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Ec426 Public Economics

3How can the MDGs be funded?

Official Development Assistance and new global funding

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1. The MDGs and their Funding2. Official Development Assistance (ODA) and

national governments3. What are the alternatives to ODA?4. Three public finance questions5. Three public finance insights

Funding the Millennium Development Goals (MDGs)

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Summary of Millennium Development Goals:by 2015

1. Halve the proportion whose income is less than $1 a day, and halve the proportion who suffer from hunger.

2.   Ensure universal primary education.

3.   Eliminate gender disparity in education.

4. Reduce by two-thirds the under-5 mortality rate.

5. Reduce by three-quarters the maternal mortality ratio. 6. Have halted by 2015, and begun to reverse, the spread of HIV/AIDS, of

malaria, and other major diseases. 7. Reverse the loss of environmental resources; halve the proportion

without sustainable access to safe drinking water; achieve a significant improvement in the lives of slum dwellers.

 8. Develop a global partnership for development.

1. The MDGs and their funding

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From funding to outcomes

External Funding

Spending

Outcome indicators

Allocation and disburseme

nt

Current inputs and

investmentLeak

ages

Ineffi

cien

cy

Focus on this

Domestic Funding

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Aid in real terms

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20

40

60

80

100

120

140

160

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Aid

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rate

s U

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billi

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OECD projections based on public announcements

Actual

UN Millennium Project Costing

Funding Gap

Scale of problem seen from 2004, and subsequent outcome

In 2010

$19b shortfall on G8 2005 commitment

2005 G8 Gleneaglescommitment

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From OECD Development Assistance Committee (DAC) Report

The United States in 2010 was the largest single donor with ODA disbursements of USD 30.2 billion, representing an increase of +3.5% in real terms over 2009. This is the highest real level of ODA recorded by a single country, except for 2005, when the US gave exceptional debt relief to Iraq.  

ODA from the fifteen EU DAC countries rose by +6.7% in 2010 to reach USD 70.2 billion, representing 0.46% of DAC-EU GNI, up from 0.44% in 2009.  ODA rose or fell as follows:Austria (+8.8%), due mainly to grants for debt forgiveness; Belgium (+19.1%), due to debt forgiveness and an increase in bilateral grants; Denmark (+4.3%), as it increased its bilateral grants; Finland (+6.9%), due to an increase in bilateral grants; France (+7.3%), mostly due to an increase in bilateral lending; Germany (+9.9%), as it increased its bilateral lending; Greece (-16.2%), due to unprecedented fiscal constraints; Ireland (-4.9%), due to fiscal constraints; Italy (-1.5%); Netherlands (+2.2%); Portugal (+31.5%), mainly due to increased bilateral lending; Spain (-5.9%), due to budgetary pressures; Sweden (-7.1%), though Sweden continues to allocate 1% of its GNI to ODA; United Kingdom (+19.4%), reflecting the continuing scaling up of aid programme.

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National government redistribution: optimal tax analysisSTEP 1: Government uses proportional income tax at rate t to fund public goods, G, for population of h identical people, each with an income Y that is a function of (1-t) with elasticity ε. Individual utility is U[Y(1-t)]+V(G), where U and V are increasing concave functions. The price of the public good is p.

Writing the Lagrangian as h[U[Y(1-t)]+V(G)] + λ[htY-pG], the first-order conditions are

h VG = λp and h Y UY = λh[Y+t∂Y/∂t]

or

hVG/UY = p/[1 – εt/(1-t)] = pθ where θ is the marginal cost of public funds. This is the standard formula for the optimal provision of public goods (the Samuelson rule), that the sum of the marginal rates of substitution equals the marginal rate of transformation (p), modified by the cost of raising distortionary taxation (θ).

STEP 2: Introduce redistribution of A per person to r recipients whose pre-redistribution income is fixed at Y0, and where the post-redistribution income is Y0+ γA, where 0 < γ ≤ 1 allows for leakage.

2. ODA and national governments

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Optimal aid policy

Social welfare function includes r recipients with utility function UR, so that Lagrangian becomes

h[U[Y(1-t)]+V(G)] + r UR[Y0+γA] + λ[htY-pG-rA],

the first-order condition for the choice of A is

r γ UYR = λr or UY

R/ UY = θ/γor

UYR/ UY < θ/γ and A = 0

Redistribution is carried to point where the social marginal valuation of income for recipients is equal to θ/γ times that for taxpayers. A may be zero.

Redistributive transfers are larger:

• the lower the marginal cost of public funds;• the smaller the income of the recipients in the absence of a transfer.

What is the effect of reduced leakage?What is the effect of fiscal tightening?How does the optimal value of change if r increases?

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What form for the social welfare function?

