Efficient Public Good Provision with Nonlinear Income Taxation

Due to the use of distortionary taxation, real-world economies should attain a lower level of public expenditures than one might suspect from the analysis of artificial models where lump-sum taxes are assumed to be available. The paper examines this popular hypothesis by means of the two-type self-selection model of income taxation. I provide sufficient conditions for both a lower and a higher level of public expenditures in second best than in first best. Contrary to conventional intuition, these results do not in the first place depend on whether the (second-best) income tax is distortive, but on whether public expenditures reduce the incentive of high-ability agents to imitate less productive individuals.