Fiscal Incidence at the Local Level

Abstract

THIS PAPER REPRESENTS an attempt to make Aaron and McGuire's [1] approach to incidence operational.2 The tax paid by any individual is interpreted by Aaron and McGuire as the sum of two components. The first is a Lindahl tax equal to the individual's marginal rate of substitution between the public good and income times the amount of the public good provided. The second component is a negative or positive transfer equal to the Lindahl tax minus the tax the individual has actually paid. This second component is used to measure the incidence or redistributional impact of a particular budget program. Empirically, Aaron and McGuire found that the computation of Lindahl taxes is highly sensitive to the choice of individual utility functions. Under certain assumptions that sensitivity is reflected in the value of a coefficient related to the marginal rate of substitution between the public good and income. Maital [16], later on, used three separate identical estimates of this coefficient to reduce the ambiguity in the computation of Lindahl taxes. This paper offers an alternative computational approach to Aaron and McGuire's. The key information on Lindahl tax prices or marginal rates of substitution is obtained from individual demand curves for public goods which are estimated using the median voter model (see [5]). An advantage of this approach over Aaron and McGuire's is that it does not assume separability of the public good and income in taxpayers' preferences. The present approach also permits the study of the incidence of a budget policy on groups defined by socio-demographic characteristics other than income. On the other hand, and because of empirical reasons which will become apparent below, the present approach is useful for the study of incidence at the local level only. Section 1 of the paper restates the measure for the simultaneous incidence of taxes and one public good, henceforth called fiscal incidence, in the context of a formalized political process. This section also discusses some of the theoretical difficulties involved in extending the case with one public good to the multi