Resume Public Economics

RESUME : Local Public Goods and Public Economics Theory and Policy

by;

Rina Samosir (7113141087)

Risma Tinambunan (71131141088)

Sahat Silverius Sijabat ( 7111141018 )

Wenny Lisa Bangun (7113141109)

MEDAN

T.A 2012/2013

Introduction

The teory of local public goods differs from the analysis of previous lecture in that goods are asumsed to be a spesific to a particular geograpical location  and consumers in deciding on their location  can exercise choice  with Respec to the quantity and types  of publick goods provided for some public goods trere maybe no spatial retriction (for examples ,the benefits from research and development);but for other the confined to one comunity (possibly with some spill over  to neighbouring communities).he contrustion of seas  defence benefit  those protected by within a certain  distance of transmitter  in this lecturer we examine  sme of the implications of the local nature  of such public  goods and their  provision by local rather   then central goverment  our focus this on the former but in the final section we consider the fiscal relation  between difrerent level of the goverment.

Local public goods and market analogy

The mobility of indiviidual  between comunities suppying local public  good has a number  of major implication  it is he particular  relevan to the  problem of relevation of preferences ,indeed  much of the interested  in local publick goods  was stimulated by  the intrigooing suggestion of the about (1956)that.if there enough comunity  individual would reveal their true preference for public goods by the choice of comunity  in withc to live  in much the same ways as indiidual  reveal the prefence for privat goods by ther choice.where trere is the wide  range of choice all thos not would  deciding to live i the same coommunity would have essentially the same taste  and therno be no problem  of reconciling conflicting prefrence  more over  it is often  asserted that such alocal  public good equilibirium would be pareto-efficient.

The paralel ignore how ever certainkey characteristic of local public goods  one of the most important of these is the essential non-convecxity associated  with the provision  of such goods to individuals citizen in these convectional analysis of maret with only privats goods. The assumtion of the covectxity  is critical in tre ways.(1) as a result of  non convecities  there may  exis non competitive  aquibilirium (2)non convecxiti in practice  ar likely are  to be associated  with varios kinds  of non compentitive  behaviour and(3) where there are noneccesarilly.  The case of that the every pareto –eficiency  allocation can be  supported by a commpetitive  equilibirium  with appropiated  lum sum redistribution .

In the case of local publick goods  non conveccities are in herent in that the cost  of supplying the cost  given quantity of publicc goods  to an additional  individualis zero (in the pure case)  as we show all a local public goods  equlibirium  may not exis  wheter and not  its does depends on the precise  equibilirium notice  employed and  as we not below  several alternative  concep suggest  themeselves.

Organisation of the lecture

In this lecture is consentrate  particulari and the optimum  provision of local public goods and its relationship  it quantity provided  under diferent market  mechanism  the analisis can became  fairly complex  and the ai of  the model presented here  its the bring out he key  poins in thesimplest  possible context  in section 17-2 we begin in the first best allocation  where optimality  is define  in therm of social  where  maximization  we first consider  the case where individual  are identical  and then we extent  the analysis to allow  for diferent of intens  taste and endowments.

17-2.Optimum provision of local public goods

For a pure public good that it not spatially limited (such as the benefit from research and development) the issue  of number and size  of communities  does not arise ,where however the benefits from a public goods  are spatially  restricted. We have to consider these question  as are as the public good is concernet.it is indeed natural to ask  why there should  be more than one comunity.if that addition of a person does not  detrack from  the benefit enjoys by others.then from this point of view the optimum  allocation is the  involve every one  living in same communities.

Basic frame work

The model is the hightly simplified one ,in wich total output ,y,in,a community can be used eiher from privat consumtion (X per person) or for the public goods,G,in that community.it is asumed that output is an increasing,concave function of the number of workers in the community

Y=f(N) f''>0,f”<0

Where f  0 as N   and f on the assumtion that everyone  in the community is the  identical and is treated  the same and the  agregate production  constrain gives:

For fix N ,this defines the consumtion opportunity set illutrated in fig.

