A Dynamic Theory of Public Spending, Taxation, and Debt

American Economic Review · 2008 · Volume 98 · Issue 1

Abstract

This paper presents a political economy theory of fiscal policy. Policy choices are made by a legislature that can raise revenues via an income tax and by borrowing. Revenues can be used to finance a public good, whose value is stochastic, and pork-barrel spending. Policymaking cycles between a "business- as-usual" regime in which legislators bargain over pork, and a "responsible policymaking" regime in which policies maximize the collective good. Transitions between regimes are brought about by shocks in the value of the public good. Equilibrium tax rates are too high, public good provision is too low, and debt levels are too high. (JEL D72, E62, H20, H50, H60)

Keywords

Models of Political Processes: Rent-seeking, Elections, Legislatures, and Voting Behavior, Fiscal Policy, Taxation, Subsidies, and Revenue: General, National Government Expenditures and Related Policies: General, National Budget, Deficit, and Debt: General

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