In the next subsections, I show the main results by identifying the type of innovation, e.g., temporal or permanent, and the response for each variable. First, I present municipal responses to positive innovations in budgetary elements over the period of ten years (see Fig.
2). As expected, since the variables are not mean reverting, the impact of innovations does not die out over time, which implies that innovations in this system have permanent effects on the elements composing the government budget constraint. Moreover, these results show that adjustments take place in the first 5–6 years, indicating that local governments require long periods of time to restore their fiscal positions. Second, for the estimations of the present value responses and for the ease of comparison, I assume, in the spirit of the previous literature, a discount rate of
\(3\%\)16 and interpret the results according to the procedure of Buettner and Wildasin (
2006).
17
7.1 Results in Colombian municipalities
Table
5 displays the estimates for the error-correction term in the sample of Colombian municipalities. The vector of coefficients
\(\theta\) confirms the error-correction representation of the fiscal deficit and supports the assumption that the intertemporal budget constraint holds in the long run. Notice that a higher deficit has a negative effect in both types of local government spending, e.g., consumption and investment. Likewise, it has a positive effect on both intergovernmental grants and own-source revenues. Debt service also responds positively which indicates that a higher fiscal deficit results in a rise in debt and, as a consequence, higher levels of debt service should be expected. By comparing these responses with the international evidence for advanced economies in the spirit of Martín-Rodriguez and Ogawa (
2017), one can observe that the response of grants to one monetary unit increase in fiscal deficits in Colombia is lower (24 cents) than in Spain (36 cents), but it is surprisingly higher than in the USA (7 cents) and Germany (5 cents), supporting the idea that the fiscal decentralization process in Colombia is far from being completed as suggested by Bird (
2012) although it is worth mentioning that the response of own-source revenues is similar to the ones reported by the USA and Germany.
Table 5
Estimates for the error-correction term in Colombian municipalities
\(\theta\) | − 0.02*** | − 0.49*** | 0.01** | 0.24*** | 0.11*** |
(0.01) | (0.09) | (0.00) | (0.07) | (0.03) |
Observations | 19,625 | 19,625 | 19,625 | 19,625 | 19,625 |
Adjusted R-squared | 0.12 | 0.33 | 0.27 | 0.21 | 0.14 |
Table
6 reports the implied present value responses of each fiscal variable to innovations in both itself and other variables. The columns show how fiscal variables adjust after a specific innovation in the system and the rows present how a particular variable reacts to unit changes in other variables. For instance, a 1 COP positive innovation in government consumption in one period is followed by a reduction in future government consumption of 38 cents, and by an increase in government investment of 25 cents, notice that this latter effect could suggest spending complementarity. Intergovernmental grants and own-source revenues react positively to this innovation with an increment of 48 cents and 38 cents, respectively. Given that this rise in government consumption could be financed through debt, there is also a positive effect on debt service of 3 cents. All of these responses are statistically significant.
