6 PART 2 ALLOCATION, DISTRIBUTION, AND PUBLIC CHOICE D. SOCIAL-GOODS ALLOCATION IN THE BUDGET ‘This general model integrates the properties of social goods into the theory of wel- fare economics, but it tells us little about how the solution is to be implemented. In the real-world setting, there is no omniscient planner who can solve the problem for us and settle the outcome at B* as was shown in Figure 5-2. A mechanism is needed by which preferences are revealed and the corresponding allocations are made. In the case of private goods, this mechanism was provided through the use of a competitive pricing system which, based on a given distribution of income, serves to secure an efficient solution. For the case of social goods, a political pro- cess is needed, with consumers expressing their preferences through voting and on the basis of a given distribution of income. Efficient Allocation To provide a link to this process, social-goods alloca- tion will now be restated in terms of a budget model, where the provision for social goods is decided upon in line with consumers’ evaluations as based on their in- comes and preferences. The cost of social goods is then covered by taxes, imposed in line with consumer evaluation—i.e., by a generalized system of benefit taxa- tion—which moves the model in the direction of realism, but we retain for the time being the assumption that preferences are known to the planner. ‘More specifically, we assume that the tax prices are set so as to charge par- ticular consumers for their consumption of social goods in accordance with a pric- ing rule similar to that operating in a competitive market for private goods, as im- plied in Figure 4-1 above. That is to say, for each consumer, all units of a good are to be sold at the same price (there is to be no higher price on intramarginal units), and the ratio of unit prices for X and S is to equal the consumer's marginal rate of substitution in consumption. A and B will pay the same unit price for X while con- suming different amounts thereof, and they will pay different unit prices for while consuming the same amout The solution is illustrated in Figure 5-4. The production possibility line CD in the upper figure shows various mixes of S (the social good) and X (the private ‘g00d) that can be produced and that are available to the economy as a whole.* The middle figure shows the position of consumer A and the lower that of B. Suppose that income is divided between A and B so that A receives a share equal to OM 0C of potential private-good output OC and B receives ON/OC, where OM + ON = OC. The broken line MV will then record the optimal allocation of A’s income between X and S at varying price ratios. It traces the point of tangency of a set of price lines anchored at M with successive indifference curves. Given the price ratio OM / OP, for instance, A's preferred position will be at Q, where MP is tangent to the highest attainable indifference curve i,2. The broken curve NW traces a similar price line for B. The assumption ofa linear transformation schedule is necessary if the pricing rule here specified is to result in the necessary equality of tax revenue and cost. Allowing for increasing cost and a concave schedule, our pricing rule yields excess revenue, because intramarginal units ofthe social good can then be produced at a lower opportunity cost as measured in terms of private goods. Hence a more complex formula or a rebating of the excess revenve would be needed.CHAPTER § SOCIAL GOODS CONSIDERED FURTHER Private good X 0 M Private good X Private good X o ECONOMY AS A WHOLE iW 1 | A’s POSITION 1 1 1 1 1 1 Social good S Social good S ‘Social ‘g00d S FIGURE 5-4 Social and private goods with given distribution.70 PART 2 ALLOCATION, DISTRIBUTION, AND PUBLIC CHOICE Following A’s positions along MV, we may trace out the corresponding posi- tions available to B, as shown by the broken curve NJ. At each pair of points, both miust consume the same amount of $, while B’s consumption of X is obtained by deducting A’s consumption (as recorded by MV) from the total supply of X (as recorded by CD). The NW curve in turn traces out the preferred positions for con- sumer B which would result if different price ratios were applied to B's purchases of social and private goods. The NJ and NW curves intersect at G, and the correct Pricing and output solution is thus obtained where B is placed at G while A is po- sitioned at F and total output is divided between private and social goods, as shown by E on the production possibility curve. Both consume OH of S, while private- good output Of is divided so that OK goes to A and OL to B where OK + OL = Ol. This solution has the following characteristics: 1. The solution conforms to the initial distribution of income, with A’s share equal to OM / OC and B’s share equal to ON/ OC. 2. Aand B both pay a tax price such that each one's marginal rate of substtu- tion for S and X in consumption is equal to each one’s price ratio, so that our pricing rule is complied with.? 3. The combined tax contribution of A and B equals the cost of $ to the group as a whole. 