Luxury for All: A Macroeconomic Theory of Public Provision

Public in-kind provision of education, healthcare, or cultural amenities accounts for a large share of government spending, even though redistribution can be achieved with cash transfers and externalities addressed with subsidies. We propose a new macroeconomic theory of in-kind provision, grounded in two features: (i) these goods are luxuries, with consumption rising more than proportionally with income; and (ii) they generate externalities that depend not only on the total level of consumption but also on its distribution across households. In a tractable heterogeneous-agent model, we show that these features make direct in-kind provision welfare-improving, even when cash transfers and subsidies are available. Using household- and country-level data, we document that most publicly provided goods exhibit both features. We then apply the framework to the design of fiscal consolidation, showing in a calibrated model that optimal consolidation falls primarily on goods without private substitutes, while preserving in-kind provision of goods with private substitutes. Finally, we develop a welfare-based imputation method for in-kind benefits, to provide a more accurate assessment of the distributional impact of government spending.