Journal Pre-proof

Political forecast cycles

Frank Bohn, Francisco José Veiga

PII: S0176-2680(20)30082-3
DOI: https://doi.org/10.1016/j.ejpoleco.2020.101934
Reference: POLECO 101934

To appear in: European Journal of Political Economy

Received Date: 1 April 2020

Revised Date: 30 July 2020
Accepted Date: 5 August 2020

Please cite this article as: Bohn, F., Veiga, Francisco.José., Political forecast cycles, European Journal
of Political Economy (2020), doi: https://doi.org/10.1016/j.ejpoleco.2020.101934.

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 Political Forecast Cycles

FRANK BOHN∗† and FRANCISCO JOSÉ VEIGA‡

July 2020

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Abstract

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A moral hazard model is used to show why overly optimistic revenue forecasts

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prior to elections can be optimal: Opportunistic governments can increase spending
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and appear more competent; ex post deficits emerge in election years, thereby produc-
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ing political forecast cycles – as also found for US states in the empirical literature.

Additionally, we obtain three theoretical results which are tested with panel data for
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Portuguese municipalities. The extent of manipulations is reduced when (i) the win-

ning margin is expected to widen; (ii) the incumbent is not re-running; and/or (iii)
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the share of informed voters (proxied by education) goes up.

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JEL classification: D72, H68, E32

Keywords: opportunistic political budget cycles; deficit; revenue forecasts; forecast errors;
asymmetric information; political economy.

∗
Corresponding author. Radboud University, Institute for Management Research, Department of Eco-
nomics, P.O. Box 9108, 6500 HK Nijmegen, The Netherlands, phone: +31-24-36-15507, fax: +31-24-36-
12379, email: f.bohn@fm.ru.nl.
†
KOF Swiss Economic Institute, Zurich, Switzerland.
‡
Universidade do Minho and NIPE, Escola de Economia e Gestão, 4710-057 Braga, Portugal, phone:
+351-253604511, fax: +351-253601380, email: fjveiga@eeg.uminho.pt.
1 Introduction

Since the Greek admission to have falsified its fiscal data on 22 September 2004 (Carassava,

2004) there has been a significant increase in academic articles on forecast errors and forecast

manipulation. For instance, Heinemann (2006) and Brück and Stephan (2006) argue that

forecast optimism may have increased in Germany and the eurozone, respectively, since

the introduction of the Stability and Growth Pact (SGP). Governments try to influence the

international and domestic public’s perception of fiscal conditions. Similarly, Gilbert and

de Jong (2017) find that the European Commission’s (EC’s) fiscal forecasts for euro-area

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countries are too optimistic when the budget deficit comes close to violating the critical

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value of 3% of GDP.

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There is also evidence that governments use financial forecasts to expand their fiscal room
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for manoeuvre in election years in order to increase their chances of re-election. Election

year forecast optimism is confirmed, for instance, by Boylan (2008) who shows for 49 US
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states for the period from 1988 to 2004 that the state revenue growth forecast error is 2.2%
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higher in election years despite constitutional balanced budget constraints. Further evidence

of opportunistic manipulation of forecasts is found, for instance, by Kauder et al. (2017)

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with respect to spending forecasts in election years by East German state governments; and
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by Boukari and Veiga (2018) with respect to revenue and expenditure forecasts in French

and Portuguese local authorities from 1998 to 2015. Pina and Venes (2011) argue that

upcoming elections induce over-optimism in the budget forecasts of Excessive-Deficit Proce-

dure (EDP) reports of European Union countries. Interestingly (and somewhat comparable

to the aforementioned result by Gilbert and de Jong (2017) on countries close to violating

the SGP), Merola and Pérez (2013) find over-optimism in election years not just in forecasts

by European governments, but also, though weaker, in forecasts for European countries by

international organisations such as the EC and the OECD.

This paper presents a political economy model that captures the idea of expanding the fiscal

room for manoeuvre by using overly optimistic forecasts. This is particularly relevant in the

1
context of Portuguese municipalities which we use in the empirical analysis. The room for

manoeuvre for mayors is quite limited, so that forecast manipulation seems a good way for

circumventing this obstacle. The first objective of our paper is, therefore, to analyse and il-

lustrate the underlying theoretical mechanism in a setting with an opportunistic government

and a partially uninformed electorate. The incumbent government can manipulate revenue

forecasts in order to be able to increase spending and, thereby expand its provision of public

goods. This is a hidden effort because uninformed voters cannot pinpoint the reason for

the expansion; instead, they attribute it to government competence, thereby raising the

government’s re-election chances.1 At the same time, deficits must increase when revenue

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forecasts are too optimistic. Since forecasts and budgets are larger in election years, we

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obtain political forecast and budget cycles. Not only do we offer a theoretical mechanism

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that can explain the existence of forecast manipulation in election years found in the earlier

empirical literature, but we also provide additional evidence based on data from Portuguese
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municipalities for the period 1998-2017.
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The second objective of our paper is to investigate the factors that are conducive to in-
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creasing the forecast manipulation even further. In the theoretical model we obtain the

following results. First, a larger ex ante expected winning margin allows the incumbent to
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reduce its revenue forecast which leads to a lower level of costly indebtedness. Second, if the
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incumbent is not re-running, its own interest in winning the elections is reduced. Again, the

motivation for high indebtedness is reduced. Third, if there are more uninformed voters,

any manipulation is more effective. Hence the government will expand its effective tool and

choose higher revenue forecasts. These findings are supported by the empirical analysis.

The expected winning margin is proxied by the previous election winning margin. Unin-

formedness is captured by alternative education proxies. There is overwhelming evidence,

both in the main results and in a battery of robustness tests, in support of our theoretical

1
Earlier theoretical moral hazard papers in which a government can appear more competent by manip-
ulating a (partially) uninformed electorate are Lohmann (1998) for political business cycles, and Shi and
Svensson (2006) for political budget cycles. In Bohn (2019), the government uses its incumbency advantage
to affect the beliefs of the electorate.

2
predictions.

The remainder of the paper is structured as follows. Section 2 outlines the model and

its solution and presents Propositions 1 to 3. Details are provided in the appendix. The

empirical model is set out in Section 3 and the results are presented in Section 4. Additional

robustness tests can be found in the appendix. Section 5 concludes.

2 Political Forecast Cycle Model

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The model captures an incumbent government which has some leverage over its revenue

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forecasts. It can manipulate them in order to expand its public services with the hope of

convincing voters of being more competent and, thereby, increasing its re-election chances.

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Voters can be informed or uninformed about the government forecasts. If they are informed
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they can use this information to deduce government competence. If they are uninformed
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they have to form expectations. Overall, the model is of the Shi and Svensson (2006)

and Bohn (2018) type; it captures moral hazard of an opportunistic government thereby
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producing political cycles.

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Preferences
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Every alternate period two opportunistic politicians run for office, an incumbent a and a

challenger b. Individual voter i’s utility depends on economic and non-economic considera-

tions:

∞
X
Uti = (β i )s−t Es [us (cs ) + G+ i
s + αχ zs ] with χi = θi − γ. (1)
s=t

The intertemporal utility function for any voter i comprises additively-separable utility from

private consumption, us (cs ), utility from public consumption G+

s , with unity marginal utility

(a simplification also used by Shi and Svensson, 2006), and a non-economic component χi zs ,

with relative weight α, in each period. Formally, discounting between periods is included

3
here, but can be ignored later on because it does not contribute to substance nor exposition

as will be seen further down. Utility derived from sympathy represents any attribute of the

candidates that does not affect economic policies, be it their stance on societal issues or

their good looks. It reflects more or less strong sympathy for one of the two candidates.

Without limiting the generality of the analysis we assume that support for incumbent a is

depicted by negative values of χi , support for challenger b by positive values. Sympathy

utility is constrained to χi zs ∈ [− 12 − γ, 12 − γ] since zt is either − 21 (when incumbent a

is elected) or + 21 (when challenger b is elected); the personal sympathy parameter θi is

uniformly distributed over the interval [−1, 1]; and γ is a shift parameter.2

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Both politicians j = a, b face a utility function similar to the one for voters consisting, again,

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of an economic and, if the politician is in power, a non-economic component. The non-

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economic component is, however, different and includes both a political rent and political
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(reputation) costs:
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∞
X ∞
X
Vtj = Vsj = (β j )s−t Es [us (cs ) + G+
s
2
+ Is Xs − Is−1 Is ξs Ds−1 ], j = a, b. (2)
s=t s=t
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

1 if in power in period r

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Ir =

0 otherwise

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Both politicians are concerned about private and public consumption. In addition, politician
2
a (in power) receives ego rent Xs and bears reputation costs (ξs Ds−1 ), if she was also in

power in the previous period. Reputation costs rise overproportionally (squared) with the

previous period deviation (Ds−1 > 0) from a balanced budget3 (Ds−1 = 0).4

2
If voter i has somewhat more sympathies for incumbent a, say at χi = − 12 , then her utility derived
from sympathy is positive ( 41 ), if the incumbent is elected (zs = − 12 ); but it is negative (− 14 ), if challenger
b is elected (zs = 21 ). If γ = 0, incumbent and challenger have equal chances of being elected; with γ > 0,
the incumbent has higher chances.
3
Most Portuguese municipalities exhibit a near-balanced budget; see page 14 in Section 3 and Table E.1
in Appendix E. Alternatively, deviations from a prespecified deficit target D̄ (i.e. Ds−1 > D̄) could also be
modelled, but would produce the same qualitative results.
4
Leaving reputation costs out would not contradict any of the findings of this paper, but would require
the inclusion of subjective discount rates and a careful discussion of interest (debt repayment) versus discount

4
For voters and politicians alike, period t consumption ct is modelled to depend upon trend

output ȳ and any deviation of output yt+ . For simplification, the tax revenues (and ex-

penditures) for trend output are not explicitly studied, but would not change the analysis;

note, however, that deadweight loss and distributional effects are ignored. What we do con-

sider are tax revenue changes caused by deviations of output, hence each agent’s additional

net-of-tax income (1 − τ )yt+ in the consumption function:5

Rt+
ct = ȳ + (1 − τ )yt+ = ȳ + (1 − τ ) . (3)
τ

The deviation from trend output, yt+ , is a random variable with mean Et [yt+ ] = 0 and

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variance σ 2 . For a constant tax rate, it can also be expressed in terms of additional revenue

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the government receives, Rt+ , which is also a random variable with mean zero.

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Fiscal policy and competence
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The planned government budget constraint is expressed in terms of additional public goods,
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G+
t , supplied by the government:
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f orec
G+ +
t = Rt − (1 + rt−1 )(Dt−1 ) + ηtj . (4)
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We assume a planned balanced budget; see Footnote 3. However, by making overly opti-
f orec
mistic revenue forecasts, Rt+ , for random variable Rt+ the incumbent can manipulate the
f orec
amount of public goods she supplies to voters.6 The variable Rt+ is thus the incumbent’s

rates. – The quadratic form is the simplest way of capturing how the government’s trustworthiness and
credibility are affected. The legislature and social groups the government has to deal with may ”tolerate”
small, but not large, deviations and dislike both surpluses and deficits.
5
Note that we keep the tax rate τ constant because possibilities for tax rate changes by Portuguese
municipalities are very limited and the tax revenue effect would be very small. See page 15 in Section 3
(the paragraph on financial autonomy and its limitations as well as the paragraph thereafter).
6
The corresponding variable in the empirical model would be the deviation of the forecast from some
moving average (MA) of the actual revenues of the previous years. This is the variable we used originally.
However, upon suggestions by referees and to be more in line with the standard in the literature, we now
use forecast errors. The results based on the MA forecast variable are reported as robustness checks in
Table F.3 in Appendix F.

5
instrument7 and forms the basis for her budget calculations; previous period deficit Dt−1

including interest at exogenous rate rt−1 must be repaid.

