The Demand and Supply of Public Goods
By James M. Buchanan
First Pub. Date
Indianapolis, IN: Liberty Fund, Inc.
First published in 1968 by Rand McNally & Company. Foreword by Geoffrey Brennan.
The text of this edition is copyright ©: 1999 Liberty Fund, Inc. Picture of James M. Buchanan: File photo detail, courtesy Liberty Fund, Inc. James M. Buchanan, Charlottesville, Virginia, 1964.
- Ch. 1, A Methodological Introduction
- Ch. 2, Simple Exchange in a World of Equals
- Ch. 3, Simple Exchange in a World of Unequals
- Ch. 4, Pure and Impure Public Goods
- Ch. 5, Many Private Goods, Many Persons
- Ch. 7, The Publicness of Political Decisions
- Ch. 8, The Institutions of Fiscal Choice
- Ch. 9, Which Goods Should Be Public
- Ch. 10, Toward a Positive Theory of Public Finance
- Supplementary Reading Materials
The Institutions of Fiscal Choice
The analytical models introduced in earlier chapters of this book are skeletons, as all useful analytical models must be. They are designed to isolate important relationships in any theory of the demand and supply of public goods. Such a theory must be supplemented with the data of experience before any genuine understanding of fiscal process can be achieved. This filling in, this discussion of the historical-institutional record, is a task for scholars whose competence differs from my own. Although this book is limited to the models of analysis, one aspect of the theory itself remains to be discussed. In keeping with the metaphor above, the ossification of the skeletons must be examined. Are there logical derivations or analytical reasons for the built-in rigidities in the institutions of fiscal choice? The theory of the demand and supply of public goods must be supplemented by a
theory of fiscal institutions before our task is finished. Public goods are demanded and supplied through processes that are themselves selected at some stage and apparently for reason. We need to understand something of the logic of institutional choice even if we cannot discuss this in great detail.
The distinction between the theory of institutions, to be examined, and the theory of demand and supply, previously examined, is one that may not seem automatically relevant to economists. Familiar analogies drawn from everyday experience in private life may prove helpful, although, as with all analogies, they will also be misleading in parts. Consider a man whose apartment is located one block from a corner newsstand. His early morning time schedule is such that on some mornings, unpredictable as to dates, he has adequate time to read the morning newspaper with his breakfast. On other mornings he must rush to work without time for even so much as a headline glance. He may, on mornings when his time is not so scarce, walk down to the newsstand and purchase the paper. Or, alternatively, he may choose to have a paper delivered to his apartment every morning, even though he recognizes that on many mornings this paper will go unread. The standard theory of the demand for morning newspapers helps us to understand the behavior of this man generally as he decides whether or not to purchase newspapers. This theory needs to be supplemented, however, by a “theory of institutions” in order to help us understand his behavior in deliberately
institutionalizing his choice, even though he recognizes that, in specific instances, the results will be inefficient.
This initial overly simplified analogy may be replaced by a still-familiar but more complex one. Consider a community decision to install a set of traffic signals. It is surely obvious to the decision makers that on many occasions, when traffic flows are light, unnecessary delays to motorists will result. Presumably, the installation is made because these inefficiencies are predicted to be more than balanced by efficiency gains when traffic flows are heavy. The working of the institution over a whole sequence of situations must be considered, and, even here, the uniform application of an institution must be justified on cost-reducing grounds. If traffic regulation is relatively costless, the efficient scheme is to have a
different institution during each period of traffic flow. A traffic patrolman can be stationed at the intersection during certain hours of the day. The fact that signals are installed which apply to all periods must suggest that, over the whole range of situations, this is a more efficient means of regulating traffic than the available alternatives.
Institutional choice must be made on the basis of some comparison of costs and benefits over the whole sequence of expected events or periods.
The Recurrence of Choice
As the analogies suggest, the possible need to create institutions that will “make choices in advance” arises only when it is predicted that similar choice situations will be confronted recurrently, either over a sequence of time periods or over separated events. There is no need for our city dweller to make an “institutional” decision about the delivery of the
New York Times if he is on a one-night stopover at a Manhattan hotel. The theory of choice in economics is concerned, for the most part, with such one-time or one-event decisions. At the least, the theory proceeds “as if” individuals choose anew among each set of alternatives that they face. The theory of public goods, as sketched out in earlier chapters, has been presented in this same manner. The choice among differing quantities of a public good (or among different bundles of public goods) and, also, the choice of tax-sharing arrangements has been discussed as if individuals participate in unique, one-at-a-time budgetary decision processes. The models contain no recognition, explicit or implicit, of the predicted repetition or recurrence of fiscal choices, roughly similar one to the other, over a whole series of time periods. In the early models, Tizio and Caio were simply assumed to face, each day, a new and current decision on the quantity of the public good and the manner in which they should share its cost. These early models of exchange, as well as the later ones of group decision processes, were limited in purpose to an explanation of the important elements determining outcomes of such unique choice events.
