63

Musgrave believes the role of government to be:

1. The provision of public goods
2. Concern with distributive justice
3. Contribution to macropolicy

65

à As a result, he feels that public-sector expansion has been a necessary and constructive development.

-          Growth of infrastructure such as highways

-          Public education

-          Rise of social insurance

-          Has contributed to economic growth and social well-being

64-65

In 1893, Wagner argued that public-sector growth (from 10% to 40%) in the West during the 20^th century would occur because of:

1. Structural changes in the economy
1. Rising interdependence among sectors of the economy
2. Urbanization
3. Technological change
4. Decline of the self-sufficient agricultural household
5. Decline of the family as a self-supporting unit
2. Democratization of society
3. An Increased concern for social justice
1. Process of civilization increases issues of distribution and Sozialpolitik

65

Other factors for public-sector growth with which Musgrave would agree:

1. Economic variables: Income, population, structural change[1]
2. Changes in the distribution of political power and institutions
3. Changes in social attitudes

64-65

Another explanation for the growth of public-sector views government as a self-aggrandizing Leviathan, in which budget growth is caused by:

1. The fallacies of majority voting
1. Counterargument: Majority rule may cause the budget to be too small as well as too large (they may think that they will receive benefits without cost, or they may believe that taxes are paid in vain).[2]
2. The usurpation of power by self-serving politicians and bureaucrats
1. Counterargument: Politicians may lead as well as abuse
3. Fiscal illusion
1. Counterargument: Fiscal illusion may work either way

65-66

Restrictions on public-sector spending à There is a limit to public-sector size in the context of a market system, but that limit is not rigid or easily established.

1. Income varies with type of tax (lump-sum, income, value-added)

2. Current outlays should be subject to the discipline of pay-as-you-go finance[3]

3. Capital budgets are to be loan financed, with economic depreciation over the life of the asset.

66-68

Public goods:

1. Consumption and Investment
1. Human investment (education and health)
2. Public investment (transportation, education, scientific advance)
2. Public Bureaus
1. Civil servants for design and administration of public programs.
2. Experts to conduct cost-benefit analysis and give policy guidance.
3. Public Production
1. Production is often best handled by private firms, even if done by public provision.
2. Exceptions: Pricing of natural monopolies, Establishments that generate dangerous externalities, Products whose nature may be difficult to specify when contracted to a private producer (e.g., schools, prisons, and courts), Products whose quality is of public interest

69

Why the government resorts to offering public goods instead of leaving it to the private sector:

1. Insufficient private demand: Private demand is not sufficient to prompt optimal supply of a beneficial product and market provision is deficient as a result.
2. Children and indigents: Product is necessary for indigents or children, but resources for such product are not supplied by parent or guardian.
3. Scarcity of product: Product is essential but scarce, or it has an inelastic supply
4. Public attitude of egalitarianism: View of distributional justice in terms of categorical equity or “selective egalitarianism.”[4]
1. Paternalistic vs. Utilitarian model of welfare maximization.
2. Looks at items of consumption rather than income at large.
5. Upfront cost for delayed benefit: Utility interdependence (?)

70

Public bads

1. Taxation of pollutants
1. Fiscal remedy for cost of pollution
2. Distorts taxation elsewhere
2. Regulatory cutbacks in pollution-generating activity
3. Trading of limited pollution rights
1. Less developed country may view it as worthwhile to accept higher levels of home pollution in exchange for goods that they value more highly.
2. Developed countries may find it more worthwhile to reduce air pollution.
4. Entitlement and categorical view vs. Market view of public bads

70-71

Transfers

1. Accounted for 22% of the rise in the GNP ratio in the U.S. during the first half of the century and accounted for the entire growth in the second half.
2. Benefit: Leaves the use of resources in private hands
3. Cost: Raises issues of distribution
4. Major forms: Poverty relief and social insurance

71-72

Relief of Poverty

1. Preventative (e.g., education, a buoyant labor market, adequate child care facilities)
2. Direct support
1. Welfare payments must decline as earnings rise and thus impose a significant marginal rate of tax on earnings à recipients work less
2. Universal demogrant financed by a flat-rate tax à decreasing subsidy with rising earnings at the lower end, turning into a net tax higher up.
3. Vanishing wage subsidy given in the form of a tax credit for earned income.

73-74

Social Insurance

1. Old age insurance
1. Importance

-          It is in the public interest that all individual be requires to insure to protect against free riding.

-          Protection against certain risks should be available on equal terms and adverse selection be avoided.

-          Society, as a matter of categorical equity, may wish to subsidize the cost at which a basic level of insurance is available to low-income individuals.

-          Carries important implications for macropolicy.

