Public Finance, 2nd Edition

criterion for taxes and transfers in a Wrst-best policy environment. They

represent, simultaneously, a complete prescription for the optimal distribu-

tion of income and for the optimal redistribution of income when starting

from a nonoptimal distribution.

Having considered how taxes and transfers help achieve the pareto-

optimal and interpersonal equity conditions of Wrst-best social welfare maxi-

mization, mainstream public sector theory has nothing more to say about

Wrst-best tax policy.

PUBLIC CHOICE AND PARETO-OPTIMAL REDISTRIBUTION

The policy implications associated with the interpersonal equity conditions

are perhaps the least convincing component of the mainstream Wrst-best

theory. On the one hand, any tax or transfer that is related to an individual's

well being, such as a personal income tax or a means-tested transfer payment,

is unlikely to be lump sum. On the other hand, the interpersonal equity

conditions rely on the social welfare function which, although a useful

analytical construct, is problematic in the extreme as a practical guide to

distributional policies. As noted in Chapter 3, there is no convincing theory

to determine what the marginal social welfare weights should be, and Arrow

proved that a democratic society may not be able to articulate a consistent

social welfare function when individuals disagree about the appropriate

weights.

Mainstream public sector economists have responded to the diYculties

of the social welfare function in one of two ways, for the most part. The Wrst

might be called the technocractic response, most closely associated with

Paul Samuelson. The idea here is to concede that economic theory has

nothing useful to say about the form of the social welfare function. At the

same time, an operative social welfare function undoubtedly exists; the

ruling politicians are setting their policies with some set of marginal social

welfare weights in mind. Therefore, simply ask the policymakers what their

social welfare function is and then tell them what the optimal policies are

given that function. Economists can solve constrained optimum problems

once they know what the objective function is. The second mainstream

response, and the more common one, is to retain the social welfare function

in normative analysis but use a Xexible form of the function that permits a

wide range of social welfare weights. The Atkinson and Jorgenson social

welfare functions described in Chapter 4 are examples. They each employ

Atkinson's aversion-to-inequality parameter, which admits the full range

of social welfare weights that people are likely to prefer, from utilitarian

indiVerence to Rawlsian egalitarianism. The idea behind the Xexible-

form approach is to see how optimal policies vary with the social welfare

weights.

10. THE FIRST-BEST THEORY OF TAXATION 309