Each contributor provides a retrospective on Shoup’s various contributions to the field, reviewing the literature and assessing its relevance to current problems in public finance theory and policy. The essays highlight and analyze fiscal theory and public policy developments from the 1930s to the present in four areas: the Shoup tax missions to Japan, Venezuela, and Liberia; the tax mix; the expenditure mix; and macro public finance.
Contributors. Lorraine Eden, Carl S. Shoup, Malcolm Gillis, Minoru Nakazato, Charles E. McLure Jr., John Bossons, Richard Goode, William Vickery, Wayne Thirsk, John Graham, Stanley Winer, W. Irwin Gillespie, Melville L. McMillan, Cliff Walsh, John G. Head, Enid Slack, Edwin G. West, Richard M. Bird, Peggy B. Musgrave, Douglas A. L. Auld, John B. Burbidge, Jack M. Mintz, John Sargent, Richard A. Musgrave
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Retrospectives on Public Finance
By Lorraine Eden
Duke University PressCopyright © 1991 Duke University Press
All rights reserved.
Retrospectives on Public Finance: An Introduction to the Issues
The purpose of this chapter is to introduce both the subject matter of this book and the papers within it. Retrospectives on Public Finance contains the edited proceedings of a conference held at Carleton University, Ottawa, Ontario, Canada, in May 1989, which brought together scholars and policy makers from Canada, Australia, Japan, and the United States for a retrospective on the discipline of public finance, in honor of one of its most famous practitioners, Carl Sumner Shoup, McVickar Professor of Political Economy Emeritus at Columbia University.
The 1989 conference marked the twentieth anniversary of Shoup's 1969 major treatise, Public Finance (Chicago: Aldine Publishing). The date also marked the anniversaries of the Shoup Mission to Japan in 1949–50 and the Shoup Mission to Venezuela in 1958–59. From his early work in the U.S. Treasury Department, through the Shoup Tax Missions to Japan, Venezuela, and Liberia, from his ongoing interest in public expenditures and size of the government sector, through the value-added tax and taxation of multinationals, Carl Shoup has successfully intermingled theoretical advances in public finance with practical advice to policy makers around the world.
Although the conference was not formally in honor of Richard A. Musgrave, his great contributions to the discipline, the similarities in his and Shoup's approaches to public finance, and the fact that 1989 is the thirtieth anniversary of his pathbreaking treatise, The Theory of Public Finance: A Study in Political Economy (New York: McGraw-Hill), are also marked by this book.
These events, the publication of two important treatises and the conclusion of two tax missions, had a substantial impact on the theory and practice of public finance from the 1930s through the 1980s. Carl Shoup and Richard Musgrave, both leading world figures, represent a branch of public finance that we can call the "prescriptive" or "political economy" school. This school is older than the optimal tax and the deadweight loss literature one associates with Harberger, Atkinson, Stiglitz, and others. The Shoup-Musgrave branch combines rigorous theory with practical policy advice. Public finance as practiced by these economists is a distinct approach, one that is prescriptive, hands-on, and firmly rooted in the political economy tradition that economics must be applicable to real world problems. These economists believe that fiscal institutions are important to our understanding of public finance and that theory and practice must interact for success in making democracy function.
Carl Shoup and Richard Musgrave have trained and been colleagues with over two generations of public finance specialists, including Richard Bird, Sijbren Cnossen, John Due, Lyle Fitch, Irwin Gillespie, John Graham, Richard Goode, Lowell Harriss, John Head, Peggy Musgrave, Charles McLure, Jr., Hirofumi Shibata, and William Vickrey, to name just a few. Their research spans the entire field of public finance, from the theory of public goods to the integration of the personal and corporate income taxes to macroeconomic policy to fiscal harmonization. These economists believe in a practical approach to public finance, one that uses theory to design realistic fiscal structures.
