Working Paper: CEPR ID: DP5646
Authors: Paula Gonzalez; Jean JG Hindriks; Ben Lockwood; Nicolas Porteiro
Abstract: In this paper, we study a model a la Rogoff (1990) where politicians distort fiscal policy to signal their competency, but where fiscal policy can be centralized or decentralized. Our main focus is on how the equilibrium probability that fiscal policy is distorted in any region (the political budget cycle, PBC) differs across fiscal regimes. With centralization, there are generally two effects that change the incentive for pooling behavior and thus the probability of a PBC. One is the possibility of selective distortion: the incumbent can be re-elected with the support of just a majority of regions. The other is a cost distribution effect, which is present unless the random cost of producing the public goods is perfectly correlated across regions. Both these effects work in the same direction, with the general result that overall, the PBC probability is larger under centralization (decentralization) when the rents to office are low (high). Voter welfare under the two regimes is also compared: voters tend to be better off when the PBC probability is lower, so voters may either gain or lose from centralization. Our results are robust to a number of changes in the specification of the model.
Keywords: Fiscal Decentralization; Local Public Goods; Political Budget Cycle
JEL Codes: D72; E32; E62; H41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal Centralization (H77) | Probability of Political Budget Cycle (PBC) (D72) |
| Low Rents to Office (R33) | Probability of Political Budget Cycle (PBC) under Fiscal Centralization (D72) |
| Selective Distortion Effect (H31) | Probability of Political Budget Cycle (PBC) (D72) |
| Cost Distribution Effect (D39) | Probability of Political Budget Cycle (PBC) (D72) |
| Probability of Political Budget Cycle (PBC) (D72) | Voter Welfare (K16) |