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Federal politics and budget deficits: evidence from the states of India

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  • Khemani, Stuti

Abstract

This paper tests two predictions implied by models of the common-pool game in federations where subnational governments are more likely to have higher deficits because they do not internalize the macroeconomic effects of fiscal profligacy. The first is that subnational governments that belong to the same political party as the central government have lower spending and deficits because they are more likely to be influenced to internalize the macroeconomic effects of additional local spending; and the second is that subnational governments that are more dependent on intergovernmental transfers have higher spending and deficits. We find that in 15 major states of India over the period 1972-1995, states in fact have substantially higher spending and deficits (higher by about 10 percent of the sample average) when their government belongs to the same party as that governing at the center; and that intergovernmental grants tend to have a counter-intuitive negative effect on spending and deficits. The additional deficit of affiliated states is financed almost entirely by additional loans from the central government (as opposed to the market) leading to our interpretation that similar political considerations influence the distribution of deficits across states as they do other intergovernmental grants. We argue that the evidence from India, contrasted with broader international evidence, indicates that the effect of fiscal institutions in a federation is sensitive to underlying political incentives. This underscores the overall importance of political institutions in determining the consolidated government deficit, relative to specific rules of intergovernmental transfers.

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  • Khemani, Stuti, 2002. "Federal politics and budget deficits: evidence from the states of India," Policy Research Working Paper Series 2915, The World Bank.
  • Handle: RePEc:wbk:wbrwps:2915
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    Cited by:

    1. Singh, Nirvikar & Vasishtha, Garima, 2004. "Some Patterns in Center-State Fiscal Transfers in India: An Illustrative Analysis," Santa Cruz Department of Economics, Working Paper Series qt1r02k470, Department of Economics, UC Santa Cruz.
    2. Singh, Nirvikar, 2006. "State Finances in India: A Case for Systemic Reform," Santa Cruz Department of Economics, Working Paper Series qt8560h76z, Department of Economics, UC Santa Cruz.
    3. World Bank, 2004. "Stabilization and Fiscal Empowerment : The Twin Challenges Facing India's States, Volume 2. Detailed Report," World Bank Publications - Reports 16775, The World Bank Group.
    4. Kaushik Basu & Sattwick Dey Biswas & Pratik Harish & Sasi Dhar & Mounik Lahiri, 2016. "Is multi-party coalition government better for the protection of socially backward classes in India?," WIDER Working Paper Series 109, World Institute for Development Economic Research (UNU-WIDER).
    5. Ritika Jain, 2018. "Contributions to the exchequer funds by state level public sector enterprises: does political alignment matter?," Constitutional Political Economy, Springer, vol. 29(1), pages 93-113, March.
    6. Khemani, Stuti, 2003. "Partisan politics and intergovernmental transfers in India," Policy Research Working Paper Series 3016, The World Bank.
    7. Khemani, Stuti, 2004. "Political cycles in a developing economy: effect of elections in the Indian States," Journal of Development Economics, Elsevier, vol. 73(1), pages 125-154, February.
    8. Liu, Lili & Waibel, Michael, 2010. "Managing subnational credit and default risks," Policy Research Working Paper Series 5362, The World Bank.
    9. Kaushik Basu & Sattwick Dey Biswas & Pratik Harish & Sasi Dhar & Mounik Lahiri, 2016. "Is multi-party coalition government better for the protection of socially backward classes in India?," WIDER Working Paper Series wp-2016-109, World Institute for Development Economic Research (UNU-WIDER).
    10. Yesim Kustepeli & Gülcan Önel, 2005. "The Effects of Political Fragmentation on Fiscal Deficits in Turkey," Discussion Paper Series 05/02, Dokuz Eylül University, Faculty of Business, Department of Economics, revised 23 Nov 2005.
    11. Stephen Howes, & Deepak Mishra, & VJ Ravishankar, 2007. "Ten Years of World Bank Sub-National Policy-Based Lending to India: A Retrospective," ASARC Working Papers 2007-18, The Australian National University, Australia South Asia Research Centre.

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