Financing of Public Goods through Taxation in a General Equilibrium Economy: Experimental Evidence

We use a laboratory experiment to compare general equilibrium economies in which agents individually allocate their private goods among consumption, investment in pro­duction. and replenishing or refurbishing a depreciating public facility in a dynamic game with long-term investment opportunities. The public facility is financed either by volun­tary anonymous contributions (VAC) or taxes. We find that rates of taxation chosen by majority vote remain at an intermediate level close to the finite-horizon optimum, and the experimental economies sustain public goods at levels between the finite- and infinite-­horizon optima. This contrasts with a rapid decline of public goods under VAC. Both the payoff efficiency and production of private goods are higher when taxes are set endoge­nously instead of being fixed at the infinite-horizon optimum level externally. When taxes are adjusted to the respective finite-horizon optimum each period, production levels and efficiency remain as high as in the voting treatments at least in the latter half of the ses­sions. When subjects choose between VAC and taxation, 23 out of 24 majority votes favor taxation, demonstrating a clear preference for enforceable taxes to finance public goods in this setting.