Effects of Fiscal Decentralization on Public Sector Growth in Austria

By Bröthaler, Johann; Getzner, Michael | Public Finance and Management, January 1, 2010 | Go to article overview

Effects of Fiscal Decentralization on Public Sector Growth in Austria


Bröthaler, Johann, Getzner, Michael, Public Finance and Management


ABSTRACT

The determinants of the growth of the public sector have drawn significant attention by researchers with an increasing focus on the effects of fiscal federalism. The objective of the paper is to test whether fiscal decentralization contributes to the growth of government expenditure in Austria for the period of 1955 to 2007. The empirical results of this paper suggest that the commonly hypothesized determinants of total government expenditure may bear some explanatory power in Austrian fiscal policies. Government expenditures seem to be determined by GDP with increases of the size of the public sector until about mid-1990s. Expenditures react to active fiscal policies influencing the unemployment rate. There is also some indication of fiscal illusion of policy makers. We find that fiscal decentralization measured by the share of sub-national expenditure to total government expenditure has a dampening effect on total government expenditure, thus corroborating the hypothesis of the efficiency of a federal system. However, decentralization in the Austrian system is mainly attributable to the significant growth of grants from the national to the sub-national levels of government. Our conclusions therefore cannot be generalized in terms of an efficiency advantage of a federal over a centralized system.

1. INTRODUCTION

At the latest since the Maastricht Treaty (signed in 1992), and the Stability and Growth Pact, fiscal policies have been on the political agenda in the European Un-ion. However, the debate on the efficiency of public provision of goods and services, and of the distribution function of the public sector, is certainly much older, and has been dealt with in the economic literature for the last hundred years. For instance, German economist Adolph Wagner empirically explored what he finally called "Law of growing state activities" suggesting a positive income elasticity of public goods and services. This "Law" has been tested empirically and theoreti-cally for a large variety of countries, with many differ-ent models and approaches, and equally different and often ambiguous results (cf. the overview of Peacock and Scott, 2000). During the last two decades, fiscal austerity placed a new emphasis on fiscal policies, in particular regarding the efficiency of government ex-penditures, and the sustainability of fiscal policies in terms of the future financing of public debt.

In times of cutting public expenditure and reducing the size of the public sector, it has also been questioned whether fiscal federalism and fiscal decentralization may lead to a more efficient public provision of goods and services, ultimately contributing to a reduction (of the growth) of the public sector.

The aim and motivation of this paper is to explore the influence of fiscal decentralization on the size of the public sector measured by the (nominal) ratio of total government expenditure to GDP, taking a base-line model specification from the Austrian fiscal policy lit-erature, and testing the hypothesis of the efficiency of decentralization by taking the Austrian economy and fiscal system as a case-study. We explore these hy-potheses by applying a number of empirical approaches such as stationarity and co-integration tests, and then estimate structural models with the aim to explain the growth of government expenditure in Austria over time (for the period of 1955 to 2007).

With the approach chosen, the paper contributes in general to the literature by providing a case study on a single country for a sufficiently long period. In particu-lar, the study adds to the ongoing public debate (e.g. Kramer, 2004) on the effects of fiscal decentralization on public sector growth by emphasizing the specifics of the Austrian system.1 In short, we find some efficiency effects of fiscal decentralization regarding public sector growth but argue that these are due to specific Austrian regulations especially regarding the use of grants. …

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