2. Reserve accumulation is needed to avoid unfair burdening of the younger generation. à Private insurance allows each beneficiary to build an individual reserve; public insurance calls for a pooled reserve (and relies on economic and demographic forecasts to avoid deficits and retroactive adjustments)

-          An alternative to reserve accumulation is a pay-as-you-go system that sets benefits not in absolute terms but equal to a fraction of average working income net of retirement contribution, which can then be adjusted every few years according to changing levels of income.[5]

-          Investment of public reserves: Public debt (which must be serviced vs. Mandatory private accounts

-          When there is a surplus on social security accounts, the government can:

§       Raise current outlays

§       Reduce taxes

§       Reduce the level of publicly held debt

§       Public capital formation

2. Health insurance

75-80

Taxation

1. Good taxation is a key test of democracy and a major piece of social capital.[6]
2. Changing perspectives

1. Older generation: Comprehensive, accretion-based and progressive personal income tax was viewed as good taxation.[7]  Corporation tax integration with taxation at the personal level.  Consumption taxes were not favorable. Property taxation accepted for local finance. 
2. Newer plans: Schedule-based treatment of capital income; Flat tax with an equal-rate personal tax on wage income; Consumption-type value-added tax; Unlimited savings allowance tax
2. Questions raised in modifying tax structure
1. Should income be replaced by consumption as base?

-          Income is a fair measure of ability-to-pay: no consideration or discrimination based on source of income (e.g., wage or capital) or use (e.g., savings or consumption)

-          John Stuart Mill: Wages only; base should equal current consumption

§        Problematic considerations in this model come about when considering substitutatibility within consumption (leisure, gifts, bequests, etc) and the utility of holding wealth.

§       Advantage of simplicity in application; no difficulties of measuring capital income (such as depreciation)

§       Benefits are lost when taxation is personal and progressive

2. Should progressive bracket rates be dropped?

-          Single-rate applied to entire base after exemption (flat rate) vs. progressive rate applied before exemptions (progressive)

-          Conclusion: Rising bracket rates should be retained to adequately reach higher incomes.

3. Should the principle of personal taxation be sacrificed to gains in simplicity?

-          The best course may be to stay with the income base and to simplify its application.  As he said before, good taxation is worth its price.

-          Visible taxation and personal participation in a tax system contribute to fiscal discipline and offer guidance in the conduct of fiscal affairs.

4. Taxation in light of globalization
1. Different terms on which tax policy operates
2. Different goals pursued
3. Fiscal competition becomes a consideration

80-82

Macropolicy: Fiscal policy + Monetary policy determine Macropolicy

1. Fiscal Instruments used to deal with Deficit/Surplus

a.     Tight fiscal stance à trade surplus (Example: Japan)

b.     Adjusting interest rates for stability may not cut it, nor will an inflexible attempt to balance the budget.  Instead, attempts at balancing should center on a baseline balance with some flexibility.

2. Effect of fiscal policy on the provision of public goods and the efficiency/equity of tax policy

a.     Allocation, distribution, and stabilization within a fiscal system influence management of the public sector.

82

Conclusions

1. Our primary task is to define the good fiscal system.
2. This task is not impossible; it is not beyond the reach of democratic society.
3. Musgrave does not agree with Hume (or Buchanan, for that matter) that, “everyone out to be considered a knave.” à His view reflects his attitude about majority rule.

83

Buchanan’s Response

83

Review of Musgrave’s position:

1. Layout

a.     Spending side/Role of government

b.     Taxation

2. Position: Musgrave defends current spending

83-85

Buchanan’s view of the role of government (Point 3, Question 5)

1. Agrees with Musgrave on the role of government as protective state: “the legal framework must be provided, to provide protection for property and contract, …predictability…in the value of money, and…enforcement of a competitive market.”
2. Disagrees with Musgrave on the role of government as a transfer/welfare state: “only 10-12% of GDP makes up genuine public goods in the technological nonrivalry sense… the problem arises when you move beyond that to the collective provision of partitionable goods or private goods.”
3. Agrees that a small welfare/transfer system for merit goods is justified from a paternalistic perspective, but is against entitlement claims (as is Musgrave).

85-

Questions raised:

1. What type of distribution – and how much redistribution – is acceptable? Can we determine some kind of distributive norm?
1. Both of these questions lead to and interact with class conflict and the churning state so that political instability – and possibly even a backwards effect – can result.
2. Is it the government’s role to establish “fairness”?
3. Should the focus be on “equality of opportunity” or “public goods”?

86-87

Views on taxation

1. In the 1980s he was in favor of a progressive tax from a constitutional perspective à Now he supports the flat tax
2. 1986 Tax Reform

1. Closed a number of loopholes
2. Lowered rates, basically to a two-bracket structure
3. Widened the base
4. Swept in very quickly
5. Analysis: After getting rid of loopholes and cutting the rates in order to widen the base, it could then immediately start raising the rates again with a wider base and start reselling rents.

88-89

Role of constitutions

1. Difference between American and European views of constitutional structure, as well as taxation.
2. American view is that constitutions are needed to constrain politicians.
3. Musgrave trusts politicians; Buchanan distrusts politicians à different view of how big government’s role should be

107

Section 3.1: Constraints on Political Action (Buchanan)

108-110

Why the government should or should not be constrained

1. Buchanan believes the government should be constrained because of potential problems of efficacy and intrusion of liberties
2. Musgrave is more optimistic about the workings of democratic politics and has a more paternalistic view of its role.
3. Both agree that the state can do good and bad, but Musgrave places more relative weight on the “good” that collective action can do, whereas Buchanan places more relative weight on the “bad” that unconstrained collective action might do.
4. Are additional constraints needed, even if the government is made up of elected representatives, subject to electoral rejection and removal by the citizenry?

