Preface to Second Edition xix
Preface to First Edition xxi
List of Figures xxiii
I PUBLIC ECONOMICS AND ECONOMIC EFFICIENCY
1 An Introduction to Public Economics 3
1.1 Public Economics 3
1.2 Methods 3
1.3 Analyzing Policy 5
1.4 Preview 6
1.5 Scope 9
2 Equilibrium and Efficiency 13
2.1 Introduction 13
2.2 Economic Models 13
2.3 Competitive Economies 14
2.4 The Exchange Economy 15
2.5 Production and Exchange 22
2.6 Efficiency of Competition 26
2.6.1 Single Consumer 27
2.6.2 Pareto-Efficiency 31
2.6.3 Efficiency in an Exchange Economy 33
2.6.4 Extension to Production 37
2.7 Lump-Sum Taxation 39
2.8 Discussion of Assumptions 41
2.9 Summary 43
3 Behavioral Economics 51
3.1 Introduction 51
3.2 Behavioral Individuals 53
3.2.1 Simple Example: How Much to Save? 53
3.2.2 Present-Bias 54
3.2.3 The (β, δ) Model of Self-Control 55
3.2.4 Reference-Dependence Bias 57
3.2.5 The Gambler’s Fallacy 58
3.2.6 Confirmation Bias 59
3.2.7 Confidence Bias 60
3.2.8 Framing Bias 60
3.2.9 Conformism Bias 62
3.2.10 Identity and Social Norms 63
3.3 Behavioral Markets 64
3.3.1 Money Pump 65
3.3.2 Complementary Mistakes 65
3.3.3 Rationality Tug-of-War 67
3.4 Behavioral Policy 67
3.4.1 Internalities versus Externalities 68
3.4.2 Automatic Enrollment 69
3.4.3 The SMarT Plan 69
3.4.4 Complementarity 70
3.5 Behavioral Welfare 71
3.5.1 New Welfare Criterion 71
3.5.2 Choice-Based Welfare Analysis 72
3.5.3 Refinement and Structural Modeling 73
3.5.4 Application: Global Warming 74
3.6 Other-Regarding Preferences 76
3.6.1 Ultimatum Game 76
3.6.2 Social Preferences 77
3.6.3 Market Impact 78
3.7 Conclusions 80
II GOVERNMENT
4 Public Sector Statistics 89
4.1 Introduction 89
4.2 Historical Development 89
4.3 Composition of Expenditure 94
4.4 Revenue 97
4.5 Government Debt 107
4.6 Measuring the Government 112
4.7 Conclusions 114
5 Theories of the Public Sector 119
5.1 Introduction 119
5.2 Justification for the Public Sector 119
5.2.1 The Minimal State 119
5.2.2 Market versus Government 121
5.2.3 Equity 122
5.2.4 Efficiency and Equity 123
5.3 Public Sector Growth 123
5.3.1 Development Models 123
5.3.2 Wagner’s Law 124
5.3.3 Baumol’s Law 125
5.3.4 A Political Model 126
5.3.5 Ratchet Effect 128
5.4 Excessive Government 129
5.4.1 Bureaucracy 130
5.4.2 Budget-Setting 132
5.4.3 Monopoly Power 133
5.4.4 Corruption 134
5.4.5 Government Agency 135
5.4.6 Cost Diffusion 137
5.5 Conclusions 138
III DEPARTURES FROM EFFICIENCY
6 Public Goods 147
6.1 Introduction 147
6.2 Definitions 148
6.3 Private Provision 150
6.4 Efficient Provision 154
6.5 Voting 156
6.6 Personalized Prices 159
6.7 Mechanism Design 163
6.7.1 Examples of Preference Revelation 163
6.7.2 Clarke–Groves Mechanism 166
6.7.3 Clarke Tax 168
6.7.4 Further Comments 169
6.8 More on Private Provision 170
6.8.1 Neutrality and Population Size 170
6.8.2 Experimental Evidence 174
6.8.3 Modifications 176
6.9 Fund-Raising Campaigns 178
6.9.1 The Contribution Campaign 179
6.9.2 The Subscription Campaign 181
6.10 Conclusions 182
7 Club Goods and Local Public Goods 191
7.1 Introduction 191
7.2 Definitions 192
7.3 Single-Product Clubs 193
7.3.1 Fixed Utilization 194
7.3.2 Variable Utilization 196
7.3.3 Two-Part Tariff 197
7.4 Clubs and the Economy 199
7.4.1 Small Clubs 200
7.4.2 Large Clubs 200
