Does Right or Left Matter? Cabinets, Credibility and Fiscal Adjustments

This paper uses the widely held assumption that left-wing cabinets prefer a larger size of government than right-wing cabinets to answer the question: does the pair cabinet ideology - fiscal action affect the persistence of fiscal adjustments? For a panel of OECD countries from 1960 to 1995, we find that left and right-wing cabinets are partisan in the expected way, namely, when cutting the deficit, the left relies on tax increases and the right on spending cuts. Our testable hypothesis is that cabinets signal commitment and gain credibility by pursuing fiscal adjustments in ways not favored by their constituents, i.e., the left cuts expenditures and the right increases taxes. Probit estimates of the impact of adjustment characteristics on the likelihood of success provide evidence in favor of the fact that cuts in spending by the left and tax increases by the right lead to more persistent adjustments than the reverse. These results are consistent with the literature on fiscal adjustments that has revealed that adjustments pursued by spending cuts are more persistent. We identify other adjustment characteristics that influence the persistence of the deficit cut: coalition cabinets, as well as majority cabinets, are less likely to be successful; a high level of public debt or a public debt that has been growing in the recent past tend to make the adjustment more credible. We also find evidence that private investment responds to the pair cabinet ideology - fiscal action in a way that is consistent with our hypothesis. First, cuts in spending by the left have a stronger stimulative effect on investment than cuts by the right, whereas increases in taxes by the left actually contract private investment, in contrast to the positive effect of tax increases by the right.