The Online Library of Liberty

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• Foreword
• Preface
• Part One: the Effects of Institutions On Fiscal Choice
• 1.: Introduction
• 2.: Individual Demand For Public Goods
• 3.: Tax Institutions and Individual Fiscal Choice Direct Taxation
• 4.: Tax Institutions and Individual Fiscal Choice Indirect Taxation
• 5.: Existing Institutions and Change the Effects of Time In Fiscal Decisions
• 6.: Earmarking Versus General-fund Financing: Analysis and Effects *
• 7.: The Bridge Between Tax and Expenditure In the Fiscal Decision Process
• 8.: “fiscal Policy” and Fiscal Choice: the Effects of Unbalanced Budgets
• 9.: Individual Choice and the Indivisibility of Public Goods
• 10.: The Fiscal Illusion
• 11.: Simple Collective Decision Models
• 12.: From Theory to the Real World
• 13.: Some Preliminary Research Results
• Part Two: the Choice Among Fiscal Institutions
• 14.: The Levels of Fiscal Choice
• 15.: Income-tax Progression *
• 16.: Specific Excise Taxation †
• 17.: The Institution of Public Debt
• 18.: Fiscal Policy Constitutionally Considered
• 19.: Fiscal Nihilism and Beyond

Foreword

James M. Buchanan is a self-declared Knut Wicksell disciple—or, at least, a disciple of the Wicksell 1896 habilitation thesis.1 The later Wicksell work on monetary theory has certainly had its influence, but in other quarters. There are three aspects of Wicksell’;s 1896 analysis in particular that Buchanan has picked up and developed. These are the analysis of market failure in the provision of public goods; the insistence on conceiving policy decisions (government expenditure decisions specifically) as the outcome of a political process (and one, moreover, not inhabited exclusively by moral heroes); and the necessity of treating the tax and expenditure sides of the budget as interconnected. Of these, the first passed into public economics orthodoxy fairly painlessly. True, there was a lapse of a half century between Wicksell’;s work and the development of public expenditure theory at the hands of Howard Bowen, Paul Samuelson, Richard Musgrave, and Buchanan in the midcentury decades, but this development was one that mainstream public finance welcomed readily—and in some quarters, enthusiastically.

Buchanan’;s role specifically in the development of public goods theory is reflected in the book The Demand and Supply of Public Goods.2 Although Buchanan’;s work in this area of scholarship has a distinctive orientation (reflecting its more self-conscious Wicksellian approach), it could hardly be claimed that it is unique in the way that his work has been in the public choice field. Put another way, public economics orthodoxy has taken up the second and third strands of the Wicksellian legacy only patchily and reluctantly. It is clear, for example, that the antipathy to the “benevolent despot” model of government evident in the Wicksell discussion is the starting point for much modern public choice analysis, and no less clear that this antipathy is a direct assault on the orthodox public finance approach. Moreover, although public choice theory bears on questions of budgetary policy, it is by no means exhausted by them. It is therefore proper that public choice theory has taken on a life of its own in political science departments, alongside political theory of other kinds, as well as in economics departments.

To see public choice theory merely as an offshoot of and servant of public finance-public economics would be entirely too narrow a view and, arguably, too broad a view also. It would, for example, be entirely possible for a public finance economist to accept the necessity of an explicit political component in policy analysis and seek to supply that element by appeal to a theory of political process other than the public choice one. Nevertheless, the practice in public economics is generally to ignore the political element as either of second order concern or as appropriately handled independently by other scholars. Whether such independent treatment is appropriate is an issue that is central to the third strand of the Wicksellian legacy. This third strand involves the insistence that taxation should be seen as connected to the expenditure side of the budget and, indeed, that both taxation and expenditure be seen as inextricable parts of a single overarching political determination. To appeal to the title of the previously referenced Buchanan book, The Demand and Supply of Public Goods, tax arrangements are a critical element in the supply side and cannot be divorced from the demand side.

