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


  • Alexander Fink
  • Thomas Stratmann


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.

Suggested Citation

  • Alexander Fink & Thomas Stratmann, 2009. "Institutionalized Bailouts and Fiscal Policy: The Consequences of Soft Budget Constraints," CESifo Working Paper Series 2827, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_2827

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    References listed on IDEAS

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    Cited by:

    1. Lars P. Feld, 2010. "Sinnhaftigkeit und Effektivität der deutschen Schuldenbremse," Perspektiven der Wirtschaftspolitik, Verein für Socialpolitik, vol. 11(3), pages 226-245, August.
    2. Aronsson, Thomas, 2010. "Optimal income taxation and decentralized fiscal federalism," Regional Science and Urban Economics, Elsevier, vol. 40(4), pages 187-195, July.

    More about this item

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H11 - Public Economics - - Structure and Scope of Government - - - Structure and Scope of Government
    • H70 - Public Economics - - State and Local Government; Intergovernmental Relations - - - General


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