Coalitional Drift and Agency Design

Sugato Dasgupta
Sanmitra Ghosh

Abstract

We consider a society with individuals of two sorts: rich and poor. There is a government
agency which uses public funds to provide a service that is valued by all citizens. The prefer-
ences of the rich and the poor are different; specifically, the rich are more fiscally conservative
than the poor. There are two political parties: one political party faithfully represents the
interests of the poor while the other caters exclusively to the rich. The political parties come
to power stochastically. The political party in power in period t is entrusted with the task
of writing the fiscal constitution (budgetary rule) under which the agency operates in period
t + 1. We explore the conditions that are required for equilibrium fiscal constitutions to be
rigid or flexible.

JEL Classification: D72, D73

Keywords: fiscal constitution, rigidity, flexibility, coalitional drift.

We thank seminar participants at the Jawaharlal Nehru University for numerous helpful comments. Special
thanks are due to Satish Jain for his steadfast encouragement and support. Of course, the usual disclaimer
applies.

Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi 110 067, India.

Department of Economics, Jadavpur University, Kolkata 700 032, India.
1 Introduction

In a representative democracy, elected legislators are invested with the power to make public
policies. But, legislators rarely implement public policies. Rather, the task of policy imple-
mentation is delegated to administrative agencies. A question naturally arises: What prevents
unelected bureaucrats from engaging in bureaucratic drift (i.e. flouting legislative intent)?
Bureaucratic drift can of course assume various forms. Hill (1985), Calvert et al. (1989), and
Ferejohn and Shipan (1990), for example, maintain that bureaucrats have policy preferences
distinct from that of legislators. Given discretion, bureaucrats may override democratic values
and implement public policies in accord with their own desires. Niskanen (1975), Miller and
Moe (1983), Banks (1989), and Banks and Weingast (1992) posit that bureaucrats seek to
maximize agency budgets. Left unmonitored, bureaucrats provide their political overseers
with inflated cost estimates for projects assigned to them. Stigler (1971), Posner (1974), and
Peltzman (1976) argue that bureaucrats entrusted with the task of regulating an industry
engage in graft and begin, instead, to champion the industrys concerns. Alesina and Tabellini
(2007, 2008) assume that top bureaucrats are motivated by career concerns. A top bureaucrat
undertakes the action that maximizes the perception of her ability in the eyes of those who
may offer her an alternative job opportunity.
Given bureaucratic drift, whatever be its form, several studies have explored the ways by
which politicians can control bureaucrats.1 Arnold (1987) emphasizes the myriad oversight
techniques available to politicians: extensive hearings can ruin bureaucratic careers, the an-
nual appropriations process can reward (punish) compliant (deviant) agencies, and the original
legislation authorizing a program can be made suitably specific. McCubbins and Schwartz
(1984) indicate how legislators have devised a system of fire-alarm oversight of agency de-
cisions. Constituents and interest groups monitor agency decisions and sound a fire alarm
when administrative errors are detected. Legislators become actively involved upon hearing
the alarm. McCubbins et al. (1987, 1989) show how agency structure and procedures con-
strain administrative options even before a choice is made. In a nutshell, ex ante control
is achieved by ensuring that groups active in the passage of a policy are represented in the
agencys decision-making process (e.g. group members are assigned to the agencys advisory
commissions).
As Horn and Shepsle (1989), Moe (1990), Moe and Wilson (1994), and Shepsle (1992)
1
For a thoughtful review of the effectiveness of these various measures, the reader is referred to Hill and
Brazier (1991).

1
rightly point out, the extensive preoccupation with the ramifications of bureaucratic drift has
glossed over other factors impacting agency design. Specifically, the aforementioned papers
suggest that an agencys structure is also fundamentally affected by the possibility of coalitional
drift. The basic idea is as follows. Consider an enacting coalition of legislators and interest
groups engaged in the task of setting up an implementing agency. By making the agencys
structure sufficiently permeable, the enacting coalition can exercise strict control over public
policy in the present (i.e. the problem of bureaucratic drift is solved in the main). Political
power is, however, ephemeral. Thus, when the enacting coalition loses power, the deal struck at
enactment is subject to predation by political coalitions with different preferences that assume
power in the future a permeable agency structure serves only to facilitate this agency capture.
In sum, an enacting coalition must create an agency that has the capacity to survive in an
uncertain political environment.
In marked contrast to extant theoretical models of agency design, we de-emphasize (but
do not assume away) bureaucratic drift. Instead, our goal is to isolate some of the design
implications of coalitional drift. We ask: In the presence of legislative turnover and coalitional
drift, what sort of agency does an enacting coalition construct?
The theoretical setup in this paper is as follows. A society consists of individuals of two
types: rich and poor. A government agency, headed by a career bureaucrat, employs public
funds to provide a service that is valued by all citizens. Since public funds, by assumption,
are raised through a proportional income tax, the rich are more fiscally conservative than the
poor i.e. the rich desire to set the agencys budget at a level that is weakly lower than that
desired by the poor.
The society under review is invested with rudimentary political structures. There are two
political parties, labeled P and R. These political parties are not office-seeking per se; rather,
political party P faithfully represents the interests of the poor while political party R caters
exclusively to the rich. Of course, this means that political party R ends up as more fiscally
conservative than political party P . The interactions between the two political parties span an
infinite sequence of structurally identical periods. The critical component of this interaction
is as follows. When a political party, P or R, is in power in period t, it lays down the fiscal
constitution (budgetary rule) under which the agency is required to operate in the next period,
t + 1. In other words, we assume that fiscal constitutions are to an extent sticky structures: it
takes one period to rewrite an existing fiscal constitution.
What determines the nature of the fiscal constitutions that emerge in equilibrium? To fix

