23 Public finance for public goods JULY.docx

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