The Dual Nature of Public Goods and Congestion: The Role of Fiscal Policy Revisited

Santanu Chatterjee
University of Georgia

Sugata Ghosh
Brunel University

March 2011

Canadian Journal of Economics, forthcoming.

ABSTRACT

The role of fiscal policy is examined when public goods provide both productive and utility services. In the presence of congestion, the consumption tax is shown to be distortionary. Optimal fiscal policy involves using consumption-based instruments in conjunction with the income tax. An income tax-financed increase in government spending dominates both lump-sum and consumption tax-financing. Replacing the lump-sum tax with an income tax to finance a given level of spending dominates introducing an equivalent consumption tax. These results contrast sharply with the literature, where the consumption tax is generally viewed as the least distortionary source of public finance.

The paper can be downloaded from the SSRN website or directly by clicking here.