An interest group theory of public goods provision: reassessing the relative efficiency of the market and the state.

Author:Newhard, Joseph Michael
 
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  1. Introduction

    Since Samuelson (1954), it has been well-understood that the efficient quantity of public goods is that which equalizes the marginal cost of production with the sum of consumers' marginal rates of substitution. To overcome the free riding that may occur under private provision due to transaction costs relating to group size (Olson 1965), government provision is deemed necessary to achieve efficiency. However, this paper argues that like the private sector, government tends toward underproduction of public goods. As the residual claimants of constitutionally unconstrained tax revenue, rulers deliberately reduce public goods output and impose taxation that exceeds the cost of production, generating a revenue surplus to be consumed directly or transferred to interest groups in exchange for political support. In fact, the interest group theory of government depends on government deviating from the Samuelson condition, since it is by this mechanism that the revenue to be transferred to rent-seekers is generated; the surplus that remains after public goods and other constrained expenses are funded is lower under efficient provision than under monopoly provision, and may even be zero or negative depending on whether marginal cost is rising or constant and whether production entails sufficiently large fixed costs. Behaving as monopolists, rulers are able to reduce public goods expenditures to fund rent-seeking activity while still taxing the population at a rate that forestalls rebellion.

    The ability of rulers to extract rent from taxpayers in this manner depends on the cost of emigration. Given heterogeneous consumer preferences and differential costs of public goods provision across jurisdictions, taxpayers are able to increase their consumer surpluses by migrating to jurisdictions that offer their preferred bundle of public goods and taxes (Oates 1999). This ability to migrate puts governments in a state of monopolistic competition with each other. Where emigration is costless, government provision converges toward the efficient level in the drive to compete for citizens (see Tiebout 1956; Oates 1969; Mieszkowski and Zodrow 1989). As the cost of emigration rises, governments converge toward the pure monopoly provision of public goods to generate monopoly rents. These rents are an essential element of the rent-seeking society, without which little or no surplus revenue would remain for rent-seeking activity after the funding of public goods under a balanced budget constraint.

    The model of government underproduction presented here conflicts with the well-established model of budget-maximizing government advanced by Niskanen (1971), in which no discretionary surplus is generated and all revenue is spent on public goods, resulting in overproduction. Yet, bureaucrats who rely on funding from their sponsors must be distinguished from rulers who, motivated by self-interest and serving as residual claimants of tax revenue, desire to maximize their discretionary spending rather than their total budgets just as firms seek to maximize profits, not output. To the extent that a society is a rent-seeking one, this paper describes a government incentive to impose emigration controls, complementing Shughart and Tollison (1986), who provide an interest-group-driven account of immigration law enforcement.

    Despite the theory of government overproduction of public goods that currently dominates, the implicit position of statists seems to be that this is superior to the underproduction of private provision, perhaps determining that too much infrastructure, law, and national defense is better than too little. Yet, given the model of deliberate government underproduction advanced below, it is not obvious that consumers are better off under government provision than under private provision. When compared to the suboptimal quantity and higher pricing of government provision, private provision may be more efficient. The remainder of this paper develops the model of government underproduction of public goods as a means of facilitating rent seeking and then assesses under what conditions private provision outperforms government provision of public goods, showing that consumer welfare may be higher under private provision.

  2. The Leviathan Model of Government

    The interest group theory of government finds its roots in the economic theory of regulation pioneered by Stigler (1971), Peltzman (1976), and Becker (1983). It describes government rulers as economic agents who facilitate wealth transfers in the economy in exchange for remuneration from industries, firms, and other factions, with interest groups that are able to organize at a lower cost enjoying a comparative advantage in this process (Ekelund and Tollison 2001; McCormick and Tollison 1981). In this approach, government is assumed to choose the level of expenditures and the tax rate "that best serve the interests of those who control the government" (Niskanen 1997). Even government's provision of public goods is viewed as motivated by self-interest (Olson 1993). Holcombe (1997; 2004) argues that state-provided public goods are a means to the end of pursuing the narrow interests of the ruling class, even if such activities are marketed to society by appealing to socially desirable or noble outcomes (Yandle 1983; Yandle 1999). Even if rulers control their total domestic outputs, some public goods will still be provided since even they derive utility from them (Brennan and Buchanan 1980).

    The disposition of government, or "the mix between that share of revenues collected that is devoted directly to the production or provision of goods and services values by taxpayers-consumers and that share directed to the provision of perquisites (pecuniary and nonpecuniary) to the politicians-bureaucrats" (Brennan and Buchanan 1980, p. 160), includes a great deal of the latter. Rulers may consume constitutionally unconstrained revenue directly or transfer it to interest groups in exchange for political support. This is possible because the power to tax in and of itself carries no obligations concerning spending and constitutional constraints governing the allocation of expenditures may be imperfectly written or imperfectly enforceable (Brennan and Buchanan 1980, p. 11); governments in general lack certain features possessed by clubs, which undermine their constitutional effectiveness in the provision of club goods (Leeson 2011). Rent-seeking requires expropriating taxes from citizens--for which they receive nothing in exchange--and so requires deviation from efficient provision, where citizens prefer to be. To the extent that the citizens do not benefit from certain expenditures, government is enabled to pursue them anyway due to its monopolistic position of violence in society, allowing it to ignore, weaken, or overturn constitutional constraints on expenditures. As noted by Leeson (2011), constitutional restraints are ultimately no match for incentives in shaping the behavior of rulers. They will pursue their own interests by increasing taxes and reducing public goods in order to generate discretionary income that facilitates rent-seeking activity. The results are a massive misallocation of resources in the economy (Harberger 1954), deadweight loss (Tullock 1967), depressed local property values (Oates 1969), and additional social costs that decrease society's wealth (Posner 1975; Dougan and Snyder 1993).

    Brennan and Buchanan (1980, p. 20) warn that "natural government is monopoly government, with all the implications that the word 'monopoly' suggests," including reduced output, higher prices, diminished consumer surplus, and deadweight loss. Thus, they assert, "a more acceptable model for rational constitutional choice would seem to be one in which the political-bureaucratic process, as it is predicted to operate postconstitutionally, involves the maximization of revenues within tax constraints that are imposed through the fiscal constitution." They continue, "If there are no constraints on the uses to which revenue may be put, revenue becomes equivalent to private income to the governmental decision makers" (Brennan and Buchanan 1980, p. 33). It seems clear that the decision makers of today enjoy wide discretion over the allocation of most, albeit not all, revenues, even in constitutional republics such as the United States. They add, "If such constraints are operative but are independent of the tax rules which form the object of our study, we might also model government as attempting to maximize revenue, because revenue becomes a proxy for 'surplus.' ... If government is assigned the authority to tax A, it will, under Leviathan assumptions, maximize the revenue it can obtain from taxes on this base. The power to tax commodity or good A is identical analytically to the assignment of a monopoly franchise for the sale of commodity A" (Brennan and Buchanan 1980, p. 73). In short, we can expect governments to maximize their revenue whether or not constitutional constraints exist.

    Meltzer and Richard (1983) cite several studies as evidence of monopoly power of government in the supply side of public goods, asserting that "Congress, bureaucrats, or 'interest groups' are able to raise government spending above the level that utility maximizing households or voters would choose in the absence of this monopoly power." They note that this may be driven by a positive cost of information and organization, resulting in the rational ignorance of voters (Downs 1957). Oates (1999) also notes that empirical evidence suggests that consumer demand for public goods is highly price inelastic, a fact that rulers are perfectly willing to exploit. This model is one of both government size and government composition, which are jointly determined by rulers...

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