Diagrammatic Exposition of a Theory of Public Expenditure

Author(s): Paul A. Samuelson

Source: The Review of Economics and Statistics, Vol. 37, No. 4 (Nov., 1955), pp. 350-356
Published by: The MIT Press
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 DIAGRAMMATIC EXPOSITION OF A THEORY
OF PUBLIC EXPENDITURE
Paul A. Samuelson
N the November I9 54 issue of this REVIEW vate consumptionsof Man i and Man 2, we can
my paper on "The Pure Theory of Public Ex- say that the total equals the sum of the separate
penditure"presented a mathematicalexposition consumptions or X1 = X1l + X21.
of a public expenditure theory that goes back (ii) A public consumption good, like an out-
to Italian, Austrian, and Scandinavian writers door circus or national defense, which is pro-
of the last 75 years. After providing that theory vided for each person to enjoy or not, according
with its needed logically-complete optimal con- to his tastes. I assume the public good can be
ditions, I went on to demonstrate the fatal in- varied in total quantity, and write X2 for its
ability of any decentralized market or voting magnitude. It differs from a private consump-
mechanism to attain or compute this optimum. tion good in that each man's consumption of it,
The present note presents in terms of two-di- X12 and X22 respectively, is related to the total
mensional diagrams an essentially equivalent X2 by a condition of equality rather than of
formulationof the theory's optimum conditions summation. Thus, by definition,X12 = X2, and
and briefly discusses some criticisms. X2 X2-
Obviously, I am introducing a strong polar
A polar-case model of government case. We could easily lighten the stringency of
Doctrinal history shows that theoretical in- our assumptions. But on reflection, I think most
sight often comes from considering strong or economists will see that this is a natural antip-
extreme cases. The grand Walrasian model of odal case to the admittedly extreme polar case
competitive general equilibrium is one such of traditional individualistic general equilib-
extreme polar case. We can formulate it so rium. The careful empiricist will recognize that
stringently as to leave no economic role for many - though not all of the realistic cases
government. What strong polar case shall the of government activity can be fruitfully ana-
student of public expenditure set alongside this lvzed as some kind of a blend of these two ex-
pure private economy? treme polar cases.
One possibility is the model of a group-mind. Graphical depiction of tastes and technology
Such a model, which has been extensively used
The first three charts summarizeour assump-
by nationalists and by Romantic critics of clas-
sical economics, can justify any, and every, tions about tastes and technology. Each diagram
configuration of government. So there is per- has a private good, such as bread, on its vertical
haps little that an economic theorist can use- axis; each has a public good on its horizontal
fully say about it. axis. The heavy indifferencecurves of Chart i
My alternative is a slightly more sophisti- summarize MVani's preferences between public
cated one, but still - intentionally - an ex- and private goods. Chart 2' Sindifference curves
treme polar case. It is consistent with individ- do the same for M1an2; and the relative flatness
ualism, yet at the same time it explicitly intro- of the contour shows that, in a sense, he has less
duces the vital external interdependencies that liking for the public good.
no theory of government can do without. Its The heavy production-possibility or oppor-
basic assumption is an oversharp distinction be- tunity-cost curve AB in Chart 3 relates the total
tween the following two kinds of goods: productions of public and private goods in the
(i) A private consumption good, like bread, usual familiar manner: the curve is convex from
wvhosetotal can be parcelled out among two or above to reflect the usual assumption of increas-
more persons, with one man having a loaf less ing relative marginal costs (or generalized di-
if another gets a loaf more. Thus if X1 is total minishinogreturns)
bread, and X'1 and X21 are the respective pri- 'Even though a public good is being compared with a

[350]

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 THEORY OF PUBLIC EXPENDITURE 35I
Because of our special definition of a public vertically-aligned points correspondingto a de-
good, the three diagrams are not independent. termination of a given total of both goods and
Each must be lined up with exactly the same a determinate parcelling out of them among all
horizontal scale. Because increasing a pubThc separate individuals will be the ethically pre-
good tor society simultaneously increases it for ferred final colfiguration?
each and every man, we must always be simul- To answer this ethical, normative question
taneously at exactly the same longitude in all we must be given a set of norms in the form of
three figures. Moving an inch east in one dia- a social welfare function that renders interper-
gram moves us the same amount east in all. sonal judgments. For expository convenience,
let us suppose that this will be supplied later and
CHART I. - INDIFFERENCE CONTOURS RELATING MAN that we know in advance it will have the follow-
IIS CONSUMPTION OF PUBLIC AND PRIVATE GOODS

