The impact of fiscal decentralization and the soft budget constraint on the local government debt

Essay from the year 2019 in the subject Business economics - Economic Policy, grade: A, University of Nairobi (School of Business), course: PhD Economics, language: English, abstract: The author aims to study the impacts of fiscal decentralization and soft budget constraint on the scale of local government debts. Moreover, the effect of soft budget constraint on the scale of local government debt under the different extent of fiscal decentralization will be discussed.Due to the linkage between economic growth and the fiscal decentralization, the expansion in the local government debt is closely related to the fiscal decentralization and the soft budget constraint (SBC) – the expectation that the local governments would be bailed out by the central government if they face debt challenges.Based on the literature fiscal decentralization is linked to local government debts as literature indicates that fiscal decentralization leads to the decentralization of the expenditure without the revenue collection powers. The Chinese local governments have increased expenditure budgets on public services but the powers of taxation are centralized. To bridge the revenue gaps, the local governments take up debts that are sunk into infrastructure and other low revenue generating investments. Soft budget constraints are thus a product of fiscal decentralization as they are based on the principal – agent relationship between the politicians and the voters, central government and local government and the local governments and the SOEs within the local jurisdictions.