FUCK ALL OF YOU
AFTERWARD TO CLARKE'S DEMAND REVELATION AND THE PROVISION OF PUBLIC GOODS
(FORTHCOMING REPRINT, iUNIVERSE PRESS, 2000)
Appendix 1 to Afterward -- Examples of Demand Revealing Governance
For readers that have little or no familiarity with the demand revealing process and those interested in recent extensions of the theory elaborated in this Afterward, I present simple examples intended to demonstrate how "a Clarke tax" and a broader "market solution to the public goods problem" works. Part A describes simple textbook examples, based on Varian's Microeconomic Analysis (1989).. Part B elaborates in terms of extensions of my earlier work in Bailey's A Constitution for A Future Country. (The Bailey book is reviewed in Appendix B). I also include in Appendix A an example of a practical application drawn from Clarke 1997.
A. Examples of Demand Revealing Governance
The examples build on the notion of "solutions" to the benefit taxation" problem of efficiently providing public goods. The problem, as set forth in Buchanan (1968), Clarke (1971, 1980) is the difficultly of obtaining efficient solutions where (a.) preferences among individuals differ or (b.) they are so distributed that if we took the preferences of a median voter as reflecting those of the overall population, we would obtain inefficient solutions through majority rule.
Consider, for example, differing preferences of nonidentical individuals. If such individuals with identical demands face equal tax prices, they would agree on same quantity. If they did not and were asked to reveal their demands with the tax prices varying in accordance with the revealed demands, there would be an incentive to behave strategically and to understate one's own preferences.
To help solve this problem and look at the possibilities in "benefit taxation", we explore the possibility of using a preference or demand-revealing rule to make decisions on a public good. This combination voting and tax scheme would work as indicated in Table 1. With reference to case (b.) above, we have a situation where majority voting with equal sharing of costs is likely to lead to a very inefficient outcome.
A Numerical Example (adapted from Varian, 1989).
The incentive effects of such a procedure can be seen in the following discrete case example. (See Table A-1). We charge the special "incentive tax" to any voter who is "pivotal" in changing the outcome.
Table A-1 presents a case where we have three voters (or representatives) who have to decide whether they want a communications technology (called E, or elasticity) in their community. It is tentatively decided that if the decision to acquire E, they will each bear an equal per capita share of the costs ($100), the total costs to them being $300. Voters 1 and 2 (call them John and Mary) are willing to pay $50 each for E while Henry is willing to pay $250. See Table A-1.
In this case, E provides a positive net value only to Henry. Thus majority voting would result in a decision not to acquire E. However, it is efficient to acquire E since the sum of the values ($350) exceeds the cost ($300).
Consider how the incentive tax works in this example. For either John or Mary, the sum of the net values in the absence of their participation is $100, and the net value for each is -$50. Thus neither John or Mary is pivotal. Since both are made worse off by the acquisition of E, either might be tempted to understate his or her preferences. In order to ensure that E is not acquired, either would have to state values of $100 or less. But if this were done, then John (or Mary) would become pivotal, and would have to pay an incentive tax equal to the amount the other two people bid (150+150=100). Thus if either understated their bid, they could each save $50, but there would be a resulting increased cost that voter of $100 in incentive taxes, leaving either with a net loss of $50.
Voter 3 (Henry) is faced with a similar situation. However, he is pivotal. Without his vote, E would not be provided and with his vote, E is provided. Henry receives a net value from the public good of $150 but pays a $100 incentive tax, leaving him with a net value from his actions of $50. By increasing his bid above the true value, he would not change any of his payoffs. By reducing it below true value, he lowers the chance that E will be provided and doesn't change the amount of tax he would have to pay. Thus, it is in the interest of John, Mary and Henry to each reveal the net value of the good.
Table A-1 Example of A Clarke Tax (adapted from Varian,1989)
|Person||Cost Share||Value||Net Value||Clarke Tax|
|A (John)||$100||$50||- $50||0|
|Net Benefit||100 (total)|
Problems with the Incentive Tax
The textbook descriptions of demand revealing also recount certain problems with the process, including coalitions, lack of information by the individual voter, and potential "waste" in the process. These problems are discussed at length in Chapter 3 of the book and potential solutions are described at length elsewhere in the book. Bailey's treatment (1997 and forthcoming) is the most satisfactory treatment that has been formulated to date.
