Estimating Fiscal Adjustments at the Local Level in Colombia

The aim of this paper is to analyze how local governments in Colombia adjust their fiscal positions in response to budget imbalances. Using a panel data set of more than 450 municipalities and 26 departments over the period 1993 to 2013, I estimate a vector error-correction model in order to identify the level of discretion in policymaking at the local level in terms of fiscal reaction functions. I show that the local governments in Colombia commit to satisfy an intertemporal budget constraint. However, I also find that there are remarkable differences in the dynamic adjustment governments follow in order to restore their fiscal position. For instance, departmental governments face greater fiscal constraints in comparison with the municipal governments since these intermediate governments are financed largely by excise taxes and grants tend to respond in a lower extent to their budgetary innovations. Likewise, decomposing the municipal sample, I show that intergovernmental grants is a key variable for the majority of municipalities and that own-source revenues do not play an important role in fiscal adjustment patterns with the exception of large cities.