Rotten Parents and Disciplined Children: A Politico-Economic Theory of Public Expenditure and Debt

57 Pages Posted: 28 Jun 2007  

Zheng Michael Song

Fudan University - School of Economics

Kjetil Storesletten

University of Oslo - Department of Economics; Centre for Economic Policy Research (CEPR)

Fabrizio Zilibotti

University of Zurich; Centre for Economic Policy Research (CEPR)

Date Written: June 2007

Abstract

This paper proposes a dynamic politico-economic theory of debt, government finance and expenditure. Agents have preferences over a private and a government-provided public good, financed through labor taxation. Subsequent generations of voters choose taxation, government expenditure and debt accumulation through repeated elections. Debt introduces a conflict of interest between young and old voters: the young want more fiscal discipline. We characterize the Markov Perfect Equilibrium of the dynamic voting game. If taxes do not distort labor supply, the economy progressively depletes its resources through debt accumulation, leaving future generations "enslaved". However, if tax distortions are sufficiently large, the economy converges to a stationary debt level which is bounded away from the endogenous debt limit. The current fiscal policy is disciplined by the concern of young voters for the ability of future government to provide public goods. The steady-state and dynamics of debt depend on the voters' taste for public consumption. The stronger the preference for public consumption, the less debt is accumulates. We extend the analysis to redistributive policies and political shocks. The theory predicts government debt to be mean reverting and debt growth to be larger under right-wing than under left-wing governments. Data from the US and from a panel of 21 OECD countries confirm these theoretical predictions.

Keywords: Fiscal discipline, Fiscal policy, Government debt, Intergenerational conflict, Left- and right-wing governments, Markov equilibrium, Political economy, Public finance, Repeated voting

JEL Classification: D72, E62, H41, H62, H63

Suggested Citation

Song, Zheng Michael and Storesletten, Kjetil and Zilibotti, Fabrizio, Rotten Parents and Disciplined Children: A Politico-Economic Theory of Public Expenditure and Debt (June 2007). Available at SSRN: https://ssrn.com/abstract=996388 or http://dx.doi.org/10.2139/ssrn.996388

Zheng Song (Contact Author)

Fudan University - School of Economics ( email )

600 GuoQuan Road
Shanghai, 200433
China

Kjetil Storesletten

University of Oslo - Department of Economics ( email )

P.O. Box 1095 Blindern
N-0317 Oslo
Norway
+47 2284 4009 (Phone)
+47 2285 5035 (Fax)

HOME PAGE: http://folk.uio.no/kjstore/

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Fabrizio Zilibotti

University of Zurich ( email )

Rämistrasse 71
Zürich, CH-8006
Switzerland

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Paper statistics

Downloads
164
Rank
145,530
Abstract Views
1,228