Financing of Public Goods through Taxation in a General Equilibrium Economy: Experimental Evidence

Abstract

We use a laboratory experiment to compare general equilibrium economies in which agents individually allocate their private goods among consumption, investment in production, and replenishing/refurbishing a depreciating public facility in a dynamic game with long-term investment opportunities. The public facility is financed either by voluntary anonymous contributions (VAC) or taxes. We find that rates of taxation chosen by majority vote remain at an intermediate level (far from zero or 100%), and the experimental economies sustain public goods at levels between the finite- and infinite-horizon optima. This contrasts with a rapid decline of public goods under VAC. Both the payoff efficiency and production of private goods are higher when taxes are set endogenously instead of being fixed at the optimum level externally. When subjects choose between VAC and taxation, 23 out of 24 majority votes favor taxation.

Keywords: Public goods, Experiment, Voting, Taxation, Evolution of institutions

JEL Classification: C72, C91, C92, G10