Political cycles in municipal revenue forecasts

Recent studies suggest that governments use overly optimistic revenue forecasts to expand their fiscal room for maneuver in election years in order to increase their chances of re-election. This paper starts by providing a theory for this observation that is based on the assumption that uninformed voters mistake the fiscal activity of the government for competence. As a result, the budget is expanded in election years, but cut in off-election years. Hence, the political process produces a budget cycle.

The paper studies the hypothesis of manipulation of fiscal revenue forecasts in the context of elections for Portuguese municipalities. The setting has several advantages as all municipalities are subject to the same laws and regulations, have the same responsibilities for public service provision, and have the same institutional structure.

The results show that revenue forecasts are indeed increased in election years. The paper then studies the determinants of the potential forecast manipulation and finds that the extent of manipulation is reduced when (i) the expected winning margin is higher, i.e., when the incumbent’s expectation of winning is higher; (ii) the incumbent is not running for re-election; and, (iii) the share of informed voters (proxied by their education level) is higher.

Click here to go to the paper by Frank Bohn and Francisco José Veiga.