Budget Deficits and Income Fluctuation in a Political Economy

Abstract

Chapter 1 showed that the “functioning-of-government” index, as published in the Economist Intelligence Unit’s Democracy Index, has a significant effect on fiscal cyclicality. This index represents the strength of governments to execute their policies independently. In this chapter, we build a theoretical model to treat this independence in order to consider how a government may determine the level of deficit and to investigate the applicability of this model empirically. If the government can control political behavior, normally, the budget deficit should increase during recession as a first-best case. However, interestingly, recession does not necessarily prompt an increase in the optimal budget deficit in the second-best case in a political economy. The response of the optimal budget deficit to income fluctuations mainly depends on the efficiency of political effort, which may correspond to the functioning of governments in a democratic society. We test the predictions of a procyclical fiscal policy and find it applicable to democratic countries with semi-efficient governments.

Appendix

Under $T_{i} = ntw_{i}$, we have

$$\frac{{d\bar{D}}}{{dw_{1} }} = - \frac{{ - U_{GG}^{1} z_{w}^{1} (1 - t) + U_{GG}^{1} (1 - z_{T}^{1} )t}}{{(1 + r)^{2} \rho U_{GG}^{2} + U_{GG}^{1} }},$$

(A.1)

$$\frac{{d\bar{D}}}{{dw_{2} }} = \frac{1 + r}{1 + \rho }\frac{{ - U_{GG}^{2} z_{w}^{2} (1 - t) + U_{GG}^{2} (1 - z_{T}^{2} )t}}{{(1 + r)^{2} \rho U_{GG}^{2} + U_{GG}^{1} }}.$$

(A.2)

Then, if

$${\text{F}} = - U_{GG}^{1} z_{w}^{1} (1 - t) + U_{GG}^{1} (1 - z_{T}^{1} )nt > 0,$$

(A.3)

the sign of (A.1) would be positive and vice versa. In other words, if the sum of the effect of after-tax income on $\bar{D},$ $- U_{GG}^{1} z_{w}^{1} (1 - t)$, and the effect of revenue on $\bar{D},$ $- U_{GG}^{1} (1 - z_{T}^{1} )nt,$ were positive, then the sign of (A.1) would become positive and (A.2) becomes negative. It is thus optimal for the government to reduce the deficit ceiling in a recession.

• Data Appendix

• Multi-Country Panel

• Domestic support subsidies for agriculture

  • From the website of the Agriculture Information Management System of the WTO

    http://www.wto.org/Pages/Pillars.aspx

    http://www.wto.org/english/tratop_e/agric_e/dataset_ds_e.xls

    (last accessed on November 17, 2014)

• GDP deflator

  • From the website of the World Economic Outlook (WEO) database of the International Monetary Fund (IMF)

    http://www.imf.org/external/pubs/ft/weo/2014/01/weodata/download.aspx

    (last accessed on November 17, 2014)

  • WEO subject code: N_GDPD

• Exchange rates

  • From the International Financial Statistics Yearbook (2002) and the website of the International Financial Statistics of the IMF

    http://elibrary-data.imf.org

    (last accessed on November 17, 2014)

  • Concept: national currency per U.S. dollar, period average

• Real GDP in agriculture

  • From the FAOSTAT website of the FAO

    http://faostat3.fao.org/download/Q/QV/E

    (last accessed on November 17, 2014)

  • Element: gross production value (constant 2004–2006 million standard local currency (SLC))

  • Item: agriculture (PIN) + total

• Population in the agricultural sector

  • From the FAOSTAT website of the FAO

    http://faostat3.fao.org/download/Q/QV/E

    (last accessed on November 17, 2014)

  • Element: total economically active population in agriculture

• Indices in Freedom in the World

  • From the website of Freedom House

    https://www.freedomhouse.org/report-types/freedom-world

    (last accessed on November 17, 2014)

• Japanese Data

  • Income, disposable income, and tax payments from 1963 to 2003 from Statistics on Trend of Management

    http://www.maff.go.jp/j/tokei/kouhyou/noukei/einou_syusi/index.html

    (last accessed on February 11, 2014)

    • Total income (in Japanese) (Column O in e005c-001-000-000-000.xls)

    • Disposable income (in Japanese) (Column O minus Column P in e005c-001-000-000-000.xls)

• Income, disposable income, and tax payments from 2004 to 2010 from Statistical Survey on Farm Management and Economy

  http://www.maff.go.jp/j/tokei/kouhyou/noukei/einou_syusi/index.html

  (last accessed on February 11, 2014)

  • Total income (in Japanese; 20 subjects from 2004 to 2008 and 22 in 2009 and 2010; from Table 1 in each annual issue.)

  • Disposable income (in Japanese; 22 subjects from 2004 to 2008 and 24 in 2009 and 2010; from Table 1 in each annual issue.)

• Spending of the central government from General Accounts—Settlement of Expenditure by Purpose

  http://www.stat.go.jp/data/chouki/05.htm

  (last accessed on February 11, 2014)

  • Agricultural spending: agriculture, forestry, and fisheries (Column x in Sheet 5-2-c)

  • Other primary spending: total value minus local government finance—bond expenditure (Columns c, m, and as in Sheet 5-2-c)

• Time series data of spending of the local government from Ordinary Accounts of Local Governments—Settlement of Expenditure by Purpose and Function http://www.stat.go.jp/data/chouki/05.htm

  (last accessed on February 11, 2014)

  • Agricultural spending: agriculture, forestry, and fishery expenses (Column i in Sheet 5-12-c)

  • Other primary spending: net total minus bond expenditure (Columns c and ao in Sheet 5-12-c)

• Panel data of spending by the local government from Ordinary Accounts of Local Governments—Settlement of Expenditure by Purpose

  http://www.soumu.go.jp/iken/zaisei/toukei.html

  (last accessed on February 24, 2014)

  • Agricultural spending: agriculture, forestry, and fishery expenses (from various issues)

  • Other primary spending: net total minus bond expenditure (from various issues)

• Deflator from Annual Report on National Accounts of 2000 and 2011

  http://www.esri.cao.go.jp/en/sna/data/kakuhou/files/kako_top.html

  (last accessed on February 11, 2014)

  Deflator: final consumption expenditure of households (Row 9 in 21ffm1dn_en.xls and 55ffm1d.xls.)

  (We adjust the latter series (68SNA series in 55ffm1d.xls) by multiplying the ratio in 1980 of the former (93SNA series in 21ffm1dn_en.xls) to the latter and then connect this with the former series.)