Fiscal Rules and Public Spending Efficiency

Abstract

Rising public debt and persistent fiscal imbalances have renewed interest in fiscal rules as key instruments of fiscal governance. While existing research largely focuses on their role in promoting fiscal discipline, less attention has been paid to whether fiscal rules are associated with the efficiency of public spending. This study examines the relationship between fiscal rule stringency and public spending efficiency using panel data for 35 OECD countries from 2006 to 2019. Employing fixed effects, dynamic panel estimators, and instrumental variable approaches, the analysis shows that stronger fiscal rules are positively and significantly associated with higher spending efficiency. The relationship is particularly pronounced during periods of fiscal deterioration and is strongest for expenditure-based rules. Overall, the findings indicate that fiscal rules operate not only as constraints on fiscal aggregates but also as institutional mechanisms that promote a more efficient use of public resources.

Keywords

fiscal rules public spending efficiency

Introduction

Persistent fiscal imbalances and the steady accumulation of public debt have heightened concerns about the sustainability and governance of public finances (Yared 2019). In response, fiscal rules have become central components of modern fiscal frameworks, designed to constrain deficits, debt, or expenditure growth through formal numerical targets (Davoodi et al. 2022; Kopits and Symansky 1998; Menguy 2024; Wyplosz 2012). By limiting discretionary expansion and reinforcing procedural discipline, such rules aim to enhance the credibility and predictability of fiscal policy. As of 2020, more than one hundred countries had adopted at least one type of fiscal rule (Brändle and Elsener 2024).

A substantial empirical literature documents that fiscal rules are associated with improved fiscal aggregates, including lower budget deficits and reduced debt accumulation (Badinger and Reuter 2017; Fatás and Mihov 2006; Grembi, Nannicini, and Troiano 2016; Potrafke 2025; Vinturis 2023). Yet fiscal sustainability cannot be assessed solely through aggregate outcomes. The long-run performance of public finances also depends on how efficiently governments transform limited fiscal resources into public services and policy outcomes. This shifts the analytical focus from fiscal discipline to fiscal performance quality. Public spending efficiency is defined here in a technical sense as the ability of governments to convert fiscal inputs into measurable outputs; governments are more efficient when they deliver equivalent services with fewer resources or achieve greater output given the same inputs.

Over the past two decades, research on public spending efficiency has expanded considerably. Using frontier methodologies such as Data Envelopment Analysis and Stochastic Frontier Analysis (Adam, Delis, and Kammas 2011; Dutu and Sicari 2020; Herrera and Pang 2005), scholars have constructed cross-country indicators that evaluate how public expenditures translate into observable outcomes (Afonso, Jalles, and Venâncio 2023; Afonso, Schuknecht, and Tanzi 2005, 2010; Antonelli and de Bonis 2019; Gupta and Verhoeven 2001; Hauner and Kyobe 2010; Montes, Bastos, and de Oliveira 2019). Despite these advances, the institutional determinants of cross-country variation in spending efficiency remain insufficiently understood.

A growing literature recently examines whether fiscal reforms and institutional constraints influence efficiency, with mixed findings (Afonso and Alves 2023a, 2023b; Apeti, Bambe, and Combes 2025; Christl, Köppl-Turyna, and Kucsera 2020). Fiscal rules may curb wasteful spending and improve resource allocation, yet rigid or poorly designed rules may reduce administrative flexibility and hinder effective policy implementation. Whether fiscal rules enhance or constrain public spending efficiency therefore remains an open empirical question.

This paper addresses this gap by examining whether the stringency and composition of fiscal rule frameworks are systematically associated with public spending efficiency in OECD countries. Using panel data for 35 OECD economies from 2006 to 2019 and established efficiency indicators (Afonso, Jalles, and Venâncio 2023, 2024), the analysis evaluates whether stronger fiscal institutions correspond to more efficient use of public resources. The empirical strategy combines fixed effects, dynamic panel estimators, and instrumental variable techniques to address persistence and potential endogeneity. It further distinguishes between different fiscal conditions and among expenditure, revenue, balanced budget, and debt rules in order to assess environmental and institutional heterogeneity.

By shifting attention from fiscal aggregates to the quality of fiscal performance, this study advances the literature on the relationship between fiscal institutions and public expenditure in several respects. It integrates the fiscal rule literature with the efficiency frontier framework, thereby extending the analysis of fiscal governance beyond aggregate budgetary outcomes. Moreover, it emphasizes institutional stringency rather than mere rule presence, while accounting for rule-type heterogeneity and variation across fiscal conditions. These contributions can clarify whether fiscal rules operate solely as instruments of fiscal restraint or also as institutional arrangements associated with improved public spending efficiency.¹

The remainder of the paper is organized as follows. Section 2 explains the theoretical foundations. Section 3 describes the data and empirical strategy. Section 4 presents the empirical findings. Section 5 concludes.

Theoretical Foundations

The relationship between fiscal rules and public spending efficiency can be framed within a behavioral and institutional theory of fiscal governance. While fiscal rules are formally designed to constrain aggregate fiscal variables, their broader relevance lies in how they reshape incentives within the budgetary process. Institutional constraints do not operate mechanically; rather, they interact with the behavior of political and administrative actors. Whether such constraints enhance technical spending efficiency depends on how institutional design modifies the strategic environment in which fiscal decisions are made.

A long-standing literature in public finance and public choice identifies several structural and behavioral sources of persistent inefficiency in public expenditure. One structural mechanism relates to the scale and complexity of government. Wagner (1890) observed that public expenditure tends to grow more rapidly than national income as economies develop, reflecting the expanding scope of state functions. As the public sector enlarges, coordination costs and administrative complexity increase. Buchanan and Tullock (1962) further argue that collective decision-making becomes increasingly costly as the number of participants and the scope of government expand. Beyond a certain threshold, government growth may therefore generate diseconomies of scale, undermining administrative efficiency rather than improving it.

Structural inefficiency may also arise from productivity differentials across sectors. Baumol and Bowen (1966) demonstrate that labor-intensive public services, such as education and health care, exhibit slower productivity growth because technological progress diffuses less effectively in these sectors. As wages in public services track private-sector wage growth despite limited productivity gains, unit costs rise over time. This cost disease increases the relative weight of low-productivity expenditures and may structurally weaken fiscal efficiency. Recent evidence confirms the persistence of this productivity gap and the continued slowdown in public-sector productivity growth (Duernecker, Herrendorf, and Valentinyi 2024).

