Creating Room for Manoeuvre: a Strategy to Generate Political Budget Cycles under Fiscal Rules

We examine the effect of a balanced budget rule on the local political budget cycle. Specifically, we pay attention to the evolution of budget deficit, taxes and capital spending around elections. Using a sample of the Spanish largest municipalities in 1994-2009, we find that the balanced budget rule has not dampened the political budget cycle in budget deficit. Therefore, our results indicate that although governments are constrained by such rule they engage in electoral-induced fiscal manipulation. In non-electoral years, they create room for manoeuvre to implement expansionary fiscal policies in electoral years. Specifically, there is saving in the pre-electoral year and deficit increase in the electoral year. This has been achieved largely through tax and fee increases during the pre-electoral year and by shifting the bulk of the capital spending increased from the pre-electoral year to the election year. Furthermore, our findings indicate that the balanced budget rule has succeeded in limiting the budget deficit.