1 The Role of the State in the

Fiscal Theory
Richard A. Musgrave

Public finance explores the fiscal tools of the state and how they can best
be used to meet the goals of public policy. It is not surprising therefore to
find different theories of state to be associated with different approaches to
public finance. How fiscal instruments function is a matter of economics,
but the purposes to which they are put depend on the image of a 'good
society' and the state's role therein. Fiscal theory, therefore, is not a matter
of economics only; and that, I will add, is its particular appeal.
That link is here sketched in a historical perspective, from its eigh-
teenth-century beginnings up to the modem period. Four pairings of state
and fiscal theory are distinguished. The first, which I call the service state,
performs a quite limited though essential role. It is to repair certain leaks
in the efficient functioning of the market as a provider of goods and to do
so in a way which stimulates what would have been a market solution.
The second, which I refer to as the welfare state, admits distributional con-
cerns. The state now seeks to correct the market-determined distribution of
income and wealth, moving it towards what society views as efficient or
fair. In both these models the state implements the choice of individuals
and their preferences. A third model, let me call it the communal state,
differs. Policy goals are now set by the state's own needs or, put more
moderately, by the public (as distinct from private) needs of its members.
This leaves a fourth perspective, of what I will call the flawed state. Fiscal
theory here no longer focuses on a normative solution, as did the first
three, but on the state's failure to obtain it, be it for technical reasons or,
worse, the pursuit of self-interest by its controlling agents. Focus switches
from market failure to state failure.
These four patterns, to be sure, are pure or ideal types only. Anyone
state at a given time offers a mixed picture. Aspects of the service and
welfare functions typically coexist, and even quite individualistic societies
serve some communal interests. Nor will the best-run state be free of flaws
and abuses. The four models nevertheless reflect distinct visions and have
shaped public finance traditions in various countries. Thus English,

35
36 Role of the State in Fiscal Theory
American and Scandinavian thought has moved in the service and welfare
frames, the German tradition has been rooted in the communal setting,
while Italian authors early on took aim at the state as a flawed institution.

I CORRECTING MARKET FAILURE: THE SERVICE STATE

Public finance, in the English tradition, grew from the same soil as did
classical economics and developed as an integral part thereof. Its roots
may be found in Adam Smith and his Wealth of Nations. The mercantilist
model with its policy of intervention and enrichment of the state was
rejected. Focus shifted to the individual as the driving force in society and
to the promotion of individual welfare. Government was discharged of the
responsibility of 'superintending the industry of private people' (to quote
Adam Smith), and reliance placed on the 'obvious and simple system of
natural liberty that will establish itself of its own accord' (Smith, 1776,
p. 180). Guided by the discipline of a competitive market, the invisible
hand secures an efficient outcome, thereby reconciling self-interest with
the common good.
The state is no longer at the centre, but still has an important role to
play. The state, 'according to the system of natural liberty', has three
duties to perform, 'duties of great importance indeed, but plain and intelli-
gible to common understandings' (Smith, 1776, p. 180). They include the
protection of society against foreign invasion and of each member against
injustice from others. In addition, they call for

erecting and maintaining those public institutions and those public

works which, tho they may be in the highest degree advantageous to a
great society are, however, of such a nature that the profits could never
repay the expense to any individual or small number of individuals, and
which it therefore cannot be expected that any individual or small
number of individuals should erect. (Smith, 1776, p. 211)

Basic education of the poor is needed as well since 'the state derives no
inconsiderable advantage from their instruction' (Smith, 1776, p. 269).
Externalities as a source of market failure were recognized and dealt
with. Nor was Smith the first to see the problem. Half a century earlier,
David Hume had observed how two neighbours can agree to drain a
meadow but a thousand persons cannot, since each will try to lay the
whole burden on others. To quote, 'thus bridges are built, by the care of
government which 'tho composed of men subject to all human infirmities,
 Richard A. Musgrave 37
becomes by one of the finest and most subtle of human inventions possible
a composition which is, in some measure, exempted from all these
infirmities' (Hume, 1739, p. 539). Government is needed, put in modem
terms, to overcome the free-rider problem in the presence of public goods.
The same theme was resumed by John Stuart Mill. 'While laissez-faire
should be the general practice' (Mill, 1848, p. 314), 'there is a multitude
of cases in which governments, with general approbation, assume powers
and execute functions ... which conduce to general convenience' (p. 150).
The legal system protection and education are again noted and, following
Smith, intervention is extended to a

variety of cases in which important public services are to be performed,

while yet there is no individual especially interested in performing
them, nor would any adequate remuneration naturally or spontaneously
attend their performance ... No one would build lighthouses from
motives of personal interest as there is no mode of intercepting the
benefit on its way to those who profit by it, unless rewarded out of a
compulsory levy by the state. (Mill, 1848, p. 342)