Table 6
Implied present value responses for Colombian municipalities
Response of G. consumption | − 0.38*** | − 0.01 | 0.05 | 0.01*** | 0.03*** |
(0.03) | (0.00) | (0.03) | (0.00) | (0.01) |
G. investment | 0.25** | − 0.72*** | − 0.29* | 0.35*** | 0.45*** |
(0.12) | (0.04) | (0.18) | (0.05) | (0.07) |
Debt service | 0.03*** | 0.00*** | − 0.55*** | 0.00 | 0.00 |
(0.01) | (0.00) | (0.05) | (0.00) | (0.00) |
Grants | 0.48*** | 0.16*** | 0.20 | − 0.58*** | − 0.01 |
(0.12) | (0.04) | (0.17) | (0.05) | (0.06) |
Own revenues | 0.38*** | 0.08*** | 0.03 | − 0.03 | − 0.48*** |
(0.04) | (0.02) | (0.05) | (0.02) | (0.04) |
Response to permanent increase G. consumption | | − 0.02 | 0.11 | 0.03*** | 0.05*** |
| (0.02) | (0.07) | (0.01) | (0.01) |
G. investment | 0.41** | | − 0.66* | 0.83*** | 0.87*** |
(0.19) | | (0.38) | (0.05) | (0.11) |
Debt service | 0.06*** | 0.01** | | 0.00 | 0.00 |
(0.01) | (0.00) | | (0.00) | (0.00) |
Grants | 0.77*** | 0.58*** | 0.44 | | − 0.02 |
(0.19) | (0.08) | (0.37) | | (0.11) |
Own revenues | 0.60*** | 0.28*** | 0.00 | − 0.07 | |
(0.07) | (0.06) | (0.11) | (0.04) | |
Furthermore, a 1 COP positive unexpected change in government investment leads to a decrease in future government investment of 72 cents, which implies that the level of investment is 28 cents above the level before the innovation takes place. Notice that in this case, government consumption decreases by 1 cent, but this change is not statistically significant, and the debt service increase is minimal. It is also worth noting that grants and own−source revenues react in a lower extent to a government investment rise (16 cents and 8 cents, respectively) than to a government consumption increase. All of these responses are statistically significant and have the expected sign.
A positive unit innovation in grants is followed by a reduction in future grants of 58 cents and 3 cents in own-source revenues, but this response is not significant. Thus, the latter impact does not support the idea that municipalities who receive more grants tend to decrease their fiscal effort (Martínez (
2016); Faguet and Sánchez (
2014)), and provides additional empirical evidence for the no existence of fiscal laziness in Colombia (see, e.g., Bonet-Morón et al. (
2018) and Cadena (
2002)). Notice, however, that these results confirm a possible flypaper effect in Colombian municipalities, given that grants have a positive and significant effect in future spending, particularly in investment, with a total increment of 35 cents. These point estimates are in line with the ones reported for US cities where a rise of one monetary unit in grants generates an increment in expenditures of 34 cents (Buettner and Wildasin
2006) and for Spanish municipalities where there is a rise in local spending of 29 cents due to an increment in grants (Solé-Ollé and Sorribas-Navarro
2012). For Germany and Japan, the responses attain a value of 35 and 55 cents, respectively, according to the estimates in Buettner (
2009) and Bessho and Ogawa (
2015). It is also important to mention that, in general, grants can have significant and positive responses to innovations in local public spending which suggests that there is a soft-budget constraint problem given that municipalities may follow an opportunistic behavior (Bessho and Ogawa
2015).
Moreover, a positive innovation in own-source revenues of 1 COP leads to a decrease in grants of 1 cent (but this impact is not significant) and in future own-source revenues of 48 cents. The impact on debt service has the expected sign, but it is not significant. Government investment reacts positively with a future increment of 45 cents and government consumption with 3 cents. Notice that these impacts are higher in comparison with the responses due to innovations in intergovernmental grants. This fact can be explained bearing in mind that when government revenues come from local taxation and not from an external source, e.g., intergovernmental grants, voters can force local governments to increase productive spending due to a higher level of accountability (Martínez
2016). The impact of innovations on government spending in Colombia is thus quite similar to the reported effects for the USA (51 cents) and Japan (38 cents), but large in magnitude if one compares these values with the ones for Germany (27 cents) and Spain (26 cents).
As suggested by the previous studies, it is also instructive to calculate the responses to permanent innovations (Bessho and Ogawa
2015; Solé-Ollé and Sorribas-Navarro
2012; Buettner
2009; Buettner and Wildasin
2006). The bottom of Table
6 reports those present value responses. Notice that a permanent positive unit innovation in both government consumption and investment is followed by an increment in grants of 77 cents and 58 cents, respectively, supporting again the existence of a soft-budget constraint problem. In addition, future own-source revenues increase by 60 cents and by 28 cents to a unit permanent innovation in government consumption and government investment, respectively. These impacts are similar to the ones computed for US municipalities where the response of own-source revenues to a permanent innovation in total local spending attains 57 cents (Buettner and Wildasin
2006). Moreover, these effects are also similar to the point estimates reported by Bessho and Ogawa (
2015) for the Japanese municipalities (51 cents), and by Buettner (
2009) for the German municipalities (43 cents).
