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Political budget cycles and fiscal decentralization

Paula González, Jean Hindriks (), Ben Lockwood () and Nicolás Porteiro

No 2006031, CORE Discussion Papers from Université catholique de Louvain, Center for Operations Research and Econometrics (CORE)

Abstract: In this paper, we study a model ` a 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 ma jority 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 of 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.

Date: 2006-03
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Working Paper: Political Budget Cycles and Fiscal Decentralization (2006) Downloads
Working Paper: Political Budget Cycles and Fiscal Decentralization (2006) Downloads
Working Paper: Political Budget Cycles and Fiscal Decentralization (2006) Downloads
Working Paper: Political Budget Cycles and Fiscal Decentralization (2006) Downloads
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