Budget flexibility, government spending, and welfare

A growing literature in economics provides a theory of budget negotiations relying on Baron and Ferejohn's legislative‐bargaining approach. This literature assumes that legislators decide on all dimensions of government spending once and for all in a period during budget negotiations. However, legislators leave allocation decision of some funds to the executive authority and let it adjust government spending according to changing priorities in a year under certain restrictions. In this paper, the author develops a legislative‐bargaining model to investigate the effects of budget flexibility on government spending and welfare. In addition, he analyzes how legislators choose the level of flexibility. He shows that, if legislators decide on all dimensions of government spending, high polarization leads to greater government spending. However, if the executive authority allocates government resources, high polarization leads to lower government spending. Besides, when the executive authority allocates government resources under high polarization, legislators cannot use their political power to induce overprovision of their preferred public good. When legislators can choose the level of budget flexibility, if the probability of polarization is high they prefer to control all dimensions of government spending. The author shows that budget flexibility benefits society only under high probability of polarization.