18 This could imply that, on average, Colombian municipalities do not face a clear limited fiscal autonomy in terms of capacity to increase their own-source revenues, in contrast to the ideas presented by Bird (
2012) and Acosta and Bird (
2005).
Table 7
Present value of change in primary surplus in Colombian municipalities
Primary surplus | 0.98 | 0.97 | 0.44 | − 0.97 | − 0.97 |
It is also interesting to assess the response of primary surplus to innovations in each fiscal variable in order to check whether the Colombian municipalities commit to satisfy an intertemporal budget constraint. Indeed, summing up the responses of fiscal variables that constitute the primary surplus, it follows that the absolute value of the changes is close to unity in all cases, but not for debt service (see Table
7). According to Buettner and Wildasin (
2006) and Buettner (
2009), the latter result in which the fiscal balance is not achieved in response to innovations in debt services could reflect temporal fluctuations in this fiscal variable. Notice that the present value response of debt services to a unit innovation in itself is -0.55 COP, which implies that 0.45 COP of this innovation is permanent. If one compares this value with the present value of the change in primary surplus (0.44) due to a unit innovation in debt services, then one can claim that this result is in line with the predictions derived from an intertemporal budget constraint approach (Bessho and Ogawa
2015; Buettner and Wildasin
2006).
7.2 Additional results: decomposing the municipal sample
In this subsection, I proceed to assess whether the above results about fiscal adjustment at the local level in Colombia change when I decompose the municipal sample bearing in mind differences in population levels, local GDP per capita, and degree of fiscal decentralization.
19 A common perception in the economic literature is that Colombian municipalities have profound disparities, different natural resource abundance, partial fiscal decentralization, high levels of public sector corruption, limited economic opportunities for people, distinct growth rates, and almost no discretion on public spending (Martínez
2016; Bird
2012). In this sense, for instance, it is possible that larger or richer cities follow different patterns of fiscal adjustment since they could have access to more resources and receive more political support from the national government.
Table 8
Implied present value responses with respect to city size
Large cities (top quartile) |
Response of |
G. consumption | − 0.34*** | 0.01 | 0.08 | 0.00 | 0.05*** |
(0.06) | (0.01) | (0.07) | (0.02) | (0.01) |
G. investment | − 0.02 | − 0.62*** | − 0.51* | 0.32*** | 0.41*** |
(0.16) | (0.10) | (0.31) | (0.08) | (0.11) |
Debt services | 0.11*** | 0.01 | − 0.54*** | − 0.01 | 0.01 |
(0.02) | (0.01) | (0.06) | (0.01) | (0.01) |
Grants | 0.38** | 0.22** | 0.12 | − 0.56*** | − 0.08 |
(0.16) | (0.09) | (0.28) | (0.07) | (0.10) |
Own revenues | 0.33*** | 0.15*** | − 0.09 | − 0.09** | − 0.42*** |
(0.08) | (0.05) | (0.14) | (0.04) | (0.07) |
Response to permanent increase | | | | | |
G. consumption | | 0.03 | 0.17 | 0.01 | 0.09*** |
(0.09) | (0.16) | (0.04) | (0.02) |
G. investment | − 0.03 | | − 1.13* | 0.74*** | 0.71*** |
(0.25) | | (0.68) | (0.10) | (0.18) |
Debt services | 0.17*** | 0.06 | | − 0.01 | 0.01 |
(0.03) | (0.20) | | (0.02) | (0.01) |
Grants | 0.58** | 0.47 | 0.24 | | − 0.14 |
(0.24) | (0.75) | (0.59) | | (0.19) |
