## _wp14209

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---

### I. Introduction and motivation
- Fiscal decentralization has progressed more on the expenditure side than on the revenue side, producing vertical fiscal imbalances (VFI).
- VFI measure: extent to which sub-national governments’ expenditures are financed through own revenues, transfers, or subnational borrowing.
- Potential channels linking VFI to fiscal performance include:
  - Indicator of soft subnational budget constraints prompting central transfers and higher central debt.
  - Higher sovereign risk and borrowing costs via perceived soft constraints.
  - Overspending or weaker tax collection incentives at subnational level.
  - Crowding-out of central government borrowing by subnational borrowing.
  - Explicit or implicit guarantees worsening the central government balance sheet.

### II. Measurement and decomposition of VFI
- VFI expands transfer dependency by incorporating subnational net borrowing.
- Notation (as presented): r_own and s_own denote subnational own revenue and spending; r and s denote total revenues and spending by subnational governments; R and S denote revenues and spending by the general government; t(+) and t(-) denote transfers received and paid; b denotes net borrowing by the subnational government.
- VFI defined following Eyraud and Lusinyan (2013); algebraic transformations shown in equations (1)–(5) in source text.
- VFI embeds revenue decentralization (d_r) and spending decentralization (d_s) measures; transfer dependency corresponds to first element on the right-hand side of the decomposition; net borrowing term (b/s_own) is additional component.

### III. Data sources, coverage, and construction
- Primary sources: IMF’s Government Finance Statistics Yearbook (GFSY) based on GFSM 2001 and SNA 2008; complementary OECD data where GFSY lacks breakdowns or coverage.
- Borrowing autonomy indicator source: World Bank (2012) (used for visualization).
- Sample construction:
  - Countries with at least 10 consecutive years of data.
  - Total countries with constructed VFI series: 47 countries.
  - Last year in sample: 2011.
  - 36 out of 47 countries have full series starting in 1995.
  - Sample observations for VFI: 1194 observations.
  - Comparison means: Eyraud and Lusinyan mean VFI = 40.1; this paper mean VFI = 40.5.
- Government debt database:
  - Combination of GFSY and OECD data to assemble general government gross debt series.
  - Sample size for general government gross debt analysis: 775 observations.
  - Reported: "For a sample of 775 observations, the average level of general government gross debt relative to GDP is 60 percent" (sentence truncated in source).
- Country examples and data notes:
  - Federal countries (Canada, Germany, Switzerland, United States) tend to have lower VFI; unitary countries (Ireland, Netherlands, Peru, U.K.) tend to have higher VFI.
  - Transfer data represent bulk of VFI in most countries; subnational borrowing smaller on average but relevant for changes in VFI.

### IV. Summary statistics and time-series properties
- VFI and decentralization summary (calculated with all available observations):
  - Vertical Fiscal Imbalance: Obs. 1194; Mean 40.51; Std. Dev. 19.80; Min 3.31; Max 88.26
  - Revenue Decentralization: Obs. 1176; Mean 20.29; Std. Dev. 13.15; Min 1.45; Max 61.09
  - Expenditure Decentralization: Obs. 1174; Mean 31.52; Std. Dev. 14.84; Min 3.90; Max 64.20
- General Government Debt (percent of GDP) summary:
  - Obs. 775; Mean 59.92; Std. Dev. 27.52; Min 6.10; Max 140.71
- Temporal patterns:
  - Average VFI historically remained within a band between 35 and 45 percent.
  - Prior to the 2008 financial crisis there was a general downward trend in VFI; notable increase associated with the 2007/2008 financial crisis.
  - Expenditure decentralization rose mid-1990s until about 2003; revenue decentralization trend less clear.
- Panel unit root tests (Im-Pesaran-Shin) for general government debt:
  - Levels: 1972–2011 = 2.20 (p-value 1.00); 1980–2011 = 1.67 (p-value 0.95); 1995–2011 = 0.31 (p-value 0.62).
  - First differences: 1972–2011 = -7.39 (p-value 0.01); 1980–2011 = -7.52 (p-value 0.00); 1995–2011 = -8.80 (p-value 0.00).
- Implication: dependent variable used in regressions is first difference of general government gross debt (percent of GDP).
- Regressors (including VFI) are stationary in levels (see Table A5); cointegration between debt and regressors ruled out.