The amount of public goods any government j can supply also depends on j’s positive

or negative competence shock, ηtj . Competence could be interpreted, for instance, as tax

collection efficiency or public goods provision efficiency. Competence ηtj consists of a skills

shocks for the current period and another one for the previous period:

ηtj = µjt + µjt−1 . (5)

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Hence competence persistence is modelled as an MA(1) process.8 Each skills shock µjt is

a random variable with mean 0, distribution function F (µjt ) = F (•) and density function

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f (µjt ) = f (•) = F 0 (•) which is (weakly) monotonously increasing up to the mean.9 Past

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shocks are common knowledge, but current or future shocks are unknown to both politicians
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and voters. Even the incumbent does not know her own current competence – an idea sug-
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gested by Shi and Svensson (2006) – because she always faces new tasks and challenges (like

the financial crisis or the European refugee crisis) or wants to start new programmes and
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cannot foresee how efficiently she can manage them. Not knowing her own competence, any
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incumbent has an incentive to provide additional public goods in order to appear more com-

petent and increase her re-election chances. Since politicians do not have an informational
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advantage, there is no signalling, only moral hazard.

The government deficit is obtained residually because forecast revenues are committed ac-

7
In the Portuguese setting, municipal forecasts comprise realistic expectations, mainly in current rev-
enues (see page 15), as well as deliberate forecast manipulation, mainly in capital revenues (such as success
optimism for funding applications and promised sales of capital goods; see page 15).
8
Limited persistence is a compromise. It allows some persistence while acknowledging that competence
also changes over time as new tasks for politicians emerge. For persistence longer than 1 period, the model
would not be easily solvable. Rogoff and Sibert (1988)’s and Rogoff (1990)’s suggestion of an MA(1) process
is one of two conditions (the other being the assumption of debt being costly) for splitting the model into
separate 2-period cycles as is common in this literature. Each cycle consists of an election period and an
off-election period. The timing of events (page 7) and the role of these assumptions is outlined further down.
9
For more unusual density functions (for instance, with F 00 (µat ) < 0 for some µat ≤ 0), we could get
ambiguous results. However, the limiting case of F 00 (µat ) = 0 for some µat ≤ 0 or even over the entire range
(uniform distribution) is acceptable.

6
cording to Equation (4), but actual revenues deviate; we can also determine the expected

deficit given Eta [Rt+ ] = 0:

f orec
Dt ≡ Rt+ − Rt+ ; (6)

f orec
Eta [Dt ] = Rt+ . (7)

Since the incumbent hopes to facilitate augmented public services in order to increase re-

election chances, she accepts (and expects) a positive deficit.

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Timing of events

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The timing of events is summarised in Table 1. In election period t, everybody observes

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last period’s deficit Dt−1 and past skills shock µat−1 . On this basis, incumbent a chooses her
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f orec
forecast of additional revenue Rt+ , thus determining the amount of additional public
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goods G+ +
t it can provide according to Equation (4). All voting individuals observe Gt ,

but only informed voters can also observe and make use of the state government’s policy
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f orec
choice of the forecast of additional revenue Rt+ . They can, therefore, deduce current
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skills µat , thereby extracting information about the future competence of the incumbent
a
(since ηt+1 = µat+1 + µat ). Uninformed voters can only form expectations of the incumbent’s
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current skills, µcat based on their perception of the government forecast of additional revenue,
\ f orec
Rt+ . Then all voters cast their votes based on their different information sets and their

different beliefs of µat . What matters is that a share of voters is uninformed, even though

they are rational in the end. If government policy could be correctly observed by all voters,

the government would gain nothing from manipulating the forecast and from expanding

public goods.

In period (t + 1), the winner (incumbent or challenger) takes office and receives an ego rent.

If the incumbent stays in office, she also suffers a reputation loss amounting to disutility
2
ξt Dt−1 for not having achieved a balanced budget; a government found to have cheated may

be in a weaker position in negotiations with the legislature and social groups. However,

7
 Table 1: The Timing of Events.

All voters and All voters observe: Informed voters: The winner of the

incumbent a observe: - additional public - deduce the incumbent’s current skills period t elections

- last period’s deficit goods µat takes office and

Dt−1 G+t - and vote. receives an ego rent.

- the incumbent’s last

period skills Informed voters Uninformed voters: If the incumbent

µat−1 observe: - form expectations of the incumbent’s stays in office, she

- the incumbent’s current period skills suffers a reputation

Incumbent a: forecast of µbat loss for a period t

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- chooses forecast of additional (based on rational expectations budget deficit.

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additional revenue revenue of the incumbent’s forecast of
f orec f orec
Rt+ Rt+ additional revenue The winner repays

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\ f orec the deficit of the
- and provides additional
Rt+ )
public goods previous year.
re - and vote.
G+t
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Period t Period t+1

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voters are no longer relevant for the politician’s decision making in (t + 1) because they
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cannot vote in period (t + 1). Politicians have no incentive for manipulating their forecast
f orec
of additional revenue Rt+ . They want to repay the previous period deficit because the
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deficit is costly10 and voters cannot sanction the politician for producing a negative amount

of additional public goods, thereby financing deficit repayment. Given that voters are only

concerned about politicians’ competence after the election it does not matter that voters

anticipate in election period t that any politician will repay the deficit in the off-election

period (t+1). Note also that voters do not consider expected utility in (t+2) in their voting

decision in t, because even informed voters cannot distinguish between the incumbent and

her challenger in (t + 2) (competence is an MA(1) process only). Politicians, too, are not

10
Repayment is guaranteed for two reasons. Firstly, because of the aforementioned reputation loss.
Secondly, technically, because the marginal utility of additional deficit-financed public goods in t is 1 (if the
subjective discount factor is set to 1 for simplicity), whereas its marginal cost and, therefore, the marginal
disutility is (1 + rt ), i.e. greater than 1. The unity marginal public goods utility assumption is also used by
Shi and Svensson (2006).

8
concerned about the more distant future, because they have no instrument for affecting

utility or re-election chances in (t + 2). The model can, therefore, be split in 2-period cycles

consisting of an election period (period t) and an off-election period (period t + 1). See also

Footnote 8.

Incumbent’s probability of winning

The incumbent maximises her expected utility in t and t + 1 (whereby the discount rate can

be set to 0 for simplicity). The t + 1 utility depends on the probability of the incumbent of

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winning the election. First, we must, therefore, determine the probability that an individual

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agent votes for incumbent a. We assume prospective voting, i.e. voting depends on whether

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a voter expects the incumbent or the challenger to deliver a higher level of utility after

the elections, i.e. in t + 1. This depends on two components: (i) on the voter’s sympathy
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χi = θi − γ towards the candidates; and (ii) on who can deliver more public goods which,
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in turn, depends on the politicians’ skills in periods t and t + 1. Agents do not know future

skills of incumbent or challenger; nor can they observe any skills of the challenger in period
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t. However, they may have expectations on the incumbent’s skills (Et [µat ]) based on her
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performance in office in period t. It is shown in Appendix A that an individual agent votes

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for incumbent a, if the following inequality holds:

Et [µat ] > α(θi − γ). (8)

First, suppose shift parameter γ is zero, then ex ante incumbent and challenger have an equal

chance of winning the election. However, even if incumbent a is expected to be (slightly)

less skilled than average, i.e. Et [µat ] < 0, a voter will vote for incumbent a, if the voter is

sufficiently sympathetic towards the incumbent (remember that θi < 0 indicates sympathy

for incumbent a and α is a positive weight). Conversely, even if a voter is sympathetic

towards the challenger (θi > 0), the incumbent could still be chosen, if the incumbent is

expected to exhibit sufficiently strong (above average) skills. Second, with shift parameter

9
γ negative, it is easier for the incumbent to convince voters to vote for her; it requires a

lower level of expected skill, Et [µat ] < 0.

On this basis, we derive (in the appendix) the probability for the incumbent to win the

election:
 
 
Etinf [µat ] 1 + γ E uninf [µat ] 1 + γ
 
 1
Prob (1 − ψ) [ + ]+ψ [ t + ] ≥ . (9)

 2α 2 } | 2α {z 2 } 2
| {z 
informed uninformed

The probability depends on whether informed voters (share (1 − ψ)) and uninformed voters

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(share ψ) think that the incumbent’s skills are above average (Et [µat ] > 0) or not. The

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difference for informed and uninformed voters occurs because informed voters have all the

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information for deducing µat from the period t planned government budget constraint (4);

uninformed voters do not. Uninformed voters do not observe the forecast of additional
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f orec
revenue Rt+ ; instead, they have to use their perception of the forecast of additional
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\ f orec \ f orec f orec

revenue Rt+ . Hence, their mistake amounts to Rt+ − Rt+ – as shown in Appendix

B. On this basis, we can derive the incumbent’s probability of winning Probwin :

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\ f orec f orec
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win
Prob = Prob µat ≥ ψ (Rt+ − Rt+ ) − αγ (10)
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\ f orec f orec
= 1 − F [ ψ (Rt+ − Rt+ ) − αγ] , (11)

where F (•) is the distribution function of the skills shock. Note that this equation shows

that, in equilibrium, the incumbent cannot increase her winning probability by using forecast

manipulations, if we assume rational expectations. For γ = 0, we obtain Probwin = 1 −

1
F [0] = 2
in equilibrium.

Incumbent’s decision problem

To determine the governments policy choice, we maximise the incumbent’s expected utility

over any 2-period cycle, i.e. period t utility plus period (t + 1) utility in case of winning

10
the election multiplied by the probability of winning (as determined in step 2) plus period

(t + 1) utility in case of losing multiplied by the probability of losing:

maxR+ f orec V = maxR+ f orec Vta + Vt+1

a
=
t t

Rt+
maxR+ f orec Eta { ut (ȳ + (1 − τ ) ) + G+ 2
t + Xt − ξDt−1 }
t τ
+
Rt+1
+ Eta { Probwin [ut+1 (ȳ + (1 − τ ) ) + G+ 2
t+1 + Xt+1 − ξDt ] }
τ
+
win Rt+1
+ Eta { (1 − Prob ) [ut+1 (ȳ + (1 − τ ) ) + G+
t+1 ] }. (12)
τ

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See Appendix C for a more detailed exposition of Equation (12) and the following steps. The
f orec
government’s optimal choice of its forecast of additional revenue Rt+

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can be characterised

by the first order condition (FOC) given that the second order condition holds. Under
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rational expectations this becomes:
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f orec 2 f orec
−rt + F 0 [−αγ]ψ[Xt+1 − ξ(Rt+ ) ] − [1 − F [−αγ]]2ξRt+ = 0. (13)
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The first term of rational expectations condition (13), −rt , is the marginal direct effect of
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the government’s forecast of additional revenue on the deficit, which is negative because
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deficit including repayment is costly. The (additional) revenue forecast is optimally chosen

by the government, when the marginal direct effect on the deficit (first term) equals the

net effect on the expected return if the incumbent stays in power (second and third terms).

The latter consists of countervailing effects. The second term depicts the positive marginal

impact of higher forecasts on the perceived skills of the incumbent and thus on the voting
f orec 2
probability of receiving the (given) expected net return (Xt+1 − ξ[Rt+ ] ). The third term

captures the negative marginal impact of increased forecasts on the punishment for the lost

reputation (since the deficit will be increasing) given the chance of winning the elections.

Rational expectations condition (13) states that the government wants to increase its fore-

cast of additional revenue until the marginal deficit cost together with the punishment effect

11
(which is very small for low levels of forecast manipulation) exceeds the marginal benefit

from spending on public goods which translates into a marginal benefit from increasing

the chances of winning. In other words, the first key result of the paper is that there are

political forecast cycles; forecasts are increased in election years. This also implies higher

deficits which are repaid in off-election years. Hence, there is also a political budget cycle

along the lines of Shi and Svensson (2006); there is moral hazard because a hidden effort

(deficit in Shi and Svensson; and forecasts here) is used by the government for expanding

public goods and trying to improve re-election chances. Overall, the theoretical part of the

paper pinpoints and illustrates the mechanism underlying the forecast manipulation found

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empirically by Boylan (2008) and others. This was the first objective of the paper (together

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with providing additional empirical evidence of such manipulation).

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Let us now turn to the second objective: How is the government’s optimal choice of its
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forecast manipulation affected by exogenous aspects of the model? In particular, we would
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like to know the effect of an increased winning margin (captured by a higher shift parameter

γ; see Proposition 1), the consequences of an incumbent who is not re-running (embodied
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by a lower ego rent for the time after the elections, Xt+1 ; see Proposition 2), and the effect

of increasing the share of uninformed voters (higher ψ; see Proposition 3).

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Three testable propositions

Proposition 1 - The Winning Margin.

