The Fiscal Common Pool Problem, Municipal Mergers, and Spillovers

Mergers of local governments, commonly referred to as municipal mergers, have been widely implemented to internalize spillover effects. Many empirical studies point out that municipalities change the intertemporal budget allocation by increasing their debt issuance before mergers and they consider that this debt issuance is induced by the “fiscal common pool problem” because of pooled budgets after mergers. However, this phenomenon has yet to be analyzed theoretically. Therefore, this paper examines the mechanism of increased debt issuance before municipal mergers. We compare the debt issuance in the merger case with the level in the socially optimal and nonmerger cases. We find that the amount of debt issuance is larger in the merger case than in both other cases. The difference vanishes when spillovers are perfect.