### V. Main regression results (dependent variable = first difference of general government gross debt, percent of GDP)
- Benchmark VFI coefficient:
  - Model (2) VFI = 0.07** (t = 2.14).
  - Interpretation: a 10 percentage point increase in VFI implies a 0.7 percentage point increase in the change in general government gross debt as percent of GDP.
- Expenditure decentralization:
  - Model (2): -0.20*** (t = -3.20).
- Lag of central government deficit:
  - Model (2): -0.34*** (t = -6.80).
- Lag of real per capita GDP growth:
  - Model (2): -0.52*** (t = -3.96).
- Lag of real interest rate:
  - Model (2): 0.21* (t = 1.83).
- Other notable coefficients:
  - Openness (Model (3) and (7)) = -0.07*** (t ≈ -3.21 / -3.24).
  - Population (Models (4) and (7)) = 0.03*** / 0.02*** (t = 3.57 / 3.11).
  - Election dummy in Model (7) = 0.23* (t = 1.80).

### VI. Robustness, interaction effects, and heterogeneity
- Stability:
  - VFI coefficient (~0.07) stable across models (1)–(7) in Table 4.
  - Excluding crisis years: VFI remains significant with average value ~0.07; central government deficit may lose significance when crisis years excluded.
  - Replacing real per capita GDP growth with unemployment reduces VFI coefficient from 0.07 to 0.06 (still significant at 10 percent in most specifications).
- Interaction regressions (Table 5) — combined effects (direct + interaction at mean of interacted variable):
  - VFI combined effect column (1): 0.09** (t = 2.77).
  - VFI combined effect column (2): 0.12** (t = 2.96).
  - VFI combined effect column (3): 0.08** (t = 2.25).
- Specific interactions:
  - VFI*Expenditure Decentralization: interaction = 0.00** (t = 2.23) in column (1); combined effect 0.09**.
  - VFI*Regional Authority Index (RAI): interaction = -0.01*** (t = -4.56) in column (2); combined effect remains positive (0.12**).
  - VFI*Fragmentation: interaction = -0.06* (t = -1.79); combined effect may be insignificant in that specification.
  - Interactions with borrowing autonomy and authority dummies show mixed significance; many combined effects remain in range 0.04–0.12 depending on specification.

### VII. Endogeneity checks and instrumental variable evidence
- Instruments used: lag of VFI, share of population above 65, fiscal autonomy from RAI (Hooghe et al. 2010).
- First-stage:
  - Lag of VFI coefficient ~0.77–0.80, t-statistics ~15.78–16.19.
- IV second-stage VFI estimates:
  - Column (1) VFI = 0.07* (t = 1.97).
  - Column (2) VFI = 0.07** (t = 2.08).
  - Column (3) VFI = 0.11* (t = 1.99) — smaller sample.
- Instrument diagnostics:
  - F-test of excluded instruments: Column (1) = 262.17 (p-value 0.00); Column (2) = 152.34 (p-value 0.00); Column (3) = 1079.88 (p-value 0.00).
  - Hansen J-statistic p-values: Column (2) = 0.58; Column (3) = 0.51.
- Conclusion: IV evidence aligns with fixed effects estimates; endogeneity does not appear to drive main results.

### VIII. Key substantive findings
- Main empirical regularity: higher VFI associated with increased accumulation of general government gross debt.
  - Representative estimate: VFI coefficient ≈ 0.07, implying a 10 percentage point increase in VFI → 0.7 percentage point increase in the change in general government gross debt (percent of GDP).
- Effect robustness: stable across specifications, samples, interaction terms, and IV estimates; exceptions when including rule of law (limited coverage) or certain institutional interactions.
- Control variables: improved central government fiscal position and higher real per capita GDP growth reduce debt accumulation; higher real interest rates increase debt accumulation.

### IX. Policy implications and recommendations
- Exercise caution in promoting fiscal decentralization when it increases subnational responsibilities without commensurate subnational revenues (i.e., increases VFI).
- Decentralization design should:
  - Explicitly consider VFI and its components (transfers and subnational borrowing).
  - Ensure efficient and responsible subnational governance via institutional arrangements and borrowing rules.
  - Clarify assignment of taxing and spending responsibilities and establish mechanisms to limit moral hazard (implicit or explicit guarantees).
  - Account for heterogeneous effects across institutional contexts (federal vs. unitary, regional authority, government fragmentation, borrowing autonomy).
- Monitoring and safeguards: pair expanded subnational responsibilities with fiscal resources or strengthened accountability to avoid unintended accumulation of general government debt.

