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Consolidation Policies in Federal Countries
Dietmar Braun and Philipp Trein
Introduction
The global economic and financial crisis that started in 2007 has forced governments to
pursue continuing adaptation policies, often in the form of rescue actions. While the initial
crisis resulted in economic recession with a sharp decrease in economic growth and rising
unemployment rates, an increase in state debts caused by decreasing revenues and
expansionary fiscal policies has become the primary problem since 2009. Consolidation
policies were needed that could cope with the challenge of rising deficits and debt burdens.
Having discussed the economic recession and its repercussions on governmental policies in
another article (Braun and Trein 2012), in the present contribution we are interested in policy
reaction during the deficit crisis between 2009 and today. Our interest is limited to only one
particular group of states, i.e. federal states.
In contrast to most unitary states, federal states suffer from one particular problem in
fiscal policy-making: the coordination of the policies of several levels of government, which
frequently have considerable autonomy, in order to have a significant impact on the economy
or on the financial market. The central government (CG), being the main actor responsible
for stabilisation policies in federations, therefore has an interest in bringing member states
(MS) in line during such a deficit crisis. MS, on the other hand, may not share this interest, as
consolidation policies can, in the short run, endanger electoral success. Where economic
conditions are less advantageous, MS may want to continue spending in favour of their
regional economies and shift the burden of consolidation to CG and other MS. How common
interests in economic and financial stability can prevail despite opportunistic interests of MS
depends on authority relations within the federation, i.e. on the distribution of rights to decide
and act in fiscal policy-making as well as on the degree of conflict and consensus. Our first
objective in this article is therefore to uncover if and under what circumstances coordination
problems have played a role in consolidation policies of federations during the deficit crisis
since 2009 and if there are significant differences between federal countries in this respect.
The degree to which opportunism plays a role can vary between federations, due
mostly to different "fiscal regimes", i.e. the rights to decide and act in fiscal policy-making
within a federation. Generally, the literature on fiscal federalism and on the political economy
of federalism makes a distinction between federations in which MS dispose of a large tax
autonomy and federations that depend mostly on transfers in form of shared taxes,
equalisation payments, or CG grants. Large tax autonomy is presumed to lead to fiscally
accountable behaviour because "fiscal illusion" of voters is avoided (Stein 1999; Rodden and
Wibbels 2002; Rodden 2002; Kim and Vammalle 2011). When revenues and expenditures
are not directly linked, as is the case in a transfer system, MS governments are induced to
overspend and borrow. Coordination problems should therefore be more prominent in the
second group.
Our second interest as political scientists is to investigate whether consolidation
policies affect the "balance of power" in federations. As Bordo et al. (2011) have
demonstrated, serious economic and/or financial crises can lead to strong pressures for
change in authority relations and subsequently to reforms in the distribution of authority
rights. During the Great Depression centralisation of such authority rights was the answer in
many federations. The recent deficit crisis can be thought of as a similar catalyst to challenge
existing fiscal regimes. The pressure to maintain stability while MS may pursue
"opportunistic" policies of overspending and borrowing may lead CG to contest the existing
arrangements and demand more powers. Crises may very well be the moment that dynamics
in federalism unfold and institutional changes occur that consolidate a new balance of power
(Benz and Broschek 2013). This is why we investigate, as our second focus, whether the
recent deficit crisis has led to such acts of centralisation and whether this has contributed to
the destabilisation of existing authority arrangements and reforms.
This chapter is connected to the contributions of Manfred G. Schmidt in three ways:
Firstly, it ties into his work on federalism (Schmidt 1994), particularly the discussion of the
capacity to pursue reforms in federations, a debate to which Manfred Schmidt has contributed
by discussing the strengths and weaknesses of federalism in Germany, particularly the
chances for successful reform policies (Schmidt 2001). In this article, we show that in times
of crisis, some federations were successful in pursuing reforms, whereas others were not.
Germany is amongst the successful states, as it finalized the second part of its reform of the
fiscal federal arrangement during the crisis. The second connection of this chapter to the
research done by Manfred G. Schmidt is the effect of the crisis on social expenditures.
Reform policies during times of financial, economic and debt crisis contained cuts in social
expenditures and public expenditure in general, for instance, in Canada and the US. Social
policy with all its dimensions and relations to other policy fields has been a central pillar of
Schmidt’s research agenda (Schmidt 1982, 2005; Schmidt et al. 2007). Thirdly, this chapter
speaks about the performance of political systems, particularly the capacity of federal states
to pursue reform policies in times of crisis. Our results show, that in some of the federations,
the crisis aggravated the problems of fiscal indiscipline and rent-seeking amongst the MS,
which might lead to system threatening instabilities, such as in Belgium and to a certain
extent in Spain, if the crisis lasts longer. In democracies, debt crisis have the capacity to
fundamentally endanger democratic legitimacy, if the state looses its capability to provide
welfare to its citizens. In this regard, this article connects to Manfred’s work, as he has been
researching extensively on democratic theory and the performance of democratic
governments (Schmidt 2002, 2010, 200 8).
We will proceed in the following way: First, we elaborate in more detail on the kind
of coordination problem federations might face in the deficit crisis and what kind of authority
shifts we may expect. The third chapter presents consolidation policies of eleven federations
during the deficit crisis. Chapter four draws lessons from empirical observations.
Conceptual clarifications
Coordination problems in the deficit crisis
Federations have a “dual” structure of revenue extraction and spending but are also
characterised by the existence of additional money flows in form of equalisation payments,
CG grants, or by tax-sharing. While CG generally has more revenue powers and income than
MS, MS have more spending obligations than CG. Discrepancies between revenues of MS
and spending obligations often lead to so-called “vertical fiscal imbalances” or “fiscal gaps”,
meaning that all revenues of MS taken together do not cover expenditures, which, in turn,
leads to the need for deficit generation or claims for additional resources from the "common
pool" of various transfer payments. In the present deficit crisis, fiscal gaps are becoming the
main problem in federations because deficit generation should, on the one hand, be excluded,
while decreasing revenues do not in principle allow additional demands to be met by MS for
transfers. As a result, MS would be obliged to curb expenditures and/or, if they have
significant tax authority, to raise taxes. In other words, they would need to implement
austerity policies; however, this is not what tends to happen. Different fiscal regimes may
give different opportunities for MS to “shirk” and avoid the option of austerity policies,
which may have undesired electoral consequences because of their negative effects on public
services and voters’ incomes.
We can distinguish between two such types of opportunistic behaviour:
Rent-seeking: Instead of raising their own taxes or cutting spending, MS can lobby for
more CG transfers, tax shares, or equalisation payments. Put differently, they may search for
“common pool resources”.
Shirk and borrow: This occurs when borrowing agreements or rules exist but are not
self-enforcing and, as a consequence, MS attempt to evade and go on with deficit generation.
In both cases one can expect negative repercussions for consolidation efforts in the
federation. The question is whether the fiscal regime allows MS to apply such opportunistic
strategies.
On the base of the literature (Kim and Vammalle 2011; Stein 1999; Blöchliger and
King 2006a), we tentatively distinguish between two different opportunity structures in
federal fiscal policy-making that are based on availability of significant tax authority or on
the availability of transfers from common pool resources.
Regime with tax authority (decentralised regime): Whether or not MS have significant
tax authority (particularly over growth taxes) is important for their fiscal behaviour of MS.
