Handbook of Public Finance (eBook)

Table of Contents 6
1 SOCIETY, STATE, AND PUBLIC FINANCE: SETTING THE ANALYTICAL STAGE 8
1. THE CAMERALIST ORIGINS OF PUBLIC FINANCE 10
2. FROM CAMERALIST ORIGINS TO CONTEMPORARY PUBLIC FINANCE 14
2.1. The Edgeworthian, Choice- Theoretic Tradition 15
2.2. The Wicksellian, Catallactical Tradition 16
3. THE PRESENT RELEVANCE OF PAST FORMULATIONS 18
4. THE ESSAYS TO FOLLOW 20
REFERENCES 25
2 WELFARE ECONOMICS AND PUBLIC FINANCE 26
1. INTRODUCTION 26
2. THE DIFFERENCE BETWEEN MARKET ACTION AND GOVERNMENT ACTION 28
3. THE CONCEPT OF ECONOMIC EFFICIENCY 29
4. THE CONCEPT OF EQUITY 31
5. PUBLIC GOODS 32
6. EXTERNALITIES 39
7. MONOPOLY AND ANTITRUST 44
8. INCOMPLETE INFORMATION 46
9. ECONOMIC STABILIZATION AND MONETARY STABILITY 48
10. REDISTRIBUTION 49
11. CONCLUSION 51
ACKNOWLEDGMENT 52
NOTES 52
REFERENCES 55
3 FISCAL CONTITUTIONALISM 59
1. THE CONSTITUTIONAL APPROACH 60
2. FISCAL CONSTITUTIONS 64
3. TAXES AS PRICES 65
3.1. The Wicksell- Lindahl Tradition 65
3.2. Majority Rule 66
4. PUBLIC FINANCE IN CONSTITUTIONAL PERSPECTIVE—ANALYSIS 67
4.1. Cost- share Determinacy 68
4.2. Cost- share Estimation — Margins versus Averages 69
4.3. Excess Burdens in Constitutional Perspective 70
4.4. Fiscal Illusion 72
4.5. Debt Financing 75
5. FISCAL CONSTITUTIONS—PROCESS 76
6. SUMMARY AND CONCLUSIONS 78
NOTES 79
REFERENCES 80
4 GROWTH IN THE REAL SIZE OF GOVERNMENT SINCE 1970* 83
1. INTRODUCTION 83
2. RECENT CHANGES IN THE SIZE OF GOVERNMENT 85
2.1. The Literature on Real Government Size 85
2.2. The Elasticity of Demand for Government Services and the Baumol Effect 86
2.3. The Income Effect and Wagner’s Law 87
2.4. Income Inequality between Mean and Median Voter 89
2.5. Other Factors Influencing Either the Demand and/or Supply of Government 91
2.6. Government Size within a Growth Equation 91
3. EVIDENCE FROM PANEL DATA ON TWENTY OECD COUNTRIES FROM 1970 TO 1997 92
3.1. Determinants of the Real Size of Government 92
3.2. The Effect of Public Sector Size on Growth 96
3.3. Simultaneity in the Growth of Government Size and Real Income 98
4. “QUIET SIDE” OF THE PUBLIC SECTOR: REGULATION AS SPENDING 102
5. CONCLUSION 105
DATA APPENDIX 106
NOTES 108
REFERENCES 110
5 RULES‚ POLITICS AND THE NORMATIVE ANALYSIS OF TAXATION 115
1. INTRODUCTION 115
2. BASIC ISSUES IN PUBLIC FINANCE 116
3. RULES OR NORMS IN RELATION TO THE BASIC ELEMENTS OF PUBLIC FINANCE 118
3.1. Outcome- oriented Rules 118
3.2. Process- oriented Rules 123
4. EVALUATION OF RULES OR NORMS 127
5. TAXATION, WELFARE ECONOMICS AND POLITICAL MARKET FAILURE 135
5.1. Three Steps to a More Comprehensive Analysis 135
5.2. Other Approaches to the Redefinition of Normative Analysis 137
6. CONCLUSION 138
NOTES 140
REFERENCES 141
6 TAXATION, PRODUCTION, AND REDISTRIBUTION 144
1. OPTIMAL TAXATION 146
2. REDUCING THE POLITICAL COSTS OF TAXATION 148
3. COMMODITY TAXES 149
4. INCOME TAXATION 151
5. THE BENEFIT PRINCIPLE 151
6. PRODUCTION 152
7. SELF-INTEREST AND PUBLIC PRODUCTION 153
8. PUBLIC PRODUCTION AND THE FISCAL CONSTITUTION 154
9. REDISTRIBUTION 155
10. THE POLITICS OF REDISTRIBUTION 156
11. REDISTRIBUTION AND THE FISCAL CONSTITUTION 158
12. THE POLITICAL MARKETPLACE 160
13. AGREEMENTS IN POLITICS AND IN MARKETS 161
14. COERCION 162
15. TAXATION, PRODUCTION, AND REDISTRIBUTION 163
NOTES 166
REFERENCES 167
7 PUBLIC REVENUE FROM LAND RENT 170
1. THE ECONOMICS OF RENT-BASED PUBLIC FINANCE 171
1.1. Land as a Factor of Production 171
1.2. The Capitalization of Externalities, Costs and Benefits 173
1.3. Speculation, the Margin of Production, and Land Use 175
1.4. The Marginal Analysis of Public Spending and Site Rentals 177
