The Political Implications of Reference-Dependent Preferences

This paper studies electoral competition over redistributive taxation between a safe incumbent and a risky opponent. With reference-dependent preferences, economically disappointed voters become risk lovers, and hence are attracted by the more risky candidate. We show that the equilibrium can display policy divergence: the intrinsically more risky candidate proposes lower taxes and is supported by a coalition of very rich and very disappointed voters, while the safe candidate proposes higher taxes. This can explain why right-wing populist parties are often supported by economically dissatisfied voters and yet they run on policy platforms of low redistribution.