Topics in Modern Public Economics

Lectureres: Massimo Bordignon, Paolo Balduzzi, Eugenio Peluso

Contents

The course aims to offer a general introduction to the field as well as some more specialized and
advanced treatment of selected topics. The course is divided in three parts, each one taught by a
different teacher. The first part (Bordignon) discusses the main economic arguments for
government intervention in market economies, as well as the limits of such an intervention. This is
basically theoretical welfare analysis, but some references will also be made to modern political
economy approaches. The second part (Peluso) covers inequality and welfare economics. It
discusses applied welfare economics and theoretical measures of poverty and inequality. The third
part covers taxation issues (Balduzzi). It discusses tax incidence, economic effects of taxation on
factor markets, optimal taxation and optimal tax enforcement theory, as well as some more policy
oriented discussion of selected issues. The general framework for the discussion is largely
theoretical, but more policy oriented considerations and modeling as well as the results of empirical
research will also be introduced.

The course does not cover issues of regulation and competition theory and does not discuss in any
systematic detail models of policy making, voting, lobbying and government behavior. These will
be the focus of a specialized treatment in a separate course.

The course is based on taught lectures and classes. Exercises will be offered and solved during
some of the classes. In the others, students will also be asked to present and discuss papers taken
from the recent and relevant literature.

Bibliography:

There is no single textbook which can cover all the material discussed in this course. Selected
chapters (or paragraphs of chapters) from the following books are suggested as background reading:

1. Mas-Colell, A., Whinston, M., Green, J., (MWG) 1995, Microeconomic Theory, Oxford,
Oxford University Press.

2. Myles, G., 1995, (My) Public Economics , Cambridge, Cambridge University Press.

3. Bruce, N., Boadway, R., (BB), 1984, Welfare Economics, Oxford, Basil Blackwell.

4. Salanié, B., (S1), 2000, Microeconomics of Market Failures, Cambridge, the Mit press.

5. Lambert, P., (L), 2003, The Distribution and Redistribution of Income, Manchester
University Press.

6. Salanié, B., (S2), 2003, The Economics of Taxation, Cambridge, the Mit press.

7. Persson, T., Tabellini, G., (PT), 2000, Political economics: explaining economic policy,
2000 Cambridge, the Mit press.

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My is a good graduate book to Public Economics in general, very useful for backgrounds reading; it
does not have the most recent stuff on taxation theory and it firmly stands in the normative –
welfare tradition. BB covers more extensively and at a more relaxed pace theoretical and applied
welfare economics; although a bit out of date, it is still very enjoyable to read. L discusses in more
analytical details the axiomatic approach to measuring income distribution and contains some more
recent material on horizontal equity and poverty measures. S1 is more advanced; not advisable for a
first reading, but useful for further thoughts. S2 is a good and recent introduction to taxation theory.
Some of the topics in Public Economics overlap with Micro-Economics; no harm in reading the
relevant chapters in MWG too. Finally, PT is a useful introduction to political economy; some
chapters are worth reading as a background introduction to the last part of the course.

Additional reading will be suggested for each topic, and handouts will be distributed during the
lectures and classes.

Part I Reasons and limits of government intervention

M. Bordignon

1. Introduction to the topic and the discipline

A worked out example. Basic principle of welfare analysis: individualistic principle and Pareto
principle. The notion of Pareto efficiency. The two Fundamental theorems of welfare economics.
Efficiency reasons: market failures. Distributive reasons: fairness and distributive reasons. The
trade off between efficiency and equity. The informational constraints on the role of the state. The
political constraints. Basic facts about governments around the world. The evolution of the field.

Boadway, R., 1997, “Public Economics and the Theory of Public Policy”, The Canadian Journal of
Economics, vol.30, p. 753-772.
Atkinson, A., and Stiglitz, J., 1980, Lectures on Public Economics, lecture 1, New York, McGraw
Hill.
Buchanan, J., Musgrave, R., 1999, Public Finance and Public Choice, two contrasting views of the
role of the State, Cambridge, the Mit press.
Roberts, K., 1984, “The theoretical limits to redistribution”, Review of Economic Studies, 177-195.
Coate, S., 1995, “Altruism, the Samaritan’s dilemma, and Government transfers’ policy”, AER, vol.
85, 46-57.

