Working Paper: CEPR ID: DP7084
Authors: Hans Gersbach; Maik Schneider
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.
Keywords: Contract Theory; Government Formation; Voting
JEL Codes: D72; D82; H55
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tax contracts (H26) | Policy outcomes of coalition governments (D72) |
| Tax contracts (H26) | Steering policies closer to ideal point (D78) |
| Tax contracts (H26) | Lower tax rates (H29) |
| Perks perceived as negative externality (D62) | Lower tax rates (H29) |
| Political polarization (D72) | Impact of tax contracts on policy outcomes (H29) |
| Tax contracts (H26) | More moderate policies in polarized societies (D72) |
| Tax contracts (H26) | More extreme policies under certain conditions (E65) |
| Policy shift effect (E65) | Significant relative impacts on welfare (D69) |
| Perks effect (M52) | Moderate welfare improvements (D69) |