The Politics of Booms and Busts

How do countries, through their political institutions, adapt fiscal policy to economic and political shocks? The goal of this dissertation is to explain variation in the response of public spending and the fiscal balance to the business and electoral cycle across a large sample of countries. I develop a theory that builds on the political agency problem to argue that a government's ability to run prudent spending decisions over the business and electoral cycle is conditional on the structure of public finance (e.g. where does revenue come from?). Government revenue stems from two main sources: general taxation, and fiscal windfalls derived from natural resource wealth such as oil royalties, or grants from foreign aid. The key assumption of the theory is that each of these two revenue sources affects the amount of information that voters have about the true state of public finance, and thus the degree of uncertainty about the extent of rent extraction by incumbents. When governments rely on fiscal windfalls to finance most of their expenditures, voters have incentives to behave as fiscal liberals and demand higher public spending in the face of a positive economic shock. The reason is that while taxes are perfectly observed by voters, windfalls that accrue directly to government coffers are not, limiting voter ability to keep rent seeking politicians under control. Thus, fiscal policy is driven by voter's demands. I offer cross-national and subnational empirical evidence that is consistent with this theory: fiscal policy is more procyclical, political budget cycles prevalent, and levels of fiscal transparency lower in places with greater dependence of windfall revenue.