2. Normative arguments for government intervention.

A general equilibrium setting. The two Fundamental theorems of welfare economics. Proofs and
interpretations. Beyond the Pareto Principle. Arrow theorem. Proof and illustration. Extensions:
Gibbard and Satterwhite theorem. Ways out.

S1, chapter 1.
MWG, chapter 16.
BB, chapter 3.
My, chapter 2.
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Roemer, J. E., 1996, Theories of Distributive Justice, Cambridge, Mass., Harvard University Press.
Dworkin, Ronald, ‘What is Equality? Part 1: Equality of Resources’, Philosophy and Public Affairs,
10, 1981, 185-246.
Dworkin, Ronald, ‘What is Equality? Part 2: Equality of Welfare’, Philosophy and Public Affairs,
10, 1981, 283-345.
Roemer, John, 1998, Equality of Opportunity, Cambridge: Cambridge University Press.
Sen, A., 1970, Collective choice and social welfare, San Francisco, Holden Bay.
Sen, A., 1979, “The impossibility of a Paretian liberal”, Journal of Political Economy, 72, 152-157.

Handbooks are useful sources for further reading. In this field, the following ones contain key
analyses:

Arrow, K. J., Sen, A.K., Suzumura, K., (eds.) 2002, Handbook of Social Choice and Welfare,
Amsterdam: Elsevier-North-Holland.

Atkinson, A. B., Bourguignon, F., (eds.) 2000, Handbook of Income Distribution, Amsterdam:
Elsevier-North-Holland.

In particular:

Brams, S.J., Fishburn, P.C., 2002, "Voting Procedures", in Arrow, K. J., Sen, A. K., Suzumura, K.,
(eds) 2002, Handbook of Social Choice and Welfare, Amsterdam: Elsevier-North-Holland.

Cowell, F.A., 2000, "Measurement of inequality", in Atkinson, A. B., Bourguignon, F., (eds.) 2000,
Handbook of Income Distribution, Amsterdam: Elsevier-North-Holland.

Fleurbaey, M., Maniquet, F., 2000, "Compensation and responsibility", in Arrow, K. J., Sen, A. K.,
Suzumura, K., (eds), Handbook of Social Choice and Welfare, vol. 2.

Le Breton, M., Weymark, J., 2002, "Arrovian social choice theory on economic domains", in
Arrow, K. .J., Sen, A. K., Suzumura, K., (eds), Handbook of Social Choice and Welfare,
Amsterdam: Elsevier-North-Holland.

3. Public Goods

Definition. Efficiency conditions. Samuelson’s rule. Extensions. Wicksell-Lindahl’s equilibrium.

Fundamental welfare theorems with public goods. Pigou’s conjecture: public goods supply with
distorting taxation. Free riding problems. Groves mechanism and Clarke taxes. Limitations: budget
balance problem and quasi-linear settings. But economists free-ride: does anybody else?

S1, chapter 5.

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Cornes, R., and Sandler, T., 1986, The Theory of Externalities, Public Goods and Club Goods.
Chapter 5 and 6; Cambridge, Cambrige University Press.
Boadway, R., and Keen, M., 1993, “Public goods, self –selection and optimal income taxation”
International Economic Review 34, 463-78.
Kay, J. and Keen, M., 1987, “On measuring the deadweight loss of taxation”, Journal of Public
Economics.
Bordignon, M., 1995, “On measuring inefficiency with public goods”, Riss, published 2004.
Martimort, D., 2005, An incomplete contract perspective on public good provision, Journal of
Economic Surveys.
Milleron, J., 1972, “Theory of Value with Public Goods: a Survey Article”, Journal of Economic
Theory, 5, 419-77.
Bewley, T., 1981, “A Critique of Tiebout’s Theory of Local Public Expenditure”, Econometrica
49, 713-40.
Rubinfield, D., 1987, “The Economics of Local Public Sector”, in Auerback, A., and Feldstein, M.,
(eds) Handbook of Public Economics, Amsterdam, North Holland.

4. Externalities.

Taxonomy. Wrong prices, missing markets, ill-defined property rights: which is which? Pigou’s
taxation. Quotas. Weitzman’s argument. Coase’s theorem. No problem then? Myerson and
Satterwhite’s theorem. Market solutions. Starret’s fundamental non-convexity in the theory of
externalities.

