Tresch Public Finance

A Normative Theory
3. Auflage 2014
ISBN: 978-0-12-416033-0
Verlag: Elsevier Science & Techn.
Format: EPUB
Kopierschutz: 6 - ePub Watermark

E-Book, Englisch, 534 Seiten

Public Finance remains the premier textbook on the normative theory of government policy, with the third edition propelling into the twenty-first century its examination of what government ought to be doing instead of what it is doing. The welfare aspects of public economics receive extensively renewed examination in this third edition. With four new chapters and other significant revisions, it presents detailed and comprehensive coverage of theoretical literature, empirical work, environmental issues, social insurance, behavioral economics, and international tax issues. With increased emphasis on the European Union, it is rigid enough for use by PhDs while being accessible to students less well trained in math. - Moves skillfully from explaining normative theory to applying it in mathematically compact and precise terms - Adds new chapters on social insurance, medical care, social security pensions, behavioral public economics, and international public finance - Includes new pedagogical supplements, including end-of-chapter questions and answers - Emphasizes European examples

Richard Tresch earned a bachelor's degree in 1965 from Williams College and a doctorate ineconomics in 1973 from the Massachusetts Institute of Technology, where he was a teaching assistantprior to joining Boston College. He joined the Boston College faculty in 1969, and during his49-year-long career in the college, Dr. Tresch has served as the Chairman of the Department ofEconomics, Director of Graduate Studies, and Director of Undergraduate Studies. Currently, he isProfessor Emeritus of Economics at Boston College. In 1996, he was chosen as the MassachusettsProfessor of the Year by the Carnegie Foundation for the Advancement of Teaching. He was oneof 585 national entrants in the foundation's U.S. Professors of the Year Program, which salutesoutstanding undergraduate instructors, with the award recognized as one of the most prestigioushonors to be bestowed on professors. Dr. Tresch, a member of the American Economic Association,has served on the board of editors of the American Economic Review and contributed to the NewEngland Journal of Business and Economics and Public Finance. Moreover, he is the editor of a fourvolumemajor reference work on public sector economics.

Autoren/Hrsg.

Tresch, Richard W.

