Intergovernmental Transfers as Determinants of Municipal Fiscal Sustainability: A Review of Theory and Empirical Evidence from Polish Municipalities

Abstract

Intergovernmental transfers play a crucial role in shaping the fiscal position of local governments, especially in countries where municipalities, such as those in Poland, exhibit a high dependence on central funding. Recent reforms and the increasing reliance on discretionary revenues transferred from the central budget have motivated a closer examination of how these instruments influence local fiscal sustainability. This article analyses how different types of transfers—general subsidies and targeted grants—affect the fiscal sustainability of Polish municipalities across several dimensions, including autonomy, solvency, efficiency and economic resilience. Using panel data, five sets of models test the crowding-out effect, developmental impact, pro-cyclicality, fiscal discipline, and fiscal replacement mechanisms. Results show that general subsidies crowd out local tax revenues, particularly in less developed municipalities, while targeted grants strengthen the tax base in rural areas. Transfers have mixed effects: targeted grants strongly stimulate investment and support local development but tend to increase debt; general subsidies weaken local tax capacity and reduce fiscal autonomy, although they improve short-term fiscal discipline. In municipalities with limited fiscal independence, transfers act as short-term compensatory tools, fostering dependence on state aid rather than self-reliance. A macroeconomic crowding-out effect also appears, as higher transfers reduce private sector resources. Regarding fiscal discipline, equalization and compensatory subsidies decrease debt levels, whereas targeted grants can raise debt in urban municipalities with co-financing obligations. General subsidies show fiscal replacement effects, substituting local revenue sources. The findings provide insights for designing transfer systems that balance financial support with incentives for local autonomy and sustainable development.