Tax tilting and politics: Some theory and evidence for Latin America

• Published in: Journal of macroeconomics Vol. 44; pp. 208 - 218
• Main Authors: Pastén, Roberto, Cover, James P.
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier Inc 01.06.2015; Elsevier Science Ltd
• Subjects: Budget deficit; Budget deficits; Debt; Government policy; Government spending; Interaction models; Latin America; Political risk; Politics; Probability; Studies; Tax rates; Tax smoothing; Tax tilting; Taxation; Taxes; Latin America; E62; Tax tilting; Tax smoothing; H62; Interaction models; H21; Political risk
• ISSN: 0164-0704; 1873-152X
• DOI: 10.1016/j.jmacro.2015.02.006

•Under tax-smoothing, deficits are temporary phenomena.•If a government tilts taxes to the future, deficits will be trendy not temporary.•This paper’s model implies that tax-tilting tends to increase with political risk.•As political risk increases the government puts less weight on the future.•As the government puts less weight on the future, it tilts taxes to the future.•Data from a panel of 19 Latin-American countries (1984–2009) support the model. A government budget deficit can exist for at least two possible reasons: tax smoothing and/or tax tilting. Under tax-smoothing, deficits are temporary phenomena resulting from the decision not to vary the tax rate in response to fluctuations in government spending (as a share of output). This is done in order to minimize the distortionary cost of taxes. Tax tilting occurs whenever the government has an incentive to discount the losses to society from taxes at a higher rate than society discounts them; hence it delays taxes or advances spending introducing an upward trend in total government debt. This paper develops a model that implies that tax-tilting tends to increase with political risk. An increase in political risk, measured by the probability of losing power, increases the rate at which the government discounts the future, causing government policy to be relatively more myopic. Hence it delays taxes or advances spending and its deficit increases. Using data from a panel of 19 Latin-American countries for the period 1984–2009, the paper presents estimation results that strongly support the proposition that an increase in political risk increases the degree of tax-tilting.