Public Finance, 2nd Edition

LUMP-SUM REDISTRIBUTIONS AND PUBLIC SECTOR THEORY

Are lump-sum redistributions a feasible policy tool for the government? This

may appear to be a relatively uninteresting question. One is tempted to

answer: ``Probably not, but even if they are feasible it hardly matters because

few governments use lump-sum taxes and transfers. For instance, no major

U.S. tax or transfer program is lump sum.'' All this is true, yet it is hard to

imagine a more important question for normative public sector theory. The

answer has a dramatic impact on all normative policy prescriptions in every

area of public sector analysis, whether they be directed at distributional or

allocational problems. In public sector theory, lump-sum redistributions

stand at the border between Wrst-best and second-best analysis.

The issue is not so much the existence of lump-sum redistributions.

Lump-sum tax and transfer programs are easy enough to describe. Poll

taxes have occasionally been used as revenue sources and they are certainly

lump sum from an economic perspective. On the transfer side, many coun-

tries have instituted per-person demogrants (e.g., Canada, which provides a

grant to all the elderly). The United States has not used demogrants, but it

may soon. In his 1996 presidential election campaign, Robert Dole proposed

a $500 per child refundable tax credit under the federal personal income tax.

It might be argued that decisions on family size are essentially economic and

would inXuence the amount of transfer received. If so, then tax credits and

demogrants to children are not strictly lump sum, although the legislation

could be drafted such that only children already living at the time of passage

would receive the transfers.

The mere existence of lump-sum taxes and transfers is not enough,

however, to render them feasible policy tools in the pursuit of equity. The

lump-sum taxes and transfers must be Xexible enough so that they can be

designed to satisfy the interpersonal equity conditions for social welfare

maximization, and this is a very tall order indeed. To be eVective, the taxes

and transfers would almost certainly have to be related to consumption or

income or wealth in order to distinguish the haves from the have nots, but

then it is doubtful that they would be lump sum.

Income taxes were thought to be essentially lump sum before 1970,

because empirical research had been unable to discover any relationship

between income tax rates and either work eVort or saving. Research since

then, employing detailed micro data sets and sophisticated microeconometric

techniques, suggests that labor supply does respond to changes in after-tax

wages, certainly the female labor supply. The evidence on saving behavior is

more mixed, but saving also appears to respond somewhat to changes in

after-tax rates of return.

1

In any event, no one today believes that income-

1

For an excellent review of the early empirical studies on labor supply and savings

elasticities, see M. Boskin, ``On Some Recent Econometric Research in Public Finance,'' AEA

66 LUMP-SUM REDISTRIBUTIONS AND PUBLIC SECTOR THEORY