From Hume to Smith to Mill, the core problem of public finance or, as
now called, of 'public economics', was thus recognized early on; but a
precise formulation only emerged in the 1880s and 1890s. Austrian
authors including Sax and Wieser joined with a group of Italians -
Panteleoni, Mazzola, Einaudi, De Viti de Marco among them (see
Buchanan, 1960) - to integrate the meadow and lighthouse problems into
the newly emerging marginal utility theory of value. Market failure in the
provision of public goods was now traced to their non-rival and/or non-
excludable nature. Nevertheless, the efficient provision of public as that of
private goods was to be subject to the same rule, that is, the equating of
price payable by consumers with their marginal utility derived. But imple-
mentation of the rule differs. Consumers of private goods are charged the
same unit price and may choose different amounts. Consumers of public
goods are provided with the same amount but are charged different prices
in line with their marginal evaluations. Benefit taxation thus offers an
efficient solution.
Wicksell readily accepted this principle as a 'law of fiscal economy' but
questioned it as a 'prescription for fiscal action' (Wicksell, 1896, p. 81).
For benefit charges to be assessed, preferences have to be known and the
problem of preference revelation had to be confronted. Unlike the market
for private goods where consumers must reveal their preferences by
bidding, consumers of the jointly available and non-rival public goods
38 Role of the State in Fiscal Theory
may act as free-riders. Linked tax-expenditure voting is needed to over-
come the problem. Voting their preferences, individuals will generate a
level of public services and tax prices in line with benefit taxation.
Conducted ideally under a unanimity rule, this would come about as a vol-
untary process. In practice a qualified majority has to do, so as to limit
transaction costs and to avoid obstruction by a minority. An element of
coercion enters as compliance with the voting outcome must be required.
Extended later by Lindahl's market analogy (Lindahl, 1919), an equilib-
rium is reached at the intersection of the supply schedule with an aggre-
gated demand schedule, arrived at by vertical addition of individual
demand curves. Thus the basis had been laid for a public choice approach
to budget determination.
This development should have been hailed by English authors since it
offered a solution analogous to a market outcome. But written in Italian
and German, the new school remained undiscovered. Even though Pigou's
Economic of Welfare (1920) dealt with externalities, concern was with
public bads, not goods. His fiscal treatise, A Study in Public Finance
(1928), addressed taxation as a problem of welfare economics, with
minimal attention to the expenditure side of the budget. There is no refer-
ence to the Wicksell-Lindahl model. The spirit of the 1880s and 1890s
entered English language discussion only a decade later. A paper based on
my doctoral dissertation examined the contribution of Wicks ell and
Lindahl (Musgrave, 1939), a contribution by Bowen followed (1943) and
a lively discussion of social goods appeared in the 1950s and 1960s.
Two lines of development emerged. One line, led by Samuelson, set
aside Wicksell's concern with the revelation problem by postulating an
omniscient referee to whom preferences are known. Based on that
premise, the efficient solution would require the marginal rate of substitu-
tion of public for private goods in production to equal that in consumption
(Samuelson, 1954). This more general solution bypassed the issue of tax
pricing, although Wicksell's and Lindahl's earlier benefit tax formulation
still qualified as a special case. Along a second line, various types of
goods were examined and the problem of preference revelation was
explored (Musgrave, 1959; Head, 1962; Buchanan, 1968). Public choice
as a new field developed and became a natural extension of public finance
(Buchanan and Tullock, 1962).
As one follows the theory of public goods and its development, there is
a clear continuity of thought from Hume and Smith to Wicksell and
Samuelson. Non-rival consumption and/or non-excludability causes
market failure. That failure is to be overcome by the service state and its
political process needed to secure preference revelation. The state thereby
 Richard A. Musgrave 39
joins with the invisible hand to approximate what the market does for the
case of private goods. As Smith put it, this is a duty 'of great importance
indeed', reaching well beyond the function of a minimal or 'nightwatch-
man' state. This completes my review of the service state and its primary
task of securing a Pareto-optimal provision of public goods. I now turn to
the welfare state and its concern with distribution.

