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A ruling party decides each of two periods on the level of public goods which it finances by means of taxation and internal debt. The debt has to be honoured by the government of the second period. Between the two periods elections take place, which may change the ruling party.
The book analyzes the fiscal decision of the first government which aims to maximize the long run utility of its representative voter. Conditions under which the government uses debt strategically in order to stay in power are identified. It is also shown how the fiscal decisions hinge on the populations' political structure and its beliefs about the future government.

Inhaltsverzeichnis

Frontmatter

1. Introduction

Abstract
Public debt has been the subject of deep concern to prominent economists already in the 18th century. Almost all of the leading British classical economists were opposed to the maintenance of a national debt. Their negative forebodings were intensified by such gloomy forecasts as Mathus’ population doctrine or the existence of diminishing returns in agriculture. Adam Smith helped to establish the mood when he prophesied that ” the enormous debts” of his time ”will in the long run probably ruin all the great nations of Europe” [1776]. p.863.
Jessica de Wolff

2. The Evolution of Public Debt

Abstract
In this section we want to sketch a picture of the fiscal behaviour of the industrialized economies. Of course there are many variables one would have to look at in order to derive a detailed picture. Nevertheless, for our purpose it suffices to provide a rough presentation. Our goal is to bring into focus the empirical puzzle that triggered the literature on the political economy of budget deficits and in particular our approach. Hence, we concentrate on some evidence concerning the trends in budget deficits and public debt in the OECD countries since the mid-1960s.
Jessica de Wolff

3. Literature Survey: The Political Economy of the Government Budget

Abstract
The literature on the political economy of fiscal policy is very large and dates back to the 19th century with the Swedish and Italian schools of public finance. Some examples are Wicksel’s rejection of the idea of a benevolent dictator, Lindahl’s work on the’ fair’ distribution of tax shares, Mazzola’s and Sax’s discussion of the demand side of public goods by identifying collective as distinct from private wants or Puviani’s idea that the’ fiscal illusion’ of voters governs the evolution of tax structures, see Ekelund/Hébert [1990], pp.631–639 and Buchanan [1960]. The political approach to economics has experienced a strong revival with the public choice school and the work of its founder Buchanan. One crucial assumption of the part of the public choice school that deals with budget deficits is the fiscal illusion of voters: Voters do not understand the government’s intertemporal budget constraint. When offered a deficit-financed expenditure program they overestimate the benefits of current expenditures and underestimate the future tax burden. Thus, they vote for ”overspending”1. Of course it is difficult for the electorate to understand the complexity of the government budget. However, there is a crucial difference between errors and illusion. If voters make uncorrelated errors, on average they do not over- or underestimate the costs and benefits of taxes and spending. An illusion implies a systematic bias in these errors. While it is uncontroversial that voters make mistakes and are imperfectly informed, it is not at all obvious why the mistakes should be biased in a certain direction.
Jessica de Wolff

4. Introduction to the Model

Abstract
We now come to present our model. Before we explain it with all the technical details we will describe it in this section only verbally and intuitively. This allows the reader to get a thorough picture of the model without being overwhelmed by technicalities. Moreover, we discuss the assumptions and the main novelties of the model, showing similarities and differences from the existing literature as described in section 3.5.
Jessica de Wolff

5. The Model

Abstract
In the previous chapter we have fully described the model and its results verbally. We now present the model formally and we derive all the results. The model is a two-period model with elections held between the periods. The economy consists of a — possibly different — government in each period and a large number of consumers.
Jessica de Wolff

6. The Implications for Fiscal Policy

Abstract
Before we now finally come to solve the fiscal policy problem of the government in power in the first period, let us recapitulate what we have done in the previous chapter. First we have solved the individual consumers’ savings problem, given some fiscal policy announcement (τ, S). We then derived the optimal tax rate the parties will wish to set in the second period given the debt inherited from the first period. We have then rewritten the problem in terms relevant for the government’s policy decision. We argued that the government is interested in the overall consequences of its actions and not in what each single individual in the society does. Rewriting the model makes it also technically easier to handle and we can even eliminate the influence of the exogeneous beliefs when solving the elections’ problem. We then derived ρ as the variable determining the whole system and analyzed the election outcome as a function of ρ. We first restricted our economy to two types of distributions so that we could derive clear-cut results concerning the electoral outcome as a function of ρ. We then derived election outcome functions for both types of society. Finally, we introduced μ as an indicator for the economy’s political attitude.
Jessica de Wolff

7. Conclusions

Abstract
The Model and its Novelties. We have presented a two-period model of political economy in which the government in power in the first period levies taxes and sells bonds to produce a public good. The government in the second period levies taxes to repay the debt to the individual savers and produce some public good. Between the periods consumers are asked to vote the party that will reign in the second period.
Jessica de Wolff

Backmatter

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