S1, chapter 6.
Cornes, R., and Sandler, T., 1986, The Theory of Externalities, Public Goods and Club Goods.
Chapter 3 and 4; Cambridge, Cambridge University Press.
Weitzman, M., 1974, “Prices versus quantities”, Review of Economics Studies, 41, 477-91.
Starret, D., 1972, “Fundamental non convexity in the theory of Externalities”, Journal of Economic
Theory, 4, 180-99.
Myerson, R., and Satterthwaite, M., 1983, “Efficient mechanisms for bilateral trading”, Journal of
Economic Theory, 29, 265-281.
Faysse, N., 2005, Coping with the Tragedy of the Commons, Journal of Economic Surveys.

5. Some political economy model

Is there a trade-off between redistribution and efficiency? Sinn’s model, again on the insurance role
of the welfare state. Political redistribution: The median voter theorem: and the Meltzer and
Richards model. When the median voter fails: ends against the middle. Epple and Romer’ model.
Intergenerational economies. Dynamic efficiency. The pension game and the aging economy.
Boldrin and Rustichini. Electoral systems and redistribution.

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PT, chapters 2, 3, 6, 7.
My chapters 13, 14.
Boadway, R., and Keen, M., “Redistribution”, Handbook of Income Distribution, Volume I, 667-
779.
Alesina, A., and Glaezter, E., 2004, Fighting poverty in the US and in Europe: a world of
difference, Oxford UP.
Alesina, A., e La Ferrara, E., 2005, “Preferences for redistribution in the land of opportunities”
Journal of Public Economics, 89: 897-931.

Sinn, H. W., 1995, An economic theory of the welfare state Scandinavian Journal of Economics 83,
263-83.
Sinn, H. W., 1996, Social Insurance, incentives and risk taking International Tax and Public
Finance, 3, 259-80.
Atkinson, T.,1999, The Economic Consequences of the Rolling back of the Welfare state, Mit press.
Bird, E.J., 2001, Does the welfare state induce risk taking?, Journal of Public Economics, 80, 357-
83.
Roberts, K., 1977, “Voting over income tax schedule”, Journal of Public Economics, 8: 329-40.
Cox, G., 1997, Making Votes count. Cambridge, Cambridge UP.
Epple, D., and Romano, R., 1996, Ends against the middle, Journal of Public Economics, 297-325.
Lizzeri, A., and Persico, N., 2001, The Provision of Public Goods under alternative electoral
systems” AER, march.
Galasso, V., and Profeta, P., 2002, “The political economy of social security”, European Journal of
Political Economy, !8.1-29.
Walque de, G., 2005, Voting on Pensions: a survey, Journal of Economic Surveys.
Azariadis, C., and Galasso, V., 2002, Fiscal Constitutions, Journal of Economic Theory, 103, 255-
281.
Boldrin, M., and Rustichini, A., 2000, Political Equilibria with Social Security, Review of
Economics Dynamics.
Besley, T., and Coate, S., 2001 “Lobbying and Welfare in a Representative Democracy”, Review of
Economic Studies, 68, 67-82.

Part II Inequality and social welfare

Eugenio Peluso

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1. Social Welfare Functions (SWF)
(Myles, Ch1.5, Boadway and Bruce, Chapter 5,7,8,9)

1.1. From the Arrow theorem to Social Welfare Functions : The informative basis of SWF
1.2. Applied welfare economice and welfare change measurement: Compensating and
Equivalent Variations.

2. Inequality, Social Welfare and poverty

(Myles, Ch. 3)

2.1. Ethical inequality measures: the Atkinson-Kolm-Sen approach

2.2. Inequality indices
2.3. Equivalence scales
2.4. Lorenz-type partial orders
2.5. Links with risk literature
2.6. Poverty indices and poverty orderings

3. Distributional effects of taxation and tax Progression

(Lambert,Ch. 6,7)

3.1. The Jacobsson theorem

3.2. Measures of Tax Progression
3.3. The impact of intra-group inequality

4. Extensions

4.1. Social mobility and equality of opportunity

4.2. Multidimensional issues

Basic Textbooks

- BOADWAY AND BRUCE (1984) Welfare Economics, Blackwell.

- P. LAMBERT (2001). The distribution and Redistribution of Income: a Mathematical Analysis.

2nd Edition. Manchester University Press, Manchester.

- GARETH D. MYLES (1995) Public Economics, Cambridge University Press.

Some important papers on inequality measurement

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 1. - Atkinson (1970). On the measurement of inequality. Journal of Economic Theory 2, pp. 244-263.

