Is tax policy improperly limited, or even corrupted, by politics? What is a valid counterfactual for judging tax systems and choices on taxation made by public decision makers? What steps are needed to define the elements and characteristics of a desirable or “good” tax system?

So far we have not directly confronted issues of this nature. Although the concept of Pareto efficiency was introduced in Chapter 4 in connection with the discussion of the Representation Theorem, the previous chapters have focused primarily on the presentation and development of theories that explain the structure of tax systems observed in democratic nations without evaluating outcomes in relation to a particular standard.

Doing research in economics, as in other social sciences, differs from the writing of a good story or play. Successful work in both fields starts with an initial premise, but the economist, unlike the playwright, will rarely reach a final cathartic conclusion. To use Frank Knight's phrase, there is simply too much “unfinished business.” In fact, one may want to go farther than Knight and claim that good research, like life, consists of unfinished business.

WHAT HAS BEEN ACHIEVED

Like other large research undertakings, this book presents new insights and also leaves significant areas to be explored. In order to provide an overall perspective, it is useful to describe briefly what, in our view, has been achieved in the preceding chapters. The book presents a new approach to the study of taxation that integrates collective choice with economic analysis and views fiscal policies as equilibrium outcomes. The resulting framework allows us to treat a wide range of issues in a unified manner. Moreover, the analysis is based on a collective choice model that allows exploration of multidimensional issues in an equilibrium setting.

Institutions do not appear explicitly in the voting model that serves as the framework for the preceding chapters. Nonetheless, the institutions of democracy are essential to the meaning of the model. It makes sense to use voting analysis as a basis for the study of fiscal systems in situations where political competition for public office is a well-established tradition. Democratic institutions are therefore an essential aspect of any such investigation, even if they are not formally part of the mathematical formulation.

In this chapter we investigate the role that certain institutional arrangements in democratic states may play in the determination of tax structure. In particular, we consider the nature of intragovernmental or structural competition in the congressional system of the United States and the parliamentary system of Canada, and we investigate the importance of differences in such competition for the determination of tax structure in the two countries.

Structural competition is an aspect of political systems that differs from competitive behavior related to political parties. The essence of such competition is best captured by the expression “checks and balances.” Following Albert Breton (1996), we may say that it exists in any situation where there are competing centers of power within a governing structure.

Explaining observed differences in the use of taxation and in the structure of fiscal systems is an important task for political economy. Taxation lies at the heart of political power and is crucial to the operation of the public sector, thus providing a test case for judging the relevance of collective decision models. At the same time, empirical research is facilitated by the existence of excellent quantitative information on government revenues, including data of both a cross-sectional and a historical nature.

In the preceding chapter we showed how applied equilibrium modeling could be used to gain a better empirical understanding of fiscal history. This chapter sets the stage for statistical modeling. We derive a general set of estimating equations that are consistent with the framework we have developed, and we use it for a discussion of the issues that arise when making the transition from theory to statistical work. The specific nature of the research presented in the following two chapters is introduced, and previous empirical work on the political economy of tax structure is reviewed.

In the preceding chapter we argued that multiple tax bases, separate rate structures, and a variety of special provisions can be understood as a set of related policy instruments that are shaped and used by the government in the course of its continuing struggle to maintain itself in elected office. In this chapter we explore this idea further, using a model that is more formal than the one presented in Chapter3. The model is also more detailed with respect to individual behavior, allowing for the possibility that voters may reduce their tax liabilities by “self-selecting” their level of work effort in order to alter their tax liabilities. Allowing taxpayers to mimic the behavior of others who face lower tax rates is a way of acknowledging that some characteristics of taxpayers that would be a useful basis for taxation, such as potential work effort or intellectual ability, cannot be directly observed by tax collectors. This means that the government must levy taxes according to surrogate characteristics that are correlated with the basis upon which it would prefer to impose taxes, while allowing for the fact that taxpayers may choose to misrepresent themselves in response to taxation based on these surrogate characteristics.

We begin the study of the power to tax in democratic states with a review of six well-known models that have been used to investigate important aspects of the formation or evolution of tax systems. Five of them include collective choice as an integral part. Johansen's challenge to “go further and to consider the public sector in another way” has not gone unanswered in the fiscal literature during the last four decades. Many authors have attempted to explain how selected aspects of tax systems, or tax structure as a whole, emerge in an equilibrium resulting from the interaction of the private economy and the political process. The major contending frameworks include the median voter model, structure-induced equilibrium, probabilistic voting, the Leviathan model, and cooperative game theory. We provide a sketch of each of these approaches.

Actual tax systems are complicated and often elaborate. Underneath their rather baroque appearance lies a simple skeleton, however, consisting of a limited number of parts. The main elements in all tax systems are tax bases, rate structures, and special provisions such as exemptions, credits, and deductions. A theoretical analysis of tax structure must explain how these elements arise as a result of private and public choices and also what determines their design and importance within the system as a whole.

The foundation of this book derives from two sources. Like most writers concerned with public finance, we rely on traditional microeconomics and general equilibrium analysis to describe the economic decisions of individuals in the private sector. To this, we link formal modeling of collective choice behavior, relying in particular on recent advances in the theory of probabilistic voting. The book examines taxation as it arises on this joint foundation – as a result of the interaction of maximizing decisions in the private and public sectors.

Although the final form of the book reflects our special interests and concerns, we have attempted to present a balanced picture, one that is more comprehensive than commonly found in the literature on taxation that includes elements of collective choice. We examine taxation and tax systems in democratic countries from a positive or predictive point of view, but we also devote considerable space to discussion of efficiency and of normative concerns. In addition, we use applied general equilibrium analysis and statistical research to link theory to empirical data. We feel that taxation as it arises out of democratic choices can best be understood if examined from all these perspectives in relation to an expanded theoretical foundation that incorporates collective choice.

Although the book was written over the past four years, the material reported in several of the chapters evolved over a longer period.

We showed in Chapter 4 that, in a world described by the probabilistic voting model, decision makers choose policies that are economically as well as politically efficient. These policies reflect three essential elements: the demands of voters, differences in their political responses and influence, and the operation and constraints of the private economy.

Taxation has been a major subject of comment and analysis throughout history. It is not difficult to understand the source of this widespread attention. Taxes directly affect the daily lives of individual citizens while also providing “the sinews of state,” as pointed out long ago by the Roman writer Cicero. They give the government access to private economic resources and make possible the provision of essential public services, such as defense, police protection, and the enforcement of property rights through the courts. Their imposition influences the distribution of personal income and may alter the division of wealth among different groups. How a society employs taxation reveals much about the relation between its citizens and the state, and thus defines an important part of the nation's character.

Economists have made many contributions to the study of taxation and fiscal choices. Although our analysis falls into this broad tradition, it also represents a new departure.