Information asymmetries further exacerbate inefficiency in large fiscal systems. The concept of fiscal illusion (Buchanan and Wagner 1977; Puviani 1897) suggests that when citizens underestimate the true cost of public spending, governments face weaker electoral discipline. Obscured tax burdens reduce voter oversight and enable expenditure expansion without commensurate accountability. As government scale increases, monitoring becomes more complex, reinforcing informational distortions and weakening allocative discipline.

These structural and informational conditions create an environment in which political and bureaucratic incentives may diverge from social welfare. Public choice theory emphasizes that policymakers and administrators may pursue self-interested objectives that generate expansionary bias and allocative distortions. Bureaucratic budget-maximization models (Migué and Bélanger 1974; Niskanen 1971) posit that agencies seek larger budgets or discretionary authority. Political budget cycle models (Nordhaus 1975) suggest that electoral incentives induce short-term fiscal manipulation. Brennan and Buchanan (1980) conceptualize the state as a Leviathan that expands revenue and authority in the absence of institutional constraints. Collectively, this literature implies that absent binding constraints, the interaction of structural complexity and self-interested behavior may systematically erode spending efficiency.

Institutional features of the budget process itself may further entrench inefficiency. Incremental budgeting (Lindblom 1959; Wildavsky 1964) generates baseline inertia by anchoring current allocations to past expenditures. The interpretation of the budget as a fiscal commons (Weingast, Shepsle, and Johnsen 1981) highlights the tendency of multiple stakeholders to extract benefits from a shared resource, leading to overexpansion. Organizational slack (Cyert and March 1963) allows agencies to embed excess resources within budgets. Soft budget constraints (Kornai 1986) and the flypaper effect in intergovernmental transfers (Hines and Thaler 1995) further reduce discipline and adaptability. These institutional characteristics amplify the inefficiencies associated with government expansion and weak accountability.

Within this theoretical landscape, fiscal rules can be interpreted as institutional responses to structural and behavioral distortions. By imposing explicit numerical limits on deficits, debt, or expenditure growth (Davoodi et al. 2022; Kopits and Symansky 1998; Wyplosz 2012), fiscal rules alter the opportunity set available to policymakers. Binding constraints increase the marginal cost of additional spending and intensify competition among programs and budget stakeholders. When fiscal scope is limited, low-productivity or redundant activities are more likely to be scrutinized, potentially encouraging reallocation toward higher-value uses (Alesina and Perotti 1996; Barro 1990). Rule-based frameworks may also enhance transparency and procedural discipline, mitigating informational asymmetries and reducing discretionary manipulation (Wyplosz 2012). The combination of ex ante quantitative constraints and ex post monitoring mechanisms thus embeds efficiency considerations into the fiscal process.

At the same time, the theoretical implications of fiscal rules for spending efficiency are not unambiguously positive. Rigid or poorly designed rules may constrain administrative flexibility, induce short-term compliance-oriented adjustments, or shift inefficiencies across expenditure categories (Pathak 2023). Reverse causality also cannot be ruled out: governments with stronger administrative capacity or higher baseline efficiency may be more likely to adopt and credibly enforce fiscal rules. The net effect therefore depends on how institutional design interacts with behavioral responses.

Recent empirical studies reflect this ambiguity (Afonso and Alves 2023a, 2023b; Apeti, Bambe, and Combes 2025; Christl, Köppl-Turyna, and Kucsera 2020; López-Herrera et al. 2023; Vinturis 2023). The evidence points to heterogeneous effects, indicating that rule design, enforcement credibility, and institutional context condition the relationship between fiscal rules and spending performance.

In sum, fiscal expansion may weaken efficiency through structural and incentive-based channels, whereas fiscal rules may mitigate these distortions by altering the constraints under which fiscal decisions are made. However, their effects remain conditional on institutional and environmental contexts. Whether stronger fiscal rule frameworks systematically improve technical public spending efficiency therefore remains an empirical question.

Methods

Data and Variables

The empirical analysis draws on a panel dataset comprising 35 OECD countries over the period 2006 to 2019.²

The dependent variable is public spending efficiency, measured using three indicators—PSE0, PSE1, and PSE2—constructed by Afonso, Jalles, and Venâncio (2024) through a nonparametric Data Envelopment Analysis framework. It assesses the relative efficiency of decision-making units by determining the maximum proportional reduction in inputs that can be achieved while maintaining observed output levels. This study applies an input-oriented specification under variable returns to scale, which accommodates differences in economic size and production technology across countries. The input orientation is particularly appropriate in the context of this study because fiscal rules primarily constrain expenditure growth and thus encourage the reallocation or restructuring of existing spending rather than an expansion of total fiscal outlays (Afonso and Alves 2023a, 2023b). The resulting efficiency scores represent the potential percentage reduction in public spending consistent with current levels of public service provision. Scores range from zero to one, where unity denotes full efficiency on the frontier and lower values indicate varying degrees of inefficiency.

Outputs in the Data Envelopment Analysis (DEA) model are summarized by a composite public sector performance index. This index integrates two dimensions of public outcomes: opportunity indicators and Musgravian indicators. Opportunity indicators capture the quality of government administration, education, health, and infrastructure, while Musgravian indicators reflect redistribution, macroeconomic stabilization, and economic performance.³ All variables are standardized within countries and aggregated by simple averaging to construct the composite public sector performance index. The input variable is total public expenditure, measured as a share of GDP.

The three efficiency indicators—PSE0, PSE1, and PSE2—represent different model specifications. PSE0 uses total public expenditure as a single input and the overall public sector performance index as a single output, providing a general measure of efficiency. PSE1 distinguishes between opportunity-related and Musgravian-related expenditures as separate inputs, while using total public sector performance as the output. PSE2 uses total expenditure as a single input and divides the outputs into opportunity public sector performance and Musgravian public sector performance, thereby capturing efficiency across functional performance dimensions. Across these models, the average efficiency scores range from approximately 0.6 to 0.7, implying that OECD governments could, on average, reduce spending by about 30 to 40 percent while maintaining existing levels of public service provision. Countries identified as fully efficient include Australia, Ireland, New Zealand, the Republic of Korea, and Switzerland.

