Public Finance in Democratic Process: Fiscal Institutions and Individual Choice

James M. Buchanan.
Buchanan, James M.
(1919- )
CEE
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Editor/Trans.
First Pub. Date
1967
Publisher/Edition
Indianapolis, IN: Liberty Fund, Inc.
Pub. Date
1999
Comments
Foreword by Geoffrey Brennan.

1. Knut Wicksell, Finanztheoretische Untersuchungen (Jena: Fischer, 1896).

2. James M. Buchanan, The Demand and Supply of Public Goods: A Defense and Restatement (Chicago: Rand-McNally, 1968), volume 5 in the series. Also see volume 15 in the series, Externalities and Public Expenditure Theory.

3. See, for example, James M. Buchanan, "Taxation in Fiscal Exchange," Journal of Public Economics 6 (1976): 17-29, in volume 14 in the series, Debt and Taxes.

4. Geoffrey Brennan and James M. Buchanan, The Power to Tax: Analytical Foundations of a Fiscal Constitution (New York: Cambridge University Press, 1980), volume 9 in the series. Also see volume 14 in the series, Debt and Taxes; James M. Buchanan, Public Finance in Democratic Process: Fiscal Institutions and Individual Choice (Chapel Hill: University of North Carolina Press, 1966).

Chapter 1

5. "The application of income to the payment of taxes is a particular case of the general law of the division of income." The recognition of this point was characterized as a major Italian contribution to the theory of public finance by Gino Borgatta in his summary preface to a volume of translations. (Gino Borgatta, "Prefazione," Nuova Collana di Economisti, Vol. IX, Finanza [Torino: Unione Tipografico Editrice Torinese, 1934], p. xxxi.)

Chapter 2

6. Paul A. Samuelson, "The Pure Theory of Public Expenditure," Review of Economics and Statistics, XXXVI (November, 1954), 387-89; "Diagrammatic Exposition of a Theory of Public Expenditure," Review of Economics and Statistics, XXXVII (November, 1955), 350-56.

7. Cf. R. A. Musgrave, The Theory of Public Finance (New York: McGraw-Hill, 1959).

8. This is noted, in a somewhat different way, by Burton A. Weisbrod in his article "Collective-Consumption Services of Individual-Consumption Goods," Quarterly Journal of Economics, LXXVIII (August, 1964), 471-77.

Chapter 3

9. This assumption means only that the marginal conditions are not directly utilized as allocative criteria for the fiscal process. To satisfy such conditions, different individuals must pay differing marginal tax-prices depending on their separate marginal evaluations of the good. It is difficult to conceive of any real-world taxing scheme that might lead to this solution.

10. The individual's behavior in reducing the tax base in response to this, or any other, institution as if the tax side is wholly independent from the spending side of the fiscal account is fully analogous, in fact is one aspect of, the "free rider" behavior that has been much discussed in the theory of public goods. This problem, generally, will be analyzed in Chapter 9.

11. For a discussion of professional estimating procedures, in the context of their importance for individual fiscal choice, see Charles J. Goetz, "Tax Preferences in a Collective Decision-Making Context" (Unpublished Ph.D. dissertation, Alderman Library, University of Virginia, 1964).

12. On some of these points, see my article "The Theory of Monopolistic Quantity Discounts," Review of Economic Studies, XX (1952-53), 199-208.

Chapter 4

13. Evsey D. Domar and Richard A. Musgrave, "Proportional Income Taxation and Risk-Taking," Quarterly Journal of Economics, LVIII (May, 1944). Reprinted in Readings in the Economics of Taxation, ed. R. A. Musgrave and C. Shoup (Homewood: Richard D. Irwin, 1959), pp. 493-524.

14. For a general discussion along these lines, see my "Externality in Tax Response," Southern Economic Journal, XXIII (July, 1966), 35-42.

Chapter 5

15. The element of behavior here is closely related, but not fully equivalent, to that discussed by Kenneth Boulding in his homostatic theory of the firm. See Kenneth Boulding, A Reconstruction of Economics (New York: John Wiley and Sons, 1950), especially Chapter 2.

