The Interaction Between Public and Private Spending When Government is Responsive to the Preferences of Citizens

Abstract

"This paper uses simple models of private and public behavior to model the relationship between public and private spending on public goods. The standard discussion of the relationship between public and private spending assumes that public spending is exogenous. When public spending is exogenous, each dollar of public spending reduces private spending by a dollar, unless public spending is large enough to drive donors to a corner solution. When government decision-making is endogenous, responding to the preferences of citizens, the observed relationship between public and private spending is never dollar-for-dollar, nor does government have to push citizens to a corner solution in order to have real effects. The relationship between public and private spending depends in predictable ways on the structure of preferences, the degree of heterogeneity among citizens, the flexibility of taxation, and the motivation for the the increase in government spending."