Public Debt and Investment Under Political Competition: Evidence from Toxic Loans

By: Julien Sauvagnat and Boris Vallée

Format:Print
| Language:English
| Pages:61

Abstract

We examine the response from local governments and their voters to a large and exogenous increase in municipal indebtedness. We first show that municipalities with loans that become “toxic” exhibit a reduction in municipal investments as large as the associated increase in indebtedness. Local taxes remain unaffected. The reduction in investments is particularly pronounced for politically contested municipalities, and a debt shock reduces the incumbent vote share at the next election. These empirical findings are consistent with a model of public investment in which electoral competition disciplines local politician budget choices, and highlight the political nature of public indebtedness.