7.4.3 Conclusion 207
7.5 Local Public Goods 208
7.6 The Tiebout Hypothesis 212
7.7 Empirical Tests 214
7.8 Conclusions 216
8 Externalities 223
8.1 Introduction 223
8.2 Externalities Defined 224
8.3 Market Inefficiency 225
8.4 Externality Examples 228
8.4.1 River Pollution 228
8.4.2 Traffic Jams 229
8.4.3 Pecuniary Externality 230
8.4.4 The Rat Race Problem 232
8.4.5 The Tragedy of the Commons 233
8.4.6 Bandwagon Effect 235
8.5 Pigouvian Taxation 236
8.6 Licenses 239
8.7 Internalization 241
8.8 The Coase Theorem 242
8.9 Nonconvexity 247
8.10 Conclusions 248
9 Imperfect Competition 255
9.1 Introduction 255
9.2 Concepts of Competition 256
9.3 Market Structure 257
9.3.1 Defining the Market 257
9.3.2 Measuring Competition 258
9.4 Welfare 260
9.4.1 Inefficiency 260
9.4.2 Incomplete Information 263
9.4.3 Measures of Welfare Loss 264
9.5 Tax Incidence 268
9.6 Specific and Ad valorem Taxation 274
9.7 Regulation of Monopoly 277
9.8 Regulation of Oligopoly 282
9.8.1 Detecting Collusion 282
9.8.2 Merger Policy 283
9.9 Unions and Taxation 285
9.10 Monopsony 286
9.11 Conclusions 288
10 Asymmetric Information 297
10.1 Introduction 297
10.2 Hidden Knowledge and Hidden Action 300
10.3 Actions or Knowledge? 301
10.4 Market Unraveling 302
10.4.1 Hazard Insurance 302
10.4.2 Government Intervention 305
10.5 Screening 307
10.5.1 Perfect Information Equilibrium 308
10.5.2 Imperfect Information Equilibrium 310
10.5.3 Government Intervention 313
10.6 Signaling 314
10.6.1 Educational Signaling 316
10.6.2 Implications 321
10.7 Moral Hazard (Hidden Action) 323
10.7.1 Moral Hazard in Insurance 323
10.7.2 Effort Observable 325
10.7.3 Effort Unobservable 326
10.7.4 Second-Best Contract 327
10.7.5 Government Intervention 329
10.8 Public Provision of Health Care 330
10.8.1 Efficiency 330
10.8.2 Redistributive Politics 332
10.9 Evidence 334
10.10 Conclusions 336
IV POLITICAL ECONOMY
11 Voting 345
11.1 Introduction 345
11.2 Stability 345
11.3 Impossibility 347
11.4 Majority Rule 350
11.4.1 May’s Theorem 350
11.4.2 Condorcet Winner 351
11.4.3 Median Voter Theorems 351
11.4.4 Multidimensional Voting 356
11.4.5 Agenda Manipulation 358
11.5 Alternatives to Majority Rule 361
11.5.1 Borda Voting 361
11.5.2 Plurality Voting 363
11.5.3 Approval Voting 363
11.5.4 Runoff Voting 364
11.6 The Paradox of Voting 365
11.7 The “Alabama” Paradox 371
11.8 Political Competition 372
11.8.1 Downsian Model 372
11.8.2 Policy Divergence 373
11.8.3 Multidimensional Competition 376
11.8.4 “Swing Voter” Politics 377
11.8.5 Citizen-Candidate Model 379
11.9 Conclusions 381
12 Rent-Seeking 387
12.1 Introduction 387
12.2 Definitions 388
12.3 Rent-Seeking Games 390
12.3.1 Deterministic Game 391
12.3.2 Probabilistic Game 394
12.3.3 Free-Entry 396
12.3.4 Risk Aversion 397
12.3.5 Conclusions 398
12.4 Social Cost of Monopoly 398
12.5 Equilibrium Effects 401
12.6 Government Policy 404
12.6.1 Lobbying 404
12.6.2 Rent Creation 406
12.6.3 Conclusions 408
12.7 Informative Lobbying 408
12.8 Controlling Rent-Seeking 413
12.9 Conclusions 414
V EQUITY AND DISTRIBUTION
13 Optimality and Comparability 423
13.1 Introduction 423
13.2 Social Optimality 424
13.3 Lump-Sum Taxes 427
13.4 Impossibility of Lump-Sum Taxes 430
13.5 Non–Tax Redistribution 434
