Federal Politics and Budget Deficits : Evidence from the States of India
This paper tests two predictions implied by models of the common-pool game in federations where subnational governments are more likely to have higher deficits because they do not internalize the macroeconomic effects of fiscal profligacy. The firs...
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| Format: | Policy Research Working Paper |
| Language: | English en_US |
| Published: |
World Bank, Washington, DC
2014
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| Online Access: | http://documents.worldbank.org/curated/en/2002/10/2874487/federal-politics-budget-deficits-evidence-states-india http://hdl.handle.net/10986/19248 |
| Summary: | This paper tests two predictions implied
by models of the common-pool game in federations where
subnational governments are more likely to have higher
deficits because they do not internalize the macroeconomic
effects of fiscal profligacy. The first is that subnational
governments that belong to the same political party as the
central government have lower spending and deficits because
they are more likely to be influenced to internalize the
macroeconomic effects of additional local spending; and the
second is that subnational governments that are more
dependent on intergovernmental transfers have higher
spending and deficits. We find that in 15 major states of
India over the period 1972-1995, states in fact have
substantially higher spending and deficits (higher by about
10 percent of the sample average) when their government
belongs to the same party as that governing at the center;
and that intergovernmental grants tend to have a
counter-intuitive negative effect on spending and deficits.
The additional deficit of affiliated states is financed
almost entirely by additional loans from the central
government (as opposed to the market) leading to our
interpretation that similar political considerations
influence the distribution of deficits across states as they
do other intergovernmental grants. We argue that the
evidence from India, contrasted with broader international
evidence, indicates that the effect of fiscal institutions
in a federation is sensitive to underlying political
incentives. This underscores the overall importance of
political institutions in determining the consolidated
government deficit, relative to specific rules of
intergovernmental transfers. |
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