SYMPOSIUM ON

TAX POLICY FROM A PUBLIC CHOICE PERSPECTIVE RANDALL G. HOLCOMBE *

Abstract - policy is a product of product of , one must under- politics, so a complete understanding of stand the political process to completely 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 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 costs account. of the tax system.

The advice of economists has had a substantial impact on the tax structure both in the 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

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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 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 , 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 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 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

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even though there is no 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 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 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 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 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 ’s benefit finance the roads. The outcome will from the , 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 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 . 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 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 could

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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. states, there are constitution. significant enough deviations to generate political costs. Frequently, states augment gas tax revenues with OPTIMAL EXCISE TAXATION revenues from other sources to fund These concepts can be applied to the roads, and it is not uncommon for some design of an optimal system of excise gas tax revenues to be diverted away taxes. Ignoring political costs, the from roads to finance other expendi- Ramsey (1927) rule would suggest tures. taxing goods in inverse proportion to their elasticities of demand. A public The tax structure can be formally choice approach to the problem would embedded in constitutional rules, but suggest taxing all goods at a single even when it is not, the tax structure uniform rate to minimize political costs. can still be a part of the effective fiscal A straightforward application of the constitution, in the sense of generally Ramsey rule ignores the fact that, in agreed-upon tax rules. When there is reality, differential rates of excise general agreement on the rules, political taxation will be a product of the political costs are not incurred to try to modify system. Because of the way tax rates are the tax structure. When the tax struc- set in reality, the political pressures ture is flexible, economic agents are imposed by interest groups will have encouraged to incur political costs to try much more to do with the actual to modify the tax system for their structure of excise taxes than differences benefit. in demand elasticities among taxed goods. If the fiscal constitution allows State income taxes can be used to different excise tax rates on different illustrate the fuzzy line between formal goods because in theory this could be constitutional provisions and the optimal, political costs will be encour- agreed-upon, nonformalized fiscal aged, and the end result of constitution. From 1961 to 1971, when is not likely to correspond with the the public sector was held in higher Ramsey rule. regard by voters than it is today, nine states established personal income The Ramsey rule tells economists how taxes. A tenth, New Jersey, added a the excess burden of taxes can be personal in 1976. After that, minimized when excise tax rates are set no states added income taxes until according to that rule. However, Connecticut did so in 1991. It was a because tax rates are set according to controversial move that, one could the political power of interest groups, argue, violated the state’s implied fiscal the political process will not produce a constitution. In 1993, Texas, which did tax structure that follows the Ramsey not have a personal income tax, nor a rule in any event, and allowing differen- provision in its constitution to prevent tial rates of excise taxation merely opens income taxation, passed an explicit the door for escalating political costs constitutional amendment prohibiting associated with excise taxation, increas- one. In effect, Texas had a fiscal ing the welfare cost of taxation. When constitution that prohibited personal political costs are factored into the income taxation, but after the Connecti- analysis, optimal excise taxation may

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well imply uniform tax rates across goods, of a social welfare function is open to not different rates for different goods as the criticism that it is not possible to the Ramsey rule implies. For example, make the interpersonal compari- North Carolina places an excise tax of 5 sons that this methodology requires. But cents per pack on cigarettes, and the public choice perspective raises yet Oklahoma, which has about the same another problem. Because the tax level of per capita income and per system necessarily plays a redistributive capita government expenditures, has an role within this framework, the optimal excise tax of 23 cents per pack. Obvi- tax system, derived this way, is likely to ously, political power has more to do imply substantial political costs as all with the determination of those groups try to get as much revenue particular taxes than the Ramsey rule. transferred to them, or as little trans- ferred away from them, as possible. If some goods are exempt from taxa- tion, or are taxed at different rates, this Any system of progressive income should be a part of the fiscal constitu- taxation inherently has this problem, tion, and not something subject to because, as Hayek (1960, p. 313) notes, political manipulation, bringing with it “Unlike proportionality, progression the associated political costs. For provides no principle which tells us what example, about half the states that have the relative burden of different persons general sales taxes exempt food from ought to be.” On this ground, taxation, and some states exempt Buchanan (1993) argues for propor- clothing. If these aspects of the tax tional taxation. 6 If proportional income system are considered a part of the taxation is accepted as a part of the fiscal constitution, then there will be fiscal constitution, the political costs of minimal political costs associated with an income tax system can be lowered them. If, however, it appears that substantially. The same argument changes in these provisions might be applies to deductions, exemptions, and politically feasible, interests on both tax credits as methods of altering the sides of the issue will incur political costs amount of income subject to taxation. If to try to change the tax structure or, on the tax system is flexible and subject to the other side of the issue, to try to negotiation, it invites the creation of maintain the status quo. political costs to try to alter it.

