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The Political Economy of Unsustainable Fiscal Deficits

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Author Info

  • Roberto Pasten
  • James P. Cover

Abstract

This paper uses an intertemporal model of public finances to show that political instability can cause taxes to be tilted to the future, resulting in a fiscal deficit that is suboptimal and only weakly sustainable (in the sense of Quintos). This occurs because political instability gives the government an incentive to implement a myopic fiscal policy in order to increase its chances of remaining in office. The government achieves this by delaying taxes (or advancing spending) in order to buy political support, which in turn causes an upward trend in the deficit process and a financial crisis. Using annual data for Chile for the 1833-1999 period, we present statistical test results that support the model.

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Bibliographic Info

Article provided by Instituto de Economía. Pontificia Universidad Católica de Chile. in its journal Cuadernos de Economía-Latin American Journal of Economics.

Volume (Year): 47 (2010)
Issue (Month): 136 ()
Pages: 169-189

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Handle: RePEc:ioe:cuadec:v:47:y:2010:i:136:p:169-189

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Related research

Keywords: Fiscal policy; political instability; weak and strong sustainability; cointegration with change in regime;

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References

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  1. International Monetary Fund, 1999. "Spend Now, Pay Later? Tax Smoothing and Fiscal Sustainability in South Asia," IMF Working Papers 99/63, International Monetary Fund.
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Cited by:
  1. Anwar, Mumtaz & Ahmad, Munazza, 2012. "Political determinants of budget deficit in Pakistan: An empirical investigation," HWWI Research Papers 135, Hamburg Institute of International Economics (HWWI).

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