Public Finance in Democratic Processes by Buchanan

James P. Buchanan, Public Finance in Democratic Processes: Fiscal Institutions and Indvidual Choice, The University of North Carolina Press, Chapel Hill, 1967.

Earmarking

The public can vote on the budget and tax rates, independently, or in the aggregate. That is, they can vote on a budget in one section of the web screen, how much to be spent on each item. Separately, they can come up with the taxing algorithm.

I proposed such a solution a while ago when many States were confronting (and now are) facing red ink and difficulties in achieving the political will to confront their budget problem. One can vote for the taxes to support all public goods combined. One also votes independently on how the money is to be spent.

However, another option is for the voting system to have the voters vote separately for each public good and for the taxes to carry them out. This was implicit in the discussion of Lindahl Equilibrium Dr. Buchanan has some graphical and algebraic models of the differences. I will create my own set for this group.(But I will probably do it during a break when I am not teaching.) In 1963, 41 per cent of state tax collections to specific functions and it was over fifty percent in the 1950's. Buchanan showed that the general fund mechanism gave a suboptimal voting and people would be more likely to get the amount of expenditures they wanted if they could vote independently for the taxes for each of two public goods. The Libertarian Right believes that having taxes earmarked for specific expenditures would better inform voters of what each public benefit from government truly costs. (This reminds me of "Every one wants to live at the expense of the state. They forget that the state counts to live at the expense of everyone" Frederic Bastiat 1801-1850 which is the essay for the 2010 Sir John W. Templeton Fellowship.) In fact, it would lead to more of a participatory democracy. And, from a participatory democracy approach, feminist, green and Catholic Social Thinkers also advocating more earmarking with specific voting for each category or type of expenditure.

Way back in 1963, Mueller surveyed individuals whether the government should spend more on various programs. Separately, they survry whether more should spent on the same programs, "even if taxes must be raises." The latter had a dramatic decrease in expenditures. Help for older people dropped by half from 70 percent to 34 percent Highways dropped from 29 to 10 percent. We see the same thing in health care today 67% of Americans said that everyone should have at least some health insurance yet 64% are opposed to a tax penalty.

James Q. Wilson and Edward Banfield looked at votes for spending in municipalities. Both low and high-income people voted for public spending--the middle income group tended to vote against taxes and spending.

Tax Knowledge

People's Knowledge of their taxes is somewhat limited. When asked what they paid in their tax, seventy percent can name a number within twenty-five percent of their true liability. Of course, now people would have better access. I would propose that they bring up their Turbo Tax or whatever tax program they use when they vote. Researchers found that lower-income tax payers tended to overestimate the bite from taxation. A study in Germany found that people had even less of a knowledge of excise taxes. And a study in Britain found that the public had a very poor knowledge of how much was spent by the government on each area and overestimated the percentage of government paid by user fees, e. g. Medicare Recipient's pay some copays as well as some of the cost of Medicare Part B. How much of the total Medicare expenditures do these fees cover?

Fiscal Constitutionalism

Dr. Buchanan talks about fiscal constitutionalism, the tendency to keep the same tax mechanisms. One would not expect country A to tax by property taxes and a VAT tax in 2010 and then switch to a personal income tax and an income tax in 2011 and then switch again in 2012. The rates may change, and of course, loopholes and "tax expenditures" or new credits will be added from year to year.

Thus, there are two levels of choices in participatory democracy. A month-to-month or year-to-year choice on the levels of things: should the income tax rate on those earning $70,000 to $80,000 be fifteen percent or eighteen percent, should a retiree on social security under these circumstances earn $13,000.00 per year or $13,473.00 per year? And there might be bigger choices when a country is being formed--should we have an income tax at all, how should the big decisons be made. How do we structure a participatory democracy Constitutional Convention?

Equal Preference Models

Chapter Eleven, particular its appendix, looks at Duncan Black's Committee models . Assume a bunch of people are voting on a tax rate or expenditure rate. Proposals to change tax or expenditure rate are accepted or rejected based on a majority basis. Duncan Black showed that the tax rate would tend to be the median of the preferred rate for each of the voters assuming that the preferences were single peaked. How can we ensure that the voters would not change their relative positions based upon a proporational distribution. Buchanan shows that the rate of increase from the tax be enough to outweight the income distribution. Individuals earning more would probably want more of the public good, let's say education or public support of culture. A good tax system would not make a higher income person more likely to vote for a higher tax for culture relative to a lower income person than they would be under a general system.

Proportional Taxation Over Time and Excise Taxation

Are excise taxes better than income taxes? Are progressive income taxes better than a proportional or flat tax. Dr. Buchanan looks at an individual who expects a different income at one time than another, e. g., less income during retirement or more income Or what about the individual who is uncertaint of how much they will make, e. g. a business owner in a cyclical feel.

Classical Economists view a tax on a specific product as a distortion as individuals will change their choices of which goods to buy independent of the purchase. (I saw this argument in my Intermediate Economics textbook "The Deadweight Loss of Excise Taxation" in Edward K. Browning and Mark A. Zupan, MicroEconomics 8/e, page 273 to 275) They would argue that an excise tax or consumption tax might create distortions while an income or direct tax would less. Alternatives are

1. lump-sum payment (like a poll tax)
2. Proportional income tax
3. A Progresive tax
4. A general consumption tax
5. or excise taxes

But, individuals expenditure needs are different over time; they might need to spend more some years on necessities in some years. An excise tax is a better method in this case as the taxation could fall heavier on luxuries (he terms these "residual needs") than on things that whose expenditures are likely to vary such as college education for children or medical care. But, of course, the American taxation system does allow us to save for our children's education, our retirement and gives a deduction for medical taxes. And to some extent, the sortition based consumption tax does this, as each item is taxed not only on its badness but whether it is a basic good or a luxury. In other words, the tax rate on fine wines and caviar is higher than that on healthy food staples. Of course this is true because individuals pay more interest than the government does.

Now, let us look at intertemporal distribution. Individuals can always lend to the government at the government rate--they can buy treasury bills. However, if they need to borrow, they will pay more interest. In this situation, a person woudl prefer a proportional rate when they expect their income to vary more than their spending.

To be looked at for for Future Thoughtful Thursdays

1. Duncan Black The Theory of Committees and Elections Cambridge: Cambridge University Press 1958
2. James Q. Wilson and Edward C. Banfield " Voting Behavior on Municipal Public Expenditures" in the Public Economy of Urban Communities edited by J. Margolis, 1965, also "Public-regardingness as a Value Premise in Voting Behavior" American Political Science Review LVIII December 1964, 876 to 887.
3. James H. Buchanan, "Public Choice: The Origins and Development of a Research Program"