CHART 2.-INDIFFERENCE CONTOURS RELATING MAN

2'S CONSUMPTION OF PUBLIC AND PRIVATE GOODS
UU
x2 a,,
X II\t\ u S XI

u2

0 Mu RU2IE

G2 D
I I ~~S
o M X2-X2
\d C HART 3.- TRANSFORMATION SCHEDULE RELATING
TOTALS OF PUBLIC AND PRIVATE GOODS
The private good on the vertical axis is sub-
ject to no new and unusual restrictions. Each XI X
X, + X,
man can be moved north or south on his indif-
ference diagramindependently. But, of course,
the third diagram does list the total of bread
summed over the private individuals; so it must A sF (X'+X,2,X2-O
have a larger vertical axis, and our momentary
northward position on it must correspond to
the sum of the independentnorthwardpositions
of the separate individuals.
Tangenzcyconditions for Pareto optima
What is the best or ideal state of the world C' ,
for such a sinple system? That is, what three E
private good, the indifference curves 'are drawn with the
usual convexity to the origin. This assumption, as well as G
the one about diminishing returns, could be relaxed without
hurting the theory. Indeed, we could recognize the possible
case .7\here one man's circus is another man's poison, by 0 M B D
permitting indifference curves to bend forward. This would
;Aot affect the analysis but would answer a critic's minor
I l \
objection. Mathematically, we could without loss of gener- ', X2
ality set X'2= any function of X2, relaxing strict equality. O ~~~~~M B

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352 THE REVIEW OF ECONOMICS AND STATISTICS
ing special individualistic property: leaving there? Obviously, for each of the infinite pos-
each person on his same indifferencelevel will sible initial indifference curves to put Man 2
leave social welfare unchanged; at any point, a on, we can derive a new highest attainable tan-
move of each man to a higher indifference gency level for Man i. So there are an infinity
cw.ve can be found that will increase social of such optimal points -as many in number
walfare. as there are points on the usual contract curve.
Given this rather weak assurance about the All of these Pareto-optimal points have the
forthcoming social welfare function, we can property that from them there exists no phys-
proceed to determine tangency conditions of an ically-feasible movement that will make every
"efficiency" type that are at least necessary, man better off. Of course we cannot compare
though definitely not sufficient. We do this by two different Pareto points until we are given
setting up a preliminary maximum problem a social welfare function. For a move from one
which will eventually necessarily have to be Pareto point to another must always hurt one
satisfied. man while it is helping another, and an inter-
Holding all but one man at specified levels of personal way of comparing these changes must
indifference, how can we be sure that the re- be supplied.
maining man reaches his highest indifference Chart 4 indicates these utility possibilities
level? on aLi ordii?al c?2Twram. Each axis provides an
Concretely, this is how we define such a tan-
gency optimum: Set Man 2 on a specified in- CHART 4. - UTILITY FRONTIER OF PARETO-OPTIMAL
difference curve, say his middle one CD. Pay- EFFICIENCY POINTS AND ITS TANGENCY TO HIGHEST
ATTAINABLE SOCIAL WELFARE CONTOUR
ing attention to Mother Nature's scarcity, as
summarizedin Chart 3's AB curve, and follow- u2
ing Man i's tastes as given by Chart i's indif-
ference curves, how high on those indifference
curves can we move Man i ?
The answer is given by the tangency point
E1, and the corresponding aligned points E2
and E.
How is this derived? Copy CD on Chart 3
and call it C'D'. The distance between C'D'
and AB represents the amounts of the two
goods that are physically available to Man i.
So subtract C'D' vertically from AB and plot
the algebraic result as cd in Chart i. Now
where on cd would Man i be best off? Obvi-
ously at the tangency point E1 where cd touches
(but does not cross) his highest attainable in-
difference contour.2 i Ug
How many such Pareto-optimal points are
2 The reader can easily derive rs and the tangency point
G, corresponding to an original specification of Man 2'S in- | S/////mmXAp
difference level at the lower level RS rather than at AB. He
can also interchange the roles of the two men, thereby deriv-
ing the point E2 by a tangency condition. As a third ap-
proach, he can vertically add Man 2'S specified indifference indicator of the two men's respective indiffer-
curve to each and every indifference curve of Man i; the ence curve levels. The utility frontier of Pareto-
resulting family of contours can be conveniently plotted on optimal points is given by pp: the double fold
Chart 3, and the final optimum can be read off from the
tangency of AB to that family at the point E- as shown infinity of "inefficient," non-Pareto-optimal
by the short broken-line indifference curve at E. It is easy points is given by the shaded area; the pp
to show that any of these tangencies are, in the two-good frontier passes from northwest to southeast to
case, equivalent to Equation (2) of my cited paper; with a
single private good my Equation (i) becomes redundant. reflect the inevitable conflict of interests char-

