Dynamic Bargaining over Redistribution in Legislatures

This paper analyzes the standard Neoclassical growth model where agents are heterogeneous in their initial wealth. Wealth can be taxed in order to finance equal lump-sum transfers. We consider a representative democracy where elected officials select the current capital tax by playing a legislative bargaining game. Specifically, one member of the legislature makes a take-it-or-leave-it proposal and decisions pass by majority rule. In case of rejection of the proposal, the capital tax that was voted in the previous period (the status quo) is kept in place for one more period. A key feature of the bargaining game is that when looking at current payoffs both the agenda setter and the legislature have aligned preferences: their most preferred static policy is full taxation. However, the strength of these preferences differ. We show that the fear of ending in a high taxation equilibrium sustains levels of capital taxes and redistribution that are empirically reasonable. The endogeneity of the status quo is a crucial ingredient which disciplines legislators and reduces commitment problems. We also find that higher wealth inequality does not necessarily increase the size of government (the share of income redistributed).