16. This conception of subjective opportunity costs, as distinct from objectively measurable opportunity costs, has not been properly incorporated in the standard "kit of tools" possessed by economists, despite the efforts of a group connected with the London School of Economics. For some of the more general discussion, see L. Robbins, "Remarks upon Certain Aspects of the Theory of Costs," Economic Journal, XLIV (March, 1934), 1-18; J. Wiseman, "Uncertainty, Costs, and Collectivist Economic Planning," Economica, XX (May, 1953), 118-28; G. F. Thirlby, "The Subjective Theory of Value and 'Accounting' Cost," Economica, XIII (February, 1946), 32-49; "The Rule," South African Journal of Economics, 14 (December, 1946), 253-76; "The Economist's Description of Business Behavior," Economica, XIX (May, 1952), 148-67; "Economists' Cost Rules and Equilibrium Theory," Economica, XXVII (May, 1960), 148-57.

17. This is explicitly recognized by Walter Heller in "CED's Stabilizing Budget Policy After Ten Years," American Economic Review, XLVII (September, 1957), 649.

18. A. T. Peacock and Jack Wiseman, The Growth of Public Expenditure in the United Kingdom (National Bureau of Economic Research, 1961).

Chapter 6

* Although it is developed somewhat differently, the basic theoretical model presented in this chapter is contained in my paper, "The Economics of Earmarked Taxes," Journal of Political Economy, LXXI (October, 1963), 457-69, circulated also as No. 73, Studies of Government Finance Reprints, Brookings Institution, 1963.

19. A recent survey by the Tax Foundation indicates that, in fiscal 1963, approximately 41 per cent of state tax collections were dedicated to specific functions. See Earmarked State Taxes (New York: Tax Foundation, 1965).

20. The analysis here, as elsewhere in the study, retains the reference system of the individual as voter-taxpayer-beneficiary. If the reference system is changed to that of the budgetary authority empowered to determine the component mix and if this entity is considered as a "person," then earmarking is not analogous to the market situation. The private person does not normally tie up particular sources of his own income for spending on particular items of consumption. This illustrates the dramatic difference in analysis generated by a change in the reference system from that of the budgetary authority to that of the individual as voter-taxpayer. The near-universal condemnation of earmarking in the literature of budgetary theory can only be explained in terms of this difference.

21. For recent statements of the theory of tie-in sales, see M. L. Burstein, "The Economics of Tie-In Sales," Review of Economics and Statistics, XLII (February, 1960), 68-73; "A Theory of Full-Line Forcing," Northwestern University Law Review, LV (1960), 62-95. See also Ward S. Bowman, Jr., "Tying Arrangements and the Leverage Problem," Yale Law Journal, LXVII (March, 1957), 19-36.

22. The geometrical construction in Figure 6.1 is based on a specific numerical model that is explained in the Appendix to this Chapter.

23. The difference between actual and imputed outlay can be demonstrated on Figure 6.1 by the difference between the position of tie-in equilibrium and the corresponding points on the respective demand curves. Only at full equilibrium will this difference disappear.

24. The rising portion of the Ip curve at the left of Figure 6.2 requires some explanation. As the budgetary mix shifts in favor of police services, imputed expenditures on both services fall, as shown. However, as a smaller and smaller share of the budget is allotted to fire protection, the degree of exploitation that consumers of police services can attain reaches some maximum. Beyond this point, the "relative tax-price reduction" that the tie-in involves is progressively diminished.

The derivation of the construction is clarified in the numerical example upon which the figures are based, which is presented in the Appendix. It should be emphasized, however, that the general results do not depend on the particulars of the example or on the shapes of the curves derived therefrom.

25. This conclusion is, in general, consistent with the conclusions of Burstein with respect to the tie-in sales of the monopolist. As he suggests, the monopolist, selling a product that is necessarily price elastic, will seek to tie in the sales of an inelastic-demand product. The monopolist can, of course, control the relevant ratio. Cf. Burstein, "The Economics of Tie-In Sales," Review of Economics and Statistics.

The analysis of general-fund financing, developed here, is simpler than the comparable analysis of monopolistic tie-in sales. In our model, the unit cost of supplying services, either jointly or separately, is always equal to the tax-price charged to "purchasers." The government does not seek to make profits. With the monopolist, the difference between unit cost and price is a central variable that the fiscal model need not include.

Chapter 7

26. This point has been stressed effectively by Earl Rolph. See The Theory of Fiscal Economics (Berkeley: University of California Press, 1954).

27. If both taxes and benefits are general throughout the community, simple majority decision rules will not distort the outcomes. However, if one side or the other should be differentially general, distortion is introduced. If benefits are specific to particular subgroups in the community, while taxes are general over the whole community, there will be a tendency to expand spending beyond "optimal" levels. The supporting analysis for this conclusion is developed in James M. Buchanan and Gordon Tullock, The Calculus of Consent (Ann Arbor: University of Michigan Press, 1962).