### X. Appendix highlights: control variables, diagnostics, and sample coverage
- Control variable definitions and sources listed (Table A3) include CG net lend./borr., GDP pc Growth, Inflation, Output gap, Unemployment, Interest rate, Openness, School, Dependency ratio, Population, Fragmentation, Borrowing Autonomy, Election/Legislative/Executive dummies, RAI, Rule of Law.
- Summary statistics for controls (Table A4) examples:
  - CG net lend./borr.: 1315; Mean -1.79; Std. Dev. 4.02; Min -30.93; Max 20.01
  - Real pc GDP growth: 1603; Mean 2.19; Std. Dev. 4.00; Min -22.53; Max 14.83
  - Real Interest Rate: 874; Mean 2.98; Std. Dev. 3.22; Min -13.99; Max 15.55
  - Openness: 1589; Mean 77.76; Std. Dev. 41.80; Min 7.60; Max 333.53
  - Population: 1880; Mean 44.30; Std. Dev. 135.95; Min 0.21; Max 1221.16
  - Borrowing Autonomy: 840; Mean 74.60; Std. Dev. 16.77; Min 33.33; Max 100.00
- Panel unit root tests for main regressors (Table A5) examples:
  - VFI Levels: -2.19 (0.01); # Observations 1096
  - VFI First differences: -14.81 (0.00); # Observations 1047
  - CG Deficit Levels: -5.25 (0.00); # Observations 1192
- Diagnostics (Table A6):
  - Wooldridge test for serial correlation: F(1,27)=4.523** (H0: No first order serial correlation)
  - Modified Wald test for groupwise heteroskedasticity: ߯ଶ(28)=3622.93*** (H0: Homoskedasticity)
  - Pesaran test of cross-sectional dependence (N(0,1)):
    - First difference of Gov. Debt (% GDP): N(0,1)=28.94***
    - Vertical Fiscal Imbalances: N(0,1)=11.94***
    - Expenditure decentralization: N(0,1)=3.91***
  - Variance inflation factors (mean VIF = 1.08); VFI VIF = 1.11.

*Italic: Source — Appendix tables, Figures, and empirical analysis presented in _wp14209 (IMF working paper PDF).*

### References .............................................................................................................

### _wp14209 - References

### Tables
- 1: Summary Statistics – Vertical Fiscal Imbalances ................................................................10
- 2: Summary Statistics – Government Gross Debt ...................................................................15
- 3: Panel Unit Root Tests ..........................................................................................................19
- 4: Main Regression Results .....................................................................................................22
- 5: Regressions with Interaction ................................................................................................25
- 6: Instrumental Variable Regressions ......................................................................................28

### Figures
- 1: Average Vertical Fiscal Imbalances (1973–2011) ...............................................................10
- 2: Average Expenditure (left) and Revenue (right) Decentralization (1973–2011) ................11
- 3: Average Vertical Fiscal Imbalances (VFI) by Country and Subnational (SN) ...................12
- 4: Composition of Vertical Fiscal Imbalances (average) .........................................................13
- 5: Changes in Vertical Fiscal Imbalances (average) ................................................................13
- 6: Vertical Fiscal Imbalances and General Government Debt .................................................19

*Source: _wp14209 - References*

### Appendix Tables

### _wp14209 - Appendix Tables

### I. Introduction — framing and motivation
- Fiscal decentralization aims to devolve authority and decision-making to lower tiers of government; endorsed by international institutions (World Bank (2000), OECD, Stegarescu (2004)).
- The move toward decentralization has been stronger on the expenditure side than on the revenue side, producing vertical fiscal imbalances (vfi).
- Vertical fiscal imbalances (vfi) measure the extent to which sub-national governments’ expenditures are financed through their own revenues, transfers, or subnational borrowing.
- Potential channels through which vfi can affect fiscal performance:
  - Indicator of soft subnational budget constraints that can prompt central government transfers and higher central debt (Rodden et al., 2003; Kornai et al., 2003; Crivelli et al., 2010).
  - Higher sovereign risk and borrowing costs if investors perceive soft constraints.
  - Overspending or weaker tax collection incentives at subnational level (Velasco, 1999).
  - Crowding-out effects on central government borrowing if subnational borrowing is large.
  - Realization of explicit or implicit guarantees could worsen central government balance sheet (IMF, 2009).