The Costs of Group Decision-Making
If the costs of making decisions are negligible, the analysis that concentrates on uniquely timed choices requires little or no emendation, even in the face of recurrent choice situations. Implicit in orthodox economic theory is the assumption that, for choices with which it is concerned, these costs are small enough to be ignored. This assumption can be defended because the theory here explains the behavior of individuals in privately organized market exchanges. These involve bilateral agreement between only two persons, and, even here, the presence of available alternatives on each side of the market converts effective choice-making into unilateral behavior. Consider the simple problem confronting the man who must decide whether to purchase corn flakes or porridge each morning in the cafeteria line. Presumably, he can make this choice in an instant and little effort or resource investment is required. He glances quickly at the relative prices, the attractiveness of the two items displayed, examines his own tastes and selects one or the other of the cereals. Once he has made this choice, the result is, for him, fully predictable. He gets what he wants; he is not required to reconsider his selection and change his mind for any reason. Economic theory, correctly, tries to explain the elements that go behind and inform such choices and simply ignores the minimal cost that the individual suffers in making up his mind even in this trivial choice process.
The individual will seldom, if ever, find it advantageous to routinize or institutionalize his morning’s cereal selection even if he knows that he will be faced with this same choice each morning for a year. In fact, we should perhaps judge him to be eccentric if he is observed to refer to a “rule” which, let us say, makes his cereal selection depend on the throw of a die each morning. The same conclusion would be valid, although to a somewhat lesser degree, for more important market decisions made by individuals.
The categorical distinction to be emphasized here is that which arises between the level of individual or private choice in the market and group or collective choice with respect to the relative significance of decision-making costs. In this second situation, these costs become sufficiently important to warrant explicit analysis, analysis supplementary to that which explains one-period, nonsequential choice. In collective choice, the theory remains seriously incomplete unless this supplement is added. The element present here and absent from private choice is the
necessity for separate individuals to reach agreement. As in choice of any sort, the individual must make up his own mind, and this in itself involves some cost. This need not be of concern, however, if this is all there is to it. In group decision, separate parties must, somehow, come to agreement on a single result, regardless of their own initial preferences. The absence of divisibility in the result does not allow them to turn to alternatives. An important cost factor is necessarily introduced that is relatively insignificant in private market choices. If the group interaction is small, negotiation and bargaining will take place. By the nature of the situation they face, individuals will invest resources in strategic bargaining, and this investment will be individually rational. They will try to secure group outcomes favorable to their own interests. Once the group becomes critically large, the costs of voluntary agreement may become prohibitive, so much so that individuals will forego the effort.
In either small or large groups, it seems obvious that the recognition of the importance of decision-making costs, along with the expectation that similar choice situations will recur over time, may suggest the relative efficiency of institutions or rules of choice. These may dramatically reduce the costs of making group decisions, although they do so necessarily at the cost of some in-period efficiency. Such institutions or rules must ossify the structure of in-period choice and must make particular outcomes less rather than more flexible. Over a whole series of choices, however, such institutions or rules may be more efficient than the relevant alternatives.
The Rules for Reaching Group Decisions
In a large-number political setting, the only one relevant for considerations of public-goods demand and supply, the first set of institutions or rules to be examined are those that define the manner of arriving at group or collective outcomes. These institutions and/or rules, as a set, make up the
political constitution. The approach suggested here allows us to examine existing and potentially alternative constitutional rules in terms of efficiency criteria that are similar to those used in orthodox economic analysis. This institutional choice approach makes it conceptually possible to derive an explanation for a political constitution from the choices of individuals as they participate in the basic decision process on the rules that determine the procedures of group choice itself.
