Comments on: “Political Economy of Tax Structure”

1. Comments on: “Political Economy of Tax Structure” Guido Tabellini Mirrlees Review, Cambridge April 2007

2. Caveat Comments based on incomplete and preliminary draft Introduction incomplete Last two sections incomplete No references, No subsection numbering, No authors…….

3. 1. Paper outline • Introduction • Britain in context • Electoral interests (size of govt) • Special Interest Politics • Government Institutions • Implications and reflections

4. 2. Basic facts on the UKa. Institutions • Strong agenda setting powers of Chancellor / PM Plurality rule, single party govt, budgetary institutions • Focus on their political goals / views, and internal organization of bureaucracy • Contrast with other countries: • US: committes or other institutions • Italy: parties in govt. coalition

5. 2. Basic facts on the UKb. Tax policy Income taxes: lower rates, higher thresholds, no change in T/Y Fiscal illusion? Indirect taxes: VAT up, other excise taxes down Politically uncontroversial – imposed by EU Contrast: Canada, Australia

6. 3. The size of governmentTheory Policy: one dimensional redistributive tax Electoral competition, two ideological parties (or attached voters?) Median voter of uncertain location, or probabilistic voting (multi-dimensional policy) Equilibrium: reflects parties’ ideologies and voters’ preferences

7. 3. The size of governmentEvidence – party manifestos Divergence between parties party ideology important Conservative party reduced taxes against wishes of median voter

8. 3. The size of governmentEvidence – voters preferences Voters want higher taxes and spending

9. 3. The size of governmentTentative conclusion Tax policy not representative of median public opinion • Plurality rule • Voters’ behavior (eg. Probabilistic voting) Size of govt below what voters’ majority wants

10. 4. Special interest politicsThe R&D tax credit Introduced at govt initiative Again: a role for govt. “ideology” Evolved under the influence of lobbying Lobbying creates a status quo bias Coate & Morris

11. 5. Political agencyincomplete Conjecture that optimal taxation results hold Appropriate rents efficiently Except that choose taxes with low visibility

12. Two common themes Importance of non-opportunistic political agenda (party’s ideology or views) Voters don’t understand the tax system Need more transparency

13. My Commentsdifficult topic • Institutions • Size of govt: is it below what voters want? • Tax transparency: is it always good? 4. Key question that the paper should have adressed – and implicit answer

14. UK institutionsstrong influence of HMT What role for independent bureaucrats? Contrast with monetary policy Benchmark: independent CB & inflation targeting Delegation to independent regulatory agencies Why not also in tax policy? (Blinder)

15. 2. Size of government is it below what voters want ? Question asked: “Suppose govt had to choose on 3 options: • Reduce taxes & spend less on health, education & social services • Increase taxes & spend more on health, education & social services • Keep both constant” Those who say 2 want more public goods, not necessarily bigger govt Status quo: Under-provision of public goods

16. Support for redistribution is eroding similar evidence from WWS

17. Alternative interpretation No divergence between pivotal voter vs party in office on overall size of govt Inefficiency of electoral competition between opportunistic parties: Systematic under-provision of public goods, excessive targeted redistribution

18. 3. Is transparency of taxes always good? Individual vs aggregate transparency 1. What I pay to the govt • What others pay to govt (aggregate tax rev.) • Improves govt incentives Discourages waste / targeted redistribution • May be counterproductive Encourages “churning” (Gavazza –Lizzeri) Tax increases interpreted as lower deficit, when instead it is more redistribution

19. What kind of transparency do we need? Voters discipline wasteful redistribution if: Taxes to myself highly visible Taxes on others not very visible Transfers to myself not very visible Transfers to others highly visible But transparency chosen by govts, who have the incentive to do just the reverse

20. 4. Key question What systematic deviations from Opt. tax? Implicit answer in the paper? Size of govt: irrelevant or shaped by ideology SIP: tax expenditures on organized interests Agency: no deviation, but prefer low transparency Optimistic conclusion: few systematic deviations, but too little transparency?

21. Distorted political incentives Ideology as party’s brand name to keep voters attached Opportunistic parties influenced by lobbies/ electoral concerns Asymmetries in political influence Swing voters not uniformly distributed across groups Organized interests Influential groups taxed less Empirical implications for tax rates / tax bases ?

22. Lack of commitment and dynamic inconsistency Large theoretical literature Capital / corporate taxes Reaction to shocks Tax amnesties How important in practice? Highly relevant in monetary policy Expectations key in tax policy as well Why neglected in practice in most countries?