## howtonote2001

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### Introduction: risks, purpose, and scope
- Mismanagement of subnational finances can entail large economic and social costs within the jurisdiction and for the country as a whole.
- Common problems at the subnational level:
  - When local governments finance expenditure from a common pool of intergovernmental transfers, they may fail to internalize the cost of expenditures and thus overspend.
  - When large tax and expenditure responsibilities are decentralized, the central government may be unable to monitor how efficiently taxes are utilized, resulting in moral hazard.
  - Clientelism and governance failures often prevail at the subnational level.
  - Administering local budgets may be challenging because of unclear spending assignments and weak public financial management systems.
- Purpose and scope:
  - Discusses how to design subnational fiscal rules, including selection and calibration.
  - Expands guidance from IMF (2018a) and IMF (2018b).
  - Provides a first analysis based on international experience and IMF technical assistance.
  - Structure: five sections — definition, analytical framework, rule selection, making rules flexible, calibrating rules.

### Definitions and the constraint spectrum
- Institutional arrangements constrain subnational finances along a fiscal-autonomy axis (Ter‑Minassian and Craig 1997):
  - Direct controls (administrative controls) = lowest fiscal autonomy (central government sets ceilings, regulates borrowing).
  - Fiscal rules = middle ground: fixed numerical limits (floors or ceilings) on fiscal variables set in legislation and binding for at least three years (Lledó and others 2017).
  - Market discipline = highest autonomy.
- Fiscal rules are more intrusive than market mechanisms but less prescriptive than direct controls.

### Difficulties and trade-offs in designing subnational rules
- Two conflicting objectives:
  - Rules must be more binding than national rules to limit deficit bias and excessive borrowing.
  - Rules must preserve flexibility to realize benefits of decentralization, given subnational budgets tend to be more rigid.
- Standard national prescriptions (debt anchor + operational rule) do not map cleanly to the subnational level.

### Choice of rule: principal options
- No “perfect” rule; context-dependent.
- Balanced-budget rule (barring any deficit) generally not warranted because it prohibits borrowing for investment.
- Rules that allow borrowing for investment:
  - Golden rule.
  - Current balance rule.
- Golden rule is inherently more restrictive than the current balance rule.
- Third option: combine a budget balance rule (nominal limit on overall fiscal deficit) with a current expenditure ceiling to better control debt while leaving space for investment.

### Flexibility and the cycle
- Cyclically adjusted balance (CAB) rules are generally not warranted at the subnational level due to complexity.
- Expenditure rules are simpler to address procyclicality but:
  - Subnational expenditure rigidity may make compliance difficult.
  - Expenditure rules impose no requirements on revenue collection; excessive deficits remain possible.
- Better alternative: nominal budget balance rule combined with a rainy day fund (RDF).

### Calibration overview
- Calibration strategy must be adapted to subnational context; commonly starts from borrowing and repayment constraints.
- Any limit on repayment capacity constrains maximum debt because debt service is proportional to debt outstanding.

### Box 1 — Summary of Main Findings: key points
- Fiscal rules vs direct controls:
  - Fiscal rules: numerical, lasting, apply to large aggregates.
  - Direct controls: procedural, ad hoc, apply to subaggregates.
- Rules can be self‑imposed, nationally imposed, or negotiated.
- Borrowing rationale and limits:
  - Purposes: (1) finance public goods and services, (2) achieve macroeconomic stabilization, (3) engage in competition.
  - Merit in allowing borrowing for investment, especially purely local projects with little spillover.
  - Weak case for borrowing to finance current expenditure, macro stabilization (except in highly decentralized countries), or to support fiscal competition.
- OECD evidence: subnational governments account for about two‑thirds of public investment (OECD 2016).
- Stabilization: generally best left to the national level except in highly decentralized countries; central government advantages listed.
- Borrowing to support competition generally undesirable.
- Primary objective of subnational rules: contain deficit bias and foster fiscal sustainability.
  - Deficit bias magnified by soft budget constraints and common pool problems.
  - Externalities: vertical (bailouts, sovereign premia) and horizontal (spillovers to other regions).
- Transposing national debt‑anchor model is limited at subnational level; anchors more naturally limits on flows than stocks.
- Stylized facts (OECD/UCLG 2016 survey of 101 countries; 90 reported subnational rules in 2013):
  - Distribution in sample of 90 countries:
    - Advanced economies: 39
    - Emerging market economies: 20
    - Low‑income economies: 31
  - Counts of rule types (from Table 1):
    - Rules on the fiscal balance: 50
    - Golden rule: 37
    - Budget balance rule: 6
    - Current balance rule: 4
    - Cyclically adjusted balance rule: 4
    - Rules on debt and debt service: 41
    - Debt ceiling: 31
    - Debt service ceiling: 19
    - Borrowing limits (quantitative): 30
    - Expenditure rules: 8
  - Quantitative borrowing limits often accompanied by administrative measures: 16 countries reported quantitative limits supported by administrative measures (within the 30 reporting quantitative limits).
- Most subnational governments apply combinations of rules; common combination: golden rule + debt rule or quantitative borrowing limit.
- Rule selection should consider:
  - (1) need for intrusiveness to counter stronger deficit bias,
  - (2) budget rigidities and limited revenue‑raising ability,
  - (3) data constraints (advantage to debt rules for timely data),
  - (4) preserving allocative efficiency by allowing revenue increases to fund spending,
  - (5) constitutional frameworks (federations tend toward self‑imposed rules).
- Example mitigation: US states combine balanced‑budget rules with “rainy day” funds to smooth cyclical revenue fluctuations.
- Operational rules allowing borrowing for investment:
  - (1) deficit ceiling leaving space for investment,
  - (2) current balance rule,
  - (3) golden rule.

### Annex — Types of fiscal rules and key features (summary)
- Budget balance rule:
  - Maximum allowed deficit corresponds to desired subnational investment.
  - Advantage: avoids explicit segregation of capital/current budgets; limits total deficit and debt accumulation.
  - Drawback: borrowing could be for current expenditures, crowding out investment.
  - Possible complement: current expenditure ceiling.
- Current balance rule:
  - Prohibits borrowing for current expenditures; allows borrowing for investment and principal repayment (rollover allowed).
  - Advantage: debt financing of past investments does not constrain new investments.
  - Downside: risk of excessive borrowing for investment; circumvention via reclassification of current spending as capital.
- Golden rule (current surplus rule):
  - Borrowing only for investment; borrowing to cover current expenditures or repay debt is not allowed.
  - Effect: forces current surpluses for principal payments on past borrowing.
  - Advantage: tighter constraint on debt accumulation than current balance rule.
  - Disadvantages: similar operational issues to current balance rule.
- Other rule types (total expenditure ceiling, current expenditure ceiling, debt rule, debt service rule):
  - Limit debt accumulation and can allow borrowing for investment.
  - Current expenditure ceilings limit crowding out of investment.
  - Limitations: may not prevent borrowing to finance current spending; should complement balance rules.