Is it possible to create this type of fiscal OPTIMAL INCOME TAXATION constitution? At the federal level, An extensive literature on optimal Ballentine (1992) argues that the Tax taxation, summarized by Mirrlees Reform Act of 1986 made the tax (1976), follows the methodology of system more stable, and more difficult determining the structure by to change, which should reduce political maximizing a social welfare function costs. 7 At the state level, this suggests subject to constraints, where social making the taxpayer’s state income tax welfare is a function of the of all liability a percentage of the taxpayer’s individuals in the society. Buchanan federal tax liability. If such a provision is (1976) criticizes this literature using an accepted as a part of the state’s fiscal argument related to the earlier discus- constitution, only the rate is subject to sion on the benefit principle, because it negotiation, greatly limiting the political fails to take account of the expenditure costs of the tax system (and the side of the budget. Of course, any use compliance costs as well).

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Interestingly enough, the conclusions of Thus, the conjecture that income taxes the optimal tax literature following create greater political costs than sales Mirrlees (1971) have pointed toward the taxes is just that: a conjecture. It may be desirability of a relatively flat rate that a state income tax tied directly to income tax structure, even though the taxpayer’s federal income tax liability methodologically that literature is quite incurs smaller political costs than a at odds with the public choice approach general , where the base is to taxation. Taking political costs into subject to redefinition at every legislative account makes proportional income session. Economists have done little taxation look much more like an empirical work on the political costs of optimum without compromise. In this taxation, even though such costs are case, a public choice approach helps obviously substantial and are a signifi- illuminate the issue of optimal income cant component of the total welfare taxation, reinforcing and clarifying some cost of a tax system. of the conclusions in the literature. In other cases, such as optimal commodity taxation discussed in the previous TAXATION AND REDISTRIBUTION section, a public choice approach yields The tax system has long been viewed as conclusions more at odds with the a mechanism for redistributing income. conventional wisdom. However, as Stigler (1970) has noted, in the real world, income tends to be redistributed from those who have SOME TAXES GENERATE HIGHER income and wealth to those who have POLITICAL COSTS THAN OTHERS political power, implying that there can Taxes are the creation of the political be substantial overlap between taxpay- system, and tax structures that are easily ers and recipients of redistribution. amended are likely to generate high Thus, public choice theory suggests that political costs. Thus, tax systems should the pattern of redistribution produced be a part of a stable fiscal constitution, by the political system is unlikely to with generally agreed-upon rules, in conform to the normative prescriptions order to minimize political costs. One of more traditional public finance would conjecture that uniform and models. Furthermore, it is likely that, if broad-based retail sales taxes would the fiscal constitution places no con- entail lower political costs than income straints on the nature of redistribution, taxes, for example, but despite the democratic decision making by itself will substantial political costs that are not lead to a stable pattern of redistri- involved in , the issue has bution. remained outside the national debate on whether a national sales tax or VAT If redistribution is envisioned as a zero- would be desirable to supplement or sum game, as in Atkinson (1995), it is replace the federal income tax, or unstable, because there is always a whether a flat rate income tax with a majority coalition that can target the redefined tax base, such as the one benefits of those who receive above- suggested by Hall and Rabushka (1985), average redistributional benefits and try would be better than the current to divide them among the coalition income tax structure. Of course, states members. The majority coalition may constantly tinker with their sales tax temporarily be successful, giving them a rates—and especially their sales tax larger than average share of the pie, but bases—creating political costs there too. this makes them a tempting target for a