According to Bailey, the only reasonably satisfactory way to get around these difficulties is through a combination of mechanisms One might, for example, think of a staged process. The "pivotal" mechanism might be used at the initial "agenda setting" stage using a sample of voters chosen by lot to represent the taste and preferences (and tax relevant, demographic) characteristics of a larger underlying population. Through appropriate incentives, also for some body that tries to approximate "benefit taxes" for each proposal put on the agenda, we may get nearly unanimous agreement on the details of most government programs and projects. However, on very major issues (involving, say, budget size and other controversial procedures, we might need to turn to more complex combinations of preference revelation mechanisms.
Entrepreneurship and Incentives to Approximate Benefit Taxes.
To illustrate such a process and suggests also how it might ameliorate the problems with "pivotal voting", we turn now to slightly more complicated combinations of mechanisms and the incentives which could drive legislative committees and public goods "entrepreneurs" towards socially desired solutions.
Consider our three voters who might, for example, be a representative sample of citizens who "mirror" a larger community. They could vote on alternatives to be presented to the latter, serving essentially as "agenda-setters". They would be given a collective incentive that would be some function of the net positive benefits from the choice of E (say a % of the $50 in net benefit from acquiring E). Their "performance payment" would also be negatively related to the dollar votes cast against the acquisition of E (i. e. a % of the $100 voted by John and Mary against the proposal).
Table A-2 Solving the Problem Through Competitive Supply of the Public Good.
(a.) Before Making Price Adjustments
|Person||Supplier 1||Supplier 2||Clarke Tax|
(B.) After Price Adjustments
|Person||Supplier 1||Supplier 2||Clarke Tax|
Accompanying this agenda setting function, we would also have an independent group (i. e. a regulatory body or "Commission") trying to set initial tax-prices as closely as possible to the "perfect" benefit-tax prices and this price setting body (or Commission) would also receive appropriate "performance payments". The Commission could also use the information generated by the actions of the sample of citizens to determine the appropriate tax prices. Of course, if the sample of citizens voted as a perfect "mirror" of the underlying population, there would be no surplus or incentive tax wastes to be disposed of, nor would coalitions arise.
Consider also the potential of the procedure to "drive" supply-side competition in a manner that mimics the operation of a perfectly competitive market. Setting aside for the moment a process, elaborated in the following chapters, by which a final selection of alternatives might be made by the underlying population through a "combination of demand revealing and other mechanisms), consider the potential of having two "agenda setting" legislative committees and/or permit private parties to submit alternative proposals. In turn, the committee or party which "wins" in the final selection will get a percentage (say 3%) of net revealed benefits less 0.5% of negative votes against the proposal.
It is possible to design procedures (incentives) that would induce entrepreneurs to "find" the combination of public goods and the financial terms of payment for them that will generate the highest net social benefit and minimize redistributive harm. These incentives would also avoid political competition aimed at redistributing income in the community in a way that would increase redistributive harm.
Take, for example, the situation shown in Table A-2. With the assistance of the regulatory price setter, supplier/committee 1 might come up with a configuration of services for E that generates $50 in net benefit, revealed by the legislative process described above (maximum net benefits and no redistributive harm). If supplier 2 (see Table A-2) offered an alternative configuration which reflects slightly higher net values (a net value of $60 as opposed to $50, or $10 more to Henry, the Commission has the incentive to adjust the distribution to achieve a distribution of net values comparable to those generated by supplier 1. Under traditional voting, and particularly if the Commission were unable to approximate the distribution shown in Table A-2, there would have been disagreement over the proposals advanced by supplier 2 and probable choice of an inefficient alternative (supplier 1's proposal or "no action").
To help avoid the problems inherent in the "incentive tax" or "pivotal" mechanism (coalitions and wastes) and to give voters a positive incentive to take the time and effort to become informed, economists have recently discovered that a combination of the "pivotal" mechanism and an "insurance" mechanism could be used at the final decision-making or referendum stage in a manner that exploits the advantages of each mechanism while mitigating their comparative disadvantages.
