Most fiscal rules can be overridden by consensus. We show that this does not make them ineffectual. Since fiscal rules determine the outside option in case of disagreement, the opposition uses them as “bargaining chips” to obtain spending concessions. We show that under some conditions this political bargain mitigates the debt-accumulation problem. We analyse various rules and find that when political polarization is high, harsh fiscal rules (e.g. government shutdown) maximize the opposition’s bargaining power and lead to lower debt accumulation. When polarization is low, less strict fiscal limits (e.g. balanced-budget rule) are preferable. Moreover, we find that the optimal fiscal rules could arise in equilibrium by negotiation. Finally, by insuring against power fluctuations, negotiable rules yield higher welfare than hard ones.

We study legislators who have a present bias for spending: they want to increase current spending and procrastinate spending cuts. We show that disagreement in legislatures can lead to policy persistence that attenuates the temptation to overspend. Depending on the environment, legislators’ decisions to be fiscally responsible may either complement or substitute other legislators’ decisions. When legislators have low discount factors, their actions are strategic complements. Thus, changes of the political environment that induce fiscal responsibility are desirable as they generate a positive responsibility multiplier and reduce spending. However, when the discount factor is high, the same changes induce some legislators to free ride on others’ responsibility which may lead to higher spending.

Once established, government spending programs tend to continue. A commonly held view is that spending inertia leads to unsustainable debt, ultimately requiring fiscal adjustments such as “sequestration.” We show that by insuring against political turnover, inertia may reduce politicians’ incentives to accumulate debt. However, large preexisting commitments and the prospect of future stabilization can lead to overspending to dilute past administrations’ commitments. Finally, we show that political polarization amplifies incentives to prioritize inertial programs, potentially explaining the increased share of mandatory spending in the US budget.