Deficits and Control of Deficits in Spanish Local Governments

1. Deficits and Control of Deficits in Spanish Local Governments Francesc Pujol Universidad de Navarra Post-graduate studies in political economy, Champéry, September 30 2004

2. 1. The Context • The Decentralisation Process in Spain • The Ley General de Estabilidad Presupuestaria

3. The Decentralisation Process in Spain Source: Molero (2002)

4. The Decentralisation Process in Spain Source: Molero (2002)

5. The Decentralisation Process in Spain • Spain as a decentralised country • Regions as clear winners of the decentralisation process • Regions actually run the competencies established in the Constitution • An increase of fiscal autonomy for regions since late 90s • Issues on interregional solidarity now emerge (extent of perequation) • Local Governments waiting for a second round of decentralisation

6. The Spanish Ley General de Estabilidad Presupuestaria, LGEP (Budgetary Stability Law) • Spain respects the budgetary Maastricht criteria since 1997 • Why not being more stringent than the European rules? • Partido Popular (PP) government passes LGEP in year 2001 • The limit of 3% is abandoned and replaced by the Balanced Budget • Rule. Respected since then.

7. How to make the case for a Balanced Budget Rule? • Benefits • Control of deficits • Progressive decrease of the financial burden of debt • Indirect control of the size of the public sector • Increase of bargaining power in Brussels • An image of sound public policies management. Positive impact • on entrepreneurs decisions and growth

8. How to make the case for a Balanced Budget Rule? Which economic justification? BUCHANAN, James (1997), "The Balanced Budget Amendment: Clarifying the Arguments", Public Choice, Vol. 90, pp. 117-138. “Why should future period taxpayers be coerced in order to meet fiscal charges that are incurred by present-period program beneficiaries ?” (p. 135) And what about public investments? "If rates of spending on capital projects are roughly uniform over time, the operation of separate current and capital budget accounts would not be different, in effect, from combination into an unified account, all of which is subject to the balanced requirement"(p. 133)

9. How to make the case for a Balanced Budget Rule? Which economic justification? But strictly productive investments “that will yield income to government over some effective life” may ve financed by debt, as they not impose a net burden (p. 133) And also a stricltly managed budgetary stabilizers policy is considered compatible with the filosophy of the balanced budget rule (p. 128)

10. How to make the case for a Balanced Budget Rule? • The internal inconsistency of the Global Balanced Budget Rule • If the main reasons for controling deficits are: • efficiency: do not to allow current expenditures to grow beyond • optimality if financed by easy money (debt) • equity: do not charge future taxpayers with the payment of • current expenditures consumed today • ... then public investments could be financed by debt for the very • same reasons: • efficiency: to avoid underprovision of public investments • equity: to avoid overburdening present taxpayers

11. How to make the case for a Balanced Budget Rule? • But in Spain we have adopted a law wich imposes: • a global balanced budget, affecting current and capital expenditures • to be respected each year • and it applies for each layer: regions must produce balanced budgets • and local government too (both current and capital expenditures). • Buchanan referred only to federal accounts!

12. How was LGEP adopted? With the opposition of the opposition parties, of course ... but without strong attacks to fiscal discipline principles

13. How was LGEP adopted? And the perverse effects on investments was considered relevant for attacking the law only for small parties

14. 2. Local Government Finances in Spain • Legal framework of activity • Regions do have political autonomy and can issue laws for their • self government. LG have only a role of administrative management • Neither the Constitution of 1978, nor the Statutes of Autonomy • were very specific with respect to the competencies of the LG. • Article 25.1 of the Spanish Constitution says: "The town, in order to • manage its own interests and within the area of its competencies, can • promote any sort of activities and provide any public services, which • contribute to satisfy the necessities and aspirations of the comunity” • This may include: security, traffic, fire extintion, environment protection, • public health, transportation, culture and sports, some education.

