The Dual Nature of Public Goods and Congestion: The Role of Fiscal Policy Revisited

Abstract:     
The role of fiscal policy is examined when public goods provide both productive and utility services. In the presence of congestion, the consumption tax is shown to be distortionary. Optimal fiscal policy involves using consumption-based instruments in conjunction with the income tax. An income tax-financed increase in government spending dominates both lumpsum and consumption tax-financing. Replacing the lumpsum tax with an income tax to finance a given level of spending dominates introducing an equivalent consumption tax. These results contrast sharply with the literature, where the consumption tax is generally viewed as the least distortionary source of public finance.

Number of Pages in PDF File: 35

Keywords: Public Goods, Congestion, Consumption-based fiscal instruments, Growth, Welfare

JEL Classification: E21, E62, H21, H41, H54

working papers series