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THE ECONOMIC AND SOCIAL REVIEW
The second aspect is that most public spending today is targeted at
subgroups of citizens (taxpayers) in society. Targeted public policies, when
paid for from the general tax fund, involve redistribution of resources among
citizens; hence we refer to them as distributive policies. The important
implication of distributive policies is that those who benefit from a specific
public policy and those who pay for it are generally not the same. Instead,
those who benefit typically pay a small share of the total cost. As a result,
politicians representing the interests of individual groups in society tend to
overestimate the net social benefit from targeted public policies, as they
perceive the full social benefit from policies targeting their constituencies, but
only that part of the social cost that the latter bear through their taxes. This
is the “common pool” property of public budgeting (von Hagen and Harden,
1996).
Both the principal-agent relationship and the common pool of property
generate potential for excessive levels of spending, taxation, and public
borrowing. The more rampant the principal-agent problem, the greater will be
the divergence between voter preferences and the level and composition of
public spending. Comparisons of jurisdictions in which public finances are
determined by direct democracy with jurisdictions in which representative
democracy prevails show that, ceteris paribus, direct democracy leads to lower
levels of government expenditure and taxes, lower levels of government
debt, an increase in local versus state spending, and a tendency to finance
government expenditure by charges rather than broad-based taxes
(Pommerehne, 1978; Matsusaka, 1995; Kirchgassner et al., 1999; Feld and
Kirchgassner, 1999).
Similarly, the more severe the common pool problem, the greater will be the
divergence between the marginal social utility and the marginal social cost of
targeted public policies. Empirical studies show that this leads to excessive
levels of spending, deficits, and debt (von Hagen 1992; von Hagen and Harden,
1994a; Strauch, 1998; Kontopoulos and Perotti, 1999). Other empirical studies
suggest that government spending and debt increase with the intensity of
ideological and ethnic divisions within a society (Roubini and Sachs, 1989;
Alesina and Perotti, 1995; Alesina et al. 1997), or by ethnolinguistic and
religious fractionalisation (Annett, 2000). To the extent that such conflicts
make voters on either side of the divide neglect the tax burden falling on those
on the other side, they aggravate the common pool problem.
Societies can create institutions that mitigate these problems. Three
institutional approaches are particularly relevant in this context.
• Imposing fiscal rules, i.e., ex ante controls such as balanced-budget con-
straints or referendum requirements for tax hikes that restrict the scope of
choices elected politicians can make regarding public finances;