Handbook of Public Economics Volume 3 (Handbooks in Economics)

709 Pages·2002·45.89 MB·English

by  Martin Feldstein

EDITORS' INTRODUCTION TO VOLUME 3
The publication of Volume 3 and the forthcoming Volume 4 of the Handbook of
Public Economics affords us several opportunities: to address lacunae in the original
two volumes of this series, to revisit topics on which there has been substantial new
research, and to address topics that have grown in importance. Indeed, many of the
papers individually encompass all three of these elements. For each chapter related
to one from an earlier volume, the new contribution is free-standing, written with
the knowledge that the reader retains the opportunity to review the earlier chapter to
compare perspectives and consider material that the current author has chosen not to
cover. Indeed, such comparisons illuminate the evolution of the field during the roughly
two decades that have elapsed since work first began on the chapters in Volume 1.
Taken together, the four volumes offer a comprehensive review of research in public
economics, in its current state and over the past few decades, written by many of the
field's leading researchers.
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.
INTRODUCTION TO THE SERIES
The aim of the Handbooks in Economics series is to produce Handbooks for various
branches of economics, each of which is a definitive source, reference, and teaching
supplement for use by professional researchers and advanced graduate students. Each
Handbook provides self-contained surveys of the current state of a branch of economics
in the form of chapters prepared by leading specialists on various aspects of this
branch of economics. These surveys summarize not only received results but also
newer developments, from recent journal articles and discussion papers. Some original
material is also included, but the main goal is to provide comprehensive and accessible
surveys. The Handbooks are intended to provide not only useful reference volumes for
professional collections but also possible supplementary readings for advanced courses
for graduate students in economics.
KENNETH J. ARROW and MICHAEL D. INTRILIGATOR
PUBLISHER'S NOTE
For a complete overview of the Handbooks in Economics Series, please refer to the
listing at the end of this volume.
CONTENTS OF THE HANDBOOK
VOLUME 1
Editors' Introduction
Chapter 1
A Brief History of Fiscal Doctrine
RICHARD A. MUSGRAVE
Chapter 2
The Theory of Excess Burden and Optimal Taxation
ALAN J. AUERBACH
Chapter 3
Public Sector Pricing
DIETER BOS
Chapter 4
Taxes and Labor Supply
JERRY A. HAUSMAN
Chapter 5
The Effects of Taxation on Savings and Risk Taking
AGNAR SANDMO
Chapter 6
Tax Policy in Open Economies
AVINASH DIXIT
Chapter 7
Housing Subsidies: Effects on Housing Decisions, Efficiency, and Equity
HARVEY S. ROSEN
Chapter 8
The Taxation of Natural Resources
TERRY HEAPS and JOHN E HELLIWELL
VOLUME 2
Chapter 9
Theory of Public Goods
WILLIAM H. OAKLAND
viii Contents of the Handbook
Chapter 10
Incentives and the Allocation of Public Goods
JEAN-JACQUES LAFFONT
Chapter 11
The Economics of the Local Public Sector
DANIEL RUBINFELD
Chapter 12
Markets, Government, and the "New" Political Economy
ROBERT INMAN
Chapter 13
Income Maintenance and Social Insurance
ANTHONY B. ATKINSON
Chapter 14
The Theory of Cost-Benefit Analysis
JEAN DREZE and NICHOLAS STERN
Chapter 15
Pareto Efficient and Optimal Taxation and the New New Welfare Economics
JOSEPH STIGLITZ
Chapter 16
Tax Incidence
LAURENCE KOTLIKOFF and LAWRENCE SUMMERS
VOLUME 3
Part I - CAPITAL INCOME TAXATION
Chapter 17
Taxation, Risk Taking and Household Portfolio Behavior
JAMES M. POTERBA
Chapter 18
Taxation and Saving
B. DOUGLAS BERNHEIM
Chapter 19
Taxation and Corporate Financial Policy
ALAN J. AUERBACH
Chapter 20
Tax Policy and Business Investment
KEVIN A. HASSETT and R. GLENN HUBBARD
Contents of the Handbook ix
Part 2 - THEORY OF TAXATION
Chapter 21
Taxation and Economic Efficiency
ALAN J. AUERBACH and JAMES R. HINES JR
Chapter 22
Tax Avoidance, Evasion, and Administration
JOEL SLEMROD and SHLOMO YITZHAKI
Chapter 23
Environmental Taxation and Regulation
A. LANS BOVENBERG and LAWRENCE H. GOULDER
Part 3 - THEORY OF GOVERNMENT
Chapter 24
Political Economics and Public Finance
TORSTEN PERSSON and GUIDO TABELLINI
Chapter 25
Economic Analysis and the Law
LOUIS KAPLOW and STEVEN SHAVELL
THE TRANSFORMATION OF PUBLIC ECONOMICS RESEARCH:
1970-2000
MARTIN FELDSTEIN*
The nature and content of research and teaching in public economics have changed
enormously during the past three decades. The field is more theoretically rigorous,
more empirical, more focused on real policy issues, and more concerned with
government spending as well as with taxation. For me, it has been an exciting time to
be a public finance economist and to contribute to this intellectual transformation.
Theoretical beginnings
When I began studying public finance as a graduate student in England in the early
1960s, the bible of the field was Richard Musgrave's The Theory of Public Finance
(1959). Unlike earlier books by authors like Pigou (1947) which were characterized
by prose unencumbered by diagrams and algebra, most of the Musgrave volume
looked like a standard price theory book with graphs and algebra showing the partial
equilibrium effects of taxes on prices and quantities and the associated effects on
deadweight losses. The Musgrave book was about the core issues of incidence and
efficiency and the positive effects on the actions of buyers and sellers without the
detailed descriptions of tax rules or administrative issues that characterized many
earlier public finance books. Although this text opened up a new era in public finance,
its limited mathematics meant that it was weak in dealing with multi-product problems
and in analyzing general equilibrium effects. The general absence of references to
econometric research reflected the state of the field at the time. Similarly, although
Musgrave discussed general principles of government spending, his classic text did not
deal with the specific areas of government spending that would become the subject of
much of public economics in the past three decades.
Arnold Harberger's work on the incidence of the corporate income tax [Harberger
(1962)] demonstrated the power and importance of simple general equilibrium
* Professor of Economics, Harvard University and President of the National Bureau of Economic
Research. This essay, written for the 30th Anniversary of the Journal of Public Economics, focuses on
research that has been described in the English language and therefore primarily on work done in the
United States and Britain. The Journal played an important role in the transformation described here.
I am grateful for the opportunity to serve as a Co-Editor of the Journal from 1972 through 1986, as an
associate editor from 1987 through 1997, and as an advisory Editor since that time.