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 THEORY OF PUBLIC EXPENDITURE 353
acterizing any contract locus; the curvature of viduals must at the margin be the same for each
the pp locus is of no particular type since we and every person.
have no need to put unique cardinal numbers (ii) The Pareto-optimal condition, which
along the indifferencecontours and can content makes relative marginal social cost equal to the
ourselves with east-west and north-south rela- sum of all persons' marginal rates of substitu-
tionships in Chart 4 without regard to numer- tion, is already assured by virtue of the fact
ical degree and to uneven stretchings of either that bliss lies on the utility frontier.5
utility axis.
Relations with earlier theories
The optimum of all the Pareto optima
This completes the graphical interpretation
Now we can answer the fundamental ques- of my mathematical model. There remains the
tion: what is the best configuration for this pleasant task of relating this graphical treat-
society? ment to earlier work of Bowen 6 and others.
Use of the word "best" indicates we are in To do this, look at Chart S, which gives an
the ascientific area of "welfare economics" and alternative depiction of the optimal tangency
must be provided with a set of norms. Eco- condition at a point like E. I use the private
nomic science cannot deduce a social welfare good X1 as numeraire, measuring all values in
function; what it can do is neutrally interpret terms of it. The MC curve is derived from the
any arbitrarily specified welfare function. AB curve of Chart 3: it is nothing but the
The heavy contours labelled U', U", and U"' absolute slope of that production-possibility
summarize all that is relevant in the provided schedule plotted against varying amounts of
social welfare function (they provide the needed the public good; it is therefore a marginal cost
ordinal scoring of every state of the world, in- curve, with MC measured in terms of the nu-
volving different levels of indifference for the meraire good.
separate individuals).' The marginal rate of substitution curves
Obviously society cannot be best off inside MRS1 and IIMRS2 are derived in a similar fash-
the utility frontier. Where then on the utility ion from the respective indifference curves of
frontier will the "best obtainable bliss point" Man i and Man 2: thus, MfRS'is the absolute
be? We will move along the utility frontier pp slope of the u'" indifference curve plotted
until we touch the highest social indifference against varying amounts of the public good;
curve: this will be at g where pp tangentially 7MRS2is the similar slope function derived from
touches, without crossing, the highest obtain- Man 2'S indifference curve CD. (All three are
able social welfare level U". In words, we can "marginal" curves, bearing the usual relation-
interpret this final tangency condition 4 in the ship to their respective "total" curves.)
following terms: These schedules look like demand curves.
(i) The social welfare significance of a unit We are accustomed to adding horizontally or
of any private good allocated to private indi- laterally the separate demand curves of individ-
'These social welfare or social indifference contours are
given no particular curvature. Why? Again because we are However, it is easy to combine this tangency with the
permitting any arbitrary ordinal indicator of utility to be earlier Pareto-type tangency to get the formulation (3) of
used on the axes of Chart 4. my cited paper, which is independent of the choice of numer-
An ethical postulate ruling out all "dog-in-the-manger ical indicators of U, u1, or U2.
phenomena" will make all partial derivatives of the social 'A remarkable duality property of private and public
welfare function U(u',u2, . . .) always positive. This will goods should be noted. Private goods whose totals add-
assure the usual negative slopes to the U contours of such as X1 XU + X21 lead ultimately to marginal con-
Chart 4. However, without hurting the Pareto part of the ditions of simultaneous equality - such as MC = MRS1 =
new welfare economics, we can relax this assumption a MRS2. Public goods whose totals satisfy a relation of simul-
little and let the contours bend forward. If, at every point taneous equality-such as X1 = X12= X22-lead ultimately
there can be found at least one positive partial derivative, to marginal conditions that add - such as MC = MRS1 +
this will be sufficient to rule out satiation points and will MRS2.
imply the necessity of the Pareto-optimal tangency condi- Howard R. Bowen, "The Interpretation of Voting in
tion of the earlier diagrams. the Allocation of Economic Resources," Quarterly Journal of
'This tangency condition would have to be expressed Economics, LVIII (November I943), 2 7-49. Much of this
mathematically in terms of numerical indicators of utility is also in Bowen's Toward Social Economy (New York,
that are not invariant under a monotonic renumbering. I948), ch. i8.