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realigned majority coalition, creating a support, which would be optimal in cyclical majority. Because redistribution Wittman’s (1989) framework, is signifi- is at best a zero-sum game, there is no cantly different in principle from optimal stable pattern of redistribution that can taxation as defined by Mirrlees (1976). be maintained under majority rule. Economists have long considered the possibility of using the tax system as a Public choice theory has offered two tool for redistributing income to explanations for how a stable redistribu- enhance the social welfare. Taking a tive outcome might be produced by public choice perspective, one must democratic institutions. Weingast, recognize that redistribution is a product Shepsle, and Johnsen (1981) suggest of a democratic decision-making process that political institutions might generate in which the beneficiaries of redistribu- a universal coalition in which everyone tion are more likely to be those who agrees to a roughly equal division. As have political power than those who are Holcombe (1986) notes, this might really needy. result in an outcome that everyone agrees to under majority rule, but that The tax system can also cause rent produces an inefficient outcome, leaving seeking to occur even when it is not everyone worse off than if the redistri- explicitly used as an income redistribu- bution had not occurred. 8 More tion tool, if the of taxes is generally, redistributive outcomes might different from the distribution of be stable because institutions prevent benefits from government expenditures. them from changing, but if so, this may Meltzer and Richard (1981) show why, make them a part of the fiscal constitu- when the decisive voter’s tax share is tion, limiting the political costs they below average, democratic decision generate. Taking a different approach, making will create pressure for increased Becker (1983) and Wittman (1989) taxation to finance redistribution. 9 Thus, argue that those in government have an as Buchanan (1976) notes, there is an incentive to redistribute in the most argument for applying the benefit efficient manner possible in order to principle of taxation to minimize the minimize the of political costs of the tax system. redistribution and maximize the political Application of the benefit principle may support of officeholders. Redistribution also lower the more traditional measure is not a zero-sum game, but a negative- of excess burden, if the tax acts as a sum game, and the process is biased . toward redistributive outcomes that minimize the total cost of redistribution. Buchanan (1963) makes an argument In other words, the process is biased for earmarked taxes, noting that, when toward pushing the negative sum as taxes are not earmarked, the political close to zero as possible. process may lead to a suboptimal level and mix of government expenditures. Hettich and Winer (1988) follow Earmarking works well when those who Becker’s approach, applied specifically to pay the earmarked tax are also the taxation, to develop a model of the tax recipients of the benefits financed by structure incorporating both democratic the tax. Otherwise, as Buchanan (1967) political institutions and the more notes, there is the incentive for potential traditional public finance notion of beneficiaries to try to finance their excess burden. Following this approach, benefits with an earmarked tax levied the tax system that maximizes voter on another group. Again, there is a

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public choice argument for the benefit revenues will be spent. One role of a principle to minimize the political costs fiscal constitution is to match the costs of the tax system. If tax shares do not and benefits of public sector expendi- correspond to the benefit principle, tures. there is always the incentive for some people to engage in rent seeking for Holcombe (1978) argues that determin- benefits that will be financed by taxes ing the level of government expendi- levied on others. tures through a democratic decision- making process without the constraint The tax system does not provide a good of a fiscal constitution leads to a bias in mechanism for redistribution, for two favor of larger government expendi- reasons. First, the explicit use of taxation tures. The reason is that political as a redistributive mechanism invites the for the support of the escalation of political costs. Second, the decisive voter implies that candidates democratic decision-making process is and parties will push to lower the taxes not well-suited to enhancing social paid by the decisive voter, in order to welfare through redistribution anyway, win that voter’s support. A simple because it favors those with political application of the law of demand power rather than those who are in implies that, when the decisive voter’s need. The largest redistribution pro- tax price is lowered, the quantity of grams in the United States—Social government demanded by the decisive Security and Medicare—illustrate both voter will rise, resulting in larger-than- of these reasons. Many recipients are optimal government expenditures. well-off compared to those who are Democracy contains an inherent paying for their benefits, and the elderly bias toward inefficiently large govern- have incurred substantial political costs ment. to make sure they retain the right to their transfers. Wicksell and Lindahl attempted to counter this bias in two ways, but ways that are really two sides of the same THE OPTIMAL SIZE AND MIX OF coin. Wicksell is remembered for his GOVERNMENT EXPENDITURES idea that a substantial consensus should Although the study of taxation is often be reached on matters of public undertaken without considering how expenditure. Seeing the problems with those revenues will be spent, public simple majority rule, he advocated an choice theory has the potential to offer approximate unanimity rule. Lindahl is insight into how a tax system can be remembered for Lindahl pricing, in designed to encourage the optimal level which everyone’s marginal tax price and mix of government expenditures. equals the value they place at the As Samuelson (1954) noted, one on the public good. These ideas problem with public expenditures is the are two sides of the same coin because difficulty of determining the efficient taxpayers will agree on the level of level of production. Indeed, this was the public expenditures only when they face very problem that Wicksell and Lindahl prices. were trying to solve. Building on Wicksell’s approach, Buchanan (1976, While it may not be practical to design a 1993) has frequently argued that an tax system that produces Lindahl pricing optimal tax system cannot be designed exactly, it is possible to keep the without taking into account how its principles of Wicksell and Lindahl in