2
ideas, let political party R be in power in period t. Suppose political party R writes a fiscal
constitution that is flexible and cedes discretion to the career bureaucrat: specifically, the
bureaucrat is instructed to set the agencys period-(t + 1) budget as a nontrivial function of the
realized period-(t + 1) demand for the agencys services. Since political fortunes are transient,
there is some chance that political party R will lose power in period t + 1. In this event, the
bureaucrat may seek to further her career ambitions by displaying loyalty to the fiscally liberal
and incumbent political party P .2 The non-neutral bureaucrat misreports the period-(t + 1)
demand for the agencys services and thereby bloats the agencys budget in period t+1. In other
words, electoral turnover and the possibility of bureaucratic non-neutrality combine to make
a discretionary fiscal constitution risky. Should this risk be deemed unacceptable, political
party R writes a rigid fiscal constitution. A rigid fiscal constitution, by definition, is a risk-free
structure the agencys budget in period t + 1 is determined in advance and independent of
the electoral fortunes of political party R. However, a rigid fiscal constitution has costs as well:
because the agencys period-(t + 1) budget is not conditioned on the circumstances in period
t + 1, outcomes are frequently not on the Pareto frontier. In sum, the nature of the equilibrium
fiscal constitution written by political party R reflects a trade-off between the riskiness of a
discretionary fiscal constitution and the inefficiency of a rigid fiscal constitution.3
How do equilibrium fiscal constitutions change as society characteristics are altered? We
provide three comparative statics conclusions that have considerable intuitive appeal. First,
consider societies s and s, where the income distribution in society s is a mean-preserving
spread of the income distribution in society s. An immediate consequence of the income
distribution difference is that the preferences of the rich and the poor are further apart in
society s than in society s. Given the possibility of bureaucratic manipulation, a discretionary
fiscal constitution is a less attractive option in society s than in society s. So, equilibrium fiscal
constitutions in society s are weakly more rigid than those in society s. In other words, when
income distribution worsens, there is an accompanying hardening of equilibrium constitutions.
Second, suppose the career bureaucrat is more likely to be politically non-neutral in society s
2
Notice that our theoretical framework incorporates a form of bureaucratic drift: with some probability, the
bureaucrat in period t + 1 caters to the wishes of her political overseer and, therefore, violates legislative intent
implicit in the fiscal constitution written in period t.
3
Our idea is similar to that developed independently by Epstein and OHalloran (1994, 1996). They construct
a one-period model of an administrative state in which the legislature determines the amount of leeway granted
to bureaucrats. Since the executive branch of government appoints agency heads, who in turn implement
public policies, the legislature places tighter constraints on bureaucrats as the preferences of the legislative and
executive branches (defined on an underlying one-dimensional policy space) move further apart. Despite the
underlying similarity between our paper and theirs, the formal structures are substantially distinct.

3
than in society s. Since the probability of bureaucratic manipulation is, by assumption, higher
in society s than in society s, a discretionary fiscal constitution is a less attractive option in
society s than in society s. As before, this means of course that equilibrium fiscal constitutions
in society s are weakly more rigid than those in society s. In other words, when bureaucratic
non-neutrality is enhanced, equilibrium constitutions become less flexible. Third, suppose the
electoral prospects of political party P are better in society s than in society s. Since political
party P worries less about political turnover (and, hence, coalitional drift) in society s than
in society s, the equilibrium fiscal constitution that it writes is weakly more discretionary in
society s than in society s. But, application of this logic to political party R shows that the
equilibrium fiscal constitution it writes is weakly less discretionary in society s than in society
s. In other words, an aggregate measure of the institutional rigidities of society s may be more
or less than that of society s.
The rest of the paper is structured as follows. Section 2 consists of essential building blocks
of our model. We describe the production function of the government agency and the pref-
erences of the individuals that constitute the society under review. We show that the rich
and the poor harbor different views on the optimal size of the agencys budget. Section 3
introduces the two political parties and describes the infinite-horizon game, involving the writ-
ing and rewriting of the agencys fiscal constitution, that these political parties play. Section
4 provides a complete characterization of the stationary subgame perfect equilibrium of the
game described in Section 3. Section 5 studies what the equilibrium says about agency design.
Section 6 concludes.

2 Building blocks

A society consists of N infinitely-lived individuals. These individuals are of two types: rich and
poor. Let (0, 1) denote the proportion of the population that is poor. Time is measured in
discrete intervals, t = 1, 2, . . . In each period t, the exogenously given income of a rich person is
yR while that of a poor person is yP . Naturally, yR strictly exceeds yP , which, in turn, weakly
exceeds 0.
There is in place a government agency which uses public funds to provide a service valued
by all members of the society. At the start of each period, Nature makes i.i.d. draws from
the distribution of a random variable . The probability density function of is f (.), which
Let t denote the period-t realization of . Without
is strictly positive on the interval [0, ].
exception, agencies provide services that are subject to demand shocks of a transitory nature.

4
We interpret t to be the period-t benefit obtained by every member of the society for each
rupee spent by the agency in period t (see footnote for an example).4
5 Let bt B
The period-t budget of the agency is exogenously bounded above by B. be the
actual period-t budget of the agency (a discussion of how bt is determined is given in Section
3). To provide bt rupees to the agency, the income of every citizen is taxed at rate (bt ) in
period t. Budget balance requires that (bt ) satisfies the following equation:

N (bt ) [yP + (1 )yR ] = bt . (1)

Given (t , bt ), let u(t , bt |yi ) denote the period-t utility of a person with pre-tax income yi , i =
P, R. This utility is the sum of two components: the value of services provided by the agency,
t bt , and the persons after-tax income, (1 (bt ))yi . In other words,

u(t , bt |yi ) = t bt + (1 (bt ))yi , i = P, R. (2)

Given t , let bo (t |yi ) denote the agencys budget that maximizes the period-t utility of a person
with income yi . Hence,

bo (t |yi ) = arg maxb[0,B]

u(t , b|yi ), i = P, R. (3)

Since u(t , b|yi ) is linear in b, the expression for bo (t |yi ) is immediate. Let y denote the mean
pre-tax income in the society and note that y = yP + (1 )yR . Then, bo (t |yi ) = 0 when
otherwise (see footnote for details).6 Figure 1 plots
y ), and bo (t |yi ) = B
t (1/N ) (yi /
bo (.|yP ) and bo (.|yR ) as functions of t .
Three features of Figure 1 turn out to be crucial for later developments. First, note that
bo ( t |yi ), i = P, R is weakly increasing in t : as the value of the agencys service increases,
a person with income yi wishes to enlarge the size of the agencys budget. Second, for any
value of t , bo (t |yP ) weakly exceeds bo (t |yR ). In other words, the rich are intrinsically more
fiscally conservative than the poor. This is intuitive. With a uniform tax rate, the rich pay
4
To make matters concrete, consider the following example. Suppose the government agency spends one
rupee on weapons in period t. The value of the extra defence capability provided to citizens as a result, t , is
large if a war is imminent in period t and is small if period t is tranquil.
5
Along the lines of Meltzer and Richard (1981), it is possible to make B endogenous by assuming that tax
collection imposes a deadweight loss on society (e.g. the labor-leisure choice is distorted). However, doing so
complicates the model and produces no new insight.
6
Equation (2) says that u(t , b|yi ) = t b + (1 (b))yi while equation (1) says that (b) = (1/N ) (b/ y ).
Therefore, u(t , b|yi ) = [b (t (1/N ) (yi / y )) + yi ]. It is immediate that [1] bo (t |yi ) = 0 when
t < (1/N ) (yi / when t > (1/N ) (yi /
y ) and [2] bo (t |yi ) = B y ). To conserve on notation, for the knife-edge
(measure zero) case wherein t equals (1/N ) (yi / y ), we set bo (t |yi ) equal to 0.

