We have discussed the failure of private consumption to significantly increase happiness after a rather low level of biological necessity and comfort (Chap. 7) and discussed some reasons and implications in other chapters. These naturally suggest the question whether we may be able to increase happiness more by increasing public spending, at least in the right areas, as also discussed in the previous chapter. However, the global trends in recent decades seem to be against public spending. The whole world is marching towards the right, with the transformation of the Soviet Union and Eastern Europe, the drastic economic reforms in China, and the privatization, liberalization, and (reversing the historical increasing trend) reduction in taxes (with the Trump’s tax reduction in December 2017 being a recent important event) and public spending in many Western countries.Footnote 1 Much of these changes are applaudable and economists may feel proud for partially contributing to these changes. However, this chapter argues that the reduction in public spending, especially in education, research, and environmental protection is counter-productive. Imagine a trebling in your income but without access to computers, television, phones, modern medical facilities, etc., wouldn’t your welfare be reduced drastically? This may not be so viewed in the narrow perspective of production and consumption especially in the short run, but is almost certainly so viewed in the wider perspective of welfare (or happiness) in the long run and at the social level. It is well known that public spending has some efficiency problems but the probably much worse inefficiency of private consumption has been largely ignored. This chapter attempts to provide a broader and more balanced picture from an interdisciplinary perspective.

15.1 Economists Overestimate the Costs of Public Spending

For a dollar of public spending, non-economists typically cost it at one dollar. However, economists typically cost it at well in excess of one dollar. An estimate by a well-known economist (Feldstein 1997) puts it at $2.65. Though this is an extreme estimate, on average the economists’ estimate is for a dollar of public expenditures to be $1.30, a premium of 30%. Such high estimates of the costs of public spending suggest that public projects should yield very high benefits before they are worthwhile to undertake; a benefit-to-cost ratio of 1.3, instead of one, has to be exceeded. This conception probably partly contributes to the worldwide trend towards cuts in public spending.

The costs of public funds include not only its direct cost (the amount of taxes imposed) but also the costs of administration, compliance, policing, and distortion. While the first three types of costs are substantial, they do not vary significantly with the amount of tax revenue raised. Hence, concentrating on the marginal costs of public spending, economists emphasize the distortionary costs or excess burden of taxation due to the fact that taxes distort the free choices of individuals, especially in discouraging work effort, i.e. the disincentive effects. At least since the time of Pigou (1928), economists have emphasized that the benefits of public goods must exceed their direct costs by an amount sufficient to outweigh the excess burden of taxation. An authoritative modern textbook by a Nobel laureate puts the Pigovian principle this way: ‘Since it becomes more costly to obtain public goods when taxation imposes distortions, normally this will imply that the efficient level of public goods is smaller than it would have been with non-distortionary taxation’ (Stiglitz 1988, p. 140). It is known that this general rule is subject to qualifications due to the presence of considerations like complementarity/substitutivity between public and private goods (Atkinson and Stiglitz 1980; King 1986; Batina 1990; Wilson 1991; Chang 2000). Specific cases or conditions under which the efficient level of public goods is not affected have also been identified (Christiansen 1981; Boadway and Keen 1993; Konishi 1995, Dahlby 2008, Chang et al. 2016, Burns and Ziliak 2017, Jacobs 2018).

In contrast to minor qualifications and special cases, a whole scale onslaught on the Pigou principle is presented by Kaplow (1996). He argues that public goods can be financed without additional distortion by using an adjustment to the income tax that offsets the benefits of the public good. The ‘preexisting income tax schedule is adjusted so that, at each income level, the tax change just offsets the benefits from the public good. By construction, an individual’s net reward from any level of work effort will be unaltered; any reduction in disposable income due to the tax adjustment is balanced by the benefits from the public good. Because an individuals’ after-tax utility as a function of his work effort will thus be unchanged, his choice of work effort − and utility level – will also be unaffected’ (Kaplow 1996, p. 514).

For example, if the benefit of a public good is proportional to the income level of the taxpayers, it may be financed by a (or an increase in) proportional income tax. The proportional income tax itself may involve a disincentive effect. However, the tax plus the public good together involve no disincentive effect. Suppose that, for each $100 earned, $20 have to be taxed. Is not the incentive to earn more income less than the case where one can keep the full $100? This lower incentive may well apply if the tax revenue is thrown into the ocean. However, normally the revenue is used for public spending that the taxpayers value more or at least no less (otherwise the public spending is inefficient even using the benefit/cost ratio of one). Suppose the tax revenue is used for police protection of property whose benefits are roughly proportional to the income level. Then, each individual may in fact has higher incentive to earn the protected $80 than the unprotected $100.

