Introduction

Taxation enables governments to draw resources from the private sector, thus creating the basis for effective political power, a fact pointed out forcefully many years ago by Joseph Schumpeter (1918), who traced the creation of the modern state to the emergence of the power to tax. To understand the functioning of the public economy, it is essential to know how governments make use of this power and how they shape and employ different tax instruments to achieve their political and economic aims.

Statistical information on the public sector reveals that there is much to be explained. Significant differences in the design of revenue systems and in the use of tax instruments exist among developed nations, as well as among states and provinces in countries with decentralized public sectors, such as the United States and Canada. We also find changing characteristics of tax systems over the course of economic development and frequent adjustments in the structure of taxation in response to short-term economic and political shocks.

Although the tax literature is large, most of it does not explain these facts. Traditionally, public finance has focused on normative questions, often within a framework that makes no allowance for political institutions and for choices of public decision makers who pursue their own ends. The role of explaining differences in the use and composition of taxation thus falls to public choice, which acknowledges the importance of utility maximization by private and public agents and provides explicit models designed to investigate collective decisions.