Presentation by Mario Solis-Garcia at the OECD Workshop on “Joint Learning for an OECD Trust Strategy” on 14 October 2013. Mr. Solis-Garcia discusses why trust matters and uses a simple economic model to see how government trust influences environment, government, households and timing.

1. Trust in government and policy effectiveness
Mario Solis-Garcia
Department of Economics
Macalester College
October 14, 2013

2. “The government says not A. Therefore A.”

3. Why government trust matters
Can trust in government have incidence over policy effectiveness?
Use simple economic model to show answer is: “yes.”
In the model, government’s tax policy announcements have very
different effects depending on trust.

4. Why government trust matters
Bottom line:
A government policy that is intended to have a particular effect
can generate a very different outcome depending on how
trustworthy households/firms/agents believe the government is.

5. A simple economy: environment
Economy lasts for one period.
Large number of household-producers and a government.
Households can produce for formal or informal sectors. Consume
profits.
Government taxes formal households’ output. Expenditure is
wasteful.

6. A simple economy: government
Taxes output of formal households at rate τ ∈ [0, 1].
Impossible to tax or impose penalty to informal households.
Government is committed to tax plan τ .
Key: households do not perceive it this way.

7. A simple economy: households
Households identical except for productivity.
Endowment is one unit time to be used as labor. No capital.
Households have level of trust for government, λ ∈ [0, 1].
Two production technologies: formal and informal.

8. A simple economy: households
Formal technology combines labor with capital to produce output.
Larger scale of production: high-productivity households benefit
more.
No capital endowment: need government “quality seal” to access
credit market. Implies formal households can’t avoid taxation.
Formal households believe government will keep policy τ with
probability λ, confiscate output with probability 1 − λ.

9. A simple economy: households
Informal technology uses labor to produce output.
Informal households cannot rent capital but don’t pay taxes.

10. A simple economy: timing
1. Households observe productivity value.
2. Government announces tax plan τ .
3. Conditional on productivity, tax plan, and government trust,
households decide technology to operate.
3a. Formal households rent capital and produce. Government taxes
according to plan.
3b. Informal households produce.

11. Results
Result 1
If there is no trust in government, all households operate informal
technology (regardless of productivity).

12. Results
Result 2
If λ ∈ (0, 1], households with productivity higher that some cutoff will
operate formal technology. Cutoff depends on government trust and is
given by
θF = A + B ln(λ)
where A > 0, B < 0 are constants that depend on model parameters.

13. Results
14
12
Productivity cutoff
10
8
6
4
2
0
0
0.1
0.2
0.3
0.4
0.5
0.6
Government trust
0.7
0.8
0.9
Figure: Productivity cutoff and trust in government.
1

14. Results
Result 3
Proportion of households choosing to operate informal technology falls as
trust in government increases.

15. Final remarks
Presented a simple model where government trust influences
household decisions.
Results depend on households’ perceptions and not on actual
government behavior.
More elaborate models should exhibit richer set of implications; do
not think main conclusion will change.