Campaign finance regulation with competing interest groups

Regulatory caps on contributions to political campaigns are the cornerstones of campaign finance legislation in many established democracies, and their introduction is considered by most emerging ones. Are these regulations desirable? This paper studies contribution caps in a menu auction lobbying model with limited budgets and costly entry. In the absence of entry, contribution caps improve welfare by "leveling the political playing field". With entry, however, a competition effect and a bargaining effect may arise, resulting in inefficient entry and exit decisions. In particular, a cap may lead to worse policies than the status quo; and even if better policies are chosen, the resulting gain in welfare may be more than offset by the entry costs. Regulation can also lead to the simultaneous entry of competing groups, creating costly rent-seeking on issues previously unaffected by lobbying.