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Institutionalized Bailouts and Fiscal Policy: The Consequences of Soft Budget Constraints

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  • Alexander Fink
  • Thomas Stratmann

Abstract

States have soft budget constraints when they can expect a bailout by the federal government in the event of a financial crisis. This gives rise to incentives for unsound state fiscal policy. We test whether states with softer budget constraints have higher debt and deficits, receive more bailouts funds, spend funds less efficiently, and are more likely to allocate funds to programs benefiting special interests. Exogenous variation in soft budget constraints across states and over time allows the identification of budget constraint softness on state fiscal policy. We take advantage of the fact that in Germany, states’ political influence is exogenous because voting weights differ in the upper chamber of the German parliament. The stronger the political influence of states, the softer their budget constraints. We show that states with softer budget constraint have higher deficits and debts, and receive more bailouts funds. Further, overrepresented states are less efficient in spending public funds and are more prone to respond to rent seeking by interest groups.

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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2827.

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Date of creation: 2009
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Handle: RePEc:ces:ceswps:_2827

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  1. Hans Pitlik & Friedrich Schneider & Harald Strotmann, 2006. "Legislative Malapportionment and the Politicization of Germany's Intergovernmental Transfer System," Public Finance Review, , , vol. 34(6), pages 637-662, November.
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  3. Stratmann, Thomas, 1992. "Are Contributions Rational? Untangling Strategies of Political Action Committees," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 100(3), pages 647-64, June.
  4. Philip J. Grossman, 1987. "A Political Theory of Inter-Governmental Grants," School of Economics Working Papers, University of Adelaide, School of Economics 1987-06, University of Adelaide, School of Economics.
  5. David E. Wildasin, 2001. "Externalities and Bailouts: Hard and Soft Budget Constraints in Intergovernmental Fiscal Relations," Public Economics, EconWPA 0112002, EconWPA.
  6. Gary Hoover & Paul Pecorino, 2005. "The Political Determinants of Federal Expenditure at the State Level," Public Choice, Springer, Springer, vol. 123(1), pages 95-113, April.
  7. Mathias Dewatripont & Eric Maskin, 2004. "Credit and efficiency in centralized and decentralized economies," ULB Institutional Repository 2013/9605, ULB -- Universite Libre de Bruxelles.
  8. Jonathan A. Rodden & Gunnar S. Eskeland (ed.), 2003. "Fiscal Decentralization and the Challenge of Hard Budget Constraints," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262182297, December.
  9. Hauk, William R. & Wacziarg, Romain, 2007. "Small States, Big Pork," International Quarterly Journal of Political Science, now publishers, now publishers, vol. 2(1), pages 95-106, March.
  10. Pitlik, Hans & Schmid, Gunther & Strotmann, Harald, 2001. " Bargaining Power of Smaller States in Germany's Landerfinanzausgleich 1979-90," Public Choice, Springer, Springer, vol. 109(1-2), pages 183-201, October.
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  12. Büttner, Thiess, 2005. "The Incentive Effect of Fiscal Equalization Transfers on Tax Policy," Center for European, Governance and Economic Development Research Discussion Papers 37, University of Goettingen, Department of Economics.
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  16. Weingast, Barry R., 2009. "Second generation fiscal federalism: The implications of fiscal incentives," Journal of Urban Economics, Elsevier, vol. 65(3), pages 279-293, May.
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Cited by:
  1. Lars P. Feld, 2010. "Sinnhaftigkeit und Effektivität der deutschen Schuldenbremse," Perspektiven der Wirtschaftspolitik, Verein für Socialpolitik, Verein für Socialpolitik, vol. 11(3), pages 226-245, 08.
  2. Aronsson, Thomas, 2010. "Optimal income taxation and decentralized fiscal federalism," Regional Science and Urban Economics, Elsevier, Elsevier, vol. 40(4), pages 187-195, July.

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