### Trade‑offs, uniformity versus differentiation
- No single rule achieves both fiscal sustainability and investment support; choice depends on societal weighting.
- If investment support prioritized: rules that allow borrowing for investment and require current balance/surplus are suitable.
- If constraining debt prioritized: budget balance rule possibly combined with current expenditure ceiling preferred.
- Uniformity arguments:
  - Appropriate with a well‑functioning equalization system.
  - Reduces harmful tax competition and administrative costs.
- Differentiation arguments:
  - Accounts for structural disparities (commodity regions), heterogeneous preferences, and fosters ownership.
  - Examples: Alberta resource revenue smoothing rule; Vietnam differentiated borrowing limits (Ho Chi Minh 150 percent and Hanoi 100 percent of capital budgets; others 30 percent).

### Making subnational rules flexible — mechanisms and rationale
- Reasons for temporary adjustments:
  - Economic stabilization: avoid procyclical policy where subnational automatic stabilizers are large.
  - Response to unexpected events: natural disasters, conflicts, severe downturns.
- Cyclically Adjusted Balance (CAB) rules:
  - CAB adjusts nominal balance for cyclical deviations (output gap).
  - CAB rare subnationally due to:
    - Need for real‑time regional output gaps (often unavailable/timely).
    - Limited access to borrowing and underdeveloped local bond markets.
    - Failures of credit market discipline (soft budget constraints).
  - Simplifying/innovative approaches:
    - Top‑down: compute CAB for subnational sector using national output gap and apportion based on revenue size (some German lander).
    - Standard with simplifying assumption: assume subnational output gap equals national output gap (Spain).
    - “Tax smoothing” approach: estimate cyclically adjusted revenue by lagged revenue times trend growth (some German lander).
- Expenditure rules:
  - Simpler than CAB rules; avoid procyclicality without output gap computation.
  - Design options:
    - Annual (Denmark, Italy) or multiyear ceilings (Austria).
    - Ceilings limited to recurrent/operating expenditures (Denmark, Estonia, Korea, Italian local governments) or total spending (Italian regions).
    - Ceilings sometimes apply to employee compensation (Brazil, Denmark, Italy, Turkey).
    - Calibration linked to current year’s revenue (Canadian provinces, Estonia, Turkey) or to drivers like population growth (Slovenia, Spanish local governments).
  - Challenges:
    - Expenditure rigidity: compliance difficult due to nondiscretionary politically sensitive spending (over 60 percent on public housing and education in OECD countries).
    - Covering total expenditure may force cuts to capital expenditure, harming growth.

### Box 2 — Expenditure rules, Rainy Day Funds (RDFs), escape clauses
- Expenditure rules: strengths and limitations
  - Potential drawback: do not constrain revenue policy; tax changes can create excessive deficits unless recalibrated.
  - Well‑designed expenditure rules:
    - Apply to expenditure growth rate set equal to potential/trend revenue growth (proxied by average recent revenue or nominal GDP growth) (Eyraud and others 2018).
    - Recommendation: limits should cover both recurrent and capital spending to contain excessive deficits and avoid creative accounting.
- Rainy Day Funds (RDFs):
  - Purpose: savings to smooth expenditure over cycle by depositing in good times and withdrawing in bad times.
  - RDFs used with nominal budget balance rules can avoid procyclicality while constraining deficits.
  - For monitoring, nominal balance under the rule should be revenue including withdrawals minus expenditure including deposits (accounting modifications may be required).
  - Typical design:
    - Deposits required if surplus or revenue higher than previous year.
    - Withdrawals permitted if projected revenue below previous year or if budget deficit would occur without withdrawal.
    - Common limits: total RDF size typically no more than 5 percent of the annual budget.
  - Track record:
    - Prior to the global financial crisis, RDFs reduced volatility of state expenditure in the United States (Paqueo and Gonzalez 2003; Sobel and Holcombe 1996; Wagner and Elder 2005).
    - RDF balances fell sharply between 2006 and 2009 (Jonas 2012).
    - US state expenditures during 2008–10 were cut around 5 percent in nominal terms on average.
  - Credibility and market effects:
    - Moody’s referenced reserve balances in rating changes more than ¾ of the time (1992–2015) (Pew Charitable Trusts 2017a).
    - Evidence: lower credit ratings associated with weak RDF deposit regulations; adoption of RDF associated with modest reduction in long‑term borrowing costs (Wagner 2004).
- Escape clauses: need and design principles
  - Purpose: allow temporary relaxation/suspension of limits after extreme shocks to meet community expectations without unlawful rule abandonment.
  - Common triggers: natural disasters (Austria, Japan, Korea); severe regional slowdowns or crises (Austria, Brazil).
  - Risks: broad/imprecise definitions can be abused.
  - Well‑designed features:
    - Precise and exogenous triggers, quantified when possible.
    - Effective control and monitoring: central government or independent fiscal council determines activation and duration where possible.
    - Corrective requirements: example—Brazil requires return to compliance within a fixed time; Germany requires amortization plan after activation for natural disasters.

### Calibrating subnational rules: methods and issues
- Calibration = choosing numerical threshold (examples given: 60 percent of revenues vs 150 percent).
- Standard national sequencing (debt ceiling → operational thresholds) hard to transpose subnationally.
- Two practical calibration approaches:
  - Based on borrowing (sometimes prohibiting borrowing or allowing positive limits).
    - If borrowing prohibited: debt ceiling consistent with zero borrowing is zero; if legacy debt exists, transition required (example: Brazil 2000 Fiscal Responsibility Law used downward reduction over 15 years).
    - Positive borrowing limits: cumulate borrowing targets assuming repayment schedules; theoretical link between borrowing and capital stock noted.
  - Based on repayment capacity (more widespread):
    - Current surplus approach (French framework):
      - Principal repayment should not exceed current surplus (golden rule).
      - Debt ceiling expressed as multiple of current surplus; moving averages may be used to smooth volatility.
      - France differentiated ceilings by government type/size:
        - Small municipalities (< 10,000 inhabitants) and intercommunal associations (> 50,000 inhabitants): debt ceilings between 11 and 13 years of current surplus.
        - Departments and city of Lyon: debt ceilings between 9 and 11 years.
        - Regions and some islands (Corsica, French Guiana, Martinique): debt ceilings of 8 to 10 years.
      - Legal reference: LOI n° 2018–32 du 22 janvier 2018 de programmation des finances publiques pour les années 2018 à 2022.
    - Prudential approach:
      - Debt service (DS) capped by a share of income: DS = iD + D/m ≤ αR, implying D ≤ α / (i + 1/m) · R.
      - Debt service ceilings at subnational level commonly range from 12 to 30 percent of subnational revenues (OECD 2016).
      - Illustrative example: a debt service cap of 20 percent of revenue → debt rule of 90 percent of revenue (assuming five‑year average debt maturity and nominal interest rate of 2 percent).
      - Observed ranges: debt ceilings vary from 60 to 150 percent of revenues; debt service ceilings range from 12 to 25 percent of revenues at the OECD level (OECD 2016).
      - Practical question: express rules as percent of “own” revenue or total revenue (including transfers):
        - Own revenues: more within subnational control; avoids breaches from central transfer cuts; can be volatile and heterogeneous.
        - Total revenues: more stable and ensures broadly similar revenue capacities; transfers sometimes accentuate volatility.
      - Recommendation: given unequal revenue bases and generally predictable transfers, the case for applying rules to total revenue seems stronger.
      - Revenues should exclude one‑off receipts (grants, asset sales) for debt and debt service rules.

