PUBLIC FINANCE

IN THEORY
AND PRACTICE
Fifth Edition

Richard A. Musgrave
H. H. Burbank Professor of Political ^Economy, Emeritus
, Harvard University
Adjunct Professor of Economics '
University of California at Santa Cruz

Peggy B. Musgrave
Professor of Economics
University of California at Santa Cruz

MCGRAW-HILL BOOK COMPANY

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 -•s

Contents

Preface to the Fifth Edition xv

Excerpt from the Preface to the First

Edition ' xvii

PART ONE WHAT THE PUBLIC SECTOR

IS ABOUT

Chapter 1 Fiscal Functions: An Overview

> A Introduction . ,
B The Allocation Function •
C The Distribution Function
D The Stabilization Function
E' Coordination of BudgefFurictiohs •
F Summary

Chapter 2 Public Sector in the Economic

Accounts
A Public Sector in the Circular Flow
B Public Sector in the National
Income Accounts
Chapter 3 Fiscal institutions
A ' Survey of United States Fiscal •'-
Structure 21
B The Constitutional Framework 23
C Implementation of Expenditure Policy 31
D Implementation of Tax Policy 33
E Other Aspects of Implementation 35
F Summary 37

vii
viii CONTENTS

PART TWO ALLOCATION, DISTRIBUTION,

AND PUBLIC CHOICE

Chapter 4 Public Provision for Social Goods 41

A Social Goods and Market Failure 42
B Provision for Social Goods 45
C Mixed Goods 49
D Giving as a Social Good 55
E Merit Goods 55
F Summary 58

Chapter 5 Social Goods Considered Further 59

A Meaning of Efficiency 60
B Efficient Provision of Private Goods 60
C Efficient Provision of Social Goods 65
. D Social-Goods Allocation in the ••
Budget 68
E Allocation or Distribution: Which
Comes First? 71
F Summary* • • '••71

Chapter 6 Equity in Distribution 73

A Does Equity Belong in Economics? 74
B Approaches to Distributive Justice 76
C Limits to Redistribution 82
D Summary •' ' 85

Chapter 7 Public Choice and Fiscal Politics 87

A Direct Democracy 88
B Representative Democracy 96
C The Leviathan Hypothesis 99
D Classes and Interest Groups 106
E Summary 108

PART THREE EXPENDITURE STRUCTURE AND POLICY

Chapter 8 Public Expenditures: Structure
and Growth 113
f- A Public Expenditure Growth 114
V^C)^ B Growth by Type of Expenditure 116
C International Comparison' 119
D Causes of Expenditure'Growth 119
E Summary ' ' ; 128
CONTENTS Ix

Chapter 9 Expenditure. Evaluation: Principles ;: 130

1
""/f.'V " ' •'/.' • j '

A Decision Rules 131

B Fundamentals of Project Evaluation 135
C Types of Benefits: arid Costs ':>•••"! 137
D Measurement of Benefits:and Costs' 139
E Assigning Weights, in Project • i
Selection ;• •:., :J 143
F Efficiency and Equity Once. More 147
G Discounting and the Cost of Capital. 150
H Risk and Economic Change ' 160
I, Summary,., •,<:., • • ri 161

Chapter 10 Case Studies in Expenditure Policy:

( i f Public Services " . 164
A 'National Defense : • 164
B Highways •- . 167
C Outdoor Recreation • . • 177
D Education • . ••<•. 1.80
E Summary 185

Chapter 11 Case Studies in Expenditure'Policy:

(2) Low-Income Support and Social
Insurance ' 187
; A Low Income Support Programs 188
/
B Effects on Work Incentives • 190
C Social.insurance Programs" , ., 195
D Issues in OASI : . 199
E Summary . 206

PART FOUR PRINCIPLES OF TAXATION

• • ; . " * ; > •.-• •-. • . , * . . . " v . • '•' • • . ..'

