Public Finance (MPA405) Dr. Khurrum S. Mughal

Lecture 8: Public Choice and the Political Process Public Finance

Intro Public expenditures and taxes affect daily life Democracy Theory of Public choice studies how decisions to allocate resources and redistribute income are made through a nation’s political system.

Plan I.Supply of public goods II.Equilibrium model (majority rule) III.Unique and cyclical equilibria IV.political process V.political Parties VI.Interest Groups VII.bureaucracy

I – Supply of public goods

The Supply of Public Goods Through Political Institutions –Public Choice is when decisions are made through political interaction of many persons according to pre- established rules. –Public choice vs. private choice Taxes Vs Voluntary Cost-Sharing

Political Equilibrium A political equilibrium is an agreement on the level of production of one or more public goods given the specified rule for making the collective choice and the distribution of tax shares among individuals.

Tax Shares or tax prices Tax shares, sometimes called tax prices, are pre-announced levies assigned to citizens. They are a portion of the unit cost of a good proposed to be provided by government. Increase in cost – increase in tax t i = tax share to individual i  t i = average cost of good

Information on costs difficult to obtain. Proposals that cannot gain approval under unamimous consent might be approced under majority rule

Individual's Choice Public Choice through Elections –Evaluation of Govt goods similar to evaluating market goods The individual makes choices given what will be the most preferred political outcome to them. Rational person will favor the quantity of the government-supplied good corresponding to the point at which the person’s tax share is exactly equal to the marginal benefit of the good to that person. –More than this quantity would make him worse-off

The Most Preferred Political Outcome of A Voter Tax Tax per Unit of Output Output per Year 0 titi Q * MB i Z

The Choice to Vote or Not Decision to vote depends on benefits, costs and the probability that voting will achieve the anticipated benefits. –Costs: Time visit poll and information collection Not to Vote: –Ability to influence the outcome –Closer the alternatives –Preferred position is too far from offered alternatives –Poor information Rational Ignorance is the idea that, to many voters, the marginal cost of obtaining information concerning an issue is greater than the marginal benefit of gaining that information. This leads the voter not to gather the information and not to vote.

Determinants of Political Equilibrium the public choice rule average and marginal costs of the public good information available on the cost and benefit the distribution of the tax shares distribution of benefits among voters

II – Equilibrium model (majority rule)

Political Equilibrium Under Majority Rule With Equal Tax Shares Marginal Benefit,Cost, and Tax (Dollars) Security Guards per Week MC = AC t MB A MB B MB C  MB E MB F MB G MB H MB M

Voting to Provide Security Protection and Election Result under Simple Majority Rule Increase Security Guards per Week to: VotersAYNNNNNN BYYNNNNN CYYYNNNN MYYYYNNN FYYYYYNN GYYYYYYN HYYYYYYY Result Pass Fail

Median Voter Model The median voter model assumes that the voter whose most-preferred outcome is the median of the most-preferred political outcomes of all those voting will become the political equilibrium.

Implications of Median Voter Model Only the median voter gets his most- preferred outcome (not 51% of voters). Others get too little or too much. The greater the dispersion, the greater the dissatisfaction The more voters’ preferences are clustered, the greater the satisfaction

Political Externalities Political Externalities are the losses in well-being that occur when voters do not obtain their most- preferred outcomes given their tax shares. Equal to zero if tax shares are adjusted to marginal benefits Political externalities don’t exist under unanimous consent. More inclusive majorities protect minorities

Political Transactions Costs Political Transactions Costs are the measure of the value of time, effort, or other resources expended to reach or enforce a collective agreement. Citizens must weigh political externalities and political transaction costs Representative government economize on political transaction costs