5
 Figure 1: bo (t |yP ) and bo (t |yR ) as a function of t .

more than the poor for the agencys services. These payment differences lead to differences
in preferences over the size of the agencys budget. Third, conflicts between the rich and the
poor over the agencys budget size crop up only when t lies between P (1/N ) (yP /
y ) and
R (1/N ) (yR /
y ). In this intermediate range, the poor want the agencys period-t budget
while the rich desire a period-t budget equal to 0. Henceforth, we refer to the
to be fixed at B
open interval (P , R ) as the preference conflict region. Note also that when t is small (i.e.
t < P ), all citizens are agreed that the agency should shut down in period t; on the other
hand, a high value of t (i.e. t > R ) makes all citizens want maximal services from the
7
agency and a period-t budget of B.
Consider, finally, how Figure 1 changes as societys distribution of pre-tax income is exoge-
nously varied. Suppose yR is raised and yP is simultaneously lowered to ensure that the mean
income y is constant. This change in income distribution causes P to shift to the left and
R to shift to the right. In other words, when the disparity between the rich and the poor is
enhanced, there is a predictable increase in the size of the preference conflict region.
7
We assume that R . Notice that R > is an uninteresting case to consider: here, the rich want the
agency to shut down regardless of the value of t .

6
3 Political institutions

We now invest the society with a rudimentary political structure. There are two infinitely-lived
political parties, labeled P and R. Party P faithfully represents the interests of the poor in
society while party R caters exclusively to the rich. The interactions between the two political
parties span an infinite sequence of structurally identical periods, t = 1, 2, . . . Each period t
consists of three phases. In phase one, the party in power determines the agencys budget
for that period. In phase two, the agencys fiscal constitution for the next period is written.
In phase three, an election determines the identity of the party in power in period t + 1. A
description of the three phases follows.

3.1 Phase one: Determining the agencys budget

Let I(t) {P, R} identify the political party in power in period t. Despite access to power,
we maintain that no politician affiliated with political party I(t) directly oversees the day-to-
day workings of the government agency in period t; rather, this task is delegated to a career
bureaucrat. So, only the bureaucrat observes the period-t realization of , i.e. t (see footnote
for an example).8 The above assumption starkly models the idea that familiarity with the
functioning of an organization makes an agent privy to more organization-specific information
than is available at large.
Given t , how is the agencys period-t budget determined? The political party in power in
period t 1 writes the fiscal constitution under which the agency operates in period t. What is
a fiscal constitution for the agency? Let = be the collection of piecewise continuous functions
to [0, B].
from [0, ] We call any element of = a fiscal constitution. The interpretation is as
follows. Suppose C = is the fiscal constitution written by the political party in power in
period t 1. Then, C(t ) is the budget of the agency in period t should the bureaucrat claim
that the period-t realization of is t . Notice that budgetary allocations must perforce depend
on such claims since t is not publicly observed.
The bureaucrat chooses t as follows. With probability k (0, 1), the bureaucrat is politi-
cally neutral and truthful: the announced t coincides with t . However, with probability 1k,
the bureaucrat attempts to further her career by investing in loyalty to the political party in
power: given t , the announced t is such that the resulting agency budget C(t ) maximizes
8
Continuing with the example of footnote 4, suppose t , the value of extra defense capability provided to
citizens by spending an extra rupee on weapons in period t, depends stochastically on whether or not a war is
imminent in period t. We are assuming that only the bureaucrat is aware of the value of t as she has access to
(and can correctly interpret) classified intelligence inputs, for example.

7
the period-t utility of the individuals represented by party I(t).9 We illustrate how a politically
non-neutral bureaucrat chooses t by means of the example below.

Example: Let C = be the fiscal constitution in place in period t. Let Cmax be the maximum
value attained by C and let Smax be the set of maximizers of C. Let Cmin be the minimum
value attained by C and let Smin be the set of minimizers of C. Assume that the political party
in power in period t is P . Recall that when t is weakly less than P (1/N ) (yP /
y ), the
utility of the poor in period t is maximized by setting the agencys budget at the lowest possible
value. Thus, the bureaucrat announces t to be some element of Smin and pegs the period-t
budget of the agency at Cmin . On the other hand, when t strictly exceeds P , the utility of
the poor in period t is maximized by setting the agencys budget at the highest possible value.
Here, the bureaucrat announces t to be some element of Smax , thereby fixing the agencys
period-t budget at Cmax .10 Given C =, the example makes an important point: the period-t
budget of the agency is either Cmin or Cmax .

3.2 Phase two: Writing the fiscal constitution

In a Westminster-style parliamentary system, the party in power is, to a first approximation,

all-powerful. We assume therefore that it is invested with the right to unilaterally stipulate the
fiscal constitution under which allocations are made to the agency in period (t + 1). In other
words, party I(t) chooses an element of = that remains operative for one period.

3.3 Phase three: An election

Once the fiscal constitution is written, an election takes place to determine the identity of the
party in power in period t + 1. We model electoral outcomes crudely and posit that political
party P wins any election with exogenous probability P (0, 1).11 Following the election,
period t ends. The sequence of events in period t + 1 replicates that in period t.
9
Our assumptions regarding the bureaucrats behavior is consistent with the evidence in Iyer and Mani
(2009). They show that bureaucrats in India have two alternative paths to career success: bureaucrats of higher
initial ability are more likely to invest in skills, but a reputation for loyalty to incumbent politicians also helps
secure important positions in the bureaucracy.
10
Suppose the period-t incumbent is political party R. In this case, the non-neutral bureaucrats period-t
announcements are as follows: [1] t Smin when t is weakly less than R (1/N ) (yR / y ), and [2] t Smax
when t strictly exceeds R .
11
Notice that the outcome of the election is always uncertain (i.e. P never assumes the value 0 or 1). A
model of probabilistic voting with appropriately specified aggregate preference shocks (see e.g. chapters 2 and
3 of Persson and Tabellini, 2000) suffices to generate ex ante uncertainty regarding the identity of the election
winner.

8
 As mentioned already, the model we consider has an infinite horizon. Both political parties
discount future payoffs at rate (0, 1) and have preferences that are separable over time.
Since political parties are not office-seeking per se but faithfully represent the interests of well-
defined constituencies, we equate the period-t payoff of party P (R) with the period-t utility of
a poor (rich) person in society. In sum, the objective functions of the two political parties are
as follows:

X
W P = E1 [ t u(t , bt |yP )], (4)
t=1

X
W R = E1 [ t u(t , bt |yR )], (5)
t=1

where WP and WR are, respectively, the objective functions of political parties P and R, bt is
the agencys budget in period t, t is the period-t realization of , and E1 is the expectation
operator conditional on information available at the start of period 1.
Our model is an infinite-horizon game played by the two political parties, P and R. The
solution concept used is stationary subgame perfect equilibrium (hereafter SSPE). Strategies
under this concept are stationary; thus, each political party makes history-independent choices
from = at all stages where it is called upon to write the agencys fiscal constitution. In other
words, associated with a SSPE is a pair of functions (CP0 , CR
0 ) = =, where C 0 , i = P, R
i
denotes the fiscal constitution written by political party i whenever it is in power. Of course,
subgame perfection imposes restrictions as well on (CP0 , CR
0 ). Specifically, the strategy of

always choosing CP0 and the strategy of always choosing CR

0 must be mutual best responses

(i.e. constitute a Nash equilibrium) in any subgame, whether proper or otherwise, of the
infinite-horizon game.

