Government Reputation and Fiscal Capacity

Abstract

How does uncertain implementation shape fiscal policy over time? We study an uninformed fiscal authority that chooses a distortionary tax-financed mandate and audit intensity while a privately informed executive decides whether to deliver or divert the proceeds. Reputation is the Bayesian state variable linking current fiscal control to future capacity. In a two-period benchmark, a mandate is also an experiment: delivery sacrifices current rents but preserves future access. We prove that the dynamic activation threshold is no greater than the square of the static reputation cutoff; the bound is exact and independent of discounting in a linear-benefit, quadratic-cost economy. A positive trial mandate may therefore be optimal when every positive tax is statically undesirable. In the infinite-horizon model, posterior reputation is a bounded martingale and its one-step conditional variance admits an exact policy-dependent formula. Zero mandates can create closed inactive classes in which fiscal activity and learning stop together. On a finite approximation, we compute stationary equilibria with noisy signals, endogenous auditing, and spending-need shocks and certify them against every action in a common adaptive cloud. The equilibria display history-dependent limiting fiscal capacity, non-monotone auditing, and nonlinear responses to spending need: shocks leave mean reputation unchanged but alter its dispersion and exposure to the inactive region.