Fiscal Slack, Rule Constraints, and Government Corruption

This article examines the effect of fiscal slack on government corruption using the US states in the period from 1998 to 2012 as a research sample. Fiscal slack in the US states is commonly referred to as "rainy day funds" (RDFs),which are intended as countercyclical reserve funds for government-wide purposes. Theoretically,bureaucracy models predict that fiscal slack might catalyze the embezzlement or misuse behaviors of bureaucrats, who are considered to be budget maximizers. However,formally established and rules-bound RDFs may function as a "strongbox" that curbs officials' discretionary power,reduces uncertainty in fiscal slack management,and ultimately restrains embezzlement and misuse behaviors. Empirically,we use the incidences and durations of natural hazards as instrumental variables for RDF balances to address the potential endogeneity problems. We find that state RDFs help reduce government corruption,especially when they are regulated by relatively looser deposit rules and stricter withdrawal rules.