4 Equilibrium of the model

Before we characterize the SSPE of the model, some extra notation is required. If the agencys
fiscal constitution C = is written in period t, let UP (C) and UR (C) denote, respectively,
the expected utility of a poor and rich person in period t + 1. Consider the expression for
Ui (C), i = P, R.
First, with probability k, the bureaucrat in period t + 1 is politically neutral and honest.
Given t+1 , the agencys budget in period t + 1 is set at C(t+1 ). This is because t+1 , the

9
period-(t + 1) announcement of the honest bureaucrat, coincides with t+1 . Notice therefore
that the expected utility of a person with income yi in period t + 1 under the honest bureaucrat
regime, denoted Ui (C|h), is as follows:
Z
Ui (C|h) = u(, C()|yi )f ()d. (6)
0

Second, with probability (1 k) P , the political party in power in period t + 1 is P and

the bureaucrat is politically non-neutral. Given t+1 , the non-neutral bureaucrats claim, t+1 ,
maximizes the period-(t + 1) utility of the poor. So, the agencys budget in period t + 1 is
set at Cmax when t+1 strictly exceeds P , and is pegged at Cmin otherwise. Therefore, the
expected utility of a person with income yi in period t + 1 under the non-neutral bureaucrat
and party-P regime, denoted Ui (C|P, n), is as follows:
Z P Z
Ui (C|P, n) = u(, Cmin |yi )f ()d + u(, Cmax |yi )f ()d. (7)
0 P

Third, with probability (1 k) (1 P ), the political party in power in period t + 1 is R

and the bureaucrat is politically non-neutral. Given t+1 , the non-neutral bureaucrats claim
in this case, t+1 , maximizes the period-(t + 1) utility of the rich. So, the agencys budget in
period t + 1 is set at Cmax when t+1 strictly exceeds R , and is pegged at Cmin otherwise.
Therefore, the expected utility of a person with income yi in period t + 1 under the non-neutral
bureaucrat and party-R regime, denoted Ui (C|R, n), is as follows:
Z R Z
Ui (C|R, n) = u(, Cmin |yi )f ()d + u(, Cmax |yi )f ()d. (8)
0 R

Of course, Ui (C), i = P, R is the probability weighted average of Ui (C|h), Ui (C|P, n) and

Ui (C|R, n), given in equations (6)-(8). Thus,

Ui (C) = k Ui (C|h) + (1 k) [P Ui (C|P, n) + (1 P ) Ui (C|R, n)]. (9)

With UP (C) and UR (C) computed, we focus now on characterizing the models SSPE. This
characterization is greatly simplified because of Lemma 1, which is an immediate consequence
of the one-shot deviation principle (for an exposition of the principle, refer to chapter 2 of
Mailath and Samuelson, 2006). Despite the infinite-horizon structure of the model, Lemma 1
says that the SSPE has a simple structure: the fiscal constitution selected by each political
party maximizes the expected utility of its constituency in just the next period.

10
LEMMA 1: (CP0 , CR
0 ) are the fiscal constitutions offered by the two political parties in a SSPE

if and only if Ci0 maximizes Ui (C) over all C =, i = P, R.

PROOF: See the Appendix.

Before proceeding further, we introduce terminology that is useful in stating Lemma 2. We

shall say that a fiscal constitution is the shutdown constitution, denoted C shut , if it dictates
that the agencys budget be set at 0 regardless of the bureaucrats announcement, . In other
= 0, [0, ].
words, C shut () We shall say that a fiscal constitution is the full capacity
constitution, denoted C f ull , if it requires the agencys budget to be fixed at the maximal level,
regardless of the bureaucrats announcement, .
B, In other words, C f ull ()
= B,
[0, ].

Notice that the shutdown constitution and the full capacity constitution share an important
feature in common: should such a fiscal constitution be written in period t, the budgetary
allocation to the agency in period t + 1 is unresponsive to the period-(t + 1) demand shock,
t+1 , and the political arrangement in period t + 1 (i.e. the identity of the party in power in
period t + 1 and whether the bureaucrat is politically neutral or otherwise).
Suppose political party P is in power in period t and assume that the bureaucrat in pe-
riod t + 1 is somehow guaranteed to be politically neutral. Then, the fiscal constitution that
maximizes the expected period-(t + 1) payoff of political party P takes a simple form, derived
in Section 2: the constitution stipulates that the agencys period-(t + 1) budget be fixed at
B if the bureaucrats announced t+1 strictly exceeds P , and is 0 otherwise. We shall call
this constitution the ideal arrangement constitution for political party P , denoted CPideal . In
= B,
other words, CPideal () > P and C ideal ()
= 0, P . Analogously, C ideal , the
P R
= B,
ideal arrangement constitution for political party R, is as follows: C ideal () > R and
R

ideal ()
CR = 0, R . Notice that the two fiscal constitutions, CPideal and CR
ideal , share an

important feature in common: should such a fiscal constitution be written in period t, the bu-
reaucrat, whether politically neutral or otherwise, is invested with the right to set the agencys
period-(t + 1) budget at 0 (the minimal feasible funding level) or B (the maximal feasible
funding level). We view CPideal and CR
ideal as fiscal constitutions that yield full discretion (see

footnote for details).12

Consider now the task of maximizing Ui (C), i = P, R with respect to C =, emphasized in
12
Observe that the fiscal constitution Ciideal , i = P, R yields full discretion because there is an announcement
such that Ciideal (L ) = 0 and an announcement H [0, ]
L [0, ] such that Ciideal (H ) = B.

11
Lemma 1. Lemma 2 provides a preliminary characterization of this problem. For each political
party i, Lemma 2 picks two fiscal constitutions from = and states that the maximizer of Ui (C)
is one of the two chosen constitutions.13

LEMMA 2: Let CP0 and CR

0 denote the fiscal constitutions offered by the two political parties

in the models SSPE. Then: (1) CP0 is either the ideal arrangement constitution for political
party P , CPideal , or the full capacity constitution, C f ull . (2) CR
0 is either the ideal arrangement

ideal , or the shutdown constitution, C shut .

constitution for political party R, CR

PROOF: See the Appendix.