n Own revenues | 0.49*** | 0.47 | − 0.19 | − 0.20* | |
(0.12) | (0.72) | (0.31) | (0.10) | |
Small cities (bottom quartile) |
Response of |
Expenditures | − 0.40*** | − 0.01 | 0.03 | 0.01 | 0.02** |
(0.06) | (0.01) | (0.03) | (0.01) | (0.01) |
Investment | − 0.03 | − 0.78*** | − 0.38 | 0.44*** | 0.51*** |
(0.25) | (0.07) | (0.25) | (0.11) | (0.12) |
Debt service | 0.01** | 0.00 | − 0.62*** | 0.00 | 0.00 |
(0.00) | (0.00) | (0.07) | (0.00) | (0.00) |
Grants | 0.29 | 0.12* | − 0.09 | − 0.48*** | 0.12 |
(0.25) | (0.07) | (0.23) | (0.10) | (0.11) |
Own revenues | 0.29*** | 0.06** | 0.09* | − 0.03 | − 0.55*** |
(0.08) | (0.03) | (0.05) | (0.04) | (0.06) |
Response to permanent increase |
Expenditures | | − 0.07 | 0.07 | 0.03* | 0.05** |
(0.06) | (0.08) | (0.02) | (0.02) |
Investment | 0.05 | | − 0.97* | 0.84*** | 1.13*** |
(0.41) | | (0.56) | (0.10) | (0.24) |
Debt service | 0.01** | 0.01 | | 0.00 | − 0.01 |
(0.01) | (0.01) | | (0.00) | (0.00) |
Grants | 0.47 | 0.47** | − 0.22 | | 0.26 |
(0.41) | (0.22) | (0.56) | | (0.25) |
Own revenues | 0.49*** | 0.26** | 0.25* | − 0.07 | |
(0.13) | (0.14) | (0.14) | (0.09) | |
Table
8 shows the implied present value responses with respect to city size. I decompose the sample in quartiles using the long-run distribution of population as in Buettner and Wildasin (
2006). I only report the results for large cities (top quartile) and small cities (bottom quartile). From the comparison of the point estimates between subsamples, it follows that indeed large cities respond increasing their own-source revenues in a greater extent than the small cities to a temporal positive unit innovation in both government consumption and government investment with a value of 33 cents and 15 cents, respectively.
Table 9
Implied present value responses with respect to local GDP
Local GDP (top quartile) |
Response of | | | | | |
Expenditures | − 0.31*** | 0.00 | 0.10 | 0.00 | 0.02* |
(0.05) | (0.01) | (0.12) | (0.01) | (0.01) |
Investment | 0.52** | − 0.76*** | − 0.51 | 0.27*** | 0.39*** |
(0.22) | (0.06) | (0.40) | (0.06) | (0.10) |
Debt service | 0.06*** | 0.00* | − 0.46*** | 0.00 | 0.00 |
(0.01) | (0.00) | (0.07) | (0.00) | (0.00) |
Grants | 0.96*** | 0.18*** | 0.30 | − 0.70*** | − 0.07 |
(0.20) | (0.06) | (0.38) | (0.05) | (0.07) |
Own revenues | 0.24*** | 0.02 | − 0.11 | 0.00 | − 0.49*** |
(0.08) | (0.02) | (0.14) | (0.03) | (0.06) |
Response to permanent increase | | | | | |
Expenditures | | 0.00 | 0.19 | 0.01 | 0.03** |
(0.04) | (0.21) | (0.03) | (0.02) |
Investment | 0.75** | | − 0.95 | 0.89*** | 0.77*** |
(0.32) | | (0.74) | (0.11) | (0.15) |
Debt service | 0.09*** | 0.02 | | − 0.01 | 0.00 |
(0.02) | (0.01) | | (0.01) | (0.01) |
Grants | 1.39*** | 0.77*** | 0.56 | | − 0.14 |
(0.29) | (0.10) | (0.70) | | (0.15) |
Own revenues | 0.35*** | 0.08 | − 0.20 | 0.00 | |
(0.12) | (0.11) | (0.26) | (0.10) | |
Local GDP (bottom quartile) |
Response of | | | | | |
Expenditures | − 0.50*** | − 0.01 | 0.09* | 0.02*** | 0.03** |
(0.07) | (0.01) | (0.05) | (0.01) | (0.01) |
Investment | 0.34*** | − 0.56*** | 0.12 | 0.23*** | 0.32*** |
(0.13) | (0.06) | (0.31) | (0.06) | (0.11) |
Debt service | 0.01 | 0.00 | − 0.50*** | 0.00 | 0.00 |
(0.01) | (0.00) | (0.04) | (0.00) | (0.00) |
Grants | 0.43*** | 0.27*** | 0.48* | − 0.68*** | − 0.14* |
(0.11) | (0.05) | (0.27) | (0.05) | (0.08) |
Own revenues | 0.37*** | 0.12*** | 0.19 | − 0.03 | − 0.48*** |
(0.10) | (0.03) | (0.17) | (0.03) | (0.07) |
Response to permanent increase | | | | | |
