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Title: Tax Contracts and Government Formation

Author(s): Hans Gersbach and Maik Schneider

Publication Date: December 2008

Keyword(s): contract theory, government formation and voting

Programme Area(s): Public Economics

Abstract: We introduce tax contracts and examine how they affect government formation and welfare of voters in a democracy with proportional elections. A tax contract specifies a range of tax rates a party is committed to if in government. We develop a new model of party competition in which parties choose tax rates, public-good provision, and perks, and we show that the introduction of tax contracts has two effects: a perks effect and a policy-shift effect. The former plays a central role in societies with a low degree of political polarization, where it tends to reduce politicians' perks. If a society is highly polarized, tax contracts can yield more moderate political outcomes. However, there are also circumstances in which tax contracts induce more extreme policies.

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Bibliographic Reference

Gersbach, H and Schneider, M. 2008. 'Tax Contracts and Government Formation'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=7084