opportunism on the part of the state implies that a “political Coase theorem,” in which the
state and private entities bargain to an efficient outcome, will often not apply (Acemoglu
2002; see also Robinson 1998).
Compounding this commitment problem is the fact that information asymmetries be-
tween state and society are likely to be large, especially in the context of revenue collection,
where the cost to the state of fully ascertaining taxpayers’ ability to pay and of monitoring
compliance is prohibitive (Levi 1988).
2
In particular, if the state is unable to commit to
leaving taxpayers with a portion of their income, then taxpayers may have an incentive to
underreport revenues, even when hiding revenues from the state is costly. In what follows,
we refer to the costliness of hiding revenues, i.e. the ease with which the state may extract
revenues from economic agents, as the taxability of economic activity.
3
One immediate implication is that a Pareto-improving trade of revenues for some publicly
provided good might never be consummated. Another is that the extent to which state and
society fall short of the Pareto frontier may depend on both the degree to which the state
can commit and the nature of the information asymmetry between state and society.
In
particular, when the public good provided by the state enhances economic productivity, the
provision of that good may be influenced by the taxability of economic activity, as well as
by the nature of commitment power.
2
On “Information and the Coase Theorem,” see Farrell (1987).
3
Problems of collective action also reduce the scope for efficient bargaining between state and society.
See Dixit and Olson (2000). In abstracting from this issue, this paper demonstrates the limits to efficient
contracting even when society can organize to negotiate a social contract.
4
Convention