Expenditures: Does It Matter How They Are Financed?

Economic analysis and popular opinion often conflict. An example is the connection between the revenues and expenditures of the public sector. Common sense suggests that there should be a strong and logical connection between the two sides of the budget. For example, if an average citizen in any country is asked what he or she thinks about the desirability of a particular expenditure increase, the answer is often related to how the respondent thinks the increase will be financed. Similarly, while most people do not like tax increases, again their attitudes seem likely to depend to at least some extent upon what they think will be financed.1 People are right. Revenues and expenditures are inextricably linked. Indeed, as Musgrave (1969) has long emphasized, “a theory of public finance remains unsatisfactory unless it comprises both the revenue and expenditure sides of the fiscal process (p. 797).” Nonetheless, despite this admonition, and despite common sense, traditionally most formal economic analysis of either tax or expenditure changes has been conducted under the assumption that there is no connection between what happens on one side of the budget account and what happens on the other side. This paper explores a few of the issues that arise when we take seriously the need to consider both sides of the budget when evaluating public expenditures. There are, of course, excellent reasons why economists operate the way they do. Life is complicated. The only way