Modern Public Economics Second edition Raghbendra Jha B 366815 Routledge Taylor Si Francis Group LONDON AND NEW YORK
Contents List of tables List of figures Preface Preface to the first edition xiv xv xix xxi PARTI Welfare economics 1 Introduction to Part I 2 1 A quick primer on consumer demand 3 1.1 Introduction 3 1.2 Some key definitions 3 1.3 Utility functions 7 1.4 The consumer's utility maximization problem 7 1.5 Some other useful relations in demand theory 13 1.6 Consumer's surplus and measurement of welfare changes 14 1.7 Conclusions 17 1.8 Appendix on welfare evaluation of economic changes 18 2 Perfect competition and Pareto optimality 28 2.1 Introduction 28 2.2 Paretian ranking of social states 28 2.3 Pareto optimality 29 2.4 The classical theorems of welfare economics 33 2.5 An extension to the case of uncertainty 43 2.6 The theorem of second best 51 2.7 Conclusions 53
viii Contents 3 Forms of the social welfare function 54 3.1 Introduction 54 3.2 Early attempts at formulating an approach to distribution 54 3.3 Aggregating individual preferences to arrive at social choice 58 3.4 Arrow's general possibility and other impossibility theorems 61 3.5 Beyond the Arrow framework 68 3.6 Forms of the social welfare function (SWF) 70 3.7 Concluding remarks 74 PART II The theory of public expenditure 75 Introduction to Part II 76 4 External effects and the market mechanism 79 4.1 Introduction 79 4.2 Effects of externalities 80 4.3 A policy example: the pricing of education 85 4.4 Common property resources 90 4.5 Multilateral externalities 92 4.6 Conclusions 94 5 The theory of pure public goods 95 5.7 Introduction 95 5.2 Pareto optimality with pure public goods 96 5.3 Public goods with distortionary taxation 99 5.4 The free-rider problem 101 5.5 Private provision of public goods 110 5.6 Voting models of public goods 115 5.7 Concluding remarks 120 6 Topics in the theory of public goods 121 6.1 Introduction 121 6.2 The theory of clubs 121 6.3 The Tiebout hypothesis 124 6.4 Multi-product clubs 129 6.5 Financing pure public goods with distortionary taxes 133
6.6 Public goods provision with asymmetric information 136 6.7 Rent seeking 143 6.8 Conclusions 150 Contents ix PART III The theory of taxation 153 Introduction to Part III 154 7 The effects of taxes on savings! 157 7.1 Introduction 157 7.2 The elementary life-cycle model of saving 157 7.3 Capital market imperfections and the life-cycle model 163 7.4 Broader life-cycle models of savings and taxes 165 7.5 Aggregate savings and taxation 166 7.6 A consumption/expenditure tax 170 7.7 Savings by firms 178 7.8 Social security, pensions, and savings 178 7.9 The extended life-cycle models of savings 180 7.10 Empirical evidence on effects of taxes on savings 182 7.11 Conclusions 184 8 Taxation and labor supply 186 8.1 Introduction 186 8.2 The basic model of labor supply 186 8.3 Comparison of the effects of various types of taxes 189 8.4 Taxation and the decision to enter the labor market 190 8.5 Effects of a progressive tax on labor supply 193 8.6 A summary of the empirical evidence on effects of lower taxes on labor supply 200 8.7 Conclusions 205 Appendix 205 9 The effects of taxes on investment behavior 208 9.1 Introduction 208 9.2 The Fisherian model 208 9.3 The aggregate approach 213 9.4 Comparing the effects of an investment tax credit versus a corporate tax cut: a Cobb Douglas example 222 9.5 Decisions on the financing of investment expenditure 224 9.6 The effective rate of taxation and the cost of finance 224
x Contents 9.7 The impact of subsidies on incentives for R&D 231 9.8 Conclusions 232 10 Taxation and risk taking 234 10.1 Introduction 234 10.2 Effects of taxation on risk taking by households 234 10.3 The Modigliani Miller theorem and decisions on the financing of investment expenditure 238 10.4 The effects of progression on risk taking 246 10.5 Concluding comments 248 i, 11 The theory of tax incidence 249 11.1 Introduction 249 11.2 Tax incidence in the two-sector model of general equilibrium 250 11.3 Tax incidence in a model of involuntary unemployment 259 11.4 Extensions of the basic model 265 11.5 Tax incidence with a rate of return regulation 266 11.6 Conclusions 271 12 Tax incidence in dynamic models 273 12.1 Introduction 273 12.2 The neoclassical model of economic growth 273 12.3 Balanced growth path tax incidence 278 12A Taxation in the life-cycle model 279 12.5 Tax incidence in a monetary version of the Solow model 282 12.6 Tax incidence in more general life-cycle models 285 12.7 Land rent taxation in an intertemporal economy 294 12.8 Tax and debt as revenue instruments 297 12.9 Conclusions 302 13 Some results in commodity taxation 304 13.1 Introduction 304 13.2 Elasticity type rules in commodity taxation 304 13.3 Uniform commodity taxation 310 13.4 Redistributive indirect taxation 311 13.5 Extent of redistribution through commodity taxation 315 13.6 The value added tax (VAT) 319 13.7 VAT and the informal sector 323 13.8 Conclusions 326
