This paper proposes a dynamic politico-economic theory of debt, government finance and expenditure. Agents have preferences over a private and a government-provided public good, financed through labor 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. We characterize the Markov Perfect Equilibrium of the dynamic voting game. If taxes do not distort labor supply, the economy progressively depletes its resources through debt accumulation, leaving future generations “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. The current fiscal policy is disciplined by the concern of young voters for the ability of future government to provide public goods. The steady-state and dynamics of debt depend on the voters’ taste for public consumption. The stronger the preference for public consumption, the less debt is accumulates. We extend the analysis to redistributive policies and political shocks. The theory predicts government debt to be mean reverting and debt growth to be larger under right-wing than under left-wing governments. Data from the US and from a panel of 21 OECD countries confirm these theoretical predictions.
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Paper provided by Institute for Empirical Research in Economics - IEW in its series IEW - Working Papers with number
iewwp325.
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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