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

In countries where subnational governments control a large partof the public finances, the central government's ability tokeep its commitment to the European Union's Stability and GrowthPact can be a difficult matter. European rules demand that theoverall budget be balanced over the medium term; applying thisrule at subcentral level may unduly reduce capital outlays andlocal budgetary autonomy. This article examines the possibleimpact of budgetary stability legislation on the capital expenditureof Spanish municipalities. The empirical findings suggest thatthe new budgetary stability framework will oblige municipalitiesto (i) limit their investments, (ii) raise the tax burden, or(iii) reduce the funds allocated to other budget items. We believethe Spanish municipal experience is generalizable to other federalcountries in Europe that are facing hard budget constraintsand high earmarked grants.