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INEQUALITY AVERSION AND THE OPTIMAL COMPOSITION OF GOVERNMENT EXPENDITURE

Published online by Cambridge University Press:  26 October 2010

John Creedy ,
Shuyun May Li  and
Solmaz Moslehi
John Creedy
Affiliation:
The University of Melbourne
Shuyun May Li
Affiliation:
The University of Melbourne
Solmaz Moslehi*
Affiliation:
Monash University
*
Address correspondence to: Solmaz Moslehi, Department of Economics, Monash University, Caulfield Campus, Victoria 3145, Australia; e-mail: solmaz.moslehi@gmail.com.
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Abstract

This paper examines the choice between government expenditure on public goods and transfer payments, in the form of a pension, in an overlapping-generations model. Government expenditure is tax-financed on a pay-as-you-go basis. A utilitarian judge chooses expenditures to maximize a social welfare function. The nonlinear solution is found to involve the ratio of a welfare-weighted average income, which depends on the inequality aversion of the judge, to arithmetic mean income. An approximation for this ratio is found that produces explicit solutions for the optimal composition. The result is used to obtain an indication of “implicit” inequality aversion for a range of countries.

Keywords

Overlapping GenerationsComposition of Government ExpenditureUtilitarian Social Welfare Function
Type
Articles
Information
Macroeconomic Dynamics , Volume 14 , Supplement S2: Public Policy, Externalities, and Economic Growth , November 2010 , pp. 290 - 306
Copyright
Copyright © Cambridge University Press 2010

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