### Box 3 — Budget identities and illustrative rules (France)
- Budget accounting identity and variables:
  - R − E_c − E_k ≡ OB ≡ ∆FA − ∆FL ≡ ∆FA − (NB − PR)
  - Definitions:
    - R = revenue
    - E_c = current expenditure
    - E_k = capital expenditure
    - OB = nominal budget balance
    - ∆FA = change in financial assets
    - ∆FL = change in financial liabilities
    - NB = new borrowing
    - PR = debt principal repayment
  - Assumptions: ∆FA = 0 and stock‑flow adjustments equal zero; constraints saturated.
- Rule formulations and implications:
  - Budget balance rule:
    - Constraint: R − (E_c + E_k) = OB*, where OB* can be negative.
    - Implication: NB = − OB* + PR.
  - Budget balance with deficit ceiling equal to capital expenditure target:
    - Constraint: R − (E_c + E_k) = − E_k*.
    - Implication: NB = E_k* + PR; if E_k = E_k* then identical to current balance rule; if E_k < E_k* the rule can allow borrowing for current expenditure.
  - Current balance rule:
    - Constraint: R − E_c = 0.
    - Implication: NB = E_k + PR.
  - Golden rule (current surplus rule):
    - Constraint: R − E_c = PR.
    - Implication: NB = E_k (borrowing equals investment).
  - Borrowing constraint:
    - NB = NB* (ad hoc ceiling on new borrowing).

*Source: IMF staff, How to Design Subnational Fiscal Rules: A Primer — Introduction, Box 1, Annex, Box 2, Box 3 (February 2020).*

### 1. Introduction ........................................................................................................

### 1. Introduction

### Introduction: risks from subnational fiscal mismanagement
- Mismanagement of subnational finances can entail large economic and social costs, not only within the affected jurisdiction, but also for a country as a whole.
- History offers many examples of costly bailouts of subnational governments by the central government (Crivelli and Staal 2013; von Hagen and others 2000).
- Subnational governments' finances are notoriously difficult to control and manage (IMF 2009).
- Common problems include:
  - When local governments finance expenditure from a common pool of intergovernmental transfers, they may fail to internalize the cost of expenditures and thus overspend.
  - When large tax and expenditure responsibilities are decentralized, the central government may be unable to monitor how efficiently taxes are utilized, resulting in moral hazard.
  - Clientelism and governance failures often prevail at the subnational level.
  - Administering local budgets may be challenging because of unclear spending assignments and weak public financial management systems.

### Purpose and scope of the note
- This note discusses how to design subnational fiscal rules, including how to select them and calibrate them.
- It expands on guidance provided at the national level on rule selection and calibration in IMF (2018a) and IMF (2018b).
- Thinking on subnational fiscal rules is still evolving (for example, Heinemann, Moessinger, and Yeter 2018; Kotia and Lledó 2016; Foremny 2014).
- The note provides a first analysis based on international experiences and the technical assistance provided by the IMF; main findings are summarized in Box 1.
- The note is divided into five sections:
  - 1. Definition of Subnational Fiscal Rules
  - 2. Analytical Framework: Rationale for Subnational Borrowing and Subnational Rules
  - 3. Selecting Subnational Rules
  - 4. Making Subnational Rules Flexible
  - 5. Calibrating Subnational Rules

### Definitions and placement of fiscal rules within the constraint spectrum
- Countries constrain subnational finances through a range of institutional arrangements. These can be classified according to the degree of fiscal autonomy left to subnational governments (Ter-Minassian and Craig 1997).
- Direct controls by the central government are associated with the lowest degree of fiscal autonomy (for example, the central government may set and revise each year’s ceilings on subnational debt or regulate the type of borrowing allowed).
- Market discipline provides the highest degree of autonomy; subnational governments are free to set their own targets, as long as their fiscal policy does not impair market confidence.
- Fiscal rules lie somewhat in the middle of this axis: they impose lasting constraints on fiscal policy and are defined as fixed numerical limits (floors or ceilings) on fiscal variables set in legislation and binding for at least three years (Lledó and others 2017).
- Fiscal rules are not as prescriptive as direct controls but are more intrusive than market mechanisms.
- Note: direct controls are also called “administrative controls” in the literature.

### Difficulties in designing subnational rules
- Standard recommendations on rule design are difficult to transpose to subnational governments (for example, the model with a debt anchor and an operational rule advocated for national governments does not map well to the subnational level).
- Subnational rule design must balance two potentially conflicting objectives:
  - Rules must be more binding than national rules to limit the scope for deficit bias and excessive borrowing, which can be larger at the subnational level.
  - Rules must leave enough flexibility to realize the benefits of decentralized decision-making tailored to local needs, especially given that subnational budgets tend to be more rigid (for example, providing for essential services).

### Choice of the rule: principal options and trade-offs
- There is no “perfect” subnational rule; the choice is context-dependent.
- A balanced-budget rule (that is, a rule barring a deficit) is usually not warranted because it prohibits borrowing for investment.
- Two other rules that allow borrowing for investment:
  - The golden rule.
  - The current balance rule.
- Between these two, a golden rule is inherently more restrictive.
- A third option is to combine a budget balance rule (imposing a nominal limit on the overall fiscal deficit) and a current expenditure ceiling; this may ensure better control over debt while leaving space for investment.

### Flexibility in response to the cycle
- Cyclically adjusted balance rules are generally not warranted for subnational governments due to their complexities.
- Expenditure rules are a simpler way to address procyclicality concerns.
- However:
  - The rigidity of subnational expenditures could make compliance difficult.
  - Expenditure rules impose no requirements on revenue collection, so excessive deficits remain possible.
- A better alternative to avoid procyclicality could be to combine a nominal budget balance rule with a rainy day fund.

