Income Inequality, Political Polarization and Fiscal Policy Gridlock

Over the past few decades, high income inequality and low output fluctuations have coincided with the rising domestic political polarization and policy gridlock in the United States. Motivated by the above fact, this paper analyzes the rigidity of tax policy in an economy with dynamic legislative bargaining and exogenous output fluctuations. First, by adopting the setup of bargaining with endogenous status quo, I account for the co-movement of economic inequality and policy gridlock. Second, by incorporating an economy-wide productivity shock, this model generates the feature that legislative stalemate occurs more frequently in times of reduced output volatility. Third, perhaps surprisingly, the model uncovers the property that equilibrium policy can be either 'present-oriented' or 'far-sighted'. In the 'far-sighted' equilibrium, the policy maker is willing to sacrifice present well-being for the sake of achieving increased bargaining power in the future. Finally, I also find policy gridlock could be alleviated by introducing additional flexibility into the tax system.