Three Essays on the Formation and Impact of Economic Policy


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PhD thesis: a PhD thesis.
Three Essays on the Formation and Impact of Economic Policy
Bacher H. U.
Brülhart M.
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Université de Lausanne, Faculté des hautes études commerciales
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In my thesis I argue that economic policy is all about economics and politics. Consequently, analysing and understanding economic policy ideally has at least two parts. The economics part, which is centered around the expected impact of a specific policy on the real economy both in terms of efficiency and equity. The insights of this part point into which direction the fine-tuning of economic policies should go. However, fine-tuning of economic policies will be most likely subject to political constraints. That is why, in the politics part, a much better understanding can be gained by taking into account how the incentives of politicians and special interest groups as well as the role played by different institutional features affect the formation of economic policies.
The first part and chapter of my thesis concentrates on the efficiency-related impact of economic policies: how does corporate income taxation in general, and corporate income tax progressivity in specific, affect the creation of new firms? Reduced progressivity and flat-rate taxes are in vogue. By 2009, 22 countries are operating flat-rate income tax systems, as do 7 US states and 14 Swiss cantons (for corporate income only). Tax reform proposals in the spirit of the "flat tax" model typically aim to reduce three parameters: the average tax burden, the progressivity of the tax schedule, and the complexity of the tax code. In joint work, Marius Brülhart and I explore the implications of changes in these three parameters on entrepreneurial activity, measured by counts of firm births in a panel of Swiss municipalities. Our results show that lower average tax rates and reduced complexity of the tax code promote firm births. Controlling for these effects, reduced progressivity inhibits firm births. Our reading of these results is that tax progressivity has an insurance effect that facilitates entrepreneurial risk taking. The positive effects of lower tax levels and reduced complexity are estimated to be significantly stronger than the negative effect of reduced progressivity. To the extent that firm births reflect desirable entrepreneurial dynamism, it is not the flattening of tax schedules that is key to successful tax reforms, but the lowering of average tax burdens and the simplification of tax codes. Flatness per se is of secondary importance and even appears to be detrimental to firm births.
The second part of my thesis, which corresponds to the second and third chapter, concentrates on how economic policies are formed. By the nature of the analysis, these two chapters draw on a broader literature than the first chapter. Both economists and political scientists have done extensive research on how economic policies are formed. Thereby, researchers in both disciplines have recognised the importance of special interest groups trying to influence policy-making through various channels. In general, economists base their analysis on a formal and microeconomically founded approach, while abstracting from institutional details. In contrast, political scientists' frameworks are generally richer in terms of institutional features but lack the theoretical rigour of economists' approaches. I start from the economist's point of view. However, I try to borrow as much as possible from the findings of political science to gain a better understanding of how economic policies are formed in reality.
In the second chapter, I take a theoretical approach and focus on the institutional policy framework to explore how interactions between different political institutions affect the outcome of trade policy in presence of special interest groups' lobbying. Standard political economy theory treats the government as a single institutional actor which sets tariffs by trading off social welfare against contributions from special interest groups seeking industry-specific protection from imports. However, these models lack important (institutional) features of reality. That is why, in my model, I split up the government into a legislative and executive branch which can both be lobbied by special interest groups. Furthermore, the legislative has the option to delegate its trade policy authority to the executive. I allow the executive to compensate the legislative in exchange for delegation. Despite ample anecdotal evidence, bargaining over delegation of trade policy authority has not yet been formally modelled in the literature. I show that delegation has an impact on policy formation in that it leads to lower equilibrium tariffs compared to a standard model without delegation. I also show that delegation will only take place if the lobby is not strong enough to prevent it. Furthermore, the option to delegate increases the bargaining power of the legislative at the expense of the lobbies. Therefore, the findings of this model can shed a light on why the U.S. Congress often practices delegation to the executive.
In the final chapter of my thesis, my coauthor, Antonio Fidalgo, and I take a narrower approach and focus on the individual politician level of policy-making to explore how connections to private firms and networks within parliament affect individual politicians' decision-making. Theories in the spirit of the model of the second chapter show how campaign contributions from lobbies to politicians can influence economic policies. There exists an abundant empirical literature that analyses ties between firms and politicians based on campaign contributions. However, the evidence on the impact of campaign contributions is mixed, at best. In our paper, we analyse an alternative channel of influence in the shape of personal connections between politicians and firms through board membership. We identify a direct effect of board membership on individual politicians' voting behaviour and an indirect leverage effect when politicians with board connections influence non-connected peers. We assess the importance of these two effects using a vote in the Swiss parliament on a government bailout of the national airline, Swissair, in 2001, which serves as a natural experiment. We find that both the direct effect of connections to firms and the indirect leverage effect had a strong and positive impact on the probability that a politician supported the government bailout.
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