Use of the "insurance" mechanism at the referendum stage, for example, allows the Commission to evaluate deliberations in the legislature(s) so as to assess the probabilities of which of the two alternatives (supplier 1 or 2's) would "win" in a referendum". Each individual will then vote by "insuring against" against its less preferred alternative. If the odds of either event were judged as equiprobable (putting zero probability on the status quo), then Henry would pay ($160-50 x .5 = $55) to vote against supplier 1's package and John and Mary would vote $25 each against supplier 2's package. Supplier 2 would be chosen with a surplus of $5 over the amounts of compensation paid to John and Mary (whose net losses would be reduced from $50 to $25 each).
The insurance system, standing alone, would not always induce the accurate revelation of demands if citizens experienced both material and nonmaterial harm (i. e. a portion of their preferences reflected what they thought was good for society). For example, Henry's net value for supplier 2's package reflected $90 in material welfare and $70 to influence John and Mary's elasticity consumption. Using the mechanisms in combination could result in incentive taxes at the referendum stage (if, for example, Henry's $70 expression of material harm swung the election, so that he paid a $10 incentive tax in addition to his insurance of $90 x .5 = $45). The only difference would be a slightly higher combined insurance and incentive tax surplus. In a large community, however, the number of voters who swing the outcome is likely to be very small, so that all most all of the surplus is in the form of amounts over and above that required to compensate losers. In some cases, however, where a community may be evenly divided on an issue, and some voters have very strong 'non-material" preferences, there could be a significant number of pivotal voters, each of whom pays a small incentive tax. [The final chapter presents an example of the combination of "pivotal' and "insurance" mechanisms in a larger community setting].
The use of a combination of preference revealing mechanisms can be used to exploit the advantages of each while reducing their disadvantages. For example, the "insurance mechanism" is mostly immune to coalitions while generating a much larger incentive for voters to ensure that the process of decisions will accurately express their preferences. It also sharply diminishes the magnitude of any surpluses which, relative to those which might be generated by "pivotal voting", are used to compensate voters for choices of less preferred outcomes and to provide rewards or incentives to "winning" suppliers and sponsoring legislative committees. Future progress in the design, and more widespread understanding of such mechanisms may eventually provide a means of blending market and political instruments in a way so as to provide "a major advance in civilization" (Bailey (1996c). I elaborate on this in Appendix B in comments on Bailey's Constitution (1997 and forthcoming)..
C. Is It Practical?
To illustrate the practicality of the method, I elaborate in the context of an example in Clarke 1997 (See Planning and Markets, Volume 2, 1999) www-pam.usc.edu
Application of the Method (A General Progress Program) to Particular "Distributive" Programs: Transportation and the Environment.
Nobel Prize pundits (Science, October 18, 1996) credit successful applications of his idea to such areas as the spectrum and Treasury debt auctions as a contributing factor in the award of the prize to William Vickrey. Why not now, in Vickrey's honor, extend the idea to expenditure allocation affecting "distributive" Federal programs? Following Vickrey's idea, an incentive-compatible approach to grant-in-aid design for "distributive" programs was initially set forth in an unpublished paper by (Clarke, 1981), entitled "Reforming the Grant-in-Aid Pork Barrel" and was briefly described with respect to "A Limited Fund Mechanism" for allocating Superfund by Tozzi and Clarke (1983). More recently, Brough, Clarke and Tideman (BCT, 1995) described a compensated incentive-compatible approach first elaborated by Tideman (1979) to airport slot management and noise regulation. This method, described in BCT, 1995) effectively separates the allocation of a resource (i. e. airport slots) from distributional questions (i. e. whether airlines should be entitled to landing rights as opposed to communities or the public at large). The method is an adaptation of the second price auction (Vickrey, 1961) and Clarke's demand revealing method for public goods allocations (Clarke, 1971).
With respect to "distributive" grants-in-aid (see Stein and Bickers, 1995), the following section of this paper illustrates the use of the procedure for allocating annual obligations to the state revolving Funds (SERFS) under the existing EPA Construction Grant Program. The method could also be adapted to the implementation of the new Safe Drinking Water Act and Hazardous Waste grant management (Superfund), as was recently described by Brough (1995)..