Lemma 2 has two important implications. First, it points out that in the SSPE, fiscal
constitutions assume an extremely simple form: political party i, i = P, R either writes its
ideal arrangement constitution Ciideal or writes a constitution that yields no discretion to the
bureaucrat. Second, recall from Section 2 that for any realization of the demand shock ,
political party P desires to spend weakly more than political party R. This is reflected in
the SSPE as follows. If the equilibrium fiscal constitution of political party P is one without
discretion, the committed budgetary allocation for the agency is at the maximal level, B (i.e.
the chosen fiscal constitution is C f ull ). On the other hand, if the equilibrium fiscal constitution
of political party R is without discretion, the committed budgetary allocation for the agency
is at the minimal level, 0 (i.e. the chosen fiscal constitution is C shut ).
Using lemmas 1 and 2, Proposition 1 provides a complete characterization of the models
SSPE.

PROPOSITION 1: Let (CP0 , CR

0 ) be the fiscal constitutions offered by the two political parties in

the models SSPE. Then: (1) CP0 is the ideal arrangement constitution for political party P ,
R R R P
CPideal , if (1 k) (1 P ) P ( P )f ()d 0 (P )f ()d; otherwise, CP0 is the full
capacity constitution, C f ull . (2) CR
0 is the ideal arrangement constitution for political party R,

13
The proof in the Appendix shows that a minor caveat to the statement of Lemma 2 is required. Specifically,
CP0 need not exactly equal CPideal or C f ull , and CR0
need not exactly equal CRideal
or C shut . When, for example,
0 ideal ideal
we provide conditions that ensure CP equals CP i.e. CP is a maximizer of UP (C) it is also optimal
for political party P to choose any fiscal constitution C = that differs from CPideal on a finite and, hence,
measure-zero set. Identical observations apply as well for C f ull and the two possibilities for CR 0 ideal
(i.e. CR and
shut
C ).

12
 ideal , if (1 k)
R R R 0 is the shutdown
CR P P (R )f ()d R ( R )f ()d; otherwise, CR
constitution, C shut .14

PROOF: See the Appendix.

The intuition behind Proposition 1 is as follows. To fix ideas, suppose political party P is
in power in period t. Consider, first, a fictitious social planner who in period t itself can commit
to implement any fiscal constitution for the agency in the following period, t + 1. Should this
social planner seek to maximize the expected payoff of political party P in period t + 1, the
implemented fiscal constitution would be as follows: the agencys budget in period t + 1 is set
if t+1 > P , and is set at 0 otherwise. Let U
at B p denote the expected payoff delivered to
political party P in period t + 1 in the social planner regime (see footnote for the derivation of
P ).15
U
Relative to the social planners allocation rule in period t + 1, what goes wrong should
political party P write its ideal arrangement constitution CPideal in period t? With probability
(1 k) (1 P ), the political party in power in period t + 1 is R and the bureaucrat
turns out to be non-neutral as well. Given t+1 , the bureaucrat announces t+1 to maximize
the period-(t + 1) payoff of the rich. Observe therefore that when t+1 lies in the preference
conflict region i.e. t+1 (P , R ) the bureaucrat shuts down the agency while the social
planner sets the agencys budget at the maximal level, B. Relative to the social planner
regime, this incongruence in behavior inflicts an expected cost on political party P of magnitude
R ( P )f ()d. In other words,
R
(1 k) (1 P ) B P
Z R
UP (CPideal ) p (1 k) (1 P ) B
=U ( P )f ()d. (10)
P

Relative to the social planners allocation rule in period t + 1, what goes wrong should
political party P write the full-capacity constitution C f ull in period t? When t+1 is less than
P , the social planner provides a budget of 0 to the agency in period t + 1. On the other
14
R R R P
Consider part 1 of Proposition 1. When (1 P ) (1 k) P
( P )f ()d equals 0
(P )f ()d ,
both of the fiscal constitutions, CPidealand C f ull
, maximize UP (C) over all C =. Instead of lengthening the
statement of Proposition 1 to take full account of this knife-edge (measure zero) case, we simply specify that
CP0 equals CPideal . The knife-edge case for part 2 of Proposition 1 is handled in the same way.
15
Given (t+1 , b), recall that the period-(t+1) payoff of political party P is u(t+1 , b|yP ) = b(t+1 P )+yP .
The fiscal constitution implemented by the social planner has [1] b equal to B when t+1 > P and [2] b equal
R
to 0 when t+1 P . So, U P equals B ( P )f ()d + yP .
P

13
hand, the full capacity constitution forces the agencys budget in period t + 1 to be set at the
Relative to the social planner regime, the rigidity of C f ull therefore imposes
maximal level, B.
R P

an expected cost on political party P of magnitude B (P )f ()d. In other words,
0
Z P
P B
UP (C f ull ) = U (P )f ()d. (11)
0

In a SSPE, Lemma 2 says that the fiscal constitution written by political party P is either
CPideal
or C f ull . A comparison of equations (10) and (11) shows that UP (CPideal ) UP (C f ull ) if
and only if P (P )f ()d (1k)(1P ) B R ( P )f ()d. But, this is precisely
R R
0 P
the condition stated in Proposition 1 for political party P to offer the ideal arrangement
constitution CPideal in the SSPE. Analogous arguments apply for the characterization of CR
0 in

Proposition 1.

5 Implications for equilibrium fiscal constitutions

This section, which comprises three propositions, discusses some of the immediate implications
of Proposition 1. The first proposition shows that a worsening of the income distribution of a
society makes equilibrium fiscal constitutions more rigid. The second proposition demonstrates
that an increase in k, the probability that the bureaucrat is honest, makes equilibrium fiscal
constitutions more flexible. The final proposition considers an increase in P , the probability
with which political party P wins an election. When the electoral prospects of political party
P are enhanced, the impact on equilibrium fiscal constitutions is ambiguous.
A society in our model is a four-tuple (yP , yR , P , k). We shall say that society (yP , yR , P , k)
is fully flexible when the associated SSPE has each political party i, i = P, R writing its ideal
arrangement constitution, Ciideal . In such a society, the budgetary allocation to the agency in
period t responds to the period-t demand shock, t . Notice also that the outcome in period t is
guaranteed to lie on the Pareto frontier since the period-t agency budget is set at the level most
preferred by the constituency of one or both of the political parties (see footnote for details).16
We shall say that society (yP , yR , P , k) is fully rigid when the associated SSPE has both
political parties writing fiscal constitutions without discretion (i.e. CP0 is C f ull while CR
0 is

C shut ). In such a society, the agencys budget in period t is unresponsive to the period-t
16
For concreteness, assume political party P is in power in period t 1 and writes the fiscal constitution
CPideal .Then, the agencys budgetary allocation in period t maximizes the period-t payoff of political party P
if [1] political party P retains power in period t or [2] the period-t bureaucrat behaves as a politically neutral
agent. In case conditions [1] and [2] are both violated, the agencys budgetary allocation in period-t maximizes
the period-t payoff of political party R.

