APPENDIX: A TWO-PERIOD MODEL
In this appendix, we look at budgeting in a two-period context to show that excess spending and excess deficits work in parallel due to the common pool problem. Thus, the government may decide to run a deficit in the first period to be financed by revenues in the second period. Denoting second-period variables with a prime, the government maximizes the preference function
where β is the time discount factor and ρ is the appropriate interest rate factor, with ρ > 1 > β > 0. We assume that βρ < 1, that is, the government discounts future events more than the capital markets.
If the government consisted of a single planner, the optimal level of spending in the first period, B, and the optimal deficit, D, would be
The optimal budget implies a deficit in the first period unless the spending targets in the second period, x*′, are sufficiently larger than the spending targets in the first period, x*.
With a government consisting of n spending ministers, each minister maximizes the following preference function,
A decentralized budget process leads to the following aggregate spending and deficit, comparing (14) and (16) leads us to two conclusions.
Consider, first, the case where no private incentives for increased spending exist (γ=0). Equation (16) implies that, whenever the collectively optimal budget (14) has a deficit in the first period, the deficit will be higher as a result of a decentralized budget process. Second, with γ > 0, the private incentives may entail a deficit in the first period from decentralized process, even if the collectively optimal budget has a surplus in the first period. Thus, a decentralized budget process leads to both a spending and a deficit bias.
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Jurgen von Hagen is a professor of economics at the University of Mannheim. He wishes to thank the Fiscal Affairs Department of the International Monetary Fund for its hospitality, where large parts of this paper where written while he was a visiting scholar. Financial support from the German Academic Exchange Service (DAAD) and the British Council are gratefully acknowledged.
Ian J. Harden is professor of Law, University of Sheffield, U.K., and currently at the Office of the Ombudsman of the European Parliament, Strasbourg, France.
This commitment is contained in Article 104c of the Maastricht Treaty.
Our sample does not include the new entrants of 1995.
Multi-year frameworks for budget preparation and lengthy accounting and discharge procedures may create even more overlap.
In Denmark, separate ministries prepare macroeconomic estimates and tax policy and revenue analysis. In Greece, the broad thrust and the coordination of economic and fiscal policies, as well as the preparation and implementation of a budget for public investments are the responsibility of the Ministry of the National Economy rather than the Ministry of Finance. In Italy, responsibilities in the planning stage are shared between the Treasury, the Finance Ministry, and the Budget Ministry; the Treasury Ministry is mainly responsible for the expenditure side while the Ministry of Finance monitors tax revenue.
In Italy, such a separate procedure was introduced only in 1978.
We can apply the Nash solution for bargaining processes to this problem.
Here we can use again the Nash equilibrium concept to determine the bargaining solution.
A more direct way to characterize this situation would let the finance minister maximize the function V subject to the constraint that the spending ministers obtain a level of utility U* large enough to assure the passing of his proposal. Both formulations lead to the same solution; a higher δ indicates a lower level of U* guaranteed for the spending ministers.
As discussed in von Hagen and Harden (1995), information asymmetries between the spending ministers and the finance minister affect the choice between these two approaches.
Another difference between the British and the French case is that procedural regulations are based on traditions in the former and written law in the latter.
This involvement results from the fact that the top civil servant in each spending department is accountable to the Treasury, though loyal to his own minister.
It is worth pointing out that, beginning in 1987, the Irish Government has managed to reduce their deficits and debt substantially. Since the early 1990s, an important element in these efforts was the commitment to the Maastricht process of the European Monetary Union, which requires the member countries to fulfill numerical entry conditions for deficits and debt. Thus, target-oriented centralization was provided externally through commitment to an international agreement.
Note, however, that the position of the finance ministry in Luxembourg can be elevated if the prime minister also acts as finance minister, as under the current government.
We refer here to the Belgian budget process prevailing during the 1970s and 1980s. Important changes have been introduced recently with the decentralization of the country and the implied acquisition of greater fiscal importance by the provinces.
This may be different for senior members of powerful parliamentary budget committees, as in the United States.
Our argument follows Tsebelis (1994) general one regarding the importance of the number of veto players in political decisions.
The government itself can propose unlimited amendments itself as a possibility to assuage parliamentary opposition against its original proposal.
Since 1995, revisions of the Greek budget require an amendment budget voted by Parliament.
All data are annual series taken from European Economy, which assures consistency of budget data definitions across countries. All data cover general government, which, in the case of Germany (the only federation in our data set) includes state governments. We decided to use general government data nevertheless for better data consistency. Legal regulations require state budget processes to follow largely the same rules as the federal government budget process in Germany.
Electoral reforms in the mid-1980s added some elements of proportionality to the French electoral system.