Inhaltsverzeichnis

1;Front Cover;1
2;Public Finance;4
3;Copyright;5
4;Contents;6
5;Preface;16
6;Part 1 Introduction: The Content and Methodology of Public Sector Theory;18
6.1;Chapter 1 - Introduction to Normative Public Sector Theory;20
6.1.1;THE FUNDAMENTAL NORMATIVE QUESTIONS;21
6.1.2;GOVERNMENT EXPENDITURE THEORY: PHILOSOPHICAL UNDERPINNINGS;22
6.1.3;GOVERNMENT EXPENDITURE THEORY AND MARKET FAILURE;26
6.1.4;THE GOVERNMENT SECTOR IN THE UNITED STATES;29
6.1.5;THE THEORY OF TAXATION;31
6.1.6;FISCAL FEDERALISM;32
6.1.7;THE THEORY OF PUBLIC CHOICE;32
6.1.8;BEHAVIORAL PUBLIC FINANCE;34
6.1.9;SUMMARY;35
6.1.10;REFERENCES;36
6.2;Chapter 2 - A General Equilibrium Model for Public Sector Analysis;38
6.2.1;A BASELINE GENERAL EQUILIBRIUM MODEL;39
6.2.2;EFFICIENCY: THE PARETO-OPTIMAL CONDITIONS;40
6.2.3;EQUITY: THE SOCIAL WELFARE FUNCTION AND THE OPTIMAL DISTRIBUTION OF INCOME;41
6.2.4;MAXIMIZING SOCIAL WELFARE;44
6.2.5;POLICY IMPLICATIONS AND CONCLUSIONS;52
6.2.6;REFERENCES;53
6.3;Chapter 3 - First-Best and Second-Best Analyses and the Political Economy of Public Sector Economics;54
6.3.1;LUMP-SUM REDISTRIBUTIONS AND PUBLIC SECTOR THEORY;54
6.3.2;FIRST-BEST ANALYSIS;55
6.3.3;SECOND-BEST ANALYSIS;57
6.3.4;SIMILARITIES BETWEEN FIRST-BEST AND SECOND-BEST ANALYSES;61
6.3.5;THE POLITICAL ECONOMY OF THE SOCIAL WELFARE FUNCTION;62
6.3.6;CONCLUSION;70
6.3.7;REFERENCES;70
7;Part 2 The Theory of Public Expenditures and Taxation: First-Best Analysis;72
7.1;Chapter 4 - The Social Welfare Function in Policy Analysis;74
7.1.1;SOCIAL WELFARE AND THE DISTRIBUTION OF INCOME: THE ATKINSON FRAMEWORK;75
7.1.2;SOCIAL WELFARE AND CONSUMPTION: THE JORGENSON ANALYSIS;82
7.1.3;SOCIAL WELFARE AND SOCIAL MOBILITY;90
7.1.4;REFERENCES;94
7.2;Chapter 5 - The Problem of Externalities-An Overview;96
7.2.1;POLICY-RELEVANT EXTERNALITIES;96
7.2.2;THE ANALYSIS OF EXTERNALITIES: MODELING PRELIMINARIES;98
7.2.3;REFERENCES;99
7.3;Chapter 6 - Consumption Externalities;100
7.3.1;HOW BAD CAN EXTERNALITIES BE?;101
7.3.2;THE WORST OF ALL WORLDS-ALL GOODS (FACTORS) ARE PURE PUBLIC GOODS (FACTORS);102
7.3.3;THE EXISTENCE OF AT LEAST ONE PURE PRIVATE GOOD;103
7.3.4;NONEXCLUSIVE GOODS-THE SAMUELSON MODEL;108
7.3.5;AGGREGATE EXTERNALITIES;119
7.3.6;REFERENCES;124
7.4;Chapter 7 - Production Externalities;126
7.4.1;THE CONDENSED MODEL FOR PRODUCTION EXTERNALITIES;127
7.4.2;AGGREGATE PRODUCTION EXTERNALITIES;128
7.4.3;CONCLUDING COMMENTS: THE PROBLEM OF NONCONVEX PRODUCTION POSSIBILITIES;138
7.4.4;REFERENCES;139
7.5;Chapter 8 - An Application of Externality Theory: Global Warming;140
7.5.1;CONSUMPTION-PRODUCTION EXTERNALITIES;140
7.5.2;LEGISLATING POLLUTION STANDARDS;143
7.5.3;DEFENSIVE ANTIPOLLUTION STRATEGIES;150
7.5.4;LONG-LIVED EXTERNALITIES;153