28. For effective criticism, see Charles J. Hitch and Roland N. McKean, The Economics of Defense in the Nuclear Age (Cambridge: Harvard University Press, 1960), pp. 46-49.

Chapter 8

29. Resources devoted to public spending must, of course, come from somewhere in the aggregate economy. If debt is issued, however, those persons who give up command of purchasing power do so in an ordinary voluntary exchange process and in no way can be said to "pay for" the benefits of the public services provided. On all this, see my book Public Principles of Public Debt (Homewood: Richard D. Irwin, 1958), and, for more recent discussion, see James M. Ferguson (ed.), Public Debt and Future Generations (Chapel Hill: The University of North Carolina Press, 1964).

30. For an early statement, see A. P. Lerner, The Economics of Control (New York: Macmillan & Co., 1944).

It is not sensible to finance deficits in such situations by the issue of interest-bearing debt. This does impose a real cost, in terms of discounted values of future taxes, a cost that is wholly unnecessary given the existence of unemployed resources to the extent assumed. The fact that the interest costs in such periods may be low does not alter the basic argument. Debt issue here can be defended only by some argument about the efficacy of rules against currency creation.

Chapter 9

31. See Paul A. Samuelson, "The Pure Theory of Public Expenditure," Review of Economics and Statistics, XXVI (November, 1954), 387-89; "Diagrammatic Exposition of a Pure Theory of Public Expenditures," XXXVII (November, 1955), 350-55. R. A. Musgrave, The Theory of Public Finance (New York: McGraw-Hill, 1959), especially Chapters 4 and 6.

For works that are specifically concentrated on the "free rider" problem, see Otto A. Davis and Andrew Whinston, "Some Foundations of Public Expenditure Theory" (Mimeographed manuscript, Carnegie Institute of Technology, November, 1961), and Mancur Olson, Jr., The Logic of Collective Action (Cambridge: Harvard University Press, 1965).

An early and important recognition of the problem is found in Knut Wicksell, Finanztheoretische Untersuchungen (Jena: Gustav Fischer, 1896).

For an application to ethics, see my "Ethical Rules, Expected Values, and Large Numbers," Ethics, LXXVI (October, 1965), 1-13.

32. Knut Wicksell, Finanztheoretische Untersuchungen. The important portions of this work are translated as "A New Principle of Just Taxation," in Classics in the Theory of Public Finance, ed. R. A. Musgrave and A. T. Peacock (London: Macmillan, 1958), pp. 72-118.

33. See James M. Buchanan and Gordon Tullock, The Calculus of Consent (Ann Arbor: University of Michigan Press, 1962).

34. Anthony Downs has discussed the problem of rational abstention from voting, although not in precisely the same context as that developed here. See Downs, An Economic Theory of Democracy (New York: Harper, 1957), especially Chapter 14.

35. This point has been made with specific reference to the "free rider" problem by Davis and Whinston, "Some Foundations of Public Expenditure Theory." My own discussion of abstention is based on an extension of the Davis-Whinston argument. A related argument, in the form of a criticism of Arrow's discussion of the general impossibility theorem, has been advanced by James S. Coleman. See Coleman, "The Possibility of a Social Welfare Function" (Mimeographed, Johns Hopkins University, November, 1964).

Chapter 10

36. Behavior under illusion is most familiar to economists through the "money illusion." Individuals are presumed to choose on the basis of money values rather than real values; the reactions of labor unions in refusing money wage cuts while acquiescing in real wage cuts generated through price inflation are cited as evidence. Whether or not this actually does reflect behavior under illusion need not concern us here.

37. In one sense, behavior under illusion is "nonlogical," as distinct from "logical" or "rational" or "irrational." The term here is Pareto's, and his attribution of this characteristic to individual behavior in the fiscal process is worth citing. In a letter written to Sensini, Pareto said:

"You do well to concern yourself with the science of finance. In that field, there is everything to do. They call it a science, and it is not even an art. It is necessary to tackle the problem from two sides. One is that of pure science, that which you mention to me. The other is that of synthesis; the study of concrete phenomena, discovering whether or not there exist uniformities which can become a pure science. Don't be in a hurry. If you want, write some monographs; but for the general scientific aspects wait until your studies have well matured. The principal difficulty is that you must construct a completely new edifice.

