LECTURE ONE

1–1 Introduction

These Lectures are concerned with the economics of the public sector. We are all constantly affected by the economic decisions of the government. This is most noticeable in the taxes we pay. Income tax, sales taxes, local taxes, and social security contributions account for a substantial proportion of our income. Owners of capital are affected by taxes on corporate profits, inheritance taxes, and capital gains taxes. Almost all of us are at one time or another recipients of income from the government: for example, via social security programmes. A large proportion of workers are paid by the government or produce goods sold to the government. Many children go to schools supported by the government. We enjoy municipal parks, swimming pools, roads, and other publicly provided facilities. Many people are concerned about public policy towards the environment or about the conservation of natural resources.

In these Lectures we attempt to describe in a systematic manner the principal consequences of such economic activities by the government and their relation to social objectives. In Part One we examine the effects of various tax and expenditure policies. This "positive" section of the book is concerned with such questions as "Does income taxation discourage work effort or risk-taking?" or "What is the incidence of the corporation tax?" In contrast, in Part Two we present the "normative" theory of public finance, which is an attempt to postulate some simple criteria for government decision-making and to follow through their logical implications. Thus, it deals with such issues as the degree of progression for the income tax, the choice between direct and indirect taxation, the provision of public goods, and pricing rules for public enterprises.

In addressing these questions, we make no attempt to provide a comprehensive coverage. The choice of the title Lectures on ... is intended to dispel any impression that the book is an exhaustive account of public economics. The aim of the Lectures is to illustrate the current state of the art, to give some flavour of the strengths and weaknesses of recent developments, and to point to areas where future research is necessary.

The ways in which the book falls short of being comprehensive should be clear from the Table of Contents. Most seriously, no attempt is made to cover stabilization and macroeconomic policy. This is an essential element in any global view of the role of the government, and many issues are dominated by macroeconomic considerations. However, the economics of publishing have changed since the time when Musgrave could devote 210 pages of The Theory of Public Finance (1959) to stabilization policy, and there are many excellent treatments in the literature. Our emphasis is therefore on goals other than those of stabilization.

Even with this restriction, the coverage is selective. Some readers will no doubt be horrified or disappointed by the omissions, which include the international aspects of taxation, the economics of property rights, externalities in production, the fiscal problems of economic development, and the administration of taxes and benefits. We hope however they will feel that this selective treatment is justified by the greater depth in which we have been able to discuss the subjects covered. These include, on the taxation side, income and wealth taxes, levies on the transfer of wealth, corporation tax, and indirect taxes. The expenditure side covers the provision of goods and services by central and local governments, and—to a lesser extent—transfer payments. Other subjects included are the national debt and the policy of public enterprises/ utilities.

As will be clear from the Lecture titles, the book stresses those subjects in which there has been considerable recent research. This is particularly true of the incidence and design of taxation, which receives rather more emphasis than the expenditure side. The past decade has indeed seen a rapid expansion of the literature, most notably in econometric investigation of the effects of taxation and in theoretical analysis of the optimal design of tax policy.

Finally, we should emphasize the obvious fact that many areas are still unresearched. Despite the long tradition of public finance, and despite the recent influx into the field of economic theorists and econometricians, a great many important issues have yet to be discussed, let alone resolved.

1–2 Role of the Government

At the beginning of this Lecture we described some of the ways in which the government affects the typical individual. The state, however, has a much more basic role to play in that its first function is to establish and enforce the "rules of the economic game". We are concerned with modern mixed capitalist economies, such as the United States, Canada, Western Europe, and Japan, where these rules typically include the legal enforceability of contracts, provisions for bankruptcy, laws defining property rights, and liabilities. This basic framework has much to do with how the economy performs, and the other functions of government are very much affected by the kind of ground rules under which the private economy operates. It may indeed be argued that the tax and expenditure activities of the government are of minor significance in relation to its primary function "of preserving and stabilizing the property relations of the capitalist economy" (Gordon, 1972, p. 322). This is not a view we find totally convincing, and we consider that it is still valuable to analyse, as in these Lectures, the impact of fiscal instruments within a given economic system. At the same time, we recognize that it gives only a partial picture of the state's role in modern society, and we return to this below.

Even within the framework of a mixed capitalist economy, the government has a wide range of instruments at its disposal. These Lectures focus on taxation, public spending, and...