### Calibration of subnational rules
- The calibration strategy needs to be adapted to the subnational context.
- It generally starts from (often ad hoc) constraints on borrowing and repayment, with the latter probably the most common approach.
- Intuition: any limit on the ability to repay constrains the maximum amount of debt that can be incurred, because debt service is proportional to the amount of debt outstanding.

*How to Design Subnational Fiscal Rules: A Primer — Introduction (International Monetary Fund | February 2020)*

### Box 1. Summary of Main Findings

### Box 1. Summary of Main Findings

### Overview
- Fiscal rules are distinct from direct controls: fiscal rules are numerical, lasting, and apply to large fiscal aggregates; direct controls tend to be procedural, ad hoc, and apply to subaggregates such as current expense.
- Rules can be self-imposed by subnational governments, imposed by the national government, or negotiated between levels of government.
- Example contrasts: US states and Canadian provinces impose their own heterogeneous rules; Brazil adopted a fiscal responsibility law in 2000 with top-down numerical rules including limits on personnel expenditure and debt.

### Analytical framework: rationale for subnational borrowing and subnational rules
- Common objective of fiscal rules: foster fiscal sustainability.
- Different approach may be required at the subnational level because borrowing motives and constraints differ from the central government.
- Key question: when should subnational governments borrow to cover gaps from transfers, own-tax revenue shortfalls, political unwillingness to raise local taxes, or cyclical swings in local revenue?

### Should subnational governments be allowed to borrow and for what?
- Purposes considered for subnational borrowing:
  - (1) finance public goods and services,
  - (2) achieve macroeconomic stabilization,
  - (3) engage in competition with other subnational entities.
- Summary judgment:
  - Merit in allowing some borrowing for investment purposes, especially for projects that are purely local and have little spillover.
  - Weak case for borrowing to finance current expenditure, macroeconomic stabilization (except in highly decentralized countries), or to support fiscal competition.

- Rationale and tradeoffs for financing capital expenditure:
  - OECD evidence: subnational governments account for about two-thirds of public investment (OECD 2016).
  - Problems with financing investment solely from subnational taxes:
    - narrow tax bases,
    - size and lumpiness of investment relative to subnational revenue,
    - inconsistency with intergenerational equity if current revenues pay for long-lived investments.
  - Problems with financing investment solely from national transfers:
    - subnational governments may be better placed to tailor financing,
    - discretionary transfers are subject to political interference,
    - ad hoc transfers create a common pool problem (individual authorities inflate needs because transfer cost is spread across jurisdictions).
  - Advantages of subnational borrowing:
    - shares cost with future generations,
    - ensures beneficiaries pay for services,
    - can encourage financial market development at the local level.
  - Conclusion: there is a case to finance part of subnational investment through subnational borrowing, especially for projects with purely local benefits; partial reliance on taxes and specific transfers remains appropriate.

### Borrowing for macroeconomic stabilization
- Stabilization is generally best left at the national level, except in highly decentralized countries (example: United States).
- Centralized countercyclical policy advantages:
  - better coordination for symmetrical shocks,
  - risk sharing for asymmetrical shocks (transfers from less-affected to more-affected subnational governments),
  - central governments borrow more efficiently and cheaply (broader tax bases, economies of scale in issuance).
- Evidence: Mélitz and Zumer (2002) find transfer systems in Canada, France, the United Kingdom, and the United States help manage asymmetric shocks on regional incomes.

### Borrowing to support subnational competition
- Local fiscal competition (tax breaks, subsidies) can induce inefficient race-to-the-bottom dynamics.
- Subnational borrowing facilitates yielding to competitive pressures and should, in general, not be used to support such policies because it postpones fiscal reckoning for local taxpayers.

### Objectives of subnational rules
- Primary objective: contain deficit bias and foster fiscal sustainability.
- Deficit bias at subnational level is magnified by:
  - soft budget constraints (expectation of gap-filling transfers, special access to local banks, deferred payments and arrears),
  - common pool problem (narrow tax bases; marginal expenditure financed with transfers shared across jurisdictions).
- Externalities:
  - vertical externalities: fiscal problems in subnational governments transmitted to national government via bailouts or higher sovereign risk premiums,
  - horizontal externalities: central support to one region can negatively affect others via tax increases or inflation.
- Secondary purpose: enhance coordination across government levels and align subnational objectives with national objectives (examples: apportion consolidation efforts, domestic stability pacts).

### Transposing the “Debt Anchor–Operational Rule” model to the subnational level
- Consensus at central government level: include a fiscal anchor (natural anchor: debt-to-GDP ratio) and one or a small number of operational rules on flow variables (for example, expenditure ceilings).
- Sequential calibration: set debt stock ceiling first, then calibrate operational rules to ensure debt remains below its “safe” ceiling (IMF 2018a).
- Limitations of transposing debt anchor at subnational level:
  - Estimating a debt limit for individual subnational governments is difficult and uncertain because of possible support from higher levels or local banks and technical difficulties identifying distress thresholds.
  - Concept of “safe debt” is elusive due to vertical spillovers; low subnational debt could be achieved by shifting debt to other government levels (undesirable).
  - Many subnational governments face de facto borrowing or repayment constraints (undeveloped and illiquid local bond markets; narrow tax bases).
- Implication: anchor of the subnational framework is more naturally a limit on flows rather than stocks; operational rules need tailoring to the subnational context.

### Stylized facts and typology on subnational fiscal rules
- Survey evidence (OECD/UCLG 2016): some 90 countries reported having subnational rules in place in 2013 in a survey of 101 countries.
- Distribution in the sample of 90 countries:
  - Advanced economies: 39
  - Emerging market economies: 20
  - Low-income economies: 31
- Most rules are imposed by the national government and are similar across subnational governments; only four countries reported self-imposed and heterogeneous rules: Australia, Canada, Switzerland, and the United States (all federations).
- Common rule types and counts (from Table 1):
  - Number of countries with subnational rules in survey: 90
  - Advanced economies: 39
  - Emerging market economies: 20
  - Low-income economies: 31
  - Number of countries with at least one subnational rule of the following type:
    - Rules on the fiscal balance: 50
    - Golden rule: 37
    - Budget balance rule: 6
    - Current balance rule: 4
    - Cyclically adjusted balance rule: 4
    - Rules on debt and debt service: 41
    - Debt ceiling: 31
    - Debt service ceiling: 19
    - Borrowing limits (quantitative): 30
    - Expenditure rules: 8
  - Note: quantitative borrowing limits are often accompanied by administrative procedural measures; 16 countries reported quantitative limits supported by administrative measures (within the 30 reporting quantitative limits).