"Emphasize that the taxpayer, who is considering to be aiming at maximizing ophelimity, gives you only one part, often very small, of the phenomena. The taxpayer does not know the many effects of taxes, or, more generally and better, of the many financial transactions; therefore his actions are not of the nature of logical action, such as occupies political economy, and for which the theory is less difficult. But they are of the nature of nonlogical action, for which the theory is much more difficult" (translation mine). G. Sensini, Corrispondenza di Vilfredo Pareto (Padua, 1948), cited in Mauro Fasiani, "Contributi di Pareto alla scienza delle finanze," Giornale degli economisti (1949), p. 156.

Note that Pareto does not rule out the application of theory to the nonlogical behavior that characterizes behavior in fiscal process.

38. For an excellent account of the importance of illusion in art, and one that is interesting to the nonspecialist, see E. H. Gombrich, Art and Illusion (London: Phaidon Press, 1960).

39. Puviani's two basic books are: Teoria della illusione nelle entrate pubbliche (Perugia, 1897), and the expanded version, Teoria della illusione finanziaria (Palermo, 1903). The content of these works is cited and discussed at length in Mauro Fasiani, Principii di scienza felle finanze, Vol. I (2nd ed.; Torino, 1951). A first edition of this work was published in 1941.

40. Amilcare Puviani, Die Illusionen in der öffentlichen Finanzwirtschaft. With an Introduction by Professor G. Schmölders (Berlin, 1960).

41. See my Fiscal Theory and Political Economy (Chapel Hill: The University of North Carolina Press, 1960), pp. 59-64.

42. This translation is being undertaken under the supervision of Charles Goetz, University of Illinois.

43. The summary presented in this section is based on two sources: Puviani, Teoria della illusione nelle entrate pubbliche; and Fasiani, Principii di scienza felle finanze, Chapter III.

44. I have discussed the issues here at some length in a paper, "Public Debt, Cost Theory, and the Fiscal Illusion," which is included in Public Debt and Future Generations, ed. James M. Ferguson (Chapel Hill: The University of North Carolina Press, 1964).

45. For a discussion which reaches somewhat different conclusions, see Francesco Forte, "Osservazioni sul metodo della trattenuta alla sorgente nelle imposte sul reddito," published in Studi in onore di Gaetano Zingali (Milano: Giuffre, 1965), pp. 209-30.

46. If confronted with increasing marginal price over quantity, choice is distorted in the direction of causing the person to choose less than his own optimally preferred quantity. The effect is the opposite of that resulting from adjustment under quantity discounting.

47. It is worth noting that the academic specialists on insurance have recently established a Committee on Social Insurance Terminology and that this committee has discussed at some length the appropriateness of using the term "insurance" to apply to Federal security programs. The argument has been, however, largely definitional, and the effects of using or not using the term seem to have been neglected. See C. Arthur Williams, Jr., "Social Insurance—Proper Terminology," The Journal of Insurance, XXX (March, 1963), 112-28.

Chapter 11

48. The construction and the use of single-peaked preference schedules is based on the work of Duncan Black. See Black, The Theory of Committees and Elections (Cambridge: Cambridge University Press, 1958).

49. For an analysis similar to that of this chapter which places somewhat more emphasis on such efficiency aspects, see my paper "Fiscal Institutions and Efficiency in Collective Outlay," American Economic Review, LIV (May, 1964), 227-35; and, also, see the Appendix to this Chapter where the equal-preference model is examined in further detail.

50. For a discussion of nonlinear "budget lines" of this nature, see R. A. Musgrave, The Theory of Public Finance (New York: McGraw-Hill, 1959), p. 122. Note that Musgrave's figure is similar to the constructions introduced here, but that he uses this for a somewhat different purpose.

Chapter 12

51. In such situations, the need for "theorizing" becomes all the more important.

"We are putting the cart before the horse when we think that a science of politics must be different from other sciences because political behavior is random and haphazard. It is not because political behavior is random and haphazard that we do not have much objective knowledge about it. It is because we do not have much objective knowledge about it that it seems random and haphazard" (Charles Frankel, The Case for Modern Man [New York: Harper & Bros., 1956], p. 132).

52. See Julius Margolis, "Metropolitan Finance Problems: Territories, Functions, and Growth," in Public Finances: Needs, Sources, and Utilization (National Bureau of Economic Research, 1961), especially pages 261-66.

