The Pure Theory of Public Expenditure

Author(s): Paul A. Samuelson

Source: The Review of Economics and Statistics, Vol. 36, No. 4 (Nov., 1954), pp. 387-389
Published by: The MIT Press
Stable URL: http://www.jstor.org/stable/1925895 .
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 THE PURE THEORY OF PUBLIC EXPENDITURE
Paul A. Samuelson
i. Assumptions. Except for Sax, Wicksell, To keep production assumptions at the mini-
Lindahl, Musgrave, and Bowen, economists mum level of simplicity, I assume a regularly
have rather neglected the theory of optimal convex and smooth production-possibilitysched-
public expenditure, spending most of their en- ule relating totals of all outputs, private and
ergy on the theory of taxation. Therefore, I collective; or F(X1, - , Xn+m) = a, with
explicitly assume two categories of goods: ordi- Fj > o and ratios Fj/Fn determinate and sub-
nary private consumption goods (X1, ***,Xn) ject to the generalized laws of diminishing re-
which can be parcelled out among different in- turns.
dividuals (I, 2, ***,i, ***,s) according to the Feasibility considerations disregarded, there
S
is a maximal (ordinal) utility frontier repre-
relations Xi = I Xi ; and collective consump-
1 senting the Pareto-optimal points - of which
tion goods (Xn+l, ..., Xn+m) which all enjoy there are an (s - i )fold infinity -with the
in common in the sense that each individual's property that from such a frontierpoint you can
consumption of such a good leads to no sub- make one person better off only by making some
traction from any other individual's consump- other person worse off. If we wish to make nor-
tion of that good, so that Xn+i = Xi n+j simul- mative judgmentsconcerningthe relative ethical
taneously for each and every ith individual and desirability of different configurations involv-
each collective consumptive good. I assume ing some individuals being on a higher level
no mystical collective mind that enjoys collec- of indifference and some on a lower, we must
tive consumption goods; instead I assume each be presented with a set of ordinal interpersonal
individual has a consistent set of ordinal pref- norms or with a social welfare function repre-
erences with respect to his consumption of all senting a consistent set of ethical preferences
goods (collective as well as private) which can among all the possible states of the system. It
be summarizedby a regularly smooth and con- is not a "scientific" task of the economist to
vex utility index ui = ui(Xil, .*.*, IXi;n+M) (any "deduce" the form of this function; this can
monotonic stretching of the utility index is of have as many forms as there are possible ethi-
course also an admissible cardinal index of cal views; for the present purpose, the only
preference). I shall throughout follow the con- restriction placed on the social welfare func-
vention of writing the partial derivative of any
tion is that it shall always increase or decrease
function with respect to its jth argument by a
when any one person's ordinal preference in-
j subscript, so that uij= Duil/Xi,, etc. Pro-
decreases, all others staying on their
vided economic quantities can be divided into creases or
levels: mathematically, we
two groups, (i) outputs or goods which every- same indifference
of its in-
one always wants to maximize and (2) inputs narrow it to the class that any one
dexes can be written U = U(u1, Us) with
, us
or factors which everyone always wants to
minimize, we are free to change the algebraic Uj > 0.
signs of the latter category and from then on
to work only with "goods," knowing that the 2. Optimal Conditions. In terms of these

case of factor inputs is covered as well. Hence norms, there is a "best state of the world"
by this convention we are sure that uij > o which is defined mathematically in simple regu-
always. lar cases by the marginal conditions
uj - (i I, 2, *--, s; r, j I, n) or (I) **,

U1r Fr (i = I, 2, *--, s; r = I;
j = 2, *., n)
i j Fn+= -m;r= I, *-,n) or (2)
...
X- i
U.r F= (= I, m; r I)
|= S Fr

U,u'k (i, q = I, , s; k = I, n) or (3)

UqUqk (q = I; X = 2, * s, S; k= i).
[ 387]

