Fiscal Adjustments at the Local Level: Evidence from Colombia

Recent research suggests that intergovernmental grants, own-source revenues, and changes in government investment play an important role in helping local governments in advanced economies to adjust their fiscal positions in response to budget shocks. At the same time, little is known about the dynamic of fiscal adjustments at the local level in emerging economies, and there are reasons to expect distinct fiscal stabilization patterns, for instance, due to weaker institutional arrangements and lower fiscal capacity. However, using a panel data set of more than 900 municipalities in Colombia over the period 1985-2015, I find that in line with the results for developed countries (i) intergovernmental grants react significantly to increases in government spending; (ii) the response of own-source revenues to innovations in government spending in large cities is higher than in the small ones; (iii) government investment is highly volatile and responds remarkably to innovations in all other budgetary components; and (iv) there is no strong empirical evidence of a reduction in fiscal effort as a result of increases in intergovernmental grants.