Mechanisms for the control of fiscal deficits

This paper shows that a simple two-stage voting mechanism may implement a constrained optimal state dependent decision about the size of the fiscal deficit. I consider a setup with strategic fiscal deficits similar to Alesina and Tabellini (1990). Three groups of voters are informed about the relative desirability of current public spending. Voters differ in their preferences for public goods and swing voters’ preferences may change over time. The current government decides on the current spending mix and it has an incentive to strategically overspend. A simple two-stage mechanism under which a deficit requires the approval by a supermajority in parliament approximates a constrained optimal decision and under certain conditions increases social welfare relative to both a strict rule and a laissez faire constitution. When the current majority is small, political bargaining may further increase social welfare. However, when the current majority is large, a supermajority mechanism with bargaining leads to a biased spending mix and it may reduce welfare whereas the laissez faire mechanism may yield the first best. An appropriately adjusted majority threshold can avoid inefficient bargaining whenever necessary.