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388 THE REVIEW OF ECONOMICS AND STATISTICS
Equations (i) and (3) are essentially those hand sides of (i) the equality with uniform
given in the chapter on welfare economics in market prices Pj/Pr and adjoin the budget
my Foundations of Economic Analysis. They equations for each individual
constitute my version of the "new welfare eco-
PlXil + p2Xi2 + *.. + PnXi = Li
nomics." Alone (i) represents that subset of =
(i II2 2,, . . S),I (I)
relations which defines the Pareto-optimal
utility frontier and which by itself represents where Li is a lump-sum tax for each individual
what I regard as the unnecessarily narrow ver- so selected in algebraic value as to lead to the
sion of what once was called the "new welfare "best" state of the world. Now note, if there
economics." were no collective consumption goods, then (i)
The new element added here is the set (2), and (i)' can have their solution enormously
which constitutes a pure theory of government simplified. Why? Because on the one hand
expenditure on collective consumption goods. perfect competition among productive enter-
By themselves (i) and (2) define the (s )- prises would ensure that goods are produced at
fold infinity of utility frontier points; only minimum costs and are sold at proper marginal
when a set of interpersonal normative condi- costs, with all factors receiving their proper
tions equivalent to (3) is supplied are we marginal productivities; and on the other hand,
able to define an unambiguously "best" state. each individual, in seeking as a competitive
Since formulating the conditions (2) some buyer to get to the highest level of indifference
years ago, I have learned from the published subject to given prices and tax, would be led as
and unpublishedwritings of Richard Musgrave if by an Invisible Hand to the grand solution
that their essential logic is contained in the of the social maximum position. Of course the
"voluntary-exchange"theories of public finance institutional framework of competition would
of the Sax-Wicksell-Lindahl-Musgrave type, have to be maintained, and political decision-
and I have also noted Howard Bowen's inde- making would still be necessary, but of a
pendent discovery of them in Bowen's writings computationally minimum type! namely, alge-
of a decade ago. A graphical interpretation of braic taxes and transfers (L', . . . Ls) would
these conditions in terms of vertical rather than have to be varied until society is swung to the
horizontal addition of different individuals' ethical observer's optimum. The servant of
marginal-rate-of-substitutionschedules can be the ethical observer would not have to make
given; but what I must emphasize is that there explicit decisions about each person's detailed
is a different such schedule for each individual consumption and work; he need only decide
at each of the (s - i)fold infinity of different about generalized purchasing power, knowing
distributions of relative welfare along the util- that each person can be counted on to allocate
ity frontier. it optimally. In terms of communicationtheory
and game terminology, each person is moti-
3. Impossibility of decentralized sponta- vated to do the signalling of his tastes needed
neous solution. So much for the involved op- to define and reach the attainable-bliss point.
timizing equations that an omniscient cal- Now all of the above remains valid even if
culating machine could theoretically solve if collective consumptionis not zero but is instead
fed the postulated functions. No such machine explicitly set at its optimum values as de-
now exists. But it is well known that an termined by (i), (2), and (3). However no
"analogue calculating machine" can be pro- decentralized pricing system can serve to de-
vided by competitive market pricing, (a) so termine optimally these levels of collective con-
long as the production functions satisfy the sumption. Other kinds of "voting" or "signal-
neoclassical assumptions of constant returns ling" would have to be tried. But, and thisis
to scale and generalized diminishing returns the point sensed by Wicksell but perhaps not
and (b) so long as the individuals' indifference fully appreciated by Lindahl, now it is in the
contours have regular convexity and, we may selfish interest of each person to give false
add, (c) so long as all goods are private. We signals, to pretend to have less interest in a
can then insert between the right- and left- given collective consumption activity than he

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 THE PURE THEORY OF PUBLIC EXPENDITURE 389
really has, etc. I must emphasize this: taxing there is still this fundamental technical differ-
according to a benefit theory of taxation can ence going to the heart of the whole problem of
not at all solve the computational problem in social economy: by departing from his indoc-
the decentralized manner possible for the first trinated rules, any one person can hope to
category of "private" goods to which the snatch some selfish benefit in a way not possible
ordinary market pricing applies and which do under the self-policing competitive pricing of
not have the "external effects" basic to the private goods; and the "external economies"
very notion of collective consumption goods. or "jointness of demand" intrinsic to the very
Of course, utopian voting and signalling concept of collective goods and governmental
schemes can be imagined. ("Scandinavian con- activities makes it impossible for the grand
sensus," Kant's "categorical imperative," and ensemble of optimizing equations to have that
other devices meaningful only under conditions special pattern of zeros which makes laissez-
of "symmetry," etc.) The failure of market faire competition even theoretically possible as
catallactics in no way denies the following an analogue computer.
truth: given sufficient knowledge the optimal
decisions can always be found by scanning over 4. Conclusion. To explore further the prob-
all the attainable states of the world and select- lem raised by public expenditurewould take us
ing the one which according to the postulated into the mathematical domain of "sociology"
ethical welfare function is best. The solution or "welfare politics," which Arrow, Duncan
"exists"; the problem is how to "find" it. Black, and others have just begun to investi-
One could imagine every person in the com- gate. Political economy can be regarded as one
munity being indoctrinated to behave like a special sector of this general domain, and it
"parametric decentralized bureaucrat" who may turn out to be pure luck that within the
reveals his preferences by signalling in response general domain there happened to be a sub-
to price parameters or Lagrangean multipliers, sector with the "simple" properties of tra-
to questionnaires, or to other devices. But ditional economics.

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