National social welfare function:

1, 2, …, h citizens of home country

World social welfare function:

1, 2, …, h, i, …, n all world citizens

Objections to world SWF:

• Concept of global justice has no meaning in the absence of world government institutions (Hobbes and T Nagel, Philosophy and Public Affairs, 2005);

• National governments have greater responsibility to own citizens;

• n much bigger than h.

Objections to purely national SWF:

• National governments do acknowledge responsibility for rest of world and give ODA;

• Individual citizens make transfers overseas.

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Individual altruism and national responsibility

Why do individuals give for overseas development?

Warm glow U[Y(1-t)] + F(A)

Public good U[Y(1-t)] + rF[Y0 + A/r]

Identification U[Y(1-t)] + mF[Y0 + A/m] where m small

(A B Atkinson, “Giving overseas and public policy”, Journal of Public Economics, vol 93, 2009.)

BUT what are the implications for the social welfare function?

“the fact that warm glows improve the description of individual behaviour does not necessarily imply that social welfare should be defined including warm glows” (P A Diamond, Journal of Public Economics, vol 90, 2006). Double-counting?

Like individuals, government could frame issue as “proportionate responsibility”:

1, 2, …, h, i, j,…, m, ,,,, n.Nation Other rich countries Poor countries

Weight in SWF 1 0 δ, 0

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GLOBAL TAXES

• Global environmental taxes;

· Tax on currency flows (the ‘Tobin tax’);

OTHER SOURCES

·  Increased private donations for development;

·  Global lottery and global prize bond;

·  Increased remittances from emigrants.

3. What are the alternatives to ODA?

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• Global taxes could yield revenue of the magnitude ($50 billion) required (energy tax) or at least half of the requirement (CTT at a wholesale rate of 2 basis points).

• These taxes are an order of magnitude smaller than the versions proposed for reasons of climate change or to stabilise currency markets;

• Unanimity is not necessary to introduce global taxes; there can be “flexible geometry”;

• There are alternatives to global taxation. • Global Lottery is potentially source of significant continuing revenues, if agreement can be reached with national lotteries.• Global Premium Bond could provide a continuing flow of loan funding.

• Supporting roles could be played by increased remittances from emigrants,

and, on a more modest scale, increased private donations.

Conclusions of report

A B Atkinson, editor, New Sources of Development Finance, 2004

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• Q1: What exactly is being proposed?

• Q2: Who bears the burden?

• Q3: Is there a double dividend?

4. Three public finance questions

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Net Addition to Development Resources or Alternative Source?

Starting Point Increased ODA

New Sources

Comparing A with B is Differential Incidence

Comparing A with O is Tax/Spending incidence

A

BO

What is the comparison?

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INCIDENCE of tax on carbon emissions/overseas financial transactions:

• Degree of shifting forward to purchasers or back to producers;

• Final users versus intermediate consumption (input-output relations);

• Distributional impact

- within countries;

- between countries.

Who pays the tax?

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Tax on polluting goods has excess benefit not excess burden, in that it reduces emissions. There is a double benefit: revenue for development and improvement in environment.

BUT

Two reasons why need to separate:

• Economic = for large effect on pollution need high elasticity; for large revenue effect need inelastic demand

• Political economy = how do coalitions get built?

Is there a double dividend?

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• (1) Fiscal architecture matters;

• (2) International burden sharing;

• (3) Different measures may be equivalent in their economic impact.

5. Three public finance insights

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National Taxation

National Government

Individual taxpayer

Agent (e.g. airline)

Tax Decision Process / Accountability

1. Fiscal architecture

19Fiscal Architecture in Global Setting

National Government

Individual taxpayer

Agent (e.g. airline)

Global development institutionWorld Tax

Authority

National Tax Decision Process

Member governments agree national tax burden

Global setting

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• ODA as an «income tax» paid by certain «rich» countries.

• What determines membership of class of donors?

• Changing world distribution of income

• Stepped income tax structure?

• Tax on rich countries or tax on rich people?

• Taking account of the distribution of income within countries.

2. International burden sharing

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Global prize bond versus global lotteryBuy lottery ticket for £1, with prize Y with probability p.

Versus

Invest £1/r in prize bond, receive £1/r back at end of year, opportunity cost £1, where r is the interest rate. Win prize Z with probability q.

Equivalent if pY = qZ, but may be perceived differently.

Carbon taxation and the auction of tradeable permits

3. Equivalent measures

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Upturn in ODA (before the economic crisis): but still funding gap.

There are realistic alternative funding mechanisms, and (slow) progress is being made (international solidarity contribution on air tickets).

Moreover, • can exploit flexible geometry where not unanimity;• subsidiarity can increase acceptability;• changing world distribution of income points to formalisation of aid donorship.

Conclusions: Grounds for optimism?