Regulation and Taxation: Analyzing Policy Interdependence

Abstract

The paper draws attention to the interdependence of regulation and taxation. We analyze the nature of policy equilibrium, as well as the implications of historically important political and economic shocks, for the joint use of the two policy instruments in a framework that embodies relationships common in the literature on political economy. Regulation is represented by barriers to entry created by the government for favored industries. Among the results are the following: the introduction of new methods of communication in politics, such as television advertising, leads to increased taxation of the average voter, lower business tax rates, greater entry barriers in private markets and greater resource use for campaign advertising, with the marginal cost of the new medium and the elasticity of supply in regulated industries playing crucial roles. Overall government size declines. The two additional shocks analyzed, namely growth in the labor force participation of women and increased off-shore production also have substantial consequences for tax rates as well as regulation. The paper concludes with a consideration of the efficiency of policy equilibrium and the analytical problems that arise in evaluating efficiency in such a context.

Keywords: regulation, taxation, policy interdependence, political advertising, efficiency of political equilibrium

JEL Classification: D78, H20, H21, K23, L50