Accountability to voters in MS is increased by a system in which revenue and spending are
closely linked, thereby avoiding “fiscal illusion”. MS generally have stronger incentives in
such systems to respect budget constraints. Federations that grant significant tax authority to
MS generally also have tax competition, a further constraining device for over-spending and
over-borrowing. On the other hand, tax competition also reduces the possibility of using tax
increases as a consolidation strategy, as tax payers may choose to “vote by feet” and leave to
regions with better tax conditions. The decentralised tax authority regimes does not preclude
the existence of transfers, but in comparison to MS’ own tax revenues, transfers are second in
importance.
Regime with a dominating transfer system (transfer regime): If MS have insignificant
or no such tax authority, they depend on transfers from common pool resources, i.e. on CG
grants, equalisation payments, or shared taxes (for an overview of the distribution of such
transfers see Blöchliger and King 2006b). Such systems can be subject to “rent-seeking” by
MS because “fiscal illusion” by voters allows negative electoral consequences to be avoided
(Stein 1999; Rodden and Wibbels 2002). Whether MS will be successful in their attempt to
obtain more resources from such transfer sources depends on CG strategies concerning
conditional and unconditional grants; on the deliberation and consensus-building in the case
of tax-sharing, which is collectively decided by CG and MS; and on CG decisions or
consensus-building regarding equalisation payments. Although there is therefore no
guarantee for success of rent-seeking in transfer systems, MS will be tempted to avoid own
efforts in austerity policies and rely instead on transfers.
On the base of what has been said, we expect that countries in the decentralised fiscal
regime give strong incentives to MS to control their expenditures and induce respectful
behaviour concerning consolidation goals. Austerity measures should prevail during the
crisis. Shifts in authority are not to be expected. In the transfer regime, however, MS will try
to avoid austerity policies and strive to achieve a redistribution of common pool resources or
borrow money from financial markets. This will lead to fiscal indiscipline and a failure in
consolidation policies, which in turn may result in CG attempts to discipline MS by
centralising competences in spending and borrowing.
Rodden argues, however, that, in order to evaluate fiscal discipline or indiscipline in
federal states, borrowing rights must be taken into consideration (2002). One can therefore
argue that fiscal regimes are characterised by two dimensions that influence the possibility
for opportunism of MS: on the one hand, we find opportunities to seek rents (high in transfer
systems, low in decentralised systems), on the other hand, there are different opportunities to
borrow. If we cross-tabulate these two dimensions, we have a four-fold table with our
expectations about the coordination problems in fiscal federal policy-making.
Table 1: Possible outcomes of opportunity structures in fiscal policy-making
Decentralised Regime
Transfer Regime
Political borrowing
autonomy high
Limited fiscal
discipline
Fiscal indiscipline
Political borrowing
autonomy low
Fiscal discipline
Limited fiscal
indiscipline
Although decentralised fiscal regimes may impose no political restrictions to borrow
(high autonomy), MS will depend nevertheless on creditors in the financial market who must
be willing to provide loans.Instead of political constraints, MS are subject to market
restrictions This is why we call this combination of high tax authority and market-restricted
borrowing "limited fiscal discipline". In general decentralised regimes will however have
some political borrowing control, often in the form of "self-imposed" rules and regulations,
such as debt brakes or referendums at the level of MS. This combination should result in high
fiscal discipline. High borrowing autonomy together with a strong transfer system may be the
combination that leads to “fiscal indiscipline” and thus to difficulties in consolidation. If
transfer countries are politically restricted by self-imposed rules, coordinated rules, or CG
regulations (see for different borrowing restriction types Ter-Minassian and Fedelino 2010),
and if these rules do indeed work effectively, fiscal indiscipline is limited. MS will have to
rely on rent-seeking only.
Authority shifts
Until now, our analytical exploration has focused exclusively on coordination problems that
can arise due to opportunistic behaviour of MS. Such opportunistic behaviour is a challenge
for CG, which is usually in charge of stabilisation policies. Fiscal indiscipline may be
punished by sanctions. Monitoring and control mechanisms may be established, and
incentives can be offered. CG can, however, also proceed without reacting to such shirking
behaviour and simply attempt to guarantee that it controls its own deficits, for example by
cutting transfers to MS. The different ways of CG to deal with the deficit crisis - in reaction
to or by ignoring MS fiscal behaviour - is decisive for possible changes in federal relations
and may result in confrontation, conflict, resistance, and power struggle in general.
The following overview attempts to summarise six CG policies that may have an effect
on the discretion and authority of MS, consequently resulting in stress for federal relations.
We distinguish between "discretion reduction" and "authority migration".
Table 2: Types of authority shifts
Discretion reduction
Authority migration
Reduction of grant payments to MS
Change the distributional formula in
tax-sharing systems in favour of CG
Reduction of demand stimulation
payments to MS
Change the borrowing regime in
favour of more CG control
Raise taxes unilaterally in dual tax
systems
A shift from non earmarked to
earmarked grants
In the case of discretion reduction no centralisation of existing authority rights takes place,
but MS are more constrained in fiscal policy-making than before: they need to compensate if
CG reduces its transfers and, in dual tax systems where both territorial levels can tax the
same source of income, they are prevented from using the tax instrument if CG has done so
before because of possible "crowding out" effects. Authority migration means that MS lose
some of their authority rights in favour of CG, either by shifting the revenue balance or by
reducing the autonomy of MS in fiscal policy making (borrowing controls; guidance by
earmarked grants). The balance of power would change.
All authority migration measures have the potential to raise conflicts with MS,
because MS lose parts of their autonomy. Discretion reduction measures, by contrast, have
the potential to increase the difficulties of MS to solve the consolidation crisis by their own
means. In the medium and long run this can contribute to the use of opportunistic strategies
by MS, but also to a loss of autonomy when deficits and fiscal gaps become so high that the
survival of MS is endangered. Discretion reduction can therefore indirectly contribute to a
destabilisation of the balance of power in federations over the long run.
By analysing fiscal polities and coordination problems in eleven federations during
the deficit crisis, we attempt to find out whether our expectations about fiscal behaviour of
federations are confirmed or must be corrected. In addition, we want to know the extent to
which such authority shifts, as explained above, have taken place.
We consider three federations as decentralised fiscal regimes because of their
significant tax authority, including growth taxes and a functioning system of tax competition.
These are Canada, Switzerland, and the USA. Eight other federations depend on the majority
of their incomes on transfers from the common pool (Blöchliger and King 2006b). If there is
tax authority, it is generally not in the field of growth taxes. Tax competition barely exists in
these federations. The countries are: Argentina, Australia, Austria, Belgium, Germany, India,
South Africa, and Spain.
Our analysis is based on information in secondary sources, for example from the IMF,
World Bank, or the OECD, but also articles dealing with fiscal federalism in the various
countries, as well as on Internet research and newspapers.
In the following chapter we will provide an overview of crisis policies in each of the
eleven countries, followed by a chapter with our interpretation.
