K. Peren Arin, Ph.D., Department of Commerce, Massey University, Private Bag 102 904, North Shore Mail Centre, Auckland, New Zealand, Viera Chmelarova, Ph.D., Department of Economics and Int'l. Business, Sam Houston State University, P.O.Box 2118, Huntsville, TX 77341-2118, Eberhard Feess, Ph.D., Economics Department, Frankfurt School of Finance & Management, Sonnemannstrasse 9-11, Frankfurt am Main, 60314, Germany, and Ansgar Wohlschlegel, Ph.D., Department of Microeconomics, RWTH Aachen University, Templergraben 64, Aachen, 52062, Germany.
This paper investigates the effect of corruption on the ability of governments in adjusting their fiscal deficits. Using a theoretical model and testing the hypothesis of the model by utilizing a panel data set of OECD countries for the period 1978-2007, we show that corrupt governments are less likely to succeed in reducing their budget deficits. We also show that, the reason for this failure is that corrupt governments bow out to political lobbying and pressure b
y doing exactly the opposite of what they need to do: cutting corporate and income taxes and increasing subsidies and benefits during large fiscal adjustment episodes.