A larger winning margin γ decreases the optimal revenue forecast by the incumbent at the

equilibrium.
f orec ∗
d(Rt+ )
< 0.
dγ

Proof: See Appendix D.

A larger winning margin allows the government to avoid costly deficits both in terms of

repayment and reputation costs.

12
Proposition 2 - When the Incumbent is not Re-running.

When the incumbent is not re-running (Xt+1 reduced), the optimal revenue forecast by the

incumbent is reduced at the equilibrium.

f orec ∗
d(Rt+ )
> 0.
dXt+1

Proof: See Appendix D.

If the incumbent does not benefit from winning so much any more, winning becomes less

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important. No longer does it pay to incur high deficit repayment and reputation costs.

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Proposition 3 - The Share of Uninformed Voters.

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A larger share of uninformed voters ψ increases the optimal revenue forecast by the incum-
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bent at the equilibrium.
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f orec ∗
d(Rt+ )
> 0.
dψ
na
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Proof: See Appendix D.

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Manipulation works because uninformed voters can be tricked. If more of them can be

cheated, the manipulation instrument becomes more effective. Hence it is used more.

3 Data, Setting, and Empirical Models

This section has three purposes. First, it describes the data and the institutional setting for

Portuguese municipalities. Second, it introduces the empirical baseline model that is used

for confirming the forecast manipulation result obtained in our theoretical model and in the

existing empirical literature. Third, it presents the changes to the baseline model which are

needed for testing the implications (propositions) derived from our theoretical model at the

end of Section 2.

13
Data and Institutional Setting

Detailed fiscal data for the 308 municipalities was obtained from the Directorate General

of Local Authorities (DGAL), information regarding the dates and results of local elections

and on mayors’ characteristics from the Ministry of Internal Affairs (MAI), and demographic

and economic data from the National Statistics Institute (INE) and from Marktest’s Sales

Index database. Our dataset covers the period from 1998 to 2017, for which DGAL’s data

on municipal initial budgets is available. Five local elections took place during our sample

period (2001, 2005, 2009, 2013, and 2017).

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Municipalities are the highest subnational government level in mainland Portugal, and the

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second in the autonomous regions of Azores and Madeira, which have regional governments.

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All municipalities are subject to the same laws and regulations, have the same responsibili-

ties for public service provision,11 and have the same institutional structure. Regarding the
re
latter, the Town Council (Câmara Municipal) holds the executive power, while the Munic-
lP

ipal Assembly holds the deliberative power, approving, among other things, the municipal
na

budgets and plans of activities. Voters elect the members of both chambers directly, by cast-

ing their votes on closed party or independent lists of candidates. The top candidate of the
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most voted list for the Town Council becomes the mayor, presides that chamber and plays
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a leading role in the executive, having substantial power and latitude. Municipal elections

are held every four years, in all municipalities at the same time, generally in October (they

were held in December until 2001). Although other elections sometimes occurred in the

same year, national, regional, or European elections were never concurrent with municipal

elections.

Local governments have financial autonomy, not needing approval from a higher-ranked

authority to elaborate and approve their own budgets and final accounts. Nevertheless,

most of them heavily depend on grants from the central government or from the European

11
Distribution of water, sewage, basic schooling, local health care, social housing, local transportation and
communication, property maintenance, promotion of culture and science, recreation and sports facilities,
environmental protection, and municipal policing.

14
Union (own revenues account, on average, for less than one third of effective total revenues).12

The municipal budget is drafted by the mayor’s team, analysed by the Town Council, and

approved by the Municipal Assembly, in the last quarter of the year prior to the relevant

fiscal year (which corresponds to the calendar year). Forecasted municipal budgets must

balance. Nonetheless, municipalities are allowed to run operational budget deficits,13 which

are, however, constrained by strict legal limits to the stock of municipal debt.

Current revenues account for about two thirds of total municipal revenues (see Table E.1 in

Appendix E). They are mainly composed of current transfers (mostly central government

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grants) and by direct taxes (mostly on property). Central government current grants are

essentially formula-determined, and are included in the central government’s budget, which

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is published before municipalities approve their own budgets. Municipalities can change

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property tax rates, but only within relatively narrow legal limits. Since the tax base is
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quite stable, property tax revenues are relatively easy to forecast. Given the above, current
lP
revenues may change (for instance, in response to increased output), but there is not much

room for opportunistic forecast manipulation in current revenues.

na

Capital revenues account for about a third of total revenues, and are mainly composed of
ur

capital transfers from the central government and from the European Union (they represent
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about 95% of effective capital revenues). On average, about 40% of capital grants are

formula-determined, while the remaining 60% are contingent on the approval of applications

for funding. This makes capital transfers harder to predict and more prone to opportunistic

forecast manipulation, as mayors can easily increase forecasted revenues by being excessively

optimistic about the approval of their applications for funding. The sales of capital goods

are also prone to opportunistic forecasting, as mayors can easily inflate forecasted revenues

12
Table E.1 in Appendix E presents descriptive statistics for the main revenue items, in real euros per
capita. Descriptive statistics for total, current and capital expenditures, and for budget balances, are also
reported.
13
The operational budget balance corresponds to the difference between total revenues and total expen-
ditures, excluding revenues and expenditures related to financial assets and liabilities. Thus, if forecasted
effective total revenues are below forecasted expenditures, the municipality will balance the budget with
revenues from financial liabilities (loans).

15
from the sale of municipal property.14

Given the uncertainty and the greater room for opportunistic forecast manipulation in

capital revenues, it is not surprising that average forecast errors15 (see the first three rows

of Table E.2 in Appendix E) are much higher for effective capital revenues (440 euros

per capita) than for current revenues (94 euros per capita). Additionally, average forecast

errors in effective capital revenues are higher in election years than in off-election years (see

Table E.3), while the opposite is true for forecast errors in total current revenues. Overall,

revenue forecasts of Portuguese municipalities are biased upwards, and total and capital

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revenue forecasts seem to be especially optimistic in election years. It is also worth noting

that financial liabilities (loans) are the only revenue item which is underpredicted in election

ro
years. This is a consequence of excessive optimism in effective total revenue forecasts, which

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leads to budget deficits that have to be funded with loans. Thus, actual loans in election
re
years are higher than forecasted.
lP

Our theoretical model indicates that, by forecasting overly optimistic revenues, opportunistic

governments can increase spending to appear more competent prior to elections. This results
na

in deficits in election years. The behaviour of forecasted revenues and of actual expenditures
ur

and budget balances, illustrated in Figure 1, appear to be consistent with the model’s
Jo

predictions. Average forecast errors in effective total and capital revenues and actual total

expenditures tend to increase in election years relative to the previous years of the electoral

cycle (except in 2013), and budget balances tend to be lower (or deficits tend to be higher)

in election years than in off-election years.16

14
This was common practice by many Portuguese municipalities, which inflated their revenues by pre-
dicting to sell municipal property. In many cases, the sales did not materialize, or the predicted sale prices
were unrealistically high.
15
Forecast errors in revenues correspond to the difference between forecasted and actual amounts, both
measured in real euros per capita (at 2017 national prices).
16
Descriptive statistics of expenditures and budget balances in election and off-election years are reported
in Table E.4 in Appendix E. As illustrated in Figure 1, mean expenditures are higher in election years than
in off-election years. Regarding average budget balances, there are deficits in election years and surpluses
in off-election years.

16
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na
ur
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Figure 1: Averages of effective total revenue forecast errors, expenditures and budget bal-

ances

Empirical Models

The theoretical model’s first main result is that there are political forecast cycles. Revenue

forecasts are more optimistic in election years (see discussion of rational expectations FOC

13 in Section 2). Thus, larger forecast errors are expected in election years than in off-

election years. Despite the fact that descriptive statistics and Figure 1 seem to support

17
these theoretical predictions, it is necessary to test them rigorously with an empirical model

that controls for the main determinants of revenue forecast errors. Our baseline empirical

model is, therefore:

f error
Ri,t = α + βElYi,t + X0i,t θ + νi + σt + ξi,t , (14)
f error
where Ri,t is the forecast error in revenues for municipality i in year t (forecasts taken

from the initial municipal budget), in real euros per capita (at 2017 national prices);17

ElYi,t is a dummy variable for the election year; Xi,t is a vector of control variables which

may affect forecasted revenues; νi represents unobserved municipality-specific effects; σt

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represents time-specific effects;18 and ξi,t is the error term. α and β are scalar coefficients,

and θ is a vector of coefficients to be estimated.

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Since elections are held in all municipalities at the same time, the coefficient for the election-

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year dummy (β) is not well-identified, as it captures not only the effects of elections, but
re
also the effects of other shocks, economic conditions, political events, etc., which occurred in
lP

election years.19 This problem is mitigated by the fact that our sample covers five elections,

and because our empirical model includes a wide set of control variables which capture the
na

effects of economic and political shocks and conditions, and a set of mandate dummies to
ur

control for time effects.20 Thus, although common shocks which occurred in specific election
Jo

17 R −R
Chatagny and Soguel (2012) define budgeting errors as Error = budgeted actual
P opulation . Dividing the error
by the cantonal population assures comparability across Swiss cantons of very different sizes. We build on
this definition, further dividing the forecast errors by the national consumer price index (using 2017 as the
base year) in order to make errors comparable across time. – As shown in robustness tests (see Table F.3 in
Appendix F), the empirical results are practically the same when we use as dependent variable percentage
forecast errors; or the difference between forecasted and average past revenues (the latter being closer to
f orec
our theoretical Rt+ variable; see Footnote 6).
18
Since the election-year dummy would be collinear with yearly dummy variables, we control for time
effects using 4-year mandate dummies (for the periods 1998-2001, 2002-2005, ... , 2014-2017).
19
We know that it is possible to separate the effects of the election year from those of common shocks
when municipal elections are staggered over different years (see Sjahrir et al., 2013 and Repetto, 2018),
as the election-year dummy can be included along with year dummies in the empirical model. However,
this identification advantage of staggered over simultaneous elections only holds under two conditions: (i)
municipalities with elections in the same year hold the elections at the same time of the year; and (ii) the
timing of elections is essentially the same across different years. If these conditions are not met, elections
may not be comparable in terms of budget information available to voters, political or weather conditions,
etc.
20
If our sample covered only one election, the effect of the election year would be insufficiently identified.

18
years may slightly affect the size of the estimated coefficient of the election-year dummy,

its sign and statistical significance still provide valid indications for the presence of political

forecast and budget cycles.

Based on the theoretical model, on previous empirical evidence of forecast manipulations

(for instance, Brück and Stephan, 2006; Boylan, 2008; Bischoff and Gohout, 2010; Boukari

and Veiga, 2018; Pina and Venes, 2011), and on political budget cycles found for Portuguese

municipalities (Veiga and Veiga, 2007; Aidt et al., 2011), we expect a positive β in Equation

(14). This means more optimistic forecasts in election years which, in turn, allow for greater

of
expenditure, and result in greater deficits.

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The vector Xi,t includes a set of political variables which may affect the degree of manip-

ulation of revenue forecasts: a dummy variable for left-wing mayors, M ayorLef t, as there

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may be an ideological bias in forecasts (Chatagny, 2015; Jochimsen and Lehmann, 2017); a
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dummy variable, M ajority, which takes the value of one when the mayor is supported by
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majorities in both the Town Council and the Municipal Assembly, and zero otherwise, to

control for political fragmentation (Jochimsen and Lehmann, 2017); the win-margin of the
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mayor’s party in the previous election, W inM argin, as a proxy for how close the election
ur

is expected to be; a dummy variable, RunReelect, for mayors who run for reelection; and a

dummy, SameP arty, for when the mayor belongs to the main national government party.
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Also included in vector Xi,t are a set of socio-economic variables that may affect revenue

forecasts: the forecast error in regional (NUTS III)21 GDP growth,22 F ErrorGDP , which

But, with five elections, the estimated coefficient for the election-year dummy variable is much less likely
to be driven by common macroeconomic shocks, as the national business cycle is not synchronized with
the municipal election cycle (Portugal had positive national GDP growth in 2001, 2005, and 2017, and
recessions in 2009 and 2013).
21
NUTS is the European Union nomenclature for territorial statistical units. Portugal is subdivided into
three NUTS I regions (Mainland, Azores and Madeira), seven NUTS II regions, and 25 NUTS III regions.
Each NUTS III region aggregates several municipalities, which correspond to the NUTS IV level. There is
no GDP data at the municipal (NUTS IV) level.
22
The forecast error in regional GDP growth for municipality i in year t is defined as the difference
between the forecasted and the actual growth rate for year t in the NUTS III region that municipality i
belongs to. Since regional GDP forecasts are not available, we obtained one-year ahead forecasts as in Bohn
and Veiga (2019a,b), estimating an ARMAX(2,1) model for the NUTS III GDP growth rates, employing

19
controls for the effects of growth surprises (Pina and Venes, 2011; Buettner and Kauder,

2015); the municipal unemployment rate, U nemp, as an indicator of economic performance

(Chatagny and Soguel, 2012; Jochimsen and Lehmann, 2017); the rate of population growth,

P opGrowth; a proxy for municipal financial autonomy, F inAuton, which corresponds to

own revenues as a percentage of effective total revenues (Boukari and Veiga, 2018); and,

the percentage of the municipal population aged 15 or above with no formal education

completed, %N oEduc. Except for the forecast error in regional GDP growth, all economic,

demographic and education control variables are lagged one year, since their values for year

t are not known at the time the revenue forecast for year t is made.