By comparing a more practical, administrative approach with an admittedly more visionary one, it is possible to better gauge why the latter may appear less acceptable to "real political actors" and the "general political science" in the "foreseeable future" (see Introduction, footnote 1). Winning the hearts and minds of the "general political science" may simply require proving that the ideas work in simple administrative settings before trying them in somewhat more controversial settings where the new "voting rules" might supplant existing voting rules. The Nobel Committee recently noted that the Vickrey auction anticipated (by a decade) the theoretical development of the pivotal mechanism as a means of ensuring "truth telling" in public project tenders. I am hopeful that, in actual experience and within a decade, the use of the principles of the former (in spectrum and Treasury note auctions) could lead to use of the latter (also in voting on public projects) in appropriately designed institutional settings.
Revisiting the Limited Fund Mechanism: A "Practical Approach".
There is currently a wellspring of activity in converting from traditional grants-in-aid to "revolving funds". Holcombe (1992) examined the general topic of revolving fund finance, focusing on the organization and administration of State Revolving Funds (SERFS) for wastewater treatment. A compensated incentive compatible (CIC) approach towards administration of revolving funds in general can be illustrated as follows.
Take, for example, the existing construction grant program funded in FY 1996 at approximately $2 billion in annual capitalization grants. Under the CIC method, an administrator would establish a initial interest rate which might be 7% (say 2% below the market rate, so as to reflect the "disutility" associated with "administrative strings" and Federal requirements). This rate, would be based on evaluations by a national "cost-benefit" advisory committee and, in future years, also reflect for any given jurisdiction the revealed wtps of other jurisdictions.
Suppose that the average state (J1) had an initial entitlement of S = $100 million. As shown in the following figure, however, J1 would take more and others would take less than their initial shares, and the willingness and ability to "flex funds" makes the "derived supply of funds" to each individual jurisdiction rather elastic. Here, the supply of funds to J1 would be determined by subtracting the amounts that all others would take at 7% from the fixed $2 billion supply of funds. Assume, given a high elasticity, that this would equate with J1's demand for funds at a rate of approximately 7¼%. The amount that J1 would pay is determined in two parts. For an extra $10 million (A - S) over the entitlement level, it pays 7% and other jurisdictions are compensated by a similar amount. For the remaining or next $10 million (B - A), it pays an average of 7 and 7¼%, which is shown by the shaded area in the figure. (This is essentially a "VCG tax", also here called a general progress payment or GPP, which motivates jurisdictions to provide an accurate expression of preferences, albeit creating a small surplus of about $17,000 in extra annual interest payments for J1 over what is needed to compensate other jurisdictions at the rate of 7%.(1)
The textbook treatments of demand revealing also recount several problems with the tax, including potential coalitions,
"waste" of the Clarke tax, and the "rational ignorance" of voters. See Chapter 3 of this volume.
The procedure can be viewed as a potentially more effective way of reconciling needs as provided by a formula or determined by a central administrator and the needs as perceived by subnational entities. As Holcombe notes (1992, page 55), the states receive very disparate portions of their EPA determined needs through the formula. "Two states -- Wyoming and North Dakota -- will receive more in SRF capitalization grants from the federal government than their EPA-estimated needs through the year 2008, while the bottom four states -- Arizona, Florida, Massachusetts, and Washington -- will receive only 5% of their estimated needs through 2008 in capitalization grants." (For comparison purposes, Holcombe at footnote 11 notes that the median state receives about 14% of estimated needs through the year 2008; the large percentages given to some states is a result of an agreement that each state will receive a minimum percentage of the total of the money regardless of other factors).
With respect to a detailed elaboration of this approach in a separate paper, it is fairly easy to see how the "administered" system might be superior to simple trading or "flexing of funds" by simple agreement between the jurisdictions so as to, for example, achieve more efficiency in equating the marginal product of investment in a particular activity (i. e. toxic waste cleanup). Except for removing incentives to strategic manipulation to alter the equilibrium price of funds or the interest rate in small number interactions, the device may not be all that superior relative to trading, but it does have growing advantages when we adjust the aggregate level of expenditure (see BCT, 1995, particularly in comparing CIC with zero revenue auctions which have been advanced in the environmental permit trading area as a means of achieving more "allocative efficiency" while preserving "distributional stability").(2)
The Limited Fund Mechanism (LFM) was originally advanced in the context of programs where the interjurisdictional spillovers (clean water, hazardous waste sites) were arguably small. However, this ignores the problem of substate allocation, where districts will vie for funds while letting the rest of the State pay for them. Also distributional considerations will intervene in that other jurisdictions may prefer, for example, that there be more clean-up of sites where, say, children are residing nearby as opposed to "brownfields" development where state wtps might be higher.
