Inequality and Efficiency of Fiscal Rules

Abstract

This study investigates the impacts of fiscal rules on inequality and efficiency within a political economy framework that considers parties negotiating resource allocation towards private transfers, public goods, and the possibility of debt issuance. Our main results show that debt ceilings, while mitigating inequality by limiting future expropriation, leads to efficiency losses. Conversely, the impact of spending limits on efficiency and inequality varies with the nature of the spending -- mandatory or discretionary -- that is capped. We also find that political bargaining increases debt levels, but only when part of the spending is not mandatory. These results underscore the pronounced trade-off between equity and efficiency can become more pronounced in the presence of fiscal rules.