- Most subnational governments apply a combination of fiscal rules, with the most common combinations being a golden rule combined with either a debt rule or a quantitative borrowing limit.

### Specific considerations for rule selection at the subnational level
- Selection of rules should consider additional decentralized-setting factors beyond national-level principles (simplicity, ease of monitoring, resilience):
  - (1) Higher tendency to run excessive deficits at subnational level implies rules may need to be more intrusive and directive (budget balance rules or borrowing constraints) rather than rules constraining only part of the fiscal position (expenditure rules or debt service rules).
  - (2) Budget rigidities are common: subnational governments in OECD countries spend half of their budgets on politically sensitive education, health, and social support programs (OECD 2015), and expenditure requirements are often set by higher levels of government; limited revenue-raising ability complicates compliance, especially for rules applying to narrow aggregates like current expenditure.
  - (3) Data constraints limit rule options: subnational financial information often submitted with long delays and incomplete (OECD 2016); this gives an operational advantage to debt rules because debt data is generally available promptly with a monthly frequency; measuring business cycles at the subnational level is difficult, complicating cyclically adjusted balance (CAB) rules.
  - (4) Need to preserve allocative efficiency: rules should leave some budgetary flexibility to allow revenue increases to fund higher spending and preserve tailoring of services to local preferences.
  - (5) Constitutional frameworks matter: in federal systems, self-imposed subnational rules are the norm; constitutions may allow or proscribe certain taxes with implications for rule choice (example: judicial interpretation of Australia’s constitution on certain sales taxes).

- Tension and tradeoffs:
  - Need for rules to be both more binding (to contain deficit bias) and more flexible (because of budget rigidities and allocative efficiency).
  - Mitigation example: US states combine balanced-budget rules with “rainy day” funds to smooth cyclical revenue fluctuations.

### Subnational rules and preserving space for investment
- Important design consideration: leave sufficient space under rules to finance public investment.
- Operational rules that allow borrowing for investment include:
  - (1) a deficit ceiling that leaves sufficient space for desired public investment,
  - (2) a current balance rule,
  - (3) a golden rule (borrowing allowed for investment but not for current expenditure).

*Source: IMF staff.*

### Annex for a description of these rules. Key differences

### howtonote2001 - Annex for a description of these rules. Key differences

### Types of fiscal rules and key features
- Budget balance rule
  - Maximum allowed deficit corresponds to the size of the desired subnational investment.
  - Advantages:
    - Avoids explicit segregation of capital and current budgets inherent in the current balance and golden rules.
    - Sets a limit on the total deficit and debt accumulation.
  - Main drawback:
    - Borrowing could be undertaken for current expenditures, crowding out public investment (18).
  - Possible complement:
    - Could be complemented by a current expenditure ceiling (19).

- Current balance rule
  - Prohibits borrowing for current expenditures but allows borrowing for investment as well as principal repayment (allows borrowing to roll over debt).
  - Advantages:
    - Debt financing of past investments does not constrain undertaking new investments.
  - Main downside:
    - Risk of excessive borrowing for investment.
    - Possibility of circumvention through “creative accounting” by classifying some current expenditures as capital expenditures.

- Golden rule (also referred to as a “current surplus” rule)
  - Borrowing is allowed only for investment. Borrowing to cover current expenditures or repay debt is not allowed.
  - Effect:
    - Forces subnational governments to realize current surpluses to cover principal payments on past borrowing.
  - Advantages:
    - Imposes a tighter constraint on debt accumulation than the current balance rule.
  - Main disadvantages:
    - Similar to those of the current balance rule.

- Other rule types (total expenditure ceiling, current expenditure ceiling, debt rule, debt service rule)
  - Allow borrowing for investment while limiting debt accumulation.
  - Current expenditure ceiling additionally limits crowding out of public investment.
  - Limitations:
    - Not sufficient to prevent borrowing to finance current spending (they can be compatible with the existence of a current deficit).
    - Should be viewed as complements to fiscal balance rules, not standalone rules.

### Trade-offs and rule selection criteria
- No “perfect” rule achieves both fiscal sustainability and investment support; choice depends on societal weighting of objectives.
- If investment support is weighted more heavily:
  - Rules that allow borrowing for investment and require subnational governments to maintain a current balance (or surplus) would be consistent with preferences and needs.
- If constraining subnational debt by avoiding excessive deficits is more important:
  - A budget balance rule (imposing a limit on the overall fiscal deficit), possibly combined with a ceiling on current expenditure, would likely be more appropriate.
- Role of investment in fiscal sustainability:
  - Investment can, under certain conditions, improve fiscal sustainability by raising potential output; thus the choice between rules is not clear cut.
- Consideration of crowding out risk (Crivelli 2011):
  - Budget balance (deficit ceiling) preferable if there is no pressure on current expenditure because it caps overall deficit and implicitly public investment.
  - If current expenditure pressures exist and there is no ceiling on them, current balance and golden rules are better because they contain the size of the current budget.
  - Between current balance and golden rule, the golden rule is inherently more restrictive.

### Should rules be similar across subnational governments? (uniformity versus differentiation) (20)
- Literature has paid little attention to uniformity versus differentiation; most policy work assumes homogeneity.
- Evidence from US states suggests tighter rules have a stronger disciplinary effect (Bohn and Inman 1996; Poterba 1994; von Hagen 1991).

- Arguments in favor of uniformity
  - Uniform rules across heterogeneous governments are generally appropriate if accompanied by a well-functioning equalization system:
    - In the absence of equalization transfers, different subnational governments have different abilities to provide public services at comparable tax rates due to differences in revenue capacity and expenditure needs.
    - Equalization transfers that compensate jurisdictions with below-average revenue capacity and above-average expenditure requirements can partially correct disparities (Boadway and Shah 2007). Well-designed equalization systems can make similar rules fair even for heterogeneous subnational entities (21).
  - Cost-related advantages of uniformity:
    - Reduces scope for harmful tax competition and a race to the bottom on tax ceilings.
    - Could reduce the need for, and consequently the cost of, coordination and monitoring by the national government (22).
    - Example: Council of the Federation and Fiscal Arrangements Working Group in Canada.

- Arguments in favor of differentiation
  - Specific characteristics:
    - Differentiation can account for structural disparities not easily offset by equalization (example: commodity-producing regions).
    - Example: In Canada, Alberta established a resource revenue smoothing rule in the Balanced Budget and Debt Retirement Act of 1995 (Tapp 2013).
    - Example: In Vietnam, the cities of Ho Chi Minh and Hanoi have differentiated borrowing limits of 150 and 100 percent of their capital budgets, respectively, whereas the limit is tighter for all other municipalities (30 percent).
  - Heterogeneous preferences:
    - Differentiation is advantageous when preferences differ markedly across regions; decentralization allows tailoring of local public services to constituents’ preferences, yielding allocative efficiency gains.
  - Need for ownership:
    - Differentiation fosters ownership with subnational governments in charge of their own policy targets, potentially increasing credibility and compliance (OECD 2014).
    - Caveat: Self-imposition of rules requires strong institutions and a culture of fiscal discipline.

