Abstract
Economic reforms are often postponed even if they are clearly beneficial. I argue that this may reflect a government's need to improve its reputation before it can enact a reform successfully. I study a model in which the government has a commitment problem in setting taxes that pay for reform. Market expectations about future policy, which determine investment, become fundamental for the reform's success. Reform may be postponed as the government builds credibility with a period of low taxes. Depending on expectations, better equilibria may exist. The robustness of this explanation and its policy implications are discussed.