A large amount of scientific literature deals with the explanation of public deficits. While some research aims at directly determining public deficits, another part pays attention to other related aspects. Among those aspects, the literature principally focuses on the public sector share in GDP, public revenue and spending and the determinants of indebtedness.
First of all, researchers started to focus their attention on the economic determinants of public deficits. Those researchers notably studied the influence of economic growth on public deficits. As commonly known, automatic stabilizers increase tax revenues and decrease public spending during an economic growth period. A higher surplus (or a lower deficit) should thus result from such a situation. Conversely, during a recession, economic stabilizers tend to decrease tax revenues and increase public spending, which would lead to larger deficits. Nevertheless, as suggested by Martin and Soguel (2004), governments would perform pro-cyclical budgetary policies that would tend to alleviate the effects of economic stabilizers. In other words, governments would be tempted to use additional revenue collected during booms in order to increase public spending. If this were to be true, the economic stabilizers effects are expected to be overturned, which would lead to smaller surpluses or larger deficits.
Some variables directly affected by the business cycle have an additional impact on public deficits. Among others, those variables include the unemployment rate. Since it affects public revenue as well as public spending, the unemployment rate is a major factor to be
taken into account when studying the determinants of fiscal balances. Indeed, because of the higher unemployment rate, social spending are higher in order to support the unemployed population. Then, as the tax base is diminished, tax revenues collected by the state will be lowered.
The question of debt also has to be handled when scrutinizing public deficits. Whereas these deficits are the origin of public debt, the latter also acts on the former. Indeed, gov- ernments will have to bear the cost of the debt, characterized by interest payments. Since interest payments are positively correlated with the debt level, the higher the debt level, the more interest payments will weigh down the fiscal balance. This situation may thus lead to some problems in terms of budgetary management (Martin 2008). Indeed, amounts allocated to the interest repayment are not allocated to public policies; it is thus a loss of elbow room in the use of public spending. Furthermore, because of deficits and the higher indebtedness level, the states appear more risky to the financial markets. That way, Laubach (2009) and Baldacci and Kumar (2010) demonstrate that states have to bear higher borrowing costs, which will further aggravate public deficits. This rollover effect of debt accumulation is known as the snowball effect of the public debt (Martner and Tromben 2012).
The political ideology of the parliament and the government also constitute a factor which may deeply influence public finance. Hibbs (1987) reveals that, as a rule, states with left-wing authorities are expected to implement more social public policies or public poli- cies aiming at fighting against unemployment than right-wing authorities. As these public policies are often relatively costly, the author assumes that public spending will be higher in countries governed by left-wing authorities. Nonetheless, he underlines that public deficits will not necessarily be higher in those countries. Indeed, as left-wing authorities are expected to raise higher taxes than right-wing ones, the final effect on public deficits is undetermined. Later, Blais et al. (1993), who scrutinize 15 liberal democracies over a period of 28 years, demonstrate that parties on the left of the political spectrum do spend slightly more than parties on the right. That way, their findings highlight that“parties do make a difference, but a small one”. Then, focusing on 16 OECD countries between 1955 and 1989, Cusack (1997) reaches similar evidence. Tellier (2006) also demonstrates that, in Canadian provinces, the
governments’ ideology has an influence on public expenditure. Indeed, her results show that left-wing parties significantly spend more than center and right-wing parties. Then, Hi- bbs’s assumptions appear to be confirmed since Allers et al. (2001) demonstrate that Dutch municipalities with “a council dominated by left-wing parties have a higher tax burden”. Nev- ertheless, although these researchers highlight that left-wing governments tend to spend more than right-wing ones, other authors alleviate the importance of the governments’ ideology for the public sector financial management. In this regard, Seitz (2000) who uses data on Ger- man Länder brings out that regional differences in public spending policy are only marginally determined by the ideological composition of the government. Similar findings are revealed by Galli and Rossi (2002) and Potrafke (2011) when they show that the composition of the government’s budgets is not driven by the governmental ideology. Moreover, in spite of the expected spending behavior of the left-wing governments, none of the previous cited studies reveal whether left-wing parties accumulate larger deficits than right-wing ones. Besides, Imbeau (2004), who focuses his study on the explanation of fiscal balances, does not find any significant differences in terms of public deficits between jurisdictions governed by left-wing or right-wing authorities either. To the best of our knowledge, only Alt and Lassen (2006), who undertake extensive research on 19 OECD countries, find evidence that“right-wing gov- ernments (for strategic reasons) tend to have higher deficits than left-wing governments”.