Properties of the social optimum

We now put these two element togather –variation in G and variation N then we immediately  have to face  the problem that variable N Opportunity  locus in convex to the origin.in the analysis so far its have been  assumed that labor is supply in elastically  but the result can readdily  be extended  and the hendri geor  therem remains valid  this is left  for the reader to consider.

Fixed population and fixed number  of communities

To this point we have assumed  that there is no obstacle  to the esthabilisment  of sufficient local communities  of optimum size accomondate  the total population . one problem thart this the total number  people may not  be and integral  multiple of N .this have been discussed in the contex of local goverment..although in a frontier  society  its maybe possible  to establish new towns and thus reduce N ,There is likely to be end  to this process .settlement in most advenced countries is retriceted to a fix number  of location.

We now consider the implication  of this features of local jurisdiction for ease of exposition ,we assumed that there are two communities denoted by one and two with identical quantity and quality of land and that a fixed population ,2N has tobe divided between them .if the social optimum involves  equal treatement  than the solution is the relatives  sraightforward there is how ever  no necessary reason why  equal treatement should be implied.

In other to examine the social optimum let us denote by N the number of people the community i and byVi the level of utilitas where Gi of chosen optimally in each community.suppose that the goverment maximizes the benthamite social welfare function.

Some possible situation are illutration in figs17-4a and b .in the first case ,the social optimum involvest all the popultion being in one jurydiction.

Diferences among individual

The analysis of the case with identical individual is mainly of interest  because is provides  the necessary  background from the general theory where individual offer,as we have seen,the hyphotesis of tiebout was that  here the heterogenous individual ,they would individuals they would thus be the homogeneous we need ask ,how ever ,under whats conditio such complete shorting is optimal

The first point concern the production side the economy such considerations were in effectassumed away by tiebout.

Leaving inside the mixing due to the interaction in production ,it is not the case that individual are always better off forming homogeneous comunities with people of identical taste.

17-3 Market Equilibria and Optimality : Identical Individuals

            We proceed in the same way as in the earlier analysis. We first assume, in this section, that people are identical. This means that the critical issue of matching people by communities does not arise, but we can still ask whether communities of the optimal size will be formed, and whether, within each community, the optimal supply of public goods will be provided.

Basic Model

            Here we assume that there identically. It is then a condition of equilibrium that all individuals have the same level of utility. For easy of analysis, we make the same simplifying assumption as earlier. There is a single private good and a single public good. There are 2 potential communities, both identical. The conditions for equilibrium may be given in terms of V(N), represents the maximum utility assuming N is constant :

           if both communities settled

            if only one community settled

            Some of the various possibilities are illustrated in Fig. 17-6. We may that continuity of V(N) is sufficient to ensure exixtence of at least equilibrium.

Land Values and Capitalization

            We modelled a state in which land is publicly owned and all model have equal access to the rents (after paying for the public goods). We give all individual unit of land but for half of the population we concentrate of ownership claims in one community (1-in the other); for the other of the population, there is in the other community (1-in the other) where >. Moreover we assume that the government is restricted imposition of rent taxes to a rate  which is less than 100 percent.

            There is an effect “capitalization” of the benefits in land values. To see the considerations involved, consider a position where >.

            From this we can see that the level of public goods is influenced by two considerations not previously present: the difference in the interest of different community members and the effect of migration. To see the effect of the former, suppose that . The level of public goods is then determined by equating the sum of the marginal rates of substitution to the MRT, but assuming that everyone places the same value on the public good as does the majority.

Differences Among Communities

            Where there are only two communities, it is reasonable to suppose that each would perceive this, and that the transfers would take place. But where we increase the number of communities and people proportionately, there are any community from which a transfers is due will attempt to be a “freerider”. It would prefer all other donor islands to provide the subsidy, while it enjoys the benefits in terms of the allocation of the population. This may lead to arguments for a central authority to enforce transfers.

