Finding alternatives in public good financing is one of the most recent issues in the government sector. Tax-financed for pure public good is well known results further problems like externalities and economic inequity. This paper only addresses the qualitative analysis in discussing benefits and costs of the society in applying some alternatives in funding public good provisions, pure and impure one.public goods

Kodrat Wibowo

English

Research Papers in Economics

Working Paper 
in Economics and 
Development Studies
Department of Economics
Padjadjaran University
Center for Economics and Development Studies,
Department of Economics, Padjadjaran University
Jalan Cimandiri no. 6, Bandung, Indonesia. 
Phone/Fax: +62-22-4204510
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Alternative Funding For Public 
Goods Provision
Kodrat Wibowo
Department of Economics, 
Padjadjaran University
July, 2002
No. 200201 
 
ALTERNATIVE FUNDING FOR PUBLIC GOODS PROVISION 
KODRAT WIBOWO 
 
 
 
 
 
 
 
 
 
 
DEPARTMENT OF ECONOMICS 
UNIVERSITY OF OKLAHOMA 
2002 Introduction 
Finding alternatives in public good financing is one of the most recent issues in 
the government sector. Tax-financed for pure public good is well known results further 
problems like externalities and economic inequity. Some scholars such as Andreoni 
(1993) also found that tax-financed contributions to a pure public good incompletely 
crowded out voluntary giving. Crowding-out was measured at a significant number, 71%. 
Pricing and tariffs problem in impure public goods, club goods has also made 
economists, policy maker and analyst start thinking to find some funding alternatives that 
can get rid out of those problems. Many studies have been conducted to analyze a long-
standing problem in club goods such as recreation areas, highways, and communication 
systems that concerns pricing under conditions of average cost. The pricing solution, so 
called nonlinear price structures or a two-part tariffs that consists of a lump-sum license 
fee for each consumer and a toll per unit of utilization still have new possible problems. 
Lewis (1941) believes that license fee should be calculated very carefully since it has 
become a reason for potential club members or club good consumers to be driven away
1. 
This paper only addresses the qualitative analysis in discussing benefits and costs 
of the society in applying some alternatives in funding public good provisions, pure and 
impure one. The alternatives we will discuss in this paper are joint-product good, 
advertising, and state lottery or video poker. This paper assumes that private sectors are 
allowed to participate in the public goods provision; so then discussion on whether non-
government is able to provide public goods is also briefly reviewed.  
                                                 
