Timothy Besley and Michael Smart

Published July 2005

---

This paper explores the logic of fiscal restraints in a political agency model with both moral hazard and adverse selection. The role of the political process is both to discipline incumbents who may act against the public interest and to sort in those politicians who are most likely act in voters' interests. We use the model to examine the optimality of inefficient taxation, limits on the size of government, increasing transparency, and yardstick competition. Some conclusions are surprising. For example, we show that some forms of fiscal restraint can only be desirable when incumbents are su¢ ciently likely to be benevolent. We are grateful to Jim Hines and a number of seminar participants for insightful comments.