13.6 Aspects of Pareto-Efficiency 436
13.7 Social Welfare Functions 440
13.8 Arrow’s Theorem 441
13.9 Interpersonal Comparability 443
13.10 Comparability and Social Welfare 446
13.11 Conclusions 450
14 Inequality and Poverty 457
14.1 Introduction 457
14.2 Measuring Income 458
14.3 Equivalence Scales 460
14.4 Inequality Measurement 466
14.4.1 The Setting 467
14.4.2 Statistical Measures 467
14.4.3 Inequality and Welfare 475
14.4.4 An Application 480
14.5 Poverty 481
14.5.1 Poverty and the Poverty Line 482
14.5.2 Poverty Measures 483
14.5.3 Two Applications 488
14.6 Unequal Opportunities 489
14.6.1 Defining Equality of Opportunity 490
14.6.2 Measuring Equality of Opportunity 491
14.6.3 Equal-Opportunity Policy 491
14.7 Intergenerational Inequality 492
14.7.1 Measuring Issues 492
14.7.2 Causal Mechanisms 493
14.8 Conclusions 496
VI TAXATION
15 Commodity Taxation 505
15.1 Introduction 505
15.2 Deadweight Loss 506
15.3 Optimal Taxation 509
15.4 Production Efficiency 513
15.5 Tax Rules 515
15.5.1 Inverse Elasticity Rule 516
15.5.2 Ramsey Rule 517
15.6 Equity Considerations 521
15.7 Applications 523
15.7.1 Reform 524
15.7.2 Optimality 526
15.8 Efficient Taxation 528
15.9 Public Sector Pricing 530
15.10 Conclusions 531
16 Income Taxation 537
16.1 Introduction 537
16.2 Equity and Efficiency 538
16.3 Taxation and Labor Supply 539
16.4 Empirical Evidence 544
16.5 Optimal Income Taxation 547
16.6 Two Specializations 555
16.6.1 Quasi-Linearity 555
16.6.2 Rawlsian Taxation 559
16.7 Numerical Results 561
16.8 Voting over a Flat Tax 563
16.9 Conclusions 565
17 Tax Evasion 575
17.1 Introduction 575
17.2 The Extent of Evasion 576
17.3 The Evasion Decision 578
17.4 Auditing and Punishment 585
17.5 Evidence on Evasion 588
17.6 Effect of Honesty 590
17.7 Tax Compliance Game 592
17.8 Behavioral Models 595
17.9 Compliance and Social Interaction 601
17.10 Conclusions 602
18 Limits to Redistribution 609
18.1 Introduction 609
18.2 Revelation Principle 611
18.3 The Tax Principle 616
18.4 Tax Mix: Separation Principle 622
18.5 Capital Income Tax 626
18.6 Non–Tax Redistribution 628
18.7 Conclusions 630
VII MULTIPLE JURISDICTIONS
19 Fiscal Federalism 637
19.1 Introduction 637
19.2 Arguments for Multi-level Government 638
19.2.1 Costs of Uniformity 639
19.2.2 Tiebout Hypothesis 641
19.2.3 Distributive Arguments 642
19.3 Optimal Structure: Efficiency versus Stability 642
19.4 Accountability 645
19.5 Risk-Sharing 648
19.5.1 Voluntary Risk-Sharing 648
19.5.2 Insurance versus Redistribution 651
19.6 Hard and Soft Budgets 652
19.7 Evidence on Decentralization 655
19.7.1 Decentralization around the World 655
19.7.2 Decentralization by Functions 657
19.7.3 Determinants of Decentralization 658
19.8 Conclusions 659
20 Fiscal Competition 667
20.1 Introduction 667
20.2 Tax Competition 667
20.2.1 Competitive Behavior 668
20.2.2 Strategic Behavior 669
20.2.3 Size Matters 675
20.2.4 Public input provision 676
20.2.5 Tax Overlap 676
20.2.6 Tax Exporting 679
20.2.7 Efficient Tax Competition 681
20.3 Income Distribution 683
20.3.1 Perfect Mobility 683
20.3.2 Imperfect Mobility 684
20.3.3 Race to the Bottom 687
20.4 Intergovernmental Transfers 688
20.4.1 Efficiency 688
20.4.2 Redistribution 691
20.4.3 Flypaper Effect 692
20.5 Evidence 693
