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Richard Eccleston, Richard Krever and Helen Smith

This chapter establishes the conceptual and theoretical foundations for the ensuing volume. It summarizes the debates concerning the key features of federal governance before providing an overview of the existing explanations of change in federal systems, with a particular emphasis on the application of new institutionalism to explanations of ‘federal dynamics’. The second section of the chapter focuses on the literature on the impact of financial and economic crises of federal governance before providing an empirical account of the economic impact of the 2008–9 financial crisis on the 12 cases included within the volume. The chapter concludes by outlining how an actor-centred institutionalism is applied to the case studies that follow.

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Paul L. Posner and Timothy J. Conlan

The Great Recession brought significant fiscal consequences for all levels of government in the United States. The federal deficit grew to record proportions as a share of gross domestic product (GDP) during peacetime, while states and localities experienced the deepest fiscal crises in the post-war era. State and local fiscal responses were predictably pro-cyclical, exacerbating subnational economic downturns through budget cuts and tax increases. The national government, on the other hand, responded by undertaking an economic stimulus program of over 5 percent of GDP, much of which was delivered through the state and local sector, which helped mitigate the worst effects of the downturn for several years. However, after several years of stimulus, the federal fiscal pump was reversed, as polarized conservative leaders captured the agenda by forcing the Obama Administration to cut the deficit through a ten-year spending reduction plan. The cyclical fiscal effects of the financial crisis were more than just temporary in nature, as they interacted with underlying structural fiscal deficits and longer-term pressures in many states and local governments. Large cities and counties, such as Detroit and San Bernadino, slipped into bankruptcy, as the recession proved to be the last act in a decades-long erosion of fiscal capacity and economic wealth. States were forced to be bankers of last resort, saddled with tackling their own fiscal imbalances as well as stepping in to rescue cities that went over the fiscal cliff. Notwithstanding significant improvements in the national economy and reductions in the deficit from 10 to 3 percent of GDP, the federal government was missing in action, hamstrung by gridlock and gripped by record polarization between the two parties. The shifting and volatile fiscal fortunes of the US intergovernmental system reflects the weak institutionalization of intergovernmental fiscal collaboration at the national level. A near-record federal stimulus that modeled the best thinking in public finance was quickly followed by federal indifference and passivity in the face of major fiscal pressures experienced by many subnational governments. The institutions of fiscal collaboration that had emerged during the era of cooperative federalism in the 1960s had largely disappeared by the 1990s. Fundamental political incentives that formerly provided incentives for bargaining and collaboration across levels of government collapsed in the wake of the nationalization and centralization of political parties and the centralization of media and interest groups. In its wake, federal intergovernmental policy-making became less systematic and more opportunistic – collaborative when, and only when, national officials perceived it to be in their interest to engage state and local capabilities. Going forward, all levels of government will be struggling with the fiscal implications of an ageing society and rising health-care costs. Whether it be rising Medicare costs at the federal level or employee pensions in state and local governments, all levels of government will be faced with paying for the elderly and their doctors from a slower growing economy featuring fewer workers. In the past several years alone, pension and health entitlements and revenue slippage are crowding out other priorities, such as education and infrastructure, at all levels of government. With common fiscal challenges, intergovernmental fiscal challenges are optimally addressed through fiscal collaboration. While some vertical fiscal equity is achieved through federal grants to states for health care, the United States has little tax sharing or fiscal equalization commonly found in other federal systems. The question facing the United States is whether and how it will step up to fashion truly intergovernmental fiscal solutions to long-term fiscal challenges that pervade public finances at all levels of government.

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Douglas M. Brown

This chapter provides an overview of the distinctive features of Canadian federalism before outlining the impact of the 2008–9 financial crisis on the Canadian economy and federalism. The chapter documents the high levels of intergovernmental cooperation in relation to the national stimulus programme that followed the crisis, confounding those who argue that high levels of decentralization in the Canadian federation hinder national policy coordination. The chapter argues that federalism in Canada can be characterized more by continuity than change in the years following the crisis, while noting that mounting fiscal pressures have the potential to contribute to intergovernmental conflict.

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Richard Eccleston and Richard Krever

This chapter provides an overview of the origins, evolution and structure of the Australian federation before describing the impact of the 2008–9 financial crisis on both the national economy and on intergovernmental relations. It argues that while Australia was not adversely affected by the crisis and its immediate aftermath owing to an effective stimulus program and the benefits of an unprecedented resources boom, mounting budget pressures are putting Australia’s highly centralized federal financial system under political pressure. The chapter suggests that in the absence of reform the Australian states are especially vulnerable to declining grants from the federal government. Despite these mounting fiscal pressures the federalism reform process launched in 2014 has been abandoned and there is little political enthusiasm for reform.