### II. Literature review — empirical and theoretical context
- Foundational theories: Oates (1972), Tiebout (1956), Brennan and Buchanan (1980), Musgrave (1959).
- Mixed empirical findings on decentralization’s effects on size of government and fiscal balances (Oates (2006), Rodden et al. (2003); De Mello (2000); Filgueira et al. (2002); Freitag and Vatter (2008); Marlow (1988); Jin and Zou (2002)).
- Relevant empirical evidence on vfi and soft budget constraints: Rodden et al. (2003); Karpowicz (2012); Crivelli et al. (2010).
- Closely related empirical studies:
  - Eyraud and Lusinyan (2013): construct modified vfi; using OECD panel find that for each 10 percentage point decrease in vfi, the general government fiscal balance improves by 1 percent of GDP.
  - Baskaran (2010): panel of 17 OECD countries; finds expenditure decentralization associated with reduction in government indebtedness; no evidence for revenue decentralization or transfer dependency affecting net government debt.

### III. Measurement — vfi definition and decomposition
- vfi expands beyond transfer dependency by incorporating subnational borrowing.
- Notation and conceptual definition (as presented):
  - r_own and s_own denote subnational government own revenue and spending; r and s denote total revenues and spending by subnational governments; R and S denote revenues and spending by the general government; t(+) and t(-) denote transfers received and paid; b denotes net borrowing by the subnational government.
  - vfi is defined following Eyraud and Lusinyan (2013), with algebraic transformations shown in equations (1)–(5) in the source text.
- The vfi measure embeds common decentralization measures:
  - Revenue decentralization (d_r = r/GDP? — presented as embedded in algebraic form in the source).
  - Spending decentralization (d_s — also embedded).
- Transfer dependency corresponds to the first element on the right-hand side of the decomposition; the net borrowing term (b/s_own) is the additional component.

### IV. Data overview — construction and key features
- Data sources:
  - Primary: IMF’s Government Finance Statistics Yearbook (GFSY), based on GFSM 2001 and SNA 2008.
  - Complementary: OECD data used where GFSY lacks subnational transfer breakdowns or coverage (e.g., Belgium, U.S., Canada, Italy prior to 1995).
  - Borrowing autonomy indicator source: WB (2012) (used for visualization).
- Dataset coverage and sample construction:
  - Cut-off: countries with at least 10 consecutive years of data.
  - Total countries with constructed vfi series: 47 countries.
  - Last year in the sample: 2011.
  - 36 out of the 47 countries have full series starting in 1995.
  - Sample observations for vfi: 1194 observations (comparison figure in text: 485 versus 1194 observations).
  - Comparison of means: Eyraud and Lusinyan’s mean vfi = 40.1; this paper’s mean vfi = 40.5.
- Key aggregate statistics (Table 1 — calculated with all available observations):
  - Vertical Fiscal Imbalance: Obs. 1194; Mean 40.51; Std. Dev. 19.80; Min 3.31; Max 88.26
  - Revenue Decentralization: Obs. 1176; Mean 20.29; Std. Dev. 13.15; Min 1.45; Max 61.09
  - Expenditure Decentralization: Obs. 1174; Mean 31.52; Std. Dev. 14.84; Min 3.90; Max 64.20
- Temporal and cross-country patterns:
  - Average vfi historically remained within a relatively narrow band between 35 and 45 percent.
  - Prior to the 2008 financial crisis there was a general downward trend in vfi, with a notable increase associated with the 2007/2008 financial crisis.
  - Expenditure decentralization showed an upward trend during the mid-1990s until about 2003; revenue decentralization trend is less clear.
  - Cross-country heterogeneity is large: examples cited include average vfi ranging from 14 percent (Germany) to 73 percent (Netherlands) in one panel; and from 13 percent (Iceland) to 81 percent (Peru) in another panel.
  - Federal countries (Canada, Germany, Switzerland, United States) tend to have lower vfi; unitary countries (Ireland, Netherlands, Peru, U.K.) tend to have higher vfi.
- Role of subnational borrowing:
  - Transfers represent the bulk of vfi in most countries.
  - Subnational borrowing is on average smaller than transfers but is relevant for explaining changes in vfi over time.
  - Empirical analyses in the paper incorporate subnational borrowing due to its role in vfi dynamics.

