Job Market Paper

Fiscal Rules and Private Investment: Theory with Evidence from the Indian States (pdf)

Fiscal rules impose constraints on fiscal policy through mandated limits on government borrowings. This paper highlights a novel aspect of fiscal rules - their ability to directly affect the private economy through firm investment. Using annual balance sheet data from the universe of public Indian firms, and by exploiting the staggered adoption of the Fiscal Responsibility and Budget Management (FRBM) Act by the Indian states, I find that a state's fiscal rule adoption leads an average firm located in the state to increase its stock of fixed capital at the end of the next financial year by $1.59 million (the pre-treatment sample average is $10.2 million). To understand the mechanism, I introduce fiscal rules into the framework of Chari, Dovis, and Kehoe (2020). Analytically characterizing the equilibrium dynamics of public debt, private investment, and bank deposits in a dynamic model of optimal taxation with fiscal rules and endogenous financial repression, I show that borrowing constraints on the government will stimulate private investment if the government is unable to commit to repay its existing debt. In this case, banks are forced to hold government bonds, and a fiscal rule causes "crowding-in" of investment and a commensurate decline in government borrowings from such financially repressed banks without an increase in deposits. Empirical evidence from state-level banking and public finance data provides support for this mechanism. Fiscal rules can be welfare-improving if the welfare loss from less tax-smoothing is dominated by the welfare gains from less crowding-out of valuable private investment. This provides a welfare-based rationale for the adoption of the FRBM Act by the federal and state governments in India, and contributes to the broader policy debate on fiscal restraints.

Working Papers

Data-Driven Auditing of Business and Self-Employment Earnings (joint with Parimal Bag and Peng Wang; pdf)

There is increasing reliance on data-driven auditing of businesses and proprietor-ship. However, the tax returns have garbled signals that are further confounded due to underreporting. Entrepreneurs’ profits depend on their individual types and a common market shock. A high ability, high profit earner underreports only when he observes his neighbor to have earned low profits: neighborhood information about the performance of other entrepreneurs in the same business prompts such strategic reporting, making the volume statistic of ‘high submissions’ a meaningful indicator of market shock. In response auditors scrutinize all low profit returns only if the proportion of high sub-missions exceeds a threshold cutoff. Because this cutoff is endogenous and depends on the stochastic types and market shock, tax returns cannot systematically avoid audit scrutiny as in exogenous cutoff tax returns models. Auditing is enriched to combat the high ‘tax gap,’ a well-known problem in tax enforcement.

Works in Progress

Political Distortions in the Choice Between Grants and Loans for Intergovernmental Transfers in a Federation (pdf)

This paper considers a multi-period political agency model in the spirit of Bracco et al. (2016) to analyse intergovernmental transfers in a federal economy. A coalition government at the center has discretion over the loan and grant transfers made to different states, and takes state elections that happen between periods into consideration. State incumbents tax their electorate and exert effort to produce a local public good. Retrospective voters can perceive their tax burden, but can not observe center-state fiscal transfers. The main theoretical result is that the interaction between the extent of alignment and the degree of swing-ness of an aligned state affects the fraction of total transfers it receives in the form of loans, with this ratio being a decreasing function of the interactive term. Predictions from the model are tested using novel data from the Indian states between 1991 and 2019. Esitmates suggest than an aligned state which is one standard deviation below the average aligned state in terms of the extent of alignment (as measured by the fraction of central cabinet portfolios held by the leading party in the state), and has the same degree of swing-ness (as measured by the fraction of seats assigned to the state in the national legislature that is controlled by the leading party at the center) as the average aligned state, has a 5.44% larger loans to total transfers ratio.

Dynamic Tax Enforcement: Theory with Evidence from Taiwan (joint with Francesco BIllari, Yu-Chun Cheng, and Hsing-Wen Han)