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Editors’ Introduction
EDITORS' INTRODUCTION
The field of Public Economics has been changing rapidly in recent years, and the sixteen chapters contained in this Handbook survey many of the new developments. As a field, Public Economics is defined by its objectives rather than its techniques, and much of what is new is the application of modern methods of economic theory and econometrics to problems that have been addressed by economists for over two hundred years. More generally, the discussion of public finance issues also involves elements of political science, finance and philosophy. These connections are evidence in several of the chapters that follow. Public Economics is the positive and normative study of government's effect on the economy. We attempt to explain why government behaves as it does, how its behavior influences the behavior of private firms and households, and what the welfare effects of such changes in behavior are. Following Musgrave (1959) one may imagine three purposes for government intervention in the economy: allocation, when market failure causes the private outcome to be Pareto inefficient, distribution, when the private market outcome leaves some individuals with unacceptably low shares in the fruits of the economy, and stabilization, when the private market outcome leaves some of the economy's resources underutilized. The recent trend in economic research has tended to emphasize the character of stabilization problems as problems of allocation in the labor market. The effects that government intervention can have on the allocation and distribution of an economy's resources are described in terms of efficiency and incidence effects. These are the primary measures used to evaluate the welfare effects of government policy. The first chapter in this volume, by Richard Musgrave, presents an historical development of these and other concepts in Public Finance, dating from Adam Smith's discussion in The Wealth of Nations of the role of government and the principles by which taxes should be set. The remaining chapters in the Handbook examine different areas of current research in Public Economics. Analyses of the efficiency and incidence of taxation, developed in Musgrave's chapter, are treated separately in Alan Auerbach's chapter in the first volume and Laurence Kotlikoff's and Lawrence Summers' chapter in the second volume, respectively. Auerbach surveys the literature on excess burden and optimal taxation, while Kotlikoff and Summers discuss various theoretical and empirical approaches that have been used to measure the distributional effects of government tax and expenditure policies.
xiv
Editors' int-oduction
These general analyses of the effects of taxation form a basis for the consideration of tax policies in particular markets or environments, as is contained in the chapters by Jerry Hausman, Agnar Sandmo, Avinash Dixit, Harvey Rosen, John Helliwell and Terry Heaps, and Joseph Stiglitz. Hausman discusses the effects of taxation on labor supply, including a treatment of how one empirically estimates such effects in the presence of tax and transfer programs. He also considers the incentive effects of social welfare programs such as unemployment compensation and social security. Sandmo focuses on the other major factor in production, capital, dealing with theory and evidence about the effects of taxation on private and social saving and risk-taking. Dixit shows how the basic results about the effects of taxation may be extended to the trade sector of the economy, casting results from the parallel trade literature in terms more familiar to students of Public Finance. Rosen's chapter brings out the characteristics of housing that make it worthy of special consideration. He considers the special econometric problems involved in estimating the response of housing demand and supply to government incentives. Because of its importance in most family budgets and its relatively low income elasticity of demand, housing has been seen as a suitable vehicle for government programs to help the poor, and Rosen discusses the efficiency and incidence effects of such programs. Helliwell and Heaps consider the effects of taxation on output paths and factor mixes in a number of natural resource industries. By comparing their results for different industries, they expose the effects that technological differences have on the impact of government policies. Stiglitz treats the literature on income and wealth taxation. The remaining chapters in the Handbook may be classified as being on the "expenditure" side rather than the "tax" side of Public Finance, though this distinction is probably too sharp to be accurate. In Volume 1, Dieter B5s surveys the literature on public sector pricing, which is closely related both to the optimal taxation discussion in Auerbach's chapter and Robert Inman's consideration, in Volume 2, of models of voting and government behavior. The question of voting and, more generally, public choice mechanisms, is treated by Jean-Jacques Laffont in his chapter. The chapters by William Oakland and Daniel Rubinfeld focus on the provision of "public" goods, i.e., goods with sufficiently increasing returns to scale or lack of excludability that government provision is the normal mode. Oakland considers the optimality conditions for the provision of goods that fall between Samuelson's (1954) "pure" public goods and the private goods provide efficiently by private markets. Rubinfeld surveys the literature on a special class of such goods: local public goods. Since the work of Tiebout (1956), much research has been devoted to the question of whether localities can provide efficient levels of public goods. The other two chapters in Volume 2 also deal with problems of public expenditures. Anthony Atkinson considers the effects of the range of social welfare programs common in Western societies aimed at improving the economic standing of the poor. Some of these policies are touched on in the chapters by Hausman and Rosen, but the coexistence of many different programs itself leads to effects that cannot be recognized
Editors' introduction
xv
by examining such programs seriatim. Jean Dreze and Nicholas Stern present a unified treatment of the techniques of cost benefit analysis, with applications to the problems of developing countries.
References Musgrave, R.A. (1959), The Theory of Public Finance (McGraw-Hill, New York). Samuelson, P.A. (1954), "The pure theory of public expenditures", Review of Economics and Statistics 36:387-389. Tiebout, C.M. (1956), "A pure theory of local expenditures", Journal of Political Economy 94:416-424.
