Why do rational politicians choose ine¢ cient policy instruments? Environmental regulation for example, often takes the form of technology standards and quotas even when cost-effective Pigou taxes are available. To shed light on this puzzle, we present a stochastic game with multiple legislative veto players and show that inefficient policy instruments are politically easier than efficient instruments to repeal. Anticipating this, heterogeneous legislators agree more readily on an inefficient policy instrument. We describe when inefficient instruments are likely to be chosen, and predict that they are used more frequently in (moderately) polarized political environments and in volatile economic environments. We show conditions under which players strictly beneÖt from the availability of the inefficient instrument.
Theoretical Economics, vol. 14, n. 4, November 2019, p. 1483–1534