Incentive-compatible Fiscal Constitutions

Andrés Carvajal

No 2827, Investigación Económica en Colombia from Fundación Pondo

Abstract: It is a fact that in most of the countries (both currently and historically) the wealthier a person is, the higher the amount that he or she has to pay in taxes. This feature of a tax system was actually considered by Adam Smith as the first maxim of a good tax regime. In the Wealth of Nations (book 5, chapter 2, part 2), Smith stated this equality principle as: “The subjects of every state ought to contribute towards the support of the government... in proportion to the revenue which they respectively enjoy under the protection of the state.” On the other hand, the literature on the economy of the state proposes that: • One important reason for the existence of states is that the society needs an agent who can protect it from foreign predation. • A good characterization of the behavior of the state must treat it as a private enterprise, interested in maximizing the rents of the ruling elite. • The focus of the research of constitutional political economists should be the design of Constitutions that provide the state with the incentives to do the job that it is supposed to. In this paper, we attempt to associate all the previous ideas. We analyze the problem in a very simple Principal-Agent framework. Under imperfect information, we assume that the problem of the society is precisely to design a fiscal constitution such that the state has the incentives to protect the wealth of the society. The interesting result is that, under mild assumptions, such incentive compatible constitution implies a strictly increasing dependance of taxes on the wealth of the tax payer. As a by-product, we also find that such constitution cannot be Pareto efficient. The paper is organized as follows. In the next section, some related literature is reviewed. Then, the next two sections set up and solve the problem. As a comparison benchmark, a Pareto efficient constitution is derived. Those are the two most important parts of the paper. The model has assumptions that range from purely technical to strong economic simplifications. For that reason, before stating the concluding remarks we discuss the assumptions and main weaknesses of the paper. An appendix includes a related problem and the proof of one of the results.

Pages: 16
Date: 2003-07-15
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Persistent link: https://EconPapers.repec.org/RePEc:col:000100:002827

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