Political Economy in a Contestable Democracy: The Case of Dividend Taxation
We show that aggregate investment is generally higher under the party that sets higher tax rates, since private firms pay out lower dividends and carry more working capital, leading to higher investment. Furthermore, both parties bias their tax rates upwards (beyond the rates that they would set if they were in power permanently) in an effort to increase investment under their regime. We also discuss how the distortion could be addressed through cooperation between the two parties.
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