An Alternative Equilibrium Concept : The Core

            The demonstration that the core is empty proceeds by a series of steps :

1. In any allocation in the core, there cannot be a subsidy members of the larger of the two communities.
2. In community 2, the worst-off person receives less than his marginal product.
3. One of the communities must be strictly smaller than other.
4. The worst-off person in community (Mr A) must be worse off than the worst-off person in community 2 (Mr B).
5. The worst-off person in community 1 (Mr C) is at least as badly off Mr A (indeed, C and A maybe the same person), and hence is worse than Mr B.

17-4 Market Equilibria and Optomality : Heteregoneus Individuals

            This section allows for differences between individuals in tastes and endowments. These do not in themselves mean that the Tiebout argument cannot be employed, and we begin with a model where communities are mixed (by virtue of the assumption made about production) but where here is unanimity about the level of public goods and this Pareto-efficient.

The Tiebout Hypothesis in Mixed Communities

            The model we employ initially is one hich the conditions of productions are such that communities must be mixed. There are two groups, who interact in production, and both are essential to produce a strictlypositive output. The two types are denoted by m and n, with number , in community  j.

                                                             (17-35)

where

                                                            (17-36)

Non-Existence of Local Public Goods Equilibrium

            The possible non-exsistence of an equilibrium is illustrated by the examples of Westhoff (1977), where there is a continuum of consumers with differing preferences and a limited number of communities. In each community the level of public goods is determined by myopic majority voting, this being at the most importsnt assumption.

            Within each community, the decisions regarding public goods are made by a majority vote. Voters are myopic and take no account of the effect on migration. Migration takes place where a person can obtain a higher utility level in different community, including the possibility of not joining. We consider in turn the possible equilibrium configurations, and indicate how a set of conditions can be derived under which no equilibrium exists :

1. A single community (which we denote by MNO). Majority voting leads to the choice of good1, preffered to 2 by m and o (who form a majority), and preffered to 3 by m and n (who form a majority).
2. Two Communities (MN and O).
3. Two Communities (N and MO)
4. Two communities (M and NO)
5. Three Communities (M, N, and O)
6. Equilibria

Land Values

            In order to bring out the implications in the context of heterogenous tastes, we now consider a model where land is owned by people whose only concern is with the effect of the choice of public goods on the land values. We have, for example a lake in each community that can be used by the resident for two decisions concerns the proportion.

            In this equilibrium, the two communities produce exactly the same public goods, in spite of the heterogeneity of tastes. Obviously, this is not a social welfare optimum; it is only the preferences of the marginal individual that are taken into account. The preferences of the intramarginal individuals-virtually the total population are completely ignored. Any social welfare function that did not assign all the weight to the median individual in society would have the different communities produce different public goods. Moreover, its quite possible to construct examples where the equilibrium is not only inconsistent with any social welfare function that does not give all weight to the median, but is actually Pareto-inefficient.

Rich and Poor communities

The Condition geographical area,the consumption of the poor does not detract from of the rich.  The rich may be interested in excludibility poor because of differences in the levels of demand for the public good the redistribution implied in the method of financing.The  poor may for a different combination of public goods and taxation, and if her specified method of financing then the taxes paid not macth benefits received.

             In order to illustrate the way in which exclusion  may be practise assume, for simplicity,that there are only two groups in the popular. The rich, referred to by a supercript R,have income( per capita) of while the poor,referred O by a supercript P, have per capita income where . The income is assumed independent of the number people living in the community- there are no costs of congestion in the law of diminishing returns.This cause the law diminishing.

Concluding Comments

Where there is a limited number of jurisdictions ,or where people act myopically,equilibrium may not exist,and when is does exist it may not be Pareto Efficient. The equilibria displayed inefficient in:

1.The numbers of individuals within the community

2.The level of people of public good and the choice of public good supplied within each community

3. The number of comunities formed

4. The matching of individuals together to form communities

Fiscal Federalisme

The appropriate instrumen for the central govermentto employ.There are several reason why tha central authority may intervene :

1. Redistribution.

Without central authority intervention,there may be a strong motivication for the formation of local communities of individuals with similar incomeor wealth.

