The Public Finance Deficit From the Perspective of the New Political Economics

The article examines mechanisms governing public finance and budget deficits in democratic countries as well as tendencies toward an increase in the overall level of public spending. The analysis is based on a dynamic theoretical model that focuses on households and their behaviors to maximize benefits resulting from the consumption of public goods. Households are divided into two groups depending on their preference for a specific type of public goods. The point of reference is an analysis of a social planning procedure designed to maximize social benefits by choosing an appropriate level of the deficit and spending on individual public goods. The institutional framework of the model is subsequently modified in two ways. The first method involves a decision-making process based on an independent choice of the consumption level for public goods by individual groups of households. The second method involves decisions made by authorities and politicians motivated by a desire to secure reelection. At the same time, the author examines what he calls “information asymmetry” in the budgetary process. An analysis of the presented model reveals that both modifications lead to an excessive/suboptimal budget deficit. The first option may additionally cause an excessive level of public spending in the economy. The study points to the existence of two important mechanisms behind an excessive public finance deficit and the consequent accumulation of debt in democratic countries. The first mechanism is based on a situation in which decisions are made by many independent entities in a decentralized budgetary process. These entities are not fully responsible for the consequences of their decisions. The second mechanism involves the problem of proper representation of the people under the information asymmetry between voters and fiscal policy makers