The Political Economy of Tax Coordination as a Bargaining Game between Bureaucrats and Politicians

In the public finance literature, the view prevails that tax competition among countries gives rise to an underprovision of public goods and that coordinated tax increases are therefore desirable. Public choice arguments, in contrast, suggest that tax coordination may not be in the interest of the taxpayers/citizens because imperfections of the political process (political distortions) may lead to a waste of tax money. According to this view, tax competition is a desirable check on the power to tax whereas tax coordination would only relax the budget constraint of an inefficient public sector. The present paper integrates the underprovision argument and the public choice view into a common theoretical framework. The government is assumed to consist of politicians and bureaucrats with diverging interests. Fiscal policy is modelled as the outcome of a bargaining game between the bureaucrats and the politicians. It turns out that coordinated tax increases always raise the provision of public goods but also increase the cost of political distortions. The effect on the welfare of the representative citizen may be positive or negative, depending in particular on the distribution of bargaining power between bureaucrats and politicians. Copyright 2000 by Kluwer Academic Publishers