[...]
The failures at tax collection and public goods provision that instead
characterize the developing world suggests that the preference structure
illustrated in Figure 1 cannot be taken for granted. The possibility of a preference
bias in the individual household’s consumption of private versus public sanitation
is therefore admitted in Figure 2. The individual’s indifference to public
cleanliness, or puN, is reflected in the shape of the indifference curves in
quadrant (II) of Figure 2, while the individual’s indifference map in quadrant (I)
displays normal preferences over private forms of consumption. For the
individual holding such a preference bias, the consumption of “public cleanliness”
is subject to rapidly diminishing returns measured in private utility terms. And the
“optimal” mix of private-public goods consumed by the individual when faced with
any reasonable set of relative prices would tend towards a corner solution. The
individual would buy into far greater amounts of private as opposed to public
cleanliness. In such a case, a state-mandated tax or charge (including no-littering
rules) that reduces the individual’s private consumption possibilities imposes a
net utility loss. That is, the individual perceives himself as being worse-off with,
rather than without, public provision8. The long term consequences for the
individual household in such a community is represented instead by the curve C
in quadrant (II), that indicates shrinkage of household access to common
facilities accompanied by a return to private consumption options in quadrant (1).
The dilemma of public goods provision proves to be fundamentally
different at the most elemental level. Thus, consider the familiar free-riding
incentive that potentially affects the stability of collective equilibrium. In Figure 1,
if the individual is honest and pays his tax share, he obtains a net increase in
welfare captured by the shift from e^o(U^o) to C (U^N) in quadrant (II). However, he
potentially obtains an even greater increase in private welfare by evading his
share of taxes. In a large number setting, tax evasion moves the individual
household towards D, on the higher indifference curve U^ev, as long as other
households continue to pay their tax share in the short run. However, in the longrun,
if other individuals attempt the same, tax collections break down and the
individual tax-evader faces the least preferred prospect of a return to e^0
, as puN tends towards a zero level of provision. The individual in Figure 1, therefore,
maintains a long term interest in enforcing honesty in tax collections, or
penalizing tax evasion. That is, each individual perceives a net gain through good
governance over time – measured by the increase in utility obtained from a move
from e^0 to C in quadrant (II).
No such surplus for good governance or honesty in tax payments exists
for the individual household defined by Figure 2. Instead, an attempt by the state
to provide an equivalent level of public goods, puN^0 within such a community
imposes significant utility losses on the individual tax payer, who is now forced
onto a lower indifference curve, U^N at C. The compulsion to evade, or lower, the
tax burden is much greater here than it is in Figure 1, and is motivated by
different considerations. While the “free-rider” is, by definition, motivated by
higher levels of private welfare attainable with the provision of a public good (at
D in Figure 1), the tax-evader in Figure 2 seeks – at the very least and through
tax evasion – to simply minimize his utility loss measured in private good terms.
Even under circumstances where such evasion or lowered tax burden leads to
poor service quality and/or a complete breakdown in service provision.
The fundamentally different incentive structure may be more starkly
illustrated by altering the pay-off matrix used in the familiar prisoner’s dilemma
game. In Figure 2A (end of document), the provision of the public good through
equal mandatory tax shares leaves both individuals – R & C -- with a worse payoff
in cell (I) – (1, 1) relative to their pre-tax position in cell (IV) - (2,2). Each
individual will therefore attempt to maintain his pre-tax position through tax
evasion even at the cost of reduced public provision – cell (III) - (2,1) or cell (II) (1, 2).
Note that the underlying indifference to the state of public cleanliness is
reflected in an unchanged private payoff perceived by the honest tax payer in the
face of tax evasion by other individuals -- across cells (I) & (II) or cells (1) & (III).
Under such a payoff structure, there exists little basis within the community to
expect, leave alone enforce, honesty in tax payments by individual households9.
Further, within a system of majoritarian democracy, the penalty threat required to
minimize tax evasion will be seen as “oppressive” and deemed politically too
costly.