1.5. Free Trade and Land- value Taxation 179
1.6. Land Value Taxation in Practice 180
2. A BRIEF HISTORY OF RENT THEORISTS 181
2.1. Land Theorists prior to Henry George 181
2.2. Henry George 182
2.3. Land Theorists after Henry George 184
3. ECONOMIC EFFECTS AND ETHICAL CONSIDERATIONS 186
3.1. Excess Burdens 186
3.2. Urban Sprawl and Blight 186
3.3. Business Cycles 187
3.4. The Ethics of Taxation 188
4. TERRITORY, GOVERNANCE, AND PUBLIC CHOICES 189
4.1. Voting and Governance Structure 189
4.2. Public Choice and Transfer Seeking 190
4.3. Demand Revelation 192
5. CONTRACTUAL COMMUNITIES AND PUBLIC RENTS 193
6. CONCLUSION 193
REFERENCES 194
8 DEBT, MONEY, AND PUBLIC FINANCE 200
1. POSTWAR CONTROVERSY OVER THE BURDEN OF PUBLIC DEBT 202
2. AUTOCRACY AND THE PERSONALIZATION OF PUBLIC DEBT 206
3. DEMOCRACY AND THE INTERMEDIARY STATE 208
4. CONSENSUAL DEMOCRATIC DEBT 210
5. FACTIONAL DEMOCRATIC DEBT 212
6. MONEY, SEIGNIORAGE, AND PUBLIC DEBT 214
7. CONCLUDING REMARKS 217
NOTES 218
REFERENCES 218
9 REGULATION BY TAXATION* 221
1. INTRODUCTION 221
2. A THEORY OF REGULATORY TAXATION 222
2.1. Tax Relief as Regulation 225
2.2. Taxation in the Theory of Regulation 227
2.3. Summary 228
3. THE PIGOUVIAN DOCTRINE 228
3.1. Was Pigou Mugged by Reality? 229
3.2. Taxation for Revenue Only 230
3.3. Summary 231
4. AN EXAMINATION OF DATA 231
4.1. State Taxation of Alcoholic Beverages 231
4.2. A Focus on Differential Effects 233
4.3. Summary 234
4.4. Taxing Environmental Use in the OECD Countries 234
5. FINAL THOUGHTS 238
NOTES 239
REFERENCES 239
10 TAXATION, BLACK MARKETS, AND OTHER UNINTENDED CONSEQUENCES 241
1. INTRODUCTION 241
2. THE BASIC MODEL 243
3. TAX EVASION AND LABOR SUPPLY 246
4. TAX EVASION AND OCCUPATIONAL CHOICE 248
5. ENFORCEMENT 250
6. THE TAX COMPLIANCE GAME 254
7. PENALTY SETTING 257
8. MORAL PRINCIPLES AND SOCIAL FACTORS 259
9. KINKED INDIFFERENCE CURVES 262
10. OPTIMAL TAXATION 264
11. POLITICAL AND CONSTITUTIONAL IMPLICATIONS 266
12. EVASION OF INDIRECT TAXES 268
13. TAX AVOIDANCE 271
14. CONCLUSIONS 273
NOTES 274
REFERENCES 276
11 PUBLIC ENTERPRISE: RETROSPECTIVE REVIEW AND PROSPECTIVE THEORY 280
1. INTRODUCTION 280
2. WHAT IS PUBLIC ENTERPRISE? 281
3. NORMATIVE DISCUSSION OF PUBLIC ENTERPRISE 283
4. THE PROPERTY RIGHTS PARADIGM AND 287
EMPIRICAL STUDIES OF PUBLIC ENTERPRISE 287
5. PUBLIC CHOICE AND PUBLIC ENTERPRISE 290
6. RECENT DEVELOPMENTS RELATED TO PUBLIC ENTERPRISE 294
6.1. Quangos 294
6.2. Public Enterprise via Asset Seizure 296
7. SUMMARY 297
REFERENCES 297
12 PRIVATIZATION, NATIONALIZATION, AND ASPECTS OF TRANSITION 304
1. INTRODUCTION 304
2. NATIONALIZATION 305
2.1. Theoretical Justification 305
2.2. Nationalization in Practice 306
2.3. Form of Organization 309
3. PRIVATIZATION 311
3.1. Progress in Economic Theory 311
3.2. Reasons for Privatizing 314
3.3. Privatization of Governmental Functions 314
4. NATIONALIZATION—PRIVATIZATION CYCLES 316
4.1. The Cycle as a Political Process 317
4.2. The Chua Study 318
5. TRANSITION 320
6. CONCLUSION 322
REFERENCES 322
13 SOCIAL INSURANCE 326
1. DEFINITIONS AND HISTORY 326
1.1. Social Insurance, Social Security, and the Welfare State 326
1.2. Explanations for the emergence of social insurance systems: motives and functions 329
1.3. What experience shows: the views of natural scientists and historians 332
2. SOCIAL INSURANCE IN MODERN TIMES 338
2.1. The Growth Pattern and the Driving Forces behind it: The Public Choice View 338
2.2. A Comparative Study of Social Insurance Systems in OECD Member States: The Views of Political Scientists 348
2.3. Social insurance and the European Single Market 361
