The Time-Inconsistency Problem of Labor Taxes and Constitutional Constraints

This paper investigates the time-inconsistency problem of labor taxes in an economy with balanced-budget policies and no capital taxes. With full commitment, we show that Ramsey labor taxes change with the cost of distortionary taxation and with the cost of not being able to tax capital. We numerically show that these make labor taxes increasing over time. With limited commitment, we find that this time-inconsistency problem leads to underprovision of public consumption. For our baseline parameter values, we find that imposing carefully chosen bounds on labor taxes as constitutional constraints can be optimal. While our proposed bounds sustain the Ramsey as the best sustainable equilibrium, our lower bounds alone or, in combination with some upper bounds, induce higher public consumption and higher welfare in the worst sustainable equilibrium

An Evaluation of Constitutional Constraints on Capital Taxation

This paper investigates the desirability of constitutional constraints on capital taxation in an environment without government debt and where benevolent governments have limited commitment. In our setup, governments can choose proportional capital and labor income taxes subject to the constitutional constraint but cannot commit to the actual path of taxes. First, we explore a form of constitutional constraint: a constant cap on capital tax rates. In our quantitative exercise, we show that a three per cent cap on capital taxes provides the highest welfare at the worst sustainable equilibrium. However, such cap decreases welfare at the best sustainable equilibrium (both because it constrains feasibility and tightens the incentive compatibility constraint). Second, we identify a form of constitutional constraint that can improve all sustainable equilibria. That constraint features a cap on capital taxes that increases with the level of capital

Political Economy of Public Deficit: Perspectives for Constitutional Reform

The paper uses a dynamic inconsistency model known from monetary policy to assess three alternative proposals how to reform fiscal constitution in order to limit government’s incentive to use fiscal policy for maximizing political support. The return to ever-balanced-budget rule, state-contingent rules, and the establishment of an independent Fiscal Policy Committee with power to set public deficit with the aim of stabilizing the economy are discussed from the constitutional perspective, analyzing different incentives that these proposals create for government and alternative means to enhance credibility of the arrangement.fiscal policy; dynamic inconsistency; political economy; public deficit

I Will Survive: Capital Taxation, Voter Turnout and Time Inconsistency

This paper reconsiders the debate around the political determination of capital income taxes and explains why such taxes survive in most OECD countries. The political economy literature on redistributive politics (Persson and Tabellini 2003) emphasizes the role played by the lower class in the political arena: being labor more concentrated than capital, the majority of the population benefits by overtaxing capital and undertaxing labour. However, in reality, political participation (voting, lobbying, protesting etc.) is positively correlated with income. Therefore, a paradoxical result emerges: why do the upper class, who is politically more active and own most of the capital, still favour a positive capital tax? Hence, voters' income is not the sole relevant variable in the political determination of the capital tax. To reconcile this apparent puzzle, we propose a model that incorporates time inconsistency à la Laibson in individual preferences We show that time inconsistent individuals are politically more homogeneous (or “single-minded”) than far-sighted, and prefer to tax more capital income, instead of labor income, since accumulated saving are below the planned (and optimal) level and the distortionary effects of a higher capital tax are not only reduced but also delayed in time. We demonstrate that, since politicians find easier to please hyperbolic voters by proposing a tax policy that includes lower labor and higher capital taxes compared to an economy with only far sighted. Moreover, we show that, as the proportion of time inconsistent individuals in the population increases, the tax policy becomes more and more biased towards capital taxation.Political Economy, Multidimensional Voting, Capital Taxation, Redistribution, Hyperbolic Discounting

Globalisation, Competitive Governments, and Constitutional Choice in Europe

The traditional school of economic policy analysis predicts that globalisation will give rise to predatory competition between the governments of the European nation states. The consequence is anticipated to be a marked reduction in, if not the destruction of, the benevolent Welfare State. The objective of this contribution is to present the main arguments that have led us to believe that, this traditional literature notwithstanding, a European constitution should not restrict but rather should encourage horizontal and vertical governmental competition. In our view the European political order, in defining the relationship among member states and also the relationship between the member states and the EU, ought to be inspired by what we know about competition in the commercial sphere.globalisation, globalization

Bureaucrats or Politicians?

politics, delegation, bureaucracies

BUDGET INFLEXIBILITY

The study of budgetary institutions has long been an important topic in the economic literature. Nonetheless, the degree of rigidity or inflexibility in budget preparation, a prime preoccupation for policy makers and in particular for finance ministers since a long time ago, has been relatively unexplored. In this paper we show that budget inflexibility can take several forms and argue that it is likely to be closely related to various types of political conflict present in the budget process. Moreover, we study one particular form of budget inflexibility and its connection with one specific (but perhaps the most important) political force driving the budget process. More specifically, we discuss some of the consequences of "expenditure inflexibility," defined as the existence of transfers to special interests enjoying constitutional or legal protection which impede their modification in the short run, in a simple model of legislative bargaining that captures the Tragedy of the Commons present in public budget allocation.Colombia, Fiscal Policy, Budget, Inflexibility

Equilibrium and government commitment

How should a government use the power to commit to ensure a desirable equilibrium outcome? In this paper, I show a misleading aspect of what has become a standard approach to this question, and I propose an alternative. I show that the complete description of an optimal (indeed, of any) policy scheme requires outlining the consequences of paths that are often neglected. The specification of policy along those paths is crucial in determining which schemes implement a unique equilibrium and which ones leave room for multiple equilibria that depend on the expectations of the private sector.Equilibrium (Economics)