Coordination of Fiscal Consolidation in Federal States

Our paper looks at federal conflicts that emerge in the context of fiscal consolidation in eleven federal states (Argentina, Australia, Austria, Belgium, Brazil, Canada, India, Germany, Spain, Switzerland, United States), and the way in which the Global Financial Crisis has intensified them. Furthermore, we identify mechanisms of coordination that are used in order to manage these conflicts. All federations in our sample have introduced domestic fiscal rules or are required to comply with supranational ones. This has triggered conflicts between federal governments and subnational governments or between subnational governments themselves. In some cases, social solidarity was questioned for the sake of consolidation. In others, highly indebted subnational governments claimed that they were not able to consolidate on their own, requesting union fellows or the federal government to provide financial assistance. We find that financial compensations provided by the federal government are important mechanisms to manage federal conflicts in federations with an integrated fiscal constitution where bargaining is the main coordination mode. This finding holds true even if the federal government applies mechanisms of hierarchical control in order to make constituent units cooperate. If an external enforcer such as the European Union is present, the federal government has a particular interest in ensuring that subnational governments consolidate their budgets. This is because the federal government presents the federation towards the supranational authorities and has to bear or distribute sanctions. In the case of dual fiscal constitutions, market discipline is the predominant mode of coordination. In both systems, the existence of independent institutions in charge of coordination of fiscal policy fosters cooperation and compliance to fiscal rules. Drawing on Bednar’s concept of federal safeguards, our findings enable us to draw conclusions on robustness or rigidity of the federal systems we study.