2. Externalities (sometimes referred to as spill-overs).

The action of one community have an important effect on externalities for other community.The important for education.

3.Correcting inefficiencies in the local public goods equilibrium

 Local Goverments be Treated as Individuals

            If the community is assumed to have preferences like an individual, the lump-sum grant has a pure income effect.Then revenue sharing is simply equivalent to a reduction in federal taxws with local taxes being increased to finance any rise in public spending.

            The equivalence may also need to be qualified if there are admministrative obstacles to the distribution by the federal goverment of taxes grant to individual proportional.Perhaps most important is the fact that individaul as voters have only limited control over the local goverment.

Mobility and the Constrains on Taxation

When production of a commodity occurs within several communities it may be impossible to ascrtain how much of the profits generated was due to the activity within any particular community. At the central goverment level,the design of policy is now constrained by the reaction both of individuals and of lower-level goverment.

EIGHTEEN

On the sources of disagreement in policy analysis

One of the most important fuctions of the analysis is to identify tje sources of disagrement.What, for example are the essential elements in the case for an expenditure tax that distiungishes the propenents from the openents? Is it disagreement about the consequences of the tax?or is it disagreement about the purpose taxation?

Failure to Trace the Full Consequences

            The may work in the opposite direcxtion and undermine the intended consequences. The assessment of policy must take account of the responses of individuals or firms,and this has been ilustrated at numerous points in these lectures. People may be led by the income tax to direct their economicactivities into forms that are untaxed or taxed a lower rate.even when economic activity is not significantly changing,efforts are made to alter the appearances in such  a way as to lower the tax rate.A tax that was apparently progressive,in terms of its effect on the distribution of income,might- as a result of changes in factor supplies and in their allocation have the reserve effect.

Differences About the Correct Model of the economy

Differences about the correct model may arise in other respects.we have referred to controversies surrounding the use of an aggregate production function.It is our view that simplified assumptions may be adequate for demostrating the potential range of effect, but a through analysis of particular tax or expenditure requires a full scale specification of the production technology and on the derved relation between factor use and factor prices.

The treetmant of disequilibrium ,particularly in the labour and comoodities markets,is another sample.Some people may feel the equilibrium models can provide no isight,others are the opinion  that they represent a useful abstration  for some purpose.Where one reaches quite different conclusions using a model where bequests moderate the forces of chances from those obtained in a model where bequest are a major force leading to the concerctration of property.Differing perspectives are also significant in assessing the literature the optimal design of taxation.

Differences About Empirical Magnitudes

Disagreement may arise even when people agree about the theorities model and about the possible patterns of response,because the differences about the magnitude of key parameters.People may agree that a tax saving could reduce saving but disagree as to whether it is empirical significant.

Such differences arise too a considerable extent becauseof the difficult of obtaining reliable evidence.Many of the relevant effects an difficult,if not impossible,to observe directly.

Finding are constructive and allow us to use available evidence. One example is the conclusion that, where the governmentb is retricted in its ability to reallocate consumption over time, it mauy be concerned with the absolute level of savings and hence it is the total rather than the compensated that is of concern.

Disagreements  over objectives

People obviously  may differ in their recomemenations about policy because they have different  objectives or differing views aout how economists should discuss normative issues. It is not the function of these lectures to resolve such Disagreements : however the analysis may go some way towards clarifying the nature of objectives and their relationship to the proposed policies.

First, many popularly expressed goas are to ill defined to be applied in a meaningful way. In this case an important contribution is to make precise exactly what is entailed. For instance it is sometimes stated that the government should do the “most good for the largest number of people”. This, as it stands, is virtually meaningless. The officislhsndbook  on the British System of Taxation describe as a principle that the burden shoul be fairly spread without impairing national properity. How should such a statement be interpreted ?