The principal explanatory variable captures the institutional implementation of national-level fiscal rules. Because fiscal rules regulate fiscal policy through multiple instruments and across different institutional dimensions, constructing a single unified numerical index is not straightforward. To avoid relying on an ad hoc measure, this study follows established approaches in the literature, particularly those of Gootjes and de Haan (2022) and Jung and Kim (2021), and constructs a composite fiscal rule index using the data provided by Davoodi et al. (2022).

The index is designed to reflect both the institutional depth and the complexity of fiscal rule frameworks, taking into account substantial cross-country heterogeneity in design and enforcement. Each of the four major types of fiscal rules—expenditure rules (ER), budget balance rules (BBR), revenue rules (RR), and debt rules (DR)—is evaluated along five institutional dimensions: (1) coverage, defined as the scope of government entities subject to the rule; (2) legal basis, referring to the statutory authority underpinning the rule; (3) supporting procedures, which include operational mechanisms such as expenditure ceilings or independent monitoring bodies; (4) enforcement mechanisms, indicating the presence and strength of sanctions or oversight arrangements; and (5) flexibility, referring to whether the rule permits temporary deviations under exceptional circumstances, such as economic crises.

Each dimension is normalized on a scale from zero to one, equally weighted, and standardized such that higher values indicate stronger institutional design. For each rule type, the rule-specific score is defined as follows:

\begin{aligned} Fiscal Rul e_{i} & = Coverage + Legal Basis + Supporting Procedures \\ + Enforcement Mechanisms + Flexibility, \\ i \in {BBR, ER, DR, RR} \end{aligned}

The composite fiscal rule index is then calculated as the arithmetic mean of the four rule-specific scores:⁴

Fiscal Rule Index = mean (Fiscal Rul e_{i})

Higher values of the index reflect more comprehensive and robust fiscal governance frameworks.

Following established empirical literature, several time-varying control variables are included to account for demographic, economic, political, and institutional factors that may influence both fiscal rules and spending efficiency. These variables include total population and working-age population (demographic factors), GDP per capita (economic development), the electoral democracy index (political institutions), trade dependence and capital account openness (international openness), government deficit and government debt as shares of GDP (fiscal position), the governance index (institutional quality), and the pre-tax Gini coefficient (income inequality).⁵

Table 1 presents descriptive statistics for the main variables. The sample covers 35 OECD countries observed over 14 years, yielding 490 country-year observations. The average values of the public spending efficiency measures are 0.615 for PSE0, 0.675 for PSE1, and 0.653 for PSE2, indicating that most OECD governments operate at relatively high efficiency levels. The mean fiscal rule index is 0.348 with a standard deviation of 0.194, ranging from 0.000 to 0.705, revealing notable cross-country variation in fiscal governance strength. Among the subcomponents, the balanced budget rule records the highest mean value (0.520), whereas the revenue rule records the lowest (0.142), suggesting that fiscal discipline tends to be stronger on the expenditure and debt sides than on the revenue side.

Table 1.

Descriptive Statistics.

Variable	Mean	SD	Min	Max	Source and Description
Public Spending Efficiency 0	0.615	0.155	0.390	1.000	Afonso, Jalles, and Venâncio (2024)
Public Spending Efficiency 1	0.675	0.139	0.460	1.000	Afonso, Jalles, and Venâncio (2024)
Public Spending Efficiency 2	0.653	0.152	0.440	1.000	Afonso, Jalles, and Venâncio (2024)
Fiscal Rule Index	0.348	0.194	0.000	0.705	Davoodi et al. (2022), author calculated
Fiscal Rule_Expenditure Rule	0.317	0.257	0.000	0.825	Davoodi et al. (2022), author calculated
Fiscal Rule_Revenue Rule	0.142	0.137	0.000	0.644	Davoodi et al. (2022), author calculated
Fiscal Rule_Balanced Budget Rule	0.520	0.248	0.000	0.893	Davoodi et al. (2022), author calculated
Fiscal Rule_Debt Rule	0.411	0.270	0.000	0.853	Davoodi et al. (2022), author calculated
Fiscal Council	0.508	0.500	0.000	1.000	Davoodi et al. (2022)
Population	16.420	1.426	12.624	19.610	World Development Indicators, logged value
Working-age Population	66.508	2.473	58.648	73.271	World Development Indicators, % of total population
GDP per capita	10.335	0.636	8.238	11.548	World Development Indicators, logged value
Democracy	0.844	0.096	0.285	0.924	V-Dem, electoral democracy index
Trade Dependence	92.380	43.971	24.390	252.249	World Development Indicators, % of GDP
Capital Openness	0.895	0.205	0.163	1.000	Chinn-Ito index
Government Deficit	−2.061	4.291	−32.108	19.562	Müller et al. (2025), % of GDP
Government Debt	65.428	43.220	3.879	210.350	Müller et al. (2025), % of GDP
Governance	1.114	0.538	−0.495	1.883	Worldwide Governance Indicators, author calculated
Income inequality	0.481	0.079	0.374	0.762	World Inequality Database, Pre-tax Gini

Note: Total observations are 490 (35 countries x 14 years).

Empirical Design

The empirical analysis follows the approach of Afonso, Jalles, and Venâncio (2024) and is based on a two-way fixed effects (TWFE) specification as the baseline model. The estimation equation is expressed as follows:

Y_{ct} = β Fiscal Rul e_{ct - 1} + X_{ct} Γ + μ_{c} + λ_{t} + ϵ_{ct}

In this model, c denotes the country and t the year. The dependent variable, $Y_{ct}$ , represents public spending efficiency, measured by the three indicators PSE0, PSE1, and PSE2. The key explanatory variable, $Fiscal Rul e_{ct - 1}$ , is the one-period lag of the fiscal rule index, which captures the institutional presence and strength of national fiscal rules. A lagged specification is adopted to account for the time it takes for fiscal institutions to influence efficiency and to mitigate potential simultaneity bias. The vector $X_{ct}$ includes a set of control variables encompassing economic, political, and institutional factors. Specifically, it comprises total population, the working-age population share, real GDP per capita, the level of democracy, trade and capital openness, fiscal indicators such as the government deficit and debt-to-GDP ratio, a governance index capturing institutional quality, and pre-tax income inequality. The terms $μ_{c}$ and $λ_{t}$ represent country and year fixed effects, respectively. Standard errors are clustered at the country level to account for serial correlation and heteroskedasticity within panels.