### V. Government debt data — measurement choices and sample
- Public debt measurement issues emphasized:
  - Cross-country comparability is affected by differences in reporting (central government vs. general government vs. extra-budgetary accounts).
  - Analyses that focus only on central government debt may miss subnational borrowing responses to vfi.
- Constructed government debt database:
  - Combination of GFSY and OECD data used to assemble general government gross debt series.
  - Sample size for general government gross debt analysis: 775 observations.
  - The source text states: "For a sample of 775 observations, the average level of general government gross debt relative to GDP is 60 percent" (sentence in the source is truncated after "standard deviation of").

### VI. Empirical implications and research design notes (as presented)
- Enlarging the sample beyond OECD countries improves robustness: this paper’s sample is substantially larger than prior work (e.g., Eyraud and Lusinyan).
- The vfi indicator used combines transfer dependency and subnational net borrowing, allowing examination of both levels and changes in imbalances.
- Borrowing autonomy is treated as a potential interacting factor with vfi when assessing impacts on general government debt.

*Source: Appendix Tables and accompanying text from _wp14209 - Appendix Tables (IMF working paper PDF)._*

### 27.5 percent.

### _wp14209 - 27.5 percent.

### Summary statistics and data scope
- General Government Debt (percent of GDP): Obs. 775; Mean 59.92; Std. Dev. 27.52; Min 6.10; Max 140.71.  
- Calculated with all available observations; source: Own calculations based on GFSY and OECD.  
- Unbalanced panel covering years 1972–2011 (varies by test and regression); country coverage in regressions typically 28–30; typical observations per regression ~600; exception when using rule of law reduces observations to 416.

### Time-series properties and estimation choices
- Panel unit root tests (Im-Pesaran-Shin) indicate levels of general government debt are non-stationary while first differences are stationary:
  - Levels: 1972–2011 = 2.20 (p-value 1.00); 1980–2011 = 1.67 (p-value 0.95); 1995–2011 = 0.31 (p-value 0.62).
  - First differences: 1972–2011 = -7.39 (p-value 0.01); 1980–2011 = -7.52 (p-value 0.00); 1995–2011 = -8.80 (p-value 0.00).
- Implication: main dependent variable is the first difference of general government gross debt (percent of GDP).
- Regressors (including vertical fiscal imbalances) are stationary in levels (see Table A5); cointegration between debt and regressors is ruled out.
- Estimation strategy: panel fixed effects with robust standard errors clustered at the country level; time dummies included. Arellano-Bond / system GMM deemed inappropriate given large T relative to N and non-stationarity of debt levels.

### Control variables used (main specification)
- Main controls (lagged): central government net lending/borrowing (surplus/deficit as % of GDP), real per capita GDP growth, real interest rate on long-term government bonds.
- Additional controls and considerations:
  - Expenditure decentralization included alongside VFI.
  - Openness (exports+imports)/GDP, population, election dummies, rule of law (WGI), Regional Authority Index (Hooghe et al. 2010), borrowing autonomy indicators, government fragmentation index, measures of subnational authority over taxing/spending/legislating.
  - Lags used to reduce endogeneity; revenue decentralization excluded in main regressions to avoid multicollinearity and accounting-driven interpretation problems.
  - Interaction terms used for exploring effect heterogeneity (e.g., VFI interacted with expenditure decentralization, RAI, fragmentation, borrowing autonomy, political-cycle indicators).

