Fiscal Rules, Decentralization and Public Finances: Making Sense of Balanced Budget Requirements for Sub-National Governments

This paper reviews the debate over fiscal rules and specifically balanced-budget requirements with regards to sub-national (state/regional) government. It will be argued that fiscal rules, if properly designed, can play an important role in balancing the relations between central and sub-national governments and build a healthy system of public finances in the long-run. Fiscal rules are required to limit the subsidiarity challenge that decentralizing governments face: How can they balance the need for locally delivered public services with a fair and sufficient financial endowment while at the same time incentivizing sub-national governments not to overspent their general resources? This paper analyzes global experiences with some of the strictest forms of fiscal policy rules - i.e. balanced-budget requirements (BBR). It will discuss and illustrate their relevance in the context of three major Asian economies with very different fiscal positions - China, India and Indonesia - but similar demands or requirements for the decentralization of public services due to their vast populations and geographical size.