Public Finance and Management

It is a cliché to observe that modern democratic states are composed of citizens with diverse interests. Yet it seems fair to say that the formal study of how heterogeneity in an electorate - of incomes, preferences, political influence and in other dimensions -plays a role in shaping the policies that emerge in competitive democratic equilibria is, if not in its infancy, still far from mature. the purpose of this symposium is to call attention to the importance of explicitly addressing the role of heterogeneity in theoretical and applied research on public policy. and to contribute to this task.

Most modern economies tax both consumption and labour income. While there is an extensive normative literature on the optimal mix of the two taxes, there is little examination of what determines the actual mix in a well specified political economy context. We use a multi-dimensional spatial voting framework to simulate endogenous political tax equilibria. the model accommodates complex interactions between many of the first three moments (mean, variance and skewness) of three distributions identified in the literature as crucial: the distribution of income, of preferences for public goods and the distribution of political influence. to simplify, we focus on a balanced and an asymmetric society and analyze how different combinations of distributional moments interact in the determination of tax equilibria. Interesting links emerge between the nature of the distribution of preferences for public expenditure, income inequality and the relative importance of consumption taxation. the analysis suggests that studies of single taxes have limited relevance for the explanation of the observed tax mix.

We analyze how institutional and political decisions are intertwined. Citizens who differ in their mobility and ability vote first on labor market integration and afterwards on education policy. the institutional decision on integration influences the succeeding education policy. More surprisingly, the prospect of voting on education policy also affects the preceding integration decision. There are incentives for citizens to vote strategically for the institutional setting in which their preferred education policy is more successful at the polls. We show how a ‘joint’ analysis of the institutional and political decision alters the results compared to an ‘isolated’ analysis of either of the two decisions. Also, we explore how the two-dimensional heterogeneity of the citizens shapes the voting equilibrium in our setting with sequential voting.

By distinguishing between surface- and deep-level heterogeneity, this paper explores how heterogeneity among voters might be incorporated into a theory of political economy. Central to this exploration is the distinction between organizations and orders. Existing theories of political economy typically assimilate a state to an organization, and with an election being a vehicle for choosing among competing plans for the organization to pursue. This treatment imposes a deep homogeneity among voters as an analytical point of departure. in contrast, we advance a treatment of polities as orders, with many different organizations operating within their boundaries. This alternative formulation provides analytical space for deep heterogeneity to enter the analysis, and also brings into the analytical foreground the constitutional framework within which state policy emerges.

One factor that is relevant to determining the optimal size of local government is whether there are economies of diseconomies of scale in municipal government expenditures. This paper examines the question by analyzing municipal government expenditures of 487 municipalities with populations greater than 50,000. At first glance it appears that municipal expenditures are characterized by diseconomies of scale, but because there is a close correlation between total population and population density, one must be careful to make sure that the effects attributed to total population are not in fact due to variations in population density. When cities are divided into groups by population density so that they are not compared with other cities with very different densities, the evidence for diseconomies of scale goes away. It appears that after variation in density is taken into account, municipal government expenditures are characterized by constant returns to scale. Thus, there is no reason to think that either consolidations or secessions at the local level would appreciably affect per capita government expenditures.

This article uses simple and self-contained optimal control theory and martingale methods to find optimal government expenditure consistent with present value balance and, implicitly sustainable saving, borrowing, and tax levels as well, since long-term sustainable paths are, in principle, not different from optimal paths. Our approach identifies time-consistent budget rules, where most other efforts to do so have not, because it makes the reasonable assumption that the stochastic nature of revenues is more or less given, and ignores the relationship between the level and kind of taxes employed and revenue growth. Further allowing the government to invest in risky as well as risk-free financial assets, we derive explicit formulas for optimal expenditure and the parameters of its future stochastic evolution, expected surpluses and deficits and their dependence on model parameters, and the probability of sustained long-term growth and its dependence on the initial size of the reserve account.