Public Debt in a Federal State: Warnings From Belgium

Abstract

This paper examines the dynamics of public debt in a fiscal federation, with a focus on Belgium from 1970 onwards. Lately, the institutions responsible for monitoring Belgium's fiscal situation have been issuing increasingly alarming alerts regarding the sustainability of the current budget deficits. We show that Belgium has experienced a cycle of high public debt and claim that the explanation for this phenomenon lies in the interplay between the different political or geographical entities in the federation. We examine whether the different entities exhibit free-riding behavior in public debt creation and find significant fiscal imbalances both at the federal level and at the subcentral level. Multiple political and constitutional mechanisms are identified as potential drivers. Furthermore, the paper presents and discusses several policy options for breaking the cycle of high public debt: a new state reform, fiscal rules, a no-bailout clause, and an insolvency framework.