111-112

Why impose self-constraints?

1. Big question: Why should anyone ever choose to constrain the choice set?
2. Restriction of individual action:

a.       Persons do adopt rules that they intend to be binding that are aimed to prevent specific actions that might be tempting in the immediate context, but have undesirable consequences in the long term

3. Restriction of collective action:

a.       Different “reason of rules” for collective action than for individual action

b.       Rules may be adopted not to restrict your own behavior, but to restrict the behavior of others whose actions may impose net costs in the context of political interaction.

c.        An individual may prefer to impose specific limits on collective action even if, in some private capacity, no self-imposed rules would be chosen.

113-115

Natural discrimination of majority rule

1. Advantages of being in the majority (113)
2. Governmental agents can, at best, represent the interests of members of the coalition whose support placed them in positions of authority.
3. Many people assume that the majority will always choose the most efficient option, but this simply is not the case:

a.       The option in which cost to the majority is minimized and benefit to the majority is financed by the minority will always dominate options in which a commonly shared good is financed by equal taxes imposed on all beneficiaries.

b.       There is no insurance that majoritarian politics will always choose to undertake only efficient projects.

c.        Furthermore, while there is an obvious threat of discrimination in the financing of commonly shared, nonpartitionable goods and services; there is an even greater threat of discrimination through direct transfers. 

116

Overview of majority problem

1. Discrimination of majority and minority interests
2. Budgetary allocation bias against commonly shared collective consumption goods in favor of direct transfers or targeted programs.

116-117

Problems that may occur regardless of majority

1. Some projects that yield negative aggregate value, in net, may be financed; some projects that yield positive net value will not be undertaken.
2. Risk averseness will dictate the relative superiority of an institutional setting with less rather than more discriminatory collective action.
3. Costs involved in the rotation of discriminatory majoritarian coalitions

118-121

Two types of constitutional constrain that can solve the majority problem à both of which result in option in which a commonly shared good is financed by equal taxes imposed on all beneficiaries and the minority does not have to bear unequal burden of cost.

1. Inclusivity: More inclusive requirements (unanimity) à increases prospects that collective action will, in net, be efficiency enhancing; makes discrimination against minorities impossible

a.       To be effective, requirement must reduce the relative size of the group that may differentially damaged through collective action.

b.       Redistribution is severely limited by unanimity because it is only on agreement among all members of the polity that transfers to selected persons can be implemented.

2. Generality constraint: Constitutional constraint dictates that collective action must be nondiscriminatory.

a.       Benefit: Majority rule will tend to generate outcomes that are those preferred by the median voter.

b.       Insures that collective action remains genuinely “public” in the sense that benefits must be equally available to all participants and that taxes be imposed on established criteria of generality.

c.        Eliminates specifically targeted benefits and specifically targeted taxation.

122-123

Redistribution

1. Majority rule can have a negative effect in terms of redistribution because it must generate familiar cycles, and there is no assurance that those persons and groups most in need of fiscal support would fare well in the cyclical rotation.
2. Generality constraint allows some redistribution

a.       On the outlay side, a scheme of equal-per-head payments, or demogrants, would meet most generality norms.

b.       On the tax side, taxes imposed generally on a well-defined base that relates to individual taxpayer capacity, on traditional ability-to-pay measures (no exemptions, no deductions, credits, exclusions for any persons or groups)

c.        Generality principle may not solve the problem of efficiency, but it would restore public respect for modern democratic processes.

3. Generalized redistribution vs. deservingness

124

Summary

1. Efficacy of possible constitutional constraints on the exercise of political authority
2. Dual classification of constraints

a.       Those that might operate on rules or procedures for reaching collective choices

b.       Those that might operate directly on the set of outcomes or positions that may be generated whatever the rules of decision.

124-125

Considerations & Application

1. U.S. structure calls for more than majority support because of all of the checks within the system, whereas the European system typically calls for a simple majority.
2. Problem associated with issue-specific majorities: Collective action that emerges may represent a coalition of particular interests, but has little or no coherence or objective beyond the single issue defined by the action.

129

Section 3.2 Response (Musgrave)

129-130

Restraints must be imposed on private sector by government, which justifies larger government

1. It is not only the state whose actions need to be restrained
2. To impose such restraints, collective action by the democratic state is needed à proper mix of restraints on collective and individual actions

130

Questions in determining the appropriate size of government

1. Regarding the scale of collective action as determined by a set of “objective” circumstances, consumer preferences, resources, and technology

a.       How large is the commons?

b.       How prevailing are the externalities?

c.        What is the shape of the communities social welfare function?

d.       What does all this tell us about the “proper” size of the budget?

2. Regarding the decision-making process that underlies collective action, and especially to the central issue of choice by voting

131

Costs of majority rule outlined by Buchanan

1. Costs: Discrimination, Rent seeking, Excessive budgets
2. Nondiscrimination clauses will restrict rent seeking and will help to reduce the budget