1. Public Goods
The public consists of two or more persons. If an economic
goods is being used by two or more persons at the same time, it is
a public good, otherwise it is private. Public goods are also
called collective goods. For example, if you eat a sandwich, it is
a private good, since it is going into your mouth and nobody
else's. On the other hand, if you and a friend are watching one
television, the TV is a public good. Clearly, the same object can
be private or collective depending on its use at a particular time,
since if you later watch the TV alone, it becomes private.
The total quantity of a private good in an economy is the sum
of the goods being used by individuals. But for public goods, each
user has access to the entire good. For example, you are protected
by the entire fire department.
When economists speak of public goods, they usually mean civic
goods, those goods and services typically provided by governments,
such as parks, streets, and security. Many economists have thought
that while private goods can be provided efficiently by a market
process, collective goods cannot and require government provision
by force. This argument is called "market failure." According to
this argument, since all individuals have access to the entire
public good, there is no way to make any individual pay for it.
People will want to be "free riders."
This argument overlooks the fact that most civic goods service
a particular territory. They make the area more desirable, and
thus increase its land rent and land value. People located in that
space must pay rent or buy land in order to live or work there.
This turns the market-failure argument on its head: users are not
free riders, since they pay rent; it is the landowners who can be
free riders if the good are not paid out of that rent.
The rent can be collected either by a government or by a
private community such as a residential association and spent for
the collective good. Civic goods then become self-financing, since
the rent generated by the good is used to pay for the good. The
use of rent also lets us determine the efficient amount of the good
to provide. So long as each extra amount of the good increases
rent more than it increases the cost, more should be provided until
the marginal cost just equals the marginal rent generated.
Some collective goods are not territorial, but are excludable
- those not paying for it can be excluded from using it. An
example is a club which offers services only to its members.
Indeed, the term "club" has become generalized in economics to mean
any organization organized for some purpose. Clubs goods can be
offered in exchange for membership dues, admissions, and other user
fees. If a service becomes crowded, the club or government can
also charge a congestion fee to encourage less usage during peak
times (or a discount during non-peak times). An example is a bus
or train that charges more during rush hours.
Non-excludable collective goods are those which are not
territorial and are available to all who want them. An example is
knowledge, once it is published. The market-failure argument is
often applied to these public goods. But in fact, many such
services are provided voluntarily. People contribute time and
money to civic and charitable projects partly for self-centered
reasons, such as to be listed as a patron, but mainly from
As discussed in Chapter 10, Adam Smith observed that people
are also motivated by sympathy to others, to communities, and to
ideas, and Henry George also discussed this desire for the well
being of others and for social approval. People will contribute to
a community or to some project when they have sympathy with it.
This sympathy can be stimulated by social entrepreneurs who lead
communities and movements.
2. Public Finance
Public finance is the branch of economics which is concerned
with how governments raise and spend money. Its topics include an
analysis of various types of taxes, government debt, budgets, and
Taxation and public revenue
A tax is a compulsory payment to a government unrelated to any
direct penalty, voluntary service, or debt. Some payments to
governments have the form of a tax, as compulsory payments, but not
the substance, since the payment is for a service or rent for the
use of property. When an oil company pays a lease for offshore oil
fields, for example, this is a rental charge for property owned by
the government on behalf of the people, so it is not a tax in
substance. Likewise, the collection of land rent by a community
may be tax in form as a compulsory payment once the land is
obtained, but not in substance, since the ownership of land is
voluntary and the payment is a rent for land if one agrees it is
properly owned by the community.
Taxes can be imposed on two basic types of items: property and
transactions. Transaction taxes includes those on sales, value-
added, income, gifts, and inheritance. The effect of imposing such
arbitrary costs on transactions is to skew the prices of the items
taxed, distorting the price signals of a market economy. Sales
taxes make goods more expensive, labor taxes make labor more
expensive, and taxes on profits make entrepreneurship and
enterprise more expensive by reducing profits. Such taxes have the
same effect as an increase in the cost of production due to more
expensive inputs. Depending on the responsiveness of supply and
demand to changes in price, transaction taxes are partly borne by
workers as lower real wages, partly by enterprises as lower total
profits, and partly by consumers as higher prices and a lower
quantity of goods purchased. Gift taxes punish the free transfer
of goods; inheritance taxes punish the preservation of family
heritage and the ability to pass on an enterprise to one's
Taxes on income and on sales have a similar effect in reducing
output, employment, and income. Taxes on wages, such as income
taxes, impose a "tax wedge" on labor, making it expensive to
employers while reducing the net wages of workers. This, especially
combined with minimum wages, creates unemployment by making the
lowest-quality labor too expensive to hire. Taxes on sales also
reduce income, since the purpose of production is consumption, and
if goods are taxed, purchasing power is reduced. A "value added"
tax is imposed at each stage of production; for example, when trees
are cut down, when lumber is cut, when furniture is made, and when
it is sold, each state gets taxed according to the increase in
value from one stage to the next. The result is higher prices,
lower output, and lower employment.