Expenditures | | − 0.03 | 0.17* | 0.08*** | 0.06** |
(0.02) | (0.10) | (0.03) | (0.03) |
Investment | 0.70*** | | 0.24 | 0.70*** | 0.61*** |
(0.25) | | (0.62) | (0.11) | (0.17) |
Debt service | 0.02 | 0.01 | | 0.00 | 0.00 |
(0.01) | (0.01) | | (0.01) | (0.00) |
Grants | 0.87*** | 0.61*** | 0.52* | | − 0.27* |
(0.18) | (0.07) | (0.52) | | (0.16) |
Own revenues | 0.74*** | 0.27*** | 0.38 | − 0.11** | |
(0.18) | (0.07) | (0.35) | (0.10) | |
Surprisingly, the impact of unexpected changes in both own-source revenues and grants on government spending are quite similar regardless of the size of the city. Notice that, in general, the volatility of government expenditures, debt service, and own-source revenues in small cities is greater than in large municipalities. These results could imply that large cities are in a better position to ensure themselves against common and idiosyncratic shocks. Despite this fact, note that, however, the negative impact on own-source revenues of unexpected changes in grants is only statistically significant for municipalities in the top quartile, giving as a result a reduction of 9 cents in response to a temporal unit innovation in intergovernmental transfers. These estimates could imply that the current fiscal scheme generates perverse incentives in those local governments.
Furthermore, using the local GDP per capita
20 as an indicator variable of local development, Table
9 displays the present value responses for cities in the top and bottom quartiles for the average local GDP per capita distribution over the period 2000–2009. It is worth noting that for municipalities in the bottom quartile, grants from the national government respond to a greater extent than for municipalities in the top quartile to innovations in government investment. This impact could be explained by the fact that grants in Colombia are distributed following constitutional rules which are based on social indicators, e.g., education attainment, mortality rates, poverty level, so relatively, the majority of grants are allocated to poor municipalities in order to close profound prosperity gaps. At the same time, and in contrast to common wisdom, it seems that poor cities increase their own-source revenues to a higher extent in response to innovation in local public spending.
In addition, I also exploit the variation in the average fiscal decentralization index—FDI—prepared by the National Planning Department over the period 2000–2013 to assess whether municipalities with better administrative capacities, higher fiscal effort, and lower dependence on grants follow a different pattern in terms of fiscal adjustments. Table
10 reports, for instance, that a 1 COP positive innovation in grants is followed by a rise of 42 cents in government investment for municipalities in the top quartile for the average FDI distribution, whereas by 21 cents in the same fiscal variable for municipalities in the bottom quartile. Moreover, as expected, grants for municipalities in the bottom 25% react in a greater extent to innovations in local spending than for governments in the top quartile. It turns out that intergovernmental grants are going to the more needed municipalities, in order to close their fiscal gaps. Likewise, the response of own-source revenues to innovations in government consumption is higher for municipalities in the top quartile than for the ones at the bottom, suggesting that, indeed, tax autonomy is an important instrument for fiscal stabilization.
