23 Public finance for public goods JULY.docx
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23PublicfinanceforpublicgoodsJULY
2.3
Publicfinanceforpublicgoods
Taxesandpublicfinance
Taxationwhenincomeisspent
Taxeswithoutanexcessburden
Administrativeandemotionalcostsoftaxation
Deferredtaxation:
Governmentborrowing
Whopaysatax?
Economy-wideeffectsoftaxes
Reponsestoagovernmentbudgetsurplus
Summary
WesawintheprevioussectionthatfinancingandsupplyofpublicgoodsisideallydeterminedbytheLindahlconsensussolution,butthatgovernmentslacktheinformationaboutpersonalbenefitsrequiredforimplementingtheLindahlsolution.TheClarketax,cost-benefitcalculations,andlocationalchoicearemeansofhopingtosolvetheinformationproblem.Weshallnowsetasidetheinformationproblem.Thequestionthatweaddressinthissectionishowtofinancepublicspendingonpublicgoods.
Wewouldhavelikedtohaveunambiguouslysolvedtheinformationproblemabouthowmuchtospendonapublicgoodbeforebeginningtoconsiderhowtofinancepublicspendingonapublicgood.Wedonothoweverhaveanunambiguoussolutiontotheinformationproblem.Weshallthereforehavetosupposethatagovernmentsomehowknowsthebenefitstothepopulationfromapublicgoodandalsoknowsthecostsofsupplyingthepublicgood.Perhapsinformationnotprovidedbymarketvalueswasobtainedthroughaccuratecost-benefitanalysis,orperhapsthegovernmentjurisdictionconsistsofpeoplewhohaverevealedtheirsimilarknownpreferencesthroughlocationalchoice.Weshallthereforenowregard∑MBforthepopulationandtheMCofthepublicgoodasknowntothegovernment,whereMCisdeterminedbythepricesoftheinputsusedtoprovidethepublicgood.
Weshallbeconcernedwithtaxeswhenpublicgoodsarenotcongestibleorcongested.Whenpublicgoodsbecomecongested,thepurposeoftaxationcanbenottofinanceapublicgood,buttodiscourageexcessiveuseandsoreducecongestion.Forpurepublicgoodsorpublicgoodsthatarenotcongested,thereasonfortaxationistoprovidemeansoffinancingpublicspending.
Publicgoodscanbefinancedbyuserpricesratherthantaxation.Userpricesrequiretheabilitytoexcludefrombenefitpeoplewhodonotpay,asforexampleexcludingusersfromatollroadorbridgeiftheydonotpay.Peoplecouldalso,forexample,payauserpriceeverytimetheycalluponthepoliceforassistance.Theuserchargescouldfinancethepolicebudget,soavoidingtheneedfortaxationandpublicfinance.Ifuserpriceswereimposedforcallingforpoliceassistance,victimswouldbepayingforpoliceservicesandpeoplewithinsufficientmoneywouldbedeniedtheprotectionoftheruleoflaw,whichappearssociallyundesirableandunethical.Sinceuserchargesforpoliceassistancewoulddiscouragepeoplefromreportingcrimes,criminalswouldalsohavegreateropportunitiestorepeattheircrimes.Thepolicealsoprovideapublicgoodthroughdeterrenceofcrime,anditisnotpossibletodirectlychargeforthebenefitsofdeterrence.Userchargesarethereforenotleviedtofinancethecostsofpoliceprotection.Whereexclusionfrombenefitofpeoplewhodonotpayispossible,voluntaryprivatepaymentishoweverinprincipleanalternativetocompulsorytaxationofpublicfinance.Weshallreturntoconsideruserpricingasanalternativetotaxationandpublicfinanceforpublicgoods.
Here,weshallnowconsidertaxationandpublicfinanceasthemeansofpayingforpublicgoods.Afterthepublicgoodshavebeenfinancedthroughtaxation,thebenefitsfrompubliclyfinancedpublicgoodsarethenavailablewithoutfurtherpaymenttoeverybody.Thefreeaccesstothepubliclyfinancedpublicgoodsisefficient,sinceonepersonbenefitingdoesnotreducethebenefittoanyotherperson.
Taxesandpublicfinance
ThepersonalLindahlpricesprovideefficientfinancingforpublicgoodsbuttheLindahlsolutioncannotbeimplemented.IfhowevertheefficientLindahlpricescouldbepersonallychargedtofinancepublicgoods,thepaymentsmakeforpublicgoodswouldbeinthemarketforapublicgood.Thatis,inthemarketforthepublicgood,peoplewouldbevoluntarilypayingtheirshareofthecostofsupply.
ThevoluntaryLindahlpaymentswithinamarketforpublicgoodscontrastwithfinancingofpublicgoodsthroughcompulsorytaxesthatareleviedonbuyersandsellersinothermarketsandnotinthemarketforthepublicgooditself.Thetaxesinothermarketscanbetaxesonincomesearnedinthelabormarketorsalestaxesonprivatespendingonprivategoods.Thesetaxesinothermarketsareanintrusionintotheseothermarkets.Theintrusionhasacost,throughapersonalefficiencylossfortaxpayers.