Empirical observations
Decentralised fiscal regime countries
USA
The economic crisis that started in 2008, and which still continues, contributed to a
substantial rise in debts and annual net lending of both the CG and MS. While the CG
stimulation programme ARRA (American Recovery and Reinvestment Act) had mitigated
the loss of income of MS by generous grants (e.g. by paying their unemployment insurance
contributions), they have not been sufficient to cover the fiscal gap MS were facing. MS are
constrained to fill this gap, as there are no equalisation funds foreseen in the system and the
search for conditional grants is not only limited by a policy of deficit reduction on the CG
level, but also by the conditions that have to be accepted by MS when obtaining such grants
(Tarr 2010). In addition, borrowing became increasingly difficult for MS, above all for one
reason: American MS are - except for Vermont - constrained by “self-imposed” rules and
regulations that demand a balanced budget. This situation forced MS to accept the least
preferred option among consolidation strategies: to implement serious austerity policies. The
success of these measures remains unclear. California and Illinois are on the brink of
insolvency; Minnesota is following closely. This situation has resulted in serious discussions
about a possible bailout which is explicitly excluded by any CG in the history of the US. As
the insolvency of a member state is not possible from a legal standpoint, CG could come
under pressure to procure financial aid. To avoid such a situation, Congress is preparing a bill
that would prohibit such a bailout (ZEIT Online, January 31, 2011; FAZ, July 8, 2011; Ter-
Minassian and Fedelino 2010).
In sum, the consolidation crisis has caused considerable stress, especially for MS.
While the fiscal regime does allow stimulation measures by CG, it has not foreseen any
coordinated consolidation policy. With the lack of an equalisation system and a “no bailout
policy” by the CG - though legally the situation is less clear - MS are mostly on their own
when dealing with the consolidation crisis. Self-imposed rules and increasingly difficult
conditions on the financial market led to the introduction of harsh austerity measures in many
of the American states, the least preferred option of MS governments. The crisis has not,
however, led to a change in federal relations. CG did not change its attitude towards MS, nor
did it ask for more powers in matters of spending or borrowing.
Switzerland
Without a doubt, Switzerland was not seriously affected by the deficit crisis until very
recently. The overall debt ratio is about 45% of GDP. Debt rates of cantons are still
favourable. This is certainly due to the rule-based approach in borrowing: In the beginning of
the 2000s, the federal level introduced a debt brake that has, up until now, functioned very
well. On the level of cantons similar regulations exist (Braun 2007; Feld 2008). Financial
referenda further limit the discretion of policy-makers at the regional level to borrow. That
these constraints have a self-enforcing influence on fiscal policy making is demonstrated by
the reaction of two MS - St. Gall and Solothurn – which, when confronted with fiscal gaps,
took immediate action via austerity measures and by using existing capital funds.
Switzerland demonstrates the positive functioning of the decentralised system: MS are
obliged to act on their own and do introduce austerity measures if necessary. Switzerland had
never had any experience with bailouts until very recently, although from a legal point of
view the question has never been seriously raised. This adds to the responsibility of cantons
for their budget. But, as in many other federations, MS had also profited from stimulation
money from the CG during the demand crisis of 2008 and 2009. When the CG reduce this
money there were some protests by the MS, which had to fill in this gap without leading to
any major confrontation (Trein and Braun forthcoming).
In sum, Switzerland can be seen as an example of a system that has introduced self-
enforcing borrowing constraints before the economic and financial crisis set in. The system
was, however, not really tested until now, as both economic development and debt rates
remained very favourable in comparison to other countries. In due course, there has been no
strain on federal relations, which had been re-balanced by a general reform of the transfer
system and authority distribution in 2006.
Canada
While the economic crisis was managed relatively successfully with the help of CG and MS
stimulation programmes, deficits became a growing concern in the aftermath of the economic
crisis. Although in 2012 the debt ratio of CG was very favourable, i.e. 34%, the overall debt
ratio was 85%, indicating the large debts many MS were running (National Post, June 1,
2012). One explanation for the difference are unilateral policies by CG, which announced a
reduction of direct transfers to provinces on unemployment benefits and pensions in 2010
(NZZ, September 11, 2011) and continued in early 2012 with cuts to health transfers (The
Gazette, Montreal, January 13, 2012). These cuts had negative consequences for MS budgets.
Protests by many provinces and talk of a “destabilisation of the federation” did not change
the mind of CG. On the other hand, it seems that the self-imposed regulations that many CG
had enacted long before the crisis did not have the intended effect in such a situation.
Exception clauses that allow MS to run deficits in times of economic hardship may have
contributed to this (Liu and Webb 2011). Discussions about a centralisation of borrowing
rights started in this context.
The hardship brought on by the crisis and the reduction of payments by CG had two
other effects: Many MS hit particularly hard by the crisis could not avoid launching serious
austerity programmes under these circumstances, consequently leading to social protest, such
as in the education sector. Second, the equalisation system itself came under serious attack.
Not only because critical voices pointed to the “shirking mentality” that is caused by the
“windfall-profits” in the equalisation system and reduces the potential for consolidation, but
more importantly, because serious deficiencies in the construction of the system were
revealed. Especially Ontario, the largest MS, complained that it was running higher deficits
despite strict austerity policies and lower spending than in other provinces. This was due to
the redistribution formula applied in the system. Discussions about the “perverse structure of
Canadian fiscal federalism” continue.
Overall, Canada's problems stem from the fact that the decentralised fiscal regime is
based on market discipline in borrowing and a lack of coordinated rules, while an implicit
bailout system is not avoided. Equalisation payments and other transfers from CG contribute
to harmonisation but also to the indirect financing of fiscal gaps. This reduces hard budget
constraints. Together with self-imposed regulations on borrowing that turned out not to be
self-enforcing, the result was continuing borrowing by MS in the crisis, while CG could
reduce its debts. The lack of coordination in borrowing raises increasing concern. In terms of
federal relations, one sees tensions both between CG and MS (unilateral move by CG) and
between MS (“have” and “have-not” provinces and the redistribution of incomes by
equalisation).
The transfer regime
Austria
Although debt ratios in Austria are still comparatively low in comparison to other countries
of the Euro-Zone (OECD 2011b), the increasing pressure to comply with the fiscal criteria
developed in the Maastricht Treaty, in the “Sixpack” arrangement, and in the “Fiscal Pact”
recently agreed upon in the Euro-Zone has resulted in constant discussions about new
agreements on fiscal consolidation. Austria is characterised by strong coordination between
CG and MS in all matters of fiscal policy: borrowing, tax-sharing, and equalisation. MS have
obtained a very strong veto position, which mostly means that a consensus is hard to find. On
the other hand, there is an elite consensus about the value of European integration, which
ultimately helps to reach agreements.
Even before the crisis, CG announced a new budget framework law that was setting
expenditure ceilings supposed to be valid throughout the country. For the most part, however,
MS did not implement these restrictions. As a consequence, most spending cuts came from
the CG and only occasionally from MS (OECD 2011a).
