Example 15.07.16

Budget deficit, size of the public sector and majority voting

Jens Siebel (University of Siegen)

Introduction

Public debt has a long history in many countries. Since long time many economic explanations of public debt have been offered. Recently, political-economic explanations have gained more and more interest. In those models politicians, voters, voting procedures and institutional settings of democratic countries are analyzed with respect to their inherent tendency to run debts. Surveys are provided by Alesina and Perotti (1995) and Persson and Tabellini (1999 and 2000).

One of the more recent theoretical papers on that issue is Tabellini and Alesina (1990) which presents a very interesting explanation of public deficits in a democracy. In their two-period model Tabellini and Alesina explore a first-period median voter?s incentive to run a budget deficit when there is uncertainty about the second-period median voter?s preferences or when it is certain that the second-period median voter will favour another composition of government consumption. Under certain conditions the first period median voter is shown to alter the second period?s allocation of two public goods to better fit her own preferences by issuing a budget deficit or a surplus. Decisive for this result are the assumptions that outstanding debt needs to be served at the end of the second period i. e. that repudiation is ruled out effectively.

Tabellini and Alesina do not model the private sector at all. In addition to issuing or repaying public debt each government is assumed to have at its disposal a lump sum amount of money (tax revenues) in order to finance its expenditures. Such a setting allows determining the allocation of both public goods but not the allocation of resources between the public and the private sector; more specifically, it does not allow determining the size of the public and the private sector.

The following analysis aims at explaining budget deficits in a democracy by means of a two- period median voter model under certainty. In contrast to the work of Tabellini and Alesina (1990) a private sector will be endogenized which is taxed in order to finance a public good. This assures that both the public budget balance and the size of the public sector are determined endogenously.

The paper is organized as follows: first, the general properties of the models will be introduced in chapter 2. Chapter 3 examines the model under several assumptions about the median voters? preferences. Chapter 4 concludes.

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4. Conclusions

The general result is that an unbalanced budget can occur when the median voters? preferences in both periods diverge. These diverging preferences can also be interpreted as a political party system with two parties favouring a different size of the public sector and thus a different fiscal policy. According to their preferences for the size of the public sector we talk about a left-wing party or government and about a conservative / right-wing party or government. The government in office in the first period knows whether it will be in office in the second period or not.

Depending on the properties of the model several results were possible:

1. The parties favour a certain budget policy regardless of their ideological preference for the size of public sector. Then their policy aims at protecting their goals against their successor?s policy. The sign of the budget balance depends on the concavity properties of the utility function.
2. If at least one government has extreme preference for either the public or the private sector the sign of the budget balance is independent of the concavity properties of the utility function. Special cases occurred, which could be interpreted by the common assumptions of partisan theory:
3. 1. Left-wing governments are more deficit prone because of their redistributive goals and their preference for a larger public sector.
   2. Right-wing governments can generate deficits in order to enforce more fiscal discipline to their left-wing successor. Furthermore deficit finance enables a right-wing government to reduce taxes imposed on the high- valued private sector.

The results presented here have all been generated under the assumption that the first period?s government acts under certainty. It would be interesting to expand this model to the case of uncertainty e. g. when the first period?s government does not know whether it will stay in office in the second period and what the policy of its successor will be.

(http://hdl.handle.net/10419/23299)