To assess the robustness of the baseline estimates, two complementary estimation strategies are employed. First, the System Generalized Method of Moments (System GMM) estimator is applied. This dynamic panel estimator controls for unobserved country-specific heterogeneity and potential endogeneity arising from lagged dependent variables. The two-step estimation procedure is implemented with finite-sample corrected cluster-robust standard errors to address downward bias in standard error estimates. Model validity is assessed through two specification tests: the AR(2) test, which examines the absence of second-order serial correlation in first-differenced residuals, and the Hansen J test for over-identifying restrictions, which evaluates the joint validity of the instruments. To prevent instrument proliferation, the instrument matrix is collapsed in all specifications.

Second, the instrumental variables (IV) approach is used to further address potential endogeneity concerns. The chosen instrument is the existence of an independent fiscal council, as reported in Davoodi et al. (2022). Independent fiscal councils function as institutional bodies responsible for monitoring and enforcing compliance with fiscal rules, thereby enhancing the credibility and consistency of fiscal policy. The existence of such councils is strongly correlated with the strength of fiscal rules, and it is likely to affect public spending efficiency through their influence on the implementation of fiscal rules. This characteristic makes the fiscal council a potential instrument for identifying the causal impact of fiscal rules on efficiency.

Estimation Results

Table 2 reports the results from the TWFE estimation of the relationship between the fiscal rule index and public sector efficiency. Columns (1)–(3) present the baseline specifications without controls, while columns (4)–(6) include the full set of control variables. All regressions include country and year fixed effects, and standard errors are clustered at the country level.

Table 2.

Estimation Results.

	(1)	(2)	(3)	(4)	(5)	(6)
	PSE0	PSE1	PSE2	PSE0	PSE1	PSE2
Fiscal Rule Index	0.203**	0.262**	0.200**	0.168**	0.232***	0.151**
	(0.089)	(0.097)	(0.093)	(0.063)	(0.074)	(0.065)
Population				0.203	0.270	0.252
				(0.195)	(0.218)	(0.190)
Working-age Population				−0.000	0.002	0.001
				(0.003)	(0.004)	(0.004)
GDP per capita				0.182**	0.148**	0.204***
				(0.068)	(0.065)	(0.059)
Democracy				−0.082	0.023	−0.125
				(0.087)	(0.109)	(0.083)
Trade Dependence				0.002	0.001	0.002**
				(0.001)	(0.001)	(0.001)
Capital Openness				−0.145**	−0.060	−0.174***
				(0.062)	(0.066)	(0.060)
Government Deficit				0.007***	0.007***	0.007***
				(0.001)	(0.001)	(0.001)
Government Debt				−0.000	0.000	0.000
				(0.000)	(0.000)	(0.000)
Governance				0.006	−0.002	0.042
				(0.042)	(0.058)	(0.044)
Income Inequality				0.638***	0.864***	0.680***
				(0.211)	(0.256)	(0.214)
Country FE	Y	Y	Y	Y	Y	Y
Year FE	Y	Y	Y	Y	Y	Y
N	455	455	455	455	455	455

Clustered standard errors at the country level in parentheses, *p < .10, **p < .05, ***p < .01.

The fiscal rule index exhibits a consistently positive and statistically significant association with all three measures of public spending efficiency across all specifications. In the baseline models, the estimated coefficients range from 0.203 to 0.262. In the fully controlled specifications, the coefficients remain between 0.151 and 0.232 and retain statistical significance at conventional levels. The stability of these estimates across specifications suggests that the relationship is unlikely to be driven by omitted macroeconomic or institutional factors.

The magnitude of the coefficients is economically meaningful. Given that the fiscal rule index ranges between 0 and 1, a one-standard-deviation increase in rule stringency is associated with a non-trivial improvement in the efficiency score. Because the dependent variable is constructed using an input-oriented DEA framework, higher efficiency scores indicate that a country operates closer to the best-practice frontier, implying a lower degree of potential waste for a given level of public service provision. The results therefore suggest that stronger fiscal rule frameworks are associated not merely with reduced expenditure levels, but with a more effective transformation of public spending into measurable policy outcomes.

Importantly, the positive association holds across alternative efficiency measures (PSE0, PSE1, and PSE2), which differ in their specification of inputs and outputs. This consistency indicates that the estimated effect is not sensitive to the particular functional decomposition of public performance, but instead reflects a broader relationship between fiscal institutional design and the effective use of public resources.

These findings support the interpretation that fiscal rules operate not only as instruments of fiscal restraint, but also as institutional mechanisms that enhance the efficiency of public spending.

Table 3 presents the results from alternative estimation strategies designed to address dynamic persistence and potential endogeneity concerns. Columns (1)–(3) report the System GMM estimates, while columns (4)–(6) present the IV results. All specifications include country and year fixed effects, with standard errors clustered at the country level.

Table 3.

Estimation Results by Alternative Methods.