7.5.5;REFERENCES;155
7.6;Chapter 9 - The Theory of Decreasing Cost Production;156
7.6.1;DECREASING COST IN GENERAL EQUILIBRIUM ANALYSIS;157
7.6.2;REFLECTIONS ON U.S. POLICY REGARDING DECREASING COST SERVICES: THE PUBLIC INTEREST IN EQUITY AND EFFICIENCY;169
7.6.3;APPENDIX: RETURNS TO SCALE, HOMOGENEITY, AND DECREASING COST;172
7.6.4;REFERENCES;173
7.7;Chapter 10 - The First-Best Theory of Taxation and Transfers;174
7.7.1;PUBLIC CHOICE AND PARETO-OPTIMAL REDISTRIBUTION;175
7.7.2;ALTRUISM, FREE RIDING, AND CROWDING OUT OF PRIVATE CHARITY;181
7.7.3;OTHER MOTIVATIONS FOR REDISTRIBUTIVE TRANSFERS;183
7.7.4;REFERENCES;185
7.8;Chapter 11 - Applying First-Best Principles of Taxation-What to Tax and How;188
7.8.1;DESIGNING BROAD-BASED TAXES: THE ECONOMIC OBJECTIVES;188
7.8.2;ABILITY TO PAY: THEORETICAL CONSIDERATIONS;190
7.8.3;HORIZONTAL EQUITY;191
7.8.4;VERTICAL EQUITY;199
7.8.5;REFLECTIONS ON THE HAIG-SIMONS CRITERION IN PRACTICE: THE FEDERAL PERSONAL INCOME TAX;204
7.8.6;THE INFLATIONARY BIAS AGAINST INCOME FROM CAPITAL2020THE ANALYSIS IN THIS SECTION FOLLOWS DIAMOND (1975), PP. 228-230.;209
7.8.7;TAXING REALIZED GAINS: AUERBACH'S RETROSPECTIVE TAXATION PROPOSAL;210
7.8.8;THE TAXATION OF HUMAN CAPITAL;213
7.8.9;SUMMARY;214
7.8.10;REFERENCES;215
8;Part 3 The Theory of Public Expenditures and Taxation: Second-Best Analysis;216
8.1;Chapter 12 - Introduction to Second-Best Analysis;218
8.1.1;A BRIEF HISTORY OF SECOND-BEST THEORY;219
8.1.2;PHILOSOPHICAL AND METHODOLOGICAL UNDERPINNINGS;223
8.1.3;PREVIEW OF PART III;223
8.1.4;REFERENCES;224
8.2;Chapter 13 - The Second-Best Theory of Taxation in One-Consumer Economies with Linear Production Technology;226
8.2.1;GENERAL EQUILIBRIUM PRICE MODELS;227
8.2.2;THE MEASUREMENT OF LOSS FROM DISTORTING TAXES;228
8.2.3;THE OPTIMAL PATTERN OF COMMODITY TAXES;242
8.2.4;SUBSTITUTIONS AMONG TAXES: IMPLICATIONS FOR WELFARE LOSS;246
8.2.5;REFERENCES;249
8.3;Chapter 14 - The Second-Best Theory of Taxation with General Production Technologies and Many Consumers;250
8.3.1;A ONE-CONSUMER ECONOMY WITH GENERAL TECHNOLOGY;250
8.3.2;MANY-PERSON ECONOMIES: FIXED PRODUCER PRICES;257
8.3.3;MANY-PERSON ECONOMY WITH GENERAL TECHNOLOGY;263
8.3.4;THE SOCIAL WELFARE IMPLICATIONS OF ANY GIVEN CHANGE IN TAXES;265
8.3.5;REFERENCES;267
8.4;Chapter 15 - Taxation under Asymmetric Information;268
8.4.1;LUMP-SUM REDISTRIBUTIONS AND PRIVATE INFORMATION;269
8.4.2;REDISTRIBUTION THROUGH COMMODITY TAXATIONS;270
8.4.3;OPTIMAL TAXATION, PRIVATE INFORMATION, AND SELF-SELECTION CONSTRAINTS;272
8.4.4;OPTIMAL INCOME TAXATION;277
8.4.5;TAX EVASION;281
8.4.6;CONCLUDING REMARKS;285
8.4.7;REFERENCES;286
8.5;Chapter 16 - The Theory and Measurement of Tax Incidence;288
8.5.1;TAX INCIDENCE: A PARTIAL EQUILIBRIUM ANALYSIS;288
