Optimal Taxation and Strategic Budget Deficit Under Political Regime Switching

Abstract

I develop a dynamic political economy theory of optimal taxation and budget distortions in a model with partisan politics. Under asymmetric information, politics affects the distribution of utilities in the economy. Political regime switching introduces fluctuations of this distribution. These fluctuations justify strategic budget distortions by governments currently holding office and willing to favour their redistributive concerns against future majority. Under quite general assumptions on preferences, these distortions take the form of budget deficits (resp. surpluses) with leftist (rightist) governments. Endogenizing the probabilities of getting elected may reverse this result.