Assessing the validity of fiscal contract theory: An examination of adopting value-added tax

The introduction of a value-added tax (VAT) resulted in higher taxation for citizens. Fiscal contract theory posits that for citizens to support the implementation of such a tax, they must perceive the government as a credible entity. This paper demonstrates that higher levels of democracy positively influence VAT adoption, and more intense competition in presidential or legislative elections correlates with increased VAT adoption. The highly democratic government offer credible commitments to their citizens, reducing compliance costs and facilitating tax adoption, thus supporting the theory.

Contrarily, when the country's leadership leans towards the right-wing rather than the left-wing, there's a greater tendency for VAT rates to rise. Fiscal contract theory would suggest that left-wing governments, capable of providing more credible commitments to the majority, should increase regressive taxes. However, this paper's findings contradict this expectation.

While fiscal contract theory implies that tax increases are feasible with credible commitments between citizens and the government, my study indicates that the theory's applicability might be limited.

H20, H21