8.5.2;FIRST-BEST THEORY, SECOND-BEST THEORY, AND TAX INCIDENCE;289
8.5.3;METHODOLOGICAL DIFFERENCES IN THE MEASUREMENT OF TAX INCIDENCE;290
8.5.4;THEORETICAL MEASURES OF TAX INCIDENCE;291
8.5.5;THE EQUIVALENCE OF GENERAL TAXES;297
8.5.6;MEASURING TAX INCIDENCE: A MANY-CONSUMER ECONOMY;299
8.5.7;THE HARBERGER ANALYSIS;301
8.5.8;IMPORTANT MODIFICATIONS OF THE HARBERGER MODEL;310
8.5.9;REFERENCES;312
8.6;Chapter 17 - Expenditure Incidence and Economy-Wide Incidence Studies;314
8.6.1;THE INCIDENCE OF GOVERNMENT TRANSFER PAYMENTS;316
8.6.2;TAX AND EXPENDITURE INCIDENCE WITH DECREASING-COST SERVICES;317
8.6.3;SAMUELSONIAN NONEXCLUSIVE GOODS;317
8.6.4;ECONOMY-WIDE INCIDENCE STUDIES;320
8.6.5;THE SOURCES AND USES APPROACH;321
8.6.6;COMPUTABLE GENERAL EQUILIBRIUM MODELS OF TAX INCIDENCE;330
8.6.7;DYNAMIC TAX INCIDENCE;331
8.6.8;APPENDIX;339
8.6.9;REFERENCES;344
8.7;Chapter 18 - The Second-Best Theory of Public Expenditures: Overview;348
8.7.1;REFERENCES;350
8.8;Chapter 19 - Transfer Payments and Private Information;352
8.8.1;FIRST-BEST INSIGHTS;352
8.8.2;CASH TRANSFERS: BROAD BASED OR TARGETED?;353
8.8.3;PRIVATE INFORMATION AND IN-KIND TRANSFERS;357
8.8.4;REFERENCES;365
8.9;Chapter 20 - Social Insurance: Medical Care;366
8.9.1;THE DEMAND FOR INSURANCE;366
8.9.2;WITHOUT INSURANCE;367
8.9.3;WITH INSURANCE;367
8.9.4;PRIVATE OR ASYMMETRIC INFORMATION;369
8.9.5;MORAL HAZARD;370
8.9.6;THE COMPETITIVE OUTCOME;371
8.9.7;THE PUBLIC POLICY RESPONSE;372
8.9.8;EX POST MORAL HAZARD44THE ANALYSIS OF EX POST MORAL HAZARD IS A VARIATION OF THE ANALYSIS IN PAULY (1968).;372
8.9.9;DEDUCTIBLES AND CO-PAYMENTS;373
8.9.10;THE VALUE OF ACCESS;373
8.9.11;ADVERSE SELECTION;374
8.9.12;EX POST VERSUS EX ANTE EFFICIENCY;374
8.9.13;THE NATURE OF ADVERSE SELECTION;375
8.9.14;ADVANTAGEOUS SELECTION;376
8.9.15;A TWO-POLICY MODEL;377
8.9.16;IS AN EQUILIBRIUM POSSIBLE?;378
8.9.17;POLICY RESPONSE TO ADVERSE SELECTION;379
8.9.18;U.S. POLICIES;380
8.9.19;MEDICARE AND MEDICAID;380
8.9.20;PATIENT PROTECTION AND AFFORDABLE CARE ACT;381
8.9.21;REFERENCES;382
8.10;Chapter 21 - Social Insurance: Social Security;384
8.10.1;THE U.S. SOCIAL SECURITY SYSTEM;385
8.10.2;SOCIAL SECURITY AS SOCIAL INSURANCE;386
8.10.3;THE MACROECONOMIC EFFECTS OF SOCIAL SECURITY;387
8.10.4;SOCIAL SECURITY AND SAVING;387
8.10.5;THE STRUCTURE OF THE ECONOMY: CONSUMPTION, PRODUCTION, AND MARKET CLEARANCE;388
8.10.6;CONCLUDING OBSERVATIONS;398
8.10.7;REFERENCES;399
8.11;Chapter 22 - Externalities in a Second-Best Environment;402
8.11.1;THE SECOND-BEST ALLOCATION OF SAMUELSONIAN NONEXCLUSIVE GOODS;402
8.11.2;THE COASE THEOREM, BARGAINING, AND PRIVATE INFORMATION;406
8.11.3;REFERENCES;412
8.12;Chapter 23 - Decreasing Costs and the Theory of the Second-Best-The Boiteux Problem;414
