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Tax Policy from a Public Choice Perspective Randall G SYMPOSIUM ON PUBLIC CHOICE TAX POLICY FROM A PUBLIC CHOICE PERSPECTIVE RANDALL G. HOLCOMBE * Abstract - Tax policy is a product of product of politics, one must under- politics, so a complete understanding of stand the political process to completely tax policy requires an explicit recogni- understand the tax system. Furthermore, tion of the political environment within if the tax structure is designed appropri- which tax policy is made. The paper ately, the collective choice process can emphasizes the concept of political costs provide a revealed preference mecha- associated with the tax system and nism that can help enhance the effi- discusses several aspects of tax policy ciency of government both on the tax using a public choice approach. The side and the expenditure side of the paper argues that the political costs ledger. Also, public choice analysis associated with taxation can be mini- might lend some insight into what mized by embedding the tax system constitutes an equitable tax structure. within a relatively inflexible fiscal The analysis that follows begins with the constitution. Despite the insights the recognition that the political system uses public choice perspective offers, most resources to design tax systems, and analysis of tax policy does not take these costs should be taken into public choice considerations into account along with other welfare costs account. of the tax system. The advice of economists has had a substantial impact on the tax structure both in the United States and world- wide. However, tax policy is the product Despite the fact that the tax structure is of political decision making, with a product of the political process, rarely economic analysis playing only a does an economic analysis of tax policy supporting role. A closer integration of take account of the political environ- public choice theory into the analysis of ment within which the tax structure is taxation can help increase our under- designed. 1 The political environment is standing of the tax system and can important for several reasons. Most improve the quality of advice that obviously, because the tax structure is a economists offer with regard to tax policy. Of course, much analysis of tax systems can be undertaken without an *Florida State University, Tallahassee, FL 32306. explicit recognition of the political 359 NATIONAL TAX JOURNAL VOL. LI NO. 2 system. For example, one does not need their benefit. Those who are being taxed to take politics into account in order to continually lobby to have their taxes estimate how much of a tax is shifted reduced or eliminated, and even if a from the group upon which the tax is group is not currently being taxed, it initially levied. Furthermore, public needs to keep an active lobbying choice analysis is relatively young and presence to guard against taxes that not well-integrated into public finance, might be placed on it in the future. so this essay will present some avenues Thus, the easier it is to modify the tax that can be explored, but there is still a structure, the higher will be the political substantial amount of work that can be costs associated with taxation. When profitably undertaken to integrate public the tax structure can be easily modified, choice analysis more fully into the taxpayers will find it in their interests to analysis of taxation. While public choice incur political costs to try to minimize theory might offer much to help their tax burdens. Thus, Buchanan advance the theory of taxation, the (1967) has argued the merits of a fiscal main focus of this essay will be policy constitution, which creates a basic tax oriented and will begin by explicitly structure that can be changed only if recognizing the political costs that are there is substantial consensus, reducing created when people try to influence tax the potential payoff from trying to lobby law for their benefit. for tax changes that create benefits for special interests. 2 The idea that rent- seeking activity can impose significant POLITICAL COSTS AS A WELFARE COST welfare costs on an economy is relatively OF TAXATION recent, dating to the articles of Tullock At the simplest level of analysis, the (1967) and Krueger (1974), and while welfare cost of taxation arises because a simple observation reveals that the costs tax causes people to substitute away are substantial, there are no really good from whatever is being taxed, resulting estimates of the political costs the in an excess burden. In addition, economy incurs because of the tax economists have long recognized that system. administrative costs (the costs that government incurs to collect taxes and Holcombe (1997) estimates the annual enforce tax laws) and compliance costs political costs of a selective excise tax to (the costs taxpayers incur in the process be in excess of ten percent of the of calculating and paying taxes) are annual revenues raised, but this is a often significant and, as Slemrod (1990) rough estimate based on limited data. notes, should be included as part of the Political costs in this range would welfare cost of the tax system. The exceed administrative and compliance political costs of the tax system are also costs combined, so if this estimate is significant, but are less often recognized even close, political costs are very in economic analysis. These costs significant. 3 One can see that, when an include the cost to the government of excise tax is levied on a narrow base, legislating tax policy and, more impor- those paying the tax have an incentive tantly, the rent seeking costs incurred by to lobby for its removal. However, the those who want to influence tax tax does not even have to be levied in legislation. order to generate political costs. If the tax is being considered, the potential Rent-seeking activity occurs because taxpayers have an incentive to lobby people want to influence tax policy for against it, resulting in political costs 360 SYMPOSIUM ON PUBLIC CHOICE even though there is no tax revenue benefits paid for by taxes levied on generated. 4 A tax structure that is easily others or against paying taxes for modified can bring with it substantial benefits received by others. 5 Application political costs, not only because people of the benefit principle has the advan- have an incentive to lobby for changes tage that majority rule decision making for their benefit, but also because they tends to lead toward efficient outcomes. must be on their guard to protect Another advantage of Lindahl pricing is themselves from changes that could that all individuals agree on the quantity harm them. These political costs have of the public good to be produced, largely been ignored by economists who making political decisions less costly to have analyzed the efficiency of the tax produce. Thus, for example, it makes system. sense to use a gas tax to finance roads for public choice reasons, because this tax is likely to approximate the benefit WICKSELL, PUBLIC FINANCE, AND principle, facilitating political agreement PUBLIC CHOICE that will result in an optimal level of that Wicksell (1896), whose insights laid a good being produced. If another tax foundation for modern public choice that does not closely correspond to the theory, was trying to design a more benefit principle is used, there will be a equitable and efficient tax system, so in struggle between those who expect to this sense, public choice can trace its be net beneficiaries because of their origins back to the theory of taxation. heavy use of the roads and those who Wicksell envisioned creating a tax expect to be net losers because they will system that assigned tax shares to pay the bulk of the taxes used to correspond to each taxpayer’s benefit finance the roads. The outcome will from the public expenditure, anticipat- depend upon which group has more ing Lindahl (1919) pricing. Wicksell’s political power. Not only will more in idea was to ensure that tax shares political costs be incurred, it will be less corresponded to Lindahl prices by likely that the political decision-making requiring an approximate unanimous process will lead toward an optimal agreement among taxpayers before provision of the good. undertaking public expenditures. The benefit principle is clearly embodied in Buchanan and Tullock (1962), extending the work of Wicksell and Lindahl, but so Wicksell’s analysis, make the distinction is the public choice notion that political between constitutional and post- agreement can be used as an indicator constitutional rules. Constitutional rules of economic efficiency. In theory, one are relatively difficult to modify, whereas can find the optimal level of public postconstitutional rules can be modified expenditures by summing the demands more easily. In order to minimize of all consumers, but in practice, political costs, a tax system should be revealing people’s preferences for public designed so that the overall structure is goods is more problematic. relatively unchangeable as a part of the fiscal constitution, with some flexibility The political process can help reveal at the postconstitutional level to modify preferences, but under majority rule, the tax system in ways that incur only efficiency can be assured only when small political costs. For example, the taxes are levied according to the benefit use of gasoline taxes to finance highway principle. Otherwise, people will be expenditures could be constitutionally revealing their preferences for receiving mandated, whereas the tax rate could 361 NATIONAL TAX JOURNAL VOL. LI NO. 2 be adjusted postconstitutionally to cut experience, Texans decided to make reflect changes in the demand for explicit what they had always believed highways. While this approximates the was a part of their implied fiscal practice of most U.S.
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