### Main regression results (Table 4 highlights; dependent variable = first difference of general government gross debt in percent of GDP)
- Benchmark coefficient on VFI:
  - Model (2) VFI = 0.07** (t = 2.14). Interpretation: a 10 percentage point increase in vertical fiscal imbalances implies a 0.7 percentage point increase in the change in general government gross debt as a percent of GDP.
- Expenditure decentralization:
  - Consistently negative and significant across models (e.g., Model (2): -0.20***, t = -3.20).
- Lag of central government deficit:
  - Negative and highly significant where included (e.g., Model (2): -0.34***, t = -6.80).
- Lag of real per capita GDP growth:
  - Negative and significant (e.g., Model (2): -0.52***, t = -3.96).
- Lag of real interest rate:
  - Positive and generally significant (e.g., Model (2): 0.21*, t = 1.83).
- Other notable coefficients:
  - Openness (Model (3) and (7)) = -0.07*** (t ≈ -3.21 / -3.24) — more open economies tend to accumulate less debt in these specifications.
  - Population (Models (4) and (7)) = 0.03*** / 0.02*** (t = 3.57 / 3.11) — larger population associated with more debt accumulation.
  - Election proximity / Election dummy: model evidence mixed; Model (7) election = 0.23* (t = 1.80).

### Robustness and sensitivity
- Stability: coefficient on VFI (~0.07) is stable across many specifications (models (1)–(7) in Table 4).
- Excluding crisis years: coefficient on VFI remains statistically significant across specifications; average value ~0.07. Central government deficit may become statistically insignificant when crisis years excluded.
- Alternative business-cycle control: replacing real per capita GDP growth with unemployment reduces VFI coefficient from 0.07 to 0.06 (still statistically significant at 10 percent in most specifications).
- Multiplicative interaction regressions (Table 5):
  - Combined effect of VFI (direct + interaction at mean of interacted variable) remains positive and often significant. Examples:
    - VFI combined effect in column (1): 0.09** (t = 2.77).
    - VFI combined effect in column (2): 0.12** (t = 2.96).
    - VFI combined effect in column (3): 0.08** (t = 2.25).
  - Interaction specifics:
    - VFI*Expenditure Decentralization: VFI effect strengthened (VFI*Expenditure = 0.00**, t = 2.23 in column (1)); combined effect 0.09**.
    - VFI*Regional Authority Index (RAI): interaction coefficient -0.01*** (t = -4.56) but combined effect remains positive in column (2) (combined 0.12**).
    - VFI*Fragmentation: interaction negative and statistically significant at 10 percent (interaction = -0.06*, t = -1.79), combined effect can be insignificant in that specification.
    - Interactions with borrowing autonomy measures and some authority dummies show limited or mixed significance; many combined effects remain around 0.04–0.12 depending on sample and interaction.

### Endogeneity checks and instrumental variable results (Table 6)
- Instruments used for VFI: lag of VFI, share of population above 65, fiscal autonomy from RAI (Hooghe et al. 2010).
- First-stage evidence: Lag of VFI strongly predictive (e.g., coefficient ~0.77–0.80, t-statistics ~15.78–16.19).
- IV second-stage VFI estimates:
  - Column (1) VFI = 0.07* (t = 1.97).
  - Column (2) VFI = 0.07** (t = 2.08).
  - Column (3) VFI = 0.11* (t = 1.99) — smaller sample for column (3).
- Tests:
  - F-test of excluded instruments: Column (1) = 262.17 (p-value 0.00); Column (2) = 152.34 (p-value 0.00); Column (3) = 1079.88 (p-value 0.00) — instruments relevant.
  - Hansen J-statistic p-values: Column (2) = 0.58; Column (3) = 0.51 — no evidence against instrument validity in these specifications.
- Conclusion from IV: endogeneity does not appear to drive main results; VFI effect remains in line with fixed effects estimates.

### Key substantive findings and interpretation
- Main empirical regularity: higher vertical fiscal imbalances (VFI) are associated with increased accumulation of general government gross debt.
  - Representative estimate: VFI coefficient ≈ 0.07 (benchmark), implying a 10 percentage point increase in VFI → 0.7 percentage point increase in the change in general government gross debt (percent of GDP).
- Effect robustness:
  - Stable across many specifications, samples, interaction terms, and IV estimates.
  - Exceptions / qualifications: inclusion of rule of law (limited coverage) reduces VFI coefficient significance; interactions can alter significance and magnitude in specific institutional contexts (e.g., fragmentation, RAI, borrowing autonomy).
- Control variables behave as expected: improved central government fiscal position and higher real per capita GDP growth reduce debt accumulation; higher real interest rates increase debt accumulation.