Chapter 13

53. See, for example, the important paper by George Stigler, "The Economics of Information," Journal of Political Economy, LXIX (June, 1961), 213-25.

54. The results of Norbert L. Enrick's studies are reported in Enrick, "A Pilot Study of Income Tax Consciousness," National Tax Journal, XVI (June, 1963), 169-73, and in "A Further Study of Income Tax Consciousness," National Tax Journal, XVII (September, 1964), 319-21.

55. Wagstaff's study was completed in the form of an unpublished dissertation at the University of Virginia (as was Enrick's initial study). See J. V. Wagstaff, "Tax Consciousness Under Withholding," on file at the Alderman Library, University of Virginia. The results are summarized in J. V. Wagstaff, "Income Tax Consciousness Under Withholding," Southern Economic Journal, XXXII (July, 1965), 73-80.

56. G. Schmölders, "Fiscal Psychology: A New Branch of Public Finance," National Tax Journal, XII (December, 1959), 340-45.

57. Schmölders' survey was conducted in 1958, and it involved interviews with 1986 persons, selected on a quota sampling basis. The particular question reported here is only one of a large set asked of respondents. For a report on the project, see Günter Schmölders, Das Irrationale in der öffentlichen Finanzwirtschaft (Hamburg: Rowohlt, 1960), with special reference to the part mentioned on pages 84-86. The methods and procedures of the survey, along with more extensive results, are reported in Steuern und Staatsausgaben in der öffentlichen Meinung der Bundesrepublik (Köln: Westdeutscher Verlag, 1960).

58. These results are reported in Bruce L. Gensemer, Jane A. Lean, and William B. Neenan, "Awareness of Marginal Income Tax Rates Among High-Income Taxpayers," National Tax Journal, XVIII (September, 1965), 258-67.

59. These results are reported in Günter Schmölders, "Unmerkliche Steuern," Finanzarchiv, Band 20 (1959), 23-34.

60. Robert Ferber, "How Aware Are Consumers of Excise Tax Changes?" National Tax Journal, VII (December, 1954), 355-58.

61. Choice in Welfare, 1965. Institute of Economic Affairs (London: October, 1965), pp. 30-33.

62. An analysis of predicted outcomes under various institutional schemes for financing and operating educational systems is contained in W. Craig Stubblebine, "Institutional Elements in the Financing of Education," in Education and the Southern Economy, Supplement to Southern Economic Journal, XXXII (July, 1965), 15-34. Stubblebine does not, however, claim to examine empirical evidence to test his hypotheses.

63. Choice in Welfare, Institute of Economic Affairs (London: July, 1963). The results of this survey are discussed in Ralph Harris and Arthur Seldon, "Welfare and Choice," The New Society (No. 43), 25 July 1963, pp. 14-16. Also, Choice in Welfare, 1965.

64. Günter Schmölders, Das Irrationale in der öffentlichen Finanzwirtschaft.

65. See Elizabeth Jane Likert David, "Public Preferences and the Tax Structure: An Examination of Factors Related to State and Local Tax Preferences" (University of Michigan Microfilm, 1961).

66. See Eva Mueller, "Public Attitudes Toward Fiscal Programs," Quarterly Journal of Economics, LXXVII (May, 1963), 210-35.

67. See James Q. Wilson and Edward C. Banfield, "Voting Behavior on Municipal Public Expenditures," in The Public Economy of Urban Communities, ed. J. Margolis (Resources for the Future, 1965), pp. 74-91. Essentially the same results are reported in James Q. Wilson and Edward C. Banfield, "Public-Regardingness as a Value Premise in Voting Behavior," American Political Science Review, LVIII (December, 1964), 876-87.

68. It is plausible to suggest that the Wilson-Banfield results, along with the Mueller attitudes, can be illustrated by the configuration presented in Figure 11.9 in the Appendix to Chapter 11.

69. W. Irwin Gillespie, "The Effect of Public Expenditures on the Distribution of Income," in Essays in Fiscal Federalism, ed. R. A. Musgrave (Washington: Brookings Institution, 1965), pp. 122-86.

70. See Otto A. Davis, "Empirical Evidence of Political Influences upon the Expenditure Policies of Public Schools," in The Public Economy of Urban Communities, ed. J. Margolis (Resources for the Future, 1965), pp. 92-111.

71. James L. Barr and Otto A. Davis, "A Political and Economic Theory of the Expenditures of Local Governments" (Mimeographed, Carnegie Institute of Technology, 1965).

