The Political Economy of Tax Coordination as a Bargaining Game Between Bureaucrats and Politicians

Abstract

In the public finance literature, the view prevails that taxcompetition among countries gives rise to an underprovision ofpublic goods and that coordinated tax increases are thereforedesirable. Public choice arguments, in contrast, suggest thattax coordination may not be in the interest of thetaxpayers/citizens because imperfections of the politicalprocess (political distortions) may lead to a waste of taxmoney. According to this view, tax competition is a desirablecheck on the power to tax whereas tax coordination would onlyrelax the budget constraint of an inefficient public sector.The present paper integrates the underprovision argument andthe public choice view into a common theoretical framework.The government is assumed to consist of politicians andbureaucrats with diverging interests. Fiscal policy ismodelled as the outcome of a bargaining game between thebureaucrats and the politicians. It turns out that coordinatedtax increases always raise the provision of public goods butalso increase the cost of political distortions. The effect onthe welfare of the representative citizen may be positive ofnegative, depending in particular on the distribution ofbargaining power between bureaucrats and politicians.