14
demand shock, t , and outcomes are frequently not on the Pareto frontier (see footnote for
details).17
Observe that Proposition 1 says that society (yP , yR , P , k) is fully flexible if and only if
the following two inequalities are satisfied:18
Z P Z R
g(P , R , P , k) (P )f ()d (1 P ) (1 k) ( P )f ()d 0. (12)
0 P
Z Z R
h(P , R , P , k) ( R )f ()d P (1 k) (R )f ()d 0. (13)
R P

Proposition 1 also says that society (yP , yR , P , k) is fully rigid if and only if both inequalities
(12) and (13) are violated.
We will require a summary measure of a societys institutional rigidity. To this end, consider
the SSPE corresponding to society (yP , yR , P , k). We define the index of rigidity of this society
as the proportion of time (in the SSPE) during which the fiscal constitution in place is rigid
(i.e. the shutdown constitution, C shut , or the full capacity constitution, C f ull ). When a society
is fully flexible (rigid), its index of rigidity is clearly 0(1). In a society where inequality (12) is
satisfied while inequality (13) is violated, the SSPE involves only political party R writing the
rigid constitution C shut (refer to Proposition 1). Thus, the index of rigidity is 1 P because
the proportion of time with political party R in power is 1 P . Similarly, when inequality
(12) is violated and inequality (13) is satisfied, the SSPE involves only political party P writing
the rigid constitution C f ull ; thus, the index of rigidity is P .
Proposition 2 studies the impact of income distribution on equilibrium fiscal constitutions.
It shows that a mean-preserving spread of the distribution of income in a society leads to fiscal
constitutions that are (weakly) more rigid.

PROPOSITION 2: Consider two societies, s (yP , yR , P , k) and s (

yP , yR , P , k) such that
the mean incomes are the same but yR > yR and yP < yP . Then, the index of rigidity of
society s weakly exceeds that of society s.

17
The full capacity constitution, C f ull , is in place P proportion of the time. Given C f ull , when the realization
of is less than P , which occurs with probability F (P ), the agencys budget is B whereas both political parties
prefer a budget of 0. Similarly, the shutdown constitution, C shut , is in place 1 P proportion of the time.
Given C shut , when the realization of exceeds R , which occurs with probability 1 F (R ), the agencys budget
is 0 whereas both political parties prefer a budget of B. Thus, outcomes are not on the Pareto frontier with
probability equal to P F (P ) + (1 P )(1 F (R )).
18
Recall that P and R in inequalities (12) and (13) are derived from (yP , yR , P , k) as follows: P (1/N )
(yP /y ) and R (1/N ) (yR /y ).

15
PROOF: Consider the left-hand side of inequalities (12) and (13). It is easy to check that [1]
g/P > 0, h/P > 0 and [2] g/R < 0, h/R < 0.
Now contrast the two societies, s and s. Since yP < yP , P (1/N ) (yP / y ) strictly
exceeds P (1/N ) ( y ). Since yR > yR , R (1/N ) (
yP / y ) strictly exceeds R
yR /
(1/N ) (yR /
y ).
But this means that g(P , R , P , k) is strictly less than g(P , R , P , k), and h(P , R , P , k)
is strictly less than h(P , R , P , k).
Suppose the SSPE corresponding to society s has political party P writing its ideal arrange-
ment constitution, C ideal . This, by Proposition 1, is equivalent to the condition g(P , R , P , k)
P
0. But, g(P , R , P , k) 0 implies that g(P , R , P , k) > 0. Hence, in the SSPE correspond-
ing to society s, political party P must also write its ideal arrangement constitution, CPideal .
Suppose the SSPE corresponding to society s has political party R writing its ideal arrange-
ment constitution, C ideal . This, by Proposition 1, is equivalent to the condition h(P , R , P , k)
R
0. But, h(P , R , P , k) > h(P , R , P , k) implies that in the SSPE corresponding to society
ideal .
s, political party R must also write its ideal arrangement constitution, CR
Hence, the index of rigidity of society s weakly exceeds that of society s.

For an intuitive account of why Proposition 2 is valid, compare the parameters of societies s
and s. It is clear that R strictly exceeds R while P is strictly less than P . Suppose, now, that
the SSPE of society s has political party P writing its ideal arrangement constitution, CPideal .
Then, the expected cost to political party P from the full capacity constitution, C f ull (i.e.
P (P )f ()d) exceeds the expected cost to political party P from its ideal arrangement
R
B 0
R ( P )f ()d).19 Observe that since P
constitution, CPideal (i.e. (1 k) (1 P ) B
R
P

exceeds P , the expected cost to political party P from the rigid constitution C f ull is larger in
society s than in society s. On the other hand, the preference conflict region of society s (i.e.
(P , R )) is a strict subset of the preference conflict region of society s (i.e. (P , R )). Hence,
the expected cost to political party P from the discretionary constitution CPideal is smaller in
society s than in society s. In other words, if political party P provides discretion by writing
the constitution CPideal in the SSPE corresponding to society s, it must do so as well in the
SSPE corresponding to society s. Because an analogous argument applies for political party
R, the index of rigidity of society s weakly exceeds that of society s.
Proposition 3 studies the link between the index of rigidity of a society and k, the proba-
19
A discussion of these costs is given prior to equations (10) and (11).

16
bility that the bureaucrat is politically neutral. It shows that an increase in k leads to fiscal
constitutions that are (weakly) less rigid.

such that
PROPOSITION 3: Consider two societies, s (yP , yR , P , k) and s (yP , yR , P , k)
k > k. Then, the index of rigidity of society s is weakly less than that of society s.

PROOF: Consider the left-hand side of inequalities (12) and (13). It is easy to check that
strictly exceeds g(P , R , P , k),
g/k > 0 and h/k > 0. But this means that g(P , R , P , k)
strictly exceeds h(P , R , P , k).
and h(P , R , P , k)
Directly applying the arguments of Proposition 2, it follows that if political party i writes
the discretionary constitution Ciideal in the SSPE corresponding to society s, it must do so as
well in the SSPE corresponding to society s. In other words, the index of rigidty of society s
is weakly less than that of society s.

The intuition behind Proposition 3 is transparent. When political party i writes its ideal
arrangement constitution Ciideal in period t, the constitution is manipulated in period t + 1
to favor the constituency of the other party only when there is legislative turnover and the
bureaucrat is politically non-neutral. Therefore, when k rises, the cost to political party i from
writing Ciideal falls. In other words, if political party i happens to write the constitution Ciideal
in the SSPE associated with society s, it must do so as well in the SSPE associated with society
s. So, the rigidity index of society s is weakly less than that of society s.
Proposition 4 studies the connection between the index of rigidity of a society and P ,
the probability with which political party P wins an election. When P is increased, two
effects ensue. First, since political party P is less likely to lose power, writing the discretionary
constitution CPideal becomes a more attractive option. Hence, an increase in P weakly reduces
the rigidity of the fiscal constitution designed by political party P . Second, since an increase
in P dampens the electoral prospects of political party R, it weakly increases the rigidity of
the fiscal constitution designed by political party R. Since these two effects are in opposite
directions, P changes have an ambiguous effect on the index of rigidity of a society. Proposition
4 formalizes the above intuition.

