This paper studies the effect of separation of government agencies on fiscal policies. We
construct a model with moral hazard which compares the integrated system and the
separated system. In the separated system, two independent agencies are in charge of taxes
and government expenditure, respectively. Meanwhile, in the integrated system, one agency
decides on both policies. In both systems, there is a third party which provides information
on the effectiveness of government expenditure only to the budget agency and is willing to
overstate in order to acquire more budget. It is shown that the separated system is better at
controlling the information provider’s incentive to mislead and can be superior under some
parameter values in spite of its coordination problem.