Fiscal Policy Under Weak Political Institutions
The purpose of this paper is to determine the normative and positive implications for fiscal policy in a weakly institutionalized economy which is not managed by a benevolent government, but is managed by a selfish dictator. We examine an economy with no capital, with fully state contingent financial instruments, and with exogenous stochastic government purchases. The dictator can use taxes and debt to extract rents, but dissatisfied households can threaten to replace him after his tenure with an equally selfish dictator. In contrast to the optimal tax rate under a benevolent government which is flat along the equilibrium path, we find that the optimal tax rate is history dependent and increasing along the equilibrium path. The reason is that the tax rate reflects the history of incentive compatibility constraints on the dictator. Providing the dictator with incentives to not steal imposes a limit on the size of government assets under his control and puts upward pressure on future tax rates, and in the long run, the tax rate reaches a maximum. Moreover, if we allow households to replace the dictator with a benevolent government at a cost, the tax rate can increase or decrease along the equilibrium path and can experience history dependence even in the long run. The reason is that providing incentives for the households to support the dictator imposes a limit on the size of government debt and puts downward pressure on future tax rates
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
|Date of creation:||03 Dec 2006|
|Date of revision:|
|Contact details of provider:|| Postal: |
Web page: http://www.EconomicDynamics.org/society.htm
More information through EDIRC
When requesting a correction, please mention this item's handle: RePEc:red:sed006:259. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann)
If references are entirely missing, you can add them using this form.