PROPOSITION 4: Consider two societies, s (yP , yR , P , k) and s (yP , yR ,

P , k) such that

P > P . Then, the index of rigidity of society s may be more or less than that of society s.

17
PROOF: Consider the left-hand side of inequalities (12) and (13). It is easy to check that
g/P > 0 and h/P < 0. Therefore, g(P , R ,
P , k) strictly exceeds g(P , R , P , k),
and h(P , R , P , k) strictly exceeds h(P , R ,
P , k).
Choose the parameters of societies s and s so that [1] g(P , R , P , k) < 0, h(P , R , P , k) >
P , k) 0.20 Then the index of rigidity of society s is
P , k) 0, h(P , R ,
0 and [2] g(P , R ,
ideal in the associated
P (since only political party R writes the discretionary constitution CR
SSPE) whereas the index of rigidity of society s is 0.
To establish a different ranking of the rigidity indices of the two societies, choose the
parameters of societies s and s so that [1] g(P , R , P , k) 0, h(P , R , P , k) 0 and [2]
g(P , R , P , k) < 0.21 Then the index of rigidity of society s is 0 whereas
P , k) > 0, h(P , R ,
the index of rigidity of society s is 1 P (since only political party P writes the discretionary
constitution CPideal in the associated SSPE).

6 Conclusion

Our paper studies a society invested with limited political structures. There are two polit-
ical parties, P and R, representing, respectively, the poor and the rich in the society, that
stochastically control a legislature. A government agency, headed by a career bureaucrat, uses
public funds to provide a service that is valued by all citizens. The political party controlling
the legislature imposes restrictions on the functioning of the agency. Specifically, the political
party in power in period t writes the fiscal constitution (budgetary rule) that the agency is
required to adhere to in period t + 1. We ask: What fiscal constitution is written by political
party i, i = P, R in the stationary subgame perfect equilibrium of the model?
In contrast to extant models, our theory of equilibrium fiscal constitutions de-emphasizes
bureaucratic drift; instead, we focus primarily on the impact of coalitional drift. We argue that
a discretionary fiscal constitution written by political party i in period t is a risky structure
since it may be manipulated by the career bureaucrat to benefit the other party should political
party i lose power in period t + 1. On the other hand, a rigid fiscal constitution written by
political party i in period t is a risk-free but inefficient structure since outcomes in period t + 1
are not conditioned on the circumstances in that period. The equilibrium fiscal constitution
written by political party i reflects a choice between the riskiness of a discretionary fiscal
20
It is easy to show that parameters of societies s and s can be chosen to satisfy [1] and [2].
21
It is easy to show that parameters of societies s and s can be chosen to satisfy [1] and [2].

18
constitution and the inefficiency of a rigid fiscal constitution.
Our paper also examines how equilibrium fiscal constitutions change as society character-
istics are altered. First, we show that as the income distribution worsens and preferences of
the rich and the poor become increasingly polarized, equilibrium fiscal constitutions become
more rigid. Second, we show that as societys corruption level decreases (and bureaucrats are
therefore less willing to manipulate private information to appease their political overseers),
there is an accompanying increase in the flexibility of equilibrium fiscal constitutions. Third,
we show that as the electoral fortunes of a political party are enhanced, the impact on the
rigidity of equilibrium fiscal constitutions is ambiguous.

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Appendix

PROOF OF LEMMA 1: We shall say that the society in period t is in state sP (sR ) if the
political party in power in that period is P (R). Thus, S, the set of states, is as follows:
S {sP , sR }.
We now assign stationary strategies to the two political parties: political party i, i = P, R
writes the fiscal constitution Ci0 whenever it is in power. Consider generic period t and let
the society in period t be in state s S.22 Given the strategies assigned to the two political
parties, let VP (s) denote the expected value of the sum of period payoffs accruing to political
party P from period t + 1 onwards, discounted up to period t.23
A recursion argument establishes the equation below:

VP (sP ) = [UP (CP0 ) + [P VP (sP ) + (1 P )VP (sR )]]. (A.1)

Consider equation (A.1). Since society is in state sP in period t, the agencys fiscal constitution
written in period t by political party P is CP0 . Thus, the expected payoff for political party P
22
Obviously, s is either sP or sR .
23
Observe that since the strategies of the two political parties are stationary, VP (.) depends on the state s
but not on the time period t.

21
in period t + 1 is UP (CP0 ). Two further possibilities now arise. With probability P , political
party P is re-elected in the period-t election; i.e. the state in period t + 1 remains sP . Then,
by definition, the expected value of the sum of period payoffs obtained by political party P
from period t + 2 onwards, discounted up to period t + 1, is VP (sP ). On the other hand, with
probability 1 P , political party P is not re-elected in the period-t election; i.e. the state in
period t + 1 switches to sR . Here, the expected value of the sum of period payoffs obtained by
political party P from period t + 2 onwards, discounted up to period t + 1, is VP (sR ). Equation
(A.1) says that from an ex ante perspective, VP (sP ) is simply [expected payoff for political
party P in the next period + the probability weighted average of VP (sP ) and VP (sR )].
In generic period t, let political party P be in power (i.e. the society is in state sP ). Now
consider the following one-shot deviation from the stationary strategy assigned to political
party P : in period t, the fiscal constitution written is h =, where h 6= CP0 ; thereafter, the
fiscal constitution written is CP0 whenever political party P is in power. Following the period-t
choice of fiscal constitution h, let VP (sP , h) denote the expected value of the sum of period
payoffs accruing to political party P from period t + 1 onwards, discounted up to period t.
Then,24

VP (sP , h) = [UP (h) + [P VP (sP ) + (1 P )VP (sR )]]. (A.2)

It follows from equations (A.1) and (A.2) that all one-shot deviations from the strategy
always write the fiscal constitution CP0 in state sP are unprofitable for political party P if
and only if UP (CP0 ) UP (h), h =. An identical analysis applied to political party R shows
that all one-shot deviations from the strategy always write the fiscal constitution CR 0 in state

0 ) U (h), h =.
sR are unprofitable for political party R if and only if UR (CR R
Using the one-shot deviation principle, the two strategies party i writes the fiscal consti-
tution Ci0 in state si , i = P, R constitute a SSPE if and only if UP (CP0 ) UP (h), h =
and UR (CR 0 ) U (h), h =.
R

PROOF OF LEMMA 2: Since the maximization problem for political party R is analogous to
that for political party P , we restrict our attention in Lemma 2 to political party P . Lemma
2 consists of three steps.

