This paper proposes a dynamic politico-economic theory of debt, government finance and expenditure. Agents have preferences over a private and government-provided public good, financed through labour taxation. Subsequent generations of voters choose taxation, government expenditure and debt accumulation through repeated elections. Debt introduces a conflict of interest between young and old voters: the young want more fiscal discipline as they are concerned with the ability to of future governments to provide public goods. We characterize the Markov Perfect Equilibrium of the dynamic voting game. If taxes do not distort labour supply, the economy progressively depletes its resources through debt accumulation, leaving future genereations "enslaved". However, if tax distortions are sufficiently large, the economy converges to a stationary debt level which is bounded away from the endogenous debt limit. We extend the analysis to redistributive policies and political shocks. Consistent with the empirical evidence, our theory predicts governement debt to be mean reverting and debt growth to be larger under right-wing than under left-wing governments.
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Paper provided by Oslo University, Department of Economics in its series Memorandum with number
05/2008.
Find related papers by JEL classification: D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Models of Political Processes: Rent-seeking, Elections, Legislatures, and Voting Behavior E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy H41 - Public Economics - - Publicly Provided Goods - - - Public Goods H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management
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