	(1)	(2)	(3)	(4)	(5)	c(6)
	System GMM			IV (Instrument = Fiscal Councils)
	PSE0	PSE1	PSE2	PSE0	PSE1	PSE2
Fiscal Rule Index	0.112*	0.102	0.098*	0.303*	0.458**	0.346*
	(0.066)	(0.067)	(0.057)	(0.161)	(0.189)	(0.180)
Population	−0.000	0.000	0.000	0.347	0.510	0.460
	(0.006)	(0.006)	(0.005)	(0.298)	(0.325)	(0.316)
Working-age Population	0.006	0.007	0.006	0.000	0.003	0.002
	(0.005)	(0.005)	(0.005)	(0.004)	(0.004)	(0.004)
GDP per capita	0.019	0.027	0.026	0.169**	0.126*	0.185***
	(0.025)	(0.026)	(0.021)	(0.066)	(0.065)	(0.057)
Democracy	−0.076	−0.035	−0.063	−0.103	−0.013	−0.156*
	(0.095)	(0.082)	(0.094)	(0.081)	(0.104)	(0.083)
Trade Dependence	0.000	0.000	0.000	0.002	0.001	0.002**
	(0.000)	(0.000)	(0.000)	(0.001)	(0.001)	(0.001)
Capital Openness	−0.038	−0.025	−0.040*	−0.153***	−0.073	−0.185***
	(0.026)	(0.027)	(0.023)	(0.058)	(0.058)	(0.065)
Government Deficit	0.003***	0.002	0.002**	0.007***	0.007***	0.007***
	(0.001)	(0.001)	(0.001)	(0.001)	(0.001)	(0.001)
Government Debt	0.000	0.000	0.000	−0.000	0.000	−0.000
	(0.000)	(0.000)	(0.000)	(0.000)	(0.000)	(0.000)
Governance	0.003	−0.010	0.002	0.015	0.012	0.054
	(0.024)	(0.024)	(0.022)	(0.040)	(0.055)	(0.044)
Income Inequality	0.329**	0.328**	0.284**	0.679***	0.933***	0.740***
	(0.151)	(0.159)	(0.133)	(0.224)	(0.276)	(0.229)
Lagged Dependent	0.817***	0.780***	0.878***
	(0.060)	(0.088)	(0.075)
(First-stage estimation)				Dependent Variable: Fiscal Rule Index
Fiscal Councils				0.071***	0.071***	0.071***
				(0.022)	(0.022)	(0.022)
AR1/AR2 p-value	0.002/0.715	0.004/0.784	0.005/0.007
Hansen test p-value	0.687	0.585	0.596
F statistic				10.600	10.600	10.600
N	455	455	455	455	455	455

Clustered standard errors at the country level in parentheses, *p < .10, **p < .05, ***p < .01. F statistic is based on Kleibergen-Paap rk Wald F statistic.

In the System GMM estimations, the fiscal rule index remains positive across all three efficiency indicators and statistically significant in two of the three specifications. The magnitude of the coefficients remains economically meaningful even after controlling for the lagged dependent variable, which is highly significant and indicates substantial persistence in efficiency levels. The continued significance of the fiscal rule index in this dynamic specification suggests that the baseline findings are not driven by static omitted-variable bias.⁶

The IV estimation results further reinforce these findings. The fiscal rule index continues to show a positive and statistically significant relationship with public spending efficiency across all specifications. These results confirm that the relationship between fiscal rules and efficiency holds even when endogeneity is addressed through the use of an external instrument.⁷

Overall, the results from both the System GMM and IV approaches confirm that the positive association between fiscal rule stringency and public spending efficiency is robust to alternative estimation strategies that account for endogeneity. These findings strengthen the interpretation that fiscal rules operate not only as instruments of fiscal discipline but also as institutional mechanisms associated with higher spending efficiency.

Table 4 examines the heterogeneity of fiscal rule effects across different fiscal conditions and rule types. Columns (1)–(4) explore whether the impact of fiscal rule stringency varies depending on fiscal circumstances—specifically, periods of rising or declining deficits and debt—while columns (5)–(7) disaggregate the composite index into its four rule components. The model specification follows the TWFE framework.

Table 4.

Heterogeneities.

	(1)	(2)	(3)	(4)	(5)	(6)	(7)
	PSE0	PSE0	PSE0	PSE0	PSE0	PSE1	PSE2
	Increase in Deficit	Decrease in Deficit	Increase in Debt	Decrease in Debt	Specific Type of Fiscal Rules
Fiscal Rule Index	0.205**	0.193**	0.214**	0.124*
	(0.090)	(0.088)	(0.080)	(0.063)
Fiscal Rule_Expenditure Rule					0.095**	0.129***	0.085**
					(0.035)	(0.038)	(0.033)
Fiscal Rule_Revenue Rule					0.023	0.092	−0.019
					(0.052)	(0.063)	(0.065)
Fiscal Rule_Balanced Budget Rule					0.097	0.125	0.177**
					(0.067)	(0.078)	(0.080)
Fiscal Rule_Debt Rule					−0.125	−0.188	−0.195*
					(0.106)	(0.120)	(0.112)
Population	0.167	−0.048	−0.429*	0.246	0.222	0.288	0.283
	(0.180)	(0.221)	(0.246)	(0.211)	(0.190)	(0.212)	(0.186)
Working-age Population	0.001	−0.001	0.003	−0.005	−0.002	0.000	−0.002
	(0.005)	(0.004)	(0.004)	(0.005)	(0.003)	(0.004)	(0.004)
GDP per capita	0.196*	0.073	0.014	0.337***	0.185***	0.148**	0.209***
	(0.101)	(0.044)	(0.043)	(0.089)	(0.067)	(0.063)	(0.058)
Democracy	−0.085	−0.240**	−0.162	−0.084	−0.089	0.022	−0.155*
	(0.092)	(0.104)	(0.120)	(0.121)	(0.092)	(0.107)	(0.086)
Trade Dependence	0.001*	−0.000	−0.001	0.001	0.002	0.001	0.002**
	(0.001)	(0.001)	(0.001)	(0.001)	(0.001)	(0.001)	(0.001)
Capital Openness	−0.191**	−0.145**	−0.150	−0.154***	−0.126*	−0.032	−0.151**
	(0.079)	(0.059)	(0.093)	(0.047)	(0.064)	(0.071)	(0.063)
Government Deficit	0.009***	0.004**	0.005***	0.002	0.007***	0.007***	0.007***
	(0.002)	(0.002)	(0.001)	(0.002)	(0.001)	(0.001)	(0.001)
Government Debt	−0.001*	−0.000	−0.001	0.001	−0.000	0.000	−0.000
	(0.000)	(0.001)	(0.001)	(0.001)	(0.000)	(0.000)	(0.000)
Governance	−0.002	0.104*	0.004	−0.032	−0.002	−0.020	0.033
	(0.047)	(0.056)	(0.059)	(0.080)	(0.041)	(0.057)	(0.044)
Income Inequality	0.393	1.153**	0.328	0.868***	0.508**	0.696***	0.565**
	(0.254)	(0.498)	(0.255)	(0.259)	(0.203)	(0.248)	(0.223)
Country FE	Y	Y	Y	Y	Y	Y	Y
Year FE	Y	Y	Y	Y	Y	Y	Y
N	253	202	262	193	455	455	455

Clustered standard errors at the country level in parentheses, *p < .10, **p < .05, ***p < .01.

