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2.7. Protection from Leviathan

Course video 13 of 34

This lecture covers the positive and normative theories of taxation, ways and means to collect public revenues, and existing informational, administrative, political constraints governments have to deal with. We consider lump sum tax as first best option which implementation in practice, unfortunately, is severely restricted by informational asymmetry. Then follows a cursory introduction into one of the most beautiful (but also most technically complex) parts of public economics which characterizes optimal tax schedules minimizing welfare losses subject to information constraints; such analysis is carried out in the so-called Mirrlees economy. Another focal point of the lecture is the role of elasticity in selecting taxes and how the concept of elasticity can be applied to the analysis of time inconsistency in taxation.

This course offers an introduction into the public economics theory. It does not aspire to cover theories of taxation, public expenditures, regulation etc. at length and in-depth. Rather, our ambition is to give a bird's-eye view of central themes of public economics and related disciplines, and teach concepts, logic, and ideas, rather than methods of analysis, which would require an entirely different course format. Our choice of topics covered by the course reflects a trade-off between salience and centrality, on the one hand, and suitability for a brief online introductory course, on the other. The course content is neither comprehensive (which would be a "mission impossible" for virtually any public economics course"), nor representative of other such courses. With these limitations and caveats in mind, we encourage our students to continue their public economics studies in a more regular fashion, and see our role inter alia in motivating interest in such "continued education". The central theme of the course is the role of government as a mechanism of resource allocation which complements and augments markets. Governments are viewed as public agencies set to correct market failures. Such agencies however are prone to failures of their own, and hence markets and governments are two imperfect alternatives. We deal with government's limitations, with particular emphasis on those that have to do with informational asymmetry, limited administrative capacity, and imperfect accountability to society. Otherwise the course's man themes are economics of taxation, regulation, politics of public economics, incentives in government, and government vis-à-vis (civil) society.

Taught By

Leonid Polishchuk
Professor

Transcript

[BLANK_AUDIO]

Let's have a look at this chart.

Suppose that there are two types of governments that can run a tax system.

And, as before, we distinguish

between benevolent governments and predatory government.

In other words, Leviathan.

Let's first assume that the government is benevolent.

Okay.

Well, in that case, suppose that the government

has to make a choice between these two markets.

As you can see, and this is a familiar picture,

we saw it before when we were discussing the Ramsey rule.

And at that time, our conclusion will be that if we

have a government... And that was an assumption made here implicitly,

we didn't make it explicit, now we do.

But if we are 100% certain the government is acting in

public interest, and the government's only objective is to collect a reasonable

amount of revenues, then it has to collect this revenues from the

government with less elastic tax base, in other words, from this market,

from the market with less elastic tax base.

Getting back to this picture, this conclusion still holds.

We have a choice between these two markets:

this one is highly elastic, this one is highly inelastic.

If government is benevolent, then it's no brainer.

The government should tax this market and leave alone this one

because in that case there would be a considerable

deadweight loss. In that case, there would be

no deadweight loss. The society would suffer far

less, lesser losses in this case than in this one.

And, remember, I explained to you

why low elasticity is good for choosing taxes.

Simply because in this case, people will be

finding refuge in less taxable areas of activity.

And precisely for that reason, the tax base is elastic.

In that case, now refuge is available and

here, therefore, distortions to economic behavior caused by taxes

will be much higher than here, and for that reason we prefer this option to this one.

Then there will be much fewer distortions in this case.

But see how this predictions or these prescriptions, if you

like, would be turned upside down if the government is Leviathan.

And this is an observation made several decades ago by another

Nobel Prize winner James Buchanan, an american economist who first

drew attention of the professional community to the threat of Leviathan.

Suppose that the government is Leviathan one, what's the difference?

Benevolent government's role is to collect a certain amount of public

revenues and to spend this money for the needs of society.

The objective of the Leviathan government is to maximize tax collection without

much concern and much regard about how this money will be used.

And the Leviathan government acts as a profit maximizing monopoly.

And the maximum tax collection available from a certain market will be different

depending, of course, on the

demand elasticity, on the tax base elasticity.

From the highly elastic market, the

opportunities to collect taxes are limited.

Precisely for the same reason that this highly

elastic market was less suitable for revenue collection.

But this time what was a problem, a

liability for the benevolent government, becomes an important plus.

There is simply not enough room for Leviathan government to

cause a lot of damage on the highly elastic market

because if the Leviathan government exceeds

what is appropriate for tax collection

purposes, then people will find refuge

from this excessively taxed market elsewhere.

So, do lock a Leviathan government to markets with high elasticity.

If, however, you were reckless enough to allow a Leviathan government to operate in

a low elasticity market, as you see,

the revenue collection would be expanded dramatically.

And there would be very few market limits

to the appetites of the Leviathan government.

And the ability for this government to extract wealth from the society would

be much broader and the damage caused by this government would be much higher.

And, therefore, if there are serious reasons

to expect that governments will not

be sufficiently accountable to the society, will

not be sufficiently controlled by the society,

if there are high odds that the government will

be a Leviathan government rather than the benevolent government,

and if you want to design your tax system taking

into account this, then your choice will be less efficient taxes.

Unfortunately.

It might be appropriate in some circumstances to

prefer taxing high elasticity markets to taxing lower elasticity markets.

And this is another political restriction on the choice of tax systems

which, as we see, can dramatically effect the choice of taxes.

Well, I'm about done with our analysis in this lecture of tax systems.

I introduced to you, necessarily briefly, sometimes unfortunately superficially,

but still introduce to you the key incentives, constraints, and

concerns which explain the choice of tax systems around the world.

They are applicable in different

combinations in different countries and jurisdictions.

And the variety of tax systems around the world can be explained by

different combinations of these incentives, concerns, and constraints.

And, of course, they reflect specific

conditions and features of different countries

such as culture, tradition, structure of economy,

political economy, so on and so forth.

Thank you.

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