a bias toward cuts in local/regional public investment programs (although the largest
adjustment in absolute terms centres upon the wage bill).

Finally, when sub-central governments enact consolidation attempts that are not part of a
central government consolidation, their cuts focus almost exclusively upon capital
expenditure, as opposed to increases in ‘own-source’ revenues or cuts in current expenditure.
The skewness toward cuts in capital expenditure represents a genuine cause for concern, as
they are likely to have long-term implications for local service provision. We discuss all these
results in more detail below, but overall they lead us to conclude that the separate roles of

2 A recent comparative review of the extent of decentralisation of spending responsibilities and fiscal autonomy of
sub-central governments is provided in Darby et al. (2003).



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