Consider a couple of additional examples of potential application to now evolving new "revolving fund" programs. EPA is now in the process of writing rules for the formula allocation of a new Safe Water Drinking Act program enacted this year. One could envision a set of simple per capita entitlements, followed by "needs" or cost-benefit assessments in which jurisdictions with higher "needs" would borrow amounts above their per capita entitlements and others would be compensated for receiving less (at assigned rates of compensation). In this and similar programs, the usual "discretionary" accounts (5 to 10% of the amounts allocated subnationally) would be allocated to states that exceed their entitlement levels by indications of their wtps -- thus in effect paying variable matching rates depending on their demand for discretionary funds. In this way, a state with high needs makes a move from a simple per capita distribution (S in Figure 1) to point A (determined by the benefits assessment, which can also take account of projects with spillovers) and then to B (reflecting actual wtps), crating a minimum "surplus" (as measured by the shaded area in Figure 1). This approach also minimizes distributional struggles in the initial allocation, where small states usually end up with some "minimum" allocation unrelated to "needs" (see Holcombe, op. cit., 1992) and we avoid asking them to explicitly loan back funds when program managers may come to believe that these are their "owned" funds (a sort of "flypaper" effect).
Appendix 2: A Review of Bailey's Constitution
Bailey's Constitution is a pathbreaking attempt to show how an economy might be operated so as to provide public goods and services in a manner that "mimics" the operation of private competitive markets. Using principles pioneered by Wicksell and Lindahl, this has long been a goal of public economics but until the advent of so-called demand revealing mechanisms (described in Chapter 2 of his book), there was to known way to achieve this result in real world institutions. Bailey has shown the way this result can be achieved through the provision of the appropriate constitutional decision making and self enforcing incentive structure in a small public economy.
The "incentive compatible" mechanisms that Bailey utilizes received recent attention by the Nobel Prize Committee. In awarding the 1996 Nobel Prize to William Vickrey, the Nobel Committee recognized the importance of Vickrey's contribution to providing ways to "overcome the public goods problem" (the subject of B&T's Chapter II). The Committee noted that an idea analogous to the Vickrey auction "underlies the so-called Clarke-Groves mechanism for eliciting truthful tenders for public projects. Vickrey anticipated this important result by an important time margin". Whereas this and other work cited by the Committee (particularly the "Vickrey auction") has had many important practical applications in the allocation of goods in private markets (i. e. spectrum auctions and Treasury debt auctions), it has been more difficult to apply the ideas in the public sector.
Part of this difficulty may be the result of certain perceived "technical limitations" of what Bailey calls the (Vickrey-Clarke-Groves" (VCG) mechanisms, the operation of which are described thoroughly in Chapter II of B&T. Over 25 years, the literature has spawned a number of criticisms centering on these technical limitations. Throughout the body of the work and especially in Part II, Bailey has shown how most, if not all, of these difficulties can be surmounted, mostly through the self enforcing incentive structure embedded in the appropriate constitution.
In my own 1980 book of which this is an Afterward (and which was an extension of my 1978 University of Chicago dissertation, I tried to deal with many of these difficulties as well as other difficulties being raised outside the conventional "rational choice" framework of analysis. For example, political scientists (Margolis, 1983) were asserting that altruism invalidates the VCG mechanisms. Bailey's work greatly extends previous attempts, such as mine, in dealing with these technical limitations and criticisms, and offers important and pathbreaking fresh perspectives as well.