The political fragmentation of the government, as the political ideology coherence of a government measured by the number of political parties in a cabinet, may be an issue in the explanation of public deficits. Roubini and Sachs (1989) assume that the disagreement between political parties in the decision making process would be another cause of public deficits. Indeed, it is increasingly difficult to reach an agreement when the number of stake- holders increases. That way, the greater the conflict between stakeholders, the more difficult it will be to enact deficit reducing measures. This assumption is consistent with the model of Valesco (2000), since he predicts that spending and deficits increase with the number of stakeholders associated in the decision-making process. Several studies have investigated the impact of government fragmentation on public deficits, and the results ensuing from them are quite contrasted. While Kontopoulos and Perotti (1999) and Ashworth and Heyndels
(2005), who respectively pay attention to OECD countries and Flemish municipalities, find evidence that the number of political parties in a coalition tends to significantly increase public spending, some other authors (Volkerink and De Haan 2001; Elgie and McMenamin 2008) do not reach the same conclusion.
Then, instead of concentrating on the number of political parties associated with the decision-making process, other researchers assess the importance of government size on pub- lic deficits. Always following the assumption of Valesco (2000), those studies aim at assessing whether or not larger cabinets generate higher deficits. That way, a larger number of spend- ing ministers in a government would be associated with higher public spending and deficits.15
This assumption is more widely defended in the literature than the previous one since several researchers focusing on OECD countries demonstrate that the number of spending minis- ters is positively correlated with the level of public deficits (Kontopoulos and Perotti 1999; Volkerink and De Haan 2001; Elgie and McMenamin 2008). Nonetheless, Ricciuti (2004) who also pays attention to OECD countries over the period 1975-1995, finds relatively poor evidence that government size influences fiscal outcomes. Therefore, as suggested by Elgie and McMenamin (2008), “the importance of political fragmentation could vary according to the institutionalization of the political systems”. Furthermore, Schaltegger and Feld (2009), who investigate Swiss cantons, also find evidence that a larger government generates signifi- cantly higher public spending. Ashworth and Heyndels (2005) also highlight that, in Flemish municipalities, during downturns, “expenditure are cut back more in municipalities with fewer ministers”.
The solidarity between the executive and the legislative powers, which may be measured as the proportion of government parties represented in the parliament, may be another aspect influencing public deficits. As suggested by Roubini and Sachs (1989), if there is no concordance between them, they will probably face difficulties in reaching agreements. The authors believe that this situation would result in excessive overall spending, and that deficits would therefore be higher. Studying a panel of 22 OECD countries, Volkerink and De Haan (2001) confirm this assumption by demonstrating that governments having a
majority in parliament have lower deficits.
Moreover, by their own behavior around electoral periods, politicians may influence fiscal outcomes; it is the so-called political business cycle. According to Nordhaus (1975), politicians do not work for the population’s general interest but are self-interested. The main objective of politicians would be to ensure their reelection. When an election approaches, politicians seek to obtain the citizens favor by increasing public spending and decreasing the tax burden. Such operations would deteriorate fiscal balances. Several studies tend to confirm this assumption. First, by focusing on a panel of 24 developing countries, Schuknecht (2000) affirms that governments tend to perform expansionary fiscal policies during election years. To achieve this objective, governments resort more largely to public spending increases in spite of tax decreases. Furthermore, as revealed by Kneebone and McKenzie (2001), opportunistic behavior is also perceptible in Canadian provinces. Indeed, their study shows that governments are inclined to increase visible public spending (e.g. schools, roads or hockey rinks) around electoral periods. The political business cycle also seems to be an issue at the municipal level, since Veiga and Veiga (2007) report that Portuguese municipalities tend to increase highly visible public spending during pre-electoral periods. Finally, Shi and Svensson (2002) found clear evidence of a political budget cycle in both developed and developing countries. Nonetheless, their findings highlight that the political budget cycle may depend on the government’s probability to remain in power and also on the share of informed voters in the electorate.16
In addition to the political determinants, a portion of the literature devoted to public deficits and indebtedness focuses on institutional factors. The study of the fiscal rules or budget constraints is one of them. Indeed, at the national or subnational level of government or sometimes even at the municipal level, some countries have introduced budget constraints in order to ensure sustainable fiscal policies. Moreover, these budget constraints may have different forms since they are attached to government deficits, taxes, expenditure or debt. However, as previously discussed, the effect of such budget rules is unclear. Indeed, there
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Instead of focusing on the parliament and government political composition as a whole, a new strand of literature also discusses the particular role played by finance ministers on the budgetary figures. Detailed evidence is presented
is little evidence about their effectiveness on the government’s fiscal soundness. For some authors, including Fatás and Mihov (2006), who scrutinize U.S. states, it is evident that fiscal rules lead to higher deficits. Contrastingly, Hallerberg et al. (2007a) have a more nuanced point of view since they argue that the effectiveness of budget rules will depend on the type of government and, hence, the political environment and constitutional characteristics, such as the electoral system. Conversely, Feld and Kirchgässner (2008) provide evidence that budget constraints allowed to reduce public deficits in Swiss cantons. Nonetheless, although Luechinger and Schaltegger (2011) reach the same conclusions, they argue that one must not rule out that deficits have been reduced, at least partially, through creative accounting operations. Some other authors, in European countries as well as in the U.S. states, put the emphasis on this perverse aspect surrounding fiscal rules.
