Real Activities Management to Prevent Fiscal Deficits: Evidence from Municipal Corporations

• In Event: Government Financial Stability and Disclosures

Abstract

Municipalities have regulatory deficit and debt targets. This means that municipalities often face a trade-off between maintaining the provision of public services and complying with fiscal restrictions. We investigate this trade-off using a novel sample of municipal corporations whose expenditure towards providing public services is consolidated within municipalities’ balanced budget calculations. We argue that the articulation of balanced budget calculation provides both opportunities and incentives for municipalities to exert pressure on their consolidated subsidiaries to shave discretionary expenditure. Our findings suggest that municipalities guide their subsidiaries’ expenditure downwards to meet the target of zero non-financial deficit insofar the political cost of low public services provision can be manageable. Further analysis points to the role of subsidies and specifically, operating grants, as a mechanism to control the level of discretionary expenditure in consolidated subsidiaries. We confirm our findings by testing these predictions on a counterfactual, that is, a sample of subsidiaries which are similarly aligned with the municipality but do not directly influence the municipality’s ability to meet its fiscal regulatory targets.

Authors

• Christina Dargenidou, University of Exeter

• Marta de Vicente Lama, UNIVERSIDAD LOYOLA ANDALUCÍA

• Beatriz Garcia Osma, Universidad Carlos III de Madrid