The introduction of new borrowing rules during the crisis was strenuous. It took two
years - from 2009 to April 2011 - to reach an agreement on a stability pact, which defined the
annual contribution of MS to the reduction of net lending and debt reduction. The
introduction of sanctions were met by MS resistance. The result was a mixed one, as some
MS implemented the agreement, yet those MS with already high deficits did not (Die Presse,
June 30, 2010, May 4, 2012). The introduction of a debt brake in the constitution failed
because of a lack of party consensus. Under pressure of recent events in the Euro-Zone,
Austria was obliged in 2011 and 2012 to implement the even more far-going restrictions
agreed upon. This meant the conclusion of a new stability pact. Following long negotiations,
MS were prepared to accept the introduction of balanced budgets from 2017 onwards, but
only if a new tax on financial transactions would be introduced and shared with the MS. If
unforeseen important changes in the health sector would appear and expenditures needed to
be adjusted upwards, the pact would not be applied. Sanctions (fines) were introduced for
failure to respect the contract, both for MS and CG (Der Standard, May 4, 2012). However,
the new controlling body that was installed will however have difficulties to enforce such
sanctions, as it is composed of politicians from CG, MS, and municipalities and any decisions
about sanctions need the unanimity of the body, which could lead to a “joint decision trap”
(Scharpf 1988).
In sum, the limits of the Austrian transfer regime are noticeable: incentives for
prudent fiscal behaviour are relatively low. Any change of rules needs approval by MS. The
pressure of the Euro-zone has helped to find an agreement in order to respect the international
treaties. While MS were able to introduce safeguards that suit them well and work as “soft
budget constraints”, federal relations have not changed. The weak role of CG in establishing
an enforceable consolidation strategy is impossible to overlook.
Germany
Germany entered the crisis with debt rates that exceeded the Maastricht criteria and could not
prevent the debt ratio from rising up to 80% in 2012 (OECD 2012). But, as in Austria,
pressure from the Euro-Zone was strong and contributed to a fiscal reform concerning
borrowing requirements and the equalisation system in general. The intention was to avoid
continued over-borrowing by MS and the CG and to respect the Maastricht limits. Three
features of the “Fiscal Pact II” in 2009 stand out: first, “fines” for MS that do not respect the
deficit limits agreed upon were introduced; second a “debt brake” was enacted which
demanded a balanced budget for MS from 2020 onwards and a maximum of 0.35% of GDP
for CG from 2016 onwards. A consolidation aid for MS until 2019 was agreed upon. Third, a
new Stability Council with finance ministers from CG and MS was created which aims to
monitor the consolidation process and can oblige MS that fail to respect the limits to establish
fiscal reform programmes. The credibility of this Council was demonstrated in December
2011when four MS were put under administration and fiscal recreation programmes were
agreed upon (FAZ, June 12, 2009).
New negotiations had to take place with the new agreements in the Euro-Zone in 2011
and 2012. Germany was obliged - as it had already established a debt brake, which is now
obligatory for all members of the Euro-Zone - to reduce its debt burden more quickly than
planned. As a result, the German CG wanted to introduce a constant and gradual annual
reduction of net lending for the federal and MS budgets. While the agreement found in the
“Fiscal Pact II” still gave MS some room for manoeuvre in terms of how to deal with the
reduction of their borrowing requirements, this should now no longer be possible. According
to critical voices among MS, such limitations would take away any discretion to combat the
economic crisis by temporary stimulation policies. The new regulation was seen as a
“dictate”, implying that MS would have to give up their remaining fiscal autonomy. As CG
needed a two-third’s majority and the consent of MS in the Second Chamber, negotiations
took place and, as in Austria, MS were only willing to consent in exchange for additional
grants by CG for various other purposes, such as for child care and for the introduction of
“German bonds” that could reduce the higher interest rates MS had to pay for borrowing in
comparison to the more favourable rates of CG. These demands were in principle accepted
but need still to be elaborated in detail. As in Austria, while CG has to make concessions to
find the approval of MS, a deal is always possible given the strong external pressures on the
fiscal regime (Süddeutsche Zeitung, March 29, 2012; FAZ, May, 10, 2012; FAZ, June 02,
2012).
Within this consolidation process federal relations between CG and MS have not
fundamentally changed. The new restrictions on fiscal policy-making valid for MS will
however have fundamental repercussions. The identity of MS themselves might come into
question: as MS in Germany have no own tax authority and now their room for manoeuver in
spending has been drastically reduced, it might become difficult to make voters believe in the
political value of “their” regional governments.
Belgium
Belgium had its fiscal regime revised in 1989 (Special Financing Act) and decentralised
important fiscal powers to the regions and “communities”. The CG took charge of all debts
that contributed to the still relatively low debt rate of MS in general government debt (about
6%). This contributes to the fact that debt making on the regional and community level is a
less salient topic than overall debts, which, while they had been substantial, with the help of
stability agreements, were reduced to about 80% before the crisis began in 2007. The main
problem in the crisis since 2007 was the political impasse in the federal government, which
led to more than two years without a functioning CG. The passing of new stability pacts,
which had been set up regularly, was impossible. Only in 2009 could such a pact be signed,
valid for 2009 and 2010. Shortly thereafter, a period without a federal government again set
in. The on-going struggle in Belgium is due to financial reasons and the ethnic conflict
between the poorer Wallonia and the richer Flemish region. The CG is furthermore
responsible for finding a balanced arrangement that equilibrates forces. While the Flemish
region has long contested the distribution of tax money for these purposes and demands more
tax authority and fewer contributions to the Wallonia region, the latter insisted on higher
payments due to the economic crisis. A (temporary) solution was not found until 2011, when
all actors agreed upon a new fiscal arrangement. Only the pressure of the Euro-Zone and a
downgrading of Belgium by a rating agency could bring the political elites to this agreement
that opened the way for a new government. As part of the compromise the CG continues to
define tax rates and base, but the MS receive more taxes (including tax administration). The
solidarity amongst the regions remains, but industrial policy and some other policy matters
were decentralised (Le Temps, September 26, 2011; Monday, October 10, 2011; Devos and
Sinardet 2012).
Due to the strong ethnic conflict in the country and the on-going polarisation, instead
of increased centralisation we rather see a further decentralisation of fiscal authority in
Belgium. As in Canada, the economic crisis contributed to increasing tensions between
regions and undermined existing equalisation programmes.
Spain
Spain is the last federation in the Euro-Zone discussed here. Already before the crisis the
country had increased the commitment of all actors to consolidation by introducing a new
Stability Law that included a debt brake and, as happened later in Germany, the threat to
oblige failing MS to accept fiscal recreation programmes. The success of these measures was
immediately questioned when the economic crisis resulted in soaring unemployment rates
and a domestic banking crisis set in that continues to threaten the overall solvability of the
country. The financial situation of many MS has seriously deteriorated and has led to harsh
austerity measures, mostly with regard to services and social transfer payments, which in turn
caused social unrest. The increasing pressure from the financial market and the Euro-Zone
have forced CG to drive stability arrangements even further, often without the explicit
consent of MS. In 2010 CG set debt rates for MS unilaterally in order to comply with EU
policy. Communities are not allowed to take up any more long-term loans (Viver 2010). In
2011 MS were obliged to cut their budgets significantly to achieve the 6% net lending rate
agreed upon this year with the Euro-Zone. When the deficit of MS was larger than the
planned 6% in early 2012, dramatic budget reductions became necessary. MS had and still
have to present their budgets to the CG and find approval (NZZ, January 9, 2012). Some MS
protested against these “re-centralising” measures and even took the matter to court, albeit
without success. During 2012 the situation of the MS deteriorated so much that they needed
to be bailed out by the CG, which opened a special fund to recapitalize the regions, in
exchange for the agreement by the MS to cut expenditures (NZZ, January, 9 2012; NZZ, June
2, 2012; FAZ, 03.09.2012).
