Endogenous Tax Policy in a Computable Economic and Political Equilibrium : With Application to the United States, 1973-1983

A computable model of economic and political competition is developed in which tax rates and the size of government are determined along with private prices and quantities in a broader equilibrium. The framework is applied to the United States by incorporating the GEMTAP model (with 19 industries) amended to include foreign capital flows and individual demands for public services. We investigate the Pareto set of fiscal policies for representative members of three interest groups defined by the level and source of factor incomes. Implementation of probabilistic spatial voting theory also allows the calibration of weights representing the relative influence of the three groups in equilibrium.The calibrated influence weights are used to study the economic and political determinants of tax policy in the United States over the decade after 1973. Simulations of what would have happened in 1983 if relative political influence had remained unchanged at 1973 levels suggest that international exposure of the U.S. economy was a critical factor in the decline of capital income taxes and the increase in taxes on labour income that occurred over the period. The simulations also indicate that an increase in the effective influence of poorer voters kept taxes on capital and high incomes from falling even further than actually occurred. More generally, the results as a whole illustrate the importance of taking the general equilibrium consequences of public policy into account when studying the political economy of fiscal history