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To test the propositions of the theoretical model, the empirical baseline model (14) is ex-

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tended to check for interaction effects with political or educational variables. The following

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extension for political variables is used for testing Propositions 1 and 2:
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f error
Ri,t = α + βElYi,t + γP oli,t + δ(ElYi,t ∗ P oli,t ) + X0i,t θ + νi + σt + ξi,t , (15)
lP

where P oli,t is a political variable for municipality i in year t, and the remaining variables

are as described above. The political variables of interest include the margin of victory in
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the previous election, a dummy for when the mayor runs for reelection, and dummies for
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left-wing mayors, for majority governments, and for incumbent party similarity with the

national government.
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The extension of baseline model (14) to include educational interaction terms replaces the

political variable P oli,t in Equation (15) by education variable Educi,t . It is used for testing

Proposition 3 according to which electoral opportunism is greater in municipalities with

higher shares of uninformed voters (see also Shi and Svensson, 2006). Here is the modified

model:
f error
Ri,t = α + βElYi,t + γEduci,t + δ(ElYi,t ∗ Educi,t ) + X0i,t θ + νi + σt + ξi,t , (16)

where Educi,t is a proxy for the education level of the population of municipality i in year

t, and the remaining variables are as described above. The models presented above are

the government’s national GDP growth forecast as an explanatory variable.

20
estimated for effective total revenues (total revenues excluding loans), current revenues,

and capital revenues (excluding loans), by fixed effects, with standard errors clustered by

municipality. Descriptive statistics of the variables used in this paper are presented in

Appendix E (Table E.2).

4 Empirical Results

Here, we present the results of the empirical analysis, which tests the main predictions of

the theoretical model; we also discuss an array of robustness tests.

of
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Baseline Model: Political Forecast Cycles

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The results of the estimation of the baseline model of Equation (14) for forecast errors in
re
revenues (in real euros per capita), by OLS with fixed effects and standard errors clustered
lP

by municipality (to account for autocorrelation in forecast errors) are reported in Table

2. Consistent with our model’s first main theoretical result embodied in the discussion of
na

the rational expectations condition (13), there is evidence of more optimistic forecasts of
ur

effective total revenues (total revenues excluding loans) in election years. In Column 1, the

dummy variable for the election year is positive and highly statistically significant, with the
Jo

forecast error in effective total revenues increasing by 69.9 euros per capita in an election

year when compared to off-election years. Since it is not possible to completely separate the

election-year effect from year effects, the estimated increase of 69.9 euros per capita should

be taken as merely indicative. But, since its bias is expected to be small, the true effect is

surely positive and consistent with the existence of political forecast cycles.23

Forecast errors in current revenues do not seem to change significantly in election years

(Column 2). The lack of opportunism in current revenue forecasts may be due to the fact

23
Irrespective of the “true” magnitude of the election-year effect being 69.9 euros per capita or 50 euros
or even 90 euros, the conclusion is still that there are PBCs in revenue forecasts. What really matters is
that the estimated effect is clearly positive and statistically significant in the main estimations and in a
battery of robustness checks.

21
that, for the vast majority of municipalities, central government formula-determined grants

account for most of the current revenues. As already mentioned in the previous section,

since the amounts to be transferred are announced before municipalities elaborate their

budgets, there is not much room for forecast manipulation in current revenues.

Although some capital grants are also formula-determined, a significant part of government

and European capital transfers are based on project approval. Additionally, the sales of

capital assets such as municipal buildings can in some years account for a large share of

capital revenues. Since voters cannot easily obtain reliable information on these capital

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revenue items, the margin of manoeuvre for opportunistic forecasting is considerably larger

for capital than for current revenues. This is consistent with the results reported in Column

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3, where the election year dummy variable is positive and highly statistically significant,

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suggesting that forecast errors in effective capital revenues increase by 70.8 euros per capita
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in election years, relative to off-election years. The political forecast cycles found for effective
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total revenues in Column 1 seem to be mainly driven by cycles in capital revenue forecasts.24
25
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Consider the effects of our control variables. First, we look at the role of political variables
ur

when they are not interacted with the election year (as done in the next subsection). There is

weak evidence that left-wing mayors are less opportunistic, but the other political variables
Jo

do not seem to directly affect forecast errors. Second, let us look at economic and other

control variables. Errors in regional GDP growth forecasts seem to play no role. However, as

expected, better economic performance (lower unemployment rates) leads to more optimistic

forecasts. The same applies to higher rates of population growth. Financial autonomy seems

24
When dummies for the pre- and post-election years are also included (see Table F.1 in Appendix F),
the former is statistically significant for total revenues and both are significant for capital revenues, but their
estimated coefficients are considerably smaller than those for the election year. Thus, the results provide
further support for the hypothesis that forecast errors are higher in election years than in off-election years.
25
In the estimations of Table 2, we control for time using 4-year mandate dummies, as year dummies
would be collinear with the election-year dummy. In the robustness tests reported in Table F.2, we estimate
the model with year dummies (and excluded the election-year dummy). Since the coeffcients for the year
dummies corresponding to election years are on average 60.49 euros per capita higher than those of off-
election years, these results further support the hypothesis of opportunistic manipulation of forecasts in
election years.

22
 Table 2: PBCs in Effective Revenue Forecasts - Baseline Results
(1) (2) (3)
VARIABLES Total Revenues Current Revenues Capital Revenues

Election year 69.926*** -0.538 70.804***

(5.430) (-0.116) (5.936)
Mayor left -66.290* -14.936 -51.798*
(-1.848) (-1.237) (-1.679)
Majority -25.141 -9.951 -15.110
(-0.861) (-0.907) (-0.592)
Win margin (previous election) 1.068 0.366 0.702
(1.082) (1.150) (0.767)
Incumbent running for reelection -5.635 3.458 -9.384
(-0.278) (0.485) (-0.533)

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Same party 1.822 -0.697 2.924

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(0.139) (-0.141) (0.253)
L.Unemployment rate -17.293*** -3.673* -13.571***

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(-3.158) (-1.860) (-2.986)
Forecast error of GDP growth (NUTS III region) -2.035 -0.039 -2.043
re (-0.928) (-0.039) (-1.168)
L.Population growth 5.730** 0.714 5.020**
lP
(2.062) (0.375) (2.047)
L.Financial autonomy (Own revenues / Effective revenues) -1.318 0.391 -1.743*
(-1.173) (0.806) (-1.708)
na

L. Budget balance -0.122** -0.035 -0.087**

(-2.369) (-1.644) (-2.164)
ur

L.% Population with no education level completed 40.395*** 1.228 39.074***

(4.875) (0.378) (4.944)
Jo

2002-2005 123.097*** -0.133 121.914***

(3.881) (-0.012) (4.351)
2006-2009 315.565*** 70.973*** 243.820***
(6.478) (3.936) (5.639)
2010-2013 388.453*** 120.394*** 267.647***
(6.428) (4.839) (4.977)
2014-2017 119.884 23.887 95.737
(1.490) (0.713) (1.335)

Observations 5,375 5,375 5,375

Municipalities 308 308 308
Adjusted R-squared 0.19 0.09 0.21

Notes: Fixed effects regressions with standard errors clustered by municipality and robust to heteroskedasticity. The dependent
variable is the forecast error (forecast - actual) in effective revenues, in real euros per capita. T-statistics are in parentheses.
*** p < 0.01, ** p < 0.05, * p < 0.10.

23
to be relatively unimportant, as it is only marginally statistically significant for effective

capital revenues. A higher budget balance (or a smaller deficit) in the previous year leads to

lower forecast errors. Finally, a less educated municipal population seems to be associated

with more optimistic forecasts.

Interactions with political variables

Although most of the political variables do not seem to have direct effects on revenue forecast

errors, it is possible that, as predicted by the theoretical model, they affect the magnitude

of
of the opportunistic manipulation of forecasts. To account for this possibility, we estimate

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the model of Equation (15), which interacts the election-year dummy with several political

variables. The results are reported in Table 3. To economize on space, we only report the

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results for the coefficients of the election-year dummy, for the political variable of interest,
re
and for the interaction term.
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In the first set of estimations, we interact the election-year dummy with the win-margin of
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the mayor’s party over the main opposition party in the previous elections. In the absence

of data on voting intentions for most municipalities, the margin of victory in the previous
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election is our proxy for how close mayors expect the next elections to be.26 As expected
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and consistent with Proposition 1, larger win-margins are associated with less optimistic

forecasts for effective total and capital revenues. Figure 2 shows the average marginal effects

of the election year, over the values of the win-margin (we omit values above 50%, which

account for 1% of the cases. The marginal effects are decreasing, and become insignificant

for win-margins of 40 percentage points or higher. That is, mayors may not feel the need

to behave opportunistically when they won the last elections by a very large margin.

The second set of estimation results corroborates our Proposition 2 which claims that a

reduced ego rent leads to less opportunistic behaviour. Obviously, forecast cycles should

26
The correlation between the win-margins of the current and of the previous elections is 0.44. The win-
margin of the previous election is also highly statistically significant in a probit model for the probability
of reelection (results available upon request).

24
 Table 3: Interactions with Political Variables
(1) (2) (3)
VARIABLES Total Revenues Current Revenues Capital Revenues

Election year 106.620*** 4.873 101.905***

(5.612) (0.631) (5.861)
Win-margin in the previous election 1.591 0.443 1.145
(1.546) (1.264) (1.195)
Election year * Win-margin in the previous election -1.862** -0.275 -1.578**
(-2.573) (-0.918) (-2.510)

Election year -5.519 -23.564** 18.851

(-0.190) (-2.189) (0.785)
Incumbent running for reelection -29.472 -3.817 -25.799

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(-1.434) (-0.501) (-1.491)
Election year * Incumbent running for reelection 95.526*** 29.154** 65.780***

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(3.175) (2.440) (2.752)

Election year 85.208*** 3.834 81.731***

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(5.112) (0.543) (5.811)
Mayor left -59.382 -12.959 -46.858
re
(-1.631) (-1.051) (-1.498)
Election year * Mayor left -28.595 -8.182 -20.446
lP

(-1.394) (-1.112) (-1.195)

Election year 88.697*** -5.254 93.741***

na

(3.404) (-0.532) (4.153)

Majority -18.835 -11.535 -7.405
ur

(-0.624) (-1.007) (-0.285)

Election year * Majority -23.263 5.844 -28.427
Jo

(-0.904) (0.645) (-1.287)

Election year 70.701*** -0.253 71.294***

(4.286) (-0.044) (5.094)
Same party 2.281 -0.528 3.214
(0.179) (-0.117) (0.283)
Election year * Same party -1.816 -0.668 -1.148
(-0.074) (-0.086) (-0.056)

Observations 5,375 5,375 5,375

Municipalities 308 308 308
Notes: Fixed effects regressions with standard errors clustered by municipality and robust to heteroskedasticity. The

dependent variable is the forecast error (forecast - actual) in effective revenues, in real euros per capita. All regressions include
the full set of control variables of Table 2. T-statistics are in parentheses. *** p < 0.01, ** p < 0.05, * p < 0.1.

vanish if the ego rent were to go away completely. As a proxy, we use a dummy for not

running again. Our estimation results do, indeed, suggest that opportunistic (and opti-

25
 of
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Figure 2: Effects of the Win-Margin on the Average Marginal Effects of the Election Year
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(vertical axis reports the revenue forecast error in real euros (of 2017) per capita)
lP

mistic) effective total and capital revenue forecasts happen only, when the mayor runs for
na

reelection. This is also consistent with the results of Veiga and Veiga (2007), who found

that opportunism in actual capital and total expenditures is greater when the incumbent
ur

mayor runs for reelection than when her party has a different candidate.
Jo

Regarding the other estimations which test for interaction effects of other political control

variables, there is no robust indication that the ideology of the mayor, the support of

majorities in both the Town Council and Municipal Assembly, or party similarity between

the mayor and the prime minister affect the magnitude of the opportunistic management of

revenue forecasts.