While Kaplow’s argument has to be qualified in the presence of tax evasion, heterogeneity of individuals at the same income level, benefits from public goods relating to ability than to income, etc., its main thrust is valid (Ng 2000a). How then do we reconcile Kaplow’s argument with the orthodox position of the high costs of public spending? First, Feldstein (1997) obtains his high estimate of $2.65 by including policy-intended effects as unwanted distortions. He emphasises that higher tax rates may not only reduce the supply of labour and capital, but also change the forms in which individuals take their compensation, including more on things that are tax deductible. However, while correctly including tax-induced expenditures on luxurious working conditions, he also includes other tax-deductible items like ‘charitable gifts, and health care’ as involving distortions. However, these items are what the society/government want to encourage either on the grounds of external benefits (e.g. the prevention of communicable diseases), poverty reduction, and possibly merit wants (though the last ground is more controversial). Provided the extent of tax-deductibility is not excessive, no net distortion is created. Or, the extent of the distortion is offset by the benefits (Ng 2000a).

Secondly, Feldstein’s (1997) high estimate ignores the argument of Kaplow (1996). Alternatively stated, while the cost of a dollar of public spending on the revenue side may be much higher than $1, the excess may be largely offset by the positive incentive (or negative disincentive) effects of the spending side. If the benefits of the public spending are not positively correlated with income such that there is no positive incentive effects on the spending side but only disincentive effects on the revenue side, there is a distributional benefit since the rich pay more and the poor pay less (Kaplow 1996; Ng 2000a).

Since high tax rates also encourage tax avoidance and evasion and since some higher benefits of public goods are related to unobservable earning ability than observable income levels, the positive incentive effects on the spending side may not completely offset the distortive effects on the revenue side, making a dollar of public spending still in excess of a dollar taking both sides into account. However, the considerations of the prevalence of environmental costs of most production and consumption, relative competition, the failure of higher private consumption to increase happiness at the social level, as argued in the previous chapters (and Ng 2003; Yan, et al. 2021), suggest that the cost of a dollar of public spending should be significantly reduced (likely to well below one dollar and possibly towards zero) or that the benefits of public spending should be significantly increased from those normally estimated by economists.

The general taxes on income and consumption, though designed mainly for the purpose of revenue raising, may in fact serve as rough counteracting measures to the environmental disruption effects involved. Thus, far from being distortive, taxation may be corrective; instead of imposing positive excess burdens or distortionary costs, taxation may serve to improve efficiency. The relative-income effects also cause a bias in favour of private spending or against public spending. In most estimates, the marginal benefit of private expenditure is likely to be taken to include the absolute-income or intrinsic consumption effects plus the internal or direct relative income effect (as these two taken together constitute the worth of private consumption as it appears to each individual), but not to include the negative external or indirect relative income effects. This creates an over-emphasis in favour of private expenditure, leading to a sub-optimal level of public spending (Ng 1987a). Similarly, the materialistic bias and the insufficient recognition of the adaptation effects suggest that the opportunity costs of reducing private consumption due to a higher public spending are not as high as most people believe.

In addition to the above considerations, there is another factor making the cost of public spending lower than normally believed – the existence of burden-free taxes. While most economists realize that corrective taxes on, say, pollution involve negative excess burden or positive efficiency gain, burden-free taxes are regarded as existent only in fairyland. However, there are goods taxes on which create not only no excess burden but no burden at all, even ignoring all the considerations above. These are pure diamond goods or goods valued for their exchange values rather their intrinsic consumption effects. People consume or hold these goods to show off their wealth, to use them as stores of value or gifts of value. Cubic zirconia looks exactly like top quality diamond but costs only a tiny fraction of true diamond. But no one gives his fiancée an engagement ring of cubic zirconia. For such goods, it is the value (price times quantity) that enters the utility function of the consumer rather than the quantity, as posited in economic analysis. As prices increase due to higher taxes on these goods, consumers may just spend the same amounts to buy the same values without real losses. The revenues raised are pure gains, suggesting arbitrarily high taxes on them (Ng 1987b). While many goods (most precious metals and stones, top brands of most goods especially conspicuous items like cars and wines) possess various degrees of diamond effect, few if any good is a pure diamond good. Nevertheless, very high taxes on mixed diamond goods are still efficient. Moreover, as consumers may wish to consume the value (pure diamond) aspect of the mixed good so much (such as to show off their wealth) as to incur negative utility on the intrinsic consumption aspect (such as health-threatening excessive drinking), taxes on such mixed diamond goods may actually make consumers better off (being able to show off to the same extent without drinking to excess) (Ng 1993).