In columns (1) to (4), the fiscal rule index remains positively associated with public spending efficiency across all fiscal conditions. However, the magnitude of the effect is substantially larger and statistically significant during periods of fiscal deterioration, when deficits or debt are increasing, compared to periods of fiscal consolidation. The coefficients during fiscal stress range from 0.205 to 0.214, whereas during periods of improving fiscal balances they are smaller and only weakly significant.

This pattern suggests that fiscal rules exert their stronger influence when they operate as binding constraints. Under fiscal stress, governments face tighter budgetary trade-offs, and rule-based frameworks may intensify scrutiny, limit discretionary expansion, and force prioritization among competing spending programs. In such contexts, institutional constraints may reduce inefficiencies that are otherwise tolerated during periods of fiscal comfort. Conversely, when fiscal conditions are improving, the marginal disciplining effect of rules appears weaker, as fiscal space reduces the need for strict expenditure prioritization. The results therefore indicate that fiscal rules are not uniformly effective across the fiscal cycle; rather, their efficiency-enhancing role becomes more salient when fiscal pressures are elevated.

Columns (5) to (7) provide further insight by decomposing the composite index into its four institutional components. Among these, expenditure rules exhibit the most consistent and robust positive association with spending efficiency across all three efficiency measures, with coefficients ranging from 0.085 to 0.129 and statistically significant at conventional levels. This finding is economically intuitive. Expenditure rules directly constrain the level or growth of public outlays and therefore operate at the allocation stage of the budget process. By imposing explicit quantitative limits on spending aggregates, they can curb incremental expansion and promote more disciplined prioritization of resources.

In contrast, revenue rules display no statistically significant relationship with efficiency, suggesting that constraints on revenue mobilization do not necessarily translate into improvements in expenditure allocation. This pattern is consistent with prior research indicating that expenditure-based fiscal adjustments are more closely associated with sustained efficiency and growth outcomes than revenue-based consolidations (Alesina and Perotti 1997; Alesina, Favero, and Giavazzi 2019; Ardagna 2004).

Balanced budget rules exhibit only limited and specification-dependent significance, while debt rules occasionally produce negative coefficients. A possible explanation lies in the distinction between flow and stock constraints. Whereas expenditure rules directly govern spending flows and influence the composition of budgetary decisions, debt rules target the stock of public liabilities. As a result, debt rules may induce adjustments aimed primarily at meeting aggregate debt targets, without necessarily improving the allocative efficiency of expenditure.

The heterogeneity analysis reinforces two central insights. First, the efficiency-enhancing effect of fiscal rules is conditional rather than uniform, becoming more pronounced when fiscal constraints are binding. Second, the institutional channel through which rules operate matters: rules that directly discipline expenditure behavior appear more closely associated with improvements in spending efficiency than rules targeting revenue or debt aggregates. These findings suggest that the design and focus of fiscal frameworks are critical in determining whether fiscal discipline translates into qualitative improvements in public resource management.

Conclusion

This study empirically investigated the relationship between fiscal rules and public sector efficiency using panel data for 35 OECD countries over the period 2006 to 2019. The analysis employed the TWFE model as the baseline specification, complemented by System GMM and IV estimations. Across all specifications, the fiscal rule index displayed a consistently positive and statistically significant association with public sector efficiency. The effect was particularly strong during periods of rising fiscal deficits and debt accumulation, and expenditure-based rules exhibited more robust and consistent effects than other rule types. These findings indicate that fiscal rules operate not merely as instruments of fiscal discipline but as institutional mechanisms that enhance the qualitative efficiency of public spending and improve the overall performance of fiscal governance.

These findings yield several important policy implications. First, fiscal rules should be understood not merely as instruments for constraining budget deficits or managing public debt ratios, but as institutional mechanisms that can enhance efficiency within the public sector. The results suggest that fiscal discipline contributes not only to macroeconomic stability but also to qualitative improvements in fiscal management and the performance of government spending. Second, the fact that the efficiency-enhancing effect of fiscal rules is stronger during periods of rising deficits or debt underscores the importance of maintaining rule-based fiscal governance that ensures policy consistency and predictability, particularly during economic downturns or fiscal stress. Strengthening institutional credibility through transparent and rules-oriented fiscal frameworks may therefore serve as an effective means of improving efficiency when fiscal space is limited. Third, the findings that expenditure rules exhibit more consistent and robust positive effects than other rule types have clear implications for the design of fiscal frameworks. Emphasizing the structure and composition of spending appears more conducive to achieving both fiscal sustainability and efficiency. This aligns with evidence suggesting that expenditure-based fiscal adjustments tend to produce more durable improvements in economic performance and public sector outcomes.

This study has several limitations that point to avenues for future research. The empirical analysis relies on country-level panel data and a composite fiscal rule index, both of which necessarily abstract from important institutional heterogeneity. As a result, the estimated relationship captures average cross-country associations rather than the specific mechanisms through which fiscal rules affect spending efficiency. Institutional effects may differ across policy sectors, program structures, and administrative capacities, dimensions that are not explicitly modeled here. In addition, fiscal rule frameworks vary in legal design, enforcement credibility, political commitment, and implementation practices, and such multidimensional variation cannot be fully represented by a single aggregate indicator. Future research could therefore employ more disaggregated data, such as sectoral or program-level efficiency measures, and develop structural frameworks that integrate political and institutional channels. Advancing research along these lines would contribute to a more precise understanding of how fiscal institutions shape incentives and promote efficient and sustainable public finance management.

Footnotes

Author Contribution

The study is solo-authored.

Data Availability Statement

Data are available upon request.

Declaration of Conflicting Interests

The author declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.

Funding

The author received no financial support for the research, authorship, and/or publication of this article.

ORCID iD

Hoyong Jung

Notes

Author Biography

Hoyong Jung is an Associate Professor in the Graduate School of Public Administration at Seoul National University. He has broad interests in public finance, political economy, education, demography, and urban affairs, particularly in the Korean context.

