A3 The Model Without Consolidation Attempts
A3.1 The Competitive Solution
In this section, we assume that each agent views G as given, ignoring the government budget constraint or the crowding-out effect of fiscal privilege on public goods. Then, each agent does not have an incentive to conduct consolidation attempts. g = 0. In other words, an agent’s budget constraint reduces to
At the competitive solution, we have as the first-order condition,
while at the first best solution we have Eq. (12.A5.1). In Fig. 12.A1, line A’B’ represents the budget constraint, Eq. (12.A6), and line AB represents the feasibility condition, Eq. (12.A4), at the optimal level of G. The competitive solution is given by point E, while the first best solution is given by point Q on line AB. At the competitive solution, fiscal privilege h is too high, while private consumption c may be too low. Hence, public good G is provided at too low a level, which corresponds to a bad fiscal condition.
Fig. 12.A1 The competitive solution without consolidation attempts