It is understandable that in such times of severe crisis the confrontation between CG
and MS increases in strength and intensity. The socialist government in the Basque country,
for example, refused to implement the consolidation policies. The CG, on the other hand,
threatened to take over control over the budget, for instance, in Asturias. Catalonia is
campaigning for a separation, claiming that succession would be better able to improve
financial conditions than remaining within the federation. Federal relations are therefore
deteriorating rapidly in the wake of the “re-centralisation” of fiscal authority that is taking
place.
South Africa
The economic and financial crisis was relatively mild in South Africa, although deficit rates
were rising clearly above average during the last years. Over-borrowing was less of a
problem, as MS are restricted considerably by legally fixed limits to borrowing (outstanding
loans may never exceed half a per cent of expected loan requirements of a province; no
foreign borrowing is allowed) and by the approval of loans by the coordinating body (Braun
2009). Fiscal mismanagement of MS can result in an intervention of CG putting the
government or parts of the government under administration and control of CG. This is
exactly what happened to Limpopo earlier this year (Daily News, January 20, 2012).
The deterioration of net lending induced the CG to adopt a Stability Pact stipulating
the maximum amount of annual net lending throughout the country, which of course also
affected the provinces, as this measure implied curbing CG transfers to provinces. Still, it
needs more.
The crisis moreover nourished a fundamental controversy between the governing
party, the ANC, and the opposition: During the crisis, it was revealed that MS were regularly
diverting CG grants to other purposes than intended in order to fill their fiscal gaps. This
“unruliness” of MS was the motivation for CG to re-launch the debate about the legitimacy of
the existence of the provinces. It claimed that the federal construction is inefficient and can
simply be replaced by a dual structure of "central state - municipalities" (Powell and Steytler
2010).
Australia
Australia is another country with a relatively favourable economic and financial position at
the onset of the crisis. MS debts were and continue to be relatively low in international
comparison. The deteriorating international context however led the CG to adopt a restrictive
stance in fiscal management that recently resulted in a unilateral reduction of CG grants for
education purposes with negative consequences for the budgets of MS. Stability pacts have
not yet been envisioned. As in Canada, Belgium, or Spain, the crisis nevertheless
demonstrated that the “solidarity system”, i.e. the equalisation system, is coming under
increasing strain, this time between the resource-rich and the other MS in Australia.
Equalisation is paid by a distribution of the General Sales Tax (GST). CG and a number of
MS demanded a higher contribution of resource-rich MS Western Australia and Queensland
to the GST, meaning their extra income should be deduced from their rights for equalisation
payments. These discussions went to far as to elicit a threat by Western Australia to leave the
GST system altogether and subsist on its incomes from China. Even separation was raised in
the discussions (The Australian, January 16, 2012; May 2, 2012; June 9, 2012). This only
further illustrates that, even in Australia, with its relatively comfortable position, the crisis’
primary backlash could be seen in form of decreasing income for many MS. These
discussions also launched debates on the redistribution system. While both the unilateral
moves of CG and the redistribution debate placed strains on federal relations, the
“collaborative federalism” (Painter 1998; Braun 2005) that has been in place in Australia
since the 1990s was not changed.
Argentina
Argentina has for a long time been a system with considerable problems to avoid both over-
spending by the CG and MS and above all over-borrowing by MS. The system is built on
“pork-barrelling” in transfers between MS which are “resource hungry” and a CG that needs
the political support of governors in the Senate (Ardanaz et al. 2010). Throughout history,
Argentina has often served as an example of a bailout system (Wibbels 2005; Rodden,
Eskeland and Litvack 2003). The financial breakdown in 2001 led to a number of changes.
MS received favourable conditions for repayment of their debts financed by CG. Fiscal
responsibility laws had already been enacted including the majority of MS since 1999. The
continuing problem was that the deficit limits contained in such laws were seldom respected.
Argentina was obliged to borrow money from the IMF and, as a consequence, had to respect
the conditions that came with this money in order to reduce future debt rates. This led to a
second fiscal responsibility law in 2004, which defined rules for the entire country (a ceiling
on regional debts if the debt services exceed 15% of the regional revenue; CG has to
authorise regional debt operations). A new “Council of Fiscal Responsibility” was set up,
composed of representatives from CG and MS. It could enforce sanctions in case of violation
of expenditure and debt limits. All MS complied with the law within two years. While the
law had some positive effects on overall borrowing, during the crisis it was revealed that MS
were not respecting the agreed upon targets (Liu 2011). The Council was clearly not
sufficiently restrictive, as loopholes for MS continued to exist.
When the crisis set in, general debt limits were abandoned in order to finance the lack
of demand in the economy. The decrease of financial resources for MS induced the CG in
2010, as in 2001, to finance a new financial recreation programme that alleviated the debt
burden of MS (Reuters, May 10, 2010; Wall Street Journal, December 28, 2011).
In sum, Argentina has been plagued by a debt problem for quite some time. There
were serious attempts in the 2000s to get handle on this development, mostly initiated by the
CG. With pressure and incentives MS accepted general fiscal restraint in the form of laws,
but all monitoring and sanctioning instruments seem to have been unable to bring about
change to the basic “pork-barrelling” structure of the system. The financing by CG of part of
the debt burden of MS is part of this structure and also demonstrates that federal relations
have not been changed by the crisis.
India
India was, like South Africa, less directly influenced by the financial crisis, as growth rates
remained relatively favourable. But India suffers historically from relatively high debt rates
and the reduction of these rates has been a constant concern of CG and the independent
"Finance Commission", which has offered the main reform propositions during the last 20
years.
India was able to pass fiscal responsibility laws on all levels in the 2000s, but, as in
Argentina, CG also contributed substantially to a reduction of MS debts by way of Debt
Swap Schemes or the "Debt Consolidation and Relief Facility".
When the economic crisis set in, deficits started to increase, not because of over-
spending or over-borrowing by MS, but simply because of declining revenues and because of
adaptations in payment schemes for state employees. CG helped MS to temporarily finance
the rising deficits by increasing the deficit limits it had fixed by law for two years. In 2010
the situation changed positively and the path of consolidation could be resumed (Agence
France Presse – English, April 23, 2010).
Altogether, India has made serious efforts to consolidate throughout the 2000s, above
all by tightening borrowing opportunities. While these efforts have witnesses some success,
West Bengal recently had to be bailed out when it came into serious financial difficulties
(Gulf News, UAE, August 8, 2011). CG achieved more fiscal responsibility by the carrot and
the stick: it offered MS financing aid, but in exchange demanded the introduction of fiscal
responsibility laws and other measures. The Finance Committee played an “enlightening
role” in this process.
There were no authority shifts during the crisis. Discretion reduction was already in
place by fiscal responsibility laws that were accepted by MS.
Comparative interpretations
In this chapter we focus on answering our general questions about the treatment of the deficit
crisis by federations, their success, and the implications for federal relations. Our first
question asks whether the federations have been subject to coordination problems, in
particular with regard to the "shirking" of MS in terms of rent-seeking and over-borrowing
and how they have reacted to such problems? Do we find differences between the two
regimes? Our second concern is whether such problems have resulted in authority shifts and,
if so, to a change in federal relations?
