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Engineering Crises: Favoritism and Strategic Fiscal Indiscipline

Gilles Saint-Paul (), Davide Ticchi and Andrea Vindigni

No 12291, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: If people understand that some macroeconomic policies are unsustainable, why would they vote for them in the first place? We develop a political economy theory of the endogenous emergence of fiscal crises, based on the idea that the adjustment mechanism to a crisis favors some social groups, that may be induced ex-ante to vote in favor of policies that are more likely to lead to a crisis. People are entitled to a certain level of a publicly provided good, which may be rationed in times of crises. After voting on that level, society votes on the extend to which it will be financed by debt. Under bad enough macro shocks, a crisis arises: taxes are set at their maximum but despite that some agents do not get their entitlement. Some social groups do better in this rationing process than others. We show that public debt -- which makes crises more likely -- is higher, as is the probability of a crisis, the greater the level of favoritism. If the favored group is important enough to be pivotal when society votes on the entitlement level, favoritism also leads to greater public expenditure. We show that the favored group may strategically favor a weaker state in order to make crises more frequent. Finally, the decisive voter when choosing expenditure may be different from the one when voting on debt. In such a case, constitutional limits on debt may raise the utility of all the poor, relative to the equilibrium outcome absent such limits.

Keywords: Entitlements; favoritism; Fiscal Crises; inequality; political economy; public debt; State Capacity. (search for similar items in EconPapers)
JEL-codes: E62 F34 H12 H6 O11 P16 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cdm, nep-mac, nep-pbe and nep-pol
Date: 2017-09
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