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Simon Lee

This chapter provides an analysis of the changing nature of intergovernmental relations in the UK in light of its unique historical and constitutional context as a ‘state-nation’, of which England is overwhelmingly the largest component. England may have become more economically dominant within the union owing to London’s important role as a global financial centre, yet politically the City of London was also a cause of the financial crisis of 2008–9. While fiscal policy is determined centrally, ongoing devolutionary reforms have conferred some budgetary independence on Scotland, Wales and Northern Ireland, and fiscal equalization under the ‘Barnett formula’ is now generating political controversy amid long-lasting economic austerity policies in the aftermath of the financial crisis. The greater level of fiscal federalism being created in the longer term will pose increasing political challenges for the devolved administrations, and the prospects of the constituent nations of the UK holding together.

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Jan Schnellenbach

Germany has been only mildly affected by the shock of the 2008–9 financial crisis and this chapter argues that Germany’s economic circumstances were quite different from many other federal countries included within the volume. The fiscal crisis has, however, occurred in a period where intergovernmental relations within Germany have already been very much in flux and, as this chapter argues, has altered the likely trajectory of federal reform in Germany. This analysis highlights how the interaction of actors, existing institutions and changing economic conditions influence change in federal systems. While negotiations relating to intergovernmental reform in Germany are ongoing ahead of the expiration of the existing regime for federal funding in 2019, the analysis presented in this chapter provides insights into both points of contention in this debate and the likely future direction of federalism reform. Reform of the German federation was on the political agenda on the eve of the financial crisis. The so-called Federalism Reform I that had come into effect in 2006 featured a cautious decentralization agenda. More significantly, however, negotiations had started for the so-called Federalism Reform II, which focused on federal fiscal relations. The most significant element of the second reform package, which was influenced by the prevailing financial crisis and passed in August 2009, was the introduction of constitutional debt limits for central and subcentral governments. The original goal of engineering a thorough reorganization of fiscal relations has, however, not been achieved. This issue has been lingering ever since, but has gained increasing attention more recently. The current system of fiscal transfers will expire at the end of 2019, and the negotiations for a new system have drawn some attention to more fundamental questions of Germany’s federal fiscal constitution.

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Nils Soguel

This chapter presents the way the Swiss cantons were impacted by the 2008–9 financial crisis and its aftermath, and the way the cantons reacted. The Federal Constitution of the Swiss Confederation provides that ‘the Confederation [central government], the Cantons [subcentral governments] and the Communes [local governments] shall take account of the economic situation in their revenue and expenditure policies (Art.100, al.4)’. Simultaneously, it stipulates that the ‘Cantons are sovereign except to the extent that their sovereignty is limited by the Federal Constitution’ (Art.3). Thus the cantons benefit from far-reaching political, financial and fiscal autonomy. In the past and despite the provision of Art.100, most of them have made use of this autonomy to engage in pro-cyclical fiscal policies. The pro-cyclical behaviour stems from a culture of rather conservative fiscal policy. This culture has indeed been transposed by individual cantons into their own legislation governing their public finance. Most have chosen to legally cap the deficit or even ban that possibility – often referred to as budget constraints – regardless of the macroeconomic conditions. This particular institutional setting points towards the difficulty to conduct a consistent macroeconomic policy not only between the different tiers of government, but also between the fiscal and the monetary policies. The financial crisis hit Switzerland in a rather indirect way. The negative performance of the banking sector affected the corporate tax paid by the banks. However, the economic crisis that followed was limited to a downturn in 2009 caused by a fall in the aggregate demand originated from the European Union (EU) and also by a fall in investments. With a low level of unemployment, Switzerland was in a relatively favourable position. Further, during the years prior to the crisis and thanks to the noticeable economic expansion, the cantons (and the central government) massively improved their financial position compared to the situation that had prevailed in the 1990s. The level of debt was strongly reduced. Despite the rather satisfactory internal macroeconomic circumstances, the alarming European and international situation elicited lively reactions and concerns among journalists, politicians, firms and the population. This added to the prevailing uncertainty regarding future development and prompted the federal (central) government to take discretionary fiscal measures. The effort was, however, rather moderate. Like in other small and open economies, the internal benefit of the measures (that is, the stimulus that does not dissipate in imports) was considered to be rather small compared to the fiscal cost of the measures (debt increase). Thus, most small countries, including Switzerland, relied instead on the economic recovery plans of their trading partners. Given the poor historical records of the cantons regarding vertical (with the Confederation) and horizontal (with other cantons) coordination, one could doubt that the cantons would contribute to the central government’s effort. To avoid this situation, the federal government relied on financial stimulus channelled through cantonal budgets. These federal transfers helped the cantons to finance mainly infrastructure maintenance and building works. The additional public expenditure of the three layers of government are estimated to total 0.7 per cent of 2009 and 2010 gross domestic product (GDP), among which more than 50 per cent came from subnational and local budgets. In this sense the effort was modest. The vertical coordination somehow worked and prevented cantons from excessive free riding. However, the horizontal coordination was less successful. The cantons failed to deploy such a collaborative solution. Only the French- and Italian-speaking cantons engaged in a dialogue; the German speaking cantons did not really. Additionally, no true vertical coordination took place within individual cantons between the canton and the municipalities. The favourable fiscal position situation allowed the cantons to participate in the counter-cyclical stance without breaking their own budget constraint. Actually some cantons even strengthened the constraint in the meantime. Simultaneously, the tax competition spread between cantons fuelled by the previous cyclical fiscal surpluses. This competition has weakened the fiscal structural balance of the cantons. A weakened fiscal structural balance, together with more stringent budget constraint, will increase the difficulties of coordinating the fiscal policy during any future recession. Unlike the central government’s budget constraint, none of the cantonal budget constraint includes a mechanism that mechanically allows some deficit in case of a negative output gap while requiring a surplus in case of a positive output gap. Given the cantonal autonomy provided by the Swiss Constitution and the lack of coordination, some degree of conditionality of the budget constraint with regards to macroeconomic conditions would be a necessary condition if cantons want to avoid appearing as free riders during the next economic downturn.