Second, certain objectives of  government policy are put forward because it is believed that their achievement will help secure a more  basic goal. They are in effect intermediate objective. In this case, analysis may hel clarify the relationship with the true, underlying, objective. There is, for instane, a wides spread belief that in tax policy government ough to pursue  a policy  of neutrality. This is a secondary objectives ; the primary objective, with which most people who ascribe to the neutrality objective would agree,is some notion of economic efficiency (say, pareto efficiency)

Third, there are objective the nature of which cannot really be assessed without exploring their full consequences. By analyising their implications sometime in idealized situations, one can help to asses the extend to they are likely to command support. If it uturns out that people principle lead consistenly to unacceptable conclusions, then this nature to a revision of  objectives.  Public economics have been important test-bed for principles of economic justice in the years.

Role of formal analyisis

In tracibg the full consequences of policy, in exploring alternative mode relating the theory to yhe empirical evidence, and in clarifying the nature objectives and the relationship between them, public economics have been importand role to play. In our view, this role can be fulfilled only the analysis is based on a fully articulate theoretical framework and a statement of its implications. The view is reflected in the fact that this basic has a ratio of equations to words well above the norm  for public financial text.

The need for formal analysis is particularly apparent in two of the areas we have emphasized- the general equilibrium effects and the design of policy when the fiorst best cannont be attained. In the both cases intuition may help explain the result  obtained mathematically but on its own may be an unreliable guide. Some of findings are quite apparent but others run footnote seeking to explain in words a proof of cournot,edgeworth comments that the general reader will perhaps be disappointed in this expectation of simplicity.

18-2 Thinking about policy :taxation

Survey in the united sttes have shown that the American public considers tax reform thethird most pressing national problem,ranking only behind the control of inflation and reduction in the crime rate. In this section we describe briefly how to analysis of these lectures may be employed to discuss two important [policy issues : the case for an expenditure tax and the comprehebnsive income tax base. The treatment is necessarily very limited ; the main purpose is to show the tools in action ilustrting both strengths and weaknesses.

The expenditure tax

The idea that direct taxation shoul be based on expenditureor consumption , rather than income has along history and has had many distinguished supporters including j.smill,marshall,Irving Fisher and Lord Kaldor.

            The arguments made in support of the expenditure tax gave shown an interesting shift over time. For marshall and others the tax was taken to be self evidently preferable in theory to an income tax, but it was fet to be incapable of pratical implementation, a position that led Keynes to conclude that although perhaps theoritically sound, it is practically impossible.(quoted in Kaldor,1955). In contrast, the recent arguments “stand that conventional wisdom precisely on its head that the theoretical arguments are at bbest rather indecisive and that the  case for expenditure tax is essentially practical.

The theoretically case is made on grounds of both efficiency and equity. The efficiencyargument has commonly been based on the distortiom associated with tehe taxation of savings under an income tax : “income tax lowers the rate of return on saving and thus distorts everyones choice between consuming today and saving for a higher level of consumption in the future. The consumption tax would eliminate this wastefull distortion. However an expenditure  tax is not itself lump-sum and affects for example the work leisure coice. One lesson that we have learnt from second best  welfare economics is that one cannot evaluate tax system simply by comparing the number of distortions involved : one has to consider the magnitude of the various  effects and their interaction and there is no prima facie  case that the exemption of the interest income is desirable.

The standard Ramsey formulation is in fact of limited interest, since with identical individuals a uniform lump-sum tax can attain the first best solution. In an intertemporaleconomy , not only might the government use lump-sum taxation to raise any requisite revenue, but also by varying the lump-sump tax ( or payment) at different dates of a person life, it can regulate  the pattern of capital accumulation to achieve  a first best allocation of consumption over time. Even when individuals differ in their wage rates, so long as the government can impose an optimal nonlinear income tax,and through one instrument or another can contro the growth path of the economy, then, applying the result of lecture 14, we can find conditions under whichc an expenditure tax is optimal, in particular where labour is weakly separable from commodities.

            This result provides theoretical support for the expenditure tax” on the other hand, it is based on strong assumptions. If

1.      there are restrictions on the government ability to control the intertemporal allocation of consumption or

2.      the government is not free to vary the nonlinear income tax schedule,or]

3.      the weak separavbility condition does not hold,or

4.      individuals differ in other respect in addition to their wage rates, then we cannot appeal to the result. There is no necessary presumption that the expenditure tax is optimal.

