Frequent government changes, often bringing reversals in ideological orientations, forced agents in economies in transition to make economic decisions without knowing the form of their next government. We develop a model of agents in a country in an early stage of transition from a planned to a market economy and suppose the transfer of property rights, once held by the state, has already occurred. However, the transition is still in progress, and the nature of the government’s future policies is unknown to the agents. We assume that the agents believe the present government will evolve into either a benevolent democratic government or a corrupt government. Each agent is forced to make economic decisions relating to his firm prior to the knowledge of which government will come into existence. Specifically, each agent must choose whether or not to shelter some of the firm’s funds out of the reach of the tax authorities to compensate for the governmental uncertainty he faces. We refer to this illegal diversion of funds by the agent as stealing. In choosing whether or not to steal, and how much to steal, the agent needs certain information. We assume that the agent needs to know, among other things, the probability that each government would come into existence, and what each government would do if it did come into existence. Knowing these things, each agent makes his economic choice, and collectively these choices yield both the tax revenue that would accrue to the ensuing government and the level of crime in the society, denoted by the proportion of agents who avoid taxes. Also, agents believe that each government, should it come into existence, would optimize its own objectives. These objectives may depend on the crime level and will be limited by the tax revenue provided by the agents. However, the crime level itself will be affected by the decisions of the ensuing government. Thus, the agents need the governments’ decisions to solve their problems, and the governments need the agents’ decisions to solve their problems. The tension between the agents and governments is resolved by endogenizing the probabilities that each government will come into existence, thus bringing these two sets of decisions into accordance. The result of the equilibrium is to produce the crime level and, should the democratic government come into existence, the optimal level of investment in infrastructure that this government would choose. We explore the impact of changes in the model’s parameters on the crime level and the democratic government’s investment in infrastructure, also illustrating our results with an example. Finally, we define capital flight within the context of tax evasion and show how it would be affected by changes in the model’s parameters.
JEL categories P37, P26, P27, K42