Discussion Paper Details

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Title: Is Centralization a Solution to the Soft Budget Constraint Problem?

Author(s): Avi Ben-Bassat, Momi Dahan and Esteban F Klor

Publication Date: August 2015

Keyword(s): bailout program, centralization, hierarchical subordination, local government and soft budget constraints

Programme Area(s): Public Economics

Abstract: This paper focuses on the centralization program implemented in Israel in 2004 to analyze whether the administrative subordination of municipalities is an effective policy to deal with problems related to soft-budget constraint of lower level governments. The results consistently show, for different specifications and samples of municipalities, that this program brought a substantial decrease of municipalities? expenditures (mostly because of decreases on salary payments), and an increase of local property tax collection. Our analysis shows that all of the fiscal impact of the program is due to the appointment of an accountant that reports directly to the central government, a relatively mild form of administrative subordination. In contrast, more intrusive forms of subordination, like the central imposition of a recovery program, do not result in any substantial improvement of municipalities? fiscal situation. This leads us to conclude that a mild form of administrative subordination is an effective tool to cope with problems related to soft-budget constraints, whereas political subordination is not an effective tool to reach that goal.

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Bibliographic Reference

Ben-Bassat, A, Dahan, M and Klor, E. 2015. 'Is Centralization a Solution to the Soft Budget Constraint Problem?'. London, Centre for Economic Policy Research.