8.12.1;THE BOITEUX PROBLEM: THE MULTIPRODUCT DECREASING-COST FIRM;414
8.12.2;CONSTRAINED GOVERNMENT AGENCIES;419
8.12.3;REFERENCES;420
8.13;Chapter 24 - General Production Rules in a Second-Best Environment;422
8.13.1;THE DIAMOND-MIRRLEES PROBLEM: ONE-CONSUMER ECONOMY;423
8.13.2;PRODUCTION DECISIONS WITH NONOPTIMAL TAXES;426
8.13.3;SECOND-BEST PRODUCTION RULES WHEN EQUITY MATTERS;430
8.13.4;CONCLUDING COMMENTS;433
8.13.5;REFERENCES;433
8.14;Chapter 25 - Behavioral Public Sector Economics;434
8.14.1;THE BEHAVIORAL ANOMALIES;434
8.14.2;PROSPECT THEORY: THE REJECTION OF EXPECTED UTILITY MAXIMIZATION;435
8.14.3;PRESENT-BIASED PREFERENCES: SELF-CONTROL ISSUES;435
8.14.4;SOCIAL PREFERENCES;435
8.14.5;FRAMING EFFECTS OR CONTEXT DEPENDENCE;436
8.14.6;MAINSTREAM REACTIONS;437
8.14.7;POSITIVE AND NORMATIVE PUBLIC SECTOR ECONOMICS;439
8.14.8;PROSPECT THEORY;440
8.14.9;APPLYING PROSPECT THEORY;442
8.14.10;NUDGES AND STANDARD POLICY PRESCRIPTIONS;443
8.14.11;STANDARD AGENTS ONLY;443
8.14.12;BEHAVIORAL AGENTS ONLY;444
8.14.13;A MIXTURE OF STANDARD AND BEHAVIORAL AGENTS;445
8.14.14;CAN MAINSTREAM AND BEHAVIORAL ECONOMIC THEORY BE RECONCILED?;446
8.14.15;REFINEMENTS;447
8.14.16;REFERENCES;447
9;Part 4 Fiscal Federalism;450
9.1;Chapter 26 - Optimal Federalism: Sorting the Functions of Government within the Fiscal Hierarchy;452
9.1.1;THE POTENTIAL FOR INCOMPATIBILITIES AND DESTRUCTIVE COMPETITION;452
9.1.2;SORTING THE FUNCTIONS OF GOVERNMENT WITHIN THE FISCAL HIERARCHY;454
9.1.3;OPTIMAL FEDERALISM AND THE DISTRIBUTION FUNCTION;457
9.1.4;REFERENCES;463
9.2;Chapter 27 - Optimal Federalism: The Sorting of People within the Fiscal Hierarchy;464
9.2.1;THE MODELING DIMENSIONS;465
9.2.2;JURISDICTION FORMATION IN ACCORDANCE WITH THE THEORY OF CLUBS;466
9.2.3;FIXED COMMUNITIES AND HOUSING SITES: ADDING THE HOUSING MARKET;470
9.2.4;ANYTHING IS POSSIBLE;474
9.2.5;MOBILITY AND REDISTRIBUTION;477
9.2.6;REFERENCES;482
9.3;Chapter 28 - The Role of Grants-in-Aid in a Federalist System of Governments;484
9.3.1;OPTIMAL FEDERALISM AND GRANTS-IN-AID: NORMATIVE ANALYSIS;484
9.3.2;ALTERNATIVE DESIGN CRITERIA;487
9.3.3;ESTIMATING THE DEMAND FOR STATE AND LOCAL PUBLIC SERVICES;490
9.3.4;THE RESPONSE TO GRANTS-IN-AID;498
9.3.5;REFERENCES;503
9.4;Chapter 29 - International Public Finance;504
9.4.1;THE TAXATION OF MOBILE CAPITAL;505
9.4.2;SUMMARY;512
9.4.3;MULTINATIONAL ENTERPRISES;512
9.4.4;CONCLUDING OBSERVATIONS;517
9.4.5;REFERENCES;517
10;Appendix;518
10.1;THE INTENSIVE AND EXTENSIVE MARGINS;518
10.2;THE DISCRETE MODEL;518
10.3;THE EXTENSIVE MARGIN;519
10.4;THE INTENSIVE MARGIN;519
10.5;DESIGNING TAX/TRANSFER PROGRAMS;520
10.6;A TRADE-OFF BETWEEN EFFICIENCY AND EQUITY?;521
10.7;REFERENCES;522
11;Index;524

