Asymmetric Information, Fiscal Capacity, and Fiscal Accountability

Abstract

I consider a model in which an autocrat can invest in fiscal capacity and thus be able to tax his subjects (citizens). Investment in fiscal capacity is costless but comes with a demand for fiscal accountability by the citizens, something akin to the spirit of the slogan no taxation without representation. An autocrat is either corrupt or honest and this is his private information. Tax revenue is used to finance a public good. Honest autocrats care about the welfare of their citizens and higher levels of taxation improve the welfare of the citizens. If autocrats have a sufficiently high ego rent from being in office, then there exists a perfect Bayesian pooling equilibrium in which an autocrat, regardless of his type, does not invest in fiscal capacity regardless of whether the citizens know the cost of the public good. There is a separating equilibrium in which both types invest in the same level of fiscal capacity, the corrupt type raises the maximum tax revenue in the current period regardless of the unit cost of the public good and is kicked out of office; if the unit cost of the public good is high, the honest type raises a smaller revenue (possibly zero) below the country's fiscal capacity in the current period, remains in power, and raises more revenue in the future. I find that less transparency in public finance management reduces the incentive to raise a higher tax revenue.