Something of this nature is required if we are to go beyond and behind the Wicksellian proposals for effective unanimity rules in the making of fiscal decisions. These proposals have been discussed several times in this book, and they are directly relevant to an understanding of the whole theory of public goods. A Wicksellian rule of unanimity is the political or institutional counterpart to the theory of choice that was developed in earlier chapters. Translated into political-choice terms, Pareto optimality becomes Wicksellian unanimity. The direct relationship between these two concepts is self-evident. Unless all members of the group agree to make a proposed change, some member or members must expect to be made worse off by the change; the proposal is disqualified by the Pareto-optimality criterion. Applied to positions, and not to proposals (a necessary distinction), if there is no change upon which unanimous agreement can be attained, then the initial or
status quo position qualifies as Pareto-optimal. Wicksell and Pareto were roughly contemporaries and worked independently one from the other. Pareto’s genius in developing the welfare criteria has been properly recognized. Wicksell’s genius in relating political rules to orthodox efficiency notions in economics has not yet received its due.
Wicksell’s contribution provides an indispensable groundwork for any further examination of political institutions or rules. It is necessary, however, to go beyond these simple efficiency limits, since even casual observation reveals that seldom, if ever, are unanimity rules (or even rules for relative unanimity) written into actual political constitutions. Experience surely suggests that efficiency in making group or collective decisions may necessarily involve departures from the restrictive Wicksellian limits, which would require that each single group choice be Pareto-Wicksell efficient. This conclusion applies to political choices in general, and not only to fiscal choices, although the latter are the primary subject of analysis here. This book is not the place, however, to discuss the derivation of a “theory of political constitutions” in general terms. This attempt has been made in other works, and repetition is not required save in capsule form. The essential point to be made is that nonunanimity rules for reaching group choices can be justified on efficiency grounds under the appropriate conditions.
Political constitutions embody a complex set of rules and institutions, and the analyst who does not construct abstract models will soon be lost in a maze of descriptive variety. One such abstract model is the simple-majority voting rule. This model is important in itself, and doubly so because it is widely held to be the central and characteristic feature of democracy. Considerable insight should be gained, therefore, into the formal properties of democratic structures when simplified models of direct majority voting are examined. This is the context within which the simple model for majority voting was introduced in Chapters 6 and 7. The model may be used here as merely illustrative of a whole set of “institutions of choice” that might be incorporated in a comprehensive evaluation of a political constitution.
Consider a community faced with a predicted series of decisions, both on the quantity and mix of public goods and on the means of sharing the costs among its citizens. The voluntary negotiation of agreed-on outcomes in each subperiod may be, and probably will be, prohibitively costly. The community adopts, explicitly or implicitly, simple-majority voting as the rule for reaching definitive results, and members agree to abide by the outcomes dictated by this rule. As it works itself out over time, there is perhaps some general expectation that, for the average or representative citizen, this decision rule is relatively more efficient than its alternatives. At least this should be the basis for its selection over alternative rules. Over time, any individual in the community will expect this rule to produce unfavorable results in particular instances, results that run counter to his own preferences. Public-goods projects which he urgently desires may not be undertaken because a majority of his fellow citizens does not agree with his evaluation. Or, conversely, he may be required to contribute to the costs of projects that he considers to be worthless. The efficiency justification for this rule, or for any other, must be found in the prediction that, on balance, the gains offset these in-period inefficiencies.
This is only a thumbnail sketch of the economic theory of majority rule. It is perhaps sufficient to suggest that any rule for making political choices must be evaluated on its own merits and against its relevant alternatives. If the decisions are largely technical ones, or if the case is one where any rule is better than no rule and differences among rules are insignificant (e.g., traffic control), delegation to bureaucratic decision makers may prove more efficient than simple-majority voting. If the decisions are predicted to be of major importance, effectively qualified majorities may be considered to be relatively efficient. For some issues and in some circumstances, one decision rule can be supported on efficiency grounds, for other issues and other circumstances another rule more closely meets efficiency criteria. It is incumbent on the analyst to examine each case and to isolate the important elements. Only in this way can a theory of institutional choice, at the level of political rules, be constructed.
Specific Fiscal Institutions
The discussion of political institutions and rules provides an essential preliminary to a discussion of the specific institutions of fiscal choice. The rules for reaching group decisions, briefly examined in the preceding section, are not likely to be applied uniquely to fiscal choices, as Wicksell seemed to hope might be the case. If simple-majority voting rules within legislative assemblies are the dominant means of making decisions about Blue Laws and Daylight Saving Time, the same rules are also likely to be adopted for making choices about the mix and quantity of public goods and about the means of allocating their costs. Even if efficiency considerations should dictate a different set of rules for fiscal decisions, and even if these considerations should be reflected in constitutional processes, it will still be useful to examine fiscal institutions separately from the rules governing the making of political decisions, including those on fiscal matters.