3. THE ECONOMIC EFFECTS OF SOCIAL INSURANCE: A GENERAL OVERVIEW 363
3.1. The Effects on Income Distribution and Economic Stability 363
3.2. Allocative effects: efficiency, labor market distortions, and capital market distortions 367
4. POPULATION AGING AND PROPOSALS FOR PENSION REFORM 372
5. CONCLUDING REMARKS 376
NOTES 377
REFERENCES 381
14 REDISTRIBUTION, POOR RELIEF, AND THE WELFARE STATE 387
1. UTILITARIAN JUSTIFICATIONS FOR WELFARE STATE REDISTRIBUTION 390
2. CONTRACTUAL ARGUMENTS FOR WELFARE STATE REDISTRIBUTION 396
2.1. Knowledge and State Competence 397
2.2. Incentive and State Competence 399
3. INTEREST GROUPS AND HORIZONTAL REDISTRIBUTION 400
REFERENCES 405
15 ECONOMIC ANALYSIS AND EFFICIENCY IN PUBLIC EXPENDITURE 408
1. INPUT AND OUTPUT CATEGORIES 411
2. ESTIMATING THE PRODUCTION FUNCTION 413
3. OPPORTUNITY COST ADJUSTMENTS 414
3.1. Taxation and Tariffs 414
3.2. Monopoly and Economies of Scale 415
3.3. Foreign Exchange 415
3.4. Unemployment, Labor and Wages 416
3.5. Intersectoral Interdependence 417
3.6. Regional unemployment 418
3.7. Summary 418
4. PRICING BENEFITS AND COSTS 419
4.1. Analogous Good Method 419
4.2. Intermediate Good Method 419
4.3. Cost Saving Method 420
4.4. Access Cost- Quantity Demanded Method 421
4.5. Rent and Hedonic Price Models 421
4.6. Contingent Valuation 422
4.7. Existence and Option Benefits 424
5. NON-MARGINAL PROJECTS 424
6. VALUATION OVER TIME 425
6.1. Differences Among Individuals 426
6.2. Cost of Capital Approach 426
6.3. Inter- generational Discounting 427
7. INVESTMENT CRITERIA 428
7.1. Net Present Value 428
7.2. Internal Rate of Return 428
7.3. Benefit- Cost Ratio 429
7.4. Criteria Comparisons 429
8. UNCERTAINTY 430
8.1. Expected Value and Expected Utility 430
9. SOCIAL WELFARE 432
10. CONCLUSION 435
NOTES 437
REFERENCES 438
16 LOCAL PUBLIC FINANCE 441
1. THE NORMATIVE THEORY OF LOCAL PUBLIC FINANCE 444
1.1. The Conceptual Point of View 444
1.2. Optimal City Size 445
1.3. Spillover Effects 448
1.4. Intergovernmental Grants 449
2. THE POSITIVE THEORY OF LOCAL GOVERNMENTS 450
2.1. The Tiebout Model 450
2.2. Critique of the Tiebout Model 454
2.3. Empirical Tests of Local Public Goods Models 462
3. THE CONSTITUTIONAL APPROACH TO LOCAL GOVERNMENT 464
3.1. Regulation of Destructive Competition among Local Governments 464
3.2. Regulation of Local Government Monopoly Power 466
4. CONCLUSION 468
NOTES 469
REFERENCES 471
17 FEDERALISM AND SUBSIDIARITY IN NATIONAL AND INTERNATIONAL CONTEXTS 477
1. A SHORT HISTORY OF FISCAL SOCIOLOGY 521
2. THE ECONOMIC APPROACH TO FEDERALISM 479
2.1. Why Federalism? 480
2.2. Which Federalism? Federalism and Subsidiarity 487
2.3. Conclusion of Section 2 494
3. FEDERATING A NATION: SUBSIDIARITY IN NATIONAL CONTEXT 495
3.1. Providing Public Goods through a Confederacy: The American Example 495
3.2. The Assignment of Prerogatives among Agents in the US Federation 499
3.3. Conclusion of Section 3 506
4. FEDERATING NATIONS: SUBSIDIARITY IN INTERNATIONAL CONTEXT 506
4.1. The Economics of an International Legal Order: The European example 507
4.2. The Assignment of Prerogatives in the European Constitutional Order 509
4.3. Conclusion of Section 4 515
5. CONCLUSION: FOUNDATIONAL CONCERNS 515
REFERENCES 516
18 FISCAL SOCIOLOGY: WHAT FOR? 521
1. A SHORT HISTORY OF FISCAL SOCIOLOGY 521
2. MAIN ISSUES 524
2.1. The Debate on the Crisis of the Tax State 524
2.2. Income Taxation 526
2.3. Applications and Issues 526
2.4. An Alphabet of Fiscal Sociology 528
3. FISCAL SOCIOLOGY AS A FIELD OF INSTRUCTION AND RESEARCH 536
3.1. Instruction 536
3.2. Research 537
4. CONCLUSION 538
NOTES 538
REFERENCES 540
INDEX 542

