FISCAL STRUCTURAL REFORM AND ECONOMIC ACTIVITY: PUBLIC SPENDING AND PRIVATE EFFORT*

Abstract

This paper explores governments' and private agents' incentives to implement or postpone fiscal structural reform attempts. Both fiscal consolidation and fiscal reorganization often create spillover effects and thereby induce free-riding problems. It is thus important to cope with the free-riding behaviour of interest groups. It is often argued that in order to attain successful outcomes, a good macroeconomic situation is needed, since we expect positive income effects. In this paper, we first explain the dynamic aspects of insufficient fiscal consolidation due to free-riding problems in the framework of private provision of public goods. Then, using a static model between central and local governments, we examine the sign of income effects for reform attempts to pursue fiscal reorganization. It is shown that good economic circumstances do not necessarily enhance reform of reorganizing fiscal expenditures, although it could enhance fiscal reconstruction.