Bailouts in a federation: A cooperative legislature at work

Willem Sas ()

ERSA conference papers from European Regional Science Association

Abstract: This paper revisits the soft budget constraint problem arising in decentralised countries. Capturing the specific dynamics of political decision making in a federation, new light is shed on the incentives at work when lower-level (state) governments overborrow and are bailed out by the federal level. An intertemporal model developed by Goodspeed (2002) is supplemented by the citizen-candidate approach of Besley and Coate (1997), to further align federal decision making with reality. In our model, where a cooperative legislature of locally elected representatives decides on federal grants going to the states, voters are shown to elect candidates with a higher preference for debt accumulation than would be expected. This strategic voting behaviour not only leads to overly generous bailout policies. Also, and compared to a setting where federal decision making follows the median voter, states are proven to overborrow more inefficiently because of this federal generosity. A case can then be made for federal constituencies where politicians are elected from across the entire federation, which would neutralize these additional inefficiencies.

Keywords: Fiscal decentralisation; bailouts; soft budget constraint; citizen-candidate model; cooperative legislature (search for similar items in EconPapers)
Date: 2013-11
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https://www-sre.wu.ac.at/ersa/ersaconfs/ersa13/ERSA2013_paper_00658.pdf (application/pdf)

Related works:
Working Paper: Soft budget constraints in a federation: the effect of regional affiliation (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:wiw:wiwrsa:ersa13p658

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