Question

Taxes are compulsory, yet communities often vote to increase taxes on themselves to pay for public goods. Under what circumstances would a voter be better off with more government spending, even with accompanying higher local taxes? Include a discussion of the Pareto efficient exchange in your response.

Answer 1

Whenever someone is spending money, he or she expects some utility in return. He or she might be buying something, lets say a car, which in turn will provide some utility to the person. Or he or she might be getting a service, such as a haircut, in which case the utility is apparent.

The same is the case with public goods- such as parks, police serive, fire stations, 911 etc.- they provide a utility at a cost. The cost are the taxes. But there is one crucial difference between our first example (of private utlity) and second example (of public utility). The difference is that public utilities are consumed by everyone in the community equally. One cant be excluded from it (at least its very costly to exclude someone).

The question that is being asked is- under what circumstances would a voter be better off with more government spending, even with accompanying higher local taxes? The answer, instinctively, is when he or she will get more utility out of the higher taxes being paid. Now we already discussed that public goods are consumed by everyone. In that case, how do we determine a condition where individual voter will benefit from higher taxes (that is, will get higher utility)? That is where Pareto efficiency comes in. Pareto efficiency is the allocation of available resources in such a way that no single person can be given more utility without reducing someone else's utility. It is an optimal state where no one is enjoying someone else's utility. As a voter, if the current allocation of public goods was such that it was pareto efficient, it stands to reason that it will make sense to me to have more government spending since it will get divided in pareto efficient manner- me getting the best utility out of my taxes provided.

In simple terms, it means that a voter will vote for higher taxes when he or she realizes or believes that the taxes are being spent in the most judicious manner and he or she is getting the best possible utility out of them.