Public finance and political economics in tax design and reforms

The traditional optimal taxation literature suggests that the structure of tax systems and the adoptions of fiscal reforms rely on some desirable solution of the classical trade-off between efficiency and equity issues. The alternative approach developed by the equitable taxation theory suggests that the interference of political influence in the market economy has to be limited. However social, political and institutional factors play an important role in shaping both fiscal policies and fiscal reforms. The growing literature on political economics suggests that the complex (multidimensional) tax structure that we observe in our countries depends on political elements and political factors, such as political instability and political influence, and predicts that tax reforms may be adopted and sustained if there exists a political support to them. This paper reviews the main contributions of the positive and normative approach to taxation of traditional public finance views, and it compares them with the suggestions of the political economy approach. The aim is to provide a theoretical interpretation, based on the interrelation between economic and political factors, of specific issues of taxation and tax reforms in European countries, focusing on the rules of tax neutrality and horizontal equity, the complexity and degree of progressivity of the income tax, the role of competition and decentralization.