The book, in my mind, does an excellent job at stimulating readers ranging from the layperson with only a rudimentary understanding of economics all the way to mathematical economists thoroughly familiar with the current state of the art in "incentive compatible" mechanism design. The great strength of the work is in how it is all put together through a combination of incentive compatible devices and self enforcing incentive mechanisms, starting in chapter II, and running through the exciting "draft constitution" in Chapter III, concluding with a Chapter IV in Part I with "perspectives and alternatives" which analyses other attempts to address the public goods problem and deals with the possible objections that others might raise to the approach suggested by Bailey. The ways in which Bailey combines the mechanisms (i e. the VCG mechanisms and the Thompson mechanism, the latter being treated separately in Chapter V of this book), for example, is particularly important and stimulates one to immediately want to explore practical applications.
Others would surely find important insights in carefully studying Bailey's response to criticisms and misunderstandings (for example the perception that altruism invalidates the VCG mechanism) all the way to perceptions that abound in the political science literature that subvert any attempts to institute decisionmaking mechanisms that would amount to a simple aggregation of individual preferences. (This is the longstanding "liberalism against populism" debate that would try to invalidate any mechanism that relies on direct democracy implemented through a mechanism that relies on voting rules that reflect the intensity of individual voter preferences). In this respect, Bailey's book is a useful supplement to Mueller's Constitutional Democracy (1996) which also provides a defense of the more complex, sophisticated procedures (though not necessarily the VCG mechanisms), leaning somewhat more to the use of the "preference intensity" rules for use in representative or parliamentary settings, rather than through individual voter referenda. All this is a roundabout way of saying that Bailey's work is a important and pathbreaking addition to the rapidly growing "constitutional democracy" literature and will be stimulating to anyone interested in this area.
I should note the relationship of this work to Bailey's other work on social choice, now readily accessible in his 1994 Essays on Normative and Positive Economics. His approach to "social choice" (contained in a "commentary" in those essays) sets the stage for this book, where he truly demonstrates that the impossibility results that haunted social choice for many decades is really a problem of a "plenty of possibilities". Whereas I may be an enthusiast for his particular perspective, the rigor and thoroughness of his work will be appreciated by those approaching the subject matter from sharply differing perspectives and who will find the rigor of his analysis helpful in sorting through the "plenty of possibilities". In this way, his work makes an important contribution to scholarly research in this important area.
I became aware of Bailey's work in late June, 1996 when Professor Bailey sent me a earlier draft. Professor Bailey has made strenuous efforts to cover some of the areas that I and others felt deserved more treatment. For example, I pointed out the altruism (Margolis) controversy and Bailey subsequently devoted an entire appendix to Chapter II in dealing with the controversy in what I believe to be a convincing and dispositive manner.
In terms of real world applicability, Bailey explicitly recognizes that a more complex Federal structure (rather than a small country) would require the use of a more complex decisionmaking structure than is set forth in this book. He has pointed the way for useful further research in this more complex area and in the field of constitutional democracy (and economics) generally. Others, like myself, have been or will likely be stimulated to develop possible real world applications of these principles in particular institutional settings. See, for example, the essays contained in Volume II.
I believe the book will be widely read by scholars in the fields of social choice and public choice. It will also command a good general audience along economists and political scientists, all of whom will find Part I readily accessible. It is hard to judge how wide ranging the general audience could be. I suspect there will be a good deal of "retailing" of Bailey's ideas, so the work will likely be widely cited in the economics, political science and some of the other social sciences. The ideas may catch on in a wider general audience in the near term and even become a public economics classic in later years. I think it could eventually become one of the "great books" in public economics. It will also possibly command some interest in such areas as philosophy and social theory and will surely become a classic in the rapidly expanding literature on "constitutional economics", perhaps ranking beside Buchanan and Tullock's Calculus of Consent (1962) which first stirred modern interest in this field.
In some respects, particularly the material contained in appendices A-D in Chapter VI) is heavy going for any nonmathematical economist, like myself. However, Chapter VI (which summarizes these appendices) is a masterful and understandable presentation of very difficult material (i.e. adjustments for income effects) that has previously perplexed me, a close student of this subject matter, for many years. I can now say I much better understand what has been a difficult real world condition (i. e. income effects) that I usefully assumed away in originally developing and presenting my formulation of the VCG mechanism, but which must be adequately dealt with in many practical settings where one seeks to make decisions based on a consistent ordering of preferences. In this respect, Bailey's treatment of the asymmetry between the "willingness to pay" of those opposed and those in favor of a public project in Chapter VI is an important new contribution to the literature.