Rent-Seeking and over-borrowing as coordination problems
We expected that countries in the "decentralised fiscal regime", i.e. Canada, Switzerland,
USA, would have been able to avoid the problem of MS shirking. This can without
reservations be confirmed for Switzerland. If we classify the three countries into the typology
presented above, all three would fall into the "fiscal discipline" sector, simply because all
three had, as one could have expected, introduced "self-imposed rules and regulations" for
borrowing at the MS level. This was, however, not always a guarantee for the avoidance of
over-borrowing. Switzerland did best with the introduction of debt brakes on both the central
and MS level early this century and, above all, with the obligation to put major changes in
spending and taxation to the vote by a referendum. The fundamental constitutional reforms in
2006, which intended to overcome perverse incentives in the transfer system, seemed to work
in a reasonable way. To be fair, it must also be said that the economic and financial pressure
was relatively low because these and other reforms had already been introduced prior to the
onset of the crisis. The functioning of the new transfer arrangements have however yet to be
put to a serious test in terms of of their sustainability.
In general, MS in the USA were also sufficiently constrained in their behaviour to
borrow, though it was only in the recent crisis that continuous spending and lending activities
have reached a threshold that forced the existing self-imposed regulations upon governments.
Any "bailout", the incentive structure that can lead MS to continue borrowing, was not
foreseen in the system, although legal confirmation of this principle is still needed given the
rising numbers of MS with serious problems of fiscal insolvency. Borrowing regulations at
the MS level do work, but apparently they have not always been put to work at the right time,
which has led to situations of serious financial turmoil in several MS. As a result, often-
drastic austerity policies, which are the last resort of MS in the deficit crisis in such a
decentralised fiscal regime, get passed and implemented., Although opportunity structures
exist in the form of CG grants, rent-seeking is an alternative minor option in the deficit crisis
because CG is reducing its transfer amounts and the conditions that have been applied by CG
when distributing such grants have always had a dissuasive effect. As a result, we see
consolidation efforts in borrowing from higher to lower levels and limited rent-seeking.
If we want to visualise these crisis policies in a more systematic way, we could use a
slightly different two-dimensional space from the typology above, which attempts to measure
the degree of the shirking or coordination problem in federal states.
Figure 1: Coordination problems in federal states
This two-dimensional space tries to give two continuums along which shirking of MS can
occur. Such a space makes the more sense, as it has become clear that even countries in the
decentralised regime have institutionalised some form of transfer payments, though these
payments are much lower as a share of total income of MS.
The negative effects that such a transfer system may have on fiscal discipline, even in
decentralised federal countries, is clearly demonstrated by Canada. While Switzerland falls
into the sector indicating "fiscal discipline" and the USA may see a switch from the sector of
limited fiscal indiscipline because of over-borrowing to more fiscal discipline, Canada may
be considered - against all expectations - as a case of "fiscal indiscipline" that does not
change position in the space. As in the USA, MS were clearly over-borrowing, despite self-
imposed regulations. These regulations therefore not seem to be sufficiently self-enforcing.
But in contrast to the United States, the equalisation system was also an incentive to continue
spending in Canada. Austerity policies increasingly became the preoccupation of richer MS
that, had to pay substantially greater sums into the equalisation system than the “have-not”
provinces. This situation has led to fundamental discussions on the necessity of centralising
the borrowing system, as well as on the fairness of the equalisation system. Until now, we
have not found significant reform steps that would indicate a shift of Canada into the
direction of the fiscal discipline sector.
Overall, the decentralised fiscal regime countries have reacted differently. Only
Switzerland is a case of fiscal discipline. In the United States borrowing restraints not worked
sufficiently have for a long time. In Canada the transfer system has added rent-seeking
problems. What the three countries have in common is that CG is not involved in the
regulation of deficits. This can be a problem if "markets" do not work sufficiently as
restraints, which seems to have been the case in the USA and Canada for quite some time.
The developments on the financial market allow us to assume that market conditions are
changing and that MS are increasingly placed with the responsibilities of reducing debts and
deficits. A hindrance in this respect is that market coordination is working imperfectly in
most federal systems, as the financing situation of the CG is always - even without
expectations for bailout - a reference point for markets. If the financial situation of CG is
favourable - as in Canada - or creditors continue to trust fiscal policies of CG, as in the USA,
MS will have more favourable conditions for borrowing than if they would act as
autonomous states. Given the dramatic increase of debts in MS and the still sluggish world
economy, , this indirect "protection" with negative consequences for fiscal discipline may
however have come to an end.
In the transfer system, we see two groups of countries. One group, Australia, Belgium, India,
and South Africa, have for different reasons reduced borrowing opportunities for MS quite
successfully, but may still fall into the trap of rent-seeking (limited fiscal indiscipline - rent-
seeking). The remaining four countries - Argentina, Austria, Germany, and Spain - are among
those federal countries where shirking opportunities for MS existed abundantly, both in terms
of borrowing and transfers. All four, however, have taken efforts to at least reduce over-
borrowing and might increasingly shift towards the direction of the four other countries in the
regime group.
Let us first take a closer look at the countries of the Euro-Zone and why Belgium,
despite being a member of the common currency, can be considered as a deviant case.
Countries in the Euro-Zone were already restricted since 1992 in their borrowing
opportunities by the Maastricht Treaty, which defined upper ceilings of the debt ratio (60%)
and annual net lending (3%). However, the EU was, despite institutionalised deficit
procedures and possible sanctions in the form of "fines", unable to enforce these criteria,
which led to permanent shirking of member states. Only the most dreadful scenario, the end
of the Euro, could change this: several new rules and sanctioning mechanisms were and
continue to be introduced (like the "Sixpack" from 2011 and the "Fiscal Pact" from early
2012), which require MS to bring their deficits and debts down to the Maastricht criteria
within a couple of years. A debt brake has become compulsory for all countries. The four
federations in the Euro-Zone - including Belgium - had to comply with these regulations,
resulting in serious pressure on all political actors in these countries. This time, success was
indispensable, meaning that measures had to be enforceable and, if possible, self-enforcing.
CG as the signing party of the contracts became the guarantor of the treaty arrangements.
Although the level of pressure was therefore the same for all four countries and despite the
fact that we find a different scenario and different process in implementing the Euro-Zone
criteria depending on the power relations, one consensus existed among the political elites:
the will to ensure the survival of the Euro and to remain part of the Euro-Zone:
In Austria, any agreement needed the consent of MS, even though CG could have
acted alone and declare a stability law that respected the criteria. But it had already turned out
that MS by no means felt compelled by such announced expenditure restrictions and shirked,
simply by not implementing these guidelines. During the deficit crisis it needed positive
coordination and this meant to gain the consent of MS. Finally, while a consensus was
achieved, it was a consensus that allowed MS sufficient possibilities to deviate from the
contract and demand other compensation by CG than already agreed upon.
In Germany, the balance of forces is similar in fiscal policy-making to Austria, though
MS have an even stronger, constitutionally anchored veto-power in all matters that concern
tax authority and spending areas. This German fiscal pact came early because it was part of a
general reform of German federalism, which had started years before. With the new fiscal
pacts on the European level, additional regulations had to be introduced. And here again, one
finds that in such transfer regimes the consensus of MS could only be obtained when CG
offered side-payments or, with regard to the Fiscal Pact II, when it helped MS financially to
achieve the fiscal objectives. One therefore sees that, as in Austria, bargaining is the
governance form in German federalism and, though the necessary compromises were found,
CG has to pay. The difference from Austria is that the contract concluded seems to have
fewer loopholes and that the arrangement may be enforceable.
