Abstract
Nobel laureate James Buchanan was influenced substantially by Knut Wicksell’s arguments in favor of unanimous consent or “qualified majorities” for approving or rejecting specific public spending programs. Buchanan thought of Wicksell’s recommendation that spending proposals be tied to dedicated revenue sources as way of erecting a bridge between the two sides of the public budget, thereby forcing politicians to face the same tradeoffs as individuals do when formulating their spending plans. We examine the history of Buchanan’s ideas on public finance and discuss how legislative processes have demolished the bridge between public expenditures and public revenues. In modern practice, tax “earmarking”, whereby local, state and federal governments ostensibly finance specific spending programs with the revenues raised by targeted consumption taxes, often becomes a smokescreen hiding the opportunistic reallocation of taxpayers’ monies to finance unrelated policies or programs. Taxes on sugar-sweetened beverages provide our main case study. Other examples from public finance, past and present, such as selective excise taxes on cigarettes, lottery tickets and motor fuels, along with Alexander Hamilton’s tax on whiskey to pay Revolutionary War debts also are examined.
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Notes
Known officially since its creation in 1969 as the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.
See the work of Adams (1998, [1993] 2001) on the history of taxes. Adams makes clear that taxes often are raised for specific purposes, but rarely are reduced or repealed after that specific purpose is attained. The War Revenue Tax Act of 1913, passed in advance of the First World War’s outbreak in August 1914, imposed duties on numerous items of consumption, such as “theater admissions, jewelry, toilet articles, luggage and chewing gum”, and reauthorized all federal excise taxes imposed during the War Between the States (1861–1865), including long-standing levies on alcohol and tobacco (Shughart 2018, p. 26). Taxes raised in wartimes or other economic emergencies seldom disappear when the crisis ends. A “temporary” tax on telephone calls was enacted during the New Deal; it was not repealed until “mid-2006, and then only in part” (Shughart 2018, p. 27).
The analysis is an insightful application to public finance of the familiar equi-marginal principles deduced from price theory (more on that point below).
In that regard, Wicksell echoed the fear of a tyranny of the majority famously expressed by James Madison in The Federalist, especially Nos. 10 and 51.
Unanimous consent, as a decision-making rule, is equivalent to insisting that the individuals advantaged by a particular collective choice compensate those who are disadvantaged by it, “if compensation is interpreted as that payment, positive or negative, which is required to secure agreement” (Buchanan and Tullock 1962, p. 91). Moreover, “without side payments, there is nothing in any voting rule to insure [sic] that collective decisions will move the group to the Pareto-optimality surface or that such decisions will keep the group on the surface if it is once attained” (Buchanan and Tullock 1962, p. 188). Requiring that winners actually compensate losers obviously undermines the orthodox Kaldor–Hicks potential compensation test for avoiding Paretian status-quo bias.
In technical terms, Lindahl taxes are set equal to the inverse of each taxpayer’s elasticity of demand for the public good whose provision is being financed.
Buchanan (1991, p. 157) also points out the need to differentiate theoretical abstractions from political reality in analyzing governmental resource use. He writes, “If the effective unanimity rule is dropped, as it must be in any approach to political reality, the model of the fiscal process dramatically changes, even if we retain the electoral democratic feature and continue to presume that an independently motivated ‘fisc’ does not exist at all”.
Given the diversity in individual’s valuations of tax-and-spending activities, tax-rate setters will confront an insurmountable Hayekian (Hayek 1945) knowledge problem. That problem is compounded by the usual political requirement of imposing a uniform tax rate per unit of the externality-generating activity.
The same principle applies in neoclassical production theory. A producer minimizes total cost (equivalently maximizes profit, given the prices at which outputs can be sold) by hiring inputs (land, labor and capital) up to the point at which the marginal product per dollar spend on them is the same.
Even when public budget balance is maintained, if dedicated funds free public revenue for uses other than financing the targeted program, earmarked taxes nevertheless can fail to accomplish the stated aims of their proponents. The next section discusses that point further.
Buchanan (1956) questioned and revealed limits to Knight’s position, but they extend far beyond the scope of this paper.
Harold Demsetz (2011) points to this disagreement between Knight and Pigou as an example of how the inexact definition of “externality” in practice and policy has overextended the definition of externalities. Demsetz (2011, p. 13) cautions that externalities occur only when resources are inefficiently allocated and argues that “the category of problems that we call externality problems now includes a great many that are not strategic in nature”.
Nearly the entire debt from the Revolution was assumed by the federal government through Hamilton’s consolidation plan (Edling 2007, p. 288). Trescott (1955) explains the complexities of the debt-relief program and documents the extent of relief by state after the Funding Act’s implementation in 1790.
Cook County repealed its soda tax only a few months later in response to public outcry.
For a discussion of the policy challenges involved with using Pigouvian policies to rectify externalities caused by policy interactions, see Browning (1999), who is concerned with fiscal externalities created by public policy. His chief example is the socialization of the healthcare costs of smoking.
One might add the federal excise tax on automobile and truck tires and state vehicle registration fees to the user-fee list.
In the context of infrastructure, Bastiat ([1850] 1964) teaches us that politicians will prefer spending money on new roads and bridges, which readily be seen and rewarded by voters, over spending on repairs and maintenance, which, because infrastructure deteriorates slowly over time, is less visible, at least until drivers begin hitting potholes and damaging tires or axles. The American Prairie Reserve supplies another example: the maintenance backlog of the National Park Service is monumental, suggesting an institutional failure of the federal oversight of national parks or indicating the inability of user fees by themselves to generate revenue sufficient for maintaining public lands.
Because the demand for gasoline is very inelastic, most of the burden of a tax on it is shifted forward to consumers in the form of higher prices at the pump. On average, a 10% price increase leads to a 5% reduction in quantities purchased (Hoffer and Shughart 2018, p. 62).
The US Department of Health, Education, and Welfare (now Health and Human Services) declared in 1964 that “Cigarette smoking is a health hazard of sufficient importance in the United States to warrant appropriate remedial action” (quoted in Hoffer et al. 2014, p. 49).
As mentioned earlier, such an externality is created, not by cigarette smoking per se, but rather by the institutions of public healthcare finance.
The State of Utah, for example, earmarks all of the revenue raised by the state’s personal income tax for financing public K-12 education; public institutions of higher learning later were added to the list of beneficiaries. (Primarily for religious reasons, Utah does not operate a state-run lottery.).
The remaining 20% of revenue from park entry fees and concessionaire agreements goes to the general fund of the National Park Service.
U.S. Congressional Research Service, Deferred maintenance of federal land management agencies: FY2009–FY2018 estimates and issues, April 2019.
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Acknowledgements
Prepared for presentation at a conference in celebration of Dr. James M. Buchanan’s centennial birthday, hosted by Middle Tennessee State University, Murfreesboro, TN, 2–5 October 2019. We thank guest editor Daniel Smith, the attendees for their useful comments and Steven Sprick Schuster for serving as discussant.
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Shughart II, W.F., Smith, J.T. The broken bridge of public finance: majority rule, earmarked taxes and social engineering. Public Choice 183, 315–338 (2020). https://doi.org/10.1007/s11127-020-00809-2
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DOI: https://doi.org/10.1007/s11127-020-00809-2