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César Colino and Eloísa del Pino

While some of the literature on the Spanish system had repeatedly pointed out several centralizing trends and mechanisms within the territorial model, not much of it had been able to show convincingly any formal shift of authority towards the centre in the last decades against the backdrop of clear decentralizing tendencies in powers and resources and increasing regional policy-discretion for most sectors of public activity. Also in the wake of the first stage of the 2008–9 financial crisis, the stimulus phase, little formal change and shift of authority was observed, since the central government had plenty of constitutionally entrenched financial and regulatory powers to deal with it and regions largely supported centrally managed stimulus measures. During the second phase of the crisis, however, we are increasingly observing that the policies of austerity have exposed the system to centralizing pressures that have been translated into some formal constitutional and statutory changes that are already having an impact on the autonomy of the autonomous communities (ACs) and on the type of distributive conflicts, which in turn has exacerbated some centrifugal tensions such as secessionism in Catalonia. Conflict between counter-cyclical measures of some regions and the centre has ensued, and demands for fiscal federalism reform increased. Through the combined effect of the international credit markets, the EU authorities’ demands for fiscal consolidation and the centralization measures of the central government in response, Spanish regions seem to be losing most of their financial autonomy and discretion and intergovernmental, fiscal and other relations seem to be transforming into a less cooperative model. Without changing the constitutional division of powers, the centralization of the system implied by these developments has affected the autonomy of elected regional governments and their accountability before their citizens, as well as the stability and legitimacy of the whole system. The chapter describes all these effects of the crisis, seeking to contribute to the growing comparative discussion on the effect of the current crisis on federal systems and fiscal federalism, their stability and fiscal sustainability and at the same time to contribute to the ongoing debate on the workings, effectiveness and the future of the Spanish Estado Auton—mico. Although Spanish federalism has been faced with several accommodation and efficiency challenges before, currently it has to deal with a combination of fiscal and political problems thus far unknown to it: stagnation and fiscal crisis, alongside increasing economic divergence among regions and the strengthening of traditional centrifugal forces in some ACs.

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Emanuele Massetti

This chapter first describes the historical process of the transition of the Italian state from its pre-1948 unitary form to the new Italian Republic’s asymmetrically regionalized system comprised of ‘special status’ and ‘ordinary status’ regions and strongly centralized finances and budgetary control. In the 1990s a transition commenced to a greater degree of federalism but the 2008–9 financial crisis and its severe impact on the Italian economy have jeopardized completion of the federalist reforms and financial devolution. Moreover, to the extent that regional financial autonomy has increased in response to the financial crisis, this has been seen as a product of cost shifting from the central level and has contributed to a backlash against the move to federalism overall. The future path of reform remains uncertain, in particular while EU-level institutions continue to develop and the EU follows its own structural reform path.