Microfoundations of Fiscal Capture and Conflictoring

The paper derives fiscal capture instead of assuming a capture threshold

The paper answers the objection that Fiscal Capture relies on an exogenous φ*. It embeds the threshold in a Laffont-Tirole-style principal-agent model where the regulator values social welfare and industry revenue.

• The target concept is the point where a harmful industry's revenue share changes regulatory behavior.
• The model links φ* to cost structure, type probabilities, and effort disutility.
• All results are proposed and not yet peer-reviewed.

A revenue-dependent regulator adds βτq to the standard welfare objective

The firm has private efficiency type θ ∈ θ , θ , with θ < θ . The regulator observes output q and total cost C, but not the split between type θ and effort e.

• Firm cost is C(q, θ) = θq + e, with effort disutility ψ(e), ψ' > 0, and ψ'' > 0.
• Social welfare is W = S(q) - hq - (1 - α)t + απ.
• Fiscal revenue is R(q) = τq, so the regulator maximizes V = W + βR(q).
• β is generated by fiscal dependence φ through an increasing convex β(φ), with β(0) = 0.

The contract menu must satisfy participation and incentive compatibility

By the revelation principle, the regulator can use direct mechanisms: the firm reports θ̂, then receives output q(θ̂) and transfer t(θ̂).

• Participation requires π(θ) ≥ 0 for each type.
• Incentive compatibility prevents θ from mimicking θ and θ from mimicking θ .
• Firm profit is π(θ) = t(θ) - θq(θ) - ψ(e(θ)).
• The efficient type earns an information rent when the inefficient-type contract must be distorted.

Fiscal weight raises output for both efficiency types

Proposition 1 states that q*(θ) increases with β. The fiscal term τβ enters the first-order condition as an added marginal benefit of output.

• Efficient type condition: S'(q_L*) - h - τβ = θ .
• Inefficient type condition: S'(q_H*) - h - τβ = θ + (ν/(1 - ν))ψ'(e_H)Δθ.
• The information-rent term is (ν/(1 - ν))ψ'(e_H)Δθ.
• When β > 0, the regulator chooses higher output than a welfare-only regulator.

φ* is tied to the inefficient-type output distortion

The paper defines φ* around the point where the inefficient-type contract crosses the welfare-maximizing benchmark. The threshold is expressed through β(φ*) rather than inserted as a free parameter.

• q_W satisfies S'(q_W) - h = θ + (ν/(1 - ν))ψ'(e_H)Δθ.
• The proposed threshold condition is β(φ*) = [θ + (ν/(1 - ν))ψ'(e_H)Δθ - (S'(q_W*) - h)] / τ.
• The threshold depends on θ , ν, Δθ, ψ'(e_H), h, τ, and β'(φ*).
• The text notes a trivial equality case when q_H(β) = q_W implies β = 0.

Higher harm, higher τ, and more efficient-type probability lower the capture threshold

The proof differentiates the φ* expression and gives directions for the threshold response. The paper's prose also states that larger cost gaps raise information rents and make capture more likely.

• ∂φ*/∂h = -1/(τβ'(φ*)) < 0.
• For positive numerator, ∂φ*/∂τ < 0, so more revenue per unit lowers the dependence level needed for capture.
• ∂φ*/∂ν < 0 because the efficient-type probability increases the rent problem.
• ∂φ*/∂Δθ > 0 in the displayed proof, while the intuition says larger cost differences make capture more likely.

Above φ*, the regulator gains revenue and the efficient firm gains rent while W falls

The paper maps fiscal capture onto the Hollow Win outcome by separating regulator payoff V, firm payoff π, and system welfare W.

• Regulator payoff includes βR(q), with R(q) = τq.
• Efficient-type rent is π(θ ) = Δθq_H* + ψ(e_H) - ψ(e_H - Δθ).
• System welfare falls when output rises beyond the welfare-maximizing level and adds excess harm hq.
• The resulting pattern is the (0,1,1) Hollow Win: W declines while regulator and firm payoffs rise.

Under-disclosure follows from fiscal revenue and information rents

The disclosure policy d ∈ [0,1] determines how much information about the firm's type is revealed to external auditors. Full disclosure constrains the contract toward the welfare benchmark.

• Regulator payoff from disclosure is V(d) = W(d) + βR(d) - c(d).
• The firm payoff π(d) falls when disclosure cuts information rents.
• At d = 1, the paper uses ∂W/∂d = 0 by the envelope theorem.
• Because disclosure lowers q_H, both βτ∂q_H/∂d and rent effects push against full disclosure.

For β > 0, the joint optimum has d* < 1

Proposition 3 derives Conflictoring as an equilibrium property of the same model, using the joint payoff V + π.

• The joint first-order condition is ∂W/∂d + β∂R/∂d + ∂π/∂d = ∂c/∂d.
• At full disclosure, the paper writes βτ∂q_H/∂d - Δθ∂q_H/∂d - c'(1) < 0.
• The equilibrium has d* = 0, d* ∈ (0,1), or d* = 1 depending on marginal fiscal benefit, rent effect, and disclosure cost.
• For φ > φ*, the fiscal term pushes d* toward zero.

Disclosure falls as β, τ, and Δθ rise

Proposition 4 gives comparative statics for the Conflictoring equilibrium. The model predicts deeper under-disclosure when fiscal dependence or information rents matter more.

• d* decreases in fiscal weight β.
• d* decreases in per-unit fiscal contribution τ.
• d* decreases in cost difference Δθ because rents rise with the gap between θ and θ .
• d* increases when the marginal cost of disclosure c'(d) is higher in the paper's stated result.

The mechanism fails if revenue dependence can be separated from output or disclosure incentives reverse

The paper gives two falsification conditions rather than treating the derivation as unfalsifiable.

• Fiscal capture fails if a regulator with β(φ) > β(φ*) can satisfy participation, incentive compatibility, and output at or below q_W* for both types.
• A nonlinear transfer schedule could break the link if it separated fiscal incentives from the output decision, but the model's observability assumptions rule that out.
• Conflictoring fails if regulator and firm do not jointly prefer under-disclosure for any β > 0.
• Full disclosure can arise if disclosure has zero cost and positive fiscal or political benefit.

The paper leaves dynamics, portfolios, and external agents outside the model

The paper is explicit about the model's limits. It uses a static, single-industry, binary-type setup with linear revenue and no collusion beyond the contract menu.

• Whistleblowers, plaintiffs, investors, and supranational regulators are exogenous.
• Multi-industry fiscal dependence would require a vector of revenue shares rather than one φ.
• Dynamic reputation, electoral constraints, and firm investment in capture are omitted.
• Nonlinear taxes, royalties, and tax expenditures would alter comparative statics but not the stated qualitative result when R'(q) > 0.

Breaking the Hollow Win means lowering fiscal dependence or adding outside disclosure pressure

The model's policy implication is narrow: if the regulator and firm both gain from output distortion and under-disclosure, internal enforcement alone may not restore the welfare benchmark.

• One route is reducing fiscal dependence below φ*.
• Another route is outside action by whistleblowers, plaintiffs, investors, or supranational regulators.
• The paper's empirical predictions concern higher τ, higher φ, weaker enforcement, lower contract disclosure, and lower φ* when h is higher.
• The deck should treat the results as formal proposals pending peer review.