Effects of Education on the Magnitude of PBCs

The estimation of the model of Equation (16) tests Proposition 3 on the effect of uninformed

voters by interacting the election-year dummy with several proxies of the education level of

26
 Table 4: Education and the Magnitude of Election-year Opportunism
(1) (2) (3)
VARIABLES Total Revenues Current Revenues Capital Revenues

Election year -83.639*** -22.078** -60.916**

(-2.959) (-2.509) (-2.470)
% Population with no education level completed 37.836*** 0.750 37.006***
(4.827) (0.254) (5.073)
Election year * % Population with no education level 11.426*** 1.567*** 9.836***
completed (5.075) (2.798) (4.827)

Election year -81.555*** -20.322** -60.551***

(-3.320) (-2.371) (-2.873)
% Population with incomplete secondary education 30.499*** 1.127 29.353***

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(4.640) (0.465) (4.629)
Election year * % Population with incomplete secondary 10.315*** 1.461*** 8.835***

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education (5.178) (2.796) (4.933)

Election year 232.650*** 46.529*** 186.600***

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(8.666) (5.609) (7.885)
% Population with at least completed secondary education -31.542** 4.914 -36.314***
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(-2.521) (1.200) (-3.284)
Election year * % Population with at least -19.773*** -5.589*** -14.200***
lP
completed secondary education (-8.068) (-6.281) (-6.752)

Observations 5,375 5,375 5,375

na

Municipalities 308 308 308

Notes: Fixed effects regressions with standard errors clustered by municipality and robust to heteroskedasticity. The dependent
variable is the forecast error (forecast - actual) in effective revenues, in real euros per capita. All regressions include the full
ur

set of control variables of Table 2. T-statistics are in parentheses. *** p < 0.01, ** p < 0.05, * p < 0.1.
Jo

the municipal population of at least 15 years of age (since there is no data on population

above 18). The results are reported in Table 4. To economize on space, again, we only report

the coefficients for the election year, the education proxy, and its interaction. Three variables

representing the education level of the municipal population are used: the percentage of the

population with no formal education level completed; the percentage of the population

with incomplete secondary education; and the percentage of the population with at least

completed secondary education.

Regardless of the education proxy used, the results of Table 4 clearly support Proposition 3,

indicating that lower education levels are associated with more optimistic revenue forecasts

in election years. This is also consistent with the model of Shi and Svensson (2006), accord-

27
ing to which opportunism is greater when there is a higher percentage of uninformed voters.

Since the coefficients of interactions with continuous variables are sometimes difficult to

interpret, we illustrate them in Figure 3, for the first and third education proxies.

As can be seen in the graphs on the left hand side, the marginal effect of the election

year becomes positive for effective total and capital revenues when the percentage of the

population at least 15 years of age which did not complete any formal education level is

close to or above 10 percent. On the right-hand-side graphs, we see that lower shares of the

population with completed secondary education are associated with higher marginal effects

of
of the election year, that is, with greater opportunism.

ro
Robustness Tests

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The robustness of our empirical results is checked in several ways.27 First, as mentioned

above, we include dummies for the pre- and post-election years in the baseline model of
lP

Equation (14). The results are reported in Table F.1 in Appendix F. Although the estimated
na

coefficient for the dummy of the pre-election years is statistically significant for effective total

revenues, and the coefficients of pre- and post-election dummies are statistically significant
ur

for capital revenues, they are considerably smaller than the coefficient of the election-year
Jo

dummy (Wald tests reject the equality of the coefficients). Thus, the results clearly indicate

that the highest forecast errors are obtained in elections years, which reinforces the results

reported in Table 2, and supports our model’s main result.

Second, we control for time effects using year dummy variables, instead of 4-year mandate

dummies. This change has the drawback of forcing the exclusion of the dummy variable for

the election year, but has the advantage of accounting for other events that may have hap-

pened in specific election years. It is thus an alternative specification, thereby mitigating the

identification problem mentioned above. As shown in Table F.2, the estimated coefficients

27
The robustness tests’ results, reported in Appendix F, are shown in tables only. Nevertheless, the
respective figures are similar to those shown above; they are available from the authors upon request.

28
 of
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na
ur
Jo

Figure 3: Effects of Education on the Average Marginal Effects of the Election Year (vertical

axis reports the revenue forecast error in real euros per capita)

of the dummies which correspond to election years are higher than the coefficients of the

previous three years of the electoral cycle (the only exception is 2013). At the bottom of

the table, we report the average effects in election and non-election years, with the former

always being higher than the latter. In fact, the difference in the averages is statistically

significant for effective total and capital revenues, with a positive sign, providing additional

29
support for the results shown in Tables 2 and F.1 and for the hypothesis that there are

Political Budget Cycles in revenue forecasts.28

Third, we use two alternative definitions of the dependent variable: (1) the percentage

forecast error, that is, the ratio between the forecasted and the actual revenues for year t;

and (2), the difference between the forecasted revenues for year t and the average revenues

of the last four years. The results of these robustness checks, reported in Table F.3, are very

similar to those of Tables 2, 3 and 4, providing further support for our theoretical model’s

main result and for the three propositions.

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Fourth, we check if the results are sensitive to two sample restrictions: (1) excluding the 30

ro
municipalities of the archipelagos of Azores and Madeira, as they have regional governments;

and (2), excluding term-limited mayors from the sample (term limits only became binding

-p
in the 2013 elections), as they have smaller incentives to behave opportunistically in election
re
years. The results, reported in Table F.4, are very similar to those of the main tables when
lP

we use a sample with just mainland municipalities. When term-limited mayors are excluded,

there is no longer evidence that the win-margin and running for reelection affect the degree
na

of opportunism.
ur

Fifth, we test our three propositions at the same time, rather than in separate regressions.
Jo

That is, the three interactions with the dummy variable for the election year were included

simultaneously in the list of explanatory variables. In fact, we do this for two different

education proxies. As shown in Table F.5, the results again support all three propositions,

indicating that it does not matter whether we test them separately or jointly.

Finally, since our theoretical model indicates that political forecast cycles are associated

with cycles in expenditures and deficits, we present in Table F.6 the results of estimations

for total, current and capital expenditures, and for the overal and the primary budget

28
The estimated coefficients for two post-election year dummies, 2006 and 2010, are larger than for the
election years of 2005 and 2009, respectively. Despite these deviations from what would be expected in the
presence of PBCs, the average of the coefficients for the election years is significantly higher than that for
the post-election years. Thus, on average, our results are clearly consistent with political budget cycles in
revenue forecasts.

30
balances. Consistent with our model, and with the results of previous studies for Portugal

(Aidt et al., 2011; Veiga and Veiga, 2007), expenditures are higher and budget balances

are lower in election years than in off-election years, providing clear indication of political

budget cycles.

5 Conclusion

This paper presents a political economy model which is consistent with the evidence (for

instance, Boylan (2008); Heinemann (2006); Boukari and Veiga (2018)) indicating that gov-

of
ernments use overly optimistic revenue forecasts to expand their fiscal room for manoeuvre

ro
in election years in order to increase their chances of re-election. Besides offering a theo-

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retical mechanism which can explain the results found in the aforementioned studies, this
re
paper also investigates the factors that affect the magnitude of the forecast manipulation.

The three propositions derived from the model indicate that: (1) a larger ex ante expected
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winning margin allows the incumbent to reduce its revenue forecast; (2) when the incumbent
na

government is not running, its own interest in winning the elections is reduced, and so is the

opportunistic manipulation; and, (3) if there are more uninformed voters, any manipulation
ur

is more effective.
Jo

These theoretical findings are supported by an empirical analysis based on data from Por-

tuguese municipalities for the period 1998-2017. In fact, we find empirical evidence support-

ing our theoretical predictions; a battery of supporting robustness tests are also presented.

Even though the election-year effect may not be perfectly identified, as all municipalities

hold elections at the same time, our results clearly suggest that there is revenue forecast ma-

nipulation in election years and that the manipulation is smaller for a higher win margin at

the previous elections (our proxy for the expected win margin), when the incumbent mayor

does not run for re-election, and for a lower education level of the municipal population (our

proxy for the percentage of uninformed voters).

31
Acknowledgements

We would like to thank for helpful comments of twice two anonymous referees, Fabio

Padovano, Johannes Blum, Monika Banaszewska, and participants at the 2019 European

Public Choice Society Meetings in Jerusalem, the 75th Annual Congress of the Interna-

tional Institute of Public Finance in Glasgow, and the 2019 Workshop in Public Economics

at the Regional and Local Level in Rennes. Francisco Veiga is thankful for the financial

support of the Portuguese Foundation for Science and Technology (FCT) within the projects

UID/ECO/03182/2019 and UIDB/03182/2020.

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lP
new test of the rational political business cycle model. Public Choice 148 (1-2), 21–44.

Bischoff, I., Gohout, W., 2010. The political economy of tax projections. International Tax
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and Public Finance 17, 133–150.

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Bohn, F., 2018. Political cycles: Beyond rational expectations. PlosOne 13 (10), 1–23.
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Bohn, F., 2019. Political budget cycles, incumbency advantage and propaganda. Economics
and Politics 31 (1), 43–70.

Bohn, F., Veiga, F., 2019a. Elections, recession expectations and excessive debt: An unholy
trinity. Public Choice 180 (3-4), 429–449.

Bohn, F., Veiga, F., 2019b. Political opportunism and countercyclical fiscal policy in
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Boukari, M., Veiga, F., 2018. Disentangling political and institutional determinants of bud-
get forecast errors: A comparative approach. Journal of Comparative Economics.

Boylan, R. T., 2008. Political distortions in state forecasts. Public Choice 136, 1091–1121.

Brück, T., Stephan, A., 2006. Do eurozone countries cheat with their budget deficit forecasts.
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Buettner, T., Kauder, B., 2015. Political biases despite external expert participation? an
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Chatagny, F., 2015. Incentive effects of fiscal rules on the finance minister’s behavior: Evi-
dence from revenue projections in swiss cantons. European Journal of Political Economy
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Chatagny, F., Soguel, N. C., 2012. The effect of tax revenue budgeting errors on fiscal
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Gilbert, N. D., de Jong, J. F., 2017. Do european fiscal rules induce a bias in fiscal forecasts?

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evidence from the stability and growth pact. Public Choice 170, 1–32.

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Jochimsen, B., Lehmann, R., 2017. On the political economy of national tax revenue fore-
casts: evidence from oecd countries. Public Choice 170, 211–230.
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Kauder, B., Potrafke, N., Schinke, C., 2017. Manipulating fiscal forecasts: Evidence from
the german states. Finanz Archiv / Public Finance Analysis 73 (2), 213–236.
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Lohmann, S., 1998. Rationalizing the political business cycle: A workhorse model. Eco-
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nomics and Politics 10 (1), 1–17.

Merola, R., Pérez, J. J., 2013. Fiscal forecast errors: Governments versus independent
agencies? European Journal of Political Economy 32, 285–299.

Pina, A. M., Venes, N. M., 2011. The political economy of edp fiscal forecasts: An empirical
assessment. European Journal of Political Economy 27, 534–546.

Repetto, L., 2018. Political budget cycles with informed voters: evidence from italy. The
Economic Journal 128, 3320–3353.

Rogoff, K., 1990. Equilibrium political budget cycles. American Economic Review 80 (1),
21–36.

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Shi, M., Svensson, J., 2006. Political budget cycles: Do they differ across countries and
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the district level. Economics Letters 120, 342–345.

