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Political budget cycles and fiscal decentralization

  • GONZALEZ, Paula
  • HINDRIKS, Jean
  • PORTEIRO, Nicolas

In this paper, we study a model ` a la Rogoff (1990) where politicians distort ï¬scal policy to signal their competency, but where ï¬scal policy can be centralized or decentralized. Our main focus is on how the equilibrium probability that ï¬scal policy is distorted in any region (the political budget cycle, PBC) differs across ï¬scal regimes. With centralization, there are generally two effects that change the incentive for pooling behavior and thus the probability of a PBC. One is the possibility of selective distortion: the incumbent can be re-elected with the support of just a ma jority of regions. The other is a cost distribution effect, which is present unless the random cost of producing the public goods is perfectly correlated across regions. Both these effects work in the same direction, with the general result that overall, the PBC probability is larger under centralization (decentralization) when the rents to office are low (high). Voter welfare under the two regimes is also compared: voters tend to be better of when the PBC probability is lower, so voters may either gain or lose from centralization. Our results are robust to a number of changes in the speciï¬cation of the model.

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Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2006031.

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Date of creation: 00 Mar 2006
Date of revision:
Handle: RePEc:cor:louvco:2006031
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