Do expected downturns kill political budget cycles?

Abstract

The political budget cycle (PBC) literature argues that governments expand deficits in election years. However, what happens when an economic downturn is expected? Will the government allow the deficit to expand even further, or will it resort to spending cuts and tax increases? When voters expect less than full automatic stabilization, our model shows that opportunistic government behavior leads to smaller deficits, thereby responding procyclically to expected downturns. Panel data evidence for 74 democracies covering the period 2000-2016 robustly supports the theoretical procyclicality prediction. Moreover, expected downturns remain significant when other context-conditional PBC effects are included in the empirical analysis.

Uninformed voters with (im)precise expectations: Explaining political budget cycle puzzles

“…However, there are other papers that do not obtain a robust uninformed voter effect. For instance, Gootjes et al (2020) and Bohn and Sturm (2021) focus on political pressures, fiscal rules, and expected downturns, respectively, but do not find a robust positive effect of press freedom on fiscal manipulation. 4 In this paper, we aim to resolve these two empirical puzzles by introducing a previously unexplored conditioning factor into a simple theoretical PBC model.…”

“…Recent research reports PBCs in OECD countries(Bohn & Sturm, 2021;Gootjes et al, 2020;Jong-A-Pin et al, 2012;Streb et al, 2009) and in Eurozone countries(Efthyvoulou, 2012;Mink & De Haan, 2006). Further,Fukumoto et al (2020) report PBCs at the subnational level in Japan.4 InGootjes et al (2020), TableA4in their Supporting Information material file shows an insignificant interaction between media freedom and the election dummy.…”

“…Further,Fukumoto et al (2020) report PBCs at the subnational level in Japan.4 InGootjes et al (2020), TableA4in their Supporting Information material file shows an insignificant interaction between media freedom and the election dummy. InBohn and Sturm (2021), Table6shows the same interaction is only significant at the 90% level.5 In effect, we argue that the existing most recent empirical PBC literature is based on a first order approximation of the stochasticShi and Svensson (2006) model, thereby failing to incorporate the nuances involved with considering the second-order approximation of the model as is done theoretically inBohn (2019). This is important, because in this context the variance of the shocks will matter for the final result.6 A nice illustration of this isEfthyvoulou (2012) who finds that PBCs in the European Union are stronger in eurozone countries than non-eurozone countries.…”

Rational erraticism

“… F false[ ∙ false] is the distribution function. For simplicity (as in Bohn and Sturm, 2021), density function f false( ∙ false) = F normal′ false[ ∙ false] is assumed to be bell-shaped. Following Lohmann (1998) and Shi and Svensson (2006), both current and future shocks are unobservable for politicians as well as voters.…”

Read My Lips? Taxes and Elections

“…Contribution to the literature: Our study is related to the empirical literature on political business cycles (e.g., Ben-Porath, 1975;Schuknecht, 1996;Bloomberg and Hess, 2003;Shi and Svensson, 2006;Desai et al, 2007;Potrafke, 2010;Aidt et al, 2011;Brender and Drazen, 2013;De Haan and Klomp, 2013;Aidt and Mooney, 2014;Foremny and Riedel, 2014;Klomp and De Haan, 2016;Baskaran et al, 2015;Dubois, 2016;Bostashvili and Ujhelyi, 2019;Aidt et al, 2020;Potrafke, 2020;Bohn and Sturm, 2021). There is no study yet that investigates electoral cycles in overall tax reforms across countries.…”