Budget flexibility, government spending, and welfare

• Author: Sezer Yaşar
• Published date: 01 December 2018
• Date: 01 December 2018
• DOI: http://doi.org/10.1111/jpet.12309

Received: 13 October 2017 Accepted: 5 May2018

DOI: 10.1111/jpet.12309

ARTICLE

Budget flexibility, government spending, and

welfare

Sezer Ya¸sar

TEDUniversity, Turkey

Thispaper has circulated under the title “Line-

ItemAppropriations and Government Spending.”

SezerYa¸sar,Department of Economics,

TEDUniversity, Ankara, 06420, Turkey

(sezer.yasar@tedu.edu.tr).

A growing literature in economics provides a theory of budget

negotiations relying on Baron and Ferejohn's legislative-bargaining

approach. This literature assumes that legislators decide on all

dimensions of government spending once and for all in a period dur-

ing budget negotiations. However, legislators leave allocation deci-

sion of some funds to the executive authority and let it adjust gov-

ernment spending according to changing priorities in a year under

certain restrictions. In this paper, the author develops a legislative-

bargaining model to investigate the effects of budget flexibility on

government spending and welfare. In addition, he analyzes how leg-

islators choose the level of flexibility. He shows that, if legislators

decide on all dimensions of government spending, high polarization

leads to greater government spending. However, if the executive

authority allocates government resources, high polarization leads to

lower government spending. Besides, when the executive authority

allocates government resources under high polarization, legislators

cannot use their political power to induce overprovisionof their pre-

ferred public good. When legislators can choose the level of bud-

get flexibility,if the probability of polarization is high they prefer to

control all dimensions of government spending. The author shows

that budget flexibility benefits society only under high probability of

polarization.

1INTRODUCTION

Government budgets are composed of mandatory and discretionary spending. Whereas mandatory spending is deter-

mined by regulations in law, discretionary spending is determined by annual appropriation bills—that is, the acts that

enable the executive authority to spend moneyfor specific purposes. Appropriation bills are approved by the legisla-

tors through negotiations. Therefore, it is important to understand the details of these negotiations for government

spending and welfare.

A growing literature, including Baron (1991, 1993) and Persson (1998), provides a theory of budget negotiations

relying on the Baron and Ferejohn (1989) model of legislative bargaining. Papers in this literature assume that dur-

ing budget negotiations legislators decide on all dimensions of government spending once and for all in a period.

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However, legislators prepare government budgets at different levels of detail and leave the allocation decision of

some funds to the executive authority (OECD,2014; Tommasi, 2007). In addition, government budgets are revised in

a year—for example, bytransferring funds between the spending items—as political priorities change (Anessi-Pessina,

Sicilia, & Steccolini, 2012, 2013).

This type of flexibility can have important effects on the size and composition of governmentspending and its effi-

ciency implications. However,no formal model is proposed in the literature to understand these effects and how the

levelof budget flexibility is determined. In this paper, I aim to fill this gap in the literature. Tothis end, I develop a model

of budget negotiations combining Baron–Ferejohn's legislative-bargaining approach with the approaches to budget

flexibility in public-administration literature.Thus, the paper also contributes to the literature on budget flexibility by

providing a formal model to analyze flexibility'swelfare effects.

In the public administration literature,budget flexibility is discussed from two different perspectives. One strand of

literature, including Anessi-Pessina et al. (2013) and Tommasi(2007), focuses on the opportunity that it provides for

adjusting government spending to changing priorities in a year.They advocate for flexibility claiming that it increases

efficiency of budget execution.The changes in priorities may stem from, for example, natural disasters, unplanned mil-

itary operations, or changes in the international environment.1On the other hand, Banks and Straussman (1999) point

out that flexibility can cause a conflict between the executive and legislative authorities: adjustments in the govern-

ment spending will be made according to the policy preferences of the executive,and the legislature's control over the

budget will weaken. They illustratesuch a conflict with the 1996 U.S. defense budget and show how President Clinton

funded Bosnia operations using the flexibilityof the federal budget despite opposition in Congress.

Before explaining how the model combines a legislative-bargaining approach with approaches to budget flexibil-

ity, let us explain the institutions that determine budget flexibilitymore precisely. I consider three institutions in the

paper.2The first is the number of line-item appropriations. Line-item appropriations are the most detailed spending

levels in an appropriation bill. A smaller number of line-item appropriations gives more flexibility to the executive

authority. The second institution is the maximum amount of funds that the executiveauthority can transfer between

the spending items in an appropriation bill. These two institutions can be determined by the legislature while writing

an appropriation bill. The third institution allows the executiveauthority to transfer funds between the spending items

after getting approval from the legislature, which is actually allowed in many governments. An appropriation bill with

a small number of line items gives an unrestricted flexibility to the executiveauthority compared to a bill with a large

number of line items, whereas the other two institutions give restricted flexibilityto the executive authority.

Toanalyze these institutions, I construct a two-period model in which there are two groups and two public goods. I

also assume that there are two states of the world, no-polarization and polarization. A legislature consists of the rep-

resentatives of both groups. Executive authority is determined differently in presidential and parliamentary regimes

(Persson, Roland, & Tabellini,2000). I present my results first for a presidential regime and then I consider a parliamen-

tary regime. Thus, we also have a president that represents one of the groups in the society. In the main model, the

legislators first decide on a budget. They can choose either a one-item budget, which only specifies the total provision

of the two public goods, or a two-item budget, which specifies the provision of each public good separately.After the

budget is selected, nature determines the state of the world. While both groups enjoy the first public good in a no-

polarization state, one of the groups enjoys the second public good in a polarization state. After nature determines the

state of the world, the president decides on the provision of both public goods under the constraint of the legislature's

budget. Under a one-item budget, government resources can be allocated for the provision of public goods according

to the president's own preferences. However,under a two-item budget allocations for the public goods are specified in

the budget. Thus, a one-item budget gives an unrestricted flexibilityto the executive.

To study institutions giving restricted flexibilityto the executive authority, I extend the model to analyze flexible

two-item budgets and legislature-approved transfers. In a flexible two-item budget, legislators specify the provision

1See,for example, GAO (2015), Tyszkiewicz and Daggett (1998), and Fisher (1974).

2Fora discussion of budgetary institutions in different countries, see Tommasi (2007) and OECD (2014), and in Italian municipalities see Anessi-Pessina et al.

(2013).

YA¸SAR 3

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