II ADJUSTING DISTRIBUTION: THE WELFARE STATE

Adam Smith, as we have seen, thought the provision of public services of

great importance, but he did not call upon the state to redistribute income.
He largely accepted Locke's dictum that entitlement to earnings is given
by natural law. 'Wherever there is great property there is great inequality',
and civil government must protect 'that valuable property, which is
acquired by the labour of many years' (Smith, 1776, p. 199). Accumulation
is needed for commerce to flourish and must be undertaken by the rich.
They can consume only so much and gain little from 'the baubles and trin-
kets which are employed in the economy of greatness' (Smith, 1759,
p. 304). A limited support of the poor was called for, but beyond this is the
distribution of income was to be left to the market to determine.
Nevertheless, considerations of fairness in the distribution of the tax
burden inevitably arise and have to be considered. 'The subjects of every
state' , as Smith claimed in his first maxim of taxation, 'ought to contribute
towards the support of the government, as nearly as possible, in proportion
to their respective abilities; that is in proportion to the revenue which they
respectively enjoy under the protection of the state ... In the observation
or neglect of this maxim consists what is called the equality or inequality
of taxation' (Smith, 1776, p. 306). The principle is not easily interpreted,
since it appears to combine two distinct rules, that of ability to pay with
that of benefit taxation. Smith may have viewed both the benefit derived
and the recipient's ability to pay for it as measured by the revenue
obtained under the state's protection, so that the two indices coincide.
Perhaps so, but thereafter the ability-to-pay principle was applied to the
distribution of the tax burden only, quite independent of benefits received.
Fiscal analysis came to be divided into two distinct parts, with problems of
taxation on one side of the ledger and problems of expenditures on the
other.
From Mill on, ability-to-pay taxation was viewed in terms of sacrifice
incurred. Various versions of equal sacrifice - equal absolute, equal pro-
portional and equal marginal sacrifice - were developed. With Edgeworth
40 Role of the State in Fiscal Theory
(1897) and later on Pigou (1928), equal marginal sacrifice was crowned the
'correct' version. Reading 'equal marginal' as 'least total' sacrifice, the
paradigm shifted from fairness to welfare maximization. Given (1) a fixed
amount of income available for distribution as well as (2) a uniformly
applicable and declining marginal utility of income function, Bentham's
utilitarian case for income equalization and progressive taxation, advanced
almost a century earlier (Bentham, 1789, p. 3; 1802, p. 305), was restated.
The quest for a 'fair' distribution of the tax burden had become an
efficiency-based rule of welfare economics. Lockean entitlement had been
discarded and the welfare state (as I use the term here) emerged.
The development of taxation theory thereafter paralleled that of welfare
economics. The challenge of good taxation was how to collect the needed
revenue at the least cost to society. The framework had been set but two
problems soon arose. First, the earlier premise of known, comparable and
cardinal utility functions was questioned and replaced with the construct
of a social welfare function. Based on the subjective view of individual
members of society an attempt was made to derive a social welfare func-
tion from conditions under which a rearrangement would yield mutual
gains (Bergson, 1938). Though appealing in some contexts, the formula-
tion hardly resolves the choice between alternative tax burden distribu-
tions along the optimality frontier, where some stand to lose while others
gain. Nor will allowance for A's satisfaction derived from redistribution to
B give the answer, as the initial state of distribution remains to be decided.
More recently, attempts have been made to rationalize the derivation of a
social welfare function, based on the ethical premise of distributive choice
from behind a veil of ignorance. Using an assumption of extreme risk
aversion a maxi-min solution is derived (Rawls, 1972); or, formulated in
utilitarian terms, the solution is shown to depend on the prevailing patterns
of risk aversion (Harsanyi, 1955). The question remains, however, how
that function comes to be revealed. The Wicksellian voting process pro-
vides an answer. Alternatively, policy outcomes may be ranked on the
basis of assumed shapes of the social welfare function (Atkinson, 1983,
p. 310), based on the author's own preference meant to reflect the commu-
nity's like or dislike of inequality.
A second development, from Dupuit (1844) through Marshall (1890) to
Pigou (1928) was to refine the measure of tax burden. Concern with
burdens extending beyond the amount collected, to be sure, was not new.
Bentham and Edgeworth argued for equalizing taxation on the assumption
of a fixed income base, but then qualified that conclusion by allowing for
detrimental taxation effects on the available base. With Pigou's announCe-
ment effects of taxation, that general concern was measured more rigor-
 Richard A. Musgrave 41
ously in terms of the excess burden or deadweight loss, which results as
economic choice is interfered with. Blossoming out later into optimal tax-
ation (Diamond and Mirrlees, 1971), 'good taxation' was no longer only a
matter of distributing the burden correctly but also (and as some would
have it, primarily) one of raising funds so as to minimize the total burden.
With deadweight loss tending to rise at the square of the marginal rate of
tax (Harberger, 1974), the utilitarian case for progression was weakened.
As in the context of the service state, the close link of fiscal theory to
general economics, now as welfare economics, is again evident. Given
two goals, policy coordination is now needed. As the goals of the service
and welfare state are combined, the tax system is confronted with two
seemingly incompatible tasks. On the one hand, in order to secure prefer-
ence revelation, the tax and public service budget should be voted upon
jointly, with taxation on a marginal net benefit basis. On the other, in order
to maximize welfare and secure an optimal distribution, a tax-transfer
system based on a social welfare function is needed. Wicksell, aware of
this problem, noted that for benefit taxation to be equitable as well as
efficient, the underlying distribution of income from which benefit taxes
are drawn must also be just (Wicksell, 1896, p. 143). In this spirit, two
fiscal branches are required, including one to provide and finance public
services in line with the benefit rule, and another to adjust the state of pre-
tax distribution (Musgrave, 1959).
The linkage of fiscal analysis to economic theory, as found in the theory
of public goods and distribution, was to micro-theory. A further linkage
to macro-theory emerged with Keynesian economics in the 1930s.
Compensatory finance was added as a new function of the service state,
needed to overcome market failure now in maintaining full employment
(Hansen, 1941; Lerner, 1944). Coordinating stabilization with the govern-
ment's more traditional service and distribution functions again called for
a multiple branch approach (Musgrave, 1959). Public finance, qua func-
tional finance (Lerner, 1994), became the heart of macroeconomics, but
that role ebbed and focus returned to the more traditional functions of the
public sector. Most recently there has been added a new vision offered by
the increasingly international setting of fiscal affairs, integrating fiscal
issues even more closely with other phases of economic life.

