Politicians, Taxes, and Debt

50 Pages Posted: 24 Sep 2007 Last revised: 20 Oct 2014

See all articles by Pierre Yared

Pierre Yared

Columbia University - Columbia Business School, Finance

Date Written: September 30, 2008

Abstract

The standard analysis of the efficient management of income taxes and debt assumes a benevolent government and ignores potential distortions arising from rent-seeking politicians. This paper departs from this framework by assuming that a rent-seeking politician chooses policies. If the politician chooses extractive policies, citizens throw him out of power. We analyze the efficient sustainable equilibrium. Unlike in the standard economy, temporary economic shocks generate volatile and persistent changes in taxes along the equilibrium path. This serves to optimally limit rent-seeking by the politician and to optimally generate support for the politician from the citizens. Taxes resembling those of the benevolent government are very costly since the government over-saves and resources are wasted on rents. Political distortions thus cause the complete debt market to behave as if it were incomplete. However, in contrast to an incomplete market economy, in the long run, taxes do not converge to zero, and under some conditions, they resemble taxes under a benevolent government.

Keywords: Optimal Taxation, Debt Management, Political Economy

JEL Classification: H21, H63, P16

Suggested Citation

Yared, Pierre, Politicians, Taxes, and Debt (September 30, 2008). Available at SSRN: https://ssrn.com/abstract=1016382 or http://dx.doi.org/10.2139/ssrn.1016382

Pierre Yared (Contact Author)

Columbia University - Columbia Business School, Finance ( email )

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