Appendix. Estimation Results for Alternative Fiscal Rule Index.

	(1)	(2)	(3)	(4)	(5)	(6)
	PSE0	PSE1	PSE2	PSE0	PSE1	PSE2
Alternative Fiscal Rule Index	0.204*	0.265**	0.200*	0.224*	0.252**	0.203*
	(0.107)	(0.105)	(0.101)	(0.123)	(0.100)	(0.107)
Population				0.117	0.109	0.189
				(0.227)	(0.250)	(0.212)
Working-age Population				0.003	0.008*	0.004
				(0.004)	(0.005)	(0.004)
GDP per capita				0.163**	0.134**	0.185***
				(0.068)	(0.065)	(0.060)
Democracy				−0.164*	−0.069	−0.213**
				(0.089)	(0.133)	(0.093)
Trade Dependence				0.002	0.002	0.002**
				(0.001)	(0.001)	(0.001)
Capital Openness				−0.164*	−0.061	−0.202**
				(0.096)	(0.107)	(0.086)
Government Deficit				0.007***	0.007***	0.007***
				(0.001)	(0.001)	(0.001)
Government Debt				−0.000	0.000	−0.000
				(0.000)	(0.001)	(0.000)
Governance				−0.002	−0.019	0.034
				(0.045)	(0.060)	(0.047)
Income Inequality				0.697***	0.905***	0.731***
				(0.242)	(0.285)	(0.239)
Country FE	Y	Y	Y	Y	Y	Y
Year FE	Y	Y	Y	Y	Y	Y
N	455	455	455	455	455	455

Clustered standard errors at the country level in parentheses, *p < .10, **p < .05, ***p < .01.

References

Adam

Delis

Kammas

. 2011. “Public Sector Efficiency: Leveling the Playing Field Between OECD Countries.” Public Choice 146 (1): 163–183. https://doi.org/10.1007/s11127-009-9588-7

Afonso

Alves

. 2023a. “Are Fiscal Consolidation Episodes Helpful for Public Sector Efficiency?” Applied Economics 55 (31): 3547–3560. https://doi.org/10.1080/00036846.2022.2115455

Afonso

Alves

. 2023b. “Does Government Spending Efficiency Improve Fiscal Sustainability?.” European Journal of Political Economy 102403. https://doi.org/10.1016/j.ejpoleco.2023.102403

Afonso

Jalles

J. T.

Venâncio

. 2023. “Government Spending Efficiency, Measurement and Applications: A Cross-Country Efficiency Dataset.” In Handbook on Public Sector Efficiency, 44–71. Cheltenham, UK; Northampton, MA, USA: Edward Elgar Publishing.

Afonso

Jalles

J. T.

Venâncio

. 2024. “A Tale of Government Spending Efficiency and Trust in the State.” Public Choice 200 (1): 89–118. https://doi.org/10.1007/s11127-024-01144-6

Afonso

Schuknecht

Tanzi

. 2005. “Public Sector Efficiency: An International Comparison.” Public Choice 123 (3): 321–347. https://doi.org/10.1007/s11127-005-7165-2

Afonso

Schuknecht

Tanzi

. 2010. “Public Sector Efficiency: Evidence for new EU Member States and Emerging Markets.” Applied Economics 42 (17): 2147–2164. https://doi.org/10.1080/00036840701765460

Alesina

Favero

Giavazzi

. 2019. “Effects of Austerity: Expenditure-and tax-Based Approaches.” Journal of Economic Perspectives 33 (2): 141–162. https://doi.org/10.1257/jep.33.2.141

Alesina

Perotti

. 1996. “Fiscal Discipline and the Budget Process.” American Economic Review 86 (2): 401–407.

10.

Alesina

Perotti

. 1997. “Fiscal Adjustments in OECD Countries: Composition and Macroeconomic Effects.” IMF Staff Papers 44 (2): 210–248. https://doi.org/10.2307/3867543

11.

Antonelli

M. A.

De Bonis

. 2019. “The Efficiency of Social Public Expenditure in European Countries: A two-Stage Analysis.” Applied Economics 51 (1): 47–60. https://doi.org/10.1080/00036846.2018.1489522

12.

Apeti

A. E.

Bambe

B. W. W.

Combes

J. L.

. 2025. “On the Macroeconomic Effects of Fiscal Reforms: Fiscal Rules and Public Expenditure Efficiency.” Public Choice, 205 (1–2), 1–29. https://doi.org/10.1007/s11127-025-01275-4

13.

Ardagna

2004. “Fiscal Stabilizations: When do They Work and why.” European Economic Review 48 (5): 1047–1074. https://doi.org/10.1016/j.euroecorev.2003.09.010

14.

Badinger

Reuter

W. H.

. 2017. “The Case for Fiscal Rules.” Economic Modelling 60: 334–343. https://doi.org/10.1016/j.econmod.2016.09.028

15.

Barro

R. J.

1990. “Government Spending in a Simple Model of Endogenous Growth.” Journal of Political Economy 98 (5): S103–S125. https://doi.org/10.1086/261726

16.

Baumol

W. J.

Bowen

W. G.

. 1966. Performing Arts: The Economic Dilemma. New York: Twentieth Century Fund.

17.

Brändle

Elsener

. 2024. “Do Fiscal Rules Matter? A Survey of Recent Evidence.” Swiss Journal of Economics and Statistics 160 (1): 11. https://doi.org/10.1186/s41937-024-00128-z

18.

Brennan

Buchanan

J. M.

. 1980. The Power to Tax: Analytical Foundations of a Fiscal Constitution. Cambridge, UK: Cambridge University Press.

19.

Buchanan

J. M.

Tullock

. 1962. The Calculus of Consent: Logical Foundations of Constitutional Democracy. Ann Arbor, MI, USA: University of Michigan Press.

20.

Buchanan

J. M.

Wagner

R. E.

. 1977. Democracy in Deficit: The Political Legacy of Lord Keynes. Vol. 4. New York: Academic Press.

21.

Christl

Köppl-Turyna

Kucsera

. 2020. “Determinants of Public-Sector Efficiency: Decentralization and Fiscal Rules.” Kyklos 73 (2): 253–290. https://doi.org/10.1111/kykl.12224

22.