72. Choice in Welfare, 1963, Table XII.

73. Choice in Welfare, 1965, Tables XXI, XXIV, XXVII.

74. See John Joseph Reid, "The Veterans' Bonuses: An Analysis of a Collective Decision" (Unpublished Ph.D. dissertation, Alderman Library, University of Virginia, 1961).

75. See William C. Birdsall, "Public Finance Allocation Decisions and the Preferences of Citizens: Some Theoretical and Empirical Considerations" (Unpublished Ph.D. dissertation, Johns Hopkins University Library, 1963).

76. See James M. Buchanan and Gordon Tullock, The Calculus of Consent (Ann Arbor: University of Michigan Press, 1962).

77. See John Robert Cooper, "Institutional Factors Affecting the Outcomes of School-Bond Referenda." Upon final completion, anticipated for 1966, this study will be presented as a Ph.D. dissertation at the University of Virginia.

Chapter 14

78. The most complete attempt to work out such a model is contained in Charles J. Goetz, "Tax Preferences in a Collective Decision-Making Context" (Unpublished Ph.D. dissertation, Alderman Library, University of Virginia, 1964). Portions of this work are contained in Charles J. Goetz, "A Variable-Tax Model of Intersectoral Allocation," Public Finance, XIX (February, 1964), 29-43.

79. The problem as posed here with reference to the choice among fiscal institutions is methodologically equivalent to the problem of choosing constitutionally among alternative rules or institutions for reaching collective decisions. Cf. James M. Buchanan and Gordon Tullock, The Calculus of Consent (Ann Arbor: University of Michigan Press, 1962).

80. See my Fiscal Theory and Political Economy (Chapel Hill: The University of North Carolina Press, 1960), pp. 15-17.

Chapter 15

** The central argument of this chapter was first presented in early 1964 in seminars and lectures at the University of Florida, University of California (Davis and Los Angeles), and Oklahoma State University.

81. Henry Simons, Personal Income Taxation (Chicago: University of Chicago Press, 1938).

82. Paul A. Samuelson, "The Pure Theory of Public Expenditure," Review of Economics and Statistics, XXXVI (November, 1954), 387-89.

83. Richard A. Musgrave, The Theory of Public Finance (New York: McGraw-Hill, 1959).

Chapter 16

† The analysis contained in this chapter was developed jointly with Professor Francesco Forte of Turin, Italy, in the spring of 1962, and the argument was first presented that year in a seminar at the University of Exeter, England. The analysis, in a somewhat different form, provides the basis for the paper, written jointly with Forte, "Fiscal Choice Through Time: A Case for Indirect Taxation?" National Tax Journal, XVII (September, 1964), 144-57, and circulated as No. 81, Studies of Government Finance Reprints, Brookings Institution, 1964. I am, of course, indebted to Professor Forte for his assistance in developing the argument, along with any other spillover effects this assistance might have had on other parts of this study.

84. E. Barone, "Studi di economia finanziaria," Giornale degli economisti (1912), II, 329-30, in notes.

85. I. M. D. Little, "Direct Versus Indirect Taxes," Economic Journal, LXI (1951), 577-84.

86. Milton Friedman, "The 'Welfare' Aspects of an Income Tax and an Excise Tax," Journal of Political Economy, LX (1952), 25-33, reprinted in Essays in Positive Economics (Chicago: University of Chicago Press, 1953), pp. 100-16.

87. Earl R. Rolph and George Break, "The Welfare Aspects of Excise Taxes," Journal of Political Economy, LVII (1949), 46-54.

88. For a summary discussion that contains references to the other works, see M. J. Farrell, "New Theories of the Consumption Function," Economic Journal, LXIX (1959), 678-96.

89. For each time period, the standard necessary conditions hold. One of these is,
(1) equation, for any two goods, i and j, equation, i not equal to j, in the set i, j = 1, 2,..., m.
Over the determined life cycle, individuals act so as to satisfy (1) in each period. If we assume that the price ratios are constant over time, necessary conditions for multiperiod "equilibrium," at the moment of planning, t0, become,
(2) equation
where the subscripts outside the parentheses refer to the time periods, t0 to tn. No explicit discounting factor need be introduced in (2) since, by assumption, prices are not paid until consumption takes place. Hence, for periods later than t0, marginal utilities and prices are discounted by a common factor. Note particularly that the satisfaction of (2) does not require that "tastes" remain constant over time. The equalization of the marginal rates of substitution can be achieved by widely differing "mixes" of the two items.