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mind so that there is some correspon- for political costs, a public finance dence between tax prices and the analysis might argue for taxation at a benefits of public expenditures. A higher level of government to internal- number of states have moved in this ize fiscal and to prevent direction by requiring supermajority taxpayers in one taxing district from free approval for taxes and expenditures in riding on the government production of their legislatures, or in some cases direct other districts. This free riding will lead voter approval, implementing the to inefficiency only if the public choice Wicksellian principle of consensus. User mechanism in local districts does not charges are an obvious mechanism for account for the benefits produced for moving toward Lindahl pricing, and those outside their districts. It is possible earmarked taxes levied on items for districts to negotiate among associated with the resulting expendi- themselves to internalize externalities, ture, such as the gas tax to finance so intergovernmental spillovers do not roads and the federal excise tax on necessarily imply a role for a higher level airline tickets to finance air traffic government on efficiency grounds. 10 control and airport improvement, are but two examples. When Lindahl pricing When politics enters the picture, one can be approximated, it creates a must balance the potential inefficiencies consensus regarding the level of public of intergovernmental spillovers against expenditures, and is a mechanism for the potential for inefficiently redistribu- leading the political process toward the tive programs if a higher level govern- optimal level and mix of public expendi- ment is employed, as Holcombe (1994) tures. The benefit principle is much notes. McKenzie and Staaf (1978) have more than just a principle of tax equity. argued that tax collection at higher levels of government to finance expen- ditures at lower levels of government FEDERALISM acts to cartelize lower levels of govern- One method of applying the benefit ment, reducing the benefits of intergov- principle is to adopt a system of fiscal ernmental competition. This line of federalism and undertake all public reasoning might be applied to tax sector expenditures at the lowest harmonization in the European Union, possible level of government. Following for example. One can think of good Tiebout’s (1956) model, this can result in reasons for having a high degree of an efficient sorting of individuals with uniformity in tax structures across different preferences for government districts, but uniformity imposed from expenditures and can provide a revealed above reduces intergovernmental preference mechanism for public competition and may produce a expenditures. It also means that there uniformly undesirable tax structure. will be less opportunity for interests in Thus, the benefits of enforced unifor- one geographic area to receive location- mity must be weighed against the specific government benefits paid for by benefits of intergovernmental competi- taxpayers in other areas. As Buchanan tion, keeping in mind that the process (1967) notes, the budgetary process of intergovernmental competition works better when the government itself might lead to more uniformity in output benefits the population in tax systems. From a public choice general, rather than a subgroup of the standpoint, a federal system with much population, and federalism helps local autonomy has much to recom- achieve this goal. Without accounting mend it.

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Public choice analysis also suggests tion to constrain the power of govern- some problems with federalism. Sobel ment. Holcombe (1994) argues that it is (1997) shows that, when two levels of in the government’s interest, even if it government tax the same base, there is wants to maximize revenues, to impose a tendency for the combined tax rates constitutional constraints on its own to be inefficiently large. This happens actions. Usher (1992) combines public because when one government chooses choice analysis with a public finance its level of taxation, it takes the other foundation to show both the role of government’s tax rate as given. Thus, a government and the benefits of rate increase by one government constraints on government. reduces the tax base of the other, but governments have no incentive to take All of these studies are suggestive, but these fiscal externalities into account. at the same time, public choice analysis This obviously applies to federal and has done little to examine the effects of state taxation of income and lends a the motivations of legislators who pass different perspective to the debate on a , and of the bureaucrats who possible national sales tax. More interpret and enforce tax law, on the tax generally, the political dynamics among system. The public choice foundation is different levels of governments need to there, but the application to taxation is be taken into account in an analysis of not, suggesting an avenue for further taxation in federal systems. research.

