Bargaining over Mandatory Spending and Entitlements

Marina Azzimonti, Gabriel P. Mihalache, Laura Karpuska

NBER Working Paper No. 27595
Issued in July 2020
NBER Program(s):Economic Fluctuations and Growth, Public Economics, Political Economy

Do mandatory spending rules improve social welfare? We analyze a dynamic political-economy model in which two parties disagree on the split of a fixed budget between public goods and private transfers. Under a mandatory spending rule, expenditures are governed by criteria set by enacted law, namely last year’s spending bill is applied in the current year unless successfully changed by a majority of policymakers. We model budget rules with an endogenous status quo and study the welfare implications of introducing entitlement programs. Entitlements depend on individual eligibility and participation and, hence, impose constraints on publicly-provided private goods and transfers. We emphasize that bargaining over entitlements is qualitatively different from bargaining over public goods provision, particularly with risk-aversion. Entitlement programs induce under-provision of public goods but also a smoother path for private consumption than discretion. Whether entitlement programs are welfare-improving depends critically on political turnover. When proposers alternate frequently, it benefits society because it reduces volatility in private consumption. Outcomes under rules can be worse than under discretion if political power is persistent enough. We contrast these findings to those from a mandatory spending rule on public goods, commonly studied in the literature. Finally, we describe conditions under which all parties would agree to the introduction of budget rules, within a bargaining equilibrium.

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Document Object Identifier (DOI): 10.3386/w27595

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