2. P. Fishburn and R. G. Vickson (1978). Theoretical foundations of stochastic dominance. In G.

Withmore and M. Findlay, editors, Stochastic Dominance, pp. 39-113. Lexington Books, London.

3. A. F. Shorrocks (1983). Ranking income distributions. Economica 50, pp. 3-17.

4. A. F. SHORROCKS AND J. FOSTER (1988). Poverty orderings. Econometrica 56, pp. 173-177.

A stronlgly suggested reading:

- WILLIAM THOMSON (2001). A guide for the young economist, MIT Press.

Useful links:

- http://mora.rente.nhh.no/projects/EqualityExchange/

- http://www.ecineq.org/

Further references will be provided during the lectures.

Part III OPTIMAL TAXATION

Paolo Balduzzi

The Effects of Taxation: Tax incidence, Distortions and Welfare Losses (2)
Partial and general equilibrium analysis. The excess burden of the commodity tax and of income
tax.

Optimal Income Taxation (4)

Redistribution in a two-type economy under perfect information and imperfect information: self
selection. Lump sum taxes, linear and non linear income taxation, flat income tax. The Mirrlees
model of optimum income taxation. Analytical results and numerical simulations from the early
literature. The pattern of optimal marginal tax rates in two special cases: no income effects on labor
supply; no income effects on consumption. Linear income taxation. Flat (one-bracket) and two-
bracket income tax.

Optimal Commodity Taxation (4)

The Ramsey Rule: derivation and interpretation. Inverse elasticity rules. Extensions: many
households, untaxed goods and uniform taxes. Analytical results and numerical simulations from
the early literature.

Criticisms and Extensions (2)

Debated topics. Introduction to Environmental taxation
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Bibliography :

Myles. G. D. [1995], Public Economics, Chapters 4 and 5, CUP.

Additional readings: textbooks

Auerbach, A.J. and Feldstein, M, Eds [1985; 1987], Handbook of Public Economics, voll. I and II, Elsevier Science
Publishers B.V..
Aurbach, A. J. [1985], The Theory of Excess Burden and Optimal Taxation (vol I)
Kotlikoff L. and Summers L. [1987], Tax incidence (vol II)
Stiglitz, J.E. [1987], Pareto efficient and optimal taxation and the new welfare economics (vol II)

Salaniè, B. [2003], The Economics of Taxation, Chapters 1, 2, 3, 4, and 7, MIT Press.

Tuomala, M., 1990, Optimal income tax and redistribution, Clarendon Press, Oxford.

Additional readings: papers

Berliant, M. and M. Gouveia, 1993, Equal sacrifice and incentive compatible income taxation,
Journal of Public Economics 51, 219-240.
Boadway, R., K. Cuff and M. Marchand, 2000, Optimal income taxation with quasi-linear
preferences revisited, Journal of Public Economic Theory 2, 435-460.
Boadway, R. and M. Keen, 2000, Redistribution, in Atkinson, A.B. and F. Bourguignon, eds.,
Handbook of Income Distribution, vol. I, (Elsevier Science B.V.).

Dahan, M. and M. Strawczynski, 2000, Optimal income taxation: An example with a U-shaped
pattern of optimal marginal tax rates: Comment, American Economic Review 90, 681-686.
Diamond, P.A., 1998, Optimal income taxation: An example with a U-shaped pattern of optimal
marginal tax rates, American Economic Review 88, 83-95.

Eaton J., and H.S. Rosen, 1980, Labor supply, uncertainty, and efficient taxation, Journal of Public
Economics 14, 365-374.

Gruber, J. and E. Saez, 2002, The elasticity of taxable income: Evidence and implications, Journal
of Public Economics 84, 1-32.

Saez, E., 2001, Using elasticities to derive optimal income tax rates, Review of Economic Studies
68, 205-229.

Slemrod, J., 1998, Methodological issues in measuring and interpreting taxable income elasticities,
National Tax Journal 51, 773-788.
Slemrod, J., 2001, A general model of the behavioral response to taxation, International Tax and
Public Finance 8, 119-128
Slemrod, J., S. Yitzhaki, J. Mayshar and M. Lundholm, 1994, The optimal two-bracket linear
income tax, Journal of Public Economics 53, 269-290.

Stiglitz, J.E., 1982, Self-selection and Pareto efficient taxation, Journal of Public Economics 17,
213-240.