Public Expenditure Smoothing at the Subnational Level: Evidence from Argentina

In this paper we aimed at investigating expenditure smoothing at the subnational level in Argentina. We develop a theoretical model that provides precise predictions about how public expenditures should react to innovations in provincial revenues. We test these predictions using provincial consumption outlays for the 1983-2005 period. Argentina is characterized by the fact that a very important source of income to finance provincial expenditures is determined by a pre-determined tax sharing rule. In addition, an important source of revenues is participations in oil revenues (regalias) which are very volatile depending on changes in oil prices. These two features implies that, compare to studies using country level data, we can perform the empirical analysis without worrying about reverse causation. We find evidence suggesting a low level of public consumption smoothing . Most of this "overreaction" beyond what theory predicts comes out of the behavior of public expenditures when facing negative realizations in the two indicated sources of income. We show that this procyclicality is in part associated with the presence of liquidity constraints.