The Political Economy of Unsustainable Fiscal Deficits

Roberto Pasten and James Cover

Latin American Journal of Economics-formerly Cuadernos de Economía, 2010, vol. 47, issue 136, 169-189

Abstract: This paper uses an intertemporal model of public finances to show that political instability can cause taxes to be tilted to the future, resulting in a fiscal deficit that is suboptimal and only weakly sustainable (in the sense of Quintos). This occurs because political instability gives the government an incentive to implement a myopic fiscal policy in order to increase its chances of remaining in office. The government achieves this by delaying taxes (or advancing spending) in order to buy political support, which in turn causes an upward trend in the deficit process and a financial crisis. Using annual data for Chile for the 1833-1999 period, we present statistical test results that support the model.

Keywords: Fiscal policy; political instability; weak and strong sustainability; cointegration with change in regime (search for similar items in EconPapers)
JEL-codes: E62 H21 H62 (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (6)

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Latin American Journal of Economics-formerly Cuadernos de Economía is currently edited by Raimundo Soto

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