### Policy implications and recommendations
- Caution in promoting fiscal decentralization: when subnational expenditures increase but are financed outside subnational governments (i.e., larger vertical fiscal imbalances), fiscal performance of the general government may deteriorate (higher deficits/debt).
- Design and implementation of decentralization strategies should:
  - Consider vertical fiscal imbalances explicitly.
  - Include measures to ensure efficient and responsible subnational governance (institutional arrangements, borrowing rules, clear assignment of taxing and spending responsibilities, mechanisms to limit moral hazard).
  - Account for heterogeneous effects across institutional settings (federal vs. unitary, degree of regional authority, government fragmentation, borrowing autonomy).
- Monitoring and safeguards: where decentralization proceeds, pair expanded subnational responsibilities with fiscal resources or strengthened accountability to avoid unintended debt accumulation at the general government level.

*Italic: Source — Own calculations and empirical analysis as presented in the provided IMF chapter (GFSY and OECD based dataset; tables and figures referenced: Table 2, Table 3, Table 4, Table 5, Table 6).*

### REFERENCES

### _wp14209 - REFERENCES

### Appendix: Country sample coverage for VFI (Table A1)
- Lists countries with sample periods and cash/non-cash coverage.
- Examples preserving exact entries:
  - Australia AU 1972-2011 Non-Cash starts 1999
  - Belgium BE 1985-2011 (*) Non-Cash starts 1995
  - India IN 1974-2009 (#) Only Cash
  - United States US 1972-2011 (**)
- Notes:
  - Based on GFSY; countries with at least 10 consecutive years of observations
  - (*) Series complemented with OECD data: BE (1985-1994), CA (1972-1990), IT (1980-1994)
  - (**) Series taken entirely from OECD data
  - (#) Missing data for subnational borrowing 1999-2001, interpolated.
  - (+) Missing data for LU (1998) and BG (2008) filled by averaging adjacent years.

### Appendix: Country sample coverage for General Government Debt (Table A2)
- Lists countries with full sample periods and whether GFSY or OECD sources used.
- Examples preserving exact entries:
  - Australia AU 1989-2011 Full OECD
  - Austria AT 1972-2011 GFSY from 1995
  - Greece GR 1995-2011 Full OECD
  - United States US 1972-2011 Full OECD

### Control variables (Table A3)
- Variable definitions and sources (preserved terminology):
  - CG net lend./borr.: Central Government net lending/borrowing (in % of GDP) — GFSY (IMF)
  - GDP pc Growth: Real GDP per capita growth (in %) — WEO (IMF)
  - Inflation: Change in CPI index (in %) — WEO (IMF)
  - Output gap: Difference (in %) between real and estimated potential GDP — WEO (IMF)
  - Unemployment: Unemployment rate — WEO (IMF)
  - Interest rate: Interest rate on long term Government bonds — OECD
  - Openness: Trade (exports + imports) to GDP ratio (in %) — World Bank - WDI
  - School: Share of school-age population (between 0 and 14 years old) in total population (in %) — World Bank - WDI
  - Dependency ratio: Share of population below 15 and above 65 years old) in working age population (in %) — World Bank - WDI
  - Population: Population — World Bank - WDI
  - Fragmentation: Herfindahl index of government fragmentation (sum of the squared seat shares of all parties in the government) — DPI Dataset, Beck et al. (2001)
  - Borrowing Autonomy: Composite index measuring six components of borrowing regulation for SNG; =0 if no autonomy on borrowing decisions, =100 if complete autonomy; plus related dummies and indices — Crivelli et al. (2010); World Bank (2012)
  - Election / Legislative / Executive: Dummies for elections and years left in current term — DPI Dataset, Beck et al. (2001)
  - RAI / Fiscal Autonomy: Regional Authority Index and sub-indicator (0 to 4) — Hooghe et al. (2010)
  - Rule of Law: Indicator ranging from -2.5 to 2.5 — World Bank - WGI
- Special note:
  - (*) Values for 1997, 1999 and 2001 obtained via interpolation; 1995 assumed equal to 1996