Given any set of political-decision rules, there may be
fiscal rules or institutions which restrict the range within which collective results may emerge. This is yet another aspect of institutional choice, and this is the subject for examination.
Consider a community that has an established political constitution. This constitution requires the election of representative assemblies, and within these assemblies, decisions on budgetary matters are made by simple-majority voting. The constitution also requires that public-spending programs be approved each year. Faced with this situation, is there a need for supplementary rules to serve, in effect, as a “fiscal constitution”?
There may be two reasons why such rules are desirable. The first has already been discussed in connection with majority rule as a cost-reducing device, costs here being those of decision-making itself. Supplementary fiscal rules that serve to limit the range of majority-rule outcomes may effectively reduce the costs of decision. The second reason is quite different. Majority rule in political decisions may substantially reduce the costs of decision-making below those that would be present under the operation of a unanimity rule, but majority rule will necessarily increase the costs measured by in-period inefficiencies. Supplementary fiscal rules and institutions may well be desired to restrict the operation of majority rule, to restore to an extent the efficiency-generating characteristics of a near-unanimity rule without incurring the additional decision-making costs that resort to more restrictive political-decision rules would introduce. This suggests that political-decision rules and fiscal rules may be substitutes for each other, a relationship that will be discussed in some detail in the next section.
In earlier chapters, it has been implicitly assumed that the collective decisions on
both sides of the budget are worked out in detail in each budgetary period, based on some relationship between the demand for public goods and the costs of supplying them. The most elementary criteria for rational choice, at the collective as well as at the private level, suggest that costs are balanced off against benefits, and that this is facilitated by the retention of maximum flexibility in adjustment on both sides. It seems proper to infer from this that simultaneous consideration of the two public-decision variables, both the tax and the expenditure mix, is a fundamental requirement for efficiency. Observation of real-world fiscal structures suggests that this procedure is rarely, if ever, followed. Naively interpreted, the observed institutional rigidities can only produce undesirable results. Inflexibility in tax-sharing arrangements may prevent majority support of presumably desirable spending projects, and, conversely, the same inflexibility promotes majority support of some projects that are intrinsically inefficient. Economists who compute cost-benefit ratios are perhaps shocked at the results of inflexible political processes, which seems to reflect so little heed given to economists’ advice.
A more comprehensive and critical approach suggests that the institutional structure may contain elements that make for efficiency but which are neglected in elementary choice theory. If the community predicts that fiscal decisions will be made each year, and that these decisions will be similar in many respects, individuals may agree to impose upon themselves, upon their legislative assemblies, rules that effectively define a fiscal constitution. Specifically, the community may preselect a set of tax-sharing arrangements, a tax system or structure, independent of the particular in-period choices to be made on the public-goods outlay. Considered exclusively from the one-period vantage point, this deliberate freezing of certain potential variables implies inefficiencies in results. The range of in-period choice is narrowed. Things may appear quite different, however, when a whole sequence of time periods is taken as the horizon for judgment. If there are no rules for tax-sharing that are to be followed, if no standing rules for the allocation of the costs of public goods are carried forward from one year to the other, the whole cost-distribution issue comes up for grabs each time. The community must face anew the tedious and resource-using task of hammering out acceptable terms of cost-sharing, which, even with only a simple legislative majority required for decision, may prove formidable indeed. In addition, if no such rules for tax-sharing are imposed constitutionally, the possible exploitation of dissident minorities that may be accomplished fiscally by majority coalitions is substantially larger than in the presence of such rules. Potential exploitation costs as well as decision-making costs may be reduced by specific tax-sharing rules that take on constitutional characteristics.
Any set of rules will limit the range of outcomes that can emerge from the political process, given any rule for making group choices. If all public goods to be financed are selected under the constraint that all revenues must be raised, say, by a proportional tax on incomes, some possible outcomes will not be feasible. The advantages and disadvantages of imposing such rules must, of course, be examined case by case and judgment cannot be dispensed with. But it seems possible to suggest influences on community attitudes toward a fiscal constitution. Under what conditions will it seem relatively efficient to lay down tax-sharing rules constitutionally? By “constitutional” in all this discussion, I mean only to refer to rules and institutions that continue in being from period to period, independently of choices made within periods. I am not concerned with semantics.