THE MOTIVATIONS OF PEOPLE IN Conclusions GOVERNMENT No analysis of tax policy is complete In the same way that neoclassical unless it includes an explicit recognition has characterized firms of the public choice environment within as maximizers, Niskanen (1971) which tax policy is made. The related has characterized government bureau- areas of public expenditures and cracies as budget maximizers. redistribution policy have already been Niskanen’s idea has crept into the analyzed much more extensively from a analysis of fiscal systems to a limited public choice perspective, and tax policy degree, but most models of taxation, would benefit from the same attention even when undertaken from a public to public choice issues. Not only is there choice perspective, paint the public a substantial opportunity for academic sector as a type of in which the research applying public choice ideas to competing demands of various interests taxation, any analysis of tax policy that are balanced against each other to does not consider the political environ- determine public policy. McKenzie and ment must be viewed as incomplete. Staaf (1978), as just noted, build upon Niskanen’s ideas to describe the efforts While this essay has suggested one of local governments to cartelize and possible direction for incorporating reduce intergovernmental competition. public choice analysis into the study of More ominously, Brennan and Buchanan taxation, the companion paper in this (1980) examine the concept of optimal issue by Winer and Hettich takes a taxation under the assumption that the different tack by depicting the tax government’s motivation is revenue structure as a political equilibrium, maximization to show the welfare- where the legislature weighs the enhancing properties of a fiscal constitu- demands of interests on all sides of an

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issue and acts as a political marketplace. code is efficiency enhancing, while the In the Chicago tradition, Becker (1983) Virginia approach argues against special and Wittman (1989) suggest that this interest provisions and, more signifi- type of political process results in an cantly, argues against allowing them to efficient outcome, and Winer and be negotiated through the political Hettich echo this idea by arguing that, process. For efficiency, any special once the political process is taken into interest provisions in the tax code account, provisions of the tax code, should be part of the fiscal constitution. including special interest provisions, can This contrast between approaches be seen as efficient responses to political shows that public choice is more a interests. In contrast, the present paper method of analysis than a set of advocates a broad-based and uniform conclusions, and that, even when public tax system that constitutionally prevents choice factors are taken into account, special interest tax benefits. there are a number of open questions with regard to tax policy. Despite some This difference between the papers is an points of disagreement, both papers are example of the difference between largely consistent with each other and what Lott (1997) and others have called show the additional insights that can be the Chicago and Virginia approaches gained by incorporating public choice to public choice. Within the context of into the study of taxation. the Coase theorem, the Chicago approach depicts transactions costs as While these essays suggest a number low enough that political markets of ways that public choice analysis could respond to political demands relatively be applied to the study of taxation, efficiently. The outcome of political relatively little has been done in this exchange, including special interest tax area. Empirical studies of political provisions, tends to be efficient. The costs would shed light on their magni- Virginia approach views transactions tude and might indicate institutional costs as more significant, preventing changes that could be made to limit political markets from allocating political costs. This avenue of inquiry resources efficiently. Parties to the would make a contribution to the political bargain may be better off, but understanding of tax policy and also to high transactions costs prevent most the understanding of rent seeking more people from participating in the political generally. Models of the policymaking exchange process, and the costs process that better capture the motiva- imposed on those outside the bargain- tions of policymakers might lend more ing group exceed the benefits generated insight into the way the tax structure for special interests. There may not even actually evolves, as Winer and Hettich be any net benefits to the interest indicate, and also might suggest groups themselves, as the rent-seeking desirable features for the fiscal constitu- literature begun by Tullock (1967) and tion. The tax system is a creation of a Kreuger (1974) has demonstrated, and political decision-making process, and when one recognizes that political costs the idea that it is worthwhile to take a are incurred by those who only want to public choice approach to the study of preserve the status quo, this conclusion tax policy says nothing more than that is reinforced. we would understand more about taxation if we understood more about In the Chicago approach, negotiating the process by which taxes are de- for special interest provisions in the tax signed.

