Abstract

The paper analyses the interaction between the fiscal rules applying to European Union member states and the fiscal decentralisation process, which has gained momentum in some European countries since the early 1990s. Three critical areas are identified. First, while compliance with European rules depends on the behaviour of all levels of government, it is the central government that is held accountable; this asymmetry increases the need for rules applying to lower government tiers. Second, European rules demand that the overall budget (both current and capital) be balanced over the medium term; applying this rule at the subnational level may unduly reduce capital outlays. Third, European rules allow for margins to deal with the budgetary effects of the economic cycle; replicating this feature at the subnational level may prove difficult. The paper examines the solutions available in principle to deal with these problems and compares them with those actually adopted by five European countries. It is argued that since European rules call for clear accountability and rapid adjustments, the introduction of explicit domestic rules may have marked advantages over purely co-operative mechanisms. However, the strengthening of consensus-based institutions and procedures has so far been privileged in the countries examined. While cooperation has proved effective in terms of deficit reduction, it may be sub-optimal in terms of the allocation of resources and it may not withstand stress-testing in terms of both economic and institutional developments.