STEP 1: Let CP0 maximize UP (C) over all C =. Then, except for finitely many points,
= B,
CP0 () (P , ].

24
The explanation for equation (A.2) mirrors that for equation (A.1).

22
PROOF: Assume the contrary. Since CP0 is a piecewise continuous function, there must be an
and [2] C 0 ()
interval (a, b) such that [1] (a, b) is a subset of the interval (P , ) < B,
P
0
(a, b). Let CP,min denote the minimum value assumed by CP0 as varies over the interval [0, ].
We construct a function C = as follows: [1] C( = C0
)
P,min , [0, P ] and [2] C() =
(P , ].
B, We shall show that UP (C) > UP (C 0 ), thereby obtaining a contradiction.
P
Recall that in a period wherein P , political party P desires to shut down the agency.
A comparison of CP0 and C shows that C( C 0 (),
) P . Recall also that in a
P
period wherein > P , political party P desires to provide the maximal budget, B, to the
agency. A comparison of CP0 and C shows that C( C 0 (),
) (P , ]\(a,
>
)
b) and C(
P
(a, b). Thus, under the honest bureaucrat regime, where announced coincides
CP0 (),
with , the expected payoff of political party P is strictly higher with fiscal constitution C than

with fiscal constitution CP0 . In other words, UP (C|h) > UP (CP0 |h).
Consider the non-neutral bureaucrat and party-P regime. We shall show that in this regime,
the expected payoff of political party P is weakly higher with fiscal constitution C than with
fiscal constitution CP0 . To this end, note that u(, b|yP ) = b + (1 (b))yP while equation
(1) says that (b) = (1/N ) (b/ y ). Therefore,

u(, b|yP ) = [b ( (1/N ) (yi /

y )) + yP ] = [b ( P ) + yP ]. (A.3)

Equation (A.3) combined with equation (7) shows that for any C =,
Z P Z
UP (C|P, n) = yP + Cmin ( P )f ()d + Cmax ( P )f ()d. (A.4)
0 P

Clearly, UP (C|P, n) depends on two values of C: Cmin and Cmax . Observe also that UP (C|P, n)
is increasing in Cmax . Since, by construction, Cmin = CP,min 0 and Cmax CP,max0 , it is
n) UP (C |P, n).
immediate that UP (C|P, 0
P
Consider the non-neutral bureaucrat and party-R regime. Once again, we shall show that
in this regime, the expected payoff of political party P is weakly higher with fiscal constitution
C than with fiscal constitution CP0 . Equation (A.3) combined with equation (8) shows that for
any C =,
Z R Z
UP (C|R, n) = yP + Cmin ( P )f ()d + Cmax ( P )f ()d. (A.5)
0 R

Clearly, UP (C|R, n) depends on two values of C: Cmin and Cmax . Observe also that UP (C|R, n)
is increasing in Cmax . Since, by construction, Cmin = CP,min 0 and Cmax CP,max
0 , it is
0
immediate that UP (C|R, n) UP (CP |R, n).
We have shown that [1] UP (C|h) n) UP (C 0 |P, n) and [3]
> UP (CP0 |h), [2] UP (C|P, P

UP (C|R, > UP (C 0 ).
n) UP (CP0 |R, n). Using equation (9), UP (C) P

23
STEP 2: Let CP0 maximize UP (C) over all C =. Then, except for finitely many points,
= x, P . Furthermore, x is the minimum value attained by C 0 as varies over
CP0 () P
0
the interval [0, ]; i.e. x = CP,min .

PROOF: Assume the contrary. Since CP0 is a piecewise continuous function, there must be an
> C0
interval (a, b) such that [1] (a, b) is a subset of the interval (0, P ) and [2] CP0 ()
P,min ,
(a, b).
As in Step 1, we construct a function C = as follows: [1] C( = C0
)
P,min , [0, P ]
= B,
)
and [2] C( (P , ].
We shall show that UP (C) > UP (C 0 ), thereby obtaining a
P
contradiction.
Recall that in a period wherein P , political party P desires to shut down the
agency. A comparison of CP0 and C shows that C( C 0 (),
) [0, P ]\(a, b) and
P
< C 0 (),
)
C( (a, b). Recall also that in a period wherein > P , political party P de-
P
sires to provide the maximal budget, B, to the agency. A comparison of C 0 and C shows that
P
C 0 (),
)
C( (P , ].
Thus, under the honest bureaucrat regime, the expected payoff of
P
political party P is strictly higher with fiscal constitution C than with fiscal constitution CP0 .

In other words, UP (C|h) > UP (CP0 |h).
Since, by construction, Cmin = CP,min 0 and Cmax CP,max
0 , the arguments in Step 1 show
0
that UP (C|P, n) UP (CP |P, n) and UP (C|R, n) UP (CP |R, n).0

We have established that [1] UP (C|h) n) UP (C 0 |P, n) and [3]

> UP (CP0 |h), [2] UP (C|P, P

UP (C|R, n) UP (CP0 |R, n). Using equation (9), UP (C) > UP (C 0 ).
P

STEP 3: Steps 1 and 2 demonstrate that except for finitely many points, CP0 has the following
= x, P and C 0 ()
structure: CP0 () = B, > P . Abusing notation slightly, we let
P
UP (x) denote the expected payoff to political party P from the above fiscal constitution. To
find the optimal level of x, we compute UP (x)/x using equations (6), (9), (A.4) and (A.5):
Z P Z R
UP (x)/x = (k+(1k)P ) (P )f ()d + (1k)(1P ) (P )f ()d. (A.6)
0 0

When UP (x)/x > 0, the optimal x is equal to B i.e. C 0 is the full capacity constitution,
P
C f ull . When UP (x)/x < 0, the optimal x is equal to 0 i.e. CP0 is the ideal arrange-
ment constitution for political party P , CPideal . In the knife-edge (measure zero) case wherein
UP (x)/x = 0, any value of x in the interval [0, B] is optimal. To economize on the length
of the statement of Lemma 2, we only pick C f ull and CPideal as optimal for political party P in
this case.

24
PROOF OF PROPOSITION 1: Lemma 2 says that in a SSPE, CP0 must either be the ideal
arrangement constitution for political party P , CPideal , or the full capacity constitution, C f ull .
Using equations (7)-(9), it is immediate that:
Z P Z R

UP (CPideal )UP (C f ull ) = B[ (P )f ()d (1k)(1P ) (P )f ()d]. (A.7)
0 P

Clearly, CP0 is the ideal arrangement constitution for political party P (full capacity constitu-
tion) if UP (CPideal )UP (C f ull ) (<) 0. In other words, CP0 equals CPideal if 0P (P )f ()d
R

(1 k) (1 P ) PR ( P )f ()d, and CP0 equals C f ull otherwise. Analogous arguments

R

establish the results for CR 0.

25