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Rotten Parents and Disciplined Children: A Politico-Economic Theory of Public Expenditure and Debt

  • Song, Zheng

    (Fudan University)

  • Storesletten, Kjetil

    ()

    (Dept. of Economics, University of Oslo)

  • Zilibotti, Fabrizio

    (Univeristy of Zürich)

This paper proposes a dynamic politico-economic theory of debt, government finance and expenditure. Agents have preferences over a private and government-provided public good, financed through labour 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 as they are concerned with the ability to of future governments to provide public goods. We characterize the Markov Perfect Equilibrium of the dynamic voting game. If taxes do not distort labour supply, the economy progressively depletes its resources through debt accumulation, leaving future genereations "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. We extend the analysis to redistributive policies and political shocks. Consistent with the empirical evidence, our theory predicts governement debt to be mean reverting and debt growth to be larger under right-wing than under left-wing governments.

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File URL: https://www.sv.uio.no/econ/english/research/unpublished-works/working-papers/pdf-files/2008/memo-05-2008.pdf
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Paper provided by Oslo University, Department of Economics in its series Memorandum with number 05/2008.

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Length: 56 pages
Date of creation: 07 Nov 2007
Date of revision:
Publication status: Forthcoming as Song, Zheng, Kjetil Storesletten and Fabrizio Zilibotti, 'Rotten Parents and Disciplined Children: A Politico-Economic Theory of Public Expenditure and Debt' in Econometrica.
Handle: RePEc:hhs:osloec:2008_005
Contact details of provider: Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway
Phone: 22 85 51 27
Fax: 22 85 50 35
Web page: http://www.oekonomi.uio.no/indexe.html
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