In Spain the deficit crisis has gone much further than in Austria and Germany and
demanded much stronger and more immediate action. The more the international pressure
was growing and Spain had to fulfil contracts for obtaining additional loans from European
funds, the more CG has become a "benevolent dictator" that enforces the contracts on MS. In
this way, we see a continuing tightening of borrowing autonomy of MS that now goes so far
that MS budgets are practically under administration of CG, a significant difference to the
coordinated borrowing procedures that existed before.
While we see in Spain probably the most far-reaching restrictions of the borrowing
autonomy among our federations, restrictions on rent-seeking seem to have received less
attention, although changes can be seen. It is, for example, clear that one of the transfer
sources in the transfer system, CG grants, have become increasingly scarce as CG itself is
under serious pressure to fulfil the contracts. Debt burden is usually higher at the level of CG
than at the level of MS. This is certainly the case in Spain because of the dramatically
deteriorating situation, but it is also felt in Austria and Germany. The latter country has also
introduced constitutional restrictions on CG grant transfers. The equalisation system,
however, has not changed in the countries but, as we will discuss below, tensions have
developed, as seen in the Canadian case. We would therefore argue that while shifts in
opportunities in rent-seeking are diminishing, they have not been changed by institutional
reforms. Both tax-sharing and equalisation systems are maintained as before, thereby
continuing to support possibilities to exploit common pool resources under certain
restrictions.
We have stated that Belgium is a deviant case with respect to these three countries.
Belgium has suffered from instability due to ethnic conflicts for a long period of time.
Several constitutional crisis and changes have taken place, which finally established a federal
country with some decentralised features in fiscal matters. This ethnic conflict prevented
Belgium to act as swiftly as would have been needed. It had, however, already developed
some experience with stability pacts before the crisis that contributed to a significant
reduction of the overall deficit. The particularity of Belgium is that MS produce only a small
share of the overall debt, which means less emphasis on the compliance of MS with overall
plans. Nevertheless, the MS spending behaviour continues to make a difference, and this is
why stability arrangements also generally have defined expenditure limits in MS (and
communities). After two periods without a government during the crisis, stability pacts
continue to be respected. The criteria of the Euro-Zone as such have therefore not produced
the main tensions in the system. The challenge was to pacify the distributional conflict
between Wallonian and the Flemish region, which erupted during the crisis, exactly because
the Wallonian region was experiencing difficulties in financing its fiscal gap and needed
more equalisation payments due to its deficient industrial structure. This conflict, and not the
crisis as such, led to a fiscal re-arrangement with further decentralisation of tax authority and
more policy competences for MS.
This background explains why Belgium seems to belong to the group with "limited
fiscal indiscipline" with continuing rent-seeking: the struggle for additional transfers by way
of the equalisation system continues. Effects from a reduction of CG grants are less
noticeable, for they are smaller than in the other three countries. Over-borrowing of MS is
less of a problem, because CG is in charge of most of the deficits and MS were successfully
integrated in previous stability pacts and are still today.
Debts, both on the CG and MS level, have been an on-going problem in Argentina,
and it seems that, despite some efforts, both over-borrowing and rent-seeking have yet to be
sufficiently restrained. First, serious efforts to deal with the borrowing problem have been
launched, starting in 1999 with the first fiscal responsibility law. Financial breakdown could
not be avoided in 2001, and even after 2001 MS continued to over-borrow. In 2004, a more
constraining and encompassing fiscal responsibility law was introduced on all levels of
government. While MS could be induced to comply with the spending and borrowing
ceilings by establishing their own laws, success remains modest, as continuing deficit
generation by MS was revealed during the crisis when the ceilings were not respected.
During the crisis itself no new laws were enacted, but CG alleviated some of the debts of MS
by a financial recreation programme. Despite the stricter stance in borrowing matters, it
seems that Argentina has been unable, until now, to introduce a "fiscal prudence" culture.
The reason for this seems to be the continuing "pork-barrelling" system that allows MS to
also use government grants for borrowing purposes while CG is able to "buy" the political
support of MS in the Senate. Illustrative of this process, we see that CG has repeatedly been
prepared to provide financial aid - bailout - if MS debts have gone too far. Both over-
borrowing and rent-seeking remain a problem in Argentina.
In addition to Belgium, three other countries have achieved acceptable borrowing
rates of MS, while rent-seeking in the overall system seems to remain a challenge.
South Africa had introduced a strong “command and control” system by way of its
coordination procedure and legal restrictions; MS deficits seemed relatively under control, as
were general government deficits at the beginning of the crisis. When deficits began to
increase during the crisis, CG unilaterally announced a stability law that imposed expenditure
cuts on MS. Rent-seeking was revealed when several MS abused conditional grants of CG in
favour of filling their fiscal gaps.
In Australia, any coordinated fiscal responsibility laws seemed unnecessary given the
country’s favourable economic and financial position. The existing borrowing system is not
built on hard sanctions, but seems, on the basis of coordination, to work well. Rent-seeking,
by contrast, was a problem and led to confrontations in the equalisation system when MS and
the CG attempted to shift some of the costs to resource-rich MS.
India, finally, has had prior to 2000 a relatively controlled borrowing system, because
MS were not allowed to borrow abroad and relied mainly on CG loans. This gave CG the
possibility to link loans to conditions of fiscally prudent behaviour. This system has become
increasingly prevalent since 2000, with most loans coming from the market. While this has
forced CG to introduce other control mechanisms, CG was aided by initiatives by of some
MS themselves to introduce fiscally responsibility laws that were ultimately enacted on the
federal and MS level. In addition, an independent expert commission is monitoring both the
grant and borrowing system. There was, therefore, a shift in the governance mechanisms to
control borrowing, but shirking of MS could be maintained at acceptable levels. Although the
new system seems to have a positive influence on MS borrowing rates, overall debt levels
remain relatively high. Rent-seeking is still part of the system, as there are numerous
occasions for MS to obtain special grants by various ministries. This system lends itself to
"collusion", but it seems that the number of such grants have gone down in recent years.
The following figure aims to position the countries and their shifts in terms of
"shirking" in the two-dimensional space:
Figure 2: Dynamics of coordination problems in federal states
The figure shows that over-borrowing has become increasingly less common for those
federations that have suffered from past fiscal indiscipline. Argentina and Canada are the two
countries that are still combining rent-seeking and over-borrowing. Rent-seeking is seldom
tackled by institutional reforms in the federations. If it is, as in Austria, Germany, and Spain,
it is because of increasing pressure by CG itself, which has to bring down its expenditures
and is less generous in providing grants to MS. It should, however, be stated clearly that the
tendencies in tightening borrowing restrictions only signify that institutional restraints are
increasing and not that the actual borrowing rights have already gone down.
Impact on federal relations
Our second concern in this article is to examine whether the deficit crisis and the search for
solutions has led to authority shifts and changing federal relations. We expected a
centralisation of competences, particularly in transfer systems that are heavily plagued by
shirking of MS. Authority shifts are either unilateral CG policies that affected the discretion
of MS negatively or legal migration of competences to the centre.