One primary consideration must be the nature of the goods and services that the community is expected to supply collectively. As a preliminary to more detailed analysis, the hypothesis suggested is that general rules on tax-sharing are more acceptable when the goods and services to be publicly supplied provide general benefits rather than special benefits. This begs several questions concerning definitions, questions that have already been discussed in some detail earlier. Ignoring real-world relevance for the moment, assume initially that the community is expected to supply publicly only goods and services that yield equal flows of homogeneous-quality consumption services to each citizen. In this extreme model, individual demands for public goods and services will differ, but they will do so only because (1) income-wealth positions differ, and (2) utility functions differ. To ignore for the moment income-generated differences in demand, assume that all members of the community earn equal incomes and have the same wealth.
Under what circumstances will members of this community find it relatively efficient to impose a constitutional rule to the effect that all collective goods are to be financed by equal-per-head taxes? If an individual predicts that, over a whole series of separate decisions on budgets, his own demands will be more or less randomly distributed relative to those of his fellow citizens, he may consider that resort to such a constitutional rule is an efficient means of reducing decision-making costs, while at the same time reducing the likelihood that he will suffer undue discrimination at the hands of majority coalitions. On the average, over the whole set of choice situations, this rule will not generate outcomes grossly unfavorable to him, and he is saved the bother of worrying about changed tax-sharing arrangements for each public good in each period. By contrast, suppose that an individual expects that, generally, his own demands for public goods over all goods and over the whole sequence of periods is likely to be well above or well below those of most of his fellow citizens. Here he may not agree to an equal-sharing rule laid down in advance, since he would prefer some alternative rule or even separately negotiated sharing arrangements in each choice situation.
Individuals do not, of course, have equal incomes, and we can relax this assumption while remaining within the extreme model where it is expected that only pure public goods and services will be supplied publicly. The possibility of securing agreement on general fiscal rules will depend on the establishment of some relationship between the predicted demands for publicly supplied goods and external criteria that reflect economic position. If all goods and services are expected to exhibit positive income elasticities for all consumers, some agreement seems plausible on tax-sharing schemes that relate payments to income or wealth. Schemes with this characteristic will not be unduly discriminatory, provided that individuals expect their own tastes, relative to those of others, to range widely over the whole set of budgetary decisions.
The pure publicness model must, of course, be dropped, but it remains useful as a benchmark. Consider goods and services that yield general benefits, in the sense that service flows are provided to substantially the whole membership of the collectivity. These goods, of the fire-station type, yield different physical flows of services to different persons in the group. They will be valued differently, not only because of income and taste differentials, but also because of the basic differences in provision of services. Even here, however, an individual may accept certain tax-sharing rules as relatively efficient if he anticipates some randomization in the separate demands for separate goods in the budgetary mix and over time. To refer to the fire-station example, the individual who lives some distance from the facility may think that, when all other publicly supplied goods and services are taken into account along with fire protection, he will be “closer” to some, “farther” from others. He may get relatively little fire protection from the distant fire station, but, balanced off against this, he may have more children to be publicly educated than the man who lives next door to the firehouse. On this sort of logic, the individual may support a general tax-sharing scheme, say proportional income taxation, to finance all public goods over all periods.
As we have suggested on several occasions, governments supply goods and services that do not fit the publicness category in any sense. Suppose that an individual expects the collectivity to supply goods and services that are, for the most part, designed specifically to provide services to particular individuals or groups in the community. Under such conditions, an individual seems less likely to support
general tax-sharing schemes at the constitutional-institutional level. He may anticipate that he will be on the receiving end of the bargains a representative share of the times, and therefore some fiscal rules may be desirable. He should also recognize, however, that, with special-benefit goods and services, constitutional rules requiring general taxation will produce a relative oversupply of public goods, given the operation of majority rule. In a regime where the publicly supplied goods and services are expected to be of the special-benefit type, tax-sharing rules laid down in advance should provide for special rather than general taxes.
Regardless of the logical or nonlogical origins that may have guided their evolution, we observe real-world fiscal systems characterized by “constitutional” rules on tax-sharing. Tax legislation is considered independent of budgetary or spending legislation, and structural changes in the tax system are discussed as quasi-permanent institutional reforms. The basic income tax law in the United States remained substantially unchanged from 1954 to 1964. Budgetary decisions on the amount and the mix of goods and services are made within a revenue system which acts as a “constitutional” constraint. One of the two public variables, the allocation of tax shares, is frozen by preselected rules. Decision-making on the remaining variable (or set of variables) on the spending side is facilitated even if the range of possible results is narrowed.