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354 THE REVIEW OF ECONOMICS AND STATISTICS
CHART 5. - INTERSECTION OF PUBLIC GOOD'S MARGINAL this Bowen type of diagram and the Lindahl
COST SCHEDULE AND THE VERTICALLY-SUMMED i oo-per-cent diagram reproduced by Mus-
INDIVIDUAL'S MARGINAL RATES OF SUBSTITUTION,
grave.8
AS ENVISAGED BY LINDAHL AND BOWEN
Once the economic theorist has related my
@/PI EMRS MC graphical and mathematical analysis to the
Lindahl and Bowen diagrams, he is in a posi-
tion, I believe, to discern the logical advantage
MRS' | of the present formulation. For there is some-
thing circular and unsatisfactory about both
MRS2 the Bowen and Lindahl constructions: they
show what the final equilibrium looks like, but
by themselves they are not generally able to
find the desired equilibrium. To see this, note
that whereas we might know MC in Chart 5,
we would not know the appropriateMRS sched-
ules for all men until we already were familiar
with the final E intersection point. (We might
MC \:MRS know AIRS2 fr6om'thespecification that Man 2
MRS2 is to be on the AB level; but then we wouldn't
know MlfRS'until Chart i's tangency had given
us Man i's highest attainable level, u"'.) Un-
der conditions of general equilibrium, Charts
MRS' I-3 logically contain Chart 5 inside them, but
not vice versa. Moreover, Charts I-3 explicitly
0 M X2 call attention to the fact that there is an in-
finite number of different diagrams of the
uals to arrive at total market demand. But this Lindahl-Bowen type, one for each specified
is valid only for private goods. As Bowen level of relative interpersonal well-being.9
rightly says, we must in the case of public goods
add different individuals' curves vertically. Concluding reflections
This gives us the heavy $MRS curve for the I hope that the analytic model outlined here
whole community. Where is equilibrium? It is may help make a small and modest step toward
at E, where the community MC curve intersects understandingthe complicatedrealities of polit-
the community VJIRS curve. Upon reflection
(February I939), 2I3-I7. This gives citations to the
the reader will realize that the equality MC = LIII
relevant works of Sax, De Viti de Marco, Wicksell, and
$MRS = MRS' + MRS2 is the precise equiv- Lindahl. I have greatly benefited from preliminary study
alent of my mathematical equation (2) and of of Professor Musgrave's forthcoming treatise on public
our Pareto-type tangency condition at E1, E,, finance, which I am sure will constitute a landmark in this
area.
or E. Why? Because of the stipulated require- 8 Musgrave, op. cit., 2I6, which is an acknowledged
ment that Chart 5's curves are to depict the adaption from Erik Lindahl, Die Gerechtigkeit in der
absolute slopes of the curves of Charts I-3. Besteuerung (Lund, I919), 89. I have not had access to
this important work. This diagram plots instead of the
Except for minor details of notation and as- functions of Chart 5 the exact same functions after each has
sumption, Chart 5 is identical with the figure been divided by the MC function. The equilibrium inter-
section corresponding to E now shows up as the point at
shown on page 3I of the first Bowen reference, which all persons will together voluntarily provide ioo per
and duplicated on page I77 of the second refer- cent of the full (unit? marginal?) cost of the public service.
ence. I am happy to acknowledge this priority. (If MC is not constant, some modifications in the Mus-
Indeed anyone familiar with Musgrave's valu- grave diagram may be required.)
'The earlier writers from Wicksell on were well aware of
able summary of the literature bearing on this this. They explicitly introduce the assumption that there
area 7 will be struck with the similarity between is to have been a prior optimal interpersonal distribution
of income, so what I have labelled E might better be
7Richard A. Musgrave, "The Voluntary Exchange The- labelled G. But the general equilibrium analyst asks: how
ory of Public Economy," Quarterly Journal of Economics, can the appropriate distribution of income be decided orn