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ENDNOTES there are advantages to voting with the majority, this can produce a situation where everybody The author gratefully acknowledges helpful votes for an outcome that makes everyone worse- comments on an earlier draft from James off. A voter who defects from the majority Buchanan, Thomas McCaleb, , and coalition loses the advantages of being in the Stanley Winer. majority, but the election outcome remains the 1 Public finance textbooks have been taking more same. account of public choice, but usually public choice 9 Meltzer and Richard (1981) argue that more analysis is confined to one chapter. Rosen (1995), income inequality increases the amount of the market leader, devotes one chapter specifically redistribution, whereas Peltzman (1980) argues the to public choice, but does not discuss public choice opposite. considerations much outside of that chapter. 10 Foldvary (1994) discusses ways in which Holcombe (1996), my public finance textbook, has communities can work together without the more chapters devoted to public choice and also intervention of higher level governments to tries to integrate public choice ideas throughout internalize intergovernmental spillovers. the book, but I will leave it to readers to decide if I am any more successful than other textbook authors. REFERENCES 2 This theme has run through much of Buchanan’s work on taxation. Brennan and Buchanan (1985) Atkinson, Anthony B. Public Economics in present a more general argument in favor of Action: The Basic Income/ Proposal. constitutional rules. Oxford: Clarendon Press, 1995. 3 Administrative costs are mainly a budgetary item, Ballentine, J. Gregory. “The Structure of Tax so they are relatively easy to estimate. Compliance System Versus the Level of Taxation: An costs are spread among all taxpayers and take the Evaluation of the 1986 Act.” Journal of form of time, storage costs for records, and Economic Perspectives 6 No. 1 (Winter, 1992): monetary payments for tax collections. Slemrod 59–68. and Sorum (1984) estimated that taxpayer Becker, Gary. “A Theory of Competition among compliance costs for the U.S. individual income tax Pressure Groups for Political Influence.” were about five to seven percent of the revenues Quarterly Journal of Economics 98 No. 3 collected. Recent estimates by the IRS indicate that (August, 1983): 371–400. compliance costs for all federal taxes are 8.7 percent of total tax collections, exceeding the Brennan, Geoffrey, and James M. Buchanan. Slemrod and Sorum estimates, and that The Power to Tax: Analytical Foundations of a administrative costs are about 0.5 percent of Fiscal Constitution. Cambridge: Cambridge collections. University Press, 1980. 4 For example, when the Tax Reform Act of 1986 Brennan, Geoffrey, and James M. Buchanan. was being written, realtors lobbied hard to retain The Reason of Rules: Constitutional Political the home mortgage interest deduction. The result Economy. Cambridge: Cambridge University was to retain the status quo, and substantial Press, 1985. political costs were incurred without raising any Buchanan, James M. “The Economics of revenue. Earmarked Taxes.” Journal of 5 Of course, people may favor using the public 71 No. 5 (October, 1963): 457–69. sector to transfer income from them to others, as Hochman and Rogers (1969) noted. Buchanan, James M. Public Finance in 6 For a public choice argument going in the other Democratic Process. Chapel Hill: University of direction, see Buchanan (1967), who argues, North Carolina Press, 1967. “under certain conditions progressive income Buchanan, James M. “Taxation in Fiscal taxation may be rationally preferred by the Exchange.” Journal of Public Economics 6 No. 1- individual, and, at least to some extent, these 2 (July/August, 1976): 17–29. conditions embody features of real-world Buchanan, James M. “Tax Reform as Political institutional choice” (p. 237). Choice.” Journal of Economic Perspectives 1 No. 7 Note, however, that Buchanan (1987) correctly 1 (Summer, 1987): 29–35. predicted that, after the reform, both tax rates and government expenditures would rise. Buchanan, James M. “The Political Efficiency of 8 This can occur because, under majority rule, voters General Taxation.” National Tax Journal 46 No. 4 realize they are unlikely to cast the decisive vote, so (December, 1993): 401–10. their vote will not determine the election outcome. Buchanan, James M., and Gordon Tullock. However, their vote always determines whether The Calculus of Consent. Ann Arbor: University they are in the majority or minority coalition. If of Michigan Press, 1962.

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