Substitution Between Political-Decision Rules and Fiscal Rules
Wicksell proposed more flexible tax-sharing arrangements as a means of securing the acceptance of spending programs by a substantially larger-than-majority proportion of the political community. These suggestions for greater flexibility in tax-sharing accompanied his proposals for applying the rule of unanimity, or of relative unanimity, to the making of collective choices on fiscal matters. Because of this inclusive rule for political choice, individuals and groups would be protected against possible majority exploitation. For this reason, they should then be willing to explore more flexible tax-sharing schemes. Until and unless something akin to the unanimity rule for making collective choices is established, however, institutional constraints imposed on tax-sharing become partial substitutes for the more inclusive political-decision rules. The degree of substitutability between these two sets of institutions was not fully appreciated by Wicksell.
The relationship may be demonstrated in a simple example. Assume that all individuals in the community share identical public-goods preferences; all utility functions are the same and all incomes are equal. Assume further that all goods to be supplied collectively are known to provide equal flows of consumption services to all persons. In this extreme model, a tax-sharing rule that dictates equal shares among persons becomes substantially equivalent to a political-decision rule of unanimity. If costs are to be shared equally by all citizens, and this is laid down as a constitutional rule, the outcomes with respect to public-goods quantities will be identical under
any and all rules for making group choices. An individual should, in this case, be indifferent as to the particular manner in which group choices are made, and he should select among these strictly on some least-cost criterion. The delegation of decision-making authority to any single person will produce results identical to those that would be forthcoming under majority voting rules or even under a unanimity rule. The collective-choice rule does not matter here
because the fiscal rule, given the conditions of this model, prevents any opportunity for differential or discriminatory treatment. If one person should be granted power of decision for the community, he cannot use this power to advance his own private interest
vis-à-vis his fellows. He cannot, by the assumptions of the model, choose that the collectivity provide goods and services which are differentially beneficial to him. And he cannot, because of the equal cost-sharing rule, secure the benefits of publicly supplied, pure public goods and services without paying his own
pro rata share of their costs.
Only in this rarified model will the selection among political-decision rules make no difference to the outcomes defined in terms of public-goods quantities. If the adherence to the equal-sharing rule is dropped, a potential dictator could escape costs by insuring that taxes be imposed only on others than himself. And a majority coalition could do likewise by imposing the bulk of the costs of all public goods on the minority. Protection against discriminatory treatment comparable to that provided by the equal-sharing rule would require a political-decision rule of effective unanimity.
Institutional constraints can also operate on the spending side of the bud-get. Even with an equal-sharing rule, if special-benefit projects are allowed, the political-decision rule makes a major difference in the expected outcomes. The limitation of public supply to those goods and services that do provide general benefits is in itself a major protection against undue discrimination on the spending side. And to the extent that this limitation is effective, not only are tax-sharing rules less urgently required, but less-inclusive political-decision rules can also be accepted.
In practical effect, the Wicksellian proposals amount to a substantial relaxation of both tax-sharing rules and budgetary criteria in exchange for a substantial tightening up in the rules for reaching political-collective decisions. In real-world settings, some compromise among these three sets of rules or institutions is likely. In Western democratic countries, political decisions are reached by majority voting in legislative assemblies, either unicameral or bicameral in nature, constrained by their own rules of procedure, and by varying interactions between legislative and executive authority. The range of fiscal outcomes that this process can produce is further limited by agreed-on rules that define, as it were, a “fiscal constitution.” Severe limits are placed upon the powers to impose arbitrarily discriminatory taxes, and less restrictive but still meaningful constraints are placed on the type of goods that may be provided publicly.
Recognizing this is not the same as suggesting that existing or observed constitutional arrangements as to political-decision rules, tax-sharing rules and budgetary criteria are necessarily, or even probably, the most efficient set that can be found. Gross inefficiencies may exist, and to locate these should be one of the purposes of analysis. The discussion here is intended to suggest only that a structure of fiscal rules, which does limit the flexibility of adjusting either taxes or the mix of public goods, can be derived from basic efficiency considerations, given the absence of Wicksellian unanimity in making political decisions. If individuals could be assured that tax-spending programs would be enacted only upon the approval of substantially the whole community, resort to additional rules on either tax-sharing or on the range of public goods supplied would be inadvisable. In this case, such constraints could only make decisions more costly, and they could not provide additional protection against exploitation. If individuals should differ substantially in their demands for goods, agreement is facilitated to the extent that tax-sharing schemes can be adjusted and other, possibly special-benefit, goods also provided. However, majority voting rules, as qualified in actual structures, provide means of reaching collective decisions without explicit agreement among all persons and groups. In this political context, fiscal rules that serve to limit (sometimes severely) the alternatives available may tend to generate more efficient outcomes over the whole sequence of choice situations.
