The optimal size of public spending and the distortionary cost of taxation

Feldstein (1997) reviews contributions in distortionary costs of taxation, estimating that the cost per incremental dollar of government spending is $2.65. Kaplow (1996) favors the supply of a public good whenever the benefit/cost ratio exceeds one, contrary to the orthodox position that has existed since Pigou (1928). This paper largely reconciles these two opposing positions. The large distortionary costs exist on the revenue side, but are largely offset by the negative distortionary costs on the spending side or by the distributional gain. Kaplow's and Feldstein's arguments have to be subject to important qualifications. Additional arguments relevant to "How big should the public spending be?" are also reviewed. Environmental disruption effects, burden-free taxes on diamond goods, and relative-income effects all favor more public spending.