Democracy and the theory of public finance: a polycentric, invisible-hand framework.

Author:Wagner, Richard E.

    Most theorizing in public finance has focused on normative issues regarding good governance, as illustrated by efforts to articulate principles of optimal taxation as surveyed by Mirrlees (1994). Recent literature on political economy has advanced positive theories where political competition yields outcomes that conform to the preferences of a median voter, or nearly so, as illustrated by Persson and Tabellini (2000) and Besley (2006). In both types of theorizing, government is treated as a monocentric entity whose activities can be apprehended in their entirety by some decision maker. Within autocratic regimes that decision maker is a king or other type of autocrat. Within democratic regimes that decision maker is a median voter, with political candidates competing with each other to secure voter approval for their programs. This monocentric framework has analytical tractability on its side in its reduction of what are really complex patterns of interaction to simple acts of choice. This reduction, however, also obscures from view much fiscal phenomena of great significance, as this paper seeks to explain.

    This paper brings a polycentric or invisible-hand framework to bear on the material of public finance. Within this alternative framework, fiscal phenomena arise through the same framework of competition among enterprises as do market phenomena, taking into account institutional differences in the constitutive frameworks of political and market enterprises and as outlined in Wagner (1997, 2006, 2007). These institutional differences are of greater significance for the positive explanation of fiscal phenomena than of market phenomena, as Ringa Raudla (2010) explores, because fiscal phenomena arise within particular sets of political institutions. In contrast, market phenomena arise universally within the abstract legal framework of property, contract, and liability, as Walter Eucken (1952) explains.

    With respect to institutional frameworks, there are significant differences in those frameworks between when public finance originated as an academic discipline and contemporary democratic settings. Fiscal theorizing, however, has not kept pace with the change in institutional setting, and this paper probes some features of what might be involved in revising the institutional framework within which positive fiscal theorizing proceeds. This revised institutional framework requires recognition that fiscal phenomena arise through processes of competitive interaction among politically-based enterprises which cannot be reduced to some simple act of choice, regardless of whether the chooser is a king or a median voter. While it is conventional to speak of a budget as originating from a chief executive, those budgets are the outcome of an on-going competitive process that lies beneath the surface just as the bulk of an iceberg lies beneath the surface. By peering beneath the surface, it can be seen that budgets arise through competition among political enterprises where those enterprises form alliances with subsets of market-based enterprises. To be competitive, moreover, political enterprises must engage in economic calculation among options just as must market enterprises. For political enterprises, however, those calculations necessarily involve parasitical relationships with markets and market prices because calculation is impossible without market prices and yet political enterprises are not capable of generating the market prices necessary for such calculation. What results is recognition that the democratic fiscal process resembles but doesn't duplicate market competition, as both occupy the same social space (Storr 2008) and reflect the same process of spontaneous ordering of complex interactions among organizations (Wagner 2010). This line of analysis ends up by reinforcing the call for incorporating constitutional analysis into public finance as expressed by such scholars as Buchanan (1967, 1968, 1990) and Ostrom (1973, 1987, 1997).


    While the origins of public finance as a systematic field of study can be dated to the cameralist writers who appeared in the Germanic lands in the 16th century (Backhaus and Wagner 1987), probably the best known early and systematic statement of public finance occurs in Book V of Adam Smith's (1776) Wealth of Nations. What is particularly notable about the origins of public finance is that they reside in times where polities were absolutist and governments accounted for relatively small shares of GDP. Within this setting, it would be quite reasonable to think of the material of public finance as arising from the choices of rulers. Public finance as a field of academic inquiry would thus follow a choice-theoretic orientation. Normative work in public finance would thus seek to offer systematic instruction to rulers. The name cameralism, for instance, refers to the chamber where a prince's advisors would gather to advise the prince. The choice-theoretic origin of public finance seems suitable for the small-scale programs of the absolutist states that were prevalent when public finance arose as a field of study.

    Modern democracies are much different from those absolutist regimes, both in terms of the organizational process through which fiscal phenomena arose and in terms of the scale of fiscal activity. Both of these differences have significant implications for pursuing a positive orientation toward public finance. In the western world, and a good deal of the rest of the world, democratic regimes have replaced autocratic regimes. The theory of public finance, however, has not kept pace with this transformation in governing regimes. In this respect, Knut Wicksell (1896; 1958, p. 82) lamented that "with some very few exceptions, the whole theory [of public finance] still rests on the new outdated political philosophy of absolutism. The theory seems to have retained the assumptions of its infancy, in the seventeenth and eighteenth centuries, when absolute power ruled almost all Europe."

    This situation has changed only modestly in the years since Wicksell voiced his lament. While fiscal theorists now recognize democratic forms of government, the formal structure of the theory remains unchanged from absolutist times in that fiscal phenomena are still treated as products of optimizing choice. The only difference is that withy democratic regimes, the choosing autocrat is a median voter who has been identified through an election and not a price who has been selected through dynastic succession. Contemporary fiscal scholarship still largely threats fiscal outcomes as reflections of absolute power, only now the holder of absolute power is commonly described as a median voter. In either case, however, the material of public finance is treated as a product some ruler's choice. Fiscal phenomena, in other words are products of rulership and not products of competitive interaction among multiple rulers.

    With democratic regimes, however, there is no single person who chooses fiscal outcomes. To the contrary those outcomes emerge through processes of interaction among multiple participants. What is particularly notable about democratic processes is the absence of positions of rulership, and the replacement of such positions with a set of participants who interact within a framework of rules which lead to negotiated outcomes that do not reflect the solution of any particular person's maximization problem, as explained by Primo (2007). Figure 1 gives a simple illustration of this point. Shown there are three people with differing preferences for two collective activities, X and Y. Prima desires the highest amount of Y among the three people and the lowest amount of X. Secundo desires the highest amount of X and occupies the middle with respect to Y. Terza desires the least amount of Y while occupying the middle with respect to X. What the collective outcome will be depends on the set of parliamentary rules through which collective outcomes emerge.


    Suppose collective choices are made by majority vote in any case, but with two distinct procedures being possible for taking those votes. In one case, a vote is taken on each issue separately. In this case the amount of Y desired by Secundo will be selected, as will the amount of X desired by Terzo. The outcome of this collective budgetary process is designated by Z in Figure 1. Under the second procedure, a single vote is taken on a motion that covers both items simultaneously. Under majority voting, the budgetary outcome will depend on the coalitional pattern that dominates the political process. Here, there are three possible coalitions, and the budgetary outcome will reside along one of the three contract curves that connect two of the three participants. While nothing more precise can be said about the budgetary outcome, what can be asserted is that whatever outcome results will differ from the outcome that would have resulted had the two items been voted on separately. In other words, fiscal outcomes depend on the frameworks of parliamentary and constitutional rules that provide structure to collective processes. Fiscal outcomes are thus products of rule-governed interaction and are not products of some ruler's choice. Fiscal outcomes are properly assimilated to theories of exchange and not theories of choice (Wagner 1997).

    But what kind of theory of exchange, it might be wondered. The issue here is whether fiscal processes are scalable or are free of scale. If they are scalable, exchange involving three people is indistinguishable from exchange involving 300 million people. But if those processes are scale free, changes in fiscal scale bring about qualitative changes in the operation of fiscal processes. Figure 1 uses a small scale model...

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