Chapter 12 Introduction to Taxation. .. 211

A Categories of Revenue . 211
B Requirements for a ','GoodV Tax
Structure. . ' •• • • • 216
! C Summary . 217
Chapter 13 Approaches to Tax Equity 218
A Application of Benefit Principle 219
B Ability to Pay: (I) Horizontal
. Equity andjChoice of Tax Base -223
,C • Ability to Pay: (2) Vertical Equity
and Rate Structure 228
D; Summary '- - 231
 CONTENTS

Chapter 14 Tax and Expenditure Incidence:

An Overview 234
A Nature of Tax Burden :.. : ' y 235
B Concepts of Incidence ? . • . '. 236
C1: Measuring Incidence . . . . . ', 239
D Incidence of the U.S: Fiscal1 :
Structure 242
E .Summary, r '. •: •;•,•. 247

Chapter 15 Principles of Tax Incidence 249

A Partial Equilibrium View of Product
Taxes • : - . . . . 250
B Partial Equilibrium' View of Factor
Taxes ~ 255
C Incidence in General Equilibrium 257
*D Imperfect Markets .v . • - 262
E M a c r o A s p e c t s i - . . •. • ••• • . 269
F Summary ... *: *_, 270

Chapter 16 Excess Burden and Efficient

Tax Design. •" >•-. . . ' , 277
A Administration arid Compliance
i t
Cost ' - • • " • ' 278
I B Tax Distortions in Partial- .
Equilibrium " •• . 279
C Tax Distortions in General*
Equilibrium '•"•.-,; 286
D Magnitude of Excess Burden •.. 293
E Further Considerations 294
F Summary 295
Chapter 17 Taxation Effects on Capacit
A Supply-Side Perspective 297
A Effects on-Work Effort 298
B Effects on Private-Sector Saving 303
C Effects on Private Investment•• 306
D Growth Effects and Tax Incidence 312
E Summary 313

PART FIVE TAX STRUCTURE

Chapter 18 Development and Composition
of United States Tax Structure 317
A Development of U.S. Tax Structure 317
B Comparison with Other Countries 321
C Summary 322

L..
CONTENTS, xl

Chapter 19 Individual Income Tax: Defining

Taxable Income 324
. _ A Major Provisions : y 325
B Structure of;the.Tax Base. 328
C Principles of Income Definition 330
D Practice of IncomeiDefinition:
(1) Exclusions;!?"''>. -. •'• '•' 335
E Practice of Income Definition:..
(2) Deductions ' 341
F Practice of" Income Definition:
(3) Credits • -, • :, ,,- ; - ,;. 347
G S u m m a r y.-.,<*• ; . . •.-.;,•• ,.' 347
Chapter 20 / Individual Income Tax:
' Further Problems 350
A . Tax .Base ini Relation to. GNP;and
P e r s o n a l I n c o m e ' . i••.-• • • 350
B Tax Preferences . 352
C High-Income Problems >• , • . • : 353
D Treatment of Low Incomes '• • 354
E Patterns of Progression • • •. 356
F Inflation Adjustment 361
G Choice of Taxable Unit "s 362
H State and Local Income Taxes 365
I Summary 367

Chapter 21 Corporation Income Tax:

Structure and Integration 369
A Structure of Federal Corporation
Income Tax " : 370
B Should There Be a Corporation
Tax? . , * 371
C Integration 375
D Further Aspects-of Base Definition 377
E Summary 379

Chapter 22 ^Corporation Income Tax:'

Further Issues 380
A Depreciation Rules 380
B Investment Tax Credit 386
C Who Bears the Tax? 387
D Small Business 390
E State Corporation Taxes 391
F Foreign Investment Income 392
G Summary 392
 1 CONTENTS
xll

Chapter 2 3 Consumption Taxes • ••'.'.: "-•394

''''"' A Sales Taxes in the U.S.Tax
Structure -. '. y 395
• '<•:• B Issues in Sales Taxation. • <; i 396
« C Value-Added Tax'; - • r-' '•. . I 399
D Burden: Distribution . . . 403
E Personal Expenditure Tax *':. <: • 404
F Summary..*- •<• '*?: •->:. >: •' 408
Chapter 24 Property and Wealth, Taxes , 410
A Rationale for Wealth Taxation '.•' .. ' 411
B Composition and Distribution, of
Wealth . . ;... • . . - 4 1 3

C Structure and Base of the'Local.. .."

