The Optimal Size of Public Spending and the Distortionary Cost of Taxation
AbstractFeldstein (1997) reviews his and others' contributions in the distortionary costs of taxation, arriving at a remarkable estimate that the cost per incremental dollar of government spending is a very high $2.65. Kaplow (1996) argues that it is optimal to supply a public good whenever the benefit/cost ratio exceeds one, contrary to the orthodox position since Pigou (1928) that the benefits of public goods must exceed their direct costs by an amount sufficient to outweigh the distortionary costs of taxation. This paper largely reconciles these two apparently opposing positions. The large distortionary costs exist on the revenue side but is largely offset by the negative distortionary costs or distributional gain on the spending side. However, both Kaplow's and Feldstein's arguments have to be subject to important qualifications. Additional arguments relevant to the central public finance question "How big should the public spending be?" are also reviewed. The prevalence of environmental disruption effects, the existence of burden-free taxes on diamond goods, and the importance of relative-income effects all favor the lowering of the required benefit/cost ratio for public goods and, as a rule, more public spending. The reason for the difference between the existence of distortion (in comparison to a lumpsum tax) as emphasized by Browning and Liu (1998) and the unitary marginal cost of public fund is also explained graphically.
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Bibliographic InfoPaper provided by Monash University, Department of Economics in its series Monash Economics Working Papers with number archive-19.
Length: 20 pages
Date of creation: 2000
Date of revision:
Publication status: Published in National Tax Journal 53:2 (June 2000) pp 253-72.
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Postal: Department of Economics, Monash University, Victoria 3800, Australia
Web page: http://www.buseco.monash.edu.au/eco/
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- H00 - Public Economics - - General - - - General
- D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
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