The importance of seigniorage relative to other sources of government revenue differs markedly across countries. This paper tries to explain this regularity by studying a political model of tax reform. The model implies that countries with a more unstable and polarized political system will have more inefficient tax structures and, thus, will rely more heavily on seigniorage. This prediction of the model is tested on cross-sectional data for 79 countries. We find that, after controlling for other variables, political instability is positively associated with seigniorage.

The importance of seignorage relative to other sources of government revenue differs markedly across countries. The main theoretical implication of this paper is that countries with more unstable and polarized political systems rely more heavily on seignorage. This result is obtained within the context of a political model of tax reform. The model implies that the more unstable and polarized the political system, the more inefficient is the equilibrium tax structure (in the sense that tax collection is more costly to administer), and the higher therefore, the reliance on seignorage. This prediction of the model is tested on cross-section data for 79 countries. It is found that, after controlling for other variables, political instability significantly contributes to explain the fraction of government revenue derived from seignorage. This finding is very robust. We also find that seignorage is positively related to political polarization, even though here the evidence is weaker because of difficulties in measuring polarization.