A Rehabilitation of Traditional Tax “Principles”?
An analysis of the “institutions of fiscal choice” suggests that, under appropriate conditions, members of a politically organized community may find it relatively efficient to adopt tax-sharing arrangements independently of particular choices on the quantity and mix of goods and services publicly supplied, arrangements or rules that are explicitly designed to be constitutional. They may be chosen with the intent that they shall remain in effect over a whole, and unpredictable, set of separate choice situations, and over a sequence of budgetary periods. In this context, it is evident that alternative tax-sharing proposals or plans must be examined in terms of some general criteria of efficiency, and not as related to specific benefit imputations from identifiable goods and services. In one respect at least, the approach seems to provide methodological legitimacy to the time-honored tradition in neoclassical public finance, the discussion of tax “principles” in rather complete isolation from any consideration of public expenditures. Does the institutional approach suggested come down, finally, to a rehabilitation of the traditional treatment after all?
The answer to this question can be affirmative only in a highly qualified sense. The end result is the same: Independent or separate principles are applied only to one-half of the fiscal account. In neoclassical public-finance theory, however, the framework for analysis is entirely different from that which suggests the institutional-choice approach. The neoclassical tradition contains no exceptions among English-language scholars, but this conclusion must be qualified, especially when Italian scholars are taken into consideration. Among the latter group, de Viti de Marco comes perhaps closer to the institutional-choice emphasis than any other scholar. In the strict English-language tradition, the independent derivation of tax-sharing norms has its origin in the “unproductive” consumption notions of the classical economists. Government outlay was considered “unproductive,” and there was, by implicit assumption, no return of services to the citizens who were taxed. This neoclassical model of public finance was not wholly divorced from an underlying and assumed model of political organization, as Wicksell acutely noted. In a political regime that devotes the bulk of government outlay to the maintenance expenses of a single sovereign, or even of an elite, there is no demonstrable return flow of services to the taxpayers. This essentially nondemocratic model of political order was, perhaps unwittingly, carried over into the democratic era by economists who paid little heed to their political presuppositions. In English-language neoclassical public finance, there was no indication that the governmental machinery is organized on democratic forms. No scholar called attention to the simple fact, noted in Italy first by Ferrara and then more emphatically by de Viti de Marco, that those who bear the costs of public services are also the beneficiaries in democratic structures. Somewhat surprisingly, English-language public finance continued to rest on the implicit assumption about taxes that Einaudi aptly labeled
imposta grandine, literally translated as “hailstorm tax.” Tax principles were discussed as if, once collected, revenues were removed forever from the economy; taxpayers, both individually and in the aggregate, were held to suffer real income losses.
Within such a framework, it followed more or less rationally that taxes should be analyzed in terms of their ability to satisfy certain minimization criteria. Taxes were discussed in terms of “least-aggregate sacrifice,” the most sophisticated of the utilitarian principles, and in terms of least-price distortion, the somewhat more widely accepted norm for market efficiency. Principles of “just” taxation and of “efficient” taxation were not based in any way on the imputation of benefits from public goods and services.
By contrast and/or by comparison, the independent consideration of tax-sharing arrangements that emerges from the institutional approach is derivative from specific predictions about the pattern of benefit imputations over many goods and many periods. In this sense, the approach falls within “benefit principle” ideas, which were largely rejected in neoclassical theory. In its more narrow and more familiar interpretations, the benefit principle lays down norms for tax-sharing that relate individual payments directly to spending flows from particular goods and services in particular budgetary periods. The institutional approach allows this direct link between specific benefit imputations and tax-shares to be broken, but the justification for this step lies in the predictability of patterns of imputations over many goods and many periods. Given certain patterns of this sort, generalized criteria for efficient tax-sharing can be discussed independently of the allocation of public expenditures.