III THE COMMUNAL STATE

I now tum to a third model. Here the state is no longer a mere handmaiden
to overcome externalities or to add distributional adjustments, made in line
42 Role of the State in Fiscal Theory
with the private preference of its members. Where before the perspective
was essentially individualistic, the state or community, as distinct from its
private member individuals, now has its own role to play. Individuals and
community interact in the broader frame of society and its changing forms.
This is the communal setting of FinanzwissenschaJt in the nineteenth-
century German tradition. Unnecessary to add, fiscal analysis in modem
Germany has joined the standard pattern and no longer suffers (or
benefits) from that tradition.
Finanzwissenschaft in that setting did not develop as an integral part of
Volkswirtschaft or general economics. Its status as a distinct science is
reflected in a long sequence of specialized treatises, in contrast to the
British tradition where fiscal issues were dealt with in the context of
general studies. Where the history of German FinanzwissenschaJt counts a
dozen or two major volumes, the British contains a handful only. This is
not to say that FinanzwissenschaJt disregarded the insights of
VolkswirtschaJt in the conduct of fiscal affairs. They were allowed for, but
in the context of goals peculiar to the interests of the state. This view
traces back to mercantilism and its political economy, the kameralist's
teachings of the seventeenth and especially the eighteenth century.
Designed to conduct the economic affairs of the prince, detailed systems
of fiscal administration were developed, and taxation became a major
concern as proceeds from public land and regalia became insufficient.
Beyond maintaining the court, the state was to coordinate the various
branches of the economy, providing linkages through the provision of road
systems and other public works. Dealt with as a guide to practical applica-
tion rather than formal theory, a tradition was laid for attention to adminis-
trative detail and to changing public institutions.
Concern with the interest of the state also derived from the philosophical
setting in which FinanzwissenschaJt developed. English authors, as noted
before, proceeded from the models of Locke and Hume, a society organ-
ized to protect and meet private interests, leaving the state with a service
function only. That vision also appeared in the German scene as Kant's
view of the individual's place in the state differed little from that in the
English model. However it did not prevail. With the rise of romanticism
from Fichte, List and Schelling to Hegel, with its rejection of eighteenth-
century rationalism, an alternative perspective took over. Focused on the
whole rather than its parts, the interest of the state became a primary
concern. Added thereto was the balkanized setting of German jurisdictions
and the search for a unifying state. The emergence of FinanzwissenschaJt
has thus been described as 'an original national product, a characteristic
expression of the German spirit' (Meisel, 1926, p. 246).
 Richard A. Musgrave 43
An early and extreme version of the romantic view, as advanced by
Adam Muller perceived the state as 'the totality of human affairs' (Muller,
1809, vol. 1, p. 48). Competition and exchange are rejected in favour of
reciprocity and value creation. Focus is on the communal linkage of indi-
viduals within the state. Taxes are viewed as 'holy contributions' (vol. 1,
p. 56) paid in return for the invisible spiritual capital which the state
renders, and by which economic effort is made effective for the benefit of
the whole (vol. 2, p. 445). 'The value of a thing is its significance for the
state and its continuing renewal' (Spann, 19, p. 101).
Not all German authors argued in this statist frame. Among the earlier
contributors, Jakob (1821) in particular built on Adam Smith, as did
Hermann (1832) and, by way of transition, Rau (1837). Thereafter the com-
munal theme prevailed, if in more moderate form. While the image of a
personified state as subject of its own needs faded out, individuals remained
to be seen in two distinct roles, as private persons with private needs and as
members of the community with communal needs. Attention to communal
needs prevailed, if in varying forms, in the writings of von Stein, Schaffte
and Wagner, the 'triad' of authors - das Dreigestim der FinanzwissenschaJt
(Beckerath, 1952, p. 416) - who, in the closing decades of the nineteenth
century gave FinanzwissenschaJt its characteristic form.
Stein, the most subtle of the three, viewed the state as including individ-
uals in two forms, (1) as equals in the human community, and (2) as
