Public Finance, 2nd Edition

Suppose, though, that the analyst decides to follow the recommendation

of modern normative theory and consider the distribution of project costs

and beneWts. The diYcult question then arises as to how this might be done in

a consistent and practical manner. The normative analysis in Part III indi-

cated time and again how distributional considerations complicate normative

policy prescriptions relative to the one-consumer-equivalent case. This was

true whatever the contextÐoptimal commodity tax rules, optimal govern-

ment responses to externalities, government production decision rules, and so

forth. Furthermore, the normative policy rules became somewhat arbitrary

and subjective, since the social welfare weights representing the distributional

component were simply assumed to reXect the distributional preferences of

society. Normative theory does not tell us how such preferences are actually

determined or what they should be. Not surprisingly, cost±beneWt analysis

suVers an identical fate as an evaluative tool. Once distributional parameters

are introduced into the evaluation, the present value calculations threaten to

become so complex and so highly subjective that the analysis may well

lose its ability to discriminate objectively among various investment alterna-

tives.

So the distribution question poses a dilemma: Include distributional

considerations and risk overwhelming complexity and subjectivity, or ignore

distributional considerations in the name of practicality and capture only a

part of each project's contribution to social welfare? As with all true di-

lemmas, there is no satisfactory resolution. All any analyst can do is decide

in advance whether or not to include distributional considerations and at-

tempt to justify the decision. Reasonable arguments can be oVered in support

of either choice

JUSTIFICATIONS FOR IGNORING

DISTRIBUTIONAL CONSIDERATIONS

Four arguments might be used to justify ignoring distributional consider-

ations, beyond the point that it greatly simpliWes the analysis. One argument

is in a negative vein and three are in a positive vein.

The negative argument is the one alluded to above, that incorporating

distributional judgments into the analysis is so subjective that no useful

information can possibly result.

1

This argument alone would suYce for

ignoring distributional considerations, but then the question arises whether

aggregate present value calculation is an appropriate criterion for project

selection. Three reasonable arguments can be made that it is.

1

Arnold Harberger argues for ignoring distributional considerations as one of his postu-

lates for applied research in A. Harberger, ``Three Postulates for Applied Welfare Economics,''

Journal of Economic Literature, September 1971. As noted in Chapter 26, he backed oV

somewhat from this position in 1978 (see p. 787, n. 12).

806 JUSTIFICATIONS FOR IGNORING DISTRIBUTIONAL CONSIDERATIONS

One could simply adopt the idealistic stance that the government should

always be striving to reach Bator's Wrst-best bliss point regardless of society's

current position. Recall that the bliss point is represented by point B in Fig.

27.1, in which U

2

U

1

is the Wrst-best utility-possibilities frontier for

persons 1 and 2, constrained only by the economy's underlying production

technology and market clearance, and W

0

,W

1

, ..., are the social welfare

indiVerence curves embodying society's distributional preferences.

According to the social welfare rankings, B is distributionally the best of all

eYcient points on the utility-possibilities frontier.

Recall that attaining point B requires three conditions:

1. All markets are perfectly competitive, with perfect information.

2. Government policies may take any form required to satisfy the Wrst-

best pareto-optimal conditions.

3. The government can tax and transfer lump sum to satisfy the inter-

personal equity conditions of the form

qW

qU

h

qU

h

qX

hi

, all h  1, ..., H, where

W  W[U

1

(),...,U

H

( )] is the Bergson±Samuelson individualistic social

welfare function and X

i

is any one of the goods or factors.

To promote the quest for the bliss point, therefore, the government must

select all projects, and only those projects, with positive aggregate present

value. This is just eYciency condition 2 applied to government investments.

Accepting projects with aggregate present value less than zero because of

their distributional consequences necessarily places society below the utility-

possibilities frontier and thereby precludes attainment of the bliss point. As

B

U

1

W

2

U

1

U

2

U

2

W

1

W

0

Person 1

Person 2

FIGURE 27.1

27. COST±BENEFIT ANALYSIS AND THE DISTRIBUTION OF INCOME 807