Future rent-seeking and current public savings

The conventional wisdom is that politicians rent seeking motives increase public debt and deficits This is because myopic politicians face political risk and prefer to extract political rents as early as possible In this paper we study the determination of government debt and deficits in a dynamic political economy model We show that this conventional wisdom relies on economic volatility being low relative to political uncertainty If economic volatility is high relative to political uncertainty then a rent-seeking government actually over saves and over taxes along the equilibrium path relative to a benevolent government This result emerges because of the option value of rent seeking a rent-seeking government over-values future funds because of the possibility of using them for future rents instead of cutting taxes in the event of a future boom (when marginal utility of private consumption is low) This over-saving bias is temporary since in the long run the rent-seeking government over-borrows relative to the benevolent government as it eventually squanders the funds it has accumulated We find that both the under-saving and over-saving bias of the government can be solved by a rule of capping deficits (C) 2010 Elsevier B V All rights reserved