Taxability, Elections, and Government Support of Business Activity

Abstract

Politicians care about tax revenues in part because they pay for transfers or public goods which are important to voters, and which are therefore important for the politician’s reelection. When economic sectors differ in their taxability, i.e. the degree to which tax revenues can be extracted by the state, politicians will thus have an incentive to allocate their support for business activity unevenly across sectors. Formalization of this idea shows that politicians will be more inclined to favor high-taxability sectors when transfers or public goods are highly valued by voters, but less likely to do so when a country’s overall tax capacity is high. Further, the allocation of support will depend on the relative size of the low- and high-taxability sectors, but not on the number of recipients of government transfers. Drawing upon a survey of firms in twenty-three postcommunist countries - where overall tax capacity is in many places quite low, differences in taxability across sectors is typically high, and government support for business activity is often lacking - the model’s predictions are shown to hold generally in countries with well-developed political rights and civil liberties, but only partially in the rest of the postcommunist world. Politicians in more democratic countries seem to be motivated by the electoral concerns central to this paper, while their counterparts in less democratic states appear to be driven by revenue considerations for nonelectoral reasons.