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 THEORY OF PUBLIC EXPENDITURE 355
ical economy. Much remains to be done. This the important unpublished thoughts of Dr.
is not the place to discuss the wider implica- Musgrave, there is much opaqueness in the lit-
tions and difficulties of the presented economic erature. Much of what goes by the name of the
theory.'0 However, I should like to comment "voluntary exchange theory of public finance"
briefly on some of the questions about this seems pure obfuscation.'2
theory that have been raised in this REVIEW." (iii) Far from my formulation's being, as
(i) On the deductive side, the theory pre- some correspondentshave thought, a revival of
sented here is, I believe, a logically coherent the voluntary exchange theory - it is in fact
one. This is true whether expressed in my orig- an attempt to demonstrate how right Wicksell
inal mathematical notation or in the present was to worry about the inherent political diffi-
diagrammatic form. Admittedly, the latter culty of ever getting men to reveal their tastes
widens the circle of economists who can under- so as to attain the definable optimum. This in-
stand and follow what is being said. The pres- trinsic "game theory" problem has been suffi-
ent version, with its tangencies of methodo- ciently stressed in my early paper so that it has
logically the same type as characterizeCournot- not been emphasized here. I may put the point
Marshall marginal theory and Bergson-Pigou most clearly in terms of the familiar tools of
welfare theory, should from its easily recog- modern literary economics as follows:
nized equivalence with the mathematical ver- Government supplies products jointly to
sion make clear my refusal to agree with Dr. many people. In ordinary market economics as
Enke's view that my use of mathematics was you increase the number of sellers of a homo-
limited "to notation." geneous product indefinitely, you pass fromn
(ii) In terms of the history of similar the- nonopoly through indeterminate oligopoly and
ories, I hope the present paper will make clear can hope to reach a determinate competitive
relationships to earlier writers. (In particular, equilibriumin the limit. It is sometimes thought
see the above discussion relating my early dia- that increasing the number of citizens who are
grams and equations to the Bowen-Lindahl for- jointly supplied public goods leads to a similar
mulation.) I shall not bore the reader with determinate result. This is reasoning from an
irrelevant details of independent rediscoveries incorrect analogy. A truer analogy in private
of doctrine that my ignorance of the available economics would be the case of a bilateral-
literature may have made necessary. Yet is it monopoly supplier of joint products whose num-
presumptuous to suggest that there does not ber of joint products - meat, horn, hide, and
exist in the present economic literature very so on - is allowed to increase without number:
much in the way of "conclusions and reason- such a process does not lead to a determinate
ing" that are, in Dr. Margolis' words, "famil- equilibrium of the harmonistic type praised in
iar"? Except for the writers I have cited, and the literature. My simple model is able to dem-
onstrate this point - which does have "policy
a prior basis before the significant problems of public con- implications."
sumptions have been determined? A satisfactory general
analysis can resist the temptation to assume (i) the level of
(iv) I regret using "the" in the title of my
government expenditure must be so small as not to affect earlier paper and have accordingly changed the
appreciably the marginal social significance of money to the preseenttitle. Admittedly, public expenditure
different individuals; (ii) each man's indifference curves run
parallel to each other in a vertical direction so that every
and regulation proceed from considerations
and all indifference curves in Chart i (or in Chart 2) give other than those emphasized in my models.
rise to the same MRS' (or MRS2) curve in Chart 5. The Here are a few:
modern theorist is anxious to free his analysis from the
incubus of unnecessarily restrictive partial equilibrium
a. Taxes and expenditure aim at redistrib-
assumptions. 1 See Gerhard Colm, "The Theory of Public Expend-
10At the I955 Christmas Meetings of the American Eco- iture," Annals of the American Academy of Political and
nomic Association and Econometric Society, I hope to Social Sciences, CLXXXIII (January I936), I-II, reprinted in
present some further developments and qualifications of this his Essays in Public Finance and Fiscal Policy (New York,
approach. 1955), 27-43 for an admirable criticism of the Graziani
"Stephen Enke, "More on the Misuse of Mathematics statement, "We know that the tax tends to take awav from
in Economics: A Rejoinder," this REVIEW, XXXVII (May each and all that quantity of wealth which they would each
I955), I3I-33; Julius Margolis,"OnSamuelsonon the Pure have voluntarily yielded to the state for the satisfaction of
Theory of Public Expenditure," this issue, p. 347. their purely collective wants" (page 32).