Contents xi 14 Aspects of income taxation 328 14.1 Introduction 328 14.2 Optimal linear taxes 328 14.3 Optimal non-linear income taxation (Mirrlees and Ramsey) 331 14.4 Information theoretic foundations of optimal tax theory 339 14.5 Optimal taxation with imperfect substitution of labor 346 14.6 Optimal wage and interest income taxation in steady state 348 14.7 The optimal mix of direct and indirect taxes 353 14.8 Conclusions 356 Appendix 357 15 Topics in the theory of taxation 359 15.1 Introduction 359 15.2 Taxation in models of endogenous growth 359 15.3 Problems of income tax indexation 364 15.4 Time inconsistency 366 15.5 Tax compliance and tax evasion 373 15.6 Intertemporal tax evasion: Andreoni's model 379 15.7 Concluding comments 382 16 Tax reform 384 16.1 Introduction 384 16.2 Welfare foundations of tax reform 390 16.3 Tax reform in a dynamic context 396 16.4 The marginal approach to tax reform 401 16.5 Conclusions 406 PART IV Applied problems in public economics 409 Introduction to Part IV 410 17 Pricing in the public sector 411 17.1 Introduction 411 17.2 The Ramsey-Boiteux linear pricing problem 411 17.3 Some simplified examples 415 17.4 The optimality of marginal cost pricing 417 17.5 Second-best Ramsey-Boiteux pricing once again 422 17.6 Redistributive Ramsey (Feldstein) pricing the general case 425
xii Contents 17.7 Multi-part tariffs 426 17.8 Peak load pricing 434 17.9 Pricing of joint products - allocation of common costs 43 7 17.10 Conclusions 443 18 International aspects of taxation 445 18.1 Introduction 445 18.2 The theory of tariffs in an open economy 445 18.3 International fiscal coordination: interest taxation 452 18.4 Integrating personal and corporate taxation in an open economy 457 18.5 Ramsey optimal taxation in an open economy 461 18.6 Concluding remarks 462 19 Tax incentives and corporate taxation 464 19.1 Introduction 464 19.2 Tax incentives 470 19.3 Effective tax rates 475 19.4 Conclusions 479 20 Global public goods 480 20.1 Introduction 480 20.2 Defining a global public good 480 203 Allocation issues with inter-generational global public goods 482 20.4 Understanding supply decision problems of global public goods 484 20.5 International cooperation and global public goods 487 20.6 Conclusions 488 21 Cost-benefit analysis and randomized evaluation 490 21.1 Introduction 490 21.2 Criteria for cost-benefit analysis 491 21.3 The social rate of discount 493 21.4 Evaluating benefits and costs - shadow prices 496 21.5 Some difficulties in the measurement of benefits and costs 504 21.6 Randomized evaluation 505 21.7 Conclusions 508
Contents 22 Environmental taxation and emission trading schemes 510 22.1 Introduction 510 22.2 Instrument choice in the design of environmental policy 511 22.3 Choosing between environmental taxes and emissions trading 514 22.4 Designing environmental taxes 515 22.5 Efficiency in permit markets 518 22.6 Comparing auctions and grandfathering 520 22.7 Conclusions 521 xiii PARTV Fiscal federalism 523 Introduction to Part V 524 23 Issues in fiscal federalism 525 23.1 Introduction and background 525 23.2 Efficiency and equity in a federal economy 526 23.3 Equity considerations with layers of governments 527 23.4 Rationale for the existence of subcentral authorities 528 23.5 Other roles of subcentral authorities 534 23.6 The optimal size of local jurisdictions 535 23.7 Conclusions 539 Appendix 540 24 Grants and taxes in federal countries 545 24.1 Introduction 545 24.2 Purposes of grants 545 24.3 Types of grants 553 24.4 The effects of various types of grants - traditional models 554 24.5 The new models of the effects of grants 559 24.6 Tax assignment in federal countries 561 24.7 Conclusions 567 Problems 569 Bibliography 582 Author index 616 Subject index 620