Cyert

R. M.

March

J. G.

. 1963. A Behavioral Theory of the Firm. Englewood Cliffs, NJ, USA: Prentice-Hall.

23.

Davoodi

Elger

Fotiou

Garcia-Macia

M. D.

Han

Lagerborg

Lam

W. R.

. 2022. Fiscal Rules and Fiscal Councils: Recent Trends and Performance During the COVID-19 Pandemic.

24.

Duernecker

Herrendorf

Valentinyi

. 2024. “Structural Change Within the Services Sector and the Future of Cost Disease.” Journal of the European Economic Association 22 (1): 428–473. https://doi.org/10.1093/jeea/jvad030

25.

Dutu

Sicari

. 2020. “Public Spending Efficiency in the OECD: Benchmarking Health Care, Education, and General Administration.” Review of Economic Perspectives 20 (3): 253–280. https://doi.org/10.2478/revecp-2020-0013

26.

Fatás

Mihov

. 2006. “The Macroeconomic Effects of Fiscal Rules in the US States.” Journal of Public Economics 90 (1-2): 101–117. https://doi.org/10.1016/j.jpubeco.2005.02.005

27.

Gootjes

de Haan

. 2022. “Procyclicality of Fiscal Policy in European Union Countries.” Journal of International Money and Finance 120: 102276. https://doi.org/10.1016/j.jimonfin.2020.102276

28.

Grembi

Nannicini

Troiano

. 2016. “Do Fiscal Rules Matter?” American Economic Journal: Applied Economics 8 (3): 1–30.

29.

Gupta

Verhoeven

. 2001. “The Efficiency of Government Expenditure: Experiences from Africa.” Journal of Policy Modeling 23 (4): 433–467. https://doi.org/10.1016/S0161-8938(00)00036-3

30.

Hauner

Kyobe

. 2010. “Determinants of Government Efficiency.” World Development 38 (11): 1527–1542. https://doi.org/10.1016/j.worlddev.2010.04.004

31.

Herrera

Pang

. 2005. Efficiency of Public Spending in Developing Countries: An Efficiency Frontier Approach. Vol. 3645. Washington, DC, USA: World Bank Publications.

32.

Hines

J. R.

Thaler

R. H.

Jr . 1995. “Anomalies: The Flypaper Effect.” Journal of Economic Perspectives 9 (4): 217–226. https://doi.org/10.1257/jep.9.4.217

33.

Jung

Kim

B. H.

. 2021. “Fiscal Rules and Income Inequality: The Case of OECD Countries.” Finanz-archiv 77 (2): 197–224. https://doi.org/10.1628/fa-2021-0008

34.

Kopits

M. G.

Symansky

M. S. A.

. 1998. Fiscal Policy Rules. Washington, DC, USA: International monetary fund.

35.

Kornai

1986. “The Soft Budget Constraint.” Kyklos 39 (1): 3–30. https://doi.org/10.1111/j.1467-6435.1986.tb01252.x

36.

Lindblom

C. E.

1959. “The Science of Muddling Through.” Public Administration Review 19 (2): 79–88. https://doi.org/10.2307/973677

37.

López-Herrera

Cordero

J. M.

Pedraja-Chaparro

Polo

. 2023. Fiscal Rules and their Influence on Public Sector Efficiency.

38.

Menguy

2024. “Limiting Public Expenditure to Ensure Public Debt Sustainability in the EMU.” Public Finance Review 52 (1): 78–110. https://doi.org/10.1177/10911421231210730

39.

Migué

J. L.

Bélanger

. 1974. “Towards a General Theory of Managerial Discretion.” Public Choice 17: 27–51. https://doi.org/10.1007/BF01718995

40.

Montes

G. C.

Bastos

J. C. A.

de Oliveira

A. J.

. 2019. “Fiscal Transparency, Government Effectiveness and Government Spending Efficiency: Some International Evidence Based on Panel Data Approach.” Economic Modelling 79: 211–225. https://doi.org/10.1016/j.econmod.2018.10.013

41.

Müller

Lehbib

Chen

. 2025. The Global Macro Database: A New International Macroeconomic Dataset (No. w33714). Cambridge, MA, USA: National Bureau of Economic Research.

42.

Niskanen

W. A

. 1971. Bureaucracy and Representative Government. Chicago, IL, USA: Aldine-Atherton.

43.

Nordhaus

W. D.

1975. “The Political Business Cycle.” Review of Economic Studies 42 (2): 169–190. https://doi.org/10.2307/2296528

44.

Pathak

2023. “Do Subnational Fiscal Rules Reduce Public Investment? The Case of Fiscal Responsibility Laws in India.” Public Finance Review 51 (3): 315–338. https://doi.org/10.1177/10911421231158199

45.

Potrafke

2025. “The Economic Consequences of Fiscal Rules.” Journal of International Money and Finance, 153, 103286. https://doi.org/10.1016/j.jimonfin.2025.103286

46.

Puviani

. 1897. Teoría della illusione nelle entrate pubbliche. Torino, Italy: Unione Tipografica Cooperativa.

47.

Vinturis

2023. “How do Fiscal Rules Shape Governments’ Spending Behavior?” Economic Inquiry 61 (2): 322–341. https://doi.org/10.1111/ecin.13120

48.

Wagner

1890. Finanzwissenschaft. 3rd ed. Leipzig: C. F. Winter.

49.

Weingast

B. R.

Shepsle

K. A.

Johnsen

. 1981. “The Political Economy of Benefits and Costs: A Neoclassical Approach to Distributive Politics.” Journal of Political Economy 89 (4): 642–664. https://doi.org/10.1086/260997

50.

Wildavsky

. 1964. The Politics of the Budgetary Process. Boston, MA, USA: Little, Brown.

51.

Wyplosz

. 2012. “Fiscal Rules: Theoretical Issues and Historical Experiences.” In Fiscal Policy After the Financial Crisis, 495–525. Chicago, IL, USA: University of Chicago Press.

52.

Yared

2019. “Rising Government Debt: Causes and Solutions for a Decades-Old Trend.” Journal of Economic Perspectives 33 (2): 115–140. https://doi.org/10.1257/jep.33.2.115