Working Paper: NBER ID: w12100
Authors: Marco Battaglini; Stephen Coate
Abstract: This paper presents a dynamic political economy theory of public spending, taxation and debt. Policy choices are made by a legislature consisting of representatives elected by geographically-defined districts. The legislature can raise revenues via a distortionary income tax and by borrowing. These revenues can be used to finance a national public good and district-specific transfers (interpreted as pork-barrel spending). The value of the public good is stochastic, reflecting shocks such as wars or natural disasters. In equilibrium, policy-making cycles between two distinct regimes: "business-as-usual" in which legislators bargain over the allocation of pork, and "responsible-policy-making" in which policies maximize the collective good. Transitions between the two regimes are brought about by shocks in the value of the public good. In the long run, equilibrium tax rates are too high and too volatile, public good provision is too low and debt levels are too high. In some environments, a balanced budget requirement can improve citizen welfare.
Keywords: public spending; taxation; debt; political economy
JEL Codes: H6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Equilibrium tax rates (H29) | Insufficient public good provision (H42) |
| Equilibrium tax rates (H29) | Excessive debt levels (F65) |
| BAU regime (F55) | Suboptimal public good allocation (H49) |
| RPM regime (E65) | Maximizing collective welfare (D69) |
| Stochastic shocks to public good value (H49) | Transition between BAU and RPM (C69) |
| Balanced budget requirements (H61) | Improved citizen welfare (I39) |
| Size of tax base (H29) | Desirability of balanced budget requirements (H61) |
| Public good spending needs (H40) | Desirability of balanced budget requirements (H61) |