The purpose of the conference was to take a retrospective look at this political economy branch of public finance in honor of Carl Shoup's contribution to it. The participants were asked to review the literature of this school and to assess its relevance to current problems in public finance theory and policy making. Each participant was asked to focus on the long view: to address the issues of what was really important, what has stood the test of time, what this branch can say to modern public finance problems, what advice can it offer to developing countries and to tax reform movements. Each paper was to be both a backward and a forward look. Given the current round of worldwide fiscal reforms (e.g., the United States, Canada, Japan, Australia, the United Kingdom, the European Community), such a retrospective look seemed particularly appropriate.
Outline of the Book
Retrospectives on Public Finance is drawn from the papers and discussant comments presented at the conference which were subsequently revised and edited for inclusion in this book. It is intended to offer the economics profession surveys that are useful, not only to academics and their graduate students, but also to practitioners of public policy in both developed and developing countries. The goal of the book is to help improve the level of policy making and economic analysis applied to public policy issues through a careful review of the prescriptive school of public finance.
Retrospectives can be a particularly effective research and learning tool. They are useful to academics, policy makers, and graduate students who wish to gain an understanding of a particular field of study. Through taking a long-run view of a field's development, authors can isolate key contributions, areas where further work needs to be done, and relevant work that has been lost to current researchers. Second, assessments of previous fiscal reform missions can be helpful in designing successful new reform missions. Such assessments link the importance of "architecture" and "engineering," to use Carl Shoup's words, to successful fiscal reform. Lastly, bringing together the senior statesmen in the profession with younger academics can lead to fruitful exchanges, linking the practical experiences of the older generation with theoretical advances of the younger group.
This volume is divided into six parts, consisting of seventeen chapters and seven comments. It is framed by two chapters, this one (Part I), which summarizes the papers and their themes, and the last chapter (Part VI) written by Richard Musgrave, which offers a personal view of the history of public finance from the 1930s through today. Part II opens with a personal retrospective by Carl Shoup on the relative importance of tax architecture, engineering, and administration in successful fiscal missions. Shoup's paper is followed by three chapters assessing the success/failure of the Shoup missions and the lessons these missions offer policy makers. Part III looks at the personal and corporate income taxes, the value added tax, and the role of the property tax in the fiscal system. Part IV contains papers on local public goods, excludable public goods, and merit wants. Part V deals with impacts of the tax structure on expenditure growth, international public finance issues, compensatory fiscal policy, and social security and public debt. The range of topics covered in Retrospectives on Public Finance is very broad, as befits a book designed to assess the political economy school of public finance and Carl Shoup's role within it. A brief outline of the key points of each of the chapters is provided below.
The Shoup Tax Missions
Carl Shoup's paper on "Melding Architecture and Engineering" asks a question he considers neglected but important: How should a tax mission allocate its resources between tax architecture, engineering, and administration? Shoup defines tax architecture as the choice of taxes to form a country's revenue base and the outlining of the essential features of each tax. Tax engineers must decide each of the substantive issues within the tax. Tax administration is concerned with how to implement the provisions in the tax law formulated by the architects and engineers. He argues that, contrary to some critics, tax architecture is an essential task for tax missions; while tax engineering and administration are both of growing importance.
Malcolm Gillis's paper on "Legacies from the Shoup Missions" notes that both Richard Musgrave and Carl Shoup are synonymous with tax missions; both are economists who can be referred to as "tax doctors." Gillis argues that the Shoup mission to Japan was a prototypical, path-breaking study since it was the first mission where distinguished public finance academics applied theory to the practical problem of reforming an entire tax system. All four of Shoup's missions emphasized tax fairness, the relation between tax systems and inflation, and the centrality of good tax administration in public finance. Gillis concludes that the legacy of the Shoup missions was not only the actual measures enacted, but also the impact of the missions on defining the agenda for tax reform in other nations.
"The Impact of the Shoup Report on Japanese Economic Development" by Minoru Nakazato notes that the report has influenced Japanese tax policy for nearly forty years. Nakazato concentrates on the tax reform aspects and asks whether the recommendations were appropriate at the time. He notes that fairness and the ideal of a comprehensive income tax were basic features of the report. Nakazato faults the mission for possibly encouraging overincorporation within Japan as a tax-minimizing technique.
