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The workings of fiscal federalism are an important concern in Latin American policy circles. Many discussions center on the tension between the proclaimed virtues of decentralization and the threat of macroeconomic mismanagement.¹ The most common recommendation arising from these discussions is for the decentralization of microeconomic management combined with the centralization of or fiscal rules for macroeconomic management. We believe such conventional wisdom to be too simplistic. The macro- and microeconomic issues are too intertwined and the historic political legacies too strong for simple, universal recipes to have any bite. We therefore argue for a more nuanced approach, using fiscal federalism in Argentina as our case.

All specialists on the subject consider Argentine fiscal federalism to be very inefficient.² The country's tax allocation and spending authorities and its system of intergovernmental transfers do not correspond to any economic criteria, and they provide all sorts of perverse incentives and obstacles for sound economic policies. In this paper, we examine the many inefficient features of Argentine fiscal federalism by applying and expanding an approach developed by Spiller and Tommasi, who view public policies as the outcome of political transactions.³ They argue that the nature and characteristics of the observed policies are conditioned by the rules of the political game under which those transactions are made. Hence, policy recommendations should be aimed not at the level of policy reform, but rather at the level of institutional reform, with emphasis on political institutions.

Our approach diverges from the predominant discussions of fiscal federalism in Latin America. The literature tends either to ignore political economy considerations while providing economic recipes or to advocate policy rules (constraining subnational borrowing, for instance). Rules are often violated, however, and they are dominated by improvements in the governance structure of the federal policymaking process. To put it in terms of the political economy literature, we advocate a discussion of rules versus improved political governance.

It is worth noting that different countries might generate similar inefficiencies. Some of the problems of fiscal federalism in Argentina that we analyze in this paper are also found in Brazil and Colombia.⁴ A rich comparative analysis of several countries' institutions and outcomes is needed, but this endeavor first requires a detailed microanalytical understanding of the workings of the polities, which was beyond the time frame of this study. Also, the source and, most important, the solution to these problems might vary from case to case.

The paper is organized as follows. The next section summarizes some key features and deficiencies of the Argentine federal system. We then present a theory that explains the features of public policies as determined by the rules of the game under which actors engage in political transactions. The theory predicts that environments that do not facilitate cooperative intertemporal exchanges will generate policies that are fairly inefficient and awkward from an economic point of view. The paper then applies the theory to the characteristics of Argentine fiscal federalism. The following section provides some evidence to support the claim that the rules of the political game in Argentina do not facilitate efficient intertemporal exchanges. The final two sections present our specific recommendations for institutional and policy reform in Argentina and a more general recommendation on how to tackle reforms in federal fiscal finances.

Key Features of Fiscal Federalism in Argentina

This section presents several stylized facts regarding the workings of fiscal federalism in Argentina. We start with a background description of some basic institutional features, including the division of expenditure and tax responsibilities between the national and provincial jurisdictions, the resulting level of vertical fiscal imbalance, and how this imbalance has been addressed through intergovernmental transfers. We then briefly describe some provincial fiscal institutions, such as the existence of formal limits for provincial borrowing and the legal status of provincial state banks. This institutional description is followed by a look at the behavior of national and provincial finances in recent years. The evidence indicates that the fiscal relation across provincial governments and between them and the national authorities has been...