Three essays in the formation and evolution of fiscal policy under uncertainty and asymmetric information

grantor: University of TorontoThis thesis examines the formation and evolution of fiscal policy within models of positive political economy. The first two essays focus on tax policy while the third essay examines the optimal provision of public goods. The central theme is that observed government policy is the outcome of its self interested behavior based on its ideology and the desire to get reelected. The first essay presents a classical signaling model in which there are two types of incumbents whose preference on income distributions is private information. The incumbents use tax policy to signal their type. The separating and pooling equilibria are characterized. In the second essay, voters know are uncertain about two relevant aspects of the incumbent's characteristics, namely his preferences towards income distribution and his rents. This additional noise in the signal prevents the voters from knowing the incumbent's exact preference towards income distribution. The incumbent takes advantage of this signal extraction problem by appearing more moderate than he really is to increase the probability of his reelection. In the second period, if he is reelected, there is no future to worry about because of term limits, so he reverts back to his preferred tax policy, creating intertemporal volatility in taxes. The first two essays examine the effects of rents, uncertainty about the location of the median voter, political polarization and income distribution on the level and the volatility of taxes. Normative theory provides efficiency conditions on the provision of public good but it fails to specify the optimal level of these goods. The third essay presents a simple model in which the incumbent has concerns about ideology and reelection. Its purpose is to determine the incumbent's privately optimal level of public goods provided. In the model, the incumbent can spend current revenues as current transfers for an immediate payoff or for the provision of public goods which are available only after the elections. Given uncertain reelection prospects, the incumbent does not fully internalize the benefits that public goods provide and this failure results in a suboptimal provision of public goods. It is demonstrated that the predictions of the model are in close conformity with data from India.Ph.D