Fiscal Federalism, European Stability Pact, and Municipal Investment Finance: A Microdata Analysis of Spanish Municipalities

In countries where subnational governments control a large part of the public finances, the central government's ability to keep its commitment to the European Union's Stability and Growth Pact can be a difficult matter. European rules demand that the overall budget be balanced over the medium term; applying this rule at subcentral level may unduly reduce capital outlays and local budgetary autonomy. This article examines the possible impact of budgetary stability legislation on the capital expenditure of Spanish municipalities. The empirical findings suggest that the new budgetary stability framework will oblige municipalities to (i) limit their investments, (ii) raise the tax burden, or (iii) reduce the funds allocated to other budget items. We believe the Spanish municipal experience is generalizable to other federal countries in Europe that are facing hard budget constraints and high earmarked grants. Copyright 2007, Oxford University Press.