A Soft Budget Constraint Problem in Korean Local Public Finance

The mechanism that causes a soft budget constraint problem in Korea is different from the usual case in local public finance. The usual case of soft budget constraint occurs at the case that central government bailouts local governments when they issue local bonds to increase their expenditure ex ante. The share of local bonds in Korean local revenues appears very low. The paper tries to inquire a soft budget constraint problem in this situation of Korea. In Korea, there is a particular mechanism that the carry-over not used that year includes huge amounts of grants as one item of non-tax revenue. Local governments can give pressure to central government through the use of the part of carry-over for next-periods in advance. Even though central government resists the use of the part of next year’s carry-over for next-periods ex ante, once local governments spend it this year central government cannot but bailout local government next year or ex post. It can be claimed that this mechanism has caused a soft budget constraints problem in Korea. In order to make clear this mechanism, the paper applies Goodspeed(2002)’s model to the case of Korea and estimates significant factors on local public finance.