### Making subnational rules flexible — rationale and mechanisms
- Reasons to adjust numerical limits temporarily:
  - Economic stabilization:
    - Flexible rules avoid procyclical fiscal policy.
    - Upward adjustment of budget deficit limits during economic slowdowns can mitigate procyclical expenditure cuts; tightening in good times prevents spending all revenue windfalls.
    - Need for flexibility greater when countries have large automatic stabilizers at the subnational level (revenue and expenditure significantly affected by the economic cycle), especially in more decentralized countries (Blöchliger and others 2010a; Foremny and von Hagen 2012; OECD 2016).
  - Response to unexpected events:
    - Flexible rules enhance resilience to shocks (natural disasters, conflicts, severe downturns).
    - Allowing temporary adjustment or suspension following extreme shocks makes rule abandonment less likely.

- Cyclically Adjusted Balance (CAB) rules
  - CAB rules allow ceilings on the fiscal deficit (or floors on the fiscal surplus) to be adjusted over the economic cycle by adjusting the nominal balance for cyclical deviations (usually measured by the output gap).
  - Effect:
    - Nominal deficit ceiling lower in good times (output gap positive) and higher in bad times (output gap negative), reducing need for procyclical cuts (see IMF 2018b).
  - CAB rules are rare at the subnational level. Practical problems include:
    - Computational difficulties:
      - Requires real-time estimates of regional or local output gaps. Regional/local GDP estimates may not be available, timely, or may be prone to revisions (OECD 2014; Ter-Minassian 2015).
    - Limited access to borrowing:
      - CAB rules require ability to borrow freely to finance higher nominal deficits in downturns; local bond markets may be underdeveloped and borrowing costs higher than for central governments (Blöchliger and Kim 2016).
    - Failures of credit market discipline:
      - Some subnational governments may have preferential borrowing access that fails to reflect credit risk (soft budget constraint), encouraging excessive debt accumulation (23).
  - Some countries use simplifying assumptions or innovative approaches to implement subnational CAB rules (Box 2):
    - Top-down approach:
      - Compute CAB for all subnational governments as a whole using the national output gap; split the general government CAB into central and subnational components via budget semi-elasticity parameters; apportion subnational component among jurisdictions based on relative revenue size (example: some German lander; Deutsche Bundesbank 2017).
    - Standard approach with simplifying assumptions:
      - Compute CAB directly for each subnational government using simplifying assumptions (e.g., assume subnational output gap equals national output gap as in Spain; Independent Authority for Fiscal Responsibility 2015).
      - Alternative: “tax smoothing” approach used in several German lander—estimate cyclically adjusted revenue by multiplying lagged revenue by trend revenue growth, assumed equal to average revenue growth in recent years (Deutsche Bundesbank 2017).

- Expenditure rules
  - Expenditure rules can avoid procyclicality while constraining excessive deficits; they are simpler than CAB rules and do not require output gap computation (IMF 2018b).
  - Prevalence and design differences:
    - Expenditure rules are rare at the subnational level; where used, ceilings may be annual (Denmark, Italy) or multiyear (Austria).
    - Ceilings commonly limited to recurrent/operating expenditures (Denmark, Estonia, Korea, Italian local governments); some constrain total spending (Italian regions).
    - Ceilings sometimes applied to specific items, e.g., employee compensation (Brazil, Denmark, Italian local governments, Turkey).
    - Calibration options:
      - Linked to current year’s revenue (Canadian provinces, Estonia, Turkey), effectively prohibiting a deficit if expenditure cannot exceed collected revenue.
      - Set based on underlying drivers of spending needs, such as population growth (Slovenia, Spanish local governments).
  - Main challenges:
    - Expenditure rigidity:
      - Compliance can be difficult due to limited flexibility to adjust spending; subnational governments often responsible for nondiscretionary and politically sensitive spending (e.g., over 60 percent of spending on public housing and education in OECD countries).
      - Significant subnational responsibility for social protection can increase automatic spending during downturns (Blöchliger and others 2010b).
      - If ceilings cover total subnational expenditure, compliance may require cuts to capital expenditure, harming growth and revenue collection.
    - Cutting subnational expenditure may have adverse effects on investment and services.

*Annex for a description of these rules. Key differences among them are: (Excerpt from howtonote2001 — HOW TO DESIGN SUBNATIONAL FISCAL RULES: A PRIMER, International Monetary Fund | February 2020)*

### Box 2. Examples of Cyclically Adjusted Balance Rules at the Subnational Level

### Box 2. Examples of Cyclically Adjusted Balance Rules at the Subnational Level

### Expenditure rules: strengths and limitations
- Potential drawback: expenditure rules may not prevent excessive deficits because they impose no constraint on revenue generation; tax policy changes by subnational governments can reduce revenue collection rapidly and create excessive deficits unless expenditure rules are recalibrated to reflect the tax policy changes.
- Advantages of well‑designed expenditure rules:
  - Strike a balance between flexibility and simplicity.
  - Avoid procyclical fiscal policy while being simpler to operate than CAB rules.
  - Practical design: apply the rule to the growth rate of expenditure and set the limit equal to the potential or trend pace of revenue growth, proxied by the average pace of revenue or nominal GDP growth over the recent past (Eyraud and others 2018).
  - An expenditure growth limit tied to trend revenue growth:
    - Prevents procyclical spending increases when revenue growth is above trend.
    - Helps avoid procyclical cuts when revenue growth is below average.
  - Simpler to compute than the output gap required by a CAB rule.
  - Recommendation: expenditure limits should cover both recurrent and capital spending to contain excessive deficits and avoid creative accounting often associated with rules applying to subaggregates.

