Institutionalized Bailouts and Fiscal Policy: The Consequences of Soft Budget Constraints

CESifo Working Paper Series No. 2827

49 Pages Posted: 12 Oct 2009

See all articles by Alexander Fink

Alexander Fink

University of Leipzig

Thomas Stratmann

George Mason University - Buchanan Center Political Economy; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: October 20, 2009

Abstract

States have soft budget constraints when they can expect a bailout by the federal government in the event of a financial crisis. This gives rise to incentives for unsound state fiscal policy. We test whether states with softer budget constraints have higher debt and deficits, receive more bailouts funds, spend funds less efficiently, and are more likely to allocate funds to programs benefiting special interests. Exogenous variation in soft budget constraints across states and over time allows the identification of budget constraint softness on state fiscal policy. We take advantage of the fact that in Germany, states’ political influence is exogenous because voting weights differ in the upper chamber of the German parliament. The stronger the political influence of states, the softer their budget constraints. We show that states with softer budget constraint have higher deficits and debts, and receive more bailouts funds. Further, overrepresented states are less efficient in spending public funds and are more prone to respond to rent seeking by interest groups.

JEL Classification: H7, H11, E62, E63

Suggested Citation

Fink, Alexander and Stratmann, Thomas, Institutionalized Bailouts and Fiscal Policy: The Consequences of Soft Budget Constraints (October 20, 2009). CESifo Working Paper Series No. 2827. Available at SSRN: https://ssrn.com/abstract=1485196

Alexander Fink (Contact Author)

University of Leipzig ( email )

Grimmaische Str. 12
Leipzig, 04109

HOME PAGE: http://www.alexander-fink.com

Thomas Stratmann

George Mason University - Buchanan Center Political Economy ( email )

4400 University Drive
Fairfax, VA 22030
United States
703-993-2330 (Phone)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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