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The Politics of Fiscal Consolidation in Federal States

  • Schnabel, Johanna (Université de Lausanne)
  • Ruiz-Palmero, Christian (Université de Lausanne)
  • Braun, Dietmar (Université de Lausanne)

Abstract

In this paper, we argue that the extent to which federal systems enact “robust” (Bednar 2009) solutions to consolidate the budget of the general government depends on the system of federal safeguards, the existence of rationalizing institutions, the use of financial compensations and the presence of an external enforcer. Fiscal consolidation is likely to trigger federal conflicts because it limits the discretion of governments to spend as they want. Furthermore, federal systems offer incentives to governments to overborrow (Rodden 2003) so that federations might fail to solve the deficit problem in an effective and sustainable way when governments refuse to cooperate. Thus, fiscal consolidation puts federal systems under stress. Looking at the adoption of fiscal rules as milestones of fiscal consolidation in eleven federal states (Argentina, Australia, Austria, Belgium, Brazil, Canada, India, Germany, Spain, Switzerland, and the United States), we explain the robustness of federations in fiscal policy. Based on the distinction of loosely coupled and tightly coupled fiscal regimes we find that different combinations of federal safeguards, rationalizing institutions, financial compensations and external enforcers explain why some federations have enacted robust solutions while others have failed to do so. We find that strong and balanced federal safeguards and the existence of rationalizing institutions are sufficient conditions for fiscal consolidation to be enacted in a robust way. However, the robustness of tightly coupled fiscal regimes also depends on the extent to which the federal government is willing and able to provide financial compensation to the subnational governments.