Charles McLure, in "Income Tax Reform in Venezuela: Thirty Years after the Shoup Mission," compares the recent World Bank report on the income tax system in Venezuela with the report of the 1958–59 Shoup mission, which he considers a classic in the field. McLure focuses on the tax engineering aspects and argues that good tax advice has had little impact in Venezuela and that little has been learned from mistakes. He attributes this to the absence of a tax research group, the lack of political will to introduce reforms, and excessive reliance on high petroleum rents as a source of tax revenue. McLure concludes that tax reform may only occur when governments are forced by revenue needs to make unpopular choices.
The Tax Mix
Richard Goode in "Changing Views of the Personal Income Tax" describes and comments on changing views of the proper form and role of the personal income tax in the economy. Goode deals with three crucial issues: the definition of the base of the tax, the appropriate rate structure, and the choice between income and expenditure taxes. The paper uses Carl Shoup's taxonomy of consensus and conflict criteria to identify three conflict and four consensus variables that influence discussion of income tax rates. The conflict variables all deal with progressivity of the rate structure: the exemption of incomes below poverty level, mild progressivity over middle range, and steep graduation at high income levels. Theconsensus criteria are general fiscal goals: adequate revenue, avoidance of excessive interference with macro goals and macro stability, and practicable administration and compliance. Goode then compares the personal income tax to the expenditure tax in terms of the consensus criteria and argues that the income tax is still superior. He concludes that the academic view of the personal income tax has changed greatly because of economic analysis and the economic environment.
In "The Corporate income tax and How to Get Rid of It," William Vickrey notes that the corporate income tax faces the widest gap between political popularity and professional esteem. He attributes this gap to the public belief that the tax is borne by someone else, while economists disagree on the incidence of the tax. Vickrey argues that the tax in the United States was changed in 1936 without a clear underlying rationale and that its structure increases the cost of equity capital for firms, having a twofold depressing effect on business investment. In addition, he notes that the tax discriminates in favor of debt-financed and speculative investment, pressures firms to increase leverage ratios, and encourages leveraged buyouts and tax-driven mergers. Uncertainty as to its incidence makes it difficult to calculate benefits and costs, while the foreign tax credit mechanism creates an incentive for other nations to adopt similar taxes in order to take advantage of the credit. Vickrey's solution is a flat tax levied on a source basis and a progressive tax levied on a destination basis. He notes that there are problems with getting rid of an old, established tax due to windfalls, uncertainties, and incentives for tax avoidance. His conclusion is that we may have to live with the tax and that returning the tax to its pre-1936 structure may be the only feasible solution.
Wayne Thirsk's "Intellectual Foundations of the VAT" identifies Carl Shoup as the intellectual father of the value-added tax (VAT). The purpose of the chapter is to identify Shoup's contributions to growth and application of value-added taxes, now used by more than fifty countries worldwide. Thirsk notes that Shoup does not provide a blanket endorsement of the VAT, on the grounds that it is not a "magic tax potion for solving all fiscal ailments"; the choice of sales tax depends on the structural peculiarities of each country. Thirsk concludes that Shoup's work on the VAT is an "impressive intellectual achievement" which developed the taxonomy used to describe value-added taxes, established the essential equivalences, compared advantages of VAT to other commodity taxes, and linked tax administration capabilities to the appropriate VAT for developing countries.
The last chapter, John Graham's "The Place of the Property Tax in the Fiscal System," is broader in scope than the other chapters in this section because it deals with both sides of the government ledger, revenues and expenditures. Graham develops an analytical framework for establishing an efficient and equitable system of local public finance, one that takes into account property taxes and the nature of municipal services and that can be operationalized by policy makers. He argues that the distinction between people and property services is erroneous since only people can benefit from public services. A more satisfactory distinction is between general and local services. Graham discusses the old and new views of incidence of the property tax; he sees the tax as a tax on the value of the service rendered by property to the owner/tenant over some time period. The paper develops a rational assignment of functions and revenues between upper- and lower-tier jurisdictions, one that is designed to achieve both vertical and horizontal fiscal balance.
