Excess Burden and the Voluntary Theory of Public Finance: The Case of Intermediate Public Goods

IJohnson and Pauly (1969) correctly pointed out that the condition for the optimal supply of public goods derived by Samuelson (1954) is based on the assumption that public goods are financed by efficient lump-sum taxes. They derived an optimal (i.e. second-best) condition for the supply of public goods in the presence of distortions due to nonlump-sum taxes, such as an excise tax. Like Samuelson they confined their analysis to public goods which are final products and therefore considered the voluntary theory of public finance which assumes that the basic decision-making unit is the individual consumer-votertaxpayer. Assuming that consumers take into consideration not only the monetary cost of the supply of public goods but also the welfare costs due to inefficient taxes, they showed that a smaller quantity of public goods is supplied under an inefficient tax than the optimal quantity supplied under an efficient tax, the marginal utility of money being assumed constant. The aim of this note is to extend their argument to the case of public goods which are intermediate goods, and to show that there are cases where pressures from industry on government cause an under-supply of public goods even when the financing is done by an earmarked lumpsum tax on the industry. In spite of Galbraith (1958) an under-supply of public goods has been thought to be the least likely result for intermediate public goods, since industries have more influence on governments than do consumers (see for example Downs, 1957, pp. 255-259).