Table 10
Implied present value responses with respect to a FD Index
FD Index (top quartile) |
Response of | | | | | |
Expenditures | − 0.28*** | 0.00 | 0.07 | 0.01 | 0.03*** |
(0.05) | (0.01) | (0.08) | (0.01) | (0.01) |
Investment | 0.08 | − 0.77*** | − 0.41 | 0.42*** | 0.60*** |
(0.27) | (0.09) | (0.34) | (0.11) | (0.12) |
Debt service | 0.09*** | 0.01** | − 0.53*** | 0.00 | 0.00 |
(0.02) | (0.00) | (0.05) | (0.00) | (0.00) |
Grants | 0.34 | 0.15* | 0.37 | − 0.52*** | 0.01 |
(0.27) | (0.09) | (0.35) | (0.11) | (0.10) |
Own revenues | 0.49*** | 0.06 | − 0.22 | − 0.02 | − 0.36*** |
(0.13) | (0.04) | (0.17) | (0.05) | (0.07) |
Response to permanent increase | | | | | |
Expenditures | | 0.01 | 0.14 | 0.01 | 0.05*** |
| (0.03) | (0.16) | (0.02) | (0.01) |
Investment | 0.11 | | − 0.90 | 0.88*** | 0.93*** |
(0.37) | | (0.76) | (0.10) | (0.15) |
Debt service | 0.12*** | 0.03 | | − 0.01 | 0.00 |
(0.02) | (0.02) | | (0.01) | (0.00) |
Grants | 0.48 | 0.62** | 0.79 | | 0.02 |
(0.36) | (0.24) | (0.74) | | (0.16) |
Own revenues | 0.68** | 0.26 | − 0.47 | − 0.05 | |
(0.17) | (0.18) | (0.35) | (0.10) | |
FD Index (bottom quartile) |
Response of | | | | | |
Expenditures | − 0.49*** | − 0.01 | 0.01 | 0.02*** | 0.02* |
(0.05) | (0.01) | (0.02) | (0.01) | (0.01) |
Investment | 0.29** | − 0.63*** | − 0.08 | 0.21*** | 0.33*** |
(0.13) | (0.06) | (0.08) | (0.07) | (0.11) |
Debt service | 0.01** | 0.00 | − 0.61*** | 0.00 | 0.00 |
(0.00) | (0.00) | (0.08) | (0.07) | (0.11) |
Grants | 0.46*** | 0.23*** | 0.20** | − 0.70*** | − 0.10 |
(0.11) | (0.04) | (0.10) | (0.05) | (0.07) |
Own revenues | 0.29*** | 0.10*** | 0.10** | − 0.04 | − 0.51*** |
(0.06) | (0.03) | (0.04) | (0.03) | (0.07) |
Response to permanent increase | | | | | |
Expenditures | | − 0.02 | 0.03 | 0.06** | 0.04* |
| (0.02) | (0.04) | (0.02) | (0.02) |
Investment | 0.57** | | − 0.21 | 0.69*** | 0.68*** |
(0.26) | | (0.22) | (0.14) | (0.18) |
Debt service | 0.01** | 0.01 | | 0.00 | − 0.01 |
(0.01) | (0.01) | | (0.01) | (0.01) |
Grants | 0.92*** | 0.62*** | 0.49** | | − 0.22 |
(0.20) | (0.07) | (0.18) | | (0.15) |
Own revenues | 0.57*** | 0.27*** | 0.25** | − 0.14 | |
(0.11) | (0.07) | (0.11) | (0.12) | |