unequals in society (von Stein, 1885, part 1, p. 5). Seen in Hegelian
fashion as a struggle between the two roles, there eventually emerges a
civic society, a 'staatsbiirgerliche GesellschaJt', where the two are recon-
ciled. The state's fiscal function is to serve community life in all its forms.
Taxes must be raised to render services, but the capital of the private
sector must be protected so as to recreate the state's base. There is no
uniquely correct tax system. As society evolves, so do the forms in which
revenue is obtained. Levies are needed at all stages, but the idea of taxa-
tion as the contribution of free and equal individuals emerges only with
the citizen state (part 2, p. 439). Transformation of economy and state
interact and Schumpeter's concept of the Steuerstaat (1918) was antici-
pated. Stein's sweeping design is impressive, but the concept of communal
needs, though essential to his construct, remains unclear. Instead, his argu-
ment shifts to the spirit of the service function when holding that outlays
are to be made 'where the service cannot be obtained by the single indi-
vidual through private purchase' (1885, part 2, p. 97).
Schiiffte, moving from a philosophical to a biological perspective,
viewed society as a set of interacting organisms. Each has its function but
prevails only as a part of the whole. Coordination among the parts is
44 Role of the State in Fiscal Theory
required and 'the purpose of the state is the realization of communal inter-
ests through the exercise of a uniform will' (1896, vol. 2, p. 433). The
highest principle of FinanzwissenschaJt is the proportional coverage of
state and private needs (1873, vol. 2, p. 110), an early view of Pigou's
later principle of equating public and private net benefits at the margin.
While the benefits of the state must exceed its costs, the state may secure
benefits where private undertakings would be unprofitable. It must provide
where the services cannot be contributed 'bit by bit' through the individual
members of the community (p. 113), but again without explanation why
this should occur.
Schliffte's organic view of society and the individual's place therein
also shaped the approach to taxation. Critical of the 'objective' view of the
tax base as a set of factor shares as developed by British authors from
Smith on, Schiiffle sought to develop a more subjective approach (1861).
With focus on the individual's place in society, the definition of the tax
base is related to the individual's personal position and sources oftaxable
capacity. From this the concept of income as accretion was to emerge.
Foreshadowed already by Hermann (1832) and culminating in the contri-
bution of Schanz (1896), that concept later became Germany's most
important contribution to the international body of fiscal literature, espe-
cially as it developed in the United States following the Second World
War (Haig, 1921; Simons, 1950). I regret to add that its principled
approach to tax base design may be lost in the current climate of tax
reform.
Wagner, the most influential of the three, rejected the 'purely individu-
alistic' theory of state underlying the economics of Adam Smith, as well
as the socialist model which disregards individual motivation and endan-
gers liberty. A compromise between the two views is needed (Wagner,
1892, p. 23). The institutions of property and competition have to be
adapted where needed to serve the public good. The narrow and rationalis-
tic view of the state is replaced by a historical and organic perspective,
leaving the state not as a necessary evil but as a positive force and (not
unlike Hume's previously noted formulation!) 'the highest form of com-
munal economy' (Wagner, 1883, p. 7).
The issue of motivation is raised and three forms are distinguished -
individualistic, communal and charitable. The first is served by the market,
self-interest and exchange. The last involves voluntary action only. The
communal principle falls in between. It calls for a variety of services, in
particular 'where needs, though experienced by the individual, can be met
only in common and in the common interest'. Humans being as they are,
the communal principle does not prevail and compulsion is required.
 Richard A. Musgrave 45
Though needs are experienced by the individual, burden allocation in line
with benefits received (as had been held by Sax) is rejected. Holding that
benefit shares cannot be assigned in the case of truly communal wants,
Wagner required taxation in line with ability to pay (Wagner, 1880, p. 17;
1890, part 2, p. 223).
Two further aspects of his contribution should be noted. First, there is
his well-known law of expanding government activity. The needed scope
