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Macroeconomic Stability and Fiscal Decentralisation: Implications for Scotland and HM Treasury. Julia Darby, Universit

Fiscal Decentralisation. Growing interest in Fiscal Decentralisation:UK, Spain, France, Italy

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Macroeconomic Stability and Fiscal Decentralisation: Implications for Scotland and HM Treasury. Julia Darby, Universit

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    2. Fiscal Decentralisation Growing interest in Fiscal Decentralisation: UK, Spain, France, Italy… Why? Allocative efficiency; Subsidiarity, democratic accountability and participation; Leviathan; Policy Innovation; Economic Growth(?)

    3. Fiscal Decentralisation Two important points: 1) Sub-central fiscal policy plays significant role in many countries; 2) Central government retains substantial degree of ‘control’ via grants and/or tax sharing.

    4. Decentralised Expenditure

    5. Fiscal Decentralisation

    6. Sources of Revenue

    7. Along with the benefits of decentralisaion are there costs in terms of macroeconomic instability? Decentralisation may lead to policy conflicts between tiers and greater macro instability Policy Disagreements - cause, outcome, solution; Political Economy; Moral hazard – free riding; Loss of central authority. Tanzi (2001), Prud’homme (1995) and Wibbels (2000)

    8. b) Impact on cyclicality of fiscal policy central govt. fiscal policy plays a key stabilisation role combined with fiscal decentralisation? Musgrave (1959): sub-central fiscal policy should be a-cyclical but if revenue sources are pro-cyclical… potentially a source of bias Along with the benefits of decentralisaion are there costs in terms of macroeconomic instability? (continued…)

    9. Existing Literature Considerable literature discussing pro-cyclical biases in (general government) fiscal policy, for recent surveys see IMF (2006), EC (2004, 2006), OECD (2003). At the same time, a number of economists claim that greater sub-central fiscal autonomy leads to a lesser degree of macroeconomic control, cf. Rodden 2002, Rodden and Wibbels, 2002, Tanzi, 2001 but empirical evidence on this is sparse and typically restricted to individual country studies.

    10. Pro-cyclical bias Consequences: counteracts automatic stabilisers, exacerbates cycle; at odds with tax smoothing, distortionary; damaging for welfare; expansionary policy used in good times, not offset ? deficit bias, debt accumulation ? sustainability?

    11. Pro-cyclical bias Causes? cyclical ratcheting of expenditure; electoral cycle & weak institutions; fiscal rules; uncertainty surrounding potential output & output gap; other factors – e.g. corruption.

    12. Our Analysis Darby and Roy (2007 in progress) “Exploring Pro-Cyclical Bias in Sub-Central Fiscal Policy: Evidence, Likely Causes and Implications” How does sub-central fiscal policy behave in light of the business cycle? Is the nature and/or level of fiscal decentralisation an important factor in determining this behaviour? What institutions and/or fiscal structures are best suited to providing macroeconomic stability?

    13. Data IMF Government Financial Statistics, 2002 Edition Best source of internationally comparable data on fiscal variables disaggregated by tier of government Consistent data for 14 OECD countries Sub-divided: Central, State and Local Unbalanced panel: 1970-2000

    14. Econometric Specification – System 1

    15. Econometric Specification – System 2

    16. Robustness checks Alternative measures of cycle: Change in output gap Change in log real GDP (per capita) 3SLS estimates - instrument output gap instruments = lags of output gap, fiscal deficit, long run real interest rate, inflation and contemporaneous terms in log OECD output, exports and oil price inflation.

    17. Results: Sub-Central Revenue

    18. Results: Sub-Central Tax Revenue

    19. Which Taxes?

    20. Which Taxes?

    21. Results: Sub-Central Tax Revenue

    22. Results: Sub-Central Tax Revenue

    23. Results: Grants

    28. Key Findings: Countries that rely on sub-central taxation (excluding property tax) face pro-cyclical sub-central revenues. Grants from Central Govt. are not used to offset this. Pro-cyclical revenues spill-over into expenditure: Capital Expenditure – highly pro-cyclical Current Expenditure – pro-cyclical (especially in countries with high levels of sub-central tax decentralisation and limited borrowing autonomy).

    29. Implications for Scotland and HM Treasury Current position: The Scottish Government’s budget is currently insulated, to a high degree, from fluctuations in the Scottish and UK economies. Macro stabilisation through automatic stabilisers operate at UK Government level. The Scottish Government and UK local government currently face relatively predictable revenues.

    30. Implications for Scotland and HM Treasury Proposals? Local Income Tax Greater revenue autonomy Greater fiscal decentralisation

    31. Implications for Scotland and HM Treasury Example - Local Income Tax replace council tax with a 3p tax on earned income BUT Council tax – a-cyclical Income tax – pro-cyclical SO the switch would result in pro-cyclicality the revenue stream and less predictability ? more risk borne by the Scottish Government.

    32. Implications for Scotland and HM Treasury Implications Adverse impact on 3 yr spending plans. Possible adverse impact from Scottish imbalances on UK macro stability. Remedies Constrained borrowing over the cycle? System of transfers from UK Government? Continuing Research Lessons from how other countries design institutional arrangements, including sub-central fiscal rules.

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