Laws for Fiscal Responsibility for Subnational Discipline:International Experience

Fiscal responsibility laws are institutions with which multiple governments in the same economy¡ªnational and subnational¡ªcan commit to avoid irresponsible fiscal behavior that could have short-term advantages to one of them but that would be collectively damaging. Coordination failures with subnational governments in the 1980s and 90s contributed to macroeconomic instability and led several countries to adopt fiscal responsibility laws as part of the remedy. The paper analyzes the characteristics and effects of fiscal responsibility laws in seven countries¡ªArgentina, Australia, Brazil, Canada, Colombia, India, and Peru. Fiscal responsibility laws are designed to address the short time horizons of policymakers, free riders among government units, and principal-agent problems between the national and subnational governments. The paper describes how the laws differ in the specificity of quantitative targets, the strength of sanctions, the methods for increasing transparency, and the level of government passing the law. Evidence shows that fiscal responsibility laws can help coordinate and sustain commitments to fiscal prudence, but they are not a substitute for commitment and should not be viewed as ends in themselves. They can make a positive contribution by adding to the collection of other measures to shore up a coalition of states with the central government in support of fiscal prudence. The commitment of the central government to its own fiscal prudence was critical for success of fiscal responsibility laws for subnational governments.