The setting is clearly different in the two models, despite the similarity in result, and, quite possibly, also in the specific norms for tax-sharing that may be derived. De Viti de Marco showed that either proportional or progressive income taxation could be justified on the basis of a model that is quite close to the institutional-choice approach, a model that contained explicit recognition of the productivity of publicly supplied goods and services. The institutional-choice approach provides a synthesis of sorts between the neoclassical ability-to-pay theory of taxation and the continental benefit theory of taxation. The neglect of the expenditure side in the former is eliminated, while, at the same time, the specific in-period connection between tax-shares and benefit-imputations in the latter is no longer necessary. In this synthesis, however, the derivation of tax-sharing norms is much more difficult than either the ability-to-pay or the benefit approach suggests. Criteria of efficiency and fairness reduce to the same thing, but in comparing alternative arrangements in terms of these many more variables must be taken into account than traditional discussion has implied. The increased importance of uncertainty pervades the whole analysis. While some of the established norms can be derived from this approach, other long-established principles can be shown to be demonstrably faulty.
The analysis of existing and alternative tax-sharing and expenditure arrangements or rules in a long-period constitutional setting will not be carried out here. The discussion of this chapter has been limited to pointing out the relevance of this institutional analysis to any comprehensive theory of demand and supply of public goods and services. The fact that an analysis of the institutions of fiscal choice must be appended to the more restricted pure theory of public-goods allocation does not, of course, make the latter analysis irrelevant or unnecessary. The pure theory, which has been the subject matter of earlier chapters, must be essentially completed before institutional analysis can even begin. Even with the pure theory of public goods, much remains to be done, and the theory of fiscal institutions has only been developed in bits and pieces. For this reason, I have not, in this chapter, tried to analyze tax-sharing and budgetary rules in terms of specifically defined alternatives. I have not, for example, tried to examine the possible derivation of a rule for proportional income taxation as opposed to one for progressive income taxation. One of the important and largely incomplete tasks of fiscal research and scholarship is precisely this of applying the institutional-choice methodology to the whole range of potentially important fiscal alternatives.
Chapter 8 is the only one in the book which summarizes, in a modified context, material that I have, jointly or independently, developed in greater detail in other works. The derivation of a set of basic constraints governing the rules for making collective choice, a political constitution, from the efficiency calculus of individuals is the primary objective of a book that was written jointly with Gordon Tullock [
The Calculus of Consent (Ann Arbor: University of Michigan Press, 1962, 1965)]. The extension of this approach to apply to the choice of fiscal institutions along with the effects of such institutions on individual behavior in politics is the objective of my later book [
Public Finance in Democratic Process (Chapel Hill: University of North Carolina Press, 1967)].
The importance of analyzing the choice of rules, as distinct from choices made under constraints imposed by a set of existing rules, has been impressed on many scholars in separate fields in the last two decades. This has been one of the by-product contributions of game theory, a contribution that has perhaps been as significant as the more specific theory itself. The standard references may be cited [J. Von Neumann and O. Morgenstern,
The Theory of Games and Economic Behavior (Princeton: Princeton University Press, 1944); R. D. Luce and H. Raiffa,
Games and Decisions (New York: John Wiley and Sons, 1957)]. My own attention to this vital distinction owes much to many oral discussions with Rutledge Vining; his approach is perhaps best summarized in his review of economic research [
Economics in the United States of America (Paris: UNESCO, 1956)].
An important, and closely related, development has been taking place in the discussion among philosophers over “rule-utilitarianism,” most notably in the works of John Rawls [“Justice as Fairness,”
Philosophical Review, LXVII (April 1958), 164-94; “Constitutional Liberty and the Concept of Justice,”
Nomos VI, edited by C. Friedrich and J. Chapman (New York: Atherton Press, 1963); and, somewhat earlier, “Two Concepts of Rules,”
Philosophical Review, LXIV (January 1955), 3-32]. Rawls’s approach has been recently applied to the income-distribution problem by W. G. Runciman [
Relative Deprivation and Social Justice (London: Faber & Faber, 1966)].
There are, without doubt, similarities between the approach suggested and that taken by the American institutionalists, perhaps notably by J. R. Commons, although I am not specifically familiar with this body of scholarship. The influence of Frank H. Knight upon my own thinking should be acknowledged, and he is, in a broad sense, properly classified as an “institutionalist,” especially in his less technical works [
The Ethics of Competition (London: Allen and Unwin, 1935);
Freedom and Reform (New York: Harper, 1947)].
As suggested in the text, the public-finance theorist who comes closest to having developed, although not explicitly, an approach consistent with an institutional-choice emphasis was Antonio de Viti de Marco [
First Principles of Public Finance, translated by E. P. Marget (New York: Harcourt Brace, 1936)].