The Expenditure Mix
"Local Public Goods: Shoup Revisited" by Lorraine Eden and Melville McMillan reviews Carl Shoup's writings on local public goods in the light of developments in this area of public finance over the past twenty years. The authors identify four key issues around which Shoup's work has centered: the characteristics of public services, the definition and measurement of output, the determination of cost functions for level of service, population, and area of the jurisdiction, and the distribution and incidence of the benefits from local public goods. The paper concludes that Shoup's major contributions lie in his work on the characteristics and distribution of local services.
Cliff Walsh's chapter on "Public Goods Provision with Price Exclusion" deals with market provision of price-excludable public goods. He notes that jointness is the key characteristic of such commodities and that jointness has important and not well understood implications for the nature of market equilibrium and public policy. Walsh investigates the implications of excludable public goods for pricing, market structure, decision making, and market behavior. He concludes that market provision may not be superior to government provision for this class of commodities.
The last chapter in this section, John Head's "Merit wants: Analysis and Taxonomy," shifts the emphasis from Social wants (public goods, externalities, joint goods) to merit goods. Head notes that social wants have dominated work in the public finance area because they embody a whole range of cases where market failure can justify government provision in order to give effect to individual preferences. Merit wants, on the other hand, appear to interfere with consumer sovereignty and thus have led a "shadowy existence on the periphery." Head proposes a broader analytical framework that extends the concept of individual sovereignty to include both psychic externalities and self-paternalism. Head's framework uses a hierarchy of preferences that includes behavioral aberrations such as impulse or weakness of will. He concludes that his framework makes the scope of merit wants fully comparable to the scope of social wants and that merit wants could perhaps be used to justify public provision in cases where congestion estimates are used to suggest priVATization.
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Table of ContentsPreface ix
1. Retrospectives on Public Finance / Lorraine Eden 3
II. The Shoup Tax Missions
2. Melding Architecture and Engineering: A Personal Retrospective on Designing Tax Systems / Carl S. Shoup 19
3. Legacies from the Shoup Tax Missions: Asia, Africa, and Latin America / Malcolm Gillis 31
4. The Impact of the Shoup Report on Japanese Economic Development / Minoru Nakazato 51
5. Income Tax Reform in Venezuela: Thirty Years after the Shoup Mission / Charles E. McClure Jr. 67
Comment: Evaluating the Tax Missions / John Bossons 86
III. The Tax Mix
6. Changing Views of the Personal Income Tax / Richard Goode 93
7. The Corporate Income Tax and How to Get Rid of It / William Vickery 118
8. Intellectual Foundations of the VAT in North America and Japan / Wayne Thirsk 133
9. The Place of the Property Tax in the Fiscal System / John F. Graham 149
Comment: Choosing an Appropriate Time Horizon for Taxation / Stanley Winer 168
Comment: Taxing Consumption and Wealth / W. Irwin Gillespie 172
IV. The Expenditure Mixture
10. Local Public Goods: Shoup Revisited / Lorraine Eden and Melville L. McMillan 177
11. Public Goods Provision and Price Exclusion: Market Behavior and Market Performance 203
12. Merit Wants: Analysis and Taxonomy / John G. Head 229
Comment: Retrospectives on Local Public Goods / Enid Slack 253
Comment: Merit Wants and Public Goods Theory / Edwin G. West 255
V. Macro Public Finanace
13. Tax Structure and the Growth of Government / Richard M. Bird 263
14. Fiscal Coordination and Competition in an International Setting / Peggy B. Musgrave 276
15. Compensatory Fiscal Policy: Evolution or Revolution? / Douglas A. L. Auld 306
16. Social Security and Public Debt in Historical Perspective / John B. Burbidge 323
Comment: The Role of Economic Policy in the Tax Reform Process / Jack M. Mintz 338
Comment: On Macro Public Finance / John Sargent 344
17. Tableau Fiscale / Richard A. Musgrave 351
Author Index 397
Subject Index 402