GOVERNMENT SUBSIDIES TO PRIVATE SPENDING ON PUBLIC-GOODS

This paper examines how the size of an efficient subsidy varies with the amount of free-riding and the presence of distorting taxation. Ironically, the existence of free-riding, where some individuals make no voluntary contribution at all, reduces the size of an efficient subsidy and makes a subsidy more attractive compared to direct taxation. For the gain to be significant, the number of donors must be extremely few in number. Even when the gains from a subsidy relative to direct taxation are small, a subsidy may dominate direct taxation because it can reveal an efficient level of the public good. The analysis distinguishes between traditional public goods such as national defense, and what I call transfer public goods, where members of society care about the consumption of a particular group in society such as the poor. I generalize the Samuelson (1954) results to derive conditions for efficiency in providing transfer public goods.