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34
Appendix and Indications for the Referees

The appendix presents indications for the model solution and the derivation of the propo-
sitions in Section 2. It also presents descriptive statistics and additional empirical results.

A Probability of individual agent to vote for the incumbent

First, we consider an individual voter, no matter if informed or uninformed. She votes for
incumbent a, if

a 1 + b 1
Et [ut+1 (cat+1 ) + G+ i b i
t+1 + α(θ − γ)(− )] ≥ Et [ut+1 (ct+1 ) + Gt+1 + α(θ − γ)(+ )](A.1)
.

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| {z 2} | {z 2}
exp. utility when a in power exp. utility when b in power

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Depending on who is in power in (t + 1), the additional provision of public goods in Equa-

-p
tion (A.1) will typically differ because of differences in politicians’ competence and voters’
re
expectations thereof:
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j j
Et [G+
t+1 ] = −Et [(1 + rt )Dt ] + Et [ηt+1 ], j = a, b. (A.2)
na

The equation says that the period t deficit must be repaid in period (t + 1). However, the
politician will be expected not to borrow in period (t + 1) because there is no election at the
ur

end of that period.29 The best revenue forecast for the incumbent in (t + 1) is, therefore,
+ f orec j +
(Rt+1 ) = Et [(Rt+1 )j ] = 0. Overall, there are probably no additional public goods in
Jo

(t + 1); instead public goods are likely to be reduced corresponding to deficit repayment
modulo the effect of the politician’s competence. Agents have no idea about the skills shock
of either potential politician in t + 1. Nor do they know the skills shock of the challenger in
period t, and, therefore, expect 0. However, they can use the incumbent’s period t public
goods provision policy to draw conclusions about her period t skills shock, µat . (How this is
done is not shown here, but further down; the difference between informed and uninformed
voters will then be exploited.)

b
Et [G+
t+1 ] = −Et [(1 + rt )Dt ]; (A.3)

a
Et [G+ a
t+1 ] = −Et [(1 + rt )Dt ] + Et [µt ]; (A.4)

29
Note that they will probably end up with a deficit or surplus though because the actual additional
revenue depends on the deviation from trend output, yt+ , which is a random variable. See also the discussion
on the timing of events on page 7.

35
Since overestimation of additional revenue has no effect in an off-election year, private
consumption in Equation (A.1) is the same irrespective of the politician in power:

Et [ut+1 (cat+1 )] = Et [ut+1 (cbt+1 )]. (A.5)

Combining Equations (A.1) and (A.3) to (A.5) we can obtain a condition for an individual
to vote for incumbent a (which corresponds to Condition (8) in the main text):

Et [µat ] ≥ α(θi − γ). (A.6)

Using the distribution of the skills shock we can determine the probability (P r) of any voter,
be she informed or uninformed, to vote for incumbent a:

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Et [µat ] − α(−1 − γ) Et [µat ] 1 + γ
P r[Et [µat ] − α(θi − γ) ≥ 0] = = + . (A.7)

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α(1 − γ) − α(−1 − γ) 2α 2

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B Probability of incumbent to win
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Now, we can determine the probability P rob that incumbent a obtains 50% of the votes in
na

the period t elections. It is the probability that the number of voters times their individual
probability P r to vote for incumbent a (as determined in Equation A.7) is greater or equal
ur

to 21 . However, the individual probability P r is different for informed and uninformed voters
because their expectations of period t skills, Et [µat ], differ. The probability for the incumbent
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to win the election – Equation (9) in the main text – is repeated here:
 
 
Etinf [µat ] 1 + γ Etuninf [µat ] 1 + γ
 
 1
Prob (1 − ψ) [ + ]+ψ [ + ] ≥ . (B.1)

 2α 2 } | 2α {z 2 } 2

| {z 
informed uninformed

So why is there a difference in expectations for informed and uninformed voters? Rewrite
the government budget constrain (4) for period t:

f orec
G+ +
t = Rt − (1 + rt−1 )(Dt−1 ) + µat + µat−1 . (B.2)

For informed voters we obtain:

f orec
Etinf [µat ] = µat = G+ +
t − Rt + (1 + rt−1 )Dt−1 − µat−1 . (B.3)

36
Additional public goods Gt , previous period deficit Dt−1 , previous period skills µat−1 , and
interest rate rt−1 can be observed by everybody. The point is that informed voters can
determine Etinf [µat ] deterministically, because they can also observe the incumbent’s revenue
f orec
forecast, Rt+ . By contrast, uninformed voters must form an estimate of the incumbent’s
cat , based on their perception of the government’s revenue forecast R\
skills, µ + f orec
t :

\
+ f orec
Etuninf [µat ] = µ
cat = G+
t − Rt + (1 + rt−1 )Dt−1 − µat−1

f orec f orec \ f orec

= G+ +
t − Rt + (1 + rt−1 )Dt−1 − µat−1 +(Rt+ − Rt+ );
| {z }
µa
t from (B.3)

f orec \ f orec
Etuninf [µat ] = µat + (Rt+ − Rt+

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). (B.4)

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f orec \ f orec
Uninformed voters overestimate the incumbent’s skills by Rt+ −Rt+ . Using Equations
win
(B.3) and (B.4) we can now determine the probability Prob that incumbent a receives

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50% of the votes in period t: re
 
f orec \ f orec
 µat 1+γ µat + Rt+ − Rt+ 1+γ 1
Probwin ≡ Prob (1 − ψ) [ + ] + ψ[ + ] ≥
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 2α 2 2α 2 2

 
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f orec \ f orec
 µa
t Rt+ − Rt+ 1+γ 1
= Prob + ψ + ≥ ;
 2α 2α 2 2
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win \ f orec f orec
Prob = Prob µat ≥ ψ (Rt+ − Rt+ ) − αγ (B.5)
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\ f orec f orec
= 1 − F [ ψ (Rt+ − Rt+ ) − αγ] , (B.6)

where F (•) is the distribution function of the skills shock. Equations (B.5) and (B.6) are
identical to Equations (10) and (11)in the main text.

Figure B.1: Bell-shaped skills density function as an example

The marked area towards the right (light grey or yellow [if in colour]) under the density
function depicted in the figure corresponds to the probability described by Equation (B.5)

37
and by the distribution function representation in Equation (B.6). If the ex ante winning
chances are the same for incumbent and challenger (shift parameter γ = 0), then the
expected skills overall (combine Equations B.3 and B.4) is always greater than the actual
skills, if the government’s revenue estimate perceived by uninformed voters is smaller than
\ f orec f orec
the actual government revenue estimate (Rt+ < Rt+ ). Then the probability (see
Equation (B.6) or the light grey [or yellow] area under the density function) is always greater
than 12 . An overly optimistic (manipulated) revenue forecast increases the government’s
chance to be re-elected. (A similar effect occurs, if uninformed voters were to reduce their
perception of the government revenue forecast for some reason.) If the ex ante winning
changes for incumbent a are larger (γ < 0), the government needs less forecast manipulation
to achieve the same effect.

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C Incumbent’s maximisation problem

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Now, we can maximise incumbent a’s utility over the entire election cycle, i.e. periods t
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and t + 1. Period t + 1 utility is the sum of the utilities for winning and losing the election
weighted by the probability determined in the previous step. A condensed version of the
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following equation is also found as Equation 12 in the main text.

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maxR+ f orec V = maxR+ f orec Vta + Vt+1

a
=
t t

Rt+
ur

f orec
maxR+ f orec Eta {ut (ȳ + (1 − τ ) ) + Rt+ 2
− (1 + rt−1 )(Dt−1 ) + ηta + Xt − ξDt−1 }
t τ | {z }
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t (eq. 4)
G+

\ f orec f orec
+ Eta {[1 − F [ψ(Rt+ − R+ ) − αγ]]
| {z t }
prob. incumbent wins
+
Rt+1 + f orec
a
a
[ut+1 (ȳ + (1 − τ ) ) + (Rt+1 ) − (1 + rt )Dt + ηt+1 + Xt+1 − ξDt2 ]}
τ | {z }
Ga
t+1

\ f orec f orec
+ Eta {[F [ψ(Rt+ − Rt+ ) − αγ]]
| {z }
prob. incumbent loses
+
Rt+1 + f orec
b
b
[ut+1 (ȳ + (1 − τ ) ) + (Rt+1 ) − (1 + rt )Dt + ηt+1 ]}. (C.1)
τ | {z }
Gbt+1

38
 f orec
Next, substitute in for the expected current debt (Eta [Dt ] = Rt+ ); simplify expectations
+
when they are zero (expectations of the additional revenue shocks, Eta [Rt+ ] = Eta [Rt+1 ]=
a
a + f orec
0; and expectations of the optimal future additional revenue forecast, Et [(Rt+1 ) ] =
+f orec b
Eta [(Rt+1 ) ] = 0); and acknowledge that the incumbent knows her past, but not her
present and future skills, nor the skills shocks of the challenger (Eta [ηta ] = Eta [µat−1 ]+Eta [µat ] =
a
Eta [µat−1 ]+0; and Eta [ηt+1 b
] = Eta [ηt+1 ] = 0). Now, the maximisation problem looks as follows:

f orec f orec
maxR+ f orec ct (ȳ) + ct+1 (ȳ) + Rt+ − (1 + rt−1 Dt−1 + µat−1 + Xt − ξDt−1
2
− (1 + rt−1 )(Rt+ )
t

\ f orec f orec f orec 2

+ [1 − F [ψ(Rt+ − Rt+ ) − αγ]] [Xt+1 − ξ(Rt+ ) ]. (C.2)

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Having verified the second order condition for a well-behaved maximisation problem we can
work from the following first order condition:

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\ f orec f orec f orec 2
−rt + F 0 [ψ(Rt+ − Rt+ ) − αγ]ψ[Xt+1 − ξ(Rt+

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)]

\ f orec f orec
re f orec
−[1 − F [ψ(Rt+ − Rt+ ) − αγ]]2ξRt+ = 0, (C.3)
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where F 0 [•] = f [•] refers to the probability density function. In equilibrium, this becomes
rational expectations condition (13) in the main text which is repeated here:
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f orec 2 f orec
−rt + F 0 [−αγ]ψ[Xt+1 − ξ(Rt+ ) ] − [1 − F [−αγ]]2ξRt+ = 0, (C.4)
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39
D Perturbation Results for Propositions

The propositions at the end of Section 2 are obtained by using the Implicit Function The-
orem. The derivations of the marginal effect of changes in exogenous variables on the
f orec ∗
equilibrium value of the government’s optimal choice of the revenue forecast (Rt+ ) are
given here:

Proposition 1:

f orec ∗ VR+ f orec γ

d(Rt+ )
= − t

dγ VR+ f orec R+ f orec

t t

f orec 2 f orec
−αF 00 [•]ψ[Xt+1 − ξ(Rt+ ) ] − αF 0 [•]2ξRt+

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= − f orec 2 f orec
−ψF 00 [•]ψ[Xt+1 − ξ(Rt+ )] − 2ψF 0 [•]2ξRt+ − (1 − F [•])2ξ

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< 0. (D.1)

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Proposition 2: re
f orec ∗ VR+ f orec X
d(Rt+ ) t+1
= − t
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dXt+1 VR+ f orec R+ f orec
t t

F 0 [•]ψ
na

= − f orec 2 f orec
−ψF 00 [•]ψ[Xt+1 − ξ(Rt+ )] − 2ψF 0 [•]2ξRt+ − (1 − F [•])2ξ
ur

> 0. (D.2)
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Proposition 3:

f orec ∗ VR+ f orec ψ

d(Rt+ )
= − t

dψ VR+ f orec R+ f orec

t t

f orec 2 f orec 2 f orec

∆RF 00 [•]ψ[Xt+1 − ξ(Rt+ ) ] + F 0 [•][Xt+1 − ξ(Rt+ ) ] + ∆RF 0 [•]2ξRt+
= − f orec 2 f orec
−ψF 00 [•]ψ[Xt+1 − ξ(Rt+ )] − 2ψF 0 [•]2ξRt+ − (1 − F [•])2ξ

\ f orec f orec
> 0; where ∆R ≡ (Rt+ − Rt+ ) = 0 under rational expectations. (D.3)

40
E Descriptive Statistics

Table E.1: Descriptive Statistics for Municipal Revenues, Expenditures and Budget Balance

Revenue Item Observations Mean St.Deviation Minimum Maximum

Total current revenues 5,375 712.67 351.73 213.12 3,381.79
Direct taxes 5,375 148.66 121.44 5.37 1,269.78
Indirect taxes 5,375 10.72 19.96 -4.10 356.21

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Fees 5,375 18.68 19.45 0.00 700.00
Property 5,375 26.70 34.93 0.00 621.79

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Current transfers 5,375 411.33 310.69 56.13 3,091.94
Sales of goods and services 5,375 87.92 66.15 1.25 691.19

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Other current revenues 5,375 8.66 15.19 -0.01 322.62
Total capital revenues 5,375 384.48 366.68 2.11 7,734.82
Sales of capital goods 5,375 12.32 36.94 -0.21 1,771.44
re
Capital transfers 5,375 289.38 265.42 0.38 5,508.58
Financial assets 5,375 2.11 28.07 0.00 1,308.35
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Financial liabilities 5,375 78.25 214.93 0.00 7,306.46

Other capital revenues 5,375 2.42 14.49 -0.11 531.16
na

Effective capital revenues 5,375 304.12 270.29 2.11 5,508.58

Total revenues 5,375 1,097.61 584.11 333.76 8,601.38
Total effective revenues 5,375 1,017.26 519.57 322.19 7,899.66
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Fiscal revenues 5,375 171.80 136.04 8.12 1,363.22

Own revenues 5,375 318.66 194.81 51.35 2,713.21
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Total expenditures 5,375 1,091.35 582.82 305.93 8,606.57

Total current expenditures 5,375 642.40 342.35 158.90 2,925.30
Total capital expenditures 5,375 448.95 339.33 46.44 6,762.57
Budget balance 5,373 -4.81 165.87 -4,034.10 855.08
Primary budget balance 5,373 12.20 161.31 -3,688.69 861.79

Source: Directorate General for Local Authorities (DGAL).