20.5.1 Race to the Bottom 693
20.5.2 Race to the Top 695
20.5.3 Tax Mimicking 695
20.6 Conclusions 696
21 Issues in International Taxation 705
21.1 Introduction 705
21.2 International Efficiency 706
21.2.1 Efficient Allocations 707
21.2.2 Markets and Efficiency 708
21.2.3 Taxation and Efficiency 710
21.3 Capital and Corporations 711
21.3.1 Capital Taxes 711
21.3.2 Corporate Taxation 713
21.3.3 Formula Apportionment 717
21.3.4 Summary 719
21.4 Transfer Pricing 719
21.5 Location 722
21.5.1 Locational Choice 723
21.5.2 Agglomeration Rents 724
21.5.3 Evidence 725
21.6 Harmonization of Taxes 727
21.7 Tax Principles 731
21.8 Tariff Policy 734
21.8.1 Welfare Cost of Tariffs 735
21.9 Trade Agreements 738
21.10 Conclusions 743
VIII ISSUES OF TIME
22 Intertemporal Efficiency 753
22.1 Introduction 753
22.2 Overlapping Generations 755
22.2.1 Time and Generations 755
22.2.2 Consumers 756
22.2.3 Production 757
22.3 Equilibrium 760
22.3.1 Intertemporal Equilibrium 761
22.3.2 Steady State 761
22.4 Optimality and Efficiency 764
22.4.1 The Golden Rule 764
22.4.2 Pareto-Efficiency 767
22.5 Testing Efficiency 771
22.6 Conclusions 772
23 Social Security 777
23.1 Introduction 777
23.2 Types of System 778
23.3 The Pensions Crisis 780
23.4 The Simplest Program 783
23.5 Social Security and Production 785
23.6 Population Growth 789
23.7 Sustaining a Program 792
23.8 Ricardian Equivalence 796
23.9 Social Security Reform 799
23.10 Conclusions 804
24 Economic Growth 811
24.1 Introduction 811
24.2 Exogenous Growth 812
24.2.1 Constant Savings Rate 812
24.2.2 Optimal Taxation 819
24.3 Endogenous Growth 825
24.3.1 Models of Endogenous Growth 826
24.3.2 Government Expenditure 828
24.4 Policy Reform 831
24.5 Empirical Evidence 835
24.6 Conclusions 839
IX APPLICATIONS
25 Cost–Benefit Analysis 849
25.1 Introduction 849
25.2 What Is Cost–Benefit Analysis? 850
25.2.1 Simple Example 851
25.2.2 Broader Approach 852
25.3 The Process of CBA 853
25.3.1 Discounting Future Values 855
25.4 Principles of CBA 858
25.4.1 Common Unit of Measurement 858
25.4.2 Revealed Preferences 859
25.4.3 Valuing Market Goods: Marshallian Surplus 860
25.4.4 Valuing Non-market Goods: Hedonic Prices 861
25.4.5 Impact Assessment 862
25.4.6 Decision Criteria 863
25.4.7 Difficulties for CBA 864
25.5 Valuing Life 867
25.6 Valuing the Future 871
25.6.1 Intertemporal Arbitrage 872
25.6.2 The UK Green Book 875
25.6.3 Adjustment for Risk 877
25.7 Theoretical Foundations of CBA 878
25.7.1 Social Welfare Evaluation 879
25.7.2 Distributive Weights 884
25.7.3 Market Prices and Shadow Prices 885
25.8 Conclusions 899
26 Economics of Climate Policy 897
26.1 Introduction 897
26.2 Special Features 899
26.3 The Science of Global Warming 902
26.3.1 Greenhouse Gases and Temperatures 902
26.3.2 Controversies 906
26.3.3 Predictions 909
26.4 Integrating Economics and Climate 912
26.4.1 Sources of Damage 913
26.4.2 Modeling Economic Damage 914
26.4.3 Effects of Policy 917
26.5 Competing Generations 919
26.6 Ecological Discounting 926
26.7 Climate Policy in Practice 931
26.7.1 Pricing and Policies 931
26.7.2 The EU Emissions Trading Scheme 933
26.7.3 International Agreements 936
26.7.4 Prices or Quantities 939
26.7.5 Other Policies 941
26.8 Conclusions 942
Index 000