of public services, as was also argued by Adam Smith, must be seen in an
historical context. They are subject to change and the need will rise with
income and technical progress (Wagner, 1883, vol. 1, p. 76). Next, there is
his principle of social policy, 'sozialpolitisches Prinzip', calling for social
programmes and taxation to moderate inequalities in the market-deter-
mined distribution of income. Unlike its derivation from utilitarian princi-
ples of welfare maximization in the English tradition, such moderation is
seen as needed as a matter of social justice. Adequate levels of existence
and a broad participation in cultural values are to be provided for by the
modern state (Wagner, 1890, p. 207). With Wagner, a leading figure of the
'pulpit socialists' (Kathedersozialisten) of Bismarck's time, taxation thus
assumed the double function of financing public services and of distribu-
tional adjustment.
After the high period of the triad, FinanzwissenschaJt lost steam. When
a renewed period of lively discussion emerged during the 1920s, the
earlier tradition was resumed. Unwillingness to build on the economic
nature of public goods still prevailed. Ritschl offered resumption of an
extreme version of the romantic strand (Ritschl, 1931), while Colm built
on Wagner's model. Policy choices are to be made by whoever runs the
state, and the economist's prime task is limited to planning and executing
their implementation (Colm, 1927). The discussion also was enriched by
offerings in fiscal sociology, but outcomes fell short of the high expecta-
tions which Schumpeter earlier held for that approach.
As we compare the service, welfare and communal models, the first
most readily fits the frame of economic analysis. The distinction between
public and private goods, as non-rival and rival, is straightforward and
may be drawn in the economist's conventional terms. The state of distribu-
tion and effective preferences based thereon are taken as given. Benefit
taxation in principle offers an optimal solution. Only the revelation
problem and how to resolve it remains puzzling. Moving to the welfare
model, the state of distribution is no longer given. Distribution and with it
the distribution of the tax burden itself becomes a concern of policy. The
safe heaven of Pareto optimality is lost and policy shifts into the more
precarious, though not less important, world of welfare economics.
46 Role of the State in Fiscal Theory
But economics, or what economists call economics, it still is. The com-
munal model is more troublesome. Where the distinction between private
and public goods is straightforward, that between communal and private
wants is complex, a concept involving psychological and philosophical
dimensions. The more sensible contributors to the communal model, to be
sure, dropped the hard-line view of the state as itself the subject of wants,
but a distinction between the individual's concern as a private person and
as a member of the community remained. This has been both a minus and
a plus for FinanzwissenschaJt.
On the minus side, concern with the distinction between private and
communal wants tended to crowd out that between private and public
goods. As a result, the development of public goods theory, a natural part
of the service model, was largely overlooked. Yet there was no need for
this, since the two problems differ and do not overlap. Private wants may
be met by public goods just as public wants may call for satisfaction by
private goods. By failing to distinguish the two issues and linking public
goods to communal and private goods to private wants, FinanzwissenschaJt
was kept from addressing the lighthouse problem on its own terms,
thereby losing linkage with standard economics.
On the plus side FinanzwissenschaJt should not be faulted for intro-
ducing communal concerns. Such concerns, to be sure, are not the kind
of thing economists like to deal with, but that need not render them
foolish. The idea of the state 'as such' having its own needs can be
readily rejected; but the distinction between the role of individuals as
private persons and as members of their community deserves serious
consideration. As we know only too well, the community concept
carried to romantic extremes has its risks, threats which are avoided
within the safe haven of self-interest. Yet, to view the world as based on
private and self-interest-oriented concerns only leaves out a significant
part of the social setting in which individuals function, viewed in either a
normative or a positive perspective. The challenge for public finance is
not to disregard that issue, but to address it in a fruitful way. My concept
of 'merit goods' was meant as a nudge in that direction (Musgrave,
1959,1987).

