Fiscal preference and balanced budget fiscal policy

Abstract

In a 1967 paper that appeared in Papers on Non-Market Decision Making (the precursor to Public Choice), J. M. Buchanan presents an analysis of tax expenditure fiscal policy alternatives in terms of a model of individual fiscal preferences. The model is based on a number of assumptions. Aggregate demand is to be maintained at a steady rate over time, and this objective is secured by the injection or withdrawal of funds through budget deficits or surpluses. There is one public good produced, and it is financed by confronting each taxpayer-voter with an invariant tax price. The question analyzed by Buchanan in this setting is how individual "purchases" of the public good are affected by various ways of creating budget deficits, which are required due to an exogenous fall in aggregate demand. Buchanan analyzes five cases of deficit creation and the impact of each case on individual fiscal preference. In this note we will discuss a simple extension of Buchanan's model to examine the case of balanced budget fiscal policy. Consider Figure 1, which duplicates part of Buchanan's Figure 1. Initially, the budget is balanced and the individual is in equilibrium with OX of the public good being produced at a tax-price of OP per unit. In drawing the representative individual's demand curve for the public good, following Buchanan, we neglect income effects.1 Now postulate that for some exogenous reason, an expansionary fiscal policy is called for. Buchanan treats all cases of deficit creation and establishes that the deficit will reduce the individual's tax price for the public good, regardless of how the deficit is created. However, consider the case where the expansionary fiscal policy is pursued while maintaining a balanced budget. A balanced increase in the *Assistant Professor of Economics, University of Oklahoma, and Associate Professor of Economics, Texas A & M University. We are greatful to James M. Buchanan for reading an earlier version of this paper. The usual caveat applies. 1The reader will note that in the extension of Buchanan's model which we develop, the introduction of an endogenous budget effect on the individual resulting from the increased taxes, would cause a reduction in demand and strengthens our result that a balanced budget expansionary policy places the individual off and alove his demand or marginal evaluation curve for the public good.