Furthermore, Switzerland, which is a direct democracy, has two particular institutional tools aiming to restrain public spending and therefore public deficits: the fiscal referendum and the right of initiative. The fiscal referendum may be described as an institutional tool, which aims to put public spending under pressure. This expected effect may occur in two ways. Firstly, it can allow citizens to express themselves concerning spending that are put to the vote. Since citizens are perceived as more fiscally conservative than elected politicians (Peltzman 1992), it is expected that citizens will use fiscal referendums to avoid new public spending.17 Secondly, fiscal referendums are launched only when a new spending exceeds
a predetermined financial threshold. That way, the government will self-regulate and will pay attention to new spending if they do not want their project subjected to the popular vote. Nevertheless, the government may avoid this constraint by resorting to loopholes. Assuming a public project exceeds the financial threshold and subsequently is put to the ballot, the government may split this project into several sub-projects so as to avoid the financial constraint. More particularly, it must be underlined that there are two kinds of fiscal referendums: the mandatory and the optional. While the mandatory one is automatically launched if a public spending exceeds the financial threshold, the optional one is not. Indeed,
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Studying the results of referendums is a good device to assess whether or not politicians respect the median voter theorem. If this were to be true, citizens would not reject a project subjected to the ballot since politicians would
with an optional referendum, voters can call for a referendum on a new public spending by collecting signatures from a predetermined number of citizens. So far, empirical studies devoted to this instrument tend to demonstrate that referendums have beneficial impacts on budget figures (Martin 2008; Feld and Matsusaka 2003).
The right of initiative is the second institutional tool that citizens can use to influence cantonal public finance, since it allows citizens to propose new laws or modifications of the constitution. Nevertheless, it seems to be particularly difficult to predict the way in which this institutional tool will affect budget figures. On the one hand, as suggested by Feld and Matsusaka (2003), the right of initiative provides a way for citizens to cancel spending programs that fall short of the referendum spending threshold. In this respect, the right of initiative would have a positive effect on cantonal fiscal soundness. However, on the other hand, one must consider the probability that new laws and modifications of the constitu- tion tend to worsen public deficits. The final effect of the popular initiative is therefore unforeseeable.
Some authors (e.g. Alesina and Perotti 1996) also devote their attention to thebudgeting process, i.e. the different steps through which the budget is developed. More particularly, the recent literature opposes the bottom-up and the top-down budget process. Kim and Park (2006) demonstrate that OECD countries that use a top-down budget process, which is based on a government fixed funding envelope attributed to each ministry, are better at restrain- ing public spending and deficits than countries that resort to bottom-up budget processes. Indeed, in a traditional bottom-up budget process, spending ministries dispose of an informa- tion asymmetry allowing them to formulate requirements that tend to be higher than their real budgetary needs, generating higher public spending and deficits. Nonetheless, Feld and Kirchgassner (1999) come to another conclusion as they find that, in Swiss municipalities,
“the bottom-up procedure incorporating direct democracy elements seems to be more promising for reducing public debt than a top-down procedure”. Furthermore, Lauth (1978) indicates that implementing Zero-Base budgeting instead of the incremental budget process allowed for a reduction of financial inefficiencies in the U.S. states. The incremental budget process is often considered as inefficient since it simply consists in proportionally increasing public
revenues and public spending of the precedent year in order to establish the current figures (Wildavsky 1986). That way, the public spending would increase year after year without any economic justification.
Finally, another strand of literature is devoted to more specific items. For instance, Martin (2008) expresses some assumptions in regard to the population age. He assumes that an elderly population tends to increase deficits since tax revenues decrease and social spending increases. He has also formulated the same assumption for a young population. According to his point a view, in the presence of a young population, the educational spending are higher and the tax revenues are smaller than in the presence of an active population. Also considering demography, Feld and Kirchgässner (2008) for instance, suggest that urban localities would suffer higher deficits since their inhabitants claim for larger public services such as public cultural goods.