This paper examines whether revenue decentralization and direct external financial supervision affect the incidence and strength of political budget cycles, using a panel of Israeli municipalities during the period 1999-2009. We find that high dependence on central government transfers — as reflected in a low share of locally raised revenues in the municipality’s budget — exacerbates political budget cycles, while tight monitoring — exercised through central government appointment of external accountants to debt accumulating municipalities — eliminates them. These results suggest that political budget cycles can result from fiscal institutions that create soft budget constraints: that is, where incumbents and rational voters can expect that the costs of pre-election expansions will be partly covered later by the central government.
Baskaran, Thushyanthan, Sebastian Blesse, Adi Brender and Yaniv Reingewertz (2015), Revenue Decentralization, Central Oversight and the Political Budget Cycle: Evidence from Israel, ZEW Discussion Paper No. 15-046, Mannheim. Download