154 4 Economic voting: The influence of tax policy on elections While we have concentrated on the effects of political considerations and institutional factors on tax reforms so far, part V.4 analyzes the effects of tax reforms on the voting decision. We first shortly review theoretical approaches in the literature and discuss main findings. Then we derive hypotheses from the theory of economic voting with respect to the possible influence of tax policy on voting decisions. Finally, we test the hypotheses empirically based on our data-set. 4.1 Economic voting and tax policy – general approach and related literature The theory of economic voting argues that the individual and the aggregated vote in elections is influenced by economic developments as well as by economic policy. One early example is Tufte (1978, p. 113) who demonstrated a strong influence of economic growth on the results of US midterm elections.272 Since then a relatively broad literature has developed.273 The main questions discussed in this literature are which economic factors are affecting the vote, whether voting decisions are more influenced by past policy decisions (retrospective voting) or by expectations on future policy decisions (prospective voting) and whether there is an asymmetry in the reaction to policies with positive or negative effects (grievance asymmetry). Most of the studies in the field follow an empirical approach. The central problem is that the influence of economic conditions on the decision-making of individual voters cannot be observed directly but is often analyzed based on aggregated variables like macroeconomic conditions and total vote share changes. Policy decisions are most of the time integrated only indirectly (via an assumed/stated effect of policy on macroeconomic conditions). Based on the existing literature some stylized facts can be distilled: retrospective voting is in most cases more important than prospective voting, the macroeconomic variables GDP growth (which is linked to unemployment) and inflation account for roughly ? of vote share changes, and there is a grievance asymmetry in that negative changes lead to stronger electoral reactions.274 272 An analysis with respect to the effects of economic conditions on the US presidential vote can be found in Erikson (1989) or Kinder et al. (1989) and of the congressional vote in Erikson (1990). Fiorina (1981) researches retrospective voting in US elections, Levitt and Snyder (1997) search for the impact of federal spending on house elections in the US. Besley/Case (1995) analyze the relationship in between tax competition, tax rate setting and re-election probabilities of incumbent governments. 273 Lewis-Beck and Paldam (2000), pp. 113 ff., were aware of approximately 200 books and papers in the field in 1998. 274 See for a discussion: Lewis-Beck and Paldam (2000), pp. 113 ff. Empirical results for Western European elections from 1960 to 1997 can be found in Chappell and Veiga (2000). 155 4.1.1 Economic voting and tax policy Electoral motives play an important role in many studies of tax policy. Large parts of the polit-economic literature, which try to explain why real world tax systems differ strongly from welfare-optimal taxation and why welfare-enhancing reforms fail to be implemented, refer to the importance of electoral motivation of governments.275 We were able to confirm the importance of opportunistic behavior and showed strong evidence for electoral motivation in the timing of tax policy (see part V.3). But although there is wide agreement on the importance of electoral motivation in tax policy, barely any studies exist which actually really analyze the effects of tax policy on the voting decision.276 Is it really worthwhile for governments to reduce the overall tax burden before elections? Or are voters completely unconcerned about these changes in tax policy? The number of existing studies asking these questions is very limited.277 One of the few existing studies is Johnson, Lynch and Walker (2005) who showed for British data that marginal and standard rates of income taxes had no influence on election results (1950-2001), but effective tax rates278 had an important and much larger effect on vote share changes than changes in unemployment and economic growth.279 Landon and Ryan (1997) studied the effects of different kinds of taxes on the vote in Canadian provincial elections. For Germany we are not aware of a well-founded study which analyzes the effects of tax policy on the electoral vote for a longer time period. One important reason for the lack of studies on the effects of taxation on voting decisions results from problems to quantify tax policy. We can overcome these problems at least partly by testing hypotheses of economic voting based on our new data-set of fiscal effects of tax reforms. 275 See for example the discussion in Findling (1995). 276 One could argue that the influence of taxation on the vote cannot be studied without taking expenditure (and public good provision) into account as taxation might not be a separate independent variable but closely linked to expenditure. If tax increases lead to an additional burden the possible effect on the vote might depend crucially on the kind of spending that is financed with that tax increase. However, we do not find this argument to be convincing. First, there is – with only some minor exceptions – not a clear linkage in between spending and taxing decisions as tax revenues are usually not earmarked for special uses. Second, and most important, we have found that there exists no clear link in between tax reforms and expenditure developments (see part V.2). Therefore, taxation and expenditure are in practice not really linked too closely and can be studied separately. 277 Most of the literature is concerned with macroeconomic variables like unemployment, GDP growth or inflation. For a discussion see Mueller (2003), pp. 429 ff. 278 Measured as the proportion of the total income an average individual pays as taxes. 279 This is contrary to Rose and Karran (1987) who find that taxation had no significant impact on election results in Britain. 156 4.1.2 Economic voting and tax reforms – hypotheses How can we analyze the relationship in between tax policy and the voting decision? Which hypotheses should we test? The best case for an analysis of the electoral consequences of tax policies would be if we could use detailed data on the distributional consequences of tax policy on a micro-level. Then we could calculate who profits from tax policy changes, who loses and how these welfare changes affect the vote. However, we are far from disposing of these data.280 Based on the data-set we employ here we have to put the question differently. The most important variables we have are the extent of tax increases and of tax reductions and the net fiscal effects of reforms (increases minus reductions). Nonetheless, we argue that these variables allow us to test important and previously inaccessible hypotheses.281 Most importantly we can analyze whether the fiscal effects of tax reforms in the legislative period previous to the election play a role in the voting decision. Based on the main questions discussed in the literature on economic voting we can test several important hypotheses based on the fiscal effects of tax reforms: As we have only data on past policies and not on voters´ expectations at the time of the elections, our first hypothesis is concerned with the general importance of past policies (retrospective voting). Do we observe an important influence of past tax policies on the re-election probabilities of incumbent governments (and how strong is it)? A sub-hypothesis is whether voters focus on tax policy decisions (reflected by the adoption of tax reforms by the chambers of parliament) or on reforms being implemented (reflecting the effective change in the tax burden). If we find evidence for retrospective voting we can ask: What is the time horizon of tax policies in the consideration of voters? Does just tax policy in election years matter, or do voters take the policy record in the whole legislative period before an election into account? Finally, we can address the question of a grievance asymmetry: Do voters punish governments more heavily for past tax increases than they reward tax reductions? 4.2 The influence of tax reforms on elections – empirical analysis To test the derived main hypotheses on tax policy and economic voting, we discuss first how to measure the independent variables in the analysis: changes in voting decisions affected by tax policies. Then we move on to the empirical analysis of economic voting which integrates macroeconomic variables and tax policy. 280 Examples for studies that analyze the consequences of a tax reform for different income deciles are Haan and Steiner (2005) or Corneo (2003). However these studies are limited to only one income tax reform. 281 See description and discussion of the data-set in part III and IV.