Going Green with Inadequately Supervised Fiscal Playgrounds for Local Governments

In this study, we examine how government debt responds to environmental policies when governments are endowed with inadequately supervised fiscal flexibility. We find that a strengthening of environmental policy worsened the local economy and encouraged Chinese local governments to increase the issuance of more flexible but less regulated off-budget debts. Further analysis indicates that the social costs of this additional flexibility were closely related to the urgency local officials felt to receive a promotion and the historical debt reliance. The Chinese experience is consistent with the predictions of theoretical models and also instructive for coordinating fiscal and environmental policies