A Dynamic Theory of Public Spending, Taxation and Debt

54 Pages Posted: 14 May 2006 Last revised: 26 Jul 2010

See all articles by Marco Battaglini

Marco Battaglini

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

Stephen Coate

Cornell University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: March 2006

Abstract

This paper presents a dynamic political economy theory of public spending, taxation and debt. Policy choices are made by a legislature consisting of representatives elected by geographically-defined districts. The legislature can raise revenues via a distortionary income tax and by borrowing. These revenues can be used to finance a national public good and district-specific transfers (interpreted as pork-barrel spending). The value of the public good is stochastic, reflecting shocks such as wars or natural disasters. In equilibrium, policy-making cycles between two distinct regimes: %u201Cbusiness-as-usual%u201D in which legislators bargain over the allocation of pork, and %u201Cresponsible-policy-making%u201D in which policies maximize the collective good. Transitions between the two regimes are brought about by shocks in the value of the public good. In the long run, equilibrium tax rates are too high and too volatile, public good provision is too low and debt levels are too high. In some environments, a balanced budget requirement can improve citizen welfare.

Suggested Citation

Battaglini, Marco and Coate, Stephen, A Dynamic Theory of Public Spending, Taxation and Debt (March 2006). NBER Working Paper No. w12100, Available at SSRN: https://ssrn.com/abstract=892125

Marco Battaglini

Princeton University - Department of Economics ( email )

213 Fisher Hall
Princeton, NJ 08544
United States
609-258-4002 (Phone)
609-258-6419 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Stephen Coate (Contact Author)

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States
607-255-1912 (Phone)
607-205-2818 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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