Working Paper: NBER ID: w20643
Authors: Stephen Coate
Abstract: This paper studies the optimal design of fiscal limits in the context of a simple political economy model. The model features a single politician and a representative voter. The politician is responsible for choosing the level of public spending for the voter but may be biased in favor of spending. The voter sets a spending limit and requires that the politician have voter approval to exceed it. This limit must be set before the voter's preferences for public spending are fully known. The paper first solves for the optimal limit and explains how it depends upon the degree of politician bias and the nature of the uncertainty concerning the voter's preferred spending level. A dynamic version of the model is then analyzed and policies which limit the rate of growth of spending are shown to dominate those that cap spending to be below some fixed fraction of community income.
Keywords: Fiscal limits; Political economy; Public spending; Voter preferences
JEL Codes: H72
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| degree of politician bias (D72) | optimal fiscal limit (H21) |
| uncertainty in voters' preferred spending levels (D72) | optimal fiscal limit (H21) |
| politician's bias exceeds threshold (D72) | optimal limit equals expected fraction (C61) |
| lower levels of bias (D91) | optimal limit may exceed expected fraction (C61) |
| structure of limits (Y20) | growth of public spending (H59) |