Municipal bailouts in Denmark – and how to avoid them

Economically robust municipalities are of great importance to the decentralised Danish public sector. The size of municipalities and the extensive equalisation system contribute to this objective, but moreover a mechanism to avoid local bail-outs and bailout-like situations has been developed since the 1980s. This institutional mechanism consists of formula-based elements with a minimum of administrative discretion. The mechanism has worked well since the late 1980s involving a number of cases, and the success originally explained by at least three factors: the thorough application of the mechanism, the local distaste for legal conflict with the central government, and the local stigma of being “under administration” by the upper level of the public sector. In recent years, the need for the mechanism seems to have diminished, because fewer and economically more sustainable municipalities accompanied by structural reforms of local governments from 2007 and the Danish budget law. The budget law has established a top-down economic control of local governments’ finances, where non-compliance with expenditure ceilings implies possible use of economic sanctions to both the municipalities in general and to specific municipalities.