Lindahl equilibrium

From Wikipedia, the free encyclopedia

Equilibrium under a Lindahl tax describes the situation in which individuals pay for the provision of a public good according to their marginal benefits. Lindahl taxes are sometimes known as benefit taxes.

Erik Lindahl, a student of Knut Wicksell, proposed this method for financing public goods in order to demonstrate the consensus politics was actually possible. Because people are all a bit different in their preferences and circumstances, consensus requires each person to pay a somewhat different tax price for every service. If each person's tax price is set equal to the marginal benefits received at the ideal service level, it turns out that each person will agree to have that service level provided.

The Lindahl equilibrium is Pareto efficient and it can be shown that an equilibrium exists for diverse environments. Unfortunately, Lindahl taxation requires knowledge of the demand functions for each individual for all private and public goods.

When information about marginal benefits is available only from the individuals themselves, this gives rise to a "preference revelation problem." Each person can lower his or her tax cost by under reporting their benefits from the public service. This informational problem implies that survey-based Lindahl taxation is not incentive compatible. Incentives to understate one's true benefits under Lindalh taxation resemble those of a Prisoner's dilemma, and people will be inclined to misrepresent their demand for the public service.

In principle, preference revelation mechanisms can be used to address that problem, although none of these have been shown to completely solve the problem. In practice, however, there are several rough solutions. For example, gasoline taxes earmarked to highway maintenance and improvements induce individuals to reveal their demands for highway services--high benefit users pay a larger share of highway costs because they drive more.

Retrieved from "http://en.wikipedia.org/wiki/Lindahl_equilibrium"