Abstract - Omission of collective choice prevents the analyst from understanding the central role of political equilibrium. To create a framework that places tax policies in a broader equilibrium context we must model the underlying collective allocation mechanism and use it as a starting point, whether we do empirical work explaining observed features of tax systems or whether we engage in research on tax efficiency. A broader perspective of this nature also forces us to re-examine well-known concepts, such as tax expenditures, flat taxation, and the marginal efficiency cost of public funds, and to question and reinterpret some of the conclusions that have been reached in the literature related to these concepts.
Omission of collective choice analysis causes us to miss a concept that is fundamental to the understanding of taxation, namely, political equilibrium. Outcomes in the public sector are a consequence of the balancing of political forces taking place in the context of resource use in both the private and the public economy. If this is acknowledged, we must create an explicit link between collective choice mechanisms describing political equilibrium and the determination of tax policies.
We show in this paper how the perspective on tax research is changed if such a broader approach is adopted. We start by considering collective allocation mechanisms that can serve as a basis for positive tax analysis. This is followed by a discussion of how an explicit acknowledgment of political equilibrium affects the normative evaluation of tax systems and tax policy proposals.
The problem of efficiency, however, is so vital that we cannot ignore it merely because our answers to it are not complete. Welfare economics, despite its limitations, provides partial answers; and I feel that to provide partial answers to vital problems is at least as important as it is to provide complete answers to lesser questions.
This chapter represents an exploration of a more inclusive welfare economics of taxation. Its nature, like that of any new enterprise, is of necessity somewhat tentative. The emphasis is on presenting an outline of ideas and illustrating them with relevant examples. Whereas some sections develop a formal analysis, others take a more intuitive approach. The organization of the material is based on the conclusions reached in the preceding chapter, where we sketched three steps required for a comprehensive welfare analysis in the presence of collective choice. (See Section 5.3.)
We begin here with the selection of the standard of reference against which to judge collective choice outcomes. This, together with a consideration of the conditions under which equilibrium policy outcomes will achieve the standard, constitutes the first step. Economists have devoted much effort to working out such an analysis for an economy with private markets, and it has been one of the important achievements of the discipline to show that an economic system with competitive markets will yield optimal (Pareto-efficient) outcomes under carefully defined conditions.
It is possible to go further and to consider the public sector in another way. One then tries to explain the actions of public authorities as determined by, for instance, such things as the various influences of social classes and pressures, the social mechanism of selection of leaders of state and municipal institutions, their knowledge or lack of knowledge when taking decisions, etc. This will be a theory about politics.
The suitability of a model depends as much on what is left out as on what is put in.
We begin the study of the power to tax in democratic states with a review of six well-known models that have been used to investigate important aspects of the formation or evolution of tax systems. Five of them include collective choice as an integral part. Johansen's challenge to “go further and to consider the public sector in another way” has not gone unanswered in the fiscal literature during the last four decades. Many authors have attempted to explain how selected aspects of tax systems, or tax structure as a whole, emerge in an equilibrium resulting from the interaction of the private economy and the political process. The major contending frameworks include the median voter model, structure-induced equilibrium, probabilistic voting, the Leviathan model, and cooperative game theory. We provide a sketch of each of these approaches.
Why should public finance theory only be allowed to investigate the effects of various tax proposals, but not be permitted to analyze the factors which determine the form they take and the choice between different proposals which is then made by the political authorities? In both cases the question is one of clarifying factual causal relationships.
It depends upon social structure and upon … political constellations whether … personal taxes or taxes on objects, income and profits taxes or land, investment, property and death taxes are to be chosen, whether the tax screw should be tightened or relieved, what groups of the population are to bear the heavier or the lighter burden, … whether expenditure is to be reduced or revenue raised, how taxation is to be combined with economic incentives, and so on.
Actual tax systems are complicated and often elaborate. Underneath their rather baroque appearance lies a simple skeleton, however, consisting of a limited number of parts. The main elements in all tax systems are tax bases, rate structures, and special provisions such as exemptions, credits, and deductions. A theoretical analysis of tax structure must explain how these elements arise as a result of private and public choices and also what determines their design and importance within the system as a whole.
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