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date: 18 December 2017

Public Finance and Soft Budgets

This is an advance summary of a forthcoming article in the Oxford Research Encyclopedia of Economics and Finance. Please check back later for the full article.

The concept of soft budget-constraint, first formulated by Kornai in 1986, describes a situation where a decision-maker finds it impossible to keep an agent to a fixed budget. In healthcare, it may refer to a nonprofit hospital that overspends, or to a lower level of government that does not balance its accounts.

A soft budget-constraint may represent optimal policy from the point of view of the regulator. However, its presence may allow strategic behavior that changes its nature considerably, as well as its desirability. In this review, soft budget constraint will be analyzed along two lines:

From a market perspective: In this case, the decision of a single hospital to run a budget deficit will be studied.

From a fiscal federalism perspective: We will study the decision of a lower tier to run a budget deficit.