Endnotes to Appendix 2
1. Bailey (1996a-c and related technical papers) has shown how the perceived "technical limitations" of demand revealing processes can be overcome, in part through the appropriate design of the "constitutional code". For an early catalogue of the "technical problems, see Groves and Ledyard, 1977): "Some Limitations of Demand Revealing Processes". Groves and Ledyard presented "five warnings" intended to "dampen any premature urge to adopt a constitutional amendment to institute one of these demand revealing mechanisms". Bailey develops his own taxonomy of the five main limitations (somewhat different from the original Groves-Ledyard list), focusing mainly on the limitations of the incentive tax or Clarke tax (i. e. the tax is (i) undefined and (ii) the known mechanism for implementing the tax lacks incentive compatibility, except (in both cases) when utility functions are of a narrowly restricted form. Further (iii) the tax creates a budget surplus that cannot be distributed without disturbing incentive compatibility. Most importantly, the mechanism may (iv) be vulnerable to collusion among voters and, in large economies, there is (v) no incentive to vote. Bailey's treatment of these issues and his way of integrating the incentive tax, the Thompson insurance mechanism (1966) into a set of theoretically convincing and practically attractive solutions for an economy based on Wicksell-Lindahl "benefit tax" principles (see also Foley, 1967) is a truly remarkable intellectual achievement.
. As I note in a 1996 paper discussing some of Bailey's work (1996, 1997) and the forthcoming book), his overall work describes in detail how a combination of incentive compatible devices can be molded into a "constitution for a small country". Three of the critical devices are (1.) "the VCG mechanism" for the official legislature (and competing legislatures or private parties), (2.) incentive payments for (a.) these legislatures and (b.) a Wicksellian tax allocator or Electoral Commission (the incentives in each case being somewhat different) and (3.) use of the Thompson insurance mechanism for referenda on the proposals advanced by the legislatures, guided by the mechanisms incorporated in (1.) and (2.). The mechanisms in (1.) and (2.) are generally similar to the mechanisms I describe in my 1996 paper applied to budgetary allocation mechanisms that might be applied in practical budgetary settings. In Bailey's work, however, they are combined in admittedly much more sophisticated ways, and there are "very" sophisticated ways (from the standpoint of technical economics) in
which budgetary surpluses are disposed of and preferences elicited when there are multiple budgetary choices,
1. In Figure 1, J1's demand schedule D1 and D2 represent its "assigned" and "actual" demand schedules, respectively. The assigned schedule might be determined by the national committee and represent rankings by project of social net present value (npv). The assigned schedule is subtracted (horizontally) from the fixed supply of funds (or some schedule that represents funds to be supplied at varying rates of interest) to determine the S1 (derived supply of funds for J1) in Figure A-1.
2. For example , the system may allow for more funding flexibility, when the collective demand for funds is greater (thus generating a surplus) or lesser (a deficit) than the sum of the initial aggregate of assigned schedules. This flexibility will also
reduce budget imbalances which must otherwise be allocated among jurisdictions (say in proportion to their initial assigned entitlements, thus creating a slight incentive for misstatements of demand) or assigned to the general funds of the government (where such incentives are eliminated all but infinitesimally). As presented here, the CIC does have a bias towards undercompensation, in that it is accomplished using assigned price schedules rather than assigned benefit schedules (which would represent the estimated npvs of displaced projects). On these points, and further elaboration of the properties of the CIC, see BCT, 1995.
Additional References (not appearing in original bibliography). Also citations to original papers by Vickrey, Clarke, Groves and Tideman and Tullock are included.
Anderson, C. (1990) Pragmatic Liberalism. Chicago: University of Chicago Press
Bailey, M. J. (1997) "Towards A New Constitution for a Future Country", Public Choice
90 (1-4) 73-115
________ (1996), "Implementation of the Thompson Mechanism" Public Choice
_______" The Demand Revealing Process: To Distribute the Surplus" (1996a) in Public Choice 89:
________ (forthcoming Constitution for A Future Country MacMillan Press
Brough, W. (1995) "Superfund Unplugged", Citizens for A Sound Economy Washington, D. C.