15.2 Specific Areas of Deficient Public Spending

In a lucid and compelling book, Frank (1999) detailed the enormous waste of conspicuous private consumption (related to relative-consumption effects discussed above) in the U.S. and discusses specific areas where additional public spending will clearly generate welfare gains far in excess of the opportunity costs. ‘A century hence, those who read the history of our time will be puzzled about the arguments we have used in defense of cutting, or refusing to fund, so many clearly useful public programs. They will wonder, for example, why we failed to replace our deteriorating municipal water systems, thereby exposing millions of families to toxic levels of lead, manganese, and other heavy metals. They will not understand why we didn’t adopt more stringent air-quality standards, which would have prevented millions of serious illnesses and many thousands of premature deaths; or why we didn’t hire more beef inspectors in response to the growing threat from deadly E-coli 0157 bacteria. They will be puzzled by our having spent so little to maintain our streets, highways, and bridges. And it will not be obvious to them why, despite our considerable wealth, we failed to pay enough to attract the best and brightest teachers for our public schools.’ (pp. 253–4). ‘A Rand Corporation study … estimated that every $1 spent on cocaine prevention and treatment programs results in a $7 savings in law-enforcement and health-care expenses. Yet consistently we say we cannot afford these programs’ (p. 62).

The above list can easily be expanded. For example, a few examples may be given to indicate that a lot more research is needed to increase welfare.

  • The very topic of the appropriate size of the public sector, regarded by Feldstein (1997) as the central public finance question, is much under-researched. For example, few if any researchers relate the important issues of relative income and happiness to this central question. While we have discussed this and other related issues above, a lot more analytical and empirical studies are needed.

  • While studies on the effects of specific drugs and ingredients have been done, it seems that a general study tracing the different types of food, drugs, and activities taken by a big enough sample of people (in hundreds of thousands) of different ages and health conditions (not just those hospitalized) over a long period (at least in decades) to discover the desirable and undesirable, short and long-run effects, may be most rewarding. Though the study would be very costly, we would gain very useful knowledge on many thousands of things simultaneously. An analysis suggests that ‘even after taking account of distorted incentives, the potential gains to medical advancement are enormous … easily justify … expenditures far above current levels’ (Murphy & Robert 2000).

  • The stimulation of certain pleasure centres in the brain can relieve acute pain, induce intense pleasure, and promote a sense of well-being without the undesirable health effects of drug addiction and without the effect of diminishing marginal utility. It can also be used as a primer such that someone who had never experienced climax before consistently achieve climax in normal sex after the brain stimulation helped to establish the pathway. This method has been known for nearly seven decades (Olds & Milner 1954). Why has the method not been perfected for common use in order to increase happiness, reduce depression, and solve many social and mental problems? (See Chap. 12 above for more details.)

15.3 Concluding Remarks

From the various factors discussed above, the costs of public spending have been grossly overestimated. While it is desirable to do away with the inefficiencies in public spending if possible, even before this is possible, increases in public spending, especially in education, research, and environmental protection, can still increase our welfare. The recent trend of checking the growth in public spending may be grossly inefficient. In fact, economic growth increases the optimal share of public spending and that, without directly dealing with environmental disruption, economic growth may reduce welfare even if the shares of public spending and environmental protection are being optimized (Ng 2003).

In addition to the above considerations, public spending on research and environmental protection is also likely to be grossly sub-optimal due to its long-term and global public-good nature. Scientific advances and a cleaner environment benefit the whole world for generations to come. Decisions taken by national governments with relatively short time horizons results in sub-optimal spending in these areas even before we consider factors accounting for the overestimation of the costs of public spending discussed above (Sect. 15.1). This suggests the need for international cooperation to increase funding for research and environmental protection. In fact, the relative-income effects at the individual level discussed above also applies to the national level, resulting in international competition for income growth, the bias against public spending and the disregard to environmental degradation. This further strengthens the need for international cooperation. The success of such cooperation partly depends on the widespread appreciation of the interdisciplinary arguments as discussed in this chapter and the rest of this book. (For a framework analysing interdisciplinary factors affecting welfare or happiness, see Ng 2004, Chap. 12.)