Tightening Balanced Budget Rules in the European Union: A Multi-Level Re-Sponse to the Financial Crisis

In the sovereign debt crisis (since 2010), European governments rushed to regain market confidence by establishing new fiscal institutions such as strict balanced budget rules. On the EU-level, according to the fiscal compact, member states committed to introduce more rigorous national balanced budget rules. In federal states, the federal government typically has to seek the approval of the constituent units to implement complementary fiscal rules to ensure effective fiscal governance. In Germany, subnational governments decided to adopt strict balanced budget rules to strengthen the credibility of the national rule. We develop an index to measure the strictness of these balanced budget rules across different tiers of government and find substantial variation on both the national and subnational level. Based on a cross-sectional regression analysis, we examine to which degree the differences across member states can be explained by economic factors, covering the fiscal sustainability and the exposure to the financial crisis, as well as political factors such as party effects, government stability and the position in equalization schemes. We then test if these factors also explain the differences between German Länder and thus whether national and subnational fiscal governance follow the same logic. While the effects of balanced budget rules on the sustainability of public finance have been extensively studied, we wish to contribute to the less advanced and less theorized debate on the determinants that lead to the introduction of strict balanced budget rules in the first place.