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Political Budget Cycles and Fiscal Decentralization

  • Gonzales, Paula

    (Universidad Pablo de Olavide, Spain)

  • Hindriks, Jean

    (Universite Catholique de Louvain, Belgium)

  • Lockwood, Ben

    (University of Warwick)

  • Porteiro, Nicolas

    (Universidad Pablo de Olavide, Spain)

In this paper, we study a model à la Rogoff (1990) where politicians distort fiscal policy to signal their competency, but where fiscal policy can be centralized or decentralized. Our main focus is on how the equilibrium probability that fiscal policy is distorted in any region (the political budget cycle, PBC) differs across fiscal 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 majority 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 off 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 specification of the model.

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Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 742.

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Length: 36 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:wrk:warwec:742
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