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31-01-2018

Budget institutions and taxation

Author: Lasse Aaskoven

Published in: Public Choice | Issue 3-4/2018

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Abstract

While a number of different studies have explored the effects of budgetary procedures and the centralization of the budget process on government debt, deficits and spending, few of them have explored whether such fiscal institutions matter for public revenue. This article argues that centralizing the budget process raises the levels of taxation by limiting the ability of individual government officials to veto tax increases in line with common-pool-problem arguments regarding public finances. Using detailed data on budgetary procedures from 15 EU countries, the empirical analysis shows that greater centralization of the budget process increases taxation as a share of GDP and that both the type of budget centralization and level of government fractionalization matter for the size of this effect. The results suggest that further centralizing the budget process limits government debt and deficits by increasing public revenues as well as constraining public spending.

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See Alesina et al. (1999) for a study of the effects of different budgetary institutions in Latin America.

For exception to these findings, see Perotti and Kontopoulos (2002).

Or the minister responsible for preparing and implementing the public budget.

This can be represented as either an ideological preference for serving their constituency or an interest in securing future electoral support.

The finance minister is implicitly assumed to be concerned with balancing the public budget.

This line of argument resembles a situation where the government has fiscal room to implement tax cuts. Here, coalition members are incentivized to maximize cuts to their constituencies’ tax payments while freeriding on the tax payments of other constituencies. This leads to a common-pool problem, where total taxes end up lower than planned. In contrast, the finance minister takes the total budget balance into account when deciding the tax cut for each tax instrument. Consequently, the tax raised from each instrument—and the total level of taxation—will be greater when the finance minister has greater agenda-setting power than in a decentralized budget regime.

For a well-cited empirical study of the role of veto players in public budgets, see Tsebelis and Chang (2004).

These are the “old” EU countries: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden and the United Kingdom.

According to personal correspondence with one of the authors, the data most reliably captures actual budget practices and rules until the 2008 financial crisis, which is therefore the end year of the panel. Excluding the years after 2004 (the year of the last survey) from the analysis yields largely similar results.

In this article, the delegation centralization index is equal to the authors’ Delegation Index, while the contract centralization index is equal to the Fiscal Targets (Long-Term) index (Hallerberg et al. 2009, p. 74). The authors also construct a full Contracts Index, which includes aspects of the budget implementation. Replacing the one type of contracts index with the other yields mostly similar results (results available upon request).

As previously mentioned, the finance minister might still play an important role as “guardian” of the fiscal targets and their implementation (Hallerberg et al. 2009, p. 51), which might also include working to raise taxes to meet the financing requirements of these fiscal targets.

The index goes from 0 to 1, lower scores denoting larger government fractionalization, which should be noted when interpreting the results in Appendix C. It is also necessary to note that the government Herfindahl index only measures government size fractionalization, not ideological distances within the government.

The results are also similar if fractionalization is measured using the govfrac variable from the Database of Political Institutions, which measures the probability of two randomly picked government deputies being from different parties (Cruz et al. 2016). Results available upon request.

Source: the Comparative Political Dataset.

New theoretical and empirical studies of veto-player dynamics, which consider issues of time-extended policymaking and credible commitments (Tommasi et al. 2014; Bäck and Lindvall 2015), also generate different or amended theoretical predictions vis-à-vis the effect of veto players on government policy stability and government fiscal policy. This article can be seen as yet another contribution to the amendment of the veto-player framework in budgetary politics.

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Title: Budget institutions and taxation
Author: Lasse Aaskoven
Publication date: 31-01-2018
Publisher: Springer US
Published in: Public Choice / Issue 3-4/2018
Print ISSN: 0048-5829
Electronic ISSN: 1573-7101
DOI: https://doi.org/10.1007/s11127-018-0507-7

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