### Rainy Day Funds (RDFs): purpose, operation, and track record
- Purpose and interaction with rules:
  - RDFs are savings accounts to smooth expenditure over the economic cycle by making deposits in good times and withdrawals in bad times.
  - RDFs can achieve a similar purpose to CAB rules or expenditure rules.
  - An RDF used with a nominal budget balance rule can avoid procyclical fiscal policy while constraining excessive deficits.
  - RDFs by themselves do not constrain the fiscal deficit or ensure fiscal sustainability; they must be used together with a fiscal rule that imposes a limit on the nominal deficit.
  - For rule monitoring, nominal balance under the rule should be measured as: revenue including withdrawals from the RDF minus expenditure including deposits to the RDF. Standard fiscal accounts treat withdrawals/deposits as “below the line” and do not show this metric (GFSM2001/2014), so RDF operation may require modification to fiscal accounting for monitoring purposes.
- Practical use:
  - RDFs used together with nominal budget balance rules mainly by subnational governments in federal countries (example: 48 US states).
  - RDF regulations differ across states; used outside the United States in Canada, Mexico, and Sweden (not necessarily with strict budget balance rules).
  - Typical design: formula‑based approach governing deposits and withdrawals. Common rules:
    - Deposits required if there is a surplus or if revenue is higher than the previous year in nominal terms.
    - Withdrawals permitted if projected revenue is below the previous year (examples: Hawaii and North Dakota) or if there would be a budget deficit without a withdrawal (example: Massachusetts).
    - Common limits: total size of RDFs typically no more than 5 percent of the annual budget; permitted withdrawal sizes and requirements to replenish RDFs within a short period post‑withdrawal are also common.
- Track record and limitations:
  - Empirical evidence: prior to the global financial crisis, RDFs reduced volatility of state expenditure in the United States (Paqueo and Gonzalez 2003; Sobel and Holcombe 1996; Wagner and Elder 2005).
  - Following the crisis, RDF balances fell sharply between 2006 and 2009 (Jonas 2012).
  - RDFs not always sufficient to stabilize state budgets in large shocks: US state expenditures during 2008–10 were cut around 5 percent in nominal terms on average, indicating RDFs were often insufficient to maintain budgets without expenditure cuts.
  - Some states left RDF balances untapped (example: Maryland); others made no use (example: Delaware).
- Credibility and market effects:
  - RDFs can signal prudence; rating agencies respond to strong RDF balances: Moody’s recorded reference to reserve balances in changes in rating from 1992–2015 more than ¾ of the time (Pew Charitable Trusts 2017a).
  - Econometric evidence: lower credit ratings associated with weak regulations on required RDF deposits; stronger credit ratings associated with RDFs where withdrawals are easier (Charles 2010).
  - Adoption of an RDF by US states associated with a modest reduction in long‑term borrowing costs (Wagner 2004).

### Escape clauses: need and design principles
- Rationale:
  - Subnational governments face larger proportional fiscal impacts from extreme shocks (natural disasters, local bank collapse, closure of major local industry) because risk sharing across jurisdictions is limited.
  - Subnational governments often have little discretion over spending and are responsible for essential, politically sensitive spending (for example, health or education) and nondiscretionary social protection entitlements, limiting scope to reallocate spending after shocks.
- Purpose of escape clauses:
  - Allow temporary relaxation or suspension of limits on fiscal aggregates after extreme shocks, enabling subnational governments to meet community expectations without unlawfully abandoning rules.
  - Preserve long‑term credibility by acknowledging ex ante that strict compliance may be infeasible after extraordinary shocks.
- Common triggers and risks:
  - Common triggers in practice: natural disasters (examples: Austria, Japan, Korea) and severe regional economic slowdowns or crises beyond the normal cycle (examples: Austria, Brazil).
  - Escape clauses often defined broadly and imprecisely, posing risk of abuse and excusing fiscal indiscipline.
- Well‑designed escape clause features:
  - Precise and exogenous triggers:
    - Events outside government control, precisely defined and tailored to subnational circumstances.
    - Quantify triggers when possible (example: size of downturns or financial crises as in Brazil for subnational governments or in Panama at the national level), noting reliance on real‑time projections.
    - Natural disaster definitions are harder to quantify; thus control and monitoring are important to prevent abuse.
    - Triggers should be genuinely extraordinary and not foreseeable in the budget preparation process.
  - Effective control and monitoring mechanisms:
    - Central government may determine valid activation and duration of escape clauses where constitutionally possible (example: Spanish regions); can also establish correction plans.
    - Independent fiscal councils could perform these functions.
    - Where central control is constitutionally limited, regional parliaments should determine activation for regional and local escape clauses.
    - Examples of corrective requirements: Brazilian Fiscal Responsibility Law requires return to compliance with state debt rule within a fixed time period; in Germany, landers must adopt an amortization plan following activation for natural disasters.

### Calibrating subnational rules: methods and issues
- Definition: “Calibration” refers to choosing the numerical threshold of the rule (example contrasts: subnational debt cannot exceed 60 percent of revenues in the Czech Republic versus 150 percent in Iceland).
- Key points:
  - Standard national sequencing (starting from debt ceiling → operational thresholds) is hard to transpose to subnational level.
  - Alternative methods reverse sequencing: start from constraints on borrowing and repayment flows to calibrate the debt stock ceiling.
  - Two main calibration approaches in practice:
    - Based on borrowing (conceptually interesting but rarely applied).
    - Based on repayment capacity (more widespread).
  - In these approaches, the debt rule is an operational rule rather than the fiscal anchor.
  - Calibration is rarely comprehensive/systematic at subnational level and often relies on policymaker judgment.
  - Proposed methods ensure consistency between subsets of rules (for example, current surplus approach links borrowing constraint, golden rule, and debt rule; prudential approach links debt service rule and debt rule). No established framework linking all possible subnational rules exists comparable to IMF 2018a.

- Calibration based on a borrowing constraint:
  - Two cases:
    - Borrowing prohibited (examples: Angola, Cambodia, Chile, Moldova per OECD/UCLG 2016 survey):
      - If no prior repayment obligation, the debt ceiling consistent with zero‑borrowing should be zero.
      - If legacy debt exists, a transition is needed: debt ceiling progressively reduced as debt is amortized (example: Brazil 2000 Fiscal Responsibility Law — Senate Resolution imposed downward reduction in debt ceilings over 15 years while preventing new credit operations when the debt limit was breached).
    - Positive (nonzero) borrowing limit:
      - Associated debt ceiling can be computed by cumulating borrowing targets assuming a repayment schedule.
      - Theoretical link: if borrowing = investment, then ∑ borrowing = ∑ inv and debt stock ≈ capital stock, but estimating desired capital stock at subnational level is difficult; returns on investment may allow debt to pay for itself.

- Calibration based on a debt repayment limit (repayment capacity)
  - Two common variants: current surplus approach and prudential approach.

  - Current surplus approach:
    - Formalized in the French subnational framework: principal debt repayment should not exceed current surplus (golden rule).
    - Practical implication: debt ceiling expressed as a multiple of the current surplus generated by the subnational government.
    - Given volatility of current surplus, a moving average of current surpluses over recent years could be used instead of the present year’s current surplus.
    - In France:
      - Current surplus = revenue (excluding transfers received from the national government) minus current spending.
      - Debt stock equals sum of future repayments; each repayment must be financed by current surplus; thus debt stock should not exceed current surplus times debt maturity.
      - Under assumption that debt maturity matches asset life, debt ceiling can be computed as average lifetime of capital stock times current surplus.
      - A 2018 law established ceilings differentiated by type/size of local government:
        - Small municipalities (fewer than 10,000 inhabitants) and intercommunal associations (more than 50,000 inhabitants): debt ceilings between 11 and 13 years of their current surplus.
        - Departments and the city of Lyon: debt ceilings between 9 and 11 years.
        - Regions and some islands (Corsica, French Guiana, Martinique): debt ceilings of 8 to 10 years.
      - Legal reference: LOI n° 2018–32 du 22 janvier 2018 de programmation des finances publiques pour les années 2018 à 2022.

