New Research: Revenue decentralization, central oversight and the political budget cycle: Evidence from Israel
The municipalities in Israel increase their budget deficits in election years, a phenomenon known as “election year economics”. The increase in the deficit reflects increased development expenditures.
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· The municipalities in Israel increase their budget deficits in election years, a phenomenon known as “election year economics”. The increase in the deficit reflects increased development expenditures.
· There are no signs that the municipalities increase their current expenses or reduce tax receipts during election years.
· The larger government transfer payments are as a share of municipal revenue, the stronger the tendency is to increase the deficit during election years, compared to other authorities with similar socioeconomic characteristics.
· Municipalities for which the Ministry of the Interior has appointed an external accountant do not increase their deficits during election years.
· In nonelection years, the municipalities reduce their per capita debt on average.
A study conducted by Adi Brender of the Bank of Israel’s Research Department, Yaniv Reingewertz of Haifa University, Thushyanthan Baskaran of the University of Siegen, and Sebastian Blesse of the University of Frankfurt and Deutsche Bundesbank examined the budgetary behavior of the municipalities in Israel during election years. The study, which was published in the European Journal of Political Economy and is now being published in Hebrew, focuses on the question of whether the extent of a municipality’s dependence on central government financing—controlling for characteristics of the municipality such as its socioeconomic standing, the unemployment rate among its residents, the size of its debt, and other factors—affects “election year economics” (the increase of the authority’s deficit during election years). In addition, the study examines the effect of external accountants, appointed by the Ministry of the Interior for municipalities that have managed their finances poorly, on the municipalities’ deficits and on the strength of election year economics in those municipalities.
The study found that the municipalities’ deficit, as measured by the annual change in per capita debt, increased markedly by a statistically significant rate in election years compared with non-election years. While during non-election years, per capita debt decreased by an average of about 2.5 percent, it increased by 2 percent during election years (Figure 1). The findings show that this increase in the deficit is not similar in all municipalities: The larger government transfer payments are as a share of municipal revenue, the stronger the expansion of the deficit is during election years (Figure 2). It was also found that in municipalities where there is an appointed external accountant, the election year economics phenomenon basically does not exist, with no signs of an increase in the deficit during election years even if a significant proportion of the municipality’s revenue is financed by the central government.
An examination of the components of the change in the municipalities’ deficit during election years shows that the increase is focused on the authorities’ development expenditures, and that there is no significant change in current expenditures or in revenue—from municipal tax or other sources. This finding is in line with previous findings that voters in municipal elections in Israel “punish” mayors who increase their deficits during election years, but are more forgiving when the increase is focused on the development budget.
The results indicate that when municipalities rely strongly on locally raised revenue, they demonstrate budgetary responsibility, since both local politicians and voters are aware that accumulating deficits will eventually be reflected in a higher tax burden on the residents in order to repay the accumulated debts. In contrast, politicians and voters in municipalities that rely on central transfers may reasonably expect that some of the accumulated debt burden will be borne by the central government—meaning the general population that does not live in that municipality (the fiscal commons). In such municipalities, the mechanism of appointing an external accountant is an effective tool for reining in the excessive budgetary behavior.