Download Ch.31 Public Choice Theory and the Economics of Taxation

Ch.31 Public Choice Theory
and the Economics of
Taxation
Jeffrey LaBeach
Revealing Preferences through
Majority Voting



Public choice Theory: the economic analysis of
government decision making, politics, and
elections.
Candidates for office offer alternative policy
packages, and citizens elect people who they
think will make the best decisions of their
collective behalf.
Public choice theory demonstrates that majority
voting can produce inefficiencies and
inconsistencies.
Inefficient Voting Outcomes
$300
Total Benefit= $1150
Total Benefit= $800
Total Cost= $900
Total Cost= $900
$700
Adams
$300 perperson tax
$350
$350
Benson Conrad
$250
Benson
“YES” “NO”
0
Benefit; Tax
Benefit; Tax
Majority voting can produce voting outcomes that
are inefficient
$200
$100
Conrad
Adams
“NO”
Inefficient “No” vote
“NO”
“YES” “YES”
0
Inefficient “Yes” vote
Projects having
greater total
benefits than
total costs may
be defeated, and
projects having
greater total
costs than total
benefits may be
approved.
Interest Groups and Logrolling
Ways to resolve the inefficiencies associated with
majority voting.
-Interest Groups: those who have a strong
preference for a public good may band together
into interest groups and use advertisements and
direct persuasion to convince others of the
merits of that public good.
-Logrolling: the trading of votes to secure
favorable outcomes.
Paradox of Voting
Paradox of voting: a situation in which society may not be
able to rank its preferences consistently through pairedchoice majority voting.
Median-Voter Model


Median-voter model is the theory that under
majority rule the median (middle) voter will be
in the dominant position to determine the
outcome of an election.
Implications
-The size of government will be largely
determined by the median preference
-Some people may “vote with their feet” by
moving into political jurisdictions where the
median voter’s preferences are closer to their
own.
Government Failure


Government failure: inefficiency due to
certain characteristics of the public sector.
Some characteristics and outcomes:




Special interest
Rent seeking
Limited and Bundled Choice
Bureaucracy and Inefficiency
Apportioning the Tax Burden


Benefits-received principle: the idea that those
who receive the benefits of goods and services
provided by government should pay the taxes
required to finance them.
Difficulties:
-How will the government determine the
benefits that individuals receive from a public
good.
-This principle cannot be logically be applied to
income redistribution programs.
Progressive, Proportional, and
Regressive Taxes



Progressive tax: average tax rate increases
as the taxpayer’s income increases. EX:
personal income tax
Regressive tax: average tax rate declines
as income increases. EX: sales tax
Proportional tax: average tax rate remains
the same regardless of the size of income.
EX: flat tax
Tax Incidence and Efficiency Loss
Tax incidence: the final resting
place of a tax
 Division of burden
An excise tax of a specified
amount, here $2 per unit,
shifts the supply curve upward
by the amount of the tax per
unit: the vertical distance
between S and St. This results
in a higher price (here $9) to
consumers and a lower aftertax price (here $7) to
producers. Thus consumers
and producers share the
burden of the tax in some
proportion (here equally at $1
per unit).

Elasticities
With a specific supply, the more inelastic the
demand for a product, the larger is the
portion of the tax shifted to consumers.
Tax incidence and elastic demand
Tax incidence and inelastic demand
Elasticities
With a specific demand, the more inelastic the
supply, the larger is the portion of the tax
borne by producers.
Tax incidence and elastic supply
Tax incidence and inelastic supply
Efficiency Loss of a Tax
Efficiency loss of the tax: the
loss is society’s sacrifice of
net benefit, because the tax
reduces production and
consumption of the product
below their levels of
economic efficiency, where
marginal benefit and marginal
cost are equal.
-For example, tax revenue to
the government is $25 million
(blue/aqua shaded part). The
efficiency loss of the tax
arises from the 2.5 million
decline in output (orange
shaded triangle).