If we assume that the individual has no control over the income that he earns, and, further, that income payments are lagged by one period, the over-all income constraint becomes,
(3) equation left side of sum
equation right side of sum
where equation measures initially held assets, and p, q, and r measure the prices, quantities, and rate of discount, respectively. If the individual is allowed to vary his earnings (income) over time (3) is not, of course, the relevant constraint, and it must be replaced by a set of production constraints. The fundamentals of the analysis do not, however, require this generalization. Hence, in the discussion that follows in the text, the individual is presumed to act as if his stream of income receipts is determined exogenously to his own behavior.

90. We are concerned here only with the individual's calculus at t0. The fact that, when t1 arrives, he may have a different set of "optimal" plans need not concern us. On this latter point, see Robert H. Strotz, "Myopia and Inconsistency in Dynamic Utility Maximization," Review of Economic Studies, XXIII (1956), 165-80.

91. Care should be taken to distinguish postponable items of residual consumption from durable consumer goods. The durable goods-nondurable goods distinction need not concern us here, and we have assumed that all services are purchased as they are actually used. A postponable service is characterized by some nonrecurrence of "need" over time.

92. The relationship between the analysis here and the traditional "double taxation of saving" argument should be explained. This latter argument, as developed by J. S. Mill, Irving Fisher, Luigi Einaudi, and others, supports the imposition of a general expenditure tax in lieu of a general income tax on efficiency criteria, holding that any income tax tends to discriminate against income that is saved. This argument assumes meaning, however, only when the distribution of the tax load among separate persons is introduced. It is not relevant here since the analysis is limited, specifically, to the calculus of a single potential taxpayer who is placed in the position of choosing among several instruments of payment. In the life-cycle pattern of saving behavior postulated, the present value of future spending must equal the present value of income receipts. If the individual is taxed on income received in each period, including income earned as a return on saving from previous periods, the rate of tax would tend to be somewhat lower than that rate which would be required to produce an equivalent present-value tax liability under some general expenditure tax.

93. The general expenditure tax is assumed here to impose a pattern of final incidence among individuals in relation to spending. This is not the place to introduce complex issues of incidence theory. However, it may be noted that, even should the final incidence of the tax not be in this pattern, the analysis traced above will hold so long as, when he considers the alternatives, the individual thinks that the incidence will be proportionate to spending.

Chapter 17

94. For several years this result has been discussed among economists at the University of Virginia as "Tullock's fallacy," since it owes its local origin to my colleague, Gordon Tullock. In a recently published paper, E. J. Mishan has indirectly noted the same point. See his "How to Make a Burden of the Public Debt," Journal of Political Economy, LXXI (1963), 529-42, especially note 5. The point is, of course, implicit in the traditional Ricardian notion that the public loan and the extraordinary tax are fundamentally equivalent for the individual, since this argument assumes that the individual is able both to borrow and to lend at the government borrowing rate.

95. The analysis of de Viti de Marco, although itself incomplete, is suggestive of the approach to debt theory developed in this section. See Antonio de Viti de Marco, First Principles of Public Finance, trans. E. P. Marget (New York: Harcourt-Brace, 1935), pp. 377-98.

96. This is not the place to repeat the analysis that demonstrates that public debt does, in fact, involve a postponing or shifting forward in time of fiscal liability. On this, see my Public Principles of Public Debt (Homewood: Richard D. Irwin, 1958). The discussion among scholars on this subject since 1958 is collected in James M. Ferguson (ed.), Public Debt and Future Generations (Chapel Hill: The University of North Carolina Press, 1964).

Chapter 18

97. Institutional rigidities in the economy may, of course, prevent the maintenance of both full employment and price-level stability along this growth path. Resolution of this conflict need not be discussed here. If inflation threatens, the policy institutions suggested are, of course, the reverse of those discussed.

98. The alternative institutional structure that might be designed to accomplish equivalent objectives is that one which allows strict adherence to in-period budget-balance, in the sense traditionally defined, and which then allows some governmentally created "monetary authority" to engage in "monetary policy." During periods of depressed community income, this authority would purchase, with new money, securities held by the public.

