Who absorbs the shock? An analysis of the fiscal impact of the COVID-19 crisis on different levels of government

Abstract

This paper discusses the fiscal impact of the COVID-19 crisis across levels of government. It contrasts the composition of revenues and expenditures of different levels of government and their main institutional differences. For revenues, an error correction model is used to estimate the short-term elasticities of different levels of government, showing that subnational governments’ (SNGs) revenues are less sensitive to economic downturns than central governments’, mostly because SNGs tend to rely more on recurrent taxes on immovable property. For expenditures, central governments are often responsible for the bulk of expenditure on social protection, while SNGs have a higher investment-to-revenue ratio. The combination of these differences of expenditure assignment with the substantial budget and borrowing constraints that SNGs face creates a tendency towards pro-cyclicality at the subnational level and counter-cyclicality at the central level. Furthermore, in the context of the COVID-19 crisis, in order for SNGs to have the fiscal capacity for necessary measures to tackle the outbreak, central governments supported SNGs mostly through intergovernmental grants. As a consequence, central governments have absorbed most of the shock.