Brough, W., Clarke E. and Tideman, T. N. (1995) "Airport Congestion and Noise: Interplay of Allocation and Distribution, Transportation Research Record 1450: 3-7
________ (1971) "Multipart Pricing of Public Goods" Public Choice 11; 17-33
_______ (1977) "Some Aspects of the Demand Revealing Process", Public Choice (special spring supplement 29(2): 37-49
________ (1980) Demand Revelation and the Provision of Public Goods
Ballinger Publishing . Co.
________ and Tozzi, J. J. (1983) "On Information and the
Regulation of Public Utilities", in A. Danielsen and D. Kamershen, Eds., Current Issues in Public Utility Economics, 133-147: Lexington: Lexington Books
_______ (1991) "The Supply of Public Goods and Bads at Free Airports" (Paper presented at the Annual meeting of the Public Choice Society, New Orleans, March 1991, unpublished)
Ferejohn J., Forsythe, R. and Noll, R. (1979) "Practical Aspects of the Construction of Decentralized Decision-Making Systems for Public Goods" in Russell, C. (ed.) Collective Decisionmaking: Applications from Public Choice Theory Baltimore: Johns Hopkins Press.. Also, Clarke (comment) and Forsythe, Ferejohn and Noll "reply" in the same volume..
Green, J. and Laffont, J. J. (1979) Incentives in Public Decision Making: Amsterdam North Holland
Groves, T. and Ledyard, J. (1977) Optimal Allocation of Public Goods; a Solution to the "Free Rider" Problem, Econometrica 45: 783-809
Holcombe, R. (1992) "Revolving Fund Finance" Public Budgeting and Finance 12 (3) 50-65
Mueller, D. (1979) Public Choice Cambridge:Cambridge University. Press)
________ (1996) Constitutional Democracy Cambridge: Cambridge University Press
Riker, W. (1979) "Is the New and Superior Process Really Superior?", Journal of Political Economy 87 (4): 875-890
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ABOUT THE AUTHOR
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Edward Clarke discovered the demand revealing process as a University of Chicago graduate student during the late 1960s. This book is an outgrowth of work he began on applications of the process as a Fellow of the Smithsonian Institution's Woodrow Wilson International Center for Scholars during 1977-78 and which he has developed further in recent years..
Dr. Clarke has had wide experience in government finance and the management of domestic economic and social programs, at the city/regional, State, Federal and international levels. He served as a special assistant to the Secretary of Treasury during 1972-73 and subsequently joined the U. S. Office of Management and Budget in 1974, where he was instrumental in initiating a program of regulatory reform and improvements in Federal regulatory management which has been ongoing for the past 25 years. During 1983-88, he also served as a chief economist in the U. S. Agency for International Development and also served in long-term field assignments in Morocco and Haiti.
He has written extensively on the theory and practical application of demand revealing processes which were noted in the 1996 Nobel Prize awards in economics. He is currently a senior economist with the Office of management and Budget in the area of government regulatory management.
This reprint of his 1980 work summarizes more recent developments in this field, aimed at applications to constitutional economics as well as more practical and immediate applications to improvements in the finance of education, the mitigation of transportation congestion and improved environmental management.
The Nobel Prize Committee in Economics (1996) awarded the prize to William Vickrey in recognition in part for the Vickrey (second-price) auction. The Committee noted that an idea analogous to the Vickrey auction "underlies the so-called Clarke-Groves mechanism for eliciting truthful tenders for public projects. Vickrey anticipated this result by an important time margin".
"A New and Superior Process for Making Collective Choices" T. N. Tideman and Gordon Tullock, describing the process in the title to their lead article appearing of the 1976 Journal of Political Economy. "It will not cure cancer, stop the tides or solve many other problems" but go on to describe many other important social problems that could be addressed by the process.
"The book is a pathbreaking attempt to show how an economy might be operated so as to provide public goods and services in a manner that 'mimics' the operation of private competitive markets". Edward Clarke, reviewing Martin Bailey's forthcoming Constitution for a Future Country , describing in his own (this) book a major new advance in public economics made possible by the demand revealing processes.