  - Prudential approach:
    - Debt service (principal plus interest) is capped by a share of income (total revenue or subset).
    - Common in practice; debt service ceilings at the subnational level range from 12 to 30 percent of subnational revenues (OECD 2016).
    - Formal relationship:
      - DS = iD + D/m ≤ αR
        - DS = debt service
        - i = implicit interest rate on debt
        - D = outstanding debt
        - m = average maturity of outstanding debt
        - α = exogenously determined prudential ratio
        - R = government revenues
      - Implies D ≤ α / (i + 1/m) · R
    - Illustrative example from the text:
      - A debt service cap of 20 percent of revenue would translate into a debt rule of 90 percent of revenue (assuming five‑year average debt maturity and a nominal interest rate of 2 percent).
    - Observed ranges and consistency checks:
      - Debt ceilings vary from 60 to 150 percent of revenues and debt service ceilings range from 12 to 25 percent of revenues at the OECD level, providing a first indication that rules are not blatantly inconsistent (OECD 2016).
    - Practical questions:
      - Whether rules should be expressed as percent of “own” revenue (excluding transfers) or total revenue:
        - Using own revenues: subnational governments have more legal power to manage own revenue; avoids unintentional breaches if central transfers are reduced; but own revenues can be volatile and heterogeneous, potentially allowing richer states more borrowing and accentuating inequalities.
        - Using total revenues including equalization grants: ensures broadly similar revenue capacities and more stable rule; but transfers can sometimes accentuate volatility.
        - Overall suggestion in the text: given unequal revenue bases and generally predictable transfers, the case for applying rules to total revenue seems stronger.
      - Revenues should exclude one‑off receipts: debt and debt service rules should be expressed in percent of “regular” revenue because subnational governments should pay debt service from regular income rather than nonrecurring receipts (grants, proceeds from sale of assets).
    - Comparison with current surplus approach:
      - Prudential approach is more flexible and ad hoc, hence more widespread.
      - Sensitive to calibration of thresholds; if too loose, debt service rule can be complied with while allowing persistent current deficits, which may be undesirable.

*Source: IMF Fiscal Affairs Department, How to Design Subnational Fiscal Rules: A Primer — Box 2. Examples of Cyclically Adjusted Balance Rules at the Subnational Level.*

### Box 3. Subnational Golden Rule and Debt Rule in France

### Box 3. Subnational Golden Rule and Debt Rule in France

### Budget Accounting Relationship
- The identity relating budgetary flows of revenue and expenditure to changes in liability and asset stocks:
  R −  E_c  −  E_k  ≡ OB ≡  ∆ FA − ∆ FL  ≡  ∆ FA −  ( NB − PR )
- Variable definitions as given:
  - R = revenue
  - E_c = current expenditure
  - E_k = capital expenditure
  - OB = nominal budget balance
  - ∆ FA = change in financial assets (= purchases minus sales of financial assets)
  - ∆ FL = change in financial liabilities (= new borrowing minus debt principal repayment)
  - NB = new borrowing
  - PR = debt principal repayment
- Assumptions stated:
  - The accounting identity assumes that stock-flow adjustments are equal to zero.
  - The appendix also assumes that ΔFA = 0 and that all constraints are saturated.1

### Budget Balance Rule (Budget Deficit Ceiling)
- Rule description:
  - Imposes a ceiling on the overall fiscal deficit.
  - Allows new borrowing for two purposes: (1) to finance the deficit up to a certain level, and (2) to repay the debt principal (debt rollover is allowed).
- Constraint:  R −  ( E_c  +  E_k ) = OB* , where OB* is the fiscal balance target, which can be negative, meaning a deficit.1
- Implication using the accounting relationship:
  - − ∆ FL = OB* .
  - Thus, NB = − OB* + PR .

### Budget Balance Rule with a Deficit Ceiling Equal to the Capital Expenditure Target
- Rule description:
  - Limits new borrowing to a budget deficit equal to the targeted subnational investment, plus principal repayment.
  - If investment is on target, the rule does not allow borrowing to cover current expenditure.
- Constraint:  R −  ( E_c  +  E_k ) = − E_k* , where E_k* is the targeted level of public investment.2
- Implications:
  - − ∆ FL = − E_k* .
  - Given NB = ∆ FL + PR , then: NB = E_k* + PR .
  - If E_k = E_k* , then R − E_c = − E_k* + E_k = 0 , meaning the rule is identical to the current balance rule described below.
  - If actual investment is below targeted investment (E_k < E_k*), then the rule creates room for borrowing for current expenditure. If E_k < E_k* , then R − E_c < 0 . The rule is compatible with the existence of a current deficit.

### Current Balance Rule (Operating Balance Rule)
- Rule description:
  - Allows new borrowing for capital expenditure and principal repayment but prevents borrowing for current expenditure.
- Constraint:  R − E_c = 0 .
- Implications:
  - Substituting into the basic accounting identity gives R − E_c − E_k = − ∆ FL = − E_k . This implies ∆ FL = E_k .
  - Thus, NB = E_k + PR .
  - Therefore, this rule is equivalent to the previous rule under the assumption that E_k = E_k* .

### Golden Rule (Current Surplus Rule)
- Rule description:
  - Requires generation of a current surplus sufficient to cover the principal repayment.
  - Allows new borrowing for capital expenditure but prevents borrowing for current expenditure and debt rollover (issuing new debt to repay past debt).
- Constraint:  R − E_c = PR .2
- Implications:
  - Substituting into the basic identity yields PR − E_k = − ∆ FL .
  - This implies ∆ FL = E_k − PR .
  - Thus, NB = E_k .

### Borrowing Constraint
- Rule description:
  - Imposes a ceiling on new borrowing in an ad hoc way.
  - Unlike the other rules, it does not link allowed borrowing to the size of the fiscal deficit, the amount of desirable capital expenditure, or the debt repayment needs.
- Implication:
  - NB = NB* .

*Source: How to Design Subnational Fiscal Rules: A Primer, Box 3. Subnational Golden Rule and Debt Rule in France.*

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_Source: https://www.imf.org/-/media/files/publications/howtonotes/2020/english/howtonote2001.pdf_