Does the Public Sector Implode from Baumol's Cost Disease?

9 Pages Posted: 26 Feb 2016

See all articles by Torben M. Andersen

Torben M. Andersen

University of Aarhus - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Date Written: April 2016

Abstract

The root of the Baumol cost disease is higher productivity increases for manufactured goods than for services. The implied increase in relative costs of service production is widely claimed to have devastating implications for the public sector as a provider of tax‚Äźfinanced services such as health, education, and care. To match the increasing costs it appears inevitable that tax rates would be ever increasing. It is shown that this inference does not follow under standard assumptions when accounting explicitly for service provision from both the private and public sectors. Strikingly under assumptions often made in the literature, the welfare maximizing tax rate for a utilitarian policy maker would remain constant despite the Baumol cost disease, and by implication the share of public employment in total employment will remain constant.

JEL Classification: H5, H11, O41

Suggested Citation

Andersen, Torben M., Does the Public Sector Implode from Baumol's Cost Disease? (April 2016). Economic Inquiry, Vol. 54, Issue 2, pp. 810-818, 2016, Available at SSRN: https://ssrn.com/abstract=2738291 or http://dx.doi.org/10.1111/ecin.12304

Torben M. Andersen (Contact Author)

University of Aarhus - Department of Economics ( email )

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