Property Tax 414
D. ; Burden Distribution of Property Tax 419
E Appraisal and Outlook for Property
Tax :. 424
' :. F Net Worth:Tax :.•: , 425
: G Capital LeVy . . ••• i 428
:
:
• H Summary •;: •' ' v.i 428
Chapter 25 Death Duties . : 431
/ ' Rationale for Death-Duties • 432
B The Federal Estate Tax ' 433
!"• c The Federal Gift Tax ,,. . . 437
D State Inheritance Taxes " . . • * "437
E Summarv 438
Chapter 26 Payroll Tax
A Level of Tax Rates and
Administration 440
B Incidence 440
C Relation to Benefits 442

PART SIX FISCAL FEDERALISM-

i .
Chapter 27 Principles of Fereance
A Spatial Dimension of Allocation •
Function . , 446
B Tax-Structure Design . . , . , , 453
C * Spatial Aspects of. Distribution
Function 454
D Spatial Aspects of Stabilization •.
Function 455

Li E Summary 455
CONTENTS xiii

Chapter 28 Principles of Federal Finance 457

A Patterns of Federalism . , 458
B Functions by Level of Government . y 458
C Principles of Grant Design ' . 461
D Taxation in the Federation 469
E Summary 471
;
Chapter 29 The Structure of Fiscal Federalism '
in the United States . 473
' i > ( ' ' ' . . - ; ' • • • • • " • : . ' . . , ; . . . * • •

A Origins 473
B The Federal-State and Local
Balance ' ' ' ' 475
C State-Local Patterns . . . 476
D Dete'rmiriants of Fiscal Position ; 479
E The Grant System . ' ' ' '. " 483
F Federal Grants and Equalization 486
G School Finance 487
H The New Federalism 492
I Summary • . . , . -. / • 493

PART SEVEN FISCAL POLICY AND STABILIZATION

Chapter 30 Principles of Stabilization Policy 499

A Multiplier Models with Investment
Fixed 500
B Multiplier Models with Investment
Variable 506
C Stabilization in the Open Economy
D Inflation . • • > " 513
E Rational Expectations.-. 518
F Summary 521
Chapter 31 Further Issues in Fiscal Policy 523
A Built-in Flexibility 524
B Timing of Fiscal Effects 527
C Tax versus Expenditure Changes 531
D Capital Formation in the Public
Sector . 532
E Fiscal Policy Experience 537
F Summary 542

Chapter 32 Economics of the Public Debt 544

A Growth of the Federal Debt 545
B Structure of the Federal Debt 546
C Public Debt and Fiscal Solvency 550
 V-

xiv CONTENTS

D . Does Debt Finance Burden Future

Generations? 552
E Maturity,Mix and Interest Cost 555
F The Market for'State'"and Local Debt 561
G Summary 563

PART EIGHT INTERNATIONAL ISSUES

Chapter 33 International Fiscal Coordinations 567
A Introduction to Tax Coordination 568
B Coordination of Income and Profits
Taxes 569
C Coordination of Product Taxes 573
D Expenditure Coordination 577
E Coordination of Stabilization
Policies " " 579
F Summary 580

Chapter 34 Development Finance 582

A Ingredients of Development 583
\ B . Fiscal Policy, Stability, and Growth •>• 587
C Tax-Structure Policy 593
; • '
/ f D Tax, Incentives • . : 601
' E Expenditure Poljcy 605
. ,
F International Aid arid Redistribution 607
G Summary 609

INDEXES
i N a m e Index 613
Subject I n d e x . . . 617

ILVV