Or at least, so Buchanan (and earlier Wicksell) argued. In fact, standard practice in public economics pretty routinely involves separate treatment of the tax and expenditure sides of the budget. In tax analysis, the usual approach is to take the level of revenue required as fixed and to explore the most “efficient” and “equitable” way to raise that fixed revenue, deliberately suppressing any feedback effects of the method of financing on the revenue level itself. This procedure indeed achieves the status of a methodological requirement via the “equirevenue comparison” principle and the “differential tax incidence” analytics. These methodological strictures may serve a useful conceptual purpose in separating different aspects of the effects of tax changes—in particular in distinguishing effects on expenditure levels from other effects. However, all too often the consequence of this procedure is that effects on expenditure levels are entirely overlooked.

By contrast, Buchanan’;s approach to tax analysis has focused directly on such feedback effects. The particular model of politics chosen has varied. In some contexts, he has followed Wicksell in assuming a bargaining model in which the tax liabilities of particular citizens emerge as an endogenous part of the bargains struck.3 In The Power to Tax and papers in that tradition, the model of government chosen is a monopoly one, and, in this case, different taxes are distinguished by the fiscal power (as reflected in maximum revenue potential) they represent. In the current volume, Public Finance in Democratic Process, the political model is a more conventional democratic one in which voters choose among alternative levels of public goods supply under relatively fixed tax arrangements and in which something like the standard median-voter model prevails.4 The title of the volume is, in this sense, totally descriptive. The argument concerns those aspects of taxation that become relevant when the financing of public activities (“public finance”) is conceived through an explicitly democratic-political lens. In particular, two related questions arise: First, how do different tax arrangements translate into different (marginal) cost shares or “marginal tax prices” for public goods to different voters? and, second, how do such changes in such tax arrangements influence voters’; net demands for public activity and the emergent majoritarian equilibrium? Since what is relevant in this connection is the set of the voters’; perceived tax prices, then fiscal illusion becomes extremely significant. Unlike orthodox tax theory, which focuses on the effects of taxes on choices between taxed and nontaxed private goods (notably including leisure) and the efficiency and equity implications of such choices, the core of attention in Public Finance in Democratic Process is the public-private choice—the effects, that is, of tax choice on the nature and size of the expenditure side of the budget.

As Buchanan emphasizes, this approach involves seeing tax phenomena through a different lens—through a different “window” to use the Nietzschean metaphor to which Buchanan appeals in the preface. (Indeed, the preface and the epilogue to the book provide an interesting incidental view of Buchanan’;s method as he himself interprets it.) However, this “alternative perspective” line should not allow the orthodox tax theorist to shrug off the implications of Public Finance in Democratic Process. Even at the most minimal level, once the possibility of feedback effects of tax arrangements on expenditure levels is allowed for, the efficiency and equity effects of alternative tax systems must take those feedback effects into account. “Democratic process” remains relevant even within the orthodox normative framework. For this reason, it is somewhat surprising that the central messages of Public Finance in Democratic Process have not been more readily accepted into public finance orthodoxy. Unlike The Power to Tax, for example, the conclusions of which might be seen as a wholesale attack on orthodox tax theory, Public Finance in Democratic Process is a work more hospitable to public finance orthodoxy and could be treated as an extension (albeit an important one) of the conventional approach.

Geoffrey Brennan

Australian National University
1998

[1. ]Knut Wicksell, Finanztheoretische Untersuchungen (Jena: Fischer, 1896).

[2. ]James M. Buchanan, The Demand and Supply of Public Goods: A Defense and Restatement (Chicago: Rand-McNally, 1968), volume 5 in the series. Also see volume 15 in the series, Externalities and Public Expenditure Theory.

[3. ]See, for example, James M. Buchanan, “Taxation in Fiscal Exchange,” Journal of Public Economics 6 (1976): 17-29, in volume 14 in the series, Debt and Taxes.

[4. ]Geoffrey Brennan and James M. Buchanan, The Power to Tax: Analytical Foundations of a Fiscal Constitution (New York: Cambridge University Press, 1980), volume 9 in the series. Also see volume 14 in the series, Debt and Taxes; James M. Buchanan, Public Finance in Democratic Process: Fiscal Institutions and Individual Choice (Chapel Hill: University of North Carolina Press, 1966).