Where the level and type of investment by the state in public facilities is
set by exogenously determined technical standards -- or by “developmental
goals” far beyond what is warranted by the prevailing preference for sanitation --
expectations of a soft-budget constraint are inescapably built into its operation
and maintenance by local agencies. Public provision will inevitably be burdened
with the necessity of subsidized or free provision to significant sections of the
population. Note that the provision of subsidies too differs in significance under
the two preference structures. In Figure 1 (the case with a normal preference for
public sanitation), subsidies in form of tax exemptions or reduced user or access
fees to a section of the population will be seen as a privilege that may, in
adherence to democratic principles, need to be satisfied through some form of
“means test”. In contrast, subsidized access to the public good, or exemption
from tax in Figure 2, far from being seen as awarding a privileged level of private
welfare, is likely to be interpreted as a “human right” – a claim to minimize the
“undue” burden of taxation. This difference in perspective across the two cases
may explain the observed inability of the state in India to impose a credible “hardbudget
constraint” on subsidized provision.
The overextension of facilities by the state in the face of such a preference
bias is likely to generate a far worse pathology of outcomes in the public sector.
With indifference to public sanitation that is widespread amongst the population,
public facilities once provided are valued by individuals only to the extent that it
allows each to reach a higher level of private consumption welfare. This is no
different from the individual behavioral response described within the “tragedy of
the commons”. In both cases individuals do not uphold a positive existence value
for the “commons” and there is an overriding incentive to “corrupt” or over-use
the commons for private individual gain. Thus, positions potentially obtainable
along the private consumption axis in Figure 2 – such as e^* or better still, e^r
-- will be individually preferred to position C, once the public good is provided. Thus,
position R in quadrant (I) represents a feasible increase in private gain through
corruption under conditions of a soft-budget constraint. R is obtained by the
individual household by a combination of tax evasion – measured in real terms
by the TF segment along the pu1 axis -- and use of the common facility for
private use – measured in real terms by C`T along the same axis. The public
park, for example, will be subject to both littering and pilferage as individuals
attempt to convert their access to the park for private ends. The allocation of
common facilities is subject to endemic corruption as individuals would seek to
obtain disproportionate benefits in quadrant (I) – from privileged access to school
admissions, hospital rooms, railway reservations, employment, etc. Only under
conditions where the soft-budget constrain breaks down, or is withdrawn, will the
corner solution, e*, be realized by the community along with a relapse towards
purely private consumption options in quadrant (I).
Until such time, the community is likely to be caught in a “low equilibrium
trap” with continuing depletion of resources within the public sector. Figure 2B
illustrates the problem by revising the payoff structure to reflect a fully subsidized
provision of the public good that is sustained by the availability of a soft-budget
constraint. Thus, unlike in Figure 2A, the private payoffs in cell (1) with public
provision remain unchanged relative to the payoffs in cell (IV) without public
provision. However, now each individual actively “exploits” the public facility for
private gain and is able to realize a significantly higher private payoff – reflected
by the payoffs (4, 2) or (2, 4) in cells (II) and (III). As in Figure 2A, the individuals
remain indifferent to the state of public provision, including its misuse by others –
across cells (1) & (II) or (1) & (III). In addition, the fully subsidized provision of the
public good means that neither individual has an immediate interest in moving
back to cell (IV) – the dominant cell in both Figure 2A and in the classic
prisoner’s dilemma game. That is, as long as the soft-budget constraint holds
and the possibility of securing higher private payoff exists, the community is
trapped between cells (II) & (III).
The persistence of such a “low equilibrium trap” over time is clearly
evident in the administrative history of public sanitation in India. Thus, under both
British India and the nationalist state, local agencies in rural and urban districts
have rarely achieved financial self-sufficiency in provision of basic services.
Instead, sanitation services tend to receive significant subsidies; sewage and
water tariffs or taxes are consistently set far below cost; collection rates even for
the subsidized charges remain low; municipal bodies are plagued by perennial
deficits and operate under soft-budget constraints; wide spread misuse and
pilferage of public facilities is observed; unreliable and poor service quality; lack of
maintenance, frequent breakdowns and resort to private supply options in the
informal sector.