The Political Economy of Taxation

by

Stanley L. Winer, Paola Profeta, Walter Hettich

• LAST REVIEWED: 27 November 2013
• LAST MODIFIED: 27 November 2013
• DOI: 10.1093/obo/9780199756223-0083

Introduction

Cicero called taxes “the sinews of the state,” pointing to the crucial role they played in the Roman Empire. Others before him and since have expressed similar sentiments. Governmental action requires economic resources, and taxation has been the most common way to acquire them. As Cicero’s well-chosen image suggests, the body politic cannot flex its muscles without taxing the private sector. Although preferred means of taxation have changed over time, governments have always had a variety of tax instruments at their disposal. The modern literature often refers to broad classes of instruments, such as direct or indirect levies, but it also contains a large amount of descriptive material on particular types of taxes, such as those on personal or corporate income. Nor is it always clear what should be called a tax and whether the term should be defined so as to include phenomena such as the deliberate debasement of the currency practiced from time to time by autocratic rulers and democratic governments. History suggests, however, that the choice of and among tax instruments has always been largely a political decision, although economic factors will usually be taken into account. We define the term “political economy of taxation” with reference to the study of such decisions. We focus on that part of the vast literature that tries to explain how fiscal systems and instruments are chosen in a political and institutional context. At the same time, important topics, such as the relation of war to taxation, are also highlighted, even though the relevant literature may not always have a strongly analytical character. This annotated bibliography is not directed to the purely economic analysis of taxation, which still makes up the primary body of the tax literature published by economists, and topics such as tax incidence and excess burden are not dealt with in detail. The focus on the choice of policy instruments under various political and institutional arrangements is made possible by a nascent literature that creates a direct link between collective choice models and the composition of public revenues in democratic countries. Some of these attempts can furthermore be generalized to nondemocratic regimes, and work can be tested empirically in both contexts. The new direction in the field holds great promise, since it allows researchers to link theory and empirical tests in a concrete manner and to give political fiscal analysis a firm foundation.

Taxation, Tax Systems, and Tax Reform

Revenue systems consist of a variety of taxes, with each causing its own set of economic and distributional consequences. In constructing and changing fiscal systems, policymakers must evaluate the size and interaction of such effects. Further complexity is added because each tax has its own structure, including a base on which the levy is imposed, a schedule of rates that is applied to the base, and a series of special provisions, including exemptions and deductions (sometimes called loopholes) that may apply selective rates to components of the base and that may hollow out the base in other ways, thus leading to a divergence between nominal tax rates and the effective rates of tax on a given base. This suggests that a complete political analysis must have the following components: (a) a discussion of the economic effects of particular taxes and how they influence political support, (b) an examination of how political support can be adjusted by varying the combination of taxes and their structure, and (c) an understanding of how support is influenced by the size of overall budgets. Here the major economic ingredients going into a political analysis are provided together with some works offering general background. This section includes three works introducing economic analysis of taxation (Rosen and Gayer 2010; Bénassy-Quéré, et al. 2010; and Salanié 2011), an early classic in the study of tax systems in the world (Musgrave 1969), a discussion of current international variations in revenue systems (Tanzi 2011), as well as research on the treatment of particular groups, such as the rich (Atkinson, et al. 2010) and on new behavioral approaches to fiscal analysis (Congdon, et al. 2011). Economic arguments about tax “reform” (which in a political economy context may be regarded just as “changes” in the tax system) are provided in a mostly nontechnical manner in Slemrod and Bakija 2008. Work on how the economic effects of taxation are evaluated in political terms by political parties and voters is discussed in later sections.

• Atkinson, A. B., Thomas Piketty, and Emmanuel Saez. “Top Incomes in the Long Run of History.” In Top Incomes: A Global Perspective. Edited by A. B. Atkinson and Thomas Piketty, 664–757. Oxford: Oxford University Press, 2010.

  Summarizes the work of these authors and of others in this and its companion volume (Top Incomes Over the Twentieth Century, Oxford: Oxford University Press, 2007) on the evolution of top incomes around the world over long periods of time. This interesting chapter speculates about the role of progressive taxation, and the role of political economy, in the search for an understanding of the history they document.

• Bénassy-Quéré, Agnès, Benoît Cœuré, Pierre Jacquet, and Jean Pisani-Ferry. “Tax Policy.” In Economic Policy: Theory and Practice. By Agnès Bénassy-Quéré, Benoît Cœuré, Pierre Jacquet, and Jean Pisani-Ferry, 537–616. Oxford: Oxford University Press, 2010.

  A concise, somewhat more advanced though largely nonmathematical introduction to theory and current policy ideas with respect to taxation, nicely integrated with useful references to data describing contemporary aspects of actual tax systems and their recent evolution in the European Union and in the Organisation for Economic Co-operation and Development (OECD).

• Congdon, William J., Jeffrey R. Kling, and Sendhil Mullainathan. “Taxation and Revenue.” In Policy and Choice: Public Finance Through the Lens of Behavioral Economics. By William J. Congdon, Jeffrey R. Kling, and Sendhil Mullainathan, 173–200. Washington, DC: Brookings Institution, 2011.

  Provides an introduction to the ways in which behavioral economics is leading to insights about how people adapt to taxation. Also includes some consideration of political economy issues.

• Musgrave, Richard A. Fiscal Systems. New Haven, CT: Yale University Press, 1969.

  A pioneering study of tax and revenue systems, fiscal development, comparative analysis of tax structure across countries, and political and economic system differences (capitalist versus socialist). It examines specific factors influencing tax structure over time, emphasizing “tax handles.” Written by an important fiscal theorist and empirical researcher of his generation and filled with interesting ideas ahead of their time.

• Rosen, Harvey S., and Ted Gayer. Public Finance. New York: McGraw-Hill Higher Education, 2010.

  Introduction to public economics for undergraduates. Includes two crucial concepts: tax incidence—the distribution of tax burden, which depends not only, or even mainly, on who pays the tax to the government—and the deadweight loss or excess burden, which is the loss in well-being from behavioral adjustments made by taxpayers to reduce their tax liabilities, a loss over and above what is collected.

• Salanié, Bernard. The Economics of Taxation. 2d ed. Cambridge, MA: MIT Press, 2011.

  An elegant, advanced introduction and overview of the economic theory of taxation.

• Slemrod, Joel, and Jon Bakija. Taxing Ourselves: A Citizen’s Guide to the Great Debate over Taxes. 4th ed. Cambridge, MA: MIT Press, 2008.

  A nontechnical and comprehensive introduction to the economic issues that arise in debates over tax reform, focused on US issues. Also includes an overview of the contemporary US tax system with some comparison to other advanced democracies.

• Tanzi, Vito. “Tax Systems in the OECD: Recent Evolution, Competition, and Convergence.” In The Elgar Guide to Tax Systems. Edited by Emilio Albi and Jorge Martinez-Vazquez, 11–36. Cheltenham, UK: Edward Elgar, 2011.

  DOI: 10.4337/9780857933898

  A useful overview of contemporary tax structures in OECD countries, with emphasis on the growing reliance on consumption taxation, the flattening of nominal personal tax rate structures, and the decline in effective corporate tax rates. Special provisions are not covered because they are so complicated and vary so widely from country to country, though a continual increase in tax complexity is documented.