Notes: Revenues, expenditures, and budget balances are measured in real euros per capita (at 2017
national prices). Effective capital revenues correspond to total capital revenuues minus the revenues from
financial assets and liabilities. Total effective revenues are the sum of total current revenues and effective
capital revenues. The budget balance is defined as the difference between total revenues and expenditures,
excluding revenues and expenditures in financial assets and liabilities. The primary budget balance further
excludes interest payments on debt.

41
 Table E.2: Descriptive Statistics

VARIABLES Observ. Mean St.Dev. Min. Max.

Forecast error in effective revenues (F orecast − Actual) 5,375.00 534.21 566.75 -754.79 7,190.87
Forecast error in current revenues (F orecast − Actual) 5,375.00 92.32 197.41 -815.34 4,366.40
Forecast error in capital revenues (F orecast − Actual) 5,375.00 441.80 466.81 -497.03 5,208.12
Election year 5,375.00 0.27 0.45 0.00 1.00
Mayor left (PS, PCP, or BE) 5,375.00 0.54 0.50 0.00 1.00
Majority (in the Town Hall and Municipal Assembly) 5,375.00 0.81 0.39 0.00 1.00
Win margin (in percentage points) in the previous election 5,375.00 19.69 14.01 0.02 75.75
Run for reelection 5,375.00 0.77 0.42 0.00 1.00
Terms mayor 5,375.00 2.37 1.70 0.00 10.00
Same party (mayor and prime minister) 5,375.00 0.44 0.50 0.00 1.00

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Unemployment rate 5,375.00 6.83 2.81 0.64 18.48
Forecast error in GDP growth (NUTS 3 region) 5,375.00 0.18 2.80 -18.17 15.28

ro
Population growth rate 5,375.00 -0.28 2.12 -21.56 24.98
Financial autonomy (own revenues as % of effective) 5,375.00 35.77 19.10 1.14 124.75

-p
Budget balance 5,373.00 -4.81 165.87 -4,034.10 855.08
% Population with no education level completed 5,375.00 14.23 5.60 2.21 38.23
re
% Population with less than complete secondary education 5,375.00 8.83 3.44 1.79 23.52
% Population with complete secondary education 5,375.00 14.13 5.89 0.51 39.13
lP

Sources: Directorate General for Local Authorities (DGAL), Ministry of Internal Affairs (MAI), National
na

Statistics Institute (INE), and Marktest’s Sales Index database.

Note: Forecast errors in revenues correspond to the difference between forecasted and actual amounts,
both measured in real euros per capita (at 2017 national prices).
ur
Jo

42
 Table E.3: Descriptive Statistics for Forecast Errors in Revenues

Forecast error in Election Years Off-election Years

Revenue items Observ. Mean St.Deviation Observ. Mean St.Deviation
Total current revenues 1,464 89.92 187.86 3,911 93.21 200.88
Direct taxes 1,464 2.63 48.32 3,911 2.54 54.04
Indirect taxes 1,464 6.96 31.48 3,911 5.61 21.56
Fees 1,464 5.21 20.45 3,911 5.46 20.47
Property income 1,464 13.49 54.79 3,911 13.72 69.38
Current transfers 1,464 19.85 71.83 3,911 25.34 83.09
Sales of goods and services 1,464 23.57 88.35 3,911 23.68 76.10
Other current revenues 1,464 18.20 95.11 3,911 16.86 90.56
Total capital revenues 1,464 451.52 546.33 3,911 442.25 493.65
Sales of capital goods 1,464 132.33 233.11 3,911 124.11 201.97

of
Capital transfers 1,464 316.82 428.61 3,911 296.65 380.53
Financial assets 1,464 3.43 54.74 3,911 4.71 45.61

ro
Financial liabilities 1,464 -15.22 265.33 3,911 3.80 226.17
Other capital revenues 1,464 14.16 76.58 3,911 12.99 76.14

-p
Effective capital revenues 1,464 463.31 510.56 3,911 433.75 449.14
Total revenues 1,464 541.32 619.48 3,911 535.63 589.90
re
Total effective revenues 1,464 553.10 601.32 3,911 527.13 553.16
Fiscal revenues 1,464 4.79 68.18 3,911 7.25 64.72
lP
Own revenues 1,464 219.67 337.61 3,911 209.52 318.32

Source: Directorate General for Local Authorities (DGAL).

na

Notes: Forecast errors in revenues correpond to the difference between forecasted and actual amounts,
both measured in real euros per capita (at 2017 national prices). Effective capital revenues correspond to
ur

total capital revenues minus the revenues from financial assets and liabilities. Total effective revenues are
the sum of total current revenues and effective capital revenues.
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43
 Table E.4: Expenditures and Budget Balances in Election and Off-election Years

Election Years Off-election Years

Observ. Mean St.Deviation Observ. Mean St.Deviation
Total expenditures 1,464 1,151.73 602.00 3,911 1,068.74 573.92
Total effective expenditures 1,464 1,076.19 546.37 3,909 1,001.19 529.64
Current expenditures 1,464 677.15 354.92 3,911 629.39 336.65
Capital expenditures 1,464 474.57 357.20 3,911 439.36 331.93
Effective capital expenditures 1,464 399.04 294.54 3,909 371.75 292.13
Budget balance 1,464 -34.63 167.08 3,909 6.35 164.05
Primary budget balance 1,464 -17.41 162.45 3,909 23.29 159.49

Source: Directorate General for Local Authorities (DGAL).

Notes: Expenditures and budget balances are measured in real euros per capita (at 2017 national prices).

of
Effective expenditures exclude financial assets and liabilities. The budget balance is defined as the
difference between total effective revenues and total effective expenditures, that is, it excludes revenues

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and expenditures in financial assets and liabilities. The primary budget balance further excludes interest
payments on debt.

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F Robustness Tests

This subsection presents the results of several robustness tests.

Table F.1: PBCs in Effective Revenue Forecasts (using 3 election dummies)

(1) (2) (3)
VARIABLES Total Revenues Current Revenues Capital Revenues
Pre-election year 25.994** 1.999 23.945**
(1.991) (0.403) (2.198)

of
Election year 86.757*** -0.609 87.481***
(5.410) (-0.122) (5.828)
Post-election year 18.166 -4.856 22.019*

ro
(1.448) (-1.259) (1.929)
Mayor left -66.102* -14.655 -51.865*

-p
(-1.835) (-1.210) (-1.675)
Majority -24.852 -9.568 -15.196
(-0.854) (-0.867) (-0.597)
Win margin (previous election)
re 1.066 0.377 0.687
(1.048) (1.161) (0.729)
Incumbent running for reelection -5.414 1.950 -7.396
lP
(-0.194) (0.221) (-0.305)
Terms mayor 0.280 -0.810 1.244
(0.031) (-0.282) (0.153)
na

Same party 2.133 -0.889 3.411

(0.163) (-0.179) (0.297)
L.Unemployment rate -17.360*** -3.606* -13.695***
(-3.171) (-1.822) (-3.006)
ur

Forecast error of GDP growth (NUTS III region) -2.657 -0.117 -2.589
(-1.189) (-0.118) (-1.457)
Jo

L.Population growth 5.879** 0.914 4.996*

(2.057) (0.466) (1.935)
L.Financial autonomy (Own revenues / Effective revenues) -1.368 0.358 -1.766*
(-1.206) (0.733) (-1.723)
L.Budget balance -0.123** -0.037* -0.086**
(-2.345) (-1.692) (-2.125)
L.% Population with no education level completed 41.016*** 1.752 39.239***
(4.567) (0.505) (4.558)
Observations 5,375 5,375 5,375
Municipalities 308 308 308
Adjusted R-squared 0.19 0.09 0.21
Notes: Fixed effects regressions with standard errors clustered by municipality and robust to heteroskedasticity. The dependent
variable is the forecast error (forecast - actual) in effective revenues, in real euros per capita. All estimations include 4-year
mandate dummies. T-statistics are in parentheses. *** p < 0.01, ** p < 0.05, * p < 0.10.

45
 Table F.2: Robustness Tests - Baseline Results with Year Dummies
(1) (2) (3)
VARIABLES Total Revenues Current Revenues Capital Revenues
1999 -15.724 -14.837*** -0.848
(-0.869) (-2.885) (-0.049)
2000 132.100*** 7.424 124.746***
(3.355) (0.428) (4.113)
2001 (election year) 200.888*** 10.664 190.289***
(5.667) (1.375) (5.488)
2002 87.948** -13.602 98.030***
(2.262) (-1.261) (2.614)
2003 158.417*** 0.340 157.675***
(3.597) (0.027) (3.740)
2004 201.971*** 5.824 195.630***
(4.395) (0.432) (4.652)
2005 (election year) 337.347*** 21.078 315.885***
(6.744) (1.347) (6.791)

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2006 377.176*** 36.674** 340.022***
(6.369) (2.121) (6.252)
2007 316.535*** 38.261* 277.881***

ro
(5.285) (1.869) (5.065)
2008 344.719*** 62.099*** 282.234***

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(5.384) (2.713) (4.767)
2009 (electionyear) 521.118*** 127.962*** 392.892***
(7.619) (5.277) (6.153)
2010
re 528.928*** 138.736*** 389.498***
(7.949) (5.054) (6.306)
2011 497.660*** 144.185*** 354.083***
lP

(6.931) (5.048) (5.359)

2012 466.420*** 146.060*** 321.194***
(5.874) (5.096) (4.406)
na

2013 (election year) 296.074*** 47.345 249.851***

(3.548) (1.559) (3.186)
2014 204.960** 10.605 195.104**
ur

(2.265) (0.312) (2.337)

2015 150.239 25.792 125.630
(1.619) (0.712) (1.464)
Jo

2016 121.337 14.606 107.525

(1.230) (0.362) (1.171)
2017 (election year) 222.991** 18.160 205.939**
(2.197) (0.459) (2.174)
Mayor left -69.557* -15.436 -54.525*
(-1.931) (-1.264) (-1.764)
Majority -25.660 -9.965 -15.579
(-0.881) (-0.906) (-0.612)
Win margin (previous election) 1.125 0.404 0.717
(1.109) (1.250) (0.762)
Incumbent running for reelection -2.592 2.675 -5.301
(-0.092) (0.301) (-0.218)
Terms mayor -0.351 -1.143 0.950
(-0.038) (-0.398) (0.115)
Same party 8.277 0.796 7.879
(0.637) (0.163) (0.686)
– continued on next page –