IV POLICY FAILURE: THE FLAWED STATE

It remains to note a fourth model, a perspective which does not view the
state and its fiscal instruments in normative terms, but as flawed institu-
tions. Focus shifts from market failure to public sector failure.
 Richard A. Musgrave 47
The Italian literature of the 1880s and 1890s again enters. It not only
made pioneering contributions to the marginalist school but also to its
opposite view. In its extreme form, Pareto denied the applicability of econ-
omic analysis and logical choice to the public sector (Pareto, 1916).
Individuals as acting agents are replaced by a rule of rotating elites and
their pursuit of minority interests. Fiscal affairs are seen as class struggle,
but unlike Marx, the concept of elites and classes is seen more broadly and
not in economic terms only. Also critical but in a more moderate vein,
Puviani (1897) pointed to inefficiencies in fiscal choice which arise as
government seeks to create fiscal illusions, designed to hide the burden of
taxation and to exaggerate the benefits of outlays. Absent a unanimity rule,
Barone stressed the coercive nature of the fiscal process (Buchanan, 1960).
The shift from a normative to a positive and critical view of fiscal oper-
ations has received massive support in recent decades. One line has
addressed the technical issues inherent in arriving at a satisfactory voting
outcome. Following Wicksell's early concern with voting as a means of
preference revelation, public choice has explored the role of coalitions,
strategy, and the political process in which voting choices are made. The
feasibility of an efficient outcome was questioned by Arrow's impossibil-
ity theorem and simple formulations such as the median voter model have
been rejected. A second line has addressed the role of governmental
agents, politicians and bureaucrats. Constructive leadership is set aside,
with emphasis placed on self-serving behaviour. Abuse of deficit finance
is seen to generate inefficient and excessive budgets, calling for new
policy instruments and constitutional restraints on governmental action
(Brennan and Buchanan, 1977). Attention also shifted from the function-
ing of the fiscal system in a closed setting to its operation in an open
economy with intergovermental competition and decentralization seen as a
remedial factor.
I will not undertake here to assess the validity of these concerns and
their proposed remedies. Voting imperfections, as I see them, may induce
deficient as well as excessive budgets; and governmental agents, including
politicians (or statesmen?) and bureaucrats (or civil servants?) may lead as
well as mislead (Musgrave, 1981). Much depends on the time and place
under consideration. Moreover, attention needs to be paid to the formation
of social forces, interest groups and classes, not only to the strategic
behaviour of individual agents. The concept of government failure, by its
own logic, also implies an image of how to do it right. Doing it right, as
we all agree, calls for efficient implementation of set goals. But it also
calls for choosing the goal, a sense of what the good society should and
can be like, and of the state's role therein. Thereby fiscal theory, in its
48 Role of the State in Fiscal Theory
various traditions, reaches beyond Pareto optimally and connects with an
underlying theory of state. This, to be sure, is troublesome since it places
public finance at the boundary where efficiency and value considerations
are difficult to keep apart. But, as I noted at the outset, this also is what
gives our field its particular appeal.

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