Tax reform and the political economy of the tax base

Abstract

This paper studies the political prospects for reform in a model where the tax base and statutory rate are separate instruments of tax policy. The model suggests that large changes in the tax code may be easier to enact than marginal reforms. The tax base faces a tipping point where even the beneficiaries from tax exemptions support reform. At this tipping point, tax reform is Pareto improving. Politically feasible tax reform occurs when fiscal needs are large, but may nonetheless involve reductions in marginal tax rates. There is strategic complementarity in lobbying for tax exemptions, resulting in multiple equilibria. The model's main predictions are consistent with recent tax reforms in OECD countries.