As Henry George (1883, p. 123) stated, "We, in fact, treat the
man who produces wealth, or accumulates wealth, as though he had
done something which public policy calls upon us to discourage."
Employment, enterprise, consumption, production, exchange - all
these are social benefits, yet taxation treats these as crimes fit
to be punished. "So, too, if a man saves, out taxes operate to
punish him for his thrift" (p. 124).
A difference in taxing income and sales or value added is that
income taxes penalize savings, while sales taxes penalize
borrowing. When income taxes are applied to savings, they reduce
the yield and punish the savor for postponing consumption. When
people borrow funds to buy something, a sales tax is applied also
to that part of the purchase paid for with borrowed funds. Suppose
a car costs $20,000 and the sales tax is 5%. The buyer needs to
borrow $1000 extra for the tax, and then pay interest on that
$1000. Since people borrow funds and save at different stages of
life, and borrowing equals savings, the macro effect of taxes on
income and on sales is similar - they hurt business.
Taxes on property fall either on natural resources or on
produced goods such as cars and buildings. A tax on a produced
good has a similar effect to that on transactions, since a good is
the product of transactions. Goods are made more expensive. But a
"tax" (in form) or charge or fee on the use of natural resources,
such as land, reduces its price. Since it has no cost of
production, its supply curve is vertical. The demand is not
affected by the charge, so it must be borne entirely by the title
holder or owner. For surface land, the formula p = r / (i+t)
indicates that the price of land p will be reduced when the tax
rate t (as a percentage of the price) is increased, r being the
annual rent and i the real interest rate.
Whereas taxes on transactions and produced goods reduce
output, a rental charge on land can increase productivity if the
land was underused, being held for prestige purposes or in
speculation waiting for higher prices. A pollution charge or fee
is a type of rent paid for the use of land as a dump, and this
charge does increase the price of goods, but this increase is
really compensation for the damage caused by the pollution, so this
increase is not an intervention but conforms to a market.
The taxes that most conform to markets and improve rather than
decrease productivity are therefore rental charges for the use of
natural resources, including surface land, underground resources
such as water and minerals and oil, air rights, electro-magnetic
(radio wave) frequency rents, and pollution charges.
Government budgets and deficits
Many national governments habitually spend more than they get
in taxes and fees because it is politically and personally
rewarding to spend money. Taxpayers don't object too much, since
the repayment of the debt is pushed into the future, probably to
future generations. There have been high annual deficits in the
United States, with trillions of dollars in official debt and much
more in unfunded liabilities such as pensions and potential
Ideally, a government budget should be split into two parts,
one an operating budget for normal annual expenses, such as paying
the salaries of the military, and the other, a capital budget for
major investments in capital goods such as a highway or dam. If
the capital project makes the economy more productive, then it
makes economic sense to borrow the funds to create it, just as
enterprises borrow funds to expand productive facilities. In that
case, the debt should consist of bonds marked specifically for the
project, with a maturity date when the bonds are to be paid back.
The total debt would consist of such bonds, thus avoiding
generalized indefinite debt.
The operations side of the budget is best funded from
current-year revenues, without any debt. As Henry George (1883, p.
162) stated, "The institution of public debts ... rests upon the
preposterous assumption that one generation can bind another
generation." In a genuine capital budget, the debt is offset by a
productive asset that is also being passed on, an asset that yields
enough to pay off the debt, hence no real burden is passed on. But
debt for current expenses has no corresponding asset value and
Of course the resources used in debt-financed operational
spending are not physically taken from the future, but from the
reduction in current private-sector consumption. The problem is
that future persons will have their consumption reduced by the
government's forcibly transferring some of their income to those
who have previously lent funds to the government. It is therefore
better morally and economically to reduce the current private
consumption by taxation or assessment, so that present-day
government-sector consumption is paid for by the present-day
There is also a public-choice aspect to a public debt. As George (1883, p. 167) realized, "A great public debt creates a great moneyed interest that wants 'strong government' and fears change." Holders of government bonds become a lobby for the preservation of that debt, as safe treasury bills and bonds become woven deep into the fabric of the financial markets.
Each section of a budget should include both the annual
expense and the source of the revenue, so that any new project or
agency is accompanied by payment.
Any voluntary association may economically spend funds
according to the desires of its members and in accord with its
constitution. Spending becomes a problem when the government is
not a voluntary association, but is imposed without unanimous
consent, at least at the constitutional level of joining a
jurisdiction. When revenues are derived from site rents, we can
determine the most efficient amount to spend on some collective
good or service. A desired territorial good will increase the land
rent of the area, so the optimal amount of the good will occur when
the marginal or extra rent generated by an extra unit of the good
just equals the marginal cost of the extra unit.
Many governments have found that contracting out many of its services results in lower costs than providing it directly. The reason is that competitive firms have an incentive to keep costs at a minimum, whereas with a government monopoly, the civic employees will benefit from high budgets and the government will lack the knowledge if not the incentive to keep the costs low.