Toseehowthepersonalefficiencylossarises,wecanconsiderataxonincome.Figure2.22showsanindividual’ssupplyoflaborfunctionSL(foraweek,ormonth,oryear).Thesupplyoflaborfunctionshowsthesubstitutionbetweenhoursworkedandfreetimewhenthenet-of-taxwagethattheindividualreceiveschanges.Asthenet-of-taxwageincreases,theindividualsubstitutesincome-earningactivityforfreetimeandlaborsupply(andeffort)increases.
Attheindividual’smarket-determinedwagewwithnotaxation,theindividualchoosestoworkL2hours.Anincometaxataconstanttpercentreducesthenet-of-taxwageperhourtow(1-t),andtheindividualrespondsbydecreasinghoursworkedtoL1.
Pre–taxwagegiveninalabormarket
Figure2.22:
Theexcessburdenofanincometax.
ThetaxoftpercentisleviedonthetaxbaseofL1hoursworked.Afterthetax,theemployercontinuestopaythecompetitivelydeterminedmarketwagew.Theindividual’spre-taxincomeinfigure2.22isABJOandnet-of-taxincomeisCDJO.ThedifferencebetweengrossincomeandnetincomeisthemoneyABCDpaidastaxestothegovernment.
Weseeinfigure2.22thatthetaxhascreatedagapbetweenthecostoflabortotheemployerwandthewagereceivedbytheemployeew(1-t).Thetaxhasalsoresultedinachangeinmarketbehavior,indicatedinthedeclineinlaborsupplyfromL2toL1.Thechangeinmarketbehaviorhasoccurredthroughasubstitutionresponse,withtheindividualsubstitutingfreetimeforproductivetime.Thesubstitutionresponseisthesourceofapersonalefficiencyloss.
Thepresenceofthepersonalefficiencylossduetothetaxisrevealedwhenweasktheindividualinfigure2.22oneoftwoquestions:
(1)Howmuchareyoupreparedtopaythegovernment,inreturnforthegovernmentnotlevyingtheincometaxonyou?
(2)Howmuchdoesthegovernmenthavetogiveyoutocompensateyouforthetaxthathasbeenleviedonyou?
Thefirstquestionpresumesthatthetaxisnotlevied,andaskshowmuchtheindividualiswillingtopaytokeepthetaxatbay.Thesecondquestionpresumesthatthetaxisinplace,andaskshowmuchtheindividualhastobepaidascompensationforthetaxhavingbeenlevied.
Letussupposethat,inansweringthequestions,theindividualinfigure2.22feelsnobenefitfromthetaxespaidtothegovernment.Theindividualthenwantsthemoneypaidintaxesreturned.Still,theanswertothequestionhowmuchtheindividualispreparedtopaytoavoidpayingthetaxismorethanthemoneypaidintaxes.Theanswertothequestionhowmuchtheindividualhastobecompensatedforhavinghadtopaythetaxisalsomorethanthevalueofthemoneypaidintaxes.Inbothcases,thereisanexcessburdenoftaxationbeyondthevalueofthemoneypaidintaxes.
TheexcessburdenoftaxationistheareaDBEinfigure2.22.Theindividualinfigure2.22ispreparedtopayanamountofmoneyDBEthatismorethanthevalueofthetaxtoavoidpayingthetax,andhastobecompensatedbytheamountofmoneyDBEmorethanthevalueofthetaxforhavingpaidthetax.
WhyisDBEapersonallossfromtaxation?
Whenlaborissupplied,apersonalcostisincurredthroughfreetimethatwouldhavebeenavailable.ThepersonalcostisexpressedthroughthelaborsupplyfunctionSL,whichisapersonalMCfunctionforlaborsupplied.TheareaunderthefunctionSLiscorrespondinglythepersonaltotalcostofsupplyinglabor.Wecannowproceedthroughthefollowingsteps:
(1)Beforethetaxisimposed,theindividual’sbenefitfrommarketparticipationinfigure2.22isOAE,whichisthebenefitorincomeAEHOfromsupplyingL2hoursoflaborminusthecostOEHofsupplyingthesehoursoflabor.
(2)Afterthetaxisimposed,theindividual’sbenefitfrommarketparticipationisOCD,whichisthedifferencebetweenpost-taxincomeABJOandthepersonalcostODJintermsoffreetimeforgoneofsupplyingL1hoursoflabor.
(3)Theeffectofthetaxhasthereforebeentoreducethegainfrommarketparticipationby(AEO-CDO)=AEDC.
(4)AEDChastwocomponents.OnecomponentisthetaxrevenueABCDpaidtothegovernment.ThesecondcomponentisDBE,whichistheadditionalpersonallossfromthetaxinexcessofthetaxrevenuepaidtothegovernment.
Theefficiencylossoftaxation
Wehavebeenviewingtheindividualbeingtaxedasnotfeelingbenefitfromthetaxpaidtothegovernment.Taxeshoweverfinancepublicspendingonpublicgoods,andthepublicgoodscanbeasourceofbenefitforthetaxpayer.ThereishowevernoprospectforgainassociatedwiththeexcessburdenDBEinfigure2.22.Theexcessburdenispurelyandsimplyanefficiencyloss,orawaste.
TheefficiencylossDBEisbornepersonallybythetaxpayerinfigure2.22.Thepersonalefficiencylossisnotdirectlyobservedasanysumofmoney.Itissomethingthatapersonhadbeforethetax,butthatdisappearedafterthetax.Nosumofmoneyequaltotheexcessburdenoftaxationchangeshands.Theexcessburdenoftaxationisinvisible.
Whenthesupply-of-laborfunc