The field of Public Economics has been changing rapidly in recent years, and the sixteen chapters contained in this Handbook survey many of the new developments. As a field, Public Economics is defined by its objectives rather than its techniques, and much of what is new is the application of modern methods of economic theory and econometrics to problems that have been addressed by economists for over two hundred years. More generally, the discussion of public finance issues also involves elements of political science, finance and philosophy. These connections are evidence in several of the chapters that follow. Public Economics is the positive and normative study of government's effect on the economy. We attempt to explain why government behaves as it does, how its behavior influences the behavior of private firms and households, and what the welfare effects of such changes in behavior are. Following Musgrave (1959) one may imagine three purposes for government intervention in the economy: allocation, when market failure causes the private outcome to be Pareto inefficient, distribution, when the private market outcome leaves some individuals with unacceptably low shares in the fruits of the economy, and stabilization, when the private market outcome leaves some of the economy's resources underutilized. The recent trend in economic research has tended to emphasize the character of stabilization problems as problems of allocation in the labor market. The effects that government intervention can have on the allocation and distribution of an economy's resources are described in terms of efficiency and incidence effects. These are the primary measures used to evaluate the welfare effects of government policy. The first chapter in this volume, by Richard Musgrave, presents an historical development of these and other concepts in Public Finance, dating from Adam Smith's discussion in The Wealth of Nations of the role of government and the principles by which taxes should be set. The remaining chapters in the Handbook examine different areas of current research in Public Economics. Analyses of the efficiency and incidence of taxation, developed in Musgrave's chapter, are treated separately in Alan Auerbach's chapter in the first volume and Laurence Kotlikoff's and Lawrence Summers' chapter in the second volume, respectively. Auerbach surveys the literature on excess burden and optimal taxation, while Kotlikoff and Summers discuss various theoretical and empirical approaches that have been used to measure the distributional effects of government tax and expenditure policies.
xiv
Editors' int-oduction
These general analyses of the effects of taxation form a basis for the consideration of tax policies in particular markets or environments, as is contained in the chapters by Jerry Hausman, Agnar Sandmo, Avinash Dixit, Harvey Rosen, John Helliwell and Terry Heaps, and Joseph Stiglitz. Hausman discusses the effects of taxation on labor supply, including a treatment of how one empirically estimates such effects in the presence of tax and transfer programs. He also considers the incentive effects of social welfare programs such as unemployment compensation and social security. Sandmo focuses on the other major factor in production, capital, dealing with theory and evidence about the effects of taxation on private and social saving and risk-taking. Dixit shows how the basic results about the effects of taxation may be extended to the trade sector of the economy, casting results from the parallel trade literature in terms more familiar to students of Public Finance. Rosen's chapter brings out the characteristics of housing that make it worthy of special consideration. He considers the special econometric problems involved in estimating the response of housing demand and supply to government incentives. Because of its importance in most family budgets and its relatively low income elasticity of demand, housing has been seen as a suitable vehicle for government programs to help the poor, and Rosen discusses the efficiency and incidence effects of such programs. Helliwell and Heaps consider the effects of taxation on output paths and factor mixes in a number of natural resource industries. By comparing their results for different industries, they expose the effects that technological differences have on the impact of government policies. Stiglitz treats the literature on income and wealth taxation. The remaining chapters in the Handbook may be classified as being on the "expenditure" side rather than the "tax" side of Public Finance, though this distinction is probably too sharp to be accurate. In Volume 1, Dieter B5s surveys the literature on public sector pricing, which is closely related both to the optimal taxation discussion in Auerbach's chapter and Robert Inman's consideration, in Volume 2, of models of voting and government behavior. The question of voting and, more generally, public choice mechanisms, is treated by Jean-Jacques Laffont in his chapter. The chapters by William Oakland and Daniel Rubinfeld focus on the provision of "public" goods, i.e., goods with sufficiently increasing returns to scale or lack of excludability that government provision is the normal mode. Oakland considers the optimality conditions for the provision of goods that fall between Samuelson's (1954) "pure" public goods and the private goods provide efficiently by private markets. Rubinfeld surveys the literature on a special class of such goods: local public goods. Since the work of Tiebout (1956), much research has been devoted to the question of whether localities can provide efficient levels of public goods. The other two chapters in Volume 2 also deal with problems of public expenditures. Anthony Atkinson considers the effects of the range of social welfare programs common in Western societies aimed at improving the economic standing of the poor. Some of these policies are touched on in the chapters by Hausman and Rosen, but the coexistence of many different programs itself leads to effects that cannot be recognized
Editors' introduction
xv
by examining such programs seriatim. Jean Dreze and Nicholas Stern present a unified treatment of the techniques of cost benefit analysis, with applications to the problems of developing countries.
References Musgrave, R.A. (1959), The Theory of Public Finance (McGraw-Hill, New York). Samuelson, P.A. (1954), "The pure theory of public expenditures", Review of Economics and Statistics 36:387-389. Tiebout, C.M. (1956), "A pure theory of local expenditures", Journal of Political Economy 94:416-424.