Two competing hypotheses have been developed in the public economics literature to explain the growth of government spending. The first, termed the fiscal illusion hypothesis, holds that governments have incentives to induce a misperception in the population about the cost of government. By constructing complex systems of taxation that obscure the true cost of government services, governments can lead the taxpayer to demand a larger quantity of services. The other hypothesis, the fiscal stress hypothesis, holds that tax complexity diversifies revenues, leading to less revenue variability and, hence, lower costs. Taxpayers, then, demand more government services. The two hypotheses make very different assumptions about the incentives of governments in regard to an informed electorate. The fiscal illusion hypothesis suggests incentives to obscure information, while the fiscal stress hypothesis suggests incentives to reveal true costs.
Accounting and financial reporting can play a role in revealing fiscal information to taxpayers, directly or indirectly, through information intermediaries. If the fiscal illusion hypothesis describes the behavior of governments, we would expect that such governments would attempt to protect the information advantage that is conveyed by a complex tax structure by minimizing accounting disclosures. On the other hand, the fiscal illusion hypothesis suggests that a government with a complex tax structure has no reason to minimize disclosure, and may have incentives publicize lower service costs.
This study examines the association of tax complexity and financial disclosure. We find that there is more disclosure in cities with more complex tax systems, a result that supports the fiscal stress hypothesis.
Sanders, G.D. and Ingram, R.W. (1994), "Municipal tax structure and accounting disclosure", Journal of Public Budgeting, Accounting & Financial Management, Vol. 6 No. 4, pp. 629-649. https://doi.org/10.1108/JPBAFM-06-04-1994-B006
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