On the others hand,this does not mean that there is support for income tax, which implies equality between the rates of tax on capital and other income. While a non-zero rate tax on interest income may raise welfare, it does not follow that it would be desirable to set at the same level  as the tax on earned incomes.

The first equity argument for an expenditure tax is that is fairer to tax people on what they consume rather than on what they produce. The expenditure tax does not get round the difficulties in incorporating unobservable elements relevant to the opputunity set such as leisure.

The second equity arguments is that in terms of the lifetime budget constraint developed inlecture 9. The assumptions of life time cumulation, of a stable tax schedule and of a perfect  capital market are howeverimportant.

This brief discussion has we hope served to show that the earlier analysis provides definite insight into the efficiency and equity arguments but leads to no clear presumption in favour of either expenditure or income taxation. Although we have on occasion drawn attention to this subject, we cannot at present call on a well developed body of analysis  that deals with the administration of taxation. None the less, there are some points that can be made.most important is the critical role played  byobservability in the design of tax structures. Distinctions that make clear economic sense may not be easily enforceable. For example , the distinction between wage and capital income is one that  economists make regularly. On the other hand, in unicorporated enterprises, even if the entrepreneur could distinguish between the two, which is itself problematic,there is effectively no way that the government can.

The fact that certain variables are not easily observable means that one may have to make distinctions for administrative reason. Much of the administrative burden is associated with these kinds of distinctions.

Comprehensive income tax

The case for a Comprehensive income tax base typically starts from the high –simons definition of income, accepting this as a measure of abiity to pay. It then focuse on the way in which the tax codes depart from this ideal definition includind :

1.      differential rates of tax on different types of incomes

2.                  total exemption of certain forms of income

3.      deduction of certain kinds of expenditure

4.      tax credits for certain items

The case for eliminating these provisions is based on equity and efficiency considerations. It is argued  that horizontal equity requires that people with the same haig-simon  income should face the same tax burden, and that vertical equity would be improved by the extension of the tax base sine the exemptions and deductions provide disproportionate benefit to the better off. On efficiency grounds, it is suggested that the specific provisions lead to the misdirection of resources and that in general the reduction in tax rates, facilitated by a broadening of the base, would reduce welfare loss associated with the income tax.

            If such a position is not taken, then one can see that there may be arguments for departing from the comprehensive tax base. First, there may be efficiency gains, for examples from treating different forms of income differently, and the trade off between equity and efficiency may indicate that some differentiation is optimal. Second, where the government cannot vary tax rates freely with ability to pay, the exemption of certain items may improve the redistributive effectiveness of the tax.moreover it may be argued from an equity standpoint that ability to pay. Third the tax policy of a federal government may have to be devised taking the behaviour of lewer level government as given and special provisions fo local taxes or borrowing may be desirable given these constraints.

            Arguments for departing from the omprehensive tax base may be seen as a varation on the standard second best analysis .where the first best ( High Simon ) tax base is not achievable, then it does not follow that we should try and approximate it as aclosely as possible. If for example the true income base deucts necessary but unobservable health costs, then we may have to accept that the second best tax base involves exempting some elements that strictly should not be deducted. If imputed rent is not observable \, then it may be that the second base woiuld involve a deduction for the housing costs of renters. In thet sense we would to move away for comprehensive definition.

18-3 Thinking about policy : expenditures.

Income maintenance

For much of the early history of social security, it was  treated as quit  two are closely interrelated, and that we need to adopt a consistent approach to the design of the two branches of government policy. It has indeed been proposed by many people,including Milton Friedman and James Meade in the 1940s and presidential candidates and chancellors of the Exchequer in the 1970s, that income maintenance be integrated with income taxation in a negative income tax or social dividend scheme.

