DOES THE PUBLIC SECTOR IMPLODE FROM BAUMOL'S COST DISEASE?

The root of the Baumol cost disease is higher productivity increases for manufactured goods than for services. The implied increase in relative costs of service production is widely claimed to have devastating implications for the public sector as a provider of tax‐financed services such as health,...

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Bibliographic Details
Published in:Economic inquiry 2016-04, Vol.54 (2), p.810-818
Main Author: Andersen, Torben M.
Format: Article
Language:English
Subjects:
Analysis
Costs (Economics)
Economic aspects
Employment
Productivity
Public sector
Studies
Tax rates
Taxation
Utility functions
Welfare economics
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Summary:The root of the Baumol cost disease is higher productivity increases for manufactured goods than for services. The implied increase in relative costs of service production is widely claimed to have devastating implications for the public sector as a provider of tax‐financed services such as health, education, and care. To match the increasing costs it appears inevitable that tax rates would be ever increasing. It is shown that this inference does not follow under standard assumptions when accounting explicitly for service provision from both the private and public sectors. Strikingly under assumptions often made in the literature, the welfare maximizing tax rate for a utilitarian policy maker would remain constant despite the Baumol cost disease, and by implication the share of public employment in total employment will remain constant. (JEL H5, H11, O41)
ISSN:0095-2583
1465-7295
DOI:10.1111/ecin.12304