The Effect of Tax Credit on Politically Distorted Allocations: A Theoretical Approach

Many countries have adopted policies to give preferential treatment for voluntary contributions to certain public goods. Taxable deductions, matching subsidies and rebate subsidies, which decrease gthe price of givingh for donors, are prototypical examples. However, the more aggressive policy of tax credit for voluntary contributions to certain public goods which decreases gthe price of givingh to zero, has not been studied so far in detail, although such a policy can be seen in several countries: the Percentage Law in Hungary, Lithuania, Poland, Romania and Slovakia, and the Hometown Tax-payment policy in Japan. In these countries, and especially in Eastern European countries, such a policy is justified because, by decentralizing the power of government, it allows individuals to reveal their gtrueh preferences and thus allows necessary adjustment for distorted government allocations. In this paper, I find that, such a policy has this adjustment effect if, and only if, the size of the tax credit exceeds certain threshold. In other words, such a policy can be totally cancelled out by a lobby-government coalition if its size falls beneath a threshold.