            The essence of such proposals is captured by considering a simple modification of the liniear income tax examined at a number of stages in these lectures. The simple straight line schedule incorporates a minimum income guarantee.G,and a tax rate t on all income ,up to a brea even level of income.equal to G/t. suppose now that we combine it with the standard “positive” income tax schedule/income maintenance system then amounts to the choice of G,t,and , subject to the condition  that they be feasible. In particular, is it possible tio improve on the existing system, which involves a high marginal  tax rate for some low income families and inadequate support for others ?

            The earlier analysis has indicated several of labour .as we have seen , this is a complicated question and individuals may be affected very differently. People at different levels of income may exhibit quite varied  responses. The effect of a change in the income  maintanence system would make some people better off, some worse off: it would raise the marginal tax rate for some , but lower it for others. The impact would depend on existing  benefits received, on family circumtances, and other factors. This variation makes it difficult to interpret  the empirical evidence even in this relatively well researched area.

             The investigation of the  responses of pre-tax income may allow the government to trace out the feasible combinations of policies to see what tax rate, , is implied for those above the break even level by programmes of differing degrees of generosity. The balancing of the cost against the benefits                   (raising G and lowering t ) clearly depends on the nature of social objectives. These do however  interact with the factors entering the constraints, particularly the elasticity of labour  supply. Thus, a Rawlsian objectives may still lead to a relatively low tax rate, where this generates  a higher revenue and hence a  higher guaranteed income. The rawlasian objective may indeed stop short of maximizing the guarantee, where the least advantaged person is in employment.

            The design of income maintenance illustrates again the need to take account of the other instruments at the disposal of the government. As we noted in lecture 11, the full range may include not just income related taxes and benefits but also wage related taxes and benefits. We need to consider the relative  programmers. The guarantee under the negative income tax is  typically taken to be differentiated only in relation to family size nd possibly Age. Suppose however that we can characterize different groups, who vary treat them differenty ?

            In effect,social insurance involves a payment  to people who statisfy certain eligibility criteria unrelated to income, where the amount of the benefit may or may not  be related to income. If people  canbe identified without error, then the use of such categorical programmes can be shown to raise welfare and we can see from the earlier  analysis  the form that the programme is likely to take. We may, for example, want to have a hgher guarantee and a lower tax rate for retired people than for the population of working age , on the grounds that the needs of the former are greater and that their labour supply (where non zero ) may be more elastic.

 The use of categorical programmes depends on it being  possible to identify people at reasonable cost and with an acceptable degree of error . this is one of the issues that attracts most public  attention. Where the accuracy is less than 100 per cent, the effectiveness of the categorical approach is lessened and its superiority may be called into question ;in addition, there are questions  of horizontal equity. The optimum design of taxation in the presence of such errors must balance the loss of welfare caused by errors in classification of taxation against the advantages fro the differentiation (stern,1977). More broadly ,considerations of administration must consider the costs  to recipients. The experience with income related benefits has shown (atkinso,1969) that the “take-up” rate is  sonsiderably less than 100 per cent , reflecting the pecuniary or psychic coct associated with claiming benefits.

            In the assessment of proposals for income maintenance, the general equilibirium and longer-run effects may well be important, although they are frequently ignored. We have reffered to the response of individual labour supply, but the implications for the general equibilirium need to be followed through. Such effects, undoubtedly important  in historical debate on the relief of provertty,are of lesser significance  when the group affected is relatively small but concentration in particular occuoations and regions may lead to a significant response. The long run consequences  may work through several different mechanisms,including those relating to education to access to well playing jobs, and to the accumulation and passing on of material wealth.

State education

Public education has been the subjects of considerable controversy. In the united kingdom, attention has focused on the replacement of selective with comprehensive schools, the size of state support to higher education. In the united stetes discussions has centredn the marked intequalityineducstionsl expenditure between scholl districts, on the provision of compensatory education for disadvantaged groups within society , on public support through tax deductions or educational vouchers ) of private education and on the financing of higher education.

