tries, the decentralization in spending is faster than revenue, for economic or political reasons.<sup>43</sup> This gives rise to large local fiscal gaps to be filled by intergovernmental transfers, which are often associated with common pool and soft budget constraint problems. Notable examples include the Bremen and Saarland’s long-term reliance on transfers following the initial bailout in Germany, and more recently, the rising local government debt and the debt swap program in China, just to name a few. The policy lesson we draw here is that, to avoid a deterioration in aggregate fiscal performance, a country should implement _balanced_ fiscal decentralization, such that any additional spending responsibilities assigned to the local level come with a sufficient increase in revenue allocated to the local governments.

# References

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- Chari, V. V. and P. J. Kehoe (2007): “On the Need for Fiscal Constraints in a Monetary Union,” _Journal of Monetary Economics_ , 54, 2399–2408.

- Cibils, V. F. and T. Ter-Minassian (2015): _Decentralizing revenue in Latin America: Why and how_ , Inter-American Development Bank.

> 43Economically, public finance literature following Musgrave (1959) argues that centralized tax collection can minimize inefficient tax competition among regional governments, while Tiebout (1956) and Oates (1972) advocate for decentralized spending to cater to different tastes of local residents. Politically, a central government may have strong incentives to hold a large share of revenue to weaken the political power of local governments. For example, Robinson and Torvik (2009) argue that soft budget constraint is politically rational because it increases the probability of politicians’ political survival.

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