### Summary statistics for control variables (Table A4)
- Exact descriptive statistics (Nº Obs., Mean, Std. Dev., Min, Max) for selected variables:
  - CG net lend./borr.: 1315; Mean -1.79; Std. Dev. 4.02; Min -30.93; Max 20.01
  - Real pc GDP growth: 1603; Mean 2.19; Std. Dev. 4.00; Min -22.53; Max 14.83
  - Real Interest Rate: 874; Mean 2.98; Std. Dev. 3.22; Min -13.99; Max 15.55
  - Openness: 1589; Mean 77.76; Std. Dev. 41.80; Min 7.60; Max 333.53
  - REER: 1744; Mean 94.48; Std. Dev. 31.40; Min 5.59; Max 476.72
  - Population: 1880; Mean 44.30; Std. Dev. 135.95; Min 0.21; Max 1221.16
  - Dependency Ratio: 1880; Mean 64.88; Std. Dev. 4.23; Min 49.16; Max 72.57
  - School-age Population: 1880; Mean 23.58; Std. Dev. 7.65; Min 13.27; Max 47.70
  - Output Gap: 1161; Mean 0.02; Std. Dev. 3.15; Min -13.38; Max 17.78
  - Unemployment: 1415; Mean 7.52; Std. Dev. 4.65; Min 0.00; Max 28.15
  - Legislative: 1500; Mean 0.27; Std. Dev. 0.44; Min 0.00; Max 1.00
  - Executive: 1501; Mean 0.07; Std. Dev. 0.26; Min 0.00; Max 1.00
  - Election: 1393; Mean 1.78; Std. Dev. 1.34; Min 0.00; Max 7.00
  - Rule of Law: 782; Mean 0.78; Std. Dev. 0.96; Min -1.29; Max 2.00
  - Govt. Fragmentation: 1427; Mean 0.70; Std. Dev. 0.28; Min 0.08; Max 1.00
  - Borrowing Autonomy: 840; Mean 74.60; Std. Dev. 16.77; Min 33.33; Max 100.00
  - High Borrowing Aut.: 840; Mean 0.52; Std. Dev. 0.50; Min 0.00; Max 1.00
  - Authority: 706; Mean 0.62; Std. Dev. 0.49; Min 0.00; Max 1.00
- Note: Calculated with all available observations. See Table A3 for details.

### Panel unit root tests for main regressors (Table A5)
- Im-Pesaran-Shin test statistics and p-values (Levels and First differences) with # Observations:
  - VFI Levels: -2.19 (0.01); # Observations 1096
  - CG Deficit Levels: -5.25 (0.00); # Observations 1192
  - GDPpc growth Levels: -15.13 (0.00); # Observations 1509
  - Real Int. Rate Levels: -1.64 (0.05); # Observations 814
  - VFI First differences: -14.81 (0.00); # Observations 1047
  - CG Deficit First differences: -17.48 (0.00); # Observations 1134
  - GDPpc growth First differences: -31.82 (0.00); # Observations 1462
  - Real Int. Rate First differences: -16.52 (0.00); # Observations 784
- Note: p-values in parenthesis

### Diagnostics and model specification tests (Table A6)
- Autocorrelation:
  - Wooldridge test for serial correlation: F(1,27)=4.523** (H0: No first order serial correlation)
- Heteroskedasticity:
  - Modified Wald test for groupwise heteroskedasticity: ߯ଶ(28)=3622.93*** (H0: Homoskedasticity)
- Cross-sectional dependence (Pesaran test of cross-sectional dependence; H0: Cross-section independence in residuals) — first-difference and variables with test statistics N(0,1):
  - First difference of Gov. Debt (% GDP): N(0,1)=28.94***
  - Vertical Fiscal Imbalances: N(0,1)=11.94***
  - Expenditure decentralization: N(0,1)=3.91***
  - Lag of Central Gov. Deficit: N(0,1)=36.18***
  - Lag of real pc GDP growth: N(0,1)=49.24***
  - Lag of real interest rate: N(0,1)=30.93***
- Multicollinearity (Variance inflation factors, rule of thumb: >20 indicative of possible multicollinearity):
  - Vertical fiscal imbalances: 1.11
  - Expenditure decentralization: 1.19
  - Lag of Central Gov. Deficit: 1.24
  - Lag of real pc GDP growth: 1.15
  - Lag of real interest rate: 1.20
  - Mean VIF: 1.08
- Note: Results based on benchmark model. *** (**,*) indicate rejection of H0 at the 1% (5%, 10%) level.

*Source: _wp14209 - REFERENCES (appendix tables and diagnostics).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2014/_wp14209.pdf_