Careful examination reveals that this alternative structure is only superficially different from the first. Since the monetary authority must be a part of the government, its own "budget" should properly be conceived as a part of the government's budget. When this is accepted, the "monetary policy" differs from the "fiscal policy" alternative only in the fact that with the former, new money is used to purchase securities only, while in the latter, the new money is used to finance public-goods supply. Viewed in this light, the fiscal policy alternative seems relatively more efficient. Other considerations may, of course, modify this tentative conclusion. Notable among these might be some consideration for the burden of outstanding public debt. The monetary policy alternative allows for some retirement qua monetization of this debt over time whereas the fiscal policy alternative does not.

99. Although the list is by no means exhaustive, the following items may be noted: A. H. Hansen and H. Perloff, State and Local Finance in the National Economy (New York: Norton, 1944), especially Chapter 4; Mabel Newcomer, "State and Local Financing in Relation to Economic Fluctuations," National Tax Journal, VII (June, 1954), 97-109; Ansel M. Sharp, "The Counter-Cyclical Fiscal Role of State Governments During the Thirties," National Tax Journal, XI (June, 1958), 138-45; James A. Maxwell, "Counter-Cyclical Role of State and Local Governments," National Tax Journal, XI (November, 1958), 371-76; Morton A. Baratz and Helen T. Farr, "Is Municipal Finance Fiscally Perverse?" National Tax Journal, XII (September, 1959), 276-84.

100. This question is raised and discussed by Clarence Barber in his monograph "The Theory of Fiscal Policy as Applied to a Province," A Study Prepared for the Ontario Committee on Taxation (June, 1964), especially in Chapter 2. I am grateful to the Committee for allowing me to have access to this study. Barber's work stimulated my own interest in elaborating some of the models of this chapter, and appropriate acknowledgment should be made of this fact.

101. This has been recognized in a slightly different connection by Ronald I. McKinnon and Wallace E. Oates, "The Implications of International Economic Integration for Domestic Monetary, Fiscal, and Exchange Rate Policies," Memorandum No. 37, Research Center in Economic Growth, Stanford University (May, 1965).

102. The models discussed are essentially the same as those examined by R. A. Mundell in his provocative paper, "Capital Mobility and Stabilization Policy Under Fixed and Flexible Exchange Rates," Canadian Journal of Economics and Political Science, XXIX (November, 1963), 475-95. See also the paper by McKinnon and Oates previously cited.

103. As noted, this analysis follows closely that presented by Mundell, "Capital Mobility," Canadian Journal of Economics and Political Science. He concludes that fiscal policy tends to be self-defeating in conditions of flexible exchange rates, and that monetary policy tends to be self-defeating under conditions of fixed rates. In effect, Mundell examines only alternatives II and III under each model, and he considers that fiscal policy must embody debt-financed deficits. As the analysis here indicates, if the first alternative is available, that of financing deficits with new money creation, this may be the most efficient policy combination under either fixed or flexible exchange rates.

Chapter 19

104. The "classic" modern works in this theory are those of Paul A. Samuelson and R. A. Musgrave. See Samuelson, "The Pure Theory of Public Expenditure," Review of Economics and Statistics, XXXVI (November, 1954), 387-89; "Diagrammatic Exposition of a Theory of Public Expenditure," Review of Economics and Statistics, XXXVII (November, 1955), 350-55; and Musgrave, The Theory of Public Finance (New York: McGraw-Hill, 1959).

105. Wicksell's basic work is Finanztheoretische Untersuchungen (Jena: Gustav Fischer, 1896). The major portions of this work are translated as "A New Principle of Just Taxation," in Classics in the Theory of Public Finance, ed. R. A. Musgrave and A. T. Peacock (London: Macmillan, 1958), pp. 72-118.

106. Specifically, the reference here is to the concept of justice that is advanced in several recent papers by John Rawls. See Rawls, "Justice as Fairness," Philosophical Review, LXVII (April, 1958), 164-94; "Constitutional Liberty and the Concept of Justice," Nomos VI, ed. C. Friedrich and J. Chapman (New York: Atherton Press, 1963); and, somewhat earlier, "Two Concepts of Rules," Philosophical Review, LXIV (January, 1955), 3-32.

107. R. A. Musgrave, The Theory of Public Finance.

108. The problem of redistribution in the setting proposed here has been discussed in somewhat more detail in James M. Buchanan and Gordon Tullock, The Calculus of Consent (Ann Arbor: University of Michigan Press, 1962), especially Chapter 13.

109. Cf. E. Rignano, The Social Significance of the Inheritance Tax, trans. W. J. Shultz (New York: Alfred A. Knopf, 1924).

End of Notes

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