Fiscal rules, fiscal institutions, and fiscal performance

Abstract

Public spending is a story of some people spending other people’s money. In modern democracies, voters elect politicians to make decisions about public spending for them, and they provide the funds by paying taxes. Two aspects of this story are worrying and have received considerable academic interest in recent years. The first is that public spending involves delegation, and, hence, principal-agent relationships. Elected politicians can extract rents from being in office, i.e., use some of the funds entrusted to them to pursue their own interests, be it outright in corruption, for perks, or simply waste. Voters might wish to eliminate the opportunity to extract rents by subjecting politicians to rules stipulating what they can and must do under given conditions. But the need to react to unforeseen developments and the complexity of the situation makes the writing of such contracts impossible. For the same reasons, politicians cannot realistically commit fully to promises made during election campaigns. Hence, like principal-agent relations in many other settings, the voter-politician relationship resembles an “incomplete contract” (Seabright, 1996; Persson et al., 1997a, b; Tabellini, 2000).