Unilateral moves by CG were found in Canada, Australia, USA, Spain, Argentina,
and Switzerland concerning the transfer of CG grants. In the USA and Switzerland this was
simply characterised as allowing stimulation measures that had been established during the
first crisis period to run out. In the other cases, CG started more restrictive fiscal policies,
which also contained the reduction of existing grants to MS. In Canada and Australia this
caused considerable tensions because such grants were substantial sums of money that had to
be replaced by other means of MS. The equalisation system was in both cases an outlet for
this problem, which, in due consequence, led to tensions between MS. The reduction in Spain
was part of the overall "emergency policy" in the deficit crisis, which increased federal
tensions considerably. We will return to this point shortly.
Other discretion reducing examples are the consolidation agreements that were
concluded in the Euro-Zone and which required all MS to respect the spending and
borrowing ceilings, such that alternative expansionary strategies had to be discarded.
At first glace, one can label all fiscal responsibility laws as they were adopted in
Argentina, India, and in the Euro-Zone as “authority migration” because they usually give
CG (or the supranational entity) the right to decide on expenditure ceilings and/or borrowing
limits. However, in Austria, Germany, and Belgium approval of MS in the formulation of
such ceilings is required and does not take place without compensation payments for MS. In
Argentina, CG usually needs the approval of the Senate in which MS have a veto position.
Independent expert committees may further constrain the discretion of CG to use this power
in a hierarchical way, for example in India and Belgium. What is more, CG itself is subject to
the same limitations as MS. While the rules that are applied reduce the room for manoeuvre
of all actors, CG is usually afforded somewhat more room to make debts than MS, but this is
due to its generally larger responsibilities for overall stability. Another constraint are
international treaties as they were concluded in the Euro-Zone and which define what CG
have to implement within the country. In sum, though MS lose competences to define fiscal
policies, it is clear that this does not mean that CG can “overawe”. There are only two
examples where CG can decide rather independently on expenditure and borrowing limits
within such fiscal responsibility laws: India and Spain. Although the Indian CG is still bound
by expert opinions, it can vary borrowing limits, something which is has done during the
crisis. The Spanish CG is perhaps the only government that uses its prerogatives in a
hierarchical way, to be explained mostly by the urgency of measures to be taken. MS in
Spain have lost more discretion than MS in the other federations and are "under
administration" of CG rule. Though one can question if this can be seen as "over-awing", as
CG is simply acting as the delegate of the Euro-Community, Spain is an example of a "re-
centralisation" during the crisis, following previous important steps to decentralisation. In the
other cases, we see checks-and-balances, such that one should perhaps rather speak of
discretion reduction than of authority migration.
Discretion reduction can, however, have important and lasting consequences for
federal relations in general. This is certainly the case in Austria and Germany, where MS are
practically devoid of any tax authority of their own. The loss of discretionary powers in
spending fundamentally questions the political value of the federalist construction, as MS
increasingly take on the role of administrative entities with a very restricted room for
manoeuvre to develop own policies. The recent discussion in Germany not only puts this
topic on the table, but also evokes already possibilities of fusing MS in the future. It is this
future loss in significance of MS that may question the federal constitution as such, without
automatically implying a centralisation of powers.
Such general consequences of the deficit crisis on federal relations can also be the
result of the "de-solidarisation" processes that have been taken place in some of the
federations (Australia, Belgium, Canada, Spain, and to some extent in Germany between the
East and the West of the country). Because of the shifting of costs produced in the crisis,
equalisation systems were challenged. The clash was usually between richer and poorer
regions in which the richer regions tried to avoid extra payments, or, when experiencing
decreasing incomes, to contest the fairness of overall arrangements. Poorer regions usually
were demanding redistribution of the common pool in their favour. This “de-solidarisation”
process does not question the vertical authority relations, but horizontal federal relations and
therefore the unity of the federation. In Spain the severity of the crisis and the imposed
austerity measures contribute to open resistance of the Basque country and to separation talks
in Catalonia, where the political elite claims it will be better off without the general transfer
system. While the struggle of richer MS against the fairness of the equalisation system is
nothing new in Germany, tensions have recently been reignited. The crisis in Belgium has
also contributed to increased claims by one region for equalisation resources, while the richer
region contests these claims. Only after more than a year without a CG, a solution by
decentralising more resources to the richer region and maintaining the overall solidarity could
be found. This solution, however, may very well end up being only temporary. In Canada the
distributional struggle has led to discussions about the federal compact as such.
Conclusions
We had two intentions in this article: First, to analyse if federal states do indeed suffer from
coordination problems during the deficit crisis, in particular, from shirking behaviour of MS -
by over-borrowing or rent-seeking. Second, we investigated whether coordination problems
and strategies to cope with such problems have had any effect on federal relations and, more
specifically, if they have resulted in centralisation processes. In sum, we can provide the
following answers to these questions:
Not all federations have suffered from borrowing coordination problems, though most
allow rent-seeking. Both countries in the decentralised and in the transfer regime can have
such problems. Those federations, which were relatively successful in avoiding shirking by
over-borrowing, were either barely contested during the crisis, such as Australia, or they had
already established built-in institutional safeguards before the crisis, as India, South Africa,
and Switzerland did. Belgium avoided the coordination problem by practically delegating
most debt obligations to the central level.
Other federations either did too little enough to overcome opportunism, like
Argentina, or were forced into fundamental reforms with strongly restraining institutions for
future borrowing. The other members of the Euro-Zone belong here, in particular Spain and
Germany, while Austria has still to prove if the new arrangements will indeed come into
effect. Canada and USA, two countries from the decentralised regime, had to learn that their
self-imposed rules and regulations of borrowing were not sufficient to avoid over-borrowing.
As a consequence, harsh austerity measures are implemented in the USA, while similar
measures have only started in some MS in Canada.
Overall, one can see a shift from fiscal indiscipline in borrowing to the development
of more credible institutional restrictions that may help to control such over-borrowing better
in the future. This shift has, however, not meant "subordination" (Rodden 2002) to CG
command. Our interpretation of "authority shifts" taking place during the crisis is more
cautious: fiscal responsibility laws - both on the central and the MS level - having been the
main institutional change that has taken place, exercised similar constraints both for CG and
MS to use fiscal policies. CG is certainly the responsible agency in all federations for
achieving stability in periods of crisis. But our findings demonstrate that CG seldom acts
alone. More often we find institutional constraints that are "coordinated", i.e. implemented
together with MS and at times also with independent expert committees. Coordination, which
gives MS some veto power, is insufficient in situations of urgency, as the current Spanish
case demonstrates.. Under such circumstances a temporary authority migration to the centre
has taken place and MS are subordinated to fiscal restraints imposed by CG. This has
however been the exception. Particularly in those federations where MS have little tax
authority, such as in Germany and Austria, the loss of discretion in fiscal policy-making may
contribute to a questioning of the "value" of MS altogether, as they lack any financial means
to actually govern.
Perhaps even more threatening for federal relations is the effect of "de-solidarisation",
which has been affecting equalisation systems in countries such as Canada, Australia,
Belgium, and Spain due to redistribution quarrels. As such disagreements can be quite intense
and pose a fundamental threat. Whether de-solidarisation will lead to the destabilisation of
federations will depend on future developments in the financial crisis.
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