46
 – continued from previous page –
(1) (2) (3)
VARIABLES Total Revenues Current Revenues Capital Revenues
Forecast error of GDP growth (NUTS III region) -1.371 -1.292 -0.126
(-0.530) (-1.101) (-0.061)
L.Unemployment rate -6.378 0.667 -7.075
(-1.012) (0.317) (-1.288)

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L.Population growth 3.899 0.505 3.442
(1.295) (0.254) (1.270)
L.Financial autonomy (Own revenues / Effective revenues) -1.996* 0.143 -2.171**

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(-1.723) (0.283) (-2.086)
L.Budget balance -0.072 -0.022 -0.050

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(-1.438) (-1.052) (-1.273)
L.% Population with no education level completed 40.941*** 1.847 39.079***
(4.552) (0.532) (4.534)
Observations
re 5,375 5,375 5,375
Municipalities 308 308 308
Adjusted R-squared 0.22 0.11 0.23
lP

Averages of the coefficients for the year dummies

Election years (average) 315.684*** 45.042** 270.971***
na

(5.113) (2.051) (4.614)

Non-election years (average) 255.192*** 43.012** 212.029***
(4.755) (2.201) (4.177)
ur

Pre-election years (average) 253.309*** 47.203** 206.266***

(4.462) (2.327) (3.852)
Post-election years (average) 239.802*** 34.483** 204.531***
Jo

(5.398) (2.123) (4.851)

Differences between the averages
(Election years - Non-election years) 60.492*** 2.030 58.942***
(4.925) (0.473) (5.240)
(Election years - Pre-election years) 62.374*** -2.161 64.705***
(5.439) (-0.417) (6.768)
(Election years - Post-election years) 75.881*** 10.559 66.440***
(3.470) (1.490) (3.253)
Notes: Fixed effects regressions with standard errors clustered by municipality and robust to heteroskedasticity. The dependent
variable is the forecast error (forecast - actual) in effective revenues, in real euros per capita. T-statistics are in parentheses.
*** p < 0.01, ** p < 0.05, * p < 0.10.

47
 Table F.3: Robustness tests - Alternative Definitions of the Dependent Variable
Percentage Difference to
Forecast Errors 4-year average revenues

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(1) (2) (3) (4) (5) (6)
Total Current Capital Total Current Capital
VARIABLES Revenues Revenues Revenues Revenues Revenues Revenues

ro
Election year 2.408*** 0.041 25.465*** 78.829*** -0.892 80.048***
(2.598) (0.082) (5.876) (5.927) (-0.197) (6.402)

-p
Election year 6.741*** 1.228 40.323*** 115.181*** -0.306 115.762***
(4.998) (1.505) (6.598) (5.492) (-0.039) (6.027)
Win margin (previous election) 0.101 0.051 0.236 1.607 0.463 1.147
re
(1.253) (1.181) (0.966) (1.400) (1.367) (1.046)
Election year * Win margin -0.220*** -0.059* -0.757*** -1.833** -0.033 -1.798**
lP
(previous election) (-4.021) (-1.838) (-3.488) (-2.276) (-0.109) (-2.561)
Election year -6.446*** -3.984*** 8.575 -24.396 8.652 -32.771
(-2.809) (-2.887) (1.038) (-0.824) (0.913) (-1.232)
Incumbent running for reelection -1.960 -0.445 -1.807 -42.500* 5.941 -48.589**
na

(-0.996) (-0.419) (-0.270) (-1.954) (0.734) (-2.552)

Election year * Incumbent running 11.160*** 5.093*** 21.193** 130.965*** -12.170 143.181***
for reelection (4.505) (3.414) (2.371) (4.159) (-1.092) (5.111)
ur

Election year -3.922* -1.902 45.590*** -89.357*** -43.970*** -44.935*

(-1.788) (-1.648) (3.994) (-3.190) (-5.425) (-1.832)
% Population with no education 2.708*** 0.810*** 6.572*** 47.515*** -2.480 49.964***
Jo

level completed (5.396) (3.036) (3.730) (5.729) (-0.801) (6.309)

Election year * % Population with no 0.478*** 0.147** -1.465** 12.792*** 3.338*** 9.444***
education level completed (2.987) (2.135) (-2.247) (5.739) (6.116) (4.743)
Observations 5,274 5,274 5,274 5,369 5,369 5,369
Municipalities 308 308 308 308 308 308
Notes: Fixed effects regressions with standard errors clustered by municipality and robust to heteroskedasticity. The dependent
variable is defined as indicated in the first row (always based on effective revenues). All regressions include the full set of control
variables used in Tables 2, 3, and 4. T-statistics are in parentheses. *** p < 0.01, ** p < 0.05, * p < 0.1.

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 Table F.4: Robustness tests - Restricted Samples
Excluding Excluding
Azores and Madeira Term-Limited Mayors

of
(1) (2) (3) (4) (5) (6)
Total Current Capital Total Current Capital
VARIABLES Revenues Revenues Revenues Revenues Revenues Revenues

ro
Election year 67.823*** -1.353 69.511*** 101.111*** 5.547 95.727***
(5.491) (-0.275) (5.911) (7.134) (1.108) (7.399)

-p
Election year 96.880*** 3.746 93.268*** 115.519*** 1.337 114.084***
(5.362) (0.461) (5.805) (5.729) (0.171) (6.196)
Win margin (previous election) 1.294 0.496 0.792 0.430 -0.010 0.438
re
(1.308) (1.300) (0.872) (0.389) (-0.027) (0.417)
Election year * Win margin -1.494** -0.259 -1.225** -0.793 0.215 -0.995
lP
(previous election) (-2.036) (-0.852) (-1.997) (-1.012) (0.662) (-1.449)
Election year -26.602 -25.274** -0.477 121.465*** 10.275 111.356***
(-1.013) (-2.344) (-0.022) (3.058) (0.810) (3.210)
Incumbent running for reelection -30.055 -1.699 -28.426 -7.905 -4.061 -4.201
na

(-1.451) (-0.211) (-1.642) (-0.258) (-0.404) (-0.163)

Election year * Incumbent running 118.751*** 30.167** 87.922*** -23.172 -5.465 -17.726
for reelection (4.134) (2.516) (3.839) (-0.597) (-0.405) (-0.531)
ur

Election year -110.586*** -19.530** -90.318*** -41.179 -15.803* -24.923

(-3.875) (-2.172) (-3.634) (-1.406) (-1.695) (-0.973)
% Population with no education 35.732*** -0.777 36.404*** 36.496*** -0.237 36.604***
Jo

level completed (4.784) (-0.246) (5.105) (4.222) (-0.074) (4.705)

Election year * % Population with no 12.996*** 1.311** 11.656*** 10.166*** 1.465** 8.680***
education level completed (5.625) (2.385) (5.499) (4.404) (2.496) (4.145)
Observations 4,985 4,985 4,985 4,449 4,449 4,449
Municipalities 278 278 278 308 308 308
Notes: Fixed effects regressions with standard errors clustered by municipality and robust to heteroskedasticity. The dependent
variable is the forecast error (forecast - actual) in effective revenues, in real euros per capita. All regressions include the full
set of control variables used in Tables 2, 3, and 4.. T-statistics are in parentheses. *** p < 0.01, ** p < 0.05, * p < 0.1.

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 Table F.5: Robustness tests - Joint Test of the Three Propositions

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(1) (2) (3) (4) (5) (6)
Total Current Capital Total Current Capital
VARIABLES Revenues Revenues Revenues Revenues Revenues Revenues

ro
Election year -106.161*** -37.183*** -68.096** 202.461*** 28.957* 174.346***
(-2.618) (-2.637) (-1.974) (4.885) (1.887) (4.865)
Win margin (previous election) 1.586 0.425 1.158 1.548 0.413 1.132

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(1.534) (1.212) (1.201) (1.489) (1.183) (1.163)
Election year * Win margin -1.746** -0.208 -1.530** -1.700** -0.219 -1.474**
(previous election)
re
(-2.425) (-0.711) (-2.397) (-2.397) (-0.756) (-2.337)
Incumbent running for reelection -24.022 -3.126 -21.054 -25.938 -2.448 -23.631
(-1.172) (-0.412) (-1.219) (-1.238) (-0.323) (-1.336)
lP
Election year * Incumbent running 78.811*** 26.958** 51.306** 71.436** 24.450** 46.414*
for reelection (2.644) (2.290) (2.153) (2.388) (2.045) (1.953)
% Population with no education 37.819*** 0.754 36.985***
na

level completed (4.816) (0.256) (5.062)

Election year * % Population with no 11.039*** 1.415** 9.605***
education level completed (4.868) (2.535) (4.685)
% Population with at least completed -31.091** 5.025 -35.977***
ur

secondary education (-2.484) (1.226) (-3.251)

Election year * % Population with at least -19.011*** -5.317*** -13.715***
Jo

completed secondary education (-7.684) (-5.898) (-6.435)

Observations 5,375 5,375 5,375 5,375 5,375 5,375
Municipalities 308 308 308 308 308 308
Adjusted R-squared 0.20 0.09 0.21 0.18 0.09 0.20
Notes: Fixed effects regressions with standard errors clustered by municipality and robust to heteroskedasticity. The dependent
variable is the forecast error (forecast - actual) in effective revenues, in real euros per capita. All regressions include the full
set of control variables used in Table 2. T-statistics are in parentheses. *** p < 0.01, ** p < 0.05, * p < 0.1.

50
 Table F.6: Results for Expenditures and the Budget Balance
(1) (2) (3) (4) (5)
Total Current Capital Buget Primary Budget
VARIABLES Expenditures Expenditures Expenditures Balance Balance

of
Election year 61.518*** 18.138*** 43.380*** -48.340*** -48.709***
(7.080) (4.641) (5.981) (-9.031) (-9.335)
Mayor left -0.954 -3.880 2.926 16.783* 17.191*

ro
(-0.051) (-0.353) (0.188) (1.828) (1.900)
Majority -1.203 13.936 -15.140 -2.105 -1.410
(-0.075) (1.293) (-1.363) (-0.232) (-0.162)

-p
Win margin (previous election) 1.264*** 0.250 1.014*** -0.255 -0.347
(2.739) (0.743) (2.657) (-1.146) (-1.608)
Incumbent running for reelection
re
10.893 1.880 9.013 -4.780 -5.819
(0.841) (0.245) (0.869) (-0.630) (-0.813)
Same party -1.711 2.790 -4.501 -1.336 -1.661
lP
(-0.200) (0.794) (-0.609) (-0.254) (-0.322)
L.Unemployment rate -20.009*** -7.001*** -13.008*** 3.448** 4.051**
(-5.382) (-3.912) (-4.343) (2.047) (2.436)
na

Forecast error of GDP growth -3.332** -1.618** -1.714* -0.652 -0.703

(NUTS III region) (-2.362) (-2.329) (-1.737) (-0.826) (-0.898)
L.Population growth -2.374 -3.490*** 1.116 -2.553* -2.559**
(-1.070) (-4.090) (0.591) (-1.936) (-1.988)
ur

L.Financial autonomy (Own revenues / -0.616 1.322*** -1.938*** 0.852** 1.004***

Effective revenues) (-0.769) (2.748) (-3.184) (2.168) (2.612)
Jo

L.Budget balance -0.036 -0.072*** 0.036 0.031 0.009

(-0.696) (-4.576) (0.765) (1.390) (0.414)
L.% Population with no education level -21.488*** -29.763*** 8.275** -8.660*** -8.908***
completed (-5.149) (-9.775) (2.574) (-4.495) (-4.740)
Observations 5,375 5,375 5,375 5,373 5,373
Municipalities 308 308 308 308 308
Adjusted R-squared 0.15 0.58 0.10 0.10 0.10
Notes: Fixed effects regressions with standard errors clustered by municipality and robust to heteroskedasticity. The dependent
variables are indicated in the column titles, and are measured in real euros per capita. All regressions include 4-year mandate
dummies. T-statistics are in parentheses. *** p < 0.01, ** p < 0.05, * p < 0.1.

51
Highlights
• Opportunistic governments use overly optimistic forecasts prior to elections.
• Increased spending leads to deficits and political forecast and budget cycles.
• We find evidence for Portuguese municipalities (as previously found for US states).
• Less manipulation when the incumbent is sure to win or not re-running.
• More manipulation when voters are less informed.

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There are no conflicts of interest.

Francisco Veiga and Frank Bohn

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