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The New Dynamic Public Finance: Can It Help Us Better Understand Taxation in the United States ?

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Stephen R. Rolandi
August 5, 2022

One of my areas of professional interest and expertise is public finance, which is studied as part of MPA-level courses in public sector budgeting and financial administration; or separately as its own course in a graduate curriculum, usually economics.

We can define public finance as the formal study of the role government plays in society; namely, it is that branch of economics that attempts to evaluate the level of revenues and expenditures in the public sector. Sometimes referred to as tax policy, the scope of public finance consists of three main areas:

– The efficient allocation of available resources;

– The distribution of income among citizens; and

– Stability of a nation’s (or jurisdiction’s) economy

Public finance is a unique blend of law, finance, economics, public policy and public administration. The changing role of government and current exciting public policy debates motivates the study of the field of public finance. And as tax policy effects individuals and businesses, public finance influences—and is influenced by—practical politics and political considerations.

Traditional public finance theory (as advanced by Jonathan Gruber and others) states that public finance should be thought of in terms of four broad questions:

– When should government intervene in the economy—usually to address a market failure or to redistribute income and wealth?

– How might government choose to intervene in such a situation?

– What would be the economic effect of such a government intervention?

–  Why do governments choose to intervene in the way that they do?

It should be noted that taxation (revenue systems) form the central part of public finance—it is the most important of all revenues as it represents the largest amount of income in government budgets, but also by the impact it has on a jurisdiction’s economy and the policy considerations that underly them. For example, the United States changed its taxation system in 1913 with the passage of the 16th Amendment to the Constitution which instituted a progressive taxation system based on income from all sources (i.e. the more one earns in income, the more one should pay in taxes). Many analysts maintain that the federal income tax system currently, to a large extent, is not a progressive income tax system.  

Tied to traditional public finance theory is the concept of “distributive justice,” i.e. the socially just distribution of goods in society advanced by John Rawls in his “A Theory of Justice” (1971). Rawls argued for a principal reconciliation of liberty and equality. Using Rawls’ methodology, one can rank tax policy alternatives on the possible outcomes that are delivered for those members of society who are not as well off as others.

A new theory of public finance has appeared on the scene in recent years, known as the “New Dynamic Public Finance” (NDPF) advanced mainly by economist Narayana R. Kocherlakota. A graduate of Princeton University and University of Chicago, Dr. Kocherlakota teaches economics at the University of Rochester, and from 2009-2015, he served as the 12th President of the U.S. Federal Reserve Bank of Minneapolis. Among his many honors was his selection by Foreign Policy magazine as one of the top 100 Global Thinkers in 2012.   

NDPF is a new approach to optimal tax design, which economists define as how to develop and implement a tax system that maximizes social welfare policy subject to economic constraints—which is a central issue in public finance. The NDPF challenges the traditional approach used in optimal tax design by focusing on: changing productivity rates over time; capital (asset ) taxation; and the role of people’s age when they borrow over long periods of time.

Most taxation and transfer systems in the United States are to a certain extent, history dependent. A good example of this is the current Social Security Disability Insurance (SSDI) program. Monthly SSDI benefits are based on pre-disability earnings, so that a person with a history of higher earnings will receive larger transfer payments than an individual with a lower earning history. Another such example is Unemployment Insurance (UI) programs, particularly at the state level.

NDPF also challenges the utility of the Value-Added Tax (VAT), which is basically a consumption tax placed on goods and services at every stage of production and distribution. The VAT is popular in nearly every country in the world except the United States (which had adopted it for a brief period of time in the 1950s and 1960s).

Perhaps the major distinction is that the NDPF concept supports adoption of a one-time wealth tax as an efficient form of wealth redistribution, assuming that government would commit to doing so on a one-time basis. NDPF supports the views of U.S. Senators Elizabeth Warren, Bernie Sanders and others who have proposed adoption of a wealth tax in some form for the United States—such proposals, many  believe, may be unconstitutional. Other legal scholars and policy analysts disagree.

This legal debate is far from being resolved.

NDPF is a relatively new concept in public finance; NDPF proponents, such as Professor Daniel Hemel of the New York University School of Law, believe that constitutional law and NDPF have not yet given us a single set of public policy prescriptions. In any event, NDPF is providing a vehicle for us to better understand the current tax and transfer system in the United States.

Postscript: Students and citizens interested in learning more about The New Dynamic Public Finance (NDPF) may wish to purchase Professor Kocherlakota’s book “The New Dynamic Public Finance” (available through Amazon) or from Princeton University Press (https//press.princeton.edu)


Author: Stephen R. Rolandi retired in 2015 after serving with the State and City of New York. He holds BA and MPA degrees from New York University, and studied law at Brooklyn Law School. He teaches public finance and management as an Adjunct Professor of Public Administration at John Jay College of Criminal Justice (CUNY) and Pace University. Professor Rolandi is a Trustee of NECoPA; President-emeritus of ASPA’s New York Metropolitan Chapter and past Senior National Council Representative. He has  served  on many  association boards. He is a frequent guest commentator on  public affairs and political issues affecting the nation and New York State. You can reach him at: [email protected] or [email protected] or  914.441.3399 or 212.237.8000.

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