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 356 THE REVIEW OF ECONOMICS AND STATISTICS
uting incomes. I am anxious to clear myself of these cases isn't there an element of variabil-
from Dr. Margolis' understandable suspicion ity in the benefit that can go to one citizen at
that I am the type of liberal who would insist the expense of some other citizens?"
that all redistributions take place through tax To this criticism, I fully agree. And that is_
policies and transfer expenditures: much public why in the present formulation I have insisted
expenditure on education, hospitals, and so on, upon the polar nature of my category. How-
can be justified by the feasibility consideration ever, to say that a thing is not located at the
that, even if these are not ioo per cent efficient South Pole does not logically place it at the
in avoiding avoidable dead-weight loss, they North Pole. To deny that most public functions
may be better than the attainable imperfect tax fit into my extreme definition of a public good
alternatives.'3 is not to grant that they satisfy the logically
b. Paternalistic policies are voted upon equally-extremecategory of a private good. To
themselves by a democraticpeople because they say that your absence at a concert may con-
do not regard the results from spontaneous mar- tribute to my enjoyment is not to say that the
ket action as optimal. Education and forced elements of public services can be put into
paces of economic development are good exam- homogeneous additive packages capable of be-
ples of this. ing optimally handled by the ordinary market
c. Governmentsprovide or regulate services calculus.
that are incapable of being produced under the Indeed, I am rash enough to think that in
strict conditions of constant returns that go to almost every one of the legitimate functions of
characterize optimal self-regulating atomistic government that critics put forward there is to
competition. be found a blending of the extreme antipodal
d. Myriad "generalized external economy models. One might even venture the tentative
and diseconomy" situations, where private pe- suspicion that any function of government not
cuniary interest can be expected to deviate possessing any trace of the defined public good
from social interests, provide obvious needs for (and no one of the related earlier described
government activity. characteristics) ought to be carefully scruti-
I am sure this list of basic considerationsun- nized to see whether it is truly a legitimate func-
derlying government expenditure could be ex- tion of government.
tended farther, including even areas where gov- (vi) Whether or not I have overstated the
ernment probably ought not to operate from applicability of this one theoretical model to
almost anyone's viewpoint. actual governmental functions, I believe I did
(v) This brief list can end with the most not go far enough in claiming for it relevance
important criticism that the various commenta- to the vast area of decreasing costs that consti-
tors on my paper have put forth. They all ask: tutes an important part of economic reality and
"Is it factually true that most-or any! -of of the welfare economics of monopolistic com-
the functions of government can be properly petition. I must leave to future research dis-
fitted into your extreme category of a public cussions of these vital issues.
good? Can education, the courts, public de-
Economic theory should add what it can to
fense, highway programs,police and fire protec-
our understanding of governmental activity. I
tion be put into this rigid category of a 'public
join with critics in hoping that its pretentious
good available to all'? In practically every one claims
will not discourage other economic ap-
13 See my "Evaluation of Real National
Income," Oxford
proaches, other contributions from neighboring
Economic Papers, N.S. ii (January I950), I8 f. for analytic disciplines, and concrete empirical investiga-
discussion of this important truth. tions.

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