1 Ng and Weisser (1974) give a solution for this problem by considering a uniform license fee across 
consumers and deriving the pareto-optimal toll, license fee and membership size. They offered two 
alternatives if increasing returns to scale are present and full financing through congestion-internalizing 
tolls poses a difficulty: (i) Ramsey pricing that leads to price discrimination, and (ii) price setting equals to 
long-run average cost that leads to a standard regulated industry. This paper is organized as follows: section II briefly reviews and summarizes the 
economic theory of public goods from previous studies on public good provision; section 
III discusses funding alternatives’ benefits and costs; section IV reviews some studies 
concerning about how to finance the public good provision; and the last section will be 
conclusions. 
Section II 
  Public goods are characterized by their alleged ability to confer benefits on 
additional persons without thereby reducing the benefits conferred on others. Moreover, 
public goods could not be divided among individuals and owing to non-excludability 
problems. 
Samuelson (1955) argued in his paper on the theory of public expenditure that 
since the marginal cost of consuming public goods is zero, therefore consistent with 
Pareto optimality condition, the price of public goods should be zero. Demsetz (1964) 
and Minasian (1964) on the other hand doubted what Samuelson argued by stating that 
besides social marginal benefits there is also private marginal benefit to users of the 
public goods, and this benefit can be measured by pricing the public goods. Only where 
scarcity is absent is it a priori reasonable to charge a zero price. All other goods including 
public goods are such their provision forces us into resource allocation problem. So then 
pricing the public goods seems to be more rational than a zero pricing policy. 
Another problem of public goods provision is that if the cost of policing the 
benefits derived from the use of these goods is low, there is an excellent reason for 
excluding those who do not pay from using these goods. By such exclusion we, or the 
market, can estimate accurately the value of diverting resources from other uses to the production of public goods. Starting with this problem, Olson (1965) and Buchanan 
(1965) began rigorous analysis of the spectrum of goods to analyze what are called 
impure public goods, a catchall term for any goods not purely public or private which are 
characterized by congestion and excludable benefit. We could imply that it is also 
appropriate for us to apply the policy of club goods to the mechanism of public goods 
provision. 
In public goods and public choice theory, the actors in the political marketplace 
are: voters, politicians, and bureaucrats. These actors make their economic choices to best 
further their own objectives. But each group is constrained in two ways: by the 
preferences of the other groups, and by what is technology feasible. The outcome of the 
choices of voters, politicians, and bureaucrats is the political equilibrium, which is the 
situation in which the choices made by voters, politicians and bureaucrats are all 
compatible and in which no group can improve its position by making a different choice. 
Two types of political equilibrium are possible: efficient and inefficient. Public interest 
theory predicts that governments make choices that achieve efficiency. Public choice 
theory recognizes the possibility of inefficient outcomes-of government failure that 
parallels the possibility of market failure. Later we will see that a decision of which of the 
alternative funding devices can be applied to fund the public good provision depends 
mainly on how those three actors deal one to others. 
Government vs. Non-government Institutional 
The debates for this controversy are still going on until today. Because of the 
market failure problem, which means the failure of a more or less idealized system of price-market institution to sustain “desirable” activity
2, government is strongly suggested 
to be the provider of public goods. Pigou (1946) support this suggestion by concerning 
the externalities, in which the action of one economic agent influences the utility or 
production function of another and no mechanism for compensation exists. For the public 
goods like national defense, so far there is no country in this world let the private to 
handle the provision. What government can do in this case is a variety of activities that 
we can see at all fiscal levels. Governments redistribute income for equity reasons; social 
security, Medicaid and progressive income taxation are some examples that are seen in 
many nations. Promotion of economic growth and stabilization of income and 
employment (i.e) fiscal policy) are other important governmental activities. 
On the other side, some other people suggest that private or non-government 
institution is better to be a public goods provider to promote the competition and 
therefore leads to a better efficiency, of course government intervention still represents, 
but not as a provider. Coase (1960) was the first economist who realized that the mere 
existence of an externality was not a sufficient reason for government intervention and 
thereby opening way for exploration of alternative institutional structures in public goods 
provision. Klein (1983) in his study support the private provision of public goods by 
stating that with private provision, the force of the private agreement is much greater, so 
the ground for social ties is more fertile. Demsetz (1970) moreover says that government 
and the policy such as taxation sometimes misrepresent the demand of public goods from 
the society, and the policy are unlikely to be related closely to benefits. 
The study of alternative nongovernmental institutional structures has been 
motivated in part by the realization that governments are characterized by their own 
                                                 
