PITFALLS OF TAXATION POLICY IN TRANSITION ECONOMIES

Abstract

This paper develops two stylised models of the transition economy that challenge, to some extent, the conventional approach to policy reforms. In the first model, the absence of market-oriented institutions is responsible for the occurrence of a non-cooperative equilibrium, where the amount of public services provided by the state is too low, which, in turn, adversely affects the global performance of the economy. In the second model, a benevolent government will choose a taxation level that pushes too many firms out of the market; hence global supply falls below its optimal level. In both models, disruptions specific to transitional systems lead to abnormal responses to standard fiscal policy.