Tax autonomy mitigates soft budget constraint: evidence from Spanish Regions

Abstract

Abstract Within the framework of the soft budget constraint problem, this article investigates the impact of a legislative reform that increased regional tax autonomy on the propensity of Spanish regional governments to incur a deficit. For this purpose, a dynamic panel data model is estimated, using data for the period 1984–2019. The sample shows a breakpoint in 2002, when the reform of the regional financing system came into force, providing Spanish regions with greater tax autonomy, more fiscal competency, and lower intergovernmental transfers. Results show that the budget constraint has hardened, as regions have fewer incentives to accumulate budgetary deficits with the expectation of future compensations from the central government. A comprehensive review of the evolution of other factors previously identified as determinants of soft budget constraints, and the analysis of two regions not included in this financing system, suggest no other possible explanation for these results.