Chapter 6 TAXATION, PRODUCTION, AND REDISTRIBUTION (p. 139-140)

Randall G. Holcombe
Florida State University
holcombe@garnet.acns.fsu.edu

Abstract
In one sense the public choice revolution of the 20th century ocurred because economic and political analysis now routinely takes into account the incentives of political decision-makers, and recognizes that political decision-making can result in inefficiencies. In another sense, this public choice revolution is seriously incomplete, because while it has succeeded in producing a theory of government failure, it has not taken the next step to develop a framework for optimal public policy in light of the characteristics of collective decision-making. This chapter takes a step in that direction by sketching out optimal policies for taxation, production and redistribution, taking into account that these public policies are products of the political system. Public choice might be thought of as applying the tools of economics to analyze political decision-making. This chapter uses the results of public choice to redevelop the theory of public finance.

Keywords
Benefit principle, commodity taxes, income taxation, optimal taxation, public choice revolution

JEL classification: H00, H20

At the beginning of the 21 st century, few economists would take issue with the idea that to maximize the well-being of a nation’s citizens, market allocation of resources is superior to government planning.1 At the same time, most economists would also argue that some role for government is necessary in an economy to undertake those activities for which the market is not wellsuited. 2 Some of those activities might be fundamental requirements for the operation of a market economy. For example, market exchange is predicated on the clear definition and protection of property rights, and the protection of property rights is one of the roles that has traditionally been undertaken by government.3 Other government actions might be desirable if they could overcome problems that markets might have in allocating resources, such as may arise with externalities and public goods. The purpose of this chapter is not to debate the optimal role and scope of government, but rather to look at the methods by which economic analysis has dealt with those questions. The conventional method of public finance has been to identify problems that might arise in the market allocation of resources and then to determine some type of optimal policy that can be used to correct this problem. The typical analysis assumes that the government can costlessly identify and implement this optimal policy. One of the important insights of public choice, as Buchanan (1975) clearly explains, is that there may be inefficiencies in government allocation of resources too, and that methodologically, an analysis should treat public sector decision-makers in the same framework as private sector decision-makers. Government can fail to allocate resources efficiently for many reasons, ranging from having inadequate information to understand or solve the problem to being unable to implement or enforce the optimal solution. This chapter ignores many of these very real problems, and focuses solely on the problems that arise from the collective decision-making process.

The chapter unrealistically assumes that a benevolent dictator would be able to produce a government policy that would result in an optimal use of resources, in order to focus on the problems that arise solely as a result of having to decide on what policy to follow through democratic decision-making. For example, one might see that air pollution is caused by excessive use of an unpriced resource, which creates an externality. However, internalizing the externality might require more information than the government has regarding how much pollution is coming from various sources, and what regulations and/or pricing mechanisms would result in the optimal control of the externality. Even if the government could figure out the optimal course of action, it may not be able to force citizens to follow the optimal course of action it has calculated. These problems are assumed away, however, to focus on the problems that arise solely as a result of the government’s decision-making process. Public choice theory already has much to say about the inefficiencies of the collective decision-making process. The purpose of this chapter is to apply that body of public choice theory to the issues dealt with by standard public finance.

There is a well-established theory of optimal taxation, for example, but that theory does not take into account the fact that taxes are the product of a political decision-making process. This chapter looks at optimal taxation from a public choice perspective and concludes that an optimal tax system is significantly different if it is produced by a democratic decision-making process than if it is created by a benevolent dictator.