Public goods, congestion, and fiscal policy: Do consumption-based instruments matter?

Abstract

We examine the impact of scal policy on macroeconomic performance when public goods play a dual role by simultaneously providing both productive and utility services to the private sector. When these services are subject to congesti on, a consumption tax is distortionary, generating a dynamic adjustment that contrasts an income tax. The design of optimal scal policy demonstrates the possibilities for using both income- and consumption-based scal instruments as opposed to relying on the income tax alone. In correcting for congestion, an income tax-consumption subsidy combination is the preferred policy when factor-substitutability in production is limited. On the other hand, an increase in the elasticity of substitution in production raises the eEcacy of a consumption tax as an alternative to the income tax. Not internalizing the dual beneCts of public goods might lead to misleading predictions regarding the eect of public policies on welfare.