            The analyisis of alternative educational policies is seriously handcapped by our limited understanding of the relation between expenditure and outcome. For instance, it is often asserted that large variation  in state expenditure per child on education is a major factor leading to inequality in incomes. This is based on the view that differential spending is likely to lead to inequality in educational attainment, and this will exacerbate inequality of incomes. These empirical propositions have been the subject  of considerable disagreement, and we cannot attempt to discuss them here. We therefore assume for  the purposes  of argument that the linkages hol to at least a limited extent.

            On the assumption that educational expenditure provides economic advantage (it may also of course generate consumption benefits ), we have to consider how this publicly provided private good should be supplied. A straightforward application of the analysis of lecture 16 suggest that the level shoul  be centrally determkned , with a balance of equity  and efficiency considerations. On a utilitarian approach, expenditure would be allocated according to its effect at the margin. There is no reasin why this should be expected to lead to compensatory education, and the policy may well involve a lower allocation of resources to the less able. In both cases, account needs to be taken of interaction  with the tax; on the other hand, the government is typically limited in its ability to levy redistributive taxes.

            The allocation of education deduced from the maximization of welfare may howefer conflict with other principles advanced in connection with education. The first  of these is that of local autonomy :that communities ought to have the right to decide on the amount of education provided to their children. This means that if we wish to influence educational expenditure_e.g. to equalize itacross communities (an input equal policy ) then we have to do it indirectly, through some system that leads communities to choose different of education from those the currently do. One proposal that has received extensive discussion is that a tax on the expenditures of rich  communities and a subsidy on those poor communities. The particular fro that is sometimes suggested is the following: a community pays taxes tW, where W denotes its wealth per capita and t is its tax rate and receive educational resources tW, where W is the mean over all communities.

The implication of this formula that the rich communities face higher effective price of education  than do poore communities. But in communities also have a higher income. Suppose the major determinants expenditures but will noy eliminate it : but if the price response is great  than the  income response, the rich communities will actually spend less the education than the poor.

             This suggest in turn a basic problem with this proposal, which related to a second principle often invoked : the right of parents to served their children to private school. It would pay parents in rich communities to close down their state schools and to have only private school . The constraint imposed by this second principle  the ability of parents to  option  of state educationa are eveb more important  when we consider the distribution of educational expendiditure. Consider, for instance. The extent of the provision of compensatory education effectively raises the cost to other children. This provides parents with an incentive to vote for less state education and possibly to opt out  of the state system altogether.

            This brief discussion highlights how the introduction of price constraints locala autonomy and parental choice coupled with decentralized decision making by majority voting eads to a problem considerably  more complex than those treated in these lectures. It does however have some of the same features of “indirect control “ that have beeb emphasized in many applications.

18-4 Policy reform and political economic

            This lecture has concentrated so far on the  arguments for and against particular tax or expenditure policies : it has not considered the process of reform, the way in which a policy change is introduced and the poloitical mechanism by which it is achieved.

            As we have emphasized in lecture 12, the result on the optimum design of policy can be applied to the more limited goal of characterizing improvements in policy, and this is possibly the most  useful interpretation. The aim should be to describe conditions under which a step can be made in a welfare-improving direction with specified objectives and constraints on policy. Thus, we may conclude that, if the labour supply of wives is sufficiently elastic, the partial exemption of their  earnings would raise tax revenue and increase the transfer that can be made  to disadvantaged groups. This does not require us to say that the exemption is optimal or to describe the optimum which may be a considerable distance from the present position.

            In order to provide content to the concept of political feasibility, one needs to examine the relation ship of policy to yhe structure of government and political institutions. Proposals have to be sold on those  responsible for their adoption. Legislators must be convinced not only  that the objectives is desirable but also that it can be achived by the means proposed and that there aree no unacceptablae side effects. In the, experts and interest groups may  not only attempt to sway public opinion but may also use the threat of political and economic power. This applies both to broad principles  of policy and to its translation  into legislation. At the administrative stage, the interests of bureaucrats may lead to policies being diverted from their intended functions and special interests may again be influential.

            These very real features of government  behavior and the wider political  structure must be taken into account in any realistic ssesment of the prospects for reform. In this return to “ political economy”, a great deal remains to be done.