DP1436 Common Agency and Coordination: General Theory and Application to Tax Policy

Author(s): Avinash K Dixit , Gene Grossman , Elhanan Helpman

Publication Date: July 1996

Keyword(s): Common Agency , Tax Policy

JEL(s): D0 , H2

Programme Areas: International Trade and Regional Economics

Link to this Page: www.cepr.org/pubs/dps/DP1436.asp

We develop a model of common agency with complete information and general preferences with non-transferable utility, and prove that the principals’ Nash equilibrium in truthful strategies implements an efficient action. We apply this theory to construct a positive model of public finance, where organized special interests can lobby the government for consumer and producer taxes or subsidies and targeted lump-sum taxes or transfers. The lobbies use only the non-distorting transfers in their non-cooperative equilibrium, but their inter-group competitition for transfers turns into a prisoners’ dilemma in which the government captures all the gain that is potentially available to the parties. Therefore, we suggest that pressure groups capable of sustaining an ex-ante agreement will make a commitment to forgo direct transfers and to confine their lobbying to distorting taxes and subsidies.