15. 2. Local Government Finances in Spain • Legal framework of activity • Relations between Regions and LG • Art. 137 Constitution: relationship based in equality • But dependency and intervencionism from Regions in practice: • it happens that regions do not spend on what they have legislated for. • At the end municipalities produce these new services without having • the legal competencies and the specific sources of financement. • Limited amount of own fiscal resources

16. 2. Local Government Finances in Spain • All these facts produce a local public sector with, in terms of • international comparison: • is small • Local Government expenditures in terms of GDP Source: Mau Pedersen (2004), OECD (2004)

17. 2. Local Government Finances in Spain • presents a limited fiscal autonomy • Tax share of total LG revenues Source: Mau Pedersen (2004), OECD (2004)

18. 3. Fiscal Rules for Spanish LG • Before LGEP • Ley Reguladora de las Haciendas Locales (1988) • Modified each year since 1996 by a complementary law attached to • the ... Central Administration budget! • Debt restricted to finance public investments • I<10% precedent current revenuesDirect decision of the Major • I> 10% precedent current revenuesApproval of Plenary LG Commission • + Central Administration Intervention.

19. 3. Fiscal Rules for Spanish LG • Before LGEP • New long term debt emissions need Central Administration authorisation • If net savings are negative (before, if lower than 2% of current revenues). • A 3 year adjustment plan has then to be presented. • If local public debt is higher than 110% of current revenues. An • adjustment plan is needed. • Criteria for receiving authorisation: economic situation of the collectivity; • the proposed amortization scheme; the economic benefits of the proposed • investment.

20. 3. Fiscal Rules for Spanish LG • Before LGEP • Restrictions to cash or short term new indebtness • Existence of positive tresorery cash. If not, long term debt restrictions • apply. • Maturity shorter than 12 months. • With a maximum of 30% of current revenues.

21. 3. Fiscal Rules for Spanish LG With LGEP Objective of stability: accounts balanced or with surplus in terms of capacity of financement. New net debts are not allowed. New debt emissions will be as much equal to past debt amortization. The Central Administration fixes the 3 year objective of budgetary stability for the LG alltoghether. A LG budget or account which does no respect the restrictions will need to propose an adjustment program. And any kind of debt operation requires authorisation from the Central Administration.

22. 4. Financial Situation of Spanish LG Source: Vallés et al. (2003)

23. 4. Financial Situation of Spanish LG Source: Vallés et al. (2003)

24. 4. Financial Situation of Spanish LG Source: Vallés et al. (2003)

25. 4. Financial Situation of Spanish LG Source: Vallés et al. (2003)

26. 4. Financial Situation of Spanish LG Source: Vallés et al. (2003)

27. 4. Financial Situation of Spanish LG Source: Vallés et al. (2003)

28. 4. Financial Situation of Spanish LG Interpretation of the results Things were not that wrong at the local level, even before the introduction of the LGEP

29. 5. Chosing between LGEP and deficits • Constraints for local and regional level are justified under • the EMU framework and Amsterdam criteria. • Compliance with European rules depends on the • behavior of all levels of government • ... But only the central level is held accountable for • respecting these rules • This asymmetry can increase incentives for lack of fiscal • discipline at sub-national level (common pool problem)

30. 5. Chosing between LGEP and deficits • But do we need a strict balanced budget rule for LG? • Specificities of LG in Spain: • LG expenditures represent only 7% of GDP or less than 15% • of total public sector: limited danger of determinant impact • in the overall public sector of even excessive deficits of LG. • Very narrow margin of (re)action of LG to fiscal adjustments • as the majority of resources are tranferts and LG have small • legal competencies concerning own revenues. • Adjustment the mainly by reducing expenditures: but LG • are already assuming public services without financial • coverage because of the inactivity of regions.

31. 5. Chosing between LGEP and deficits • In many cases, the better solution in Spain to cover LG deficits is • an increase of transfers (or debt), instead of increasing taxes • or reducing expenditures: • Level of income below average (perequation) • Suffering from recession in a higher extent than average • Need of infrastructure. • Demographic conditions (concentration of old or young people) • Higher cost for providing mandatory local services • Spain cannot sacrify the needed amount of public investments • in order to satisfy a Balanced Budget rule.