Optimal Provision of Public Goods:A Synthesis

Abstract

There currently exist two competing approaches in the literature on the optimal provision of public goods. The standard approach highlights the importance of distortionary taxa-tion and distributional concerns. The new approach neutralizes distributional concerns by adjusting the non-linear income tax, and finds that this reinvigorates the simple Samuelson rule when preferences are separable in goods and leisure. We provide a synthesis by demon-strating that both approaches derive from the same basic formula. We further develop the new approach by deriving a general, intuitive formula for the optimal level of a public good without imposing any separability assumptions on preferences. This formula shows that distortionary taxation may have a role to play as in the standard approach. However, the main determinants of optimal provision are completely different and the traditional formula with its emphasis on MCF only obtains in a very special case. (JEL: H41, H23, H11) ∗We are grateful to Kenneth Small for discussions leading up to this paper. We also wish to thank Henrik Jacobsen Kleven for detailed comments on a previous draft.