4. The solution meets the efficiency criterion of the Samuelson model—ice., that the sum of the marginal rates of substitution equals the marginal rate of transformation."" The solution E thus reflects a point on the utility frontier of Figure 5-2, it being that point which corresponds to a given income distribution and specified pricing rule, Extension to Voting This view of the fiscal problem takes one step toward reality, since an initial distribution of money income is assumed to exist and tax shares are determined on that basis. But it remains unsatisfactory in that it is still implemented through a planner to whom preferences are known. In the real-world setting, there is no omniscient planner to whom the preferences of Figure 5-4 are revealed and who can derive an optimal solution therefrom. Nor is the case of re- alism helped by substituting an assumption of voluntary bidding. As was noted ear- lier in our discussion of Figure 4-1, this solution breaks down with a large number of voters, where the free-rider problem arises. To provide an operational view of the budget, the model must thus be extended to incorporate a theory of the voting process. * Note in Figure 5-4 thatthe unit price for private good X or Py isthe same for both A and B, but the unit price for § differs. A's price ratio P/Py as given by price line MR equals OM/OR. Since A's price line is tangent tothe indifference curve at F, the price ratio equals the marginal rate of substitution in consumption. The same holds for B's ratio P2 Py equal to ON/OU, with price line NU again tangent to the indifference curve iy at G. "©The amount of t&x paid by A, of T,, equals P2/OH. Given P'/Py= OM/OR and setting Px = 1, we bave P? = OMIOR and 7, = (OM/OR)OH. Since OM/OR = KM/KF = KM/OH, we obtain 7, = KM. Atguing similarly for B, we obtain Ty = LN. Since OM + ON = OC and by con- struction of NW we know that OL. + OK = O1, it follows that T, + Tq = IC. For the group as a whole, the price ratio is given by Ps/Py = OCTOD. Setting P, = 1, we have P, = OCIOD, with the cost of supply OH of S equal to (OC/OD)OH, which again reduces 10 IC. See, however, footnote 8 above. "¥ This follows because (OM/OR) + (ON/OU) = (KM/OH) + (LN/OH) = IC/OH.CHAPTER § SOCIAL GOODS CONSIDERED FURTHER n More specifically, the task is to devise a voting system which is effective in securing preference revelation and an efficient system of tax-expenditure determi- nation. The solution should approximate an efficient pricing rule, such as that shown in Figure 5-4.'? Through the voting process, the pseudo-demand schedules Of the earlier discussion tend to be revealed, the budget size determined, and the tax price applied. This is the best we can do, although as will be shown in Chapter 7, the voting process by its very nature cannot bring about a perfect result. Except for a society where preferences are so homogeneous as to permit unanimity, some voters will remain dissatisfied. Yet some procedures will do better than others and the task is to find the best approximation. —. ALLOCATION OR DISTRIBUTION: WHICH COMES FIRST? Voting on the provision of social goods and assignment of their cost through taxes presumes the distribution of income to be given, just as did the solution of private- goods allocation through the market mechanism. This presumption suggests a pol- icy sequence of first setting the “‘correct’” state of distribution via tax transfer pol- icies and then determining the allocation of resources to the provision of social goods. At closer consideration, however, such a procedure becomes questionable. ‘The way in which resources are used in the provision of public or private goods will affect factor and product prices and thus have a bearing on how real income is distributed in the market. Thus both the allocation and distribution aspects of bud- get policy must be determined simultaneously in a general-equilibrium system. Al- though efficient resource use and ‘“*just"” distribution pose distinct policy problems, an omniscient budget planner would resolve them simultaneously. But this is not a feasible procedure in practice, Here the political process by which preferences for social goods are revealed must be conducted on the basis of a given distribution. Such being the case, there is much to be said for distinguish- ing measures of redistribution from those which allocate resources to public use. Lest this is done, the efficient provision of public services tends to be distorted by distributional considerations, and vice versa. The two-step procedure thus remains a useful (if not perfect) model.'* F, SUMMARY ‘This chapter has followed up the preceding discussion of social goods with a closer look at the underlying theoretical formulation, based on the economic concept of efficiency. "2 To be efficient, the pricing mule used to solicit preference revelation must equate each consum- fer's rate of substitution with his or her price ratio at the margin. But it is not required that the intramarginal units be sold at the same price. Charging higher prices for intramarginal units ofthe social ‘good would tax away “consumer surplus.” Thus more than one efficient pricing rule is available ‘Among them, that one should be used which best permits implementation through the voting process. 9 See p. 6 above.