Leseproben

Chapter 1

Introduction to Normative Public Sector Theory

Abstract

Chapter 1 describes the norms that underlie the mainstream economic theory of the public sector and then discusses how these norms dictate the fundamental normative questions within the theories of public expenditures, taxation, and fiscal federalism. The chapter also considers the competing perspectives of public choice and behavioral public finance.

Keywords

Asymmetric information; Behavioral economics; Consumer sovereignty; Decentralized policies; Decreasing cost production; End-results equity; Externalities; Fiscal federalism; Humanism; Pareto optimality; Process equity; Public choice; Two fundamental theorems of welfare economics

Chapter Outline

The Fundamental Normative Questions 4

Government Expenditure Theory: Philosophical Underpinnings 5

Humanism, Consumer Sovereignty, Capitalism, and the Government 5

The Legitimate Functions of Government 6

The Goals of Government Policy 6

Efficiency 6

Equity 6

Process Equity 6

End-Results Equity 7

The Government as Agent 8

Government Expenditure Theory and Market Failure 9

The Fundamental Theorems of Welfare Economics 9

The Distribution of Income 9

The Allocation of Resources 10

Private or Asymmetric Information 10

The Government Sector in the United States 12

The Theory of Taxation 14

Fiscal Federalism 15

The Theory of Public Choice 15

Behavioral Public Finance 17

Summary 18

References 19

Public sector economics is the study of government economic policy. Its primary goal is to determine whether government policies promote a society's economic objectives. This happens to be quite an ambitious goal. The advanced Western market economies experienced enormous growth in the size and influence of their government sectors during the last half of the twentieth century, and economic analysis of the public sector has reflected this growth. No single textbook on public sector economics can possibly hope to capture the variety and richness of the professional economic literature on government policy, even at an introductory level. Consequently, a public sector text must begin by defining its limits.

We have chosen to limit both the subject matter and the approach of this text. The text concentrates on the microeconomic theory of the public sector in the context of capitalist market economies. The macroeconomic theory of the public sector, commonly referred to as fiscal policy, receives little attention. In addition, the text focuses on the normative theory of the public sector rather than the positive theory. The normative theory considers what governments ought to be doing in accordance with norms that are broadly accepted by a society. In contrast, the positive theory of the public sector emphasizes the incentives generated by existing governmental institutions and policies and their resulting economic effects, without necessarily judging their effectiveness in terms of some accepted norms. A complete separation of normative and positive theory is impossible, of course. A normative analysis must make assumptions about how agents will respond to various government polices; otherwise, it cannot predict whether a given policy will achieve particular norms. Therefore, the text pays some attention to the empirical literature on the responses to government policies, for example, how the supply of labor responds to income taxation. In every chapter, though, our primary emphasis is on the normative theory of government policy under standard assumptions about economic behavior, such as utility maximization by consumers and profit maximization by producers.

That a consensus, mainstream, normative theory of the public sector should have evolved at all in Western economic thought is perhaps surprising, yet there is remarkable agreement on the problems the government ought to address and the appropriate course of government action in solving them. The consensus has arisen in part because the vast majority of Western public sector economists embrace the same set of policy norms, even though their political tastes may vary along the entire liberal–conservative spectrum. In addition, most public sector economists have chosen the same basic model to analyze all public sector economic problems. Given the same norms and a common analytical framework, consensus was inevitable.

The only serious competitors to the mainstream view of the public sector are the theory of public choice and behavioral economics. James Buchanan was the founding father of the theory of public choice, for which he received the Nobel Memorial Prize in Economics. He garnered an enthusiastic following, and his public choice perspective has been influential in policy analysis. Public choice remains a distinctly minority view, however, and its approach is more positive than normative. For these reasons, this text considers the public choice perspective only when it has been especially influential in challenging mainstream positions.

Behavioral economics is a newer competitor to the mainstream theory. It attempts to apply psychological principles to help understand behavior that is otherwise at odds with the mainstream assumption that people act to maximize their own self-interests. It is gaining momentum within the profession in all areas of economics, enough so that we have devoted a chapter to explore some of its positive and normative implications for public sector theory. It is far from ready to supplant the mainstream economic theory of the public sector, however.

The first three chapters introduce the mainstream normative theory of the public sector. Chapter 1 begins by describing the four fundamental questions that a normative analysis must address and shows how a particular set of values or norms shared by virtually all Western economists has produced a consensus on how to answer them. The chapter also introduces the public choice perspective on the appropriate economic role of the government.

Chapter 2 presents a baseline “textbook” version of the basic general equilibrium model that is used to develop normative public sector decision rules. The chapter emphasizes how the norms described in Chapter 1 are incorporated into the formal model.

Chapter 3 concludes the introductory material with two methodological points. The first point is the distinction between first-best and second-best analyses. First-best analysis assumes that a government is free to pursue whatever policies are necessary to reach society's economic goals. It is restricted only by the two natural fundamentals inherent in any economy: individuals' preferences over goods and factor supplies and the available production technologies for turning inputs into outputs. Second-best theory assumes, more realistically, that a government is constrained beyond the two fundamentals in pursuing society's goals. For example, a government may lack the information it needs about individuals' preferences or production technologies to design first-best policies, or it may be forced to use certain kinds of taxes that distort economic decisions.

The second methodological point relates to the political content of the baseline general equilibrium model developed in Chapter 2. The discussion centers on the general impossibility theorem of Kenneth Arrow, another Nobel Laureate in economics. Arrow's theorem, which he published in 1951, stands as one of the landmark results of twentieth-century political philosophy (Arrow, 1951). He proved that, in general, the political decisions needed to achieve any social objective, economic or otherwise, cannot be made in a manner that would be acceptable to a democratic society. This was a devastating blow to the concept of a democratic or representative government. Any normative economic theory of the public sector must acknowledge the huge political shadow cast over it by Arrow's theorem.

The Fundamental Normative Questions

A normative economic theory of the public sector addresses four fundamental questions:

1. The primary normative question, upon which all others turn, is the question of legitimacy: In what areas of economic activity can the government legitimately become involved? The legitimacy question points to the expenditure side of government budgets, asking what items we should expect to find there and why.

2. Once the appropriate sphere of government activity has been determined, the next question concerns how the government should proceed. What decision rules should the government follow in each area?

Taken together, these two questions comprise the heart of normative public sector theory, commonly referred to as the theory of government expenditures.

3. The theory of government expenditures in turn suggests a third normative question: How should the government finance these expenditures? Analysis of this question provides the basis for a comprehensive normative theory of taxation (more generally, a theory of government revenues). The theory of taxation is not necessarily distinct from the theory of government expenditures, however. Frequently, the decision rules for government expenditures incorporate taxes as part of the solution. When this occurs, the theory of taxation is effectively subsumed within the theory of government expenditures. A common example...