(Thursday, 24th May 2012)
In order to understand the determinants of government size, redistribution and taxation, a growing literature in macroeconomics analyzes the political process governing policy decisions. The standard approach in macroeconomics is to focus on median-voter equilibria. We depart from this literature by explicitly modeling post-election legislative bargaining.
Our change of framework is motivated by the observation that in actual democracies public choices are usually the result of some sort of negotiation among elected policymakers.
We find that policymakers may not propose (or accept) high capital taxes because this increases the status quo, and thus the bargaining power of low wealth agents in future negotiations. Taking this future cost into account, we find that reasonably low capital taxes become time consistent.
Comparative statics analysis shows that the political environment and the number of checks and balances specied in the constitution are key determinants of government size.