2 “Activities” broadly defined, to cover consumption as well as production of goods. political analogues of market failure and also by the apparent success of alternative 
institutional arrangement for dealing with conflicts over scarce resources. Thus, 
nongovernmental corrections to market failures have continued to grow in importance. 
Some mechanisms have been proposed, including Clarke-Groves taxes, which provide 
individuals, in the absence of income effects, the proper incentives to reveal honestly 
their preferences for pure public goods. In the instance of local public goods, Tiebout 
(1956) hypothesis suggested that the mix of public goods-tax packages offered by various 
local jurisdictions would induce an optimal partitioning of population through a process 
of voting with one’s feet. This process is believed to lead to efficiency, provided that 
there were no impediments to mobility and that there were a sufficient number of 
jurisdictions to choose from. Cornes and Sandler (1986) showed that nongovernmental 
alternative to the provision of public goods can be provided by club theory. 
Question about what institutional structure could be the best provider of public 
goods now becomes more important since technological factor come into the topic. The 
level of exchange and police cost that are required for effective marketing and the costs 
of government substitute services depend on how well the technology influences the 
operating markets and government. Technological advances have made it possible to 
choose whether or not to exclude individuals from consumption of public goods and 
emerging technological developments will make the use of markets or governments more 
economic than they are now. Again, there are alternatives ways of providing and 
distributing consumption services to individual, and the choice between them can often 
involve a choice between technologies exhibiting varying degrees of excludability and indeed, non-rivalry. Technology is one of the key answers of how nongovernmental 
institutional structures correct the problem of market failure and externality. 
I would like to argue in this paper, that no matter what the institutional structure 
is, the provision of public goods should be based on the efficiency or optimality because 
the technological advances have made it possible either for government or non-
government sector to internalized the externalities, correct the market failures and 
furthermore to achieved the Pareto optimality or efficiency in public goods provision. 
Section III 
Alternative Devices to Finance the Public Goods Provision 
The use of taxation for the provision of scarce goods must be defended on 
grounds other than the usual rationale of their being public goods. As we have seen, 
insofar as efficiency is concerned, the fact that nonpurchasers from the acquisition can 
derive side benefits by others of these goods is inconclusive. Taxation is the most 
common application of zero pricing policy according to Samuelson. However, Demsetz 
(1964) brilliantly the weakness of this device, he mentioned indirect cost implied by zero 
pricing over taxing policy which is that the tax will lead to inefficiency small rates of 
production of other goods (assuming competitive markets). This is most easily seen by 
supposing that an excise tax is levied on other goods to finance the public goods. Levying 
of an income tax will inefficiently reduce the quantities of income generating activities 
undertaken by those taxes. Property tax would tend to discourage the seeking out of more 
valuable uses of property. Demsetz also believes that in a world in which exchange and 
police cost of providing alternative political devices are all zero, reliance on the political 
mechanism of a smoothly run democracy will result in less efficiency that will reliance on the market. In a one–man, one-vote democracy, where votes are not for sale, the 
polling place will generate information that is based on majority’s principles rather than 
on maximum benefit principles. In spite of the problem it has, for some public goods that 
have a high police cost, taxation may be the most practical method of finance though. 
Tie-in Sales or Joint Product 
Besides taxation there are other methods which are likely to arise in the market 
and which will lower the required police cost. As we have seen, extending the firm and 
the practice of sale-in-combination may overcome many instances of high exchange cost. 
These devices can also be used to reduce high police cost. Using famous railway 
example, Demsetz (1964) stated that the extension of the firm together with the 
combination-sale devices that are associated with differential land rent are extremely 
important alternatives to government action. These devices can extend considerably the 
usefulness of markets for revealing and measuring the value of many side effects. Klein 
(1983) called this alternative as tie-in sales or joint product and stated if it makes 
collective goods are possible to provided successfully by the private sector. There are 
other indirect devices for internalizing via combination sales. The activities of labeling, 
branding, and advertising allow for internalization of side effects by tying in the sale of 
information with other goods. Clubs can also provide a nongovernmental alternative to 
the provision of public goods. 
Advertising 
 Radio and Television are two kinds of public goods that very well known can be 
provided by advertising device very successfully.  Demsetz (1964) mentioned briefly 
how possible the advertising can finance the provision of television and radio. Further we 
can also take a look how Minasian (1963) critics Samuelson about how television 
provided in his paper. Advertising surely becomes more popular as one alternative device 
in financing the public goods since many governments realize the limitation of the 
amount of their budget and how inefficient the public goods provision by governmental 
institution. The takes over from government to nongovernmental institution in public 
goods provision surely need consideration about how non-government institutions 
finance their activity to provide the goods or service. Advertising initially is one of the 
alternative devices under a most common device so called “tie-in” arrangement. In tie-in 
arrangement, the public goods are provided by tying its provision with its complement 
private goods provision.  
 
REFERENCES 
Andreoni, James, 1993. "An Experimental Test of the Public-Goods Crowding-Out 
Hypothesis," American Economic Review, American Economic Association, vol. 
83(5), pages 1317-27 
Buchanan, J. M. (1965) ‘An economic theory of clubs’, Economica, N.S., 32 (125): 1-14. 
Demsetz, Harold. 1964. “The Exchange and Enforcement of Property Rights,” Journal of 
Law and Economics,7: 11-26. 
 Coase, Ronald (1960), “The Problem of Social Cost”,  Journal of Law and Economics 3, 
1-44 
Minasian, J. R. 1964. Television Pricing and the Theory of Public Goods. The Journal of 
Law and Economics Vol.7: 71-80 
Ng, Yew-Kwang and Weisser, Mendel (1974) "Optimal Pricing with Budgetary 
Constraints: The Case of the Two-Part Tariff", Review of Economic Studies, July 
1974, 337-345 
Olson, M. (1965). The Logic of Collective Action. Cambridge, MA: Harvard University 
Press 
 
Samuelson, P. A. (1955). Diagrammatic Exposition of a Theory of Public Expenditure, 
in: Review of Economics and Statistics, 37, 350-356. 
 

Alternative Funding For Public Goods Provision

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