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On the Unintended Consequence of Fiscal Rules: Evidence from Fiscal Expenditures

Author

Listed:
  • Rabah Arezki
  • Gregoire Rota-Graziosi
  • Van Dao Le

Abstract

This paper documents the unintended consequence of fiscal rules in the form of tax expenditures using both theory and data. We first introduce a simple fiscal model where the government has time-inconsistent preferences with a present bias toward public spending in line with Halac and Yared (2014). We then empirically validate the main prediction of the model by providing evidence that the adoption of a binding fiscal rule on public spending leads to an increase in tax expenditures, whereas revenue rules, which do not constrain spending, leave them unaffected. Our findings suggest the existence of a robust "innovation channel" in the fiscal domain—paralleling regulatory capital requirements in banking.

Suggested Citation

  • Rabah Arezki & Gregoire Rota-Graziosi & Van Dao Le, 2026. "On the Unintended Consequence of Fiscal Rules: Evidence from Fiscal Expenditures," CESifo Working Paper Series 12741, CESifo.
    • Handle: RePEc:ces:ceswps:_12741
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    References listed on IDEAS

    as
    1. Marina Halac & Pierre Yared, 2014. "Fiscal Rules and Discretion Under Persistent Shocks," Econometrica, Econometric Society, vol. 82, pages 1557-1614, September.
    2. International Monetary Fund, 2019. "Tax Expenditure Reporting and Its Use in Fiscal Management: A Guide for Developing Economies," IMF Fiscal Affairs Department 2019/002, International Monetary Fund.
    3. Leonard E. Burman & Marvin Phaup, 2012. "Tax Expenditures, the Size and Efficiency of Government, and Implications for Budget Reform," NBER Chapters, in: Tax Policy and the Economy, Volume 26, pages 93-124, National Bureau of Economic Research, Inc.
    4. International Monetary Fund, 2019. "Tax Expenditure Reporting and Its Use in Fiscal Management; A Guide for Developing Economies," IMF Fiscal Affairs Department 19/02, International Monetary Fund.
    5. Marcela Eslava, 2011. "The Political Economy Of Fiscal Deficits: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 25(4), pages 645-673, September.
    6. Jones, David, 2000. "Emerging problems with the Basel Capital Accord: Regulatory capital arbitrage and related issues," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 35-58, January.
    7. Marina Halac & Pierre Yared, 2018. "Fiscal Rules and Discretion in a World Economy," American Economic Review, American Economic Association, vol. 108(8), pages 2305-2334, August.
    8. von Hagen, Jurgen & Harden, Ian J., 1995. "Budget processes and commitment to fiscal discipline," European Economic Review, Elsevier, vol. 39(3-4), pages 771-779, April.
    9. Velasco, Andres, 2000. "Debts and deficits with fragmented fiscal policymaking," Journal of Public Economics, Elsevier, vol. 76(1), pages 105-125, April.
    10. Leonard E. Burman & Marvin Phaup, 2012. "Tax Expenditures, the Size and Efficiency of Government, and Implications for Budget Reform," Tax Policy and the Economy, University of Chicago Press, vol. 26(1), pages 93-124.
    11. Weingast, Barry R & Shepsle, Kenneth A & Johnsen, Christopher, 1981. "The Political Economy of Benefits and Costs: A Neoclassical Approach to Distributive Politics," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 642-664, August.
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    More about this item

    